**UNITED STATES**

# **SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K/A**

**AMENDMENT NO. 1**

 

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

 

**For the fiscal year ended December 31, 2004**

 

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

 

**For the transition period from                   to                   **

 
| **1-12181-01**                                                  | ** ** | **1-12181**                                                     |
|-----------------------------------------------------------------|------------|-----------------------------------------------------------------|
| (Commission File Number)                                        | ** ** | (Commission File Number)                                        |
| ** **                                                      | ** ** | ** **                                                      |
| **Protection  One, Inc.**                                       |       | **Protection  One Alarm Monitoring, Inc.**                      |
| (Exact Name of Registrant as Specified in  Charter)             | ** ** | (Exact Name of Registrant as Specified in  Charter)             |
| ** **                                                      | ** ** | ** **                                                      |
| **Delaware**                                                    | ** ** | **Delaware**                                                    |
| (State of Other Jurisdiction of  Incorporation or Organization) | ** ** | (State of Other Jurisdiction of Incorporation  or Organization) |
| ** **                                                      | ** ** | ** **                                                      |
| **93-1063818**                                                  | ** ** | **93-1064579**                                                  |
| (I.R.S. Employer Identification No.)                            | ** ** | (I.R.S. Employer Identification No.)                            |
| ** **                                                      | ** ** | ** **                                                      |
| **1035 N 3rd Street, Suite 101,  Lawrence, Kansas 66044**       | ** ** | **1035 N 3rd Street, Suite 101,  Lawrence, Kansas 66044**       |
| (Address of Principal Executive Offices,  Including Zip Code)   | ** ** | (Address of Principal Executive Offices,  Including Zip Code)   |
| ** **                                                      | ** ** | ** **                                                      |
| **(785) 856-5500**                                              | ** ** | **(785) 856-5500**                                              |
| (Registrant’s Telephone Number, Including  Area Code)      | ** ** | (Registrant’s Telephone Number, Including  Area Code)      |

 

Securities registered pursuant to Section12(b) of the Act:

 
| **Title of Each Class** | ** ** | **Name of Each Exchange On Which Registered** |
|-------------------------|------------|-----------------------------------------------|
| None                    |       | None                                          |

 

Securities registered pursuant to Section12(g) of the Act:

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

 

Indicate by check mark whether each of the registrants (1) has filedall reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat such registrant was required to file such reports) and (2) has beensubject to such filing requirements for the past 90 days.  Yes ý   No o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of each registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or any amendmentto this Form 10-K.  o

 

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

 

The aggregate marketvalue of common stock of Protection One, Inc. held by nonaffiliates on June 30,2004 (based on the last sale price of such shares on the over the counterbulletin board) was $3,767,443.

 

As of March 10, 2005, Protection One, Inc.had 18,198,571 shares of Common Stock outstanding, par value $0.01 pershare.  As of such date, Protection OneAlarm Monitoring, Inc. had outstanding 110 shares of Common Stock, par value$0.10 per share, all of which shares were owned by Protection One, Inc.  Protection One Alarm Monitoring, Inc. meetsthe conditions set forth in General Instructions I (1)(a) and (b) for Form 10-Kand is therefore filing this form with the reduced disclosure format set forththerein.  Protection One’s sole asset isProtection One Alarm Monitoring and Protection One Alarm Monitoring’s whollyowned subsidiaries, as such there are no separate financial statements forProtection One Alarm Monitoring, Inc.

 

Portionsof the Company’s proxy statement or information statement relating to theannual meeting of stockholders to be held in 2005 are incorporated by referenceinto Part III, Items 10–14, of this report.

 

 

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**EXPLANATORYNOTE**

 

This amended annual report on Form 10-K/A isbeing filed to correct an inadvertent printing error.  In the original annual report on Form 10-K, whichwas filed with the Securities and Exchange Commission on March 17, 2005, theline “Other” in the current asset section of the Consolidated Balance Sheetswas omitted.  This amendment provides thecorrect amounts of other current assets (in thousands) of $2,375 and $2,536 forthe years ended December 31, 2004 and 2003, respectively.  Total current assets and total assets foreach of the years are correct as originally reported.   This amendment also includes an updatedconsent of the independent registered public accounting firm as well as updatedcertifications of our principal executive officer and principal financialofficer.  Accordingly, pursuant to Rule12b-15 under the Securities and Exchange Act of 1934, this amendment containsthe complete text of Item 8, “Financial Statements and Supplementary Data” andItem 15, “Exhibits, Financial Statement Schedules”, as amended.

 

2

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**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

To the Stockholders of Protection One, Inc.:

 

We have audited the accompanying consolidated balance sheets ofProtection One, Inc. and subsidiaries (the “Company”) as of December 31, 2004and 2003, and the related consolidated statements of operations andcomprehensive loss, stockholders’ equity (deficiency in assets) and cash flowsfor each of the three years in the period ended December 31, 2004.  Ouraudits also included the financial statement schedule listed in Item15(a)2.  These financial statements and the financial statement scheduleare the responsibility of the Company’s management.  Our responsibility isto express an opinion on the financial statements and the financial statementschedule based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  TheCompany is not required to have, nor were we engaged to perform, an audit ofits internal control over financial reporting. Our audit included consideration of internal control over financialreporting as a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the financial position of Protection One, Inc. andsubsidiaries as of December 31, 2004 and 2003, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2004, in conformity with accounting principles generally acceptedin the United States of America.  Also, in our opinion, such financialstatement schedule, when considered in relation to the basic consolidatedfinancial statements taken as a whole, present fairly in all material respectsthe information set forth therein.

 

The accompanying consolidated financial statements have been preparedassuming that the Company will continue as a going concern.  As discussed in Note 15 “Going Concern andManagement’s Plan” to the consolidated financial statements, the Company’srequirement to repay or refinance a significant amount of outstanding seniordebt maturing in 2005, resulting in a deficiency in working capital, along withhistorical recurring losses from operations raise substantial doubt about itsability to continue as a going concern. Management’s plans concerning these matters are also described in Note15.  The consolidated financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

 

As described in Note 18, the Company completed a transaction subsequentto year end and is currently evaluating if it will result in the adoption of anew basis of accounting.

 

 
| /s/ Deloitte & Touche LLP |   |
|-------------------------------|--------|
|                          |
| Kansas City, Missouri         |
| March 15, 2005                |

 

3

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEET****S**

**(Dollar amounts in thousands, except for pershare amounts)**

 
| ** **                                                                                                                         | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                         | ** ** | **2004**         | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                                         | ** ** | ** **       | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                    |       |             |       |   |   |
| Cash and cash equivalents                                                                                                          |       | $                | 52,528     |   | $ | 35,203 |   |
| Restricted cash                                                                                                                    |       | 926              |       | 1,810 |   |
| Receivables, net                                                                                                                   |       | 24,219           |       | 23,670 |   |
| Inventories, net                                                                                                                   |       | 5,228            |       | 6,221 |   |
| Prepaid expenses                                                                                                                   |       | 5,793            |       | 5,522 |   |
| Related party tax receivable                                                                                                       |       | —           |       | 26,088 |   |
| Deferred tax assets                                                                                                                |       | —           |       | 33,899 |   |
| Other miscellaneous receivables                                                                                                    |       | 5,494            |       | 1,419 |   |
| Other                                                                                                                              |       | 2,375            |       | 2,536 |   |
| Total current assets                                                                                                               |       | 96,563           |       | 136,368 |   |
| Property and equipment, net                                                                                                        |       | 31,152           |       | 31,921 |   |
| Customer accounts, net                                                                                                             |       | 176,155          |       | 244,744 |   |
| Goodwill                                                                                                                           |       | 41,847           |       | 41,847 |   |
| Deferred tax assets, net of current portion                                                                                        |       | —           |       | 252,411 |   |
| Deferred customer acquisition costs                                                                                                |       | 107,310          |       | 94,225 |   |
| Other                                                                                                                              |       | 8,017            |       | 7,506 |   |
| Total Assets                                                                                                                       |       | $                | 461,044    |   | $ | 809,022 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIENCY IN ASSETS)**                                                               | ** ** | ** **       | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                               |       |             |       |   |   |
| Current portion of long-term debt,  including $201,000 and $215,500 due to related party in 2004 and 2003,  respectively           |       | $                | 395,417    |   | $ | 215,500 |   |
| Accounts payable                                                                                                                   |       | 2,266            |       | 5,041 |   |
| Accrued liabilities                                                                                                                |       | 37,088           |       | 31,258 |   |
| Due to related parties                                                                                                             |       | 335              |       | 273 |   |
| Deferred revenue                                                                                                                   |       | 34,017           |       | 33,253 |   |
| Total current liabilities                                                                                                          |       | 469,123          |       | 285,325 |   |
| Long-term debt, net of current portion                                                                                             |       | 110,340          |       | 331,874 |   |
| Deferred customer acquisition revenue                                                                                              |       | 57,433           |       | 44,209 |   |
| Other liabilities                                                                                                                  |       | 1,757            |       | 1,440 |   |
| Total Liabilities                                                                                                                  |       | 638,653          |       | 662,848 |   |
| Commitments and contingencies (see Note 12)                                                                                        |       |             |       |   |   |
| Stockholders’ equity:                                                                                                         |       |             |       |   |   |
| Preferred stock, $.10 par value, 5,000,000  shares authorized                                                                      |       | —           |       | — |   |
| Common stock, $.01 par value, 150,000,000  shares authorized, 2,562,512 shares issued at December 31, 2004 and 2003 (see  Note 17) |       | 26               |       | 26 |   |
| Additional paid-in capital                                                                                                         |       | 1,380,728        |       | 1,380,689 |   |
| Accumulated other comprehensive income                                                                                             |       | 162              |       | 78 |   |
| Deficit                                                                                                                            |       | (1,523,913       | )          | (1,200,007 | ) |
| Treasury stock, at cost, 596,858 shares at  December 31, 2004 and 2003                                                             |       | (34,612          | )          | (34,612 | ) |
| Total stockholders’ equity (deficiency in  assets)                                                                            |       | (177,609         | )          | 146,174 |   |
| Total Liabilities and Stockholders’ Equity  (Deficiency in Assets)                                                            |       | $                | 461,044    |   | $ | 809,022 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

4

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS AND C****OMPREHENSIVE LOSS**

**(Dollar amounts in thousands, except for pershare amounts)**

 
| ** **                                                                          | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                          | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:                                                                           |       |                        |       |   |   |   |   |
| Monitoring and related services                                                     |       | $                           | 247,498    |   | $ | 256,266 |   | $ | 270,854 |   |
| Other                                                                               |       | 21,761                      |       | 20,819 |   | 19,726 |   |
| Total revenues                                                                      |       | 269,259                     |       | 277,085 |   | 290,580 |   |
| Cost of revenues (exclusive of amortization  and depreciation shown below):         |       |                        |       |   |   |   |   |
| Monitoring and related services                                                     |       | 69,598                      |       | 73,205 |   | 78,635 |   |
| Other                                                                               |       | 31,981                      |       | 29,000 |   | 34,523 |   |
| Total cost of revenues                                                              |       | 101,579                     |       | 102,205 |   | 113,158 |   |
| Gross profit (exclusive of amortization and  depreciation shown below)              |       | 167,680                     |       | 174,880 |   | 177,422 |   |
| Operating expenses:                                                                 |       |                        |       |   |   |   |   |
| Selling                                                                             |       | 33,495                      |       | 31,517 |   | 28,607 |   |
| General and administrative                                                          |       | 71,377                      |       | 77,744 |   | 84,377 |   |
| Change in control and debt restructuring  costs                                     |       | 24,382                      |       | — |   | — |   |
| Amortization and depreciation                                                       |       | 78,455                      |       | 80,252 |   | 82,440 |   |
| Loss on impairment of customer accounts                                             |       | —                      |       | — |   | 338,104 |   |
| Loss on impairment of goodwill                                                      |       | —                      |       | — |   | 103,937 |   |
| Total operating expenses                                                            |       | 207,709                     |       | 189,513 |   | 637,465 |   |
| Operating loss                                                                      |       | (40,029                     | )          | (14,633 | ) | (460,043 | ) |
| Other (income) expense                                                              |       |                        |       |   |   |   |   |
| Interest expense                                                                    |       | 26,316                      |       | 25,087 |   | 28,270 |   |
| Related party interest                                                              |       | 18,082                      |       | 15,014 |   | 14,753 |   |
| (Gain) loss on retirement of debt                                                   |       | 47                          |       | — |   | (19,337 | ) |
| Other                                                                               |       | (147                        | )          | (2,829 | ) | (602 | ) |
| Loss from continuing operations before  income taxes                                |       | (84,327                     | )          | (51,905 | ) | (483,127 | ) |
| Income tax (expense) benefit                                                        |       | (239,579                    | )          | 17,494 |   | 148,852 |   |
| Loss from continuing operations before  accounting change                           |       | (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                                                               |       | —                      |       | — |   | (541,330 | ) |
| Discontinued operations                                                             |       | —                      |       | — |   | (2,283 | ) |
| Net Loss                                                                            |       | $                           | (323,906   | ) | $ | (34,411 | ) | $ | (880,855 | ) |
| Other comprehensive income, net of tax:                                             |       |                        |       |   |   |   |   |
| Unrealized gain on marketable securities                                            |       | 84                          |       | 78 |   | — |   |
| Unrealized gain on currency translation                                             |       | —                      |       | — |   | 863 |   |
| Reclassification adjustment for losses  included in sales of foreign operations     |       | —                      |       | — |   | 1,499 |   |
| Comprehensive loss                                                                  |       | $                           | (323,822   | ) | $ | (34,333 | ) | $ | (878,493 | ) |
| Net loss per common share, basic and  diluted:                                      |       |                        |       |   |   |   |   |
| Loss from continuing operations per common  share                                   |       | $                           | (164.78    | ) | $ | (17.53 | ) | $ | (170.43 | ) |
| Loss from discontinued operations per  common share                                 |       | —                      |       | — |   | (1.51 | ) |
| Cumulative effect of accounting change on  continuing operations per common share   |       | —                      |       | — |   | (275.99 | ) |
| Cumulative effect of accounting change on  discontinued operations per common share |       | —                      |       | — |   | (1.16 | ) |
| Net loss per common share                                                           |       | $                           | (164.78    | ) | $ | (17.53 | ) | $ | (449.09 | ) |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

5

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

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

**(Dollar amounts in thousands)**

 
| ** **                                                                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                          | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from operating activities:                                                               |       |                        |       |   |   |   |   |
| Net loss                                                                                            |       | $                           | (323,906   | ) | $ | (34,411 | ) | $ | (880,855 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities:                    |       |                        |       |   |   |   |   |
| (Gain) loss on retirement of debt                                                                   |       | 47                          |       | — |   | (19,337 | ) |
| Loss on discontinued operations, net of  taxes                                                      |       | —                      |       | — |   | 2,967 |   |
| Cumulative effect of accounting change, net  of taxes                                               |       | —                      |       | — |   | 543,613 |   |
| Loss on impairment of customer accounts                                                             |       | —                      |       | — |   | 338,104 |   |
| Loss on impairment of goodwill                                                                      |       | —                      |       | — |   | 103,937 |   |
| Senior notes received in tax sharing  settlement                                                    |       | (26,640                     | )          | — |   | — |   |
| Gain on sale of branch assets                                                                       |       | (93                         | )          | (2,092 | ) | (722 | ) |
| Amortization and depreciation                                                                       |       | 78,455                      |       | 80,252 |   | 82,440 |   |
| Amortization of debt costs and premium                                                              |       | 681                         |       | 735 |   | 2,281 |   |
| Amortization of deferred customer  acquisition costs in excess of amortization of deferred revenues |       | 21,542                      |       | 17,027 |   | 19,714 |   |
| Deferred income taxes                                                                               |       | 286,309                     |       | 8,469 |   | (129,273 | ) |
| Provision for doubtful accounts                                                                     |       | 729                         |       | 774 |   | 4,566 |   |
| Other                                                                                               |       | (69                         | )          | 2 |   | 195 |   |
| Changes in assets and liabilities, net of  effects of acquisitions and dispositions:                |       |                        |       |   |   |   |   |
| Receivables                                                                                         |       | (1,278                      | )          | 1,637 |   | 5,262 |   |
| Related party tax receivable                                                                        |       | 26,087                      |       | (5,343 | ) | (19,090 | ) |
| Other assets                                                                                        |       | (3,951                      | )          | (175 | ) | (2,319 | ) |
| Accounts payable                                                                                    |       | (3,139                      | )          | (683 | ) | 108 |   |
| Deferred revenue                                                                                    |       | 638                         |       | (2,577 | ) | (4,426 | ) |
| Other liabilities                                                                                   |       | 6,402                       |       | (4,580 | ) | (3,774 | ) |
| Net cash provided by operating activities                                                           |       | 61,814                      |       | 59,035 |   | 43,391 |   |
| Cash flows from investing activities:                                                               |       |                        |       |   |   |   |   |
| Installations and purchases of new accounts                                                         |       | (14                         | )          | (311 | ) | (1,653 | ) |
| Deferred customer acquisition costs                                                                 |       | (42,720                     | )          | (42,823 | ) | (45,533 | ) |
| Deferred customer acquisition revenue                                                               |       | 21,317                      |       | 18,852 |   | 17,068 |   |
| Purchase of property and equipment                                                                  |       | (9,323                      | )          | (7,450 | ) | (8,056 | ) |
| Purchase of parent company bonds                                                                    |       | —                      |       | — |   | (67,492 | ) |
| Proceeds from sale of parent company bonds                                                          |       | —                      |       | — |   | 67,492 |   |
| Sale (purchase) of AV One, Inc.                                                                     |       | —                      |       | 1,411 |   | (1,378 | ) |
| Proceeds from disposition of assets and  sale of customer accounts                                  |       | 371                         |       | 2,850 |   | 18,609 |   |
| Net cash used in investing activities                                                               |       | (30,369                     | )          | (27,471 | ) | (20,943 | ) |
| Cash flows from financing activities:                                                               |       |                        |       |   |   |   |   |
| Payments on long-term debt                                                                          |       | (14,500                     | )          | (10,159 | ) | (84,032 | ) |
| Proceeds from long-term debt                                                                        |       | —                      |       | — |   | 44 |   |
| Borrowings from revolving credit facility                                                           |       | —                      |       | — |   | 78,000 |   |
| Sale (purchase) of parent company stock  held as treasury                                           |       | —                      |       | 11,940 |   | (13,537 | ) |
| Purchase of treasury stock                                                                          |       | —                      |       | (3 | ) | (2,178 | ) |
| Proceeds from trademark licensing fees                                                              |       | 160                         |       | 450 |   | — |   |
| Issuance costs and other                                                                            |       | —                      |       | 359 |   | (1,941 | ) |
| Funding from (payment to) parent                                                                    |       | 220                         |       | (722 | ) | (1,306 | ) |
| Net cash provided by (used in) financing  activities                                                |       | (14,120                     | )          | 1,865 |   | (24,950 | ) |
| Net cash provided by discontinued  operations                                                       |       | —                      |       | 229 |   | 376 |   |
| Net increase (decrease) in cash and cash  equivalents                                               |       | 17,325                      |       | 33,658 |   | (2,126 | ) |
| Cash and cash equivalents:                                                                          |       |                        |       |   |   |   |   |
| Beginning of period                                                                                 |       | 35,203                      |       | 1,545 |   | 3,671 |   |
| End of period                                                                                       |       | $                           | 52,528     |   | $ | 35,203 |   | $ | 1,545 |   |
| Cash paid for interest                                                                              |       | $                           | 45,003     |   | $ | 40,989 |   | $ | 45,202 |   |
| Cash paid for taxes, exclusive of benefits  received from parent                                    |       | $                           | 327        |   | $ | 296 |   | $ | 231 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

6

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY (DEFICIENCY IN ASSET****S)**

**(Dollar amounts in thousands)**

 
| ** **                             | ** ** | **Common Stock** | ** ** | **Treasury  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Investment  In Parent  Securities** | ** **  | ** ** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|----------------------------------------|------------|------------------|------------|---------------------|------------|----------------------------------|------------|---------------------------------------|-------------|------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                             | ** ** | **Shares**       | ** ** | **Amount**          | ** ** | ** **                       | ** ** | ** **                            | **Deficit** | ** ** | ** ** | ** **                                           |
| **Common  Stock**                      |       |             |       |                |       |                             |       |                                  |        |       |       |                                                 |       |                                  |       |   |   |
| ***December 31, 2001***                |       | 1,968,110        |       | $                   | 26         |                             | $          | (32,431                               | )           | $          | 1,382,696  |                                                 | $          | (1,413                                | )          | $ | (284,741 | ) | $ | (2,361 | ) | $ | 1,061,776 |   |
| Exercise of  options and warrants      |       | 1,221            |       | —              |       | —                           |       | 225                                   |        | —     |       | —                                               |       | —                                |       | 225 |   |
| Shares  issued-ESPP                    |       | 9,796            |       | —              |       | —                           |       | 377                                   |        | —     |       | —                                               |       | —                                |       | 377 |   |
| Intercompany  transactions             |       | —           |       | —              |       | —                           |       | (22                                   | )           | —     |       | —                                               |       | —                                |       | (22 | ) |
| Unrealized  loss-currency translation  |       | —           |       | —              |       | —                           |       | —                                |        | —     |       | —                                               |       | 2,361                                 |       | 2,361 |   |
| Acquisition of  treasury stock         |       | (20,000          | )          | —              |       | (2,178                           | )          | —                                |        | —     |       | —                                               |       | —                                |       | (2,178 | ) |
| Investment in  parent securities       |       | —           |       | —              |       | —                           |       | —                                |        | (13,537    | )          | —                                               |       | —                                |       | (13,537 | ) |
| Net loss                               |       | —           |       | —              |       | —                           |       | —                                |        | —     |       | (880,855                                             | )          | —                                |       | (880,855 | ) |
| ***December 31, 2002***                |       | 1,959,127        |       | $                   | 26         |                             | $          | (34,609                               | )           | $          | 1,383,276  |                                                 | $          | (14,950                               | )          | $ | (1,165,596 | ) | $ | — |   | $ | 168,147 |   |
| Exercise of  options and warrants      |       | 3,572            |       | —              |       | —                           |       | 170                                   |        | —     |       | —                                               |       | —                                |       | 170 |   |
| Shares  issued-ESPP                    |       | 3,005            |       | —              |       | —                           |       | 253                                   |        | —     |       | —                                               |       | —                                |       | 253 |   |
| Unrealized  gain-marketable securities |       | —           |       | —              |       | —                           |       | —                                |        | —     |       | —                                               |       | 78                                    |       | 78 |   |
| Acquisition of  treasury stock         |       | (50              | )          | —              |       | (3                               | )          | —                                |        | —     |       | —                                               |       | —                                |       | (3 | ) |
| Investment in  parent securities       |       | —           |       | —              |       | —                           |       | (3,010                                | )           | 14,950     |       | —                                               |       | —                                |       | 11,940 |   |
| Net loss                               |       | —           |       | —              |       | —                           |       | —                                |        | —     |       | (34,411                                              | )          | —                                |       | (34,411 | ) |
| ***December 31, 2003***                |       | 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 | ) |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

7

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.             TheCompany:**

 

Protection One, Inc., referred to as Protection One or theCompany, a Delaware corporation, is a publicly traded security alarm monitoringcompany.  Protection One is principallyengaged in the business of providing security alarm monitoring services, whichincludes sales, installation and related servicing of security alarm systemsfor residential and business customers. On February 17, 2004, the Company’s former majority owner, WestarIndustries, Inc., a Delaware corporation, referred to as Westar Industries, awholly owned subsidiary of Westar Energy, Inc., which together with WestarIndustries is referred to as Westar, sold approximately 87% of the issued andoutstanding shares of the Company’s common stock, par value $0.01 per share toPOI Acquisition I, Inc., a wholly owned subsidiary of POI Acquisition,L.L.C.  Both POI Acquisition, L.L.C. andPOI Acquisition I, Inc. are entities formed by Quadrangle Capital PartnersL.P., Quadrangle Select Partners L.P., Quadrangle Capital Partners-A L.P. andQuadrangle Master Funding Ltd, collectively referred to as Quadrangle.  Westar retained approximately 1% of theCompany’s common stock, representing shares underlying restricted stock unitsgranted to current and former employees of Westar.  As part of the sale transaction, WestarIndustries also assigned its rights and obligations as the lender under therevolving credit facility to POI Acquisition, L.L.C.  Quadrangle paid approximately $122.2 millionto Westar as consideration for both the common stock and the revolving creditfacility, including accrued interest of $2.2 million, and Westar receivedadditional consideration related to post-closing events.

 

Upon the Westar sale transaction and as a result of liquidity problemscaused by its significant debt burden and continuing net losses, the Companyretained Houlihan Lokey Howard & Zukin Capital as its financialadvisor and began discussions regarding a proposed restructuring withQuadrangle and its affiliates, the lenders under the credit facility, andcertain holders of its publicly-held debt. In November 2004, the Company received $73.0 million pursuant to a taxsharing settlement agreement with Westar that terminated the Westar tax sharingagreement, generally settled all claims with Westar relating to the tax sharingagreement and generally settled all claims between Quadrangle and Westarrelating to the Westar sale transaction. Contemporaneously, the Company entered into a debt-for-equity exchangeagreement with Quadrangle that provided for the principal balance outstandingunder the Quadrangle credit facility to be reduced by $120.0 million inexchange for the issuance to Quadrangle of the equivalent of 16 million sharesof the Company’s common stock (on a post-reverse stock split basis).   The exchange was completed on February 8,2005 and was accompanied by a one-share-for-fifty-shares reverse stock split ofthe Company’s outstanding shares of common stock.  The newly issued shares, together with sharesalready owned by Quadrangle, result in Quadrangle owning approximately 97.3% ofthe Company’s common stock.

 

All prior share and per share amounts included in the financialstatements and the accompanying notes give retroactive effect to aone-share-for-fifty shares reverse stock split effected February 8, 2005.

 

* *The Company iscurrently evaluating whether it will be required to adopt a new basis ofaccounting as a result of Quadrangle’s increased ownership following thedebt-for-equity exchange.  In accordancewith SEC Staff Accounting Bulletin Topic 5J, the Company may be required to “pushdown” Quadrangle’s cost of acquiring its 97.3% interest in the Company to theCompany’s assets and liabilities.  If adopted,the “push-down” accounting adjustments will not impact cash flows. The primaryimpact of the adjustments will be to the carrying values of certain long-termassets and liabilities as well as to shareholders’ equity.

 

See Note 5, “Debt” forfurther discussion of the Company’s outstanding debt, Note 8, “Income Taxes”for a discussion relating to the Company’s tax sharing agreement with Westar,Note 15, “Going Concern and Management’s Plan” and Note 18, “Subsequent Events”for a discussion of recent events relating to the restructuring.

 

The Company prepares its financial statements in conformity withgenerally accepted accounting principles. The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosures of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ from those estimates.  The accompanying consolidated financialstatements include the accounts of Protection One’s wholly ownedsubsidiaries.  All significantintercompany balances have been eliminated in consolidation.

 

**2.             Summaryof Significant Accounting Policies:**

 

*(a)          Stock BasedCompensation.* In December 2002, the Financial Accounting Standards Board, or FASB,issued Statement of Financial Accounting Standards, or SFAS, No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure,” which amends SFAS No.123, “Accounting for Stock-Based Compensation.” SFAS No. 148 provides alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation.  In addition, it amends thedisclosure requirements of SFAS 123 to require prominent disclosures in bothannual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  This statement requires thatcompanies follow the prescribed format and provide the additional disclosuresin their annual reports for fiscal years ending after December 15, 2002.  The Company applies the recognition andmeasurement principles of Accounting Principles Board,

 

8

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or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” asallowed by SFAS Nos. 123 and 148, and related interpretations in accounting forits stock-based compensation plans, as described in Note 7 of the ConsolidatedFinancial Statements “Stock Warrants and Options.”  The Company has adopted the disclosurerequirements of SFAS No. 148.

 

For purposes of the pro forma disclosures required by SFAS No. 148, theestimated fair value of the options is amortized to expense on a straight-linemethod over the options’ vesting period. Under SFAS No. 123, compensation expense would have been $0.7 million ineach of 2004 and 2003 and $0.9 million in 2002. Information related to the pro forma impact on the Company’s earningsand earnings per share follows (dollar amounts in thousands, except earningsper share amounts).

 
| ** **                                                                                                        | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                        | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Loss available for common stock, as  reported                                                                     |       | $                           | (323,906   | ) | $ | (34,411 | ) | $ | (880,855 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss, net of related taxes               |       | 34                          |       | 89 |   | 89 |   |
| Deduct: Total stock option expense  determined under fair value method for all awards, net of related tax effects |       | (672                        | )          | (676 | ) | (880 | ) |
| Loss available for common stock, pro forma                                                                        |       | $                           | (324,544   | ) | $ | (34,998 | ) | $ | (881,646 | ) |
| Net loss per common share (basic and  diluted):                                                                   |       |                        |       |   |   |   |   |
| As reported                                                                                                       |       | $                           | (164.78    | ) | $ | (17.53 | ) | $ | (449.09 | ) |
| Pro forma                                                                                                         |       | $                           | (165.11    | ) | $ | (17.83 | ) | $ | (449.49 | ) |

 

*(b)          Revenue Recognition*

 

Revenues are recognized when security services are provided.  System installation revenues, sales revenueson equipment upgrades and direct and incremental costs of installations andsales are deferred for residential customers with monitoring servicecontracts.  For commercial customers andour national account customers, revenue recognition is dependent upon eachspecific customer contract.  In instanceswhen the Company passes title to a system unaccompanied by a service agreementor the Company passes title at a price that it believes is unaffected by anaccompanying but undelivered service, the Company recognizes revenues and costsin the period incurred.  In cases wherethe Company retains title to the system or it prices the system lower than itotherwise would because of an accompanying service agreement, the Companydefers and amortizes revenues and direct costs.

 

The Company follows Staff Accounting Bulletin 104, or SAB104, whichrequires the Company to defer certain system sales and installation revenuesand expenses, primarily equipment, direct labor and direct and incrementalsales commissions incurred.  Deferredsystem and upgrade installation revenues are recognized over the expected lifeof the customer utilizing an accelerated method for residential and commercialcustomers and a straight-line method for our Network Multifamilycustomers.  Deferred costs in excess of deferredrevenue are recognized over the initial contract term, utilizing astraight-line method, typically two to three years for Protection OneMonitoring and five to ten years for Network Multifamily systems.  To the extent deferred costs are less than deferredrevenues, such costs are recognized over the estimated life of the customer.

 

  In 2004, the Company deferred approximately$21.3 million in revenues and approximately $42.7 million of associated directand incremental selling and installation costs. In 2003, the Company deferred approximately $18.9 million in revenuesand approximately $42.8 million of associated direct and incremental sellingand installation costs.  In 2002, theCompany deferred approximately $17.1 million in revenues and approximately$45.5 million of associated direct and incremental selling and installationcosts.

 

Deferred revenues also result from customers who are billed formonitoring and extended service protection in advance of the period in whichsuch services are provided, on a monthly, quarterly or annual basis.  Revenues from monitoring activities arerecognized in the period such services are provided.

 

*(c)           Inventories*

 

Inventories, primarily comprised of alarm systems and parts, are statedat the lower of average cost or market. Inventory is shown net of an obsolescence reserve of $2.0 million and$2.8 million at December 31, 2004 and 2003, respectively.  This reserve is determined based primarilyupon current usage of the individual parts included in inventory.

 

*(d)          Property andEquipment*

 

Property and equipment are stated at cost and depreciated using thestraight-line method over estimated useful lives.  Gains or losses from retirements anddispositions of property and equipment are recognized in income in the periodrealized.  Repair and maintenance costsare expensed as incurred.

 

9

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Estimated useful lives of property and equipment are as follows:

 
| Furniture, fixtures and equipment     |   | 5-10 years                       |   |
|---------------------------------------|--------|----------------------------------|--------|
| Data processing and telecommunication |   | 3-7 years                        |   |
| Leasehold improvements                |   | lease term; generally 5-10 years |   |
| Vehicles                              |   | 5 years                          |   |
| Buildings                             |   | 40 years                         |   |

 

*(e)           Income Taxes*

 

The Company recognizes a liability or asset for the deferred taxconsequences of temporary differences between the tax basis of assets and liabilitiesand their reported amounts in the financial statements.  These temporary differences will result intaxable or deductible amounts in future years when reported amounts of theassets or liabilities are recovered or settled. The deferred tax assets are periodically reviewed for recoverability.

 

The Company had a tax sharing agreement with Westar Energy during theperiod that Westar owned a controlling interest in the Company.  Pursuant to this agreement, Westar Energymade payments to the Company for current tax benefits utilized by Westar Energyin its consolidated tax return irrespective of whether the Company wouldrealize these current benefits on 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 whereby Westarsold its investment in the Company, $285.9 million of the Company’s netdeferred tax assets were not expected to be realizable, and the Companytherefore recorded a non-cash charge against income in the first quarter of2004 to establish a valuation allowance for these assets.

 

In addition, as a result of the sale, except for amounts owed withrespect to losses the Company incurred prior to leaving the Westar consolidatedtax group, the Company is no longer entitled to receive payments from WestarEnergy.  In 2003, the Company receivedaggregate payments from Westar Energy of $20.0 million.  The loss of these payments will have a materialadverse effect on the Company’s cash flow. On November 12, 2004, the Company entered into a tax sharing settlementagreement with Westar and Quadrangle that, among other things, terminated theWestar tax sharing agreement and settled all of its claims with Westar relatingto the tax sharing agreement.  Inaccordance with the Westar tax sharing settlement, among other things, Westarpaid the Company approximately $45.9 million in cash and transferred to it 73/8%senior notes of the Company, due 2005, with aggregate principal and accruedinterest of approximately $27.1 million. In 2004, the Company recorded a tax benefit of approximately $46.9million as a result of the Westar tax sharing settlement.  The Company is also potentially entitled tocertain contingent payments, depending on whether Westar claims and receivescertain additional tax benefits in the future with respect to the February 17,2004 sale transaction.  The Company isunable to determine at this time whether Westar will claim any such benefitsor, if Westar were to claim any such benefits, the amount of the benefits thatWestar would claim or when or whether Westar would actually receive any suchbenefits.  Due to the uncertainty, theCompany has not recorded any tax benefit with respect to any such potentialcontingent payments.  See the discussionin Note 6, “Related Party Transactions.”

 

*(f)            Comprehensive Loss*

 

Comprehensive loss comprises net loss plus the unrealized gains andlosses associated with foreign currency translations and available-for-saleinvestment securities.

 

*(g)          Customer Accounts*

 

Customer accounts are stated at cost and are amortized over theestimated customer life.  The costincludes amounts paid to dealers and the estimated fair value of accountsacquired in business acquisitions. Internal costs incurred in support of acquiring customer accounts areexpensed as incurred.

 

The choice of an amortization life is based on estimates and judgmentsabout the amounts and timing of expected future revenues from customer accountsand average customer account life. Selected periods were determined because, in management’s opinion, theywould adequately match amortization cost with anticipated revenue.  The Company periodically uses an independentappraisal firm to perform lifing studies on its customer accounts in order toassist management in determining appropriate lives of its customeraccounts.  These reviews are performedspecifically to evaluate the Company’s historic amortization policy in light ofthe inherent declining revenue curve over the life of a pool of customeraccounts, and the Company’s historical attrition experience.  The Company has identified three distinctpools of customer accounts, each of which has distinct attributes that effectdiffering attrition characteristics.  Forthe Protection One Monitoring pool, the results of lifing studies indicatedthat the Company can expect attrition to be greatest in years one through fiveof asset life and that a declining balance (accelerated) method would thereforebest match the future amortization costs with the estimated revenue stream fromthese 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.

 

10

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The amortization rates consider the average estimated remaining lifeand historical and projected attrition rates. The amortization method for each customer pool is as follows:

 
| **Pool**                              | ** ** | **Method**                            | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|
| Protection One Monitoring             |       |                                  |       |
| —Acquired Westinghouse Customers |       | Eight-year  120% declining balance(a) |       |
| —Other Customers                 |       | Ten-year  135% declining balance      |       |
| Network Multifamily                   |       | Nine-year  straight-line              |       |

 

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(a)          The Westinghouse customer pool is fullyamortized as of December 31, 2004.

 

The results of a lifing study performed by a third party appraisal firmin the first quarter of 2002 showed a deterioration in the average remaininglife of customer accounts.  The reportshowed the Company’s Protection One Monitoring customer pool can expect adeclining revenue stream over the next 30 years with an estimated averageremaining life of nine years.  TheCompany’s Network Multifamily pool can expect a declining revenue stream overthe next 30 years with an estimated average remaining life of ten years.  Taking into account the results of the lifingstudy and the inherent expected declining revenue streams for Protection OneMonitoring and Network Multifamily, in particular during the first five years,the Company adjusted the amortization of customer accounts for its ProtectionOne Monitoring and Network Multifamily customer pools to better match the rateand period of amortization expense with the expected decline in revenues.  In the first quarter of 2002, the Companychanged its amortization rate for its Protection One Monitoring pool to aten-year 135% declining balance method from a ten-year 130% declining balancemethod.  The change to this ten-year 135%accelerated method, provides for a better matching to the declining revenuestream, in particular during the first five years, when the year over yeardecline is greatest and a significant portion of the revenue stream is expectedto be received.  For the NetworkMultifamily pool, the Company will continue to amortize on a straight-linebasis, utilizing a shorter nine year life. The change to the nine year life straight-line method provides for abetter matching to the declining revenue stream, in particular during the firstfive years, when the decline is greatest and a significant portion of therevenue stream is expected to be received. The Company accounted for these amortization changes prospectivelybeginning January 1, 2002, as a change in estimate.

 

Effective January 1,2002, the Company adopted SFAS No. 142, “Accounting for Goodwill and OtherIntangible Assets,” and SFAS No. 144, “Accounting for the Impairment andDisposal of Long-Lived Assets.”  Toimplement the new standards, an independent appraisal firm was engaged to helpmanagement estimate the fair values of goodwill and customer accounts.  Based on this analysis completed during 2002,the Company recorded a net charge of approximately $765.2 million, net of tax,of which $543.6 million was related to goodwill and $221.6 million was relatedto customer accounts.  These accountingstandards, the related charge and other related information are detailed inNote 14, “Impairment Charges.”

 

The Company is required to perform impairment tests for long-livedassets prospectively when the Company determines that indicators of impairmentare present.  Declines in market value ofits business or the value of its customer accounts that may be incurredprospectively may also require additional impairment charges.  Any such impairment charges could bematerial.

 

*(h)          Goodwill*

 

Goodwill represents the excess of the purchase price over the fairvalue of net assets of businesses acquired.

 

Accounting rules adopted on January 1, 2002 do not permit amortizationof goodwill and require an annual impairment test.  See Note 14 “Impairment Charges” forinformation regarding an impairment recorded in 2002.  The Company established July 1 as its annualimpairment testing date and performed impairment testing during the thirdquarter of 2003 and the third quarter of 2004 and determined that no additionalimpairment was required as of each testing date.

 

*(i)           Cash and CashEquivalents*

 

All highly liquid investments purchased with a remaining maturity ofthree months or less at the date acquired are cash equivalents.  These investments, consisting of money marketfunds, are stated at cost, which approximates market.

 

*(j)            Restricted Cash*

 

Restricted cash on the accompanying balance sheet represents a trustaccount established as collateral for the benefit of the insurer of the Company’sworkers’ compensation claims.  TheCompany receives interest income earned by the trust.

 

*(k)          Receivables*

 

Gross receivables, which consist primarily of trade accountsreceivable, of $29.8 million at December 31, 2004 and $30.6 million at December31, 2003 have been reduced by allowances for doubtful accounts of $5.6 millionand $6.9 million, respectively.

 

The Company’s policy for Protection One Monitoring is to establish areserve for a percentage of a customer’s total receivable balance when anyportion of that receivable balance is greater than 30 days past due.  This percentage, which is based on theCompany’s historical collections experience, is increased as any portion of thereceivable ages until it is fully reserved and written off when it is 120 dayspast due and the account is disconnected and turned over to a collection agency.  Additionally, once the

 

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customer’s balance is greaterthan 120 days past due, all other receivable balances associated with thatcustomer, irrespective of how many days past due, are deemed to be 120 dayspast due and fully reserved.  In certaininstances, based upon the discretion of the local general manager, credit canbe extended and the account may remain active.

 

The Company’s policy for Network Multifamily’s reserve is based on thespecific identification approach.

 

*(l)           Marketablesecurities*

 

The Company’s marketablesecurities are available-for-sale and consist of 16,168 shares of MetLife stockreceived as part of MetLife’s demutualization.  The securities are recorded at market value with a balance of $0.7million at December 31, 2004, which includes $0.2 million of unrealized gains.

 

*(m)          Advertising Costs*

 

Printed materials are expensed as incurred.  Broadcast advertising costs are expensed uponthe first broadcast of the respective advertisement.  Total advertising expense was $2.5 million,$2.8 million and $3.9 million, during the years ended December 31, 2004, 2003,and 2002, respectively.

 

*(n)          Concentrations ofCredit Risk*

 

Financial instruments which potentially subject the Company toconcentrations of credit risk consist principally of trade receivables from alarge number of customers, including both residential and commercial, dispersedacross 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 potentialcredit losses.  The Company has customerslocated throughout the United States.  TheCompany does not believe a significant risk of loss from a concentration ofcredit risk exists.

 

*(o)          Loss Per Share*

 

Loss per share is presented in accordance with SFAS No. 128 “EarningsPer Share.”  Weighted average sharesoutstanding were as follows:

 
| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------|------------|
| ** **                          | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Weighted average shares outstanding |       | 1,965,654        |       | 1,962,587 |   | 1,961,424 |   |

 

No outstanding stock options and warrants represent dilutive potentialcommon shares for the year ended December 31, 2004.  The Company had outstanding stock options andwarrants of which approximately 111 and 34.3 thousand, on a post-reverse stocksplit basis, represent dilutive potential common shares for the years endedDecember 31, 2003 and 2002, respectively.   These securities were not included in the computation of dilutedearnings per share since to do so would have been antidilutive for all periodspresented.

 

*(p)**                               NewAccounting Standards*

 

*Revenue Recognition. *InDecember 2003, the Securities and Exchange Commission (“SEC”) issued StaffAccounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” whichsupercedes SAB 101, “Revenue Recognition in Financial Statements.” SAB 104’sprimary purpose is to rescind accounting guidance contained in SAB 101 relatedto multiple element revenue arrangements, superceded as a result of theissuance of EITF 00-21, “Accounting for Revenue Arrangements with MultipleDeliverables.” The issuance of SAB 104 reflects the concepts contained in EITF00-21.  The other revenue recognitionconcepts contained in SAB 101 remain largely unchanged.  The issuance of SAB 104 did not have amaterial impact on the Company’s results of operations, financial position orcash flows.

 

*Share-Based Payment.*  In December 2004, the FASB issued Statementof Financial Accounting Standards No. 123R (Revised 2004), Share-Based Payment(“SFAS No. 123R”), which requires that the compensation cost relating toshare-based payment transactions be recognized in financial statements based onalternative fair value models.  Theshare-based compensation cost will be measured based on the fair value of theequity or liability instruments issued. The Company currently discloses pro forma compensation expense quarterlyand annually by calculating the stock option grants’ fair value using the Black-Scholesmodel and disclosing the impact on net income and net income per share in aNote to the Consolidated Financial Statements. Upon adoption, pro forma disclosure will no longer be an alternative.  The Company will begin to apply SFAS No. 123Rusing the most appropriate fair value model as of the interim reporting periodending September 30, 2005.

 

*Other-Than-Temporary Impairment. *InNovember 2003, the Emerging Issues Task Force (“EITF”) of the FinancialAccounting Standards Board (“FASB”) reached a consensus on EITF IssueNo. 03-1, “The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments.” EITF 03-1 provides guidance on determining other-than-temporaryimpairments and its

 

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application to marketableequity securities and debt securities accounted for under SFAS No. 115, “Accountingfor Certain Investments in Debt and Equity Securities.”  In September 2004, the FASB issued FASBStaff Position (“FSP”) EITF Issue 03-1-1 which delayed the effective date forthe measurement and recognition guidance contained in the EITF 03-1 pendingfinalization of the draft FSP EITF Issue 03-1-a, “Implementation Guidance forthe Application of Paragraph 16 of EITF 03-1.”  The disclosure requirements of EITF 03-1remain in effect.  The Company adoptedthe disclosure requirements of EITF 03-1 as of December 31, 2004.  The adoption of the recognition and measurementprovisions of EITF 03-1 are not expected to have a material impact on the Company’sresults of operations, financial position or cash flows.

 

        *Inventory.*  In November 2004, the FASB issued SFASNo. 151, “*Inventory Costs*,an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 amendsAccounting Research Bulletin (“ARB”) No. 43, Chapter 4, to clarifythat abnormal amounts of idle facility expense, freight, handling costs andwasted materials (spoilage) should be recognized as current-periodcharges.  In addition, SFAS No. 151requires that allocation of fixed production overhead to inventory be based onthe normal capacity of the production facilities. SFAS No. 151 iseffective for inventory costs incurred during fiscal years beginning afterJune 15, 2005.  The adoption of thisnew standard is not expected to have a material impact on the Company’s resultsof operations, financial position or cash flows.

 

*(q)**                               PriorYear Reclassification*

 

Certain reclassifications have been made to prior year information toconform with current year presentation.

 

**3.****                                      Propertyand Equipment:**

 

Property and equipment are summarized as follows (dollar amounts inthousands):

 
| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|------------------|------------|
| ** **                            | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Furniture, fixtures and equipment     |       | $                | 8,112      |   | $ | 7,507 |   |
| Data processing and telecommunication |       | 75,474           |       | 69,894 |   |
| Leasehold improvements                |       | 3,819            |       | 3,127 |   |
| Vehicles                              |       | 14,501           |       | 14,066 |   |
| Buildings and other                   |       | 6,188            |       | 6,194 |   |
|                                  |       | 108,094          |       | 100,788 |   |
| Less accumulated depreciation         |       | (76,942          | )          | (68,867 | ) |
| Property and equipment, net           |       | $                | 31,152     |   | $ | 31,921 |   |

 

Depreciation expense was $9.9 million, $11.6 million and $13.5 millionfor the years ended December 31, 2004, 2003 and 2002, respectively.

 

**4.****                                      IntangibleAssets—Customer Accounts and Goodwill:**

 

The following is a rollforward of the investment in customer accountsfor the following years (dollar amounts in thousands):

 
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|------------------|------------|
| ** **                       | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Beginning customer accounts      |       | $                | 680,928    |   | $ | 680,349 |   |
| Acquisition of customer accounts |       | 14               |       | 259 |   |
| Sale of accounts                 |       | (1               | )          | (28 | ) |
| Purchase holdbacks and other     |       | (21              | )          | 348 |   |
|                             |       | 680,920          |       | 680,928 |   |
| Less accumulated amortization    |       | (504,765         | )          | (436,184 | ) |
| Ending customer accounts, net    |       | $                | 176,155    |   | $ | 244,744 |   |

 

Amortization expense was $68.6 million, $68.6 million and $68.9 millionfor the years ended December 31, 2004, 2003 and 2002, respectively.

 

The table below reflects the estimated aggregate customer accountamortization for each of the five succeeding years on the Company’s existingcustomer account base as of December 31, 2004 (dollar amounts in thousands):

 
| ** **                     | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Estimated amortization expense |       | $        | 52,324     |     | $          | 51,963   |       | $        | 45,642     |     | $          | 20,001 |   | $ | 5,770 |   |
|                                |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

There were no changes in carrying amounts of goodwill for the yearsended December 31, 2004 or 2003.

 

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**5.****                                      Debt:**

 

Long-term debt and the fixed or weighted average interest rates are asfollows (dollar amounts in thousands):

 
| ** **                                                                 | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                 | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Quadrangle Credit Facility maturing August  15, 2005, variable 9.0% (a)    |       | $                | 201,000    |   | $ | 215,500 |   |
| Senior Subordinated Notes, maturing January  2009, fixed 8.125%            |       | 110,340          |       | 110,340 |   |
| Senior Unsecured Notes, maturing August  2005, fixed 7.375%                |       | 164,285          |       | 190,925 |   |
| Senior Subordinated Discount Notes,  maturing June 2005, fixed 13.625% (b) |       | 30,132           |       | 30,609 |   |
|                                                                       |       | 505,757          |       | 547,374 |   |
| Less current portion                                                       |       | (395,417         | )          | (215,500 | ) |
| Total long-term debt                                                       |       | $                | 110,340    |   | $ | 331,874 |   |

 

----

(a)          Represents weighted average interest ratebefore fees on borrowings under the facility at December 31, 2004.  The weighted-average annual interest ratebefore fees on borrowings at December 31, 2003 was 7.8%.

(b)         The effective rate to the Company is 11.8% dueto amortization of a premium related to the notes.  The unamortized balance of the premium atDecember 31, 2004 and 2003 was $0.3 million and $0.7 million, respectively.

 

*Impact of Event of Change in Control*

 

As part of the February 8, 2005 restructuring (see Note 18 “SubsequentEvents”), the Company initiated the change of control repurchase offer at 101%for the Company’s approximately $29.9 million of outstanding 135/8%senior subordinated discount notes.  TheCompany completed the repurchase of all of these notes on March 11, 2005.

 

The $201.0 million outstanding as of December 31, 2004 under theQuadrangle credit facility was in default due to the change in control of ProtectionOne consummated on February 17, 2004 and non-compliance with financialcovenants.  The Company had entered intoa standstill agreement with Quadrangle, however, pursuant to which, among otherthings, Quadrangle agreed to waive the change in control default and otherspecified defaults, and the Company agreed, among other things, that it couldnot borrow any additional amounts under the revolving credit facility.  Upon the expiration or termination of thisstandstill agreement, Quadrangle could have exercised its rights under therevolving credit facility and declared the indebtedness to be due andpayable.  Acceleration of the Quadranglecredit facility, if not rescinded or satisfied, would have caused cross defaultsunder the Company’s other debt instruments.

 

*Quadrangle Credit Facility*

 

On February 17, 2004, Westar sold approximately 86.8%of the issued and outstanding shares of the Company’s common stock toQuadrangle.  As part of the saletransaction, Westar also assigned to Quadrangle its rights and obligations asthe lender under the Company’s revolving credit facility. Quadrangle initiallypaid approximately $122.2 million to Westar as consideration for both thecommon stock and the revolving credit facility, including accrued interest of$2.2 million, with approximately $1.7 million of the initial paymentbeing consideration for the common stock. In addition, Westar received a rightto additional consideration related to post-closing events, and onNovember 12, 2004, in connection with the Westar tax sharing settlementagreement Quadrangle paid to Westar $32.5 million as additionalconsideration.

 

Also on November 12, 2004, theCompany entered into an exchange agreement with Quadrangle to restructure thedebt under the Quadrangle credit facility. Upon the closing of the exchange agreement on February 8, 2005,Quadrangle reduced the aggregate principal amount outstanding under theQuadrangle credit facility by $120.0 million in exchange for 16 million sharesof the Company’s common stock on a post-reverse stock split basis.  In connection with the closing, the Companyentered into an amended and restated credit facility with Quadrangle to extendthe final maturity on the Quadrangle credit facility and to otherwise amend andrestate the Quadrangle credit facility. The final maturity date under the amended and restated credit agreementis August 15, 2005, provided that the Company may elect to extend the maturitydate to January 15, 2006 upon certification that no defaults or events ofdefault then exist and payment of an extension fee of 1% of the totalcommitment outstanding on August 15, 2005.

 

In addition, in connection with the restructuring, the Quadranglecredit facility was also amended and restated to include, among other things,the following:

 

•                  interestrate increased to 700 basis points over the London Interbank Offered Rate(LIBOR), and a requirement, subject to certain restrictions, that all loans bein LIBOR, as opposed to base rate;

 

•                  mandatoryprepayment of 100% of net asset sale or debt proceeds or excess cash, if any,on a monthly basis, subject to the Company’s ability to maintain a minimum cashbalance of $7.0 million plus (A) the aggregate amount of all

 

14

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accrued but unpaid interestunder the Quadrangle credit facility, 81/8% SeniorSubordinated Notes, 135/8% Senior Subordinated DiscountNotes and 73/8% Senior Unsecured Notes as of the date ofprepayment and (B) the aggregate amount of restricted cash (e.g., any cashnecessary to secure letters of credit or maintain insurance);

 

•                  assignmentof loans or change of agent will not require consent of the Company, providedthat any assignments must be in an amount not less than $1.0 million;

 

•                  aone-time fee of $1.15 million, paid upon consummation of the debt-for-equityexchange in connection with the exchange and amendment of the Quadrangle creditfacility; and

 

•                  theremoval of the letter of credit subfacility and elimination of the revolverfeature, or the ability to reborrow a loan once repaid.

 

Quadrangle also waived and released all defaults andevents of default under the Quadrangle credit facility existing immediatelyprior to the consummation of the debt-for-equity exchange.

 

At December 31, 2004 the Quadrangle credit facility provided forborrowings up to $201.0 million with a variable interest rate.   The weighted-average annual interest rateafter fees on all borrowings under the facility was 8.4%, 6.3% and 7.0% for theyears ended December 31, 2004, 2003, and 2002, respectively.

 

*Senior Subordinated Notes*

 

In 1998, the Company issued $350 million aggregate principal amount ofunsecured 81/8% senior subordinated notes.  As a result of the completion of a registeredoffer to exchange a new series of 81/8% Series B seniorsubordinated notes for a like amount of the Company’s outstanding 81/8%senior subordinated notes, effective June 1, 2001 the annual interest rate onall of such outstanding notes decreased from 85/8% to 81/8%.  Interest on these notes is payablesemi-annually on January 15 and July 15.

 

The notes are redeemable at the Company’s option, in whole or in part,at a predefined price.

 

*Senior Notes*

 

In 1998, the Company issued $250 million of 73/8%senior notes.  Interest is payablesemi-annually on February 15 and August 15. On November 12, 2004, as part of the Westar tax sharing settlementagreement, Westar transferred approximately $26.6 million principal of thesenotes to the Company, which were subsequently retired.

 

*Senior Subordinated Discount Notes*

 

In 1995, a predecessor to the Company issued $166 million aggregateprincipal amount of unsecured senior subordinated discount notes with a fixedinterest rate of 135/8% which were revalued to reflect an11.8% effective interest rate in connection with a 1997 businesscombination.  Interest payments began in1999 and are payable semi-annually on June 30 and December 31.  In March 2005, the remaining outstandingnotes were repurchased and retired.

 

*Debt Maturities*

 

Debt maturities other than under the Quadrangle credit facility are asfollows (dollar amounts in thousands):

 

| 2005  |   | $       | 194,157 |  (a) |
|-------|--------|---------|---------|-----------|
| 2006  |   | —  |    |
| 2007  |   | —  |    |
| 2008  |   | —  |    |
| 2009  |   | 110,340 |    |
| Total |   | $       | 304,497 |      |

 

----

(a)           Excludes $0.3million premium on the 135/8% senior subordinateddiscount notes at December 31, 2004.

 

*Financial and operating covenants*

 

Most of these debt instruments contain restrictions based on earningsbefore interest, taxes, depreciation, and amortization, or EBITDA.  The definition of EBITDA varies among thevarious indentures and the Quadrangle credit facility.  EBITDA is generally derived by adding toincome (loss) before income taxes, the sum of interest expense and depreciationand amortization expense, including amortization of deferred customeracquisition costs and deducting amortization of deferred revenues.  However, under the varying definitions of theindentures, additional adjustments are sometimes required.  In addition, the Quadrangle credit facilitycontains financial and operating covenants which may restrict the Company’sability to incur additional debt, pay dividends, make loans or advances andsell assets.

 

15

----

 
| **Debt  Instrument**       | ** ** | **Financial Covenant**                                                                                                          | ** ** |
|----------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|
| Quadrangle Credit Facility |       | Total  consolidated debt/annualized most recent quarter EBITDA—less than 5.75 to 1.0                                       |       |
|                       |       | Consolidated  annualized most recent quarter EBITDA/latest four fiscal quarters interest  expense—greater than 2.10 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, 2004, the Company was not in compliance with thecovenants under the Quadrangle credit facility, described above, and did notmeet the tests under the indentures relating to the Company’s ability to incuradditional indebtedness or to pay dividends. See discussion above on the amendment to the Quadrangle credit facilityand related waiver and release of all defaults and events of default.

 

See Note 18 “Subsequent Events” for further discussion regarding therestructuring transactions.

 

**6.****                                      RelatedParty Transactions**

 

**Kansas Corporation Commission**

 

On November 8, 2002, the Kansas Corporation Commission, or KCC, issuedOrder No. 51 which required Westar Energy to initiate a corporate and financialrestructuring, reverse specified accounting transactions described in theOrder, review, improve and/or develop, where necessary, methods and proceduresfor allocating costs between utility and non-utility businesses for KCCapproval, refrain from any action that would result in its electric businessessubsidizing non-utility businesses, reduce outstanding debt giving priority toreducing utility debt and, pending the corporate and financial restructuring,imposed standstill limitations on Westar Energy’s ability to finance non-utilitybusinesses including the Company.

 

On January 2, 2004, Westar Energy and Westar Industries filed a JointMotion with the KCC to sell Westar Industries’ equity interest in ProtectionOne to Quadrangle.  The Joint Motion alsosought to assign Westar Industries’ interest in the revolving credit facilityto Quadrangle.  In the alternative, theJoint Motion sought permission for Westar Energy to sell its shares of stock inWestar Industries to Quadrangle, at which time Westar Industries’ assets andliabilities would consist of the revolving credit facility and its equityinterest in Protection One.  On February13, 2004, the KCC approved the Joint Motion.

 

**Settlement Regarding Tax Sharing Payments***.*

 

The Company was a member of Westar’s consolidated tax group since1997.  During that time, Westar madepayments to the Company for tax benefits attributable to the Company andutilized by Westar in its consolidated tax return pursuant to the terms of atax sharing agreement.  Following theconsummation of the sale of Westar’s ownership interests in the Company, it isno longer a part of the Westar consolidated tax group.

 

On November 12, 2004, the Company entered into a taxsharing settlement agreement with Westar and Quadrangle that, among otherthings, terminated the Westar tax sharing agreement, settled all of the Company’sclaims with Westar relating to the tax sharing agreement and settled claimsbetween Quadrangle and Westar relating to the Westar sale transaction.  In accordance with the Westar tax sharing settlement,among other things, Westar paid the Company approximately $45.9 million in cashand transferred to the Company its 73/8% senior notes due2005 with aggregate principal and accrued interest of approximately $27.1million.  The Company had a receivablebalance of $26.1 million at December 31, 2003 relating to the tax sharingagreement with Westar, and the Company recorded a tax benefit of approximately$46.9 million as a result of the Westar tax sharing settlement.  The Company cancelled the 73/8%senior notes due 2005 that it received pursuant to the Westar tax sharingsettlement, resulting in an approximately $26.6 million reduction in theprincipal amount of the Company’s indebtedness. The Company also used a portion of the proceeds from the Westar taxsharing settlement to make a $14.5 million principal payment on the revolvingcredit facility with Quadrangle, further reducing its outstandingindebtedness.  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.  The Company is unable to determine at thistime whether Westar will claim any such benefits or, if Westar were to claim anysuch benefits, the amount of the benefits that Westar would claim or when orwhether Westar would actually receive any such benefits.  Due to this uncertainty, the Company has notrecorded any tax benefit with respect to any such potential contingent payments.

 

**Administrative Services and Management Services Agreements**

 

Westar Energy provided administrative services at its fully loaded costto the Company pursuant to an agreement which is referred to as theadministrative services agreement, which includes accounting, tax, audit, humanresources, legal, purchasing and facilities services.  Charges of approximately $3.1 million wereincurred for the year ended December 31, 2004, compared to charges ofapproximately $4.3 million and $3.9 million for the year ended December 31,2003 and 2002, respectively.  The Companyhad a

 

16

----

 

net balance due to WestarEnergy primarily for these services of $0.4 million and $0.3 million atDecember 31, 2004 and 2003, respectively. Prior to relocation of corporate headquarters on November 18, 2004, theCompany rented office space for its corporate headquarters from Westar on amonth-to-month basis.  The Company paidapproximately $0.4 million for rent for the year ended December 31, 2004 andapproximately $0.6 million for rent for each of the years ended December 31,2003 and 2002.

 

In November 2001, the Company entered into an agreement, which isreferred to as the management services agreement, pursuant to which it paid toWestar Industries, beginning with the quarter ended March 31, 2002, a financialadvisory fee, payable quarterly, equal to 0.125% of the Company’s consolidatedtotal assets at the end of each quarter. The Company incurred $3.6 million of expense for the year ended December31, 2002 for the financial advisory fee which is included in general andadministrative expenses on the income statement.  This management services agreement wasterminated in 2002.

 

**AV ONE and Protection One Data Services**

 

On June 5, 2002, the Company acquired the stock of a wholly ownedsubsidiary of Westar Industries named Westar Aviation, Inc. for approximately$1.4 million.  The Company subsequentlychanged the name of the newly acquired corporation to AV ONE, Inc. (“AV ONE”)and entered into an aircraft reimbursement agreement with WestarIndustries.  Under this agreement, WestarIndustries agreed to reimburse AV ONE for certain costs and expenses relatingto its operations.  Through September 30,2002, AV ONE incurred approximately $1.4 million in expenses for which theCompany received reimbursement from Westar Industries in October 2002.  Westar Energy reimbursed the Company for allcosts incurred relating to the services provided to Westar Energy and WestarIndustries and on March 21, 2003, repurchased the stock of AV ONE at bookvalue.  The Company did not incur anygain or loss on the transaction since the sale was transacted at book value.

 

In June 2002, the Company formed a wholly owned subsidiary namedProtection One Data Services, Inc. (PODS) and on July 1, 2002 transferred to itapproximately 42 of its Information Technology employees.  Effective July 1, 2002, PODS entered into anoutsourcing agreement with Westar Energy pursuant to which PODS provided WestarEnergy information technology services. As a condition of the agreement, PODS offered employment toapproximately 100 Westar Energy Information Technology employees.  Operation of the subsidiary and the provisionof such services were discontinued as of December 31, 2002.  Revenues from these operations totaled $11.2million for the six months of their operation ending December 31, 2002 and netincome of $0.3 million for that period are included in the consolidatedstatements of operations under “discontinued operations.”  The approximately 142 Information Technologyemployees that had accepted employment with PODS were transferred back to theirrespective companies as of the December 31, 2002.  PODS had a $1.1 million receivable from WestarEnergy as of December 31, 2002.  On March21, 2003,  Westar Energy paid the Company$1.1 million for the balance due under the outsourcing agreement as of December31, 2002.

 

**Additional Transactions with Westar**

 

In 2004, the Company received $26.6 million face value of its 73/8% Senior Unsecured Notes from Westar as a result of the tax sharingsettlement.  The 73/8%Senior Unsecured Notes that were received pursuant to the Westar tax sharingsettlement were cancelled, resulting in an approximately $46.6 thousand loss onretirement of debt.  No bonds wererepurchased from Westar Industries in 2003. During 2002 the Company acquired from Westar Industries $83.9 millionface value of the Company’s bonds for $66.8 million.  These bonds were purchased at WestarIndustries’ cost, which generally approximated fair value.  As a result of these transactions, a gain of$16.6 million was recognized in 2002.

 

During 2002, the Company acquired approximately $41.2 million of WestarEnergy 6.25% notes, approximately $21.6 million of Westar Energy 6.875% notesand approximately $4.6 million of Westar Energy 7.125% notes.  All of these notes were subsequently sold atcost to Westar Energy prior to June 30, 2002. In addition, in the first quarter of 2002, the Company acquired $0.3million of Westar Energy preferred securities and $0.1 million of ONEOK, Inc.common stock, all of which were subsequently sold at cost to Westar Energy onMarch 27, 2002.  During 2002, the Companyacquired in open market purchases approximately $12.6 million of Westar Energycommon stock and approximately $1.5 million of Westar Energy preferredstock.  During 2002, the Company receiveddividends of approximately $0.1 million and $0.5 million on Westar Energypreferred stock and common stock, respectively. The dividends were recorded as a reduction in basis in Westar Energyequity securities.  At December 31, 2002,the Company held 850,000 shares of Westar Energy common stock at a cost ofapproximately $13.0 million and 34,213 shares of Westar Energy preferred stockat a cost of approximately $2.0 million for a combined cost of approximately$15.0 million.  These securities weresold to Westar Energy on February 14, 2003 for approximately $11.6million.  The difference between the costand proceeds received from Westar Energy was reflected as a reduction ofcontributed capital from Westar Energy in the first quarter of 2003.

 

**Sale ofTrademark Rights**

 

On June 30, 2003, WestarIndustries paid the Company approximately $0.5 million partially asconsideration for the Company’s grant of a license to Protection One EuropeHolding S.A. to use the Protection One trademark and name in certain Europeancountries.   Revenues from this agreementare being recognized over the life of the licensing agreement.

 

17

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**Credit Facility**

 

The Company had outstanding borrowings under thecredit facility with Quadrangle of $201.0 million at December 31, 2004.  The Company had outstanding borrowings undera revolving credit facility with Westar Industries of $215.5 million atDecember 31, 2003.   The Company accruedinterest expense of $17.2 million, $12.6 million and $12.3 million and madeinterest payments of $17.2 million, $13.1 million and $12.4 million onborrowings under the facility for the years ended December 31, 2004, 2003 and2002, respectively.

 

**Quadrangle Debt Restructuring Reimbursement**

 

In addition tointerest accrued and paid under the Quadrangle credit facility, discussedabove, the Company paid $0.6 million and owed $0.3 million to Quadrangle forlegal expenses incurred by Quadrangle for the year ended December 31,2004.  The Company has agreed to pay thecosts for the financial and legal advisors for both the senior and subordinateddebt holders relating to the restructuring of the Company’s indebtedness.  See Note 18, “Subsequent Events” forinformation relating to the debt restructuring.

 

**Other Related Party Information**

 

The Company’s chief executive officer,Richard Ginsburg, and its chief financial officer, Darius Nevin, held similarpositions with Guardian International, Inc. (Guardian) prior to taking theircurrent positions with the Company.  TheCompany granted Guardian an option to purchase an aggregate of 5,000 shares ofthe Company’s common stock in connection with the Company’s hiring of Mr.Ginsburg.  See Note 7, “Stock Warrantsand Options” for additional discussion regarding these options.

 

**7.             StockWarrants and Options:**

 

The Company accounts for employee stock options in accordance withAccounting Principles Board, or APB, Opinion No. 25, “Accounting for StockIssued to Employees.”  Under APB No. 25,the Company recognizes no compensation expense related to employee stockoptions that are granted with an exercise price at or greater than the marketprice on the day of grant.

 

No options were granted in 2004. A summary of warrant and option activity for the Company’s common stockfrom December 31, 2001 through December 31, 2004 (after giving effect to theone-for-fifty shares reverse stock split on February 8, 2005) is as follows:

 
| ** **                       | ** ** | **Warrants  And Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|----------------------------------|------------|---------------------------|------------|----------------------------------------|------------|
| Outstanding at December 31, 2001 |       | 118,402                   |       | $                                      | 234.55     |   |
| Granted                          |       | 15,950                    |       | 110.05                                 |       |
| Exercised                        |       | (1,212                    | )          | 71.10                                  |       |
| Surrendered                      |       | (22,883                   | )          | 503.15                                 |       |
| Outstanding at December 31, 2002 |       | 110,257                   |       | $                                      | 162.60     |   |
| Granted                          |       | 800                       |       | 60.00                                  |       |
| Exercised                        |       | (3,572                    | )          | 9.15                                   |       |
| Surrendered                      |       | (15,859                   | )          | 283.60                                 |       |
| Outstanding at December 31, 2003 |       | 91,626                    |       | $                                      | 146.65     |   |
| Granted                          |       | —                    |       | —                                 |       |
| Exercised                        |       | —                    |       | —                                 |       |
| Surrendered                      |       | (6,142                    | )          | 128.50                                 |       |
| Outstanding at December 31, 2004 |       | 85,484                    |       | $                                      | 147.95     |   |

 

18

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The table below summarizes stock options and warrants for the Company’scommon stock outstanding as of December 31, 2004 (after giving effect to theone-for-fifty shares reverse stock split on February 8, 2005):

 
| **Description**    | ** ** | **Range of  Exercise Price** | ** ** | **Number of  Shares of  Common  Stock** | ** ** | **Weighted-  Average  Remaining  Contractual  Life in years** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|--------------------|------------|------------------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------|------------|
| *Exercisable*      |       |                         |       |                                    |       |                                                          |       |                                   |       |
| * *           |       |                         |       |                                    |       |                                                          |       |                                   |       |
| 1995 Options       |       | $318.75-$400.00              |       | 456                                     |       | < 1 year                                                   |       | $                                      | 382.90     |   |
| 1996 Options       |       | 475.00-693.75                |       | 640                                     |       | 1 year                                                        |       | 516.00                                 |       |
| 1997 Options       |       | 475.00                       |       | 360                                     |       | 2 years                                                       |       | 475.00                                 |       |
| 1998 Options       |       | 428.125-550.00               |       | 4,908                                   |       | 3 years                                                       |       | 533.90                                 |       |
| 1999 Options       |       | 262.50-446.375               |       | 3,944                                   |       | 4 years                                                       |       | 440.80                                 |       |
| 2000 Options       |       | 65.625-71.875                |       | 4,322                                   |       | 5 years                                                       |       | 71.70                                  |       |
| 2001 Options       |       | 43.75-74.00                  |       | 35,987                                  |       | 6 years                                                       |       | 66.55                                  |       |
| 2002 Options       |       | 103.50-137.50                |       | 10,133                                  |       | 7 years                                                       |       | 113.10                                 |       |
| 2003 Options       |       | 60.00                        |       | 267                                     |       | 8 years                                                       |       | 60.00                                  |       |
| 2001 Warrants      |       | 65.825                       |       | 5,000                                   |       | 6 years                                                       |       | 65.85                                  |       |
| 1995 Note Warrants |       | 194.50                       |       | 15,617                                  |       | < 1 year                                                   |       | 194.50                                 |       |
|               |       |                         |       | 81,634                                  |       |                                                          |       |                                   |       |
| *Not exercisable*  |       |                         |       |                                    |       |                                                          |       |                                   |       |
| 2002 Options       |       | 103.50-135.00                |       | 3,317                                   |       | 7 years                                                       |       | 105.55                                 |       |
| 2003 Options       |       | 60.00                        |       | 533                                     |       | 8 years                                                       |       | 60.00                                  |       |
|               |       |                         |       | 3,850                                   |       |                                                          |       |                                   |       |
| *Outstanding*      |       |                         |       | 85,484                                  |       |                                                          |       |                                   |       |
|                    |            |                              |            |                                         |            |                                                               |            |                                        |            |  |

 

On April 16, 2001, the Company granted an option to purchase anaggregate of 17,500 post-reverse split shares of its common stock to RichardGinsburg as part of his employment agreement with the Company.  The option has a term of ten years and vestedratably over the subsequent three years. The post-reverse split purchase price of the shares issuable pursuant tothe option is $66.00 per share while the fair market value of the common stockat the date of the option grant was $89.50 per share resulting in $0.4 millionin deferred compensation expense amortized over three years.  The expense amount was approximately $40.0thousand for the year ended December 31, 2004 and $0.1 million for each of theyears ending December 31, 2003 and 2002.

 

On April 16, 2001, the Company also granted a warrant to purchase anaggregate of 5,000 post-reverse split shares of its common stock to GuardianInternational, Inc. (Guardian) in connection with the hiring of RichardGinsburg as the Company’s new chief executive officer, who was formerly thechief executive officer of Guardian.  Thewarrant has a term of ten years and vested ratably over three years andtherefore fully vested in 2004.  The post-reversesplit purchase price of the shares issuable pursuant to the option is $66.00per share while the fair market value of the common stock at the date of theoption grant was $89.50 per share resulting in $0.4 million expense in 2001.

 

***1994 Stock Option Plan***

 

The 1994 Stock Option Plan, which is referred to as the Plan, approvedby the Protection One stockholders in June 1994, provides for the award ofincentive stock options to directors, officers and key employees under thePlan.  A total of 26,000 post-reversesplit shares 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 Plan provides for the granting of options that qualify as incentivestock options under the Internal Revenue Code and options that do not soqualify.

 

The purchase price of the shares issuable pursuant to the options isequal to (or greater than) the fair market value of common stock at the date ofoption grant.  The vesting period wasaccelerated on November 24, 1997 and all remaining options are currentlyexercisable.

 

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

 

The 1997 Long-Term Incentive Plan, which is referred to as the LTIP,approved by the Protection One stockholders on November 24, 1997, provides forthe award of incentive stock options to directors, officers and keyemployees.  Under the LTIP, 114,000post-reverse split shares are reserved for issuance, subject to such adjustmentas may be necessary to reflect changes in the number or kinds of shares ofcommon stock or other securities of Protection One.  The LTIP provides for the granting of optionsthat qualify as incentive stock options under the Internal Revenue Code andoptions that do not so qualify.

 

Each option has a term of ten years and typically vests ratably overthree years.  The purchase price of theshares issuable pursuant to the options is equal to (or greater than) the fairmarket value of the common stock at the date of the option grant.

 

The vesting of options granted to our senior management was acceleratedbecause of the change in control of the Company when Westar sold its interestin the Company to Quadrangle.

 

The weighted average fair value of options granted during 2003 and 2002estimated on the date of grant using the Black-Scholes Option Pricing Model andon a post-reverse split basis was $40.00 and $89.00, respectively.   As mentioned above, no options were grantedin 2004.  The fair value was calculatedfor the respective year using the following assumptions:

 
| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **2003**                    | ** ** | **2002** | ** ** |
| Expected stock price volatility |       | 67.1                        | %          | 91.3 | % |
| Risk free interest rate         |       | 3.2                         | %          | 4.8 | % |
| Remaining expected option life  |       | 7 years                     |       | 6 years |   |

 

19

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**8.****                                      IncomeTaxes:**

 

Components of income tax (expense) benefit are as follows (dollaramounts in thousands):

 
| ** **                                     | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Federal                                        |       |                        |       |   |   |   |   |
| Current                                        |       | $                           | 46,913     |   | $ | 23,071 |   | $ | 20,745 |   |
| Deferred                                       |       | (286,309                    | )          | (7,493 | ) | 127,886 |   |
| State                                          |       |                        |       |   |   |   |   |
| Current                                        |       | (183                        | )          | 2,892 |   | 264 |   |
| Deferred                                       |       | —                      |       | (976 | ) | (43 | ) |
|                                           |       | (239,579                    | )          | 17,494 |   | 148,852 |   |
| Tax on discontinued operations                 |       | —                      |       | — |   | 674 |   |
| Tax on cumulative effect of accounting  change |       | —                      |       | — |   | 72,335 |   |
| Total                                          |       | $                           | (239,579   | ) | $ | 17,494 |   | $ | 221,861 |   |

 

The difference between the income tax (expense) benefit at the federalstatutory rate and income tax (expense) benefit in the accompanying statementsof operations is as follows:

 
| ** **                                                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal statutory tax rate                                     |       | 35       | %          | 35       | %          | 35       | %          |
| State income tax benefit, net of federal  expense              |       | 4        |       | —   |       | —   |       |
| Non-deductible goodwill                                        |       | —   |       | —   |       | (16      | )          |
| Non-deductible change in control and debt  restructuring costs |       | (5       | )          | —   |       | —   |       |
| Valuation allowance                                            |       | (318     | )%         | —   |       | —   |       |
| Other                                                          |       | —   |       | (1       | )          | 1        |       |
|                                                           |       | (284     | )%         | 34       | %          | 20       | %          |

 

The Company had a taxsharing agreement with Westar Energy during the period that Westar owned acontrolling interest in the Company. 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 ofDecember 31, 2003, other than for net operating loss carryforwards, novaluation allowance had been established by the Company because the tax sharingagreement utilized a parent company down approach in the allocation of incometax expense among members of the consolidated tax group and, consistent withthat approach, no valuation allowance had been allocated to the Company.  As a result of the February 17, 2004 sale transactionwhereby Westar sold its investment in the Company, $285.9 million of theCompany’s net deferred tax assets were not expected to be realizable, and theCompany therefore recorded a non-cash charge against income in the firstquarter of 2004 to establish a valuation allowance for these assets.

 

On November 12, 2004, theCompany entered into a tax sharing settlement agreement with Westar andQuadrangle that, among other things, terminated the Westar tax sharingagreement and settled all of its claims with Westar relating to the tax sharingagreement.  In accordance with the Westartax sharing settlement, among other things, Westar agreed to pay the Companyapproximately $45.9 million in cash and transfer to it 73/8%senior notes of the Company, due 2005, with aggregate principal and accruedinterest of approximately $27.1 million for total consideration of $73.0million.  As a result of the Westar taxsharing settlement, the Company recorded a 2004 tax benefit of $46.9million.  The tax sharing settlement alsoprovided for a mutual general release, except with respect to certainindemnification obligations pursuant to the purchase agreement betweenQuadrangle and Westar and certain alarm monitoring and other service agreementsbetween the Company and Westar.  Inaddition, Westar and POI Acquisition I, Inc. agreed to join in making Section338(h)(10) elections under the Code.  Aspart of the settlement, the parties mutually agreed to the purchase priceallocation to be used for the election.

 

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.  The Company is unable to determine at this timewhether Westar will claim any such benefits or, if Westar were to claim anysuch benefits, the amount of the benefits that Westar would claim or when orwhether Westar would actually receive any such benefits.  Due to the uncertainty, the Company has notrecorded any tax benefit with respect to any such potential contingentpayments.

 

Management believes theCompany’s remaining net deferred tax assets are not likely realizable andtherefore the deferred tax assets are fully reserved as can be seen in thetable below.  In assessing whetherdeferred taxes are realizable, management considers whether it is more likelythan not that some portion or all deferred tax assets will be realized.  The ultimate realization of deferred taxassets is dependent upon the generation of future taxable income during theperiods in which those temporary differences become deductible.  Management considers the projected futuretaxable income and tax planning strategies in making this assessment.

 

20

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Deferred income taxassets and liabilities were composed of the following (dollar amounts inthousands):

 
| ** **                                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax asset, current:                           |       |     |       |     |       |
| Accrued liabilities                                    |       | $        | 5,877      |     | $          | 4,085 |   |
| Accounts receivable, due to allowance                  |       | 1,285    |       | 615      |       |
| Revolving credit facility                              |       | 11,150   |       | 28,844   |       |
| Other                                                  |       | (163     | )          | 355      |       |
| Valuation allowance                                    |       | (18,149  | )          | —   |       |
|                                                   |       | $        | —     |     | $          | 33,899 |   |
| Deferred tax asset, noncurrent:                        |       |     |       |     |       |
| Net operating loss carryforwards (a)                   |       | $        | 14,371     |     | $          | 8,307 |   |
| Property & equipment                               |       | 2,357    |       | 742      |       |
| Deferred customer acquisition costs (net of  revenues) |       | (21,223  | )          | (12,795  | )          |
| Customer accounts                                      |       | 20,632   |       | 138,751  |       |
| Goodwill                                               |       | 4,699    |       | 68,321   |       |
| Other intangibles                                      |       | 10,822   |       | —   |       |
|                                                   |       |     |       |     |       |
| OID amortization                                       |       | —   |       | 3,343    |       |
| Installed systems                                      |       | —   |       | 40,328   |       |
| AMT credit carryforwards                               |       | —   |       | 20,001   |       |
| Other                                                  |       | 1,698    |       | (6,280   | )          |
| Valuation allowance                                    |       | (33,356  | )          | (8,307   | )          |
|                                                   |       | $        | —     |     | $          | 252,411 |   |

 

----

(a)          Afederal net operating loss carryforward of $37,328 will expire in the year2024.  Total state net operating lossesof approximately the same amount have various expiration dates.

 

**9.****                                      EmployeeBenefit Plans:**

 

*401(k) Plans*

 

The Company maintains a tax-qualified, defined contribution plan thatmeets the requirements of Section 401(k) of the Internal Revenue Code for eachof its segments.

 

*Protection One 401(k) Plan*.  The Company makes contributions to theProtection One 401(k) Plan, which contributions are allocated amongparticipants based upon the respective contributions made by the participantsthrough salary reductions during the applicable plan year.  The Company’s matching contribution may bemade in common stock, in cash or in a combination of both stock and cash.  For the years ended December 31, 2004, 2003,and 2002, Protection One made matching cash contributions to the plan of $1.0million, $1.0 million and $1.1 million, respectively.  The funds of the plan are deposited with atrustee and at each participant’s option in one or more investment funds,including a Company stock fund. Contributions to the Company stock fund were suspended during 2003, andthe Company did not resume contributions in 2004.  The plan was amended effective January 1,2001 requiring the Company to match employees’ contributions up to specifiedmaximum limits.

 

*Network Multifamily 401(k) Plan*.  The Company makes contributions to theNetwork Multifamily 401(k) Plan, which contributions are allocated amongparticipants based upon the respective contributions made by the participantsthrough salary reductions during the applicable plan year.  The Company’s matching contribution are madein cash.  For each of the years endedDecember 31, 2004 and 2003, the Company made matching cash contributions to theplan of $0.2 million.  The Company madematching contributions to the plan of $0.1 million for the year ended December31, 2002.  The funds of the plan aredeposited with a trustee and at each participant’s option in one or moreinvestment funds.

 

*Employee Stock Purchase Plan*

 

Participation in the Employee Stock Purchase Plan, which is referred toas the ESPP, was suspended during 2003 due to the sales process associated withWestar selling its ownership interest in the Company.  All amounts contributed by employees throughthe ESPP in 2003 were returned in November 2003.  Participation in the ESPP has not resumed.

 

The ESPP is designed to qualify as an “Employee Stock Purchase Plan”within the meaning of Section 423 of the Internal Revenue Code, and to alloweligible employees to acquire shares of common stock at periodic intervalsthrough their accumulated payroll deductions. A total of 93,000 post-reverse split shares of common stock have beenreserved for issuance under the Employee Stock Purchase Plan and a total of21,257 post-reverse split shares have been issued including the issuance of3,005 post-reverse split shares in January 2003.

 

21

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The purchase price of shares of common stock purchased under the ESPPduring any purchase period will be the lower of 85% of the fair market value ofthe common stock on the first day of that purchase period and 85% of the fairmarket value of the common stock on the purchase date.

 

Termination of a participant’s employment for any reason (includingdeath, disability or retirement) cancels participation in the ESPPimmediately.  The ESPP will in all eventsterminate upon the earliest to occur of

 

•                                thelast business day in September 2005;

 

•                                thedate on which all shares available for issuance under the plan have been sold;and

 

•                                thedate on which all purchase rights are exercised in connection with anacquisition of Protection One of all or substantially all of its assets.

 

*Management Employment Agreements and Key Employee Retention Plan*

 

In July and August 2004, the Company’s senior executives entered intonew employment agreements to ensure that the Company will have their continuedservices during and after the period of the Company’s anticipatedrestructuring.  The previous employmentagreements with these senior executives would have expired on or about August17, 2004.  The new employment agreementssupersede and replace these previous employment agreements.

 

 These employment agreements provide for, among other things,minimum annual base salaries, bonus awards, payable in cash or otherwise, andparticipation in all of the Company’s employee benefit plans and programs ineffect for the benefit of senior executives, including stock option, 401(k) andinsurance plans, and reimbursement for all reasonable expenses incurred inconnection with the conduct of the business of the Company, provided theexecutive officers properly account for any such expenses in accordance withCompany policies.  The employment agreements also containprovisions providing for compensation to the senior executives under certaincircumstances after a change in control of the Company and in certain othercircumstances.

 

In order to retain the services of seniormanagement and selected key employees who may have felt uncertain about theCompany’s future ownership and direction due to the previous discussions withthe Company’s creditors regarding the restructuring of the Company’sindebtedness, the Company’s Board of Directors authorized senior management inJune 2004 to implement a new key employee retention plan.  The new retention plan applied toapproximately 30 senior managers and selected key employees and providedincentives for such individuals to remain with the Company through therestructuring.  These newretention agreements superseded and replaced previous retention agreementswhich provided additional severance upon a change in control.   The aggregate payout under the plan was approximately $3.9 million ofwhich approximately $3.5 million was accrued for and approximately $0.7 millionwas paid as of December 31, 2004.  Theremaining $3.2 million was paid in January and February of 2005.

 

**10.****                               Leases:**

 

The Company leases office facilities for lease terms maturing through2012.  Future minimum lease paymentsunder non-cancelable operating leases are as follows (dollar amounts inthousands):

 

| **Year ended  December 31,** | ** ** | ** ** | ** ** |
|------------------------------|------------|------------|------------|
| 2005                         |       | $          | 5,028      |   |
| 2006                         |       | 3,627      |       |
| 2007                         |       | 2,471      |       |
| 2008                         |       | 1,225      |       |
| 2009                         |       | 623        |       |
| Thereafter                   |       | 899        |       |
|                         |       | $          | 13,873     |   |

 

Total rent expense for the years ended December 31, 2004, 2003 and2002, was $7.2 million, $9.2 million and $11.7 million respectively.

 

Prior to moving corporate headquarters in November 2004, the Companyrented office space from Westar on a month-to month basis.  The Company paid approximately $0.4 millionfor rent for the year ended December 31, 2004 and $0.6 million for rent foreach of the years ended December 31, 2003 and 2002.

 

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

 

For certain of the Company’s financial instruments, including cash andcash equivalents, accounts receivable, accounts payable and other accruedliabilities, the carrying amounts approximate fair market value due to theirshort maturities.

 

22

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The fair value of the Company’s debt instruments are estimated based onquoted market prices except for the Quadrangle credit facility, which had noavailable quote and was estimated by the Company.    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** | ** ** |
|-----------------------------------------------|------------|----------------|------------|--------------------|------------|
| ** **                                    | ** ** | **2004**       | ** ** | **2003**           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Quadrangle Credit Facility                    |       | $              | 201,000    |               | $          | 133,088 |   | $ | 201,000 |   | $ | 215,500 |   |
| Senior Subordinated Notes (8.125%)            |       | 105,926        |       | 76,135             |       | 110,340 |   | 110,340 |   |
| Senior Notes (7.375%)                         |       | 165,928        |       | 175,651            |       | 164,285 |   | 190,925 |   |
| Senior Subordinated Discount Notes  (13.625%) |       | 28,677         |       | 28,378             |       | 30,132 |   | 30,609 |   |
|                                          |       | $              | 501,531    |               | $          | 413,252 |   | $ | 505,757 |   | $ | 547,374 |   |

 

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

 

**12.****                               Commitmentsand Contingencies:**

 

**Rogers Litigation**

 

On August 2, 2002,Protection One, Westar and certain of the Company’s former employees, as wellas certain third parties, were sued in the District Court of Jefferson County,Texas, by Regina Rogers, a resident of Beaumont, Texas (Case No.  D167654). Ms. Rogers asserted various claims due to casualty losses, propertydamage and mental anguish she allegedly suffered as a result of a fire at herresidence on August 17, 2000.  Althoughthe complaint did not specify the amount of damages sought, counsel for theplaintiff had previously alleged actual damages of approximately $7.5 million.  On January 24, 2005, all claims against thedefendants were settled by the mutual agreement of the parties (and with theconsent and participation of the Company’s primary and excess insurancecarriers).

 

**Dealer Litigation**

 

On May 10, 2004, Nashville Burglar Alarm, LLC, a former dealer, filed ademand for arbitration against the Company with the American ArbitrationAssociation, or AAA, alleging breach of contract, misrepresentation, breach ofimplied covenant of good faith, violation of consumer protection statues andfranchise law violations.  NashvilleBurglar Alarm, along with five other former dealers, was an original plaintiffin a putative class action lawsuit filed against the Company in May 1999, inthe U.S.  District Court for the WesternDistrict of Kentucky (Total Security Solutions, Inc., et al.  v. Protection One Alarm Monitoring, Inc., Civil Action No.3:99CV-326-H).  In that matter, the courtgranted the Company’s motion to stay the proceeding pending the individualplaintiffs’ pursuit of arbitration as required by the terms of their dealeragreements, and AAA refused plaintiffs’ motion to require that all of theclaims of the plaintiffs be heard collectively.

 

Since that time, two of the original plaintiffs in the Total SecuritySolutions case (not including Nashville Burglar Alarm) were either settled bythe mutual agreement of the parties, or dismissed by the AAA.  The remaining original plaintiffs in theTotal Security Solutions case have not pursued claims in arbitration.  Discovery is ongoing in the Nashville BurglarAlarm matter.

 

Two other dealers (not plaintiffs in the original Total SecuritySolutions litigation) filed similar claims in arbitration against theCompany:  Beachwood Security and IraBeer, who is owner of both Security Response Network, Inc. and Homesafe Security,Inc.  Discovery is ongoing in the Beermatter, and the Beachwood matter was dismissed by AAA.

 

The Company believes that it has complied with terms of the contractswith these former dealers and intends to aggressively defend against theseclaims.  In the opinion of management,none of these pending dealer claims, either alone or in the aggregate, willhave a material adverse effect upon the Company’s consolidated financialposition or results of operations.

 

Other Protection One dealers have threatened, and may bring, claimsagainst the Company based upon a variety of theories surrounding calculationsof holdbacks and other payments, or based on other theories of liability.  The Company believes that it has materiallycomplied with the terms of its contracts with its dealers.  The Company cannot predict the aggregateimpact of these potential disputes with its dealers, which could be material.

 

**University of New Hampshire Litigation**

 

In August 2003, the University of New Hampshire and Dr. Stacia Sower, aprofessor at the University, filed separate lawsuits against the Company in NewHampshire Superior Court (Stacia Sower v. Protection One Alarm Monitoring, Inc. and University of New Hampshire v.  Protection One Alarm Monitoring, Inc.  & CU Security, Docket No.  03-C-0199). The suit arose from the Company’s alleged failure to properly monitor alow-temperature freezer used by the University to store research specimens,which failure allegedly caused damage to or destruction of scientificspecimens.

 

23

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In December 2004, after mediation and negotiations, all claims againstthe defendants were settled by the mutual agreement of the parties (and withthe consent and participation of the Company’s insurance carrier).  The lawsuit was dismissed with prejudice onDecember 21, 2004.

 

**Milstein Litigation**

 

On May 20, 2003, Joseph G. Milstein filed a putative class action suitagainst the Company in Los Angeles Superior Court (Milstein v.  Protection One Alarm Services, Inc., JohnDoes 1-100, including Protection One Alarm Monitoring, Inc., Case No.  BC296025). The complaint alleges that Mr. Milstein and similarly situatedProtection One customers in California should not be required to continue topay for alarm services during the term of their contracts if the customer movesfrom the monitored premises.  Thecomplaint seeks money damages and disgorgement of profits based on severalpurported causes of action.  On May 29,2003, the plaintiff added the Company as a defendant in the lawsuit.  On October 28, 2003, the Court granted theCompany’s motion to compel arbitration of the dispute pursuant to the terms ofthe customer contract.

 

A Clause Construction hearing was conducted August 10, 2004, and onOctober 27, 2004, the arbitrator ruled that the arbitration clause permits theplaintiff to seek to proceed on behalf of a class.  On February 24, 2005, a class certificationhearing was conducted and the parties are awaiting the arbitrator’s ruling onwhether the matter may proceed as a class action.  Discovery has commenced in the matter.

 

The Company maintains that the claims asserted in this matter arewithout merit, and it intends to vigorously defend against any and all claimsrelating to this matter.

 

**Encompass Insurance Subrogation Claim**

 

On May 20, 2004, Encompass Insurance Company, as subrogee of Patrickand Ann Hylant, brought suit in the Circuit Court of Michigan, County of Emmetagainst Protection One, two other monitoring companies and the manufacturer ofalarm system equipment, alleging improper and faulty installation of the alarmsystem.  (Encompass Insurance Company, asSubrogee of Patrick and Ann Hylant v. Sunrise of Petoskey, Inc., Protection One Alarm Monitoring, Inc., AdemcoDistribution, Inc.  and Emergency 24,Inc., Case No.  04-8236-N2).  The suit arose from a fire which purportedlyoccurred on October 1, 2002 at the Hylant’s residence.  The complaint alleged negligence, breach ofimplied warranties, breach of contract and gross negligence on the part of thedefendants, and sought damages in excess of $1 million for alleged casualtylosses and property damage.

 

On January 25, 2005, the court granted the Company’s motion to dismissall of plaintiff’s causes of action against it and on February 8, 2005 enteredits final order dismissing such claims.

 

**Atlanta Public School Litigation**

 

In May 2004, the Atlanta Independent School District, or AISD, filedthird-party claims against the Company in the Superior Court of Fulton County,Georgia (Open Options Systems, Inc. v. Atlanta Independent School District v.Protection One Alarm Monitoring, Inc. d/b/a Protection One, Civil Action No.2004-CV-84437).  The initial complaint inthis litigation was filed in April 2004 by Open Options Systems, Inc. againstthe Atlanta Independent School District. Open Options claims the AISD owes Open Options approximately $1.5million in connection with work on school security systems that was performedby Open Options pursuant to one or more contracts awarded by the AISD to Monitoring.  The AISD asserted defenses and counterclaimsagainst Open Options and third-party claims against Monitoring.  The AISD’s allegations include that the AISDhas paid all the money it owes, that certain work was not performed at all orwas performed improperly, that AISD and the Company (not Open Options) are theparties to any contracts covering the work, that the Company fraudulentlymisrepresented the contractual relationship between the Company and OpenOptions, and that the Company is obligated to indemnify the AISD against theclaims by Open Options against the AISD.

 

Subsequently, the Company and Open Options each filed claims againstthe other.  Open Options’ claims includethat the Company failed to pay Open Options money that Monitoring received forwork performed by Open Options, and that Open Options and the Company mustarbitrate (rather than litigate) the claims each has against the other.  The Company’s claims include that OpenOptions must indemnify the Company against the claims of the AISD, and that theCompany is entitled to offset claims by the Company against Open Optionsagainst any claims Open Options may have against the Company.

 

Discovery is ongoing, and is scheduled to continue until July2005.  The Court has not yet set a trialdate.  In connection with thislitigation, the Company intends to vigorously assert its counterclaims andcross-claims, and to vigorously defend against any and all claims against theCompany.  In the opinion of management,the net outcome of these disputes will not have a material adverse effect uponthe Company’s consolidated financial position or results of operations.

 

**General Claims and Disputes**

 

The Company is a party to claims and matters of litigation incidentalto the normal course of its business. Additionally, the Company receives notices of consumer complaints filedwith various state agencies.  The Companyhas developed a dispute resolution process for addressing these administrativecomplaints.  The ultimate outcome of suchmatters cannot presently be determined; however,

 

24

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in the opinion of management, the resolution of such matters will nothave a material adverse effect upon the Company’s consolidated financialposition or results of operations.

 

**Debt Restructuring Charges**

 

In addition to its own financial and legaladvisors, the Company agreed to pay the costs for the financial and legaladvisors for both the senior and subordinated debt holders relating to therestructuring of the Company’s indebtedness. In addition to amounts paid to thefinancial and legal advisors, the Company paid success and other fees to thefinancial advisors in an aggregate amount of approximately $6.9 million in February 2005.For the twelve months ended December 31, 2004, the Company expensed $7.9million relating to these advisors.

 

**ATX Preferred Stock**

 

**In1999, the Company sold its Mobile Services division to ATX Technologies, Inc.,or ATX, for cash, a note, and shares of preferred stock of ATX. The Company didnot record a carrying value for the preferred shares at that time based onuncertainties regarding realization value. To the extent ATX has legallyavailable funds, the preferred stock is redeemable at the Company’s option,which could result in a gain of up to approximately $4.4 million. In responseto the Company’s redemption request in August 2004, ATX advised theCompany that it did not have legally available funds to redeem the preferredstock. Gain, if any, from the redemption of the preferred stock will berecorded only upon realization.**

** **

**SEC Inquiry**

 

Onor about November 1, 2002, the Company, Westar Energy and its formerindependent auditor, Arthur Andersen LLP, were advised by the Staff of theSecurities and Exchange Commission that the Staff would be inquiring into thepractices of the Company and Westar Energy with respect to the restatement oftheir first and second quarter 2002 financial statements announced in November 2002and the related announcement that the 2000 and 2001 financial statements of theCompany and Westar Energy would be reaudited. Since that time, the Company hasreceived no further communications from the SEC regarding this matter, and hasno information that would indicate that the SEC Staff is actively pursuing itsinquiry at this time. The Company has cooperated and intends to cooperatefurther with the Staff in connection with any additional information it mayrequest.

 

**Administrative Services Agreement**

 

The Company understands that Westar Energy, Inc.may claim that the Company should reimburse Westar Energy for as much as $1.2million for an allocation of the costs incurred by Westar in the development ofthe application systems shared with the Company under the administrativeservice agreement, described in Note 6, “Related Party Transactions—Administrative Services Agreement.”

 

**13.****                               SegmentReporting:**

 

The Company’s operating segments are definedas components 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 (formerly referred to as North America), and NetworkMultifamily. Protection One Monitoring provides residential, commercial, andwholesale security alarm monitoring services, which include sales, installationand related servicing of security alarm systems for residential and businesscustomers in the United States of America. Network Multifamily providessecurity alarm services to apartments, condominiums and other multifamilydwellings. During the third quarter of 2002, the Company identified a newreportable segment, Data Services, with the creation of PODS. As discussed inNote 6, “Related Party Transactions,” the operations of this segment werediscontinued in the fourth quarter of 2002, and accordingly, they are notincluded in the amounts reported below.

 

The accounting policies of the operatingsegments are the same as those described in the summary of significantaccounting policies. The Company manages its business segments based onearnings before interest, income taxes, depreciation, amortization (includingamortization of deferred customer acquisition costs and revenues) and otheritems, referred to as Adjusted EBITDA.

 

25

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Reportable segments (dollar amounts inthousands):

 
| ** **                                                                     | ** ** | **For the  year ended December 31, 2004** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                     | ** ** | **Protection  One  Monitoring  (1)**           | ** ** | **Network  Multi-  family(2)** | ** ** | **Adjustments  (3)** | ** ** | **Consolidated  Total** | ** ** |
| 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 revenues |       | 16,757                                         |       | 4,785 |   |   |   | 21,542 |   |
| Change in  control, debt restructuring and retention bonus expense             |       | 25,681                                         |       | 2,167 |   |   |   | 27,848 |   |
| Operating  income (loss)                                                       |       | (44,584                                        | )          | 4,555 |   |   |   | (40,029 | ) |
| Interest  income                                                               |       | 490                                            |       | — |   |   |   | 490 |   |
| Interest  expense                                                              |       | 41,312                                         |       | 3,576 |   |   |   | 44,888 |   |
| 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 |   |
|                                                                                |            |                                                |            |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                     | ** ** | **For the  year ended December 31, 2003** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                     | ** ** | **Protection  One  Monitoring  (1)**           | ** ** | **Network  Multi-  family (2)** | ** ** | **Adjustments  (3)** | ** ** | **Consolidated  Total** | ** ** |
| Revenue                                                                        |       | $                                              | 238,999    |   | $ | 38,086 |   |   |   | $ | 277,085 |   |
| Adjusted  EBITDA (4)                                                           |       | 73,161                                         |       | 15,652 |   |   |   | 88,813 |   |
| Amortization  of intangibles and depreciation expense                          |       | 75,335                                         |       | 4,917 |   |   |   | 80,252 |   |
| Amortization  of deferred costs in excess of amortization of deferred revenues |       | 12,874                                         |       | 4,153 |   |   |   | 17,027 |   |
| Retention  bonus and sale expense                                              |       | 4,674                                          |       | 1,493 |   |   |   | 6,167 |   |
| Operating  income (loss)                                                       |       | (19,722                                        | )          | 5,089 |   |   |   | (14,633 | ) |
| Interest  income                                                               |       | 862                                            |       | — |   |   |   | 862 |   |
| Interest  expense                                                              |       | 36,033                                         |       | 4,930 |   |   |   | 40,963 |   |
| Segment  assets                                                                |       | 778,384                                        |       | 91,331 |   | (60,693 | ) | 809,022 |   |
| Expenditures  for property                                                     |       | 6,553                                          |       | 897 |   |   |   | 7,450 |   |
| Investment  in new accounts, net                                               |       | 19,623                                         |       | 4,659 |   |   |   | 24,282 |   |
|                                                                                |            |                                                |            |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                     | ** ** | **For the  year ended December 31, 2002** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                     | ** ** | **Protection  One  Monitoring  (1)**           | ** ** | **Network  Multi-  family (2)** | ** ** | **Adjustments  (3)** | ** ** | **Consolidated  Total** | ** ** |
| Revenue                                                                        |       | $                                              | 252,504    |   | $ | 38,076 |   |   |   | $ | 290,580 |   |
| Adjusted  EBITDA (4)                                                           |       | 73,021                                         |       | 15,167 |   |   |   | 88,188 |   |
| Amortization  of intangibles and depreciation expense                          |       | 77,173                                         |       | 5,267 |   |   |   | 82,440 |   |
| Amortization  of deferred costs in excess of amortization of deferred revenues |       | 14,644                                         |       | 5,070 |   |   |   | 19,714 |   |
| Facility  closure and severance expense                                        |       | 4,036                                          |       | — |   |   |   | 4,036 |   |
| Impairment  charge                                                             |       | 442,041                                        |       | — |   |   |   | 442,041 |   |
| Operating  income (loss)                                                       |       | (464,873                                       | )          | 4,830 |   |   |   | (460,043 | ) |
| Interest  income                                                               |       | 1,321                                          |       | — |   |   |   | 1,321 |   |
| Interest  expense                                                              |       | 39,051                                         |       | 5,293 |   |   |   | 44,344 |   |
| Segment  assets                                                                |       | 791,593                                        |       | 98,757 |   | (52,778 | ) | 837,572 |   |
| Expenditures  for property                                                     |       | 7,046                                          |       | 1,010 |   |   |   | 8,056 |   |
| Investment  in new accounts, net                                               |       | 24,373                                         |       | 5,745 |   |   |   | 30,118 |   |
|                                                                                |            |                                                |            |  |  |  |  |  |  |  |  |  |

 

----

(1)          Includes allocation ofholding company expenses reducing Adjusted EBITDA by $3.0 million, $7.0 millionand $6.0 million for the years ended December 31, 2004, 2003 and 2002,respectively.

(2)          Includes allocation ofholding company expenses reducing Adjusted EBITDA by $0.7 million, $1.8 millionand $1.2 million for the years ended December 31, 2004, 2003 and 2002,respectively.

(3)          Adjustment to eliminateintersegment accounts receivable.

(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, such as income (loss)before income taxes or cash flow from operations. Items excluded from AdjustedEBITDA 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.

 

26

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| ** **                                                                     | ** ** | **Year Ended  December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                     | ** ** | **Consolidated**                  | ** ** | **Consolidated** | ** ** | **Consolidated** | ** ** |
| ** **                                                                     | ** ** | **(Dollars in thousands)**        | ** ** |
| Income  (loss) before income taxes                                             |       | $                                 | (84,327    | ) | $ | (51,905 | ) | $ | (483,127 | ) |
| Plus:                                                                          |       |                              |       |   |   |   |   |
| Interest  expense                                                              |       | 44,398                            |       | 40,101 |   | 43,023 |   |
| Amortization  of intangibles and depreciation expense                          |       | 78,455                            |       | 80,252 |   | 82,440 |   |
| Amortization  of deferred costs in excess of amortization of deferred revenues |       | 21,542                            |       | 17,027 |   | 19,714 |   |
| Reorganization  costs (a)                                                      |       | 27,848                            |       | 6,167 |   | 4,036 |   |
| Loss on  impairment                                                            |       | —                            |       | — |   | 442,041 |   |
| Less:                                                                          |       |                              |       |   |   |   |   |
| Gain on  retirement of debt                                                    |       | —                            |       | — |   | $ | (19,337 | ) |
| Other income                                                                   |       | $                                 | (100       | ) | $ | (2,829 | ) | $ | (602 | ) |
| Adjusted  EBITDA                                                               |       | $                                 | 87,816     |   | $ | 88,813 |   | $ | 88,188 |   |

 

----

(a)          Reorganizationcosts for 2004 include change in control, debt restructuring and retentionbonus expense. Reorganization costs for 2003 include retention bonus and saleexpense. Reorganization costs for 2002 include facility closure and severanceexpense.

 

**14.****                               ImpairmentCharges:**

 

Effective January 1, 2002, the Companyadopted SFAS No. 142, “Accounting for Goodwill and Other IntangibleAssets,” and SAFS No. 144, “Accounting for the Impairment and Disposal ofLong-Lived Assets. To implement the standards, the Company engaged anindependent appraisal firm to help estimate the fair values of goodwill andcustomer accounts. Based on this analysis, the Company recorded a net charge ofapproximately $765.2 million in the first quarter of 2002. The charge isdetailed as follows:

 

| ** **                                      | ** ** | **Goodwill**       | ** ** | **Customer  Accounts** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|------------------------|------------|-----------|------------|
| ** **                                      | ** ** | **(in  millions)** | ** ** |
| Protection  One Monitoring Segment:             |       |               |       |                   |       |      |       |
| Impairment charge—continuing  operations   |       | $                  | 509.4      |                   | $          | 338.1     |       | $ | 847.5 |   |
| Impairment  charge—discontinued operations |       | 2.3                |       | 1.9                    |       | 4.2       |       |
| Estimated  income tax benefit                   |       | (65.1              | )          | (118.4                 | )          | (183.5    | )          |
| Net charge                                      |       | $                  | 446.6      |                   | $          | 221.6     |       | $ | 668.2 |   |
| Network  Multifamily Segment:                   |       |               |       |                   |       |      |       |
| Impairment  charge                              |       | $                  | 104.2      |                   | $          | —    |       | $ | 104.2 |   |
| Estimated  income tax benefit                   |       | (7.2               | )          | —                 |       | (7.2      | )          |
| Net charge                                      |       | $                  | 97.0       |                   | $          | —    |       | $ | 97.0 |   |
| Total  Company:                                 |       |               |       |                   |       |      |       |
| Impairment  charge                              |       | $                  | 615.9      |                   | $          | 340.0     |       | $ | 955.9 |   |
| Estimated  income tax benefit                   |       | (72.3              | )          | (118.4                 | )          | (190.7    | )          |
| Net charge                                      |       | $                  | 543.6      |                   | $          | 221.6     |       | $ | 765.2 |   |

 

Another impairment test was completed by the Companyas of July 1, 2002 (the date selected for its annual impairment test),with the independent appraisal firm providing the valuation of the estimatedfair value of its reporting units, and no impairment was indicated. Afterregulatory actions (see Item 8, Note 6 “Related Party Transactions”), includingKansas Corporation Commission Order No. 55, which prompted Westar toadvise the Company that it intended to dispose of its investment in theCompany, an independent appraisal firm was retained to perform an additionalvaluation of the Company’s reporting units, so an impairment test as of December 31,2002 could be performed. The order limited the amount of capital Westar Energycould provide to the Company, which increased its risk profile. Therefore, theCompany reevaluated its corporate forecast, reducing the amount of capitalinvested over the forecast horizon and lowered the base monthly recurring revenueto incorporate actual 2002 results, which resulted in a lower valuation thanthe July 1, 2002 valuation. In December 2002, the Company recorded anadditional $90.7 million impairment charge, net of $13.3 million tax, toreflect the impairment of all remaining goodwill of its Protection OneMonitoring segment.

 

The first quarter 2002 impairment charge for goodwillis reflected in the consolidated statement of income as a cumulative effect ofa change in accounting principle. The impairment charge for customer accountsand the subsequent impairment charge for goodwill are reflected in theconsolidated statement of income as an operating cost. These impairment chargesreduced the recorded value of these assets to their estimated fair values at January 1,2002 and in December 2002, the Company recorded an additional $90.7million impairment charge, net of $13.3 million tax, to reflect the impairmentof all remaining goodwill of its Protection One Monitoring segment.

 

27

----

 

The Company completed its annual impairment testingduring the third quarter of 2004 and 2003 on its Network Multifamily segmentand determined that no additional impairment of goodwill was required. TheCompany’s Protection One Monitoring segment has no goodwill and, therefore,does not require testing.

 

A deferred tax asset in the amount of $190.7million was recorded in the first quarter of 2002 for the tax benefit estimatedabove and an additional deferred tax benefit of $13.3 million was recorded withthe fourth quarter impairment charge. As a result of the sale transactionwhereby Westar sold its investment in the Company, the Company’s net deferredtax assets, which were $286.3 million at December 31, 2003, are notexpected to be realizable and the Company is not expected to be in a positionto record a tax benefit for losses incurred.

 

**15.**                               Going Concern andManagement’s Plan:

** **

The accompanying consolidated financialstatements have been prepared on a going concern basis, which contemplates therealization of assets and the satisfaction of liabilities in the normal courseof business. At December 31, 2003, the Company faced liquidity problemscaused by continuing net losses, the impact of the change of control on theCompany’s cash flow from operations and a significant debt burden. During 2004,the Company improved its capital structure through a tax sharing settlementwith Westar and Quadrangle. The Company also executed a debt-for-equityexchange with Quadrangle and an extension of the maturity of the Quadranglecredit facility with closing of both transactions expected to occur in early2005. At December 31, 2004 the Company’s liabilities included $395.4million of current maturities of its senior debt and the Company continued toface similar conditions to those it faced at December 31, 2003. Absent arecapitalization and restructuring of its debts, the Company’s projected cashflows would have been insufficient to support its debt balances.

 

Subsequent to year-end, the Company did consummatethe debt-for-equity exchange with Quadrangle and the extension of theQuadrangle credit facility. The Company has retired $152.9 million of debt thatwas outstanding on December 31, 2004. In aggregate, approximately $194.0million of its senior debt that was outstanding on September 30, 2004 hasbeen retired.

 

*Westar Tax SharingSettlement*. On November 12, 2004, the Companyentered into a tax sharing settlement with Westar and Quadrangle. In accordancewith the Westar tax sharing settlement, Westar, among other things, paid theCompany approximately $45.9 million in cash and transferred to it a portion ofthe Company’s 73/8% Senior Unsecured Notes, withaggregate principal and accrued interest of approximately $27.1 million thathad been held by Westar. The Company has cancelled the 73/8%Senior Unsecured Notes that it received pursuant to the Westar tax sharingsettlement, resulting in an approximately $26.6 million reduction in theprincipal amount of our indebtedness. The Company used a portion of theproceeds from the Westar tax sharing settlement to make a $14.5 millionprincipal payment and a $2.2 million interest payment on the Quadrangle creditfacility, further reducing its outstanding indebtedness.

 

*Debt-for-EquityExchange.* On November 12, 2004, the Companyentered into an exchange agreement with Quadrangle to restructure the debtunder the Quadrangle credit facility. Upon the closing of the exchangeagreement on February 8, 2005, Quadrangle reduced the aggregate principalamount outstanding under the Quadrangle credit facility by $120.0 million inexchange for 16 million shares of the Company’s common stock on a post-reversestock split basis. The newly issued shares, together with the shares currentlyowned by Quadrangle, resulted in Quadrangle’s owning approximately 97.3% of theCompany’s common stock as of the closing of the debt-for-equity exchange.

 

*Amendment of theQuadrangle Credit Facility.* Pursuant to the exchangeagreement entered into in connection with the restructuring, Quadrangle agreedto extend the final maturity on the Quadrangle credit facility and to otherwiseamend and restate the Quadrangle credit facility. The final maturity date underthe amended and restated credit agreement is August 15, 2005, providedthat the Company may elect to extend the maturity date to January 15, 2006upon certification that no defaults or events of default then exist and paymentof an extension fee of 1% of the total commitment outstanding on August 15,2005.

 

The Company is currently engaged in discussionsto repay or refinance its senior debt that is maturing in August 2005 andwill seek to conclude a refinancing before the end of the second quarter. Ifsuccessful in their refinancing efforts, with current levels of indebtednessand extended maturities, the Company expects to generate cash flow in excess ofthat required for its operations and for interest payments.

 

The Company’soverall goal is to strengthen its leadership position in delivering securitymonitoring services and related installation services in principal marketsacross the United States in order to improve returns on the capital it investscreating and serving customers. Specific goals include (i) loweringattrition rates; (ii) reducing acquisition costs for each dollar of RMRcreated; (iii) increasing RMR additions; and (iv) increasing theefficiency of monitoring and service activities. The Company plans to achievethese objectives by building upon its core strengths, including its nationalbranch platform, its improving brand recognition, its internal sales forcemodel and its highly skilled and experienced management team and workforce.

 

28

----

 

**16.**                               Summarized Combined Financial Information of the Subsidiary Guarantors ofDebt:

** **

Protection OneAlarm Monitoring, Inc., a wholly-owned subsidiary of the Company, has debtsecurities outstanding (see Note 5, “Debt”) that are fully and unconditionallyguaranteed by Protection One, Inc. The following tables present condensedconsolidating financial information for Protection One, Inc., ProtectionOne Alarm Monitoring, Inc., Network Multifamily and all othersubsidiaries. Condensed financial information for Protection One, Inc. andProtection One Alarm Monitoring, Inc. on a stand-alone basis are presentedusing the equity method of accounting for subsidiaries in which they own orcontrol twenty percent or more of the voting shares.

 

29

----

 

**ConsolidatingStatement of Operations**

**For theyear ended December 31, 2004**

**(dollaramounts in thousands)**

 
| ** **                                           | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Network  Multifamily** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|--------------------------------|------------|---------------------------------------|------------|--------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Revenues:                                            |       |                           |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Monitoring  and related services                     |       | $                              | —     |                                  | $          | 201,228                  |       | $                                 | 36,074     |             | $          | 10,196           |       | — |   | $ | 247,498 |   |
| Other                                                |       | —                         |       | 20,089                                |       | 1,672                    |       | —                            |       | —           |       | 21,761           |       |
| Total  revenues                                      |       | —                         |       | 221,317                               |       | 37,746                   |       | 10,196                            |       | —           |       | 269,259          |       |
| Cost of  revenues:                                   |       |                           |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Monitoring  and related services                     |       | —                         |       | 57,292                                |       | 7,836                    |       | 4,470                             |       | —           |       | 69,598           |       |
| Other                                                |       | —                         |       | 25,810                                |       | 6,171                    |       | —                            |       | —           |       | 31,981           |       |
| Total cost  of revenues                              |       | —                         |       | 83,102                                |       | 14,007                   |       | 4,470                             |       | —           |       | 101,579          |       |
| Gross profit                                         |       | —                         |       | 138,215                               |       | 23,739                   |       | 5,726                             |       | —           |       | 167,680          |       |
| Operating  expenses:                                 |       |                           |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Selling                                              |       | —                         |       | 30,733                                |       | 2,465                    |       | 297                               |       | —           |       | 33,495           |       |
| General and  administrative                          |       | 4,752                          |       | 56,124                                |       | 9,537                    |       | 964                               |       | —           |       | 71,377           |       |
| Change in  control and debt restructuring costs      |       | 22,839                         |       | —                                |       | 1,543                    |       | —                            |       | —           |       | 24,382           |       |
| Amortization  and depreciation                       |       | 2                              |       | 73,046                                |       | 4,895                    |       | 512                               |       | —           |       | 78,455           |       |
| Holding  company allocation                          |       | (3,720                         | )          | 2,976                                 |       | 744                      |       | —                            |       | —           |       | —           |       |
| Corporate  overhead allocation                       |       | —                         |       | (1,123                                | )          | —                   |       | 1,123                             |       | —           |       | —           |       |
| Total  operating expense                             |       | 23,873                         |       | 161,756                               |       | 19,184                   |       | 2,896                             |       | —           |       | 207,709          |       |
| Operating  income (loss)                             |       | (23,873                        | )          | (23,541                               | )          | 4,555                    |       | 2,830                             |       | —           |       | (40,029          | )          |
| Other income  (loss):                                |       |                           |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Interest  income (expense) (a)                       |       | —                         |       | (22,744                               | )          | (3,576                   | )          | 4                                 |       | —           |       | (26,316          | )          |
| Related  party interest                              |       | —                         |       | (18,082                               | )          | —                   |       | —                            |       | —           |       | (18,082          | )          |
| Other                                                |       | —                         |       | 100                                   |       | —                   |       | —                            |       | —           |       | 100              |       |
| Equity  lossin subsidiary                            |       | (302,029                       | )          | (231                                  | )          | —                   |       | —                            |       | 302,260          |       | —           |       |
| Loss from  continuing operations before income taxes |       | (325,902                       | )          | (64,498                               | )          | 979                      |       | 2,834                             |       | 302,260          |       | (84,327          | )          |
| Income tax  (expense) benefit                        |       | 1,996                          |       | (237,531                              | )          | (2,282                   | )          | (1,762                            | )          |             |       | (239,579         | )          |
| Net income  (loss)                                   |       | (323,906                       | )          | (302,029                              | )          | (1,303                   | )          | 1,072                             |       | 302,260          |       | (323,906         | )          |
|                                                      |            |                                |            |                                       |            |                          |            |                                   |            |                  |            |                  |            |  |  |  |  |  |

 

----

(a) Protection One Alarm Monitoring, Inc. allocated $3,576 ofits interest expense to Network Multifamily.

 

30

----

 

# **Consolidating Statement of Operations**

**For theyear ended December 31, 2003**

**(dollaramounts in thousands)**

 
| ** **                                                    | ** ** | **Protection  One,  Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Network  Multifamily** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|--------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Revenues:                                                     |       |                       |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Monitoring  and related services                              |       | $                          | —     |                                  | $          | 210,445                  |       | $                                 | 36,090     |             | $          | 9,731            |       | — |   | $ | 256,266 |   |
| Other                                                         |       | —                     |       | 18,823                                |       | 1,996                    |       | —                            |       | —           |       | 20,819           |       |
| Total  revenues                                               |       | —                     |       | 229,268                               |       | 38,086                   |       | 9,731                             |       | —           |       | 277,085          |       |
| Cost of  revenues:                                            |       |                       |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Monitoring  and related services                              |       | —                     |       | 60,667                                |       | 8,402                    |       | 4,136                             |       | —           |       | 73,205           |       |
| Other                                                         |       | —                     |       | 23,117                                |       | 5,883                    |       | —                            |       | —           |       | 29,000           |       |
| Total cost  of revenues                                       |       | —                     |       | 83,784                                |       | 14,285                   |       | 4,136                             |       | —           |       | 102,205          |       |
| Gross profit                                                  |       | —                     |       | 145,484                               |       | 23,801                   |       | 5,595                             |       | —           |       | 174,880          |       |
| Operating  expenses:                                          |       |                       |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Selling                                                       |       | —                     |       | 28,563                                |       | 2,662                    |       | 292                               |       | —           |       | 31,517           |       |
| General and  administrative                                   |       | 8,798                      |       | 58,423                                |       | 9,373                    |       | 1,150                             |       | —           |       | 77,744           |       |
| Amortization  and depreciation                                |       | 2                          |       | 74,860                                |       | 4,917                    |       | 473                               |       | —           |       | 80,252           |       |
| Holding  company allocation                                   |       | (8,798                     | )          | 7,038                                 |       | 1,760                    |       | —                            |       | —           |       | —           |       |
| Corporate  overhead allocation                                |       | —                     |       | (1,040                                | )          | —                   |       | 1,040                             |       | —           |       | —           |       |
| Aviation  services                                            |       | (661                       | )          | —                                |       | —                   |       | 661                               |       | —           |       | —           |       |
| Total  operating expense                                      |       | (659                       | )          | 167,844                               |       | 18,712                   |       | 3,616                             |       | —           |       | 189,513          |       |
| Operating  income (loss)                                      |       | 659                        |       | (22,360                               | )          | 5,089                    |       | 1,979                             |       | —           |       | (14,633          | )          |
| Other income  (loss):                                         |       |                       |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Interest  income (expense) (a)                                |       | 577                        |       | (20,754                               | )          | (4,930                   | )          | 20                                |       | —           |       | (25,087          | )          |
| Related  party interest                                       |       | —                     |       | (15,014                               | )          | —                   |       | —                            |       | —           |       | (15,014          | )          |
| Other                                                         |       | (161                       | )          | 2,990                                 |       | —                   |       | —                            |       | —           |       | 2,829            |       |
| Equity loss  in subsidiary                                    |       | (34,934                    | )          | (411                                  | )          | —                   |       | —                            |       | 35,345           |       | —           |       |
| Income  (loss) from continuing operations before income taxes |       | (33,859                    | )          | (55,549                               | )          | 159                      |       | 1,999                             |       | 35,345           |       | (51,905          | )          |
| Income tax  (expense) benefit                                 |       | (552                       | )          | 21,200                                |       | (2,136                   | )          | (1,018                            | )          |             |       | 17,494           |       |
| Net income  (loss)                                            |       | (34,411                    | )          | (34,349                               | )          | (1,977                   | )          | 981                               |       | 35,345           |       | (34,411          | )          |
|                                                               |            |                            |            |                                       |            |                          |            |                                   |            |                  |            |                  |            |  |  |  |  |  |

 

----

(a) Protection One Alarm Monitoring, Inc. allocated $4,930 ofits interest expense to Network Multifamily

 

31

----

 

# **Consolidating Statement of Operations**

**For theyear ended December 31, 2002**

**(dollaramounts in thousands)**

 
| ** **                                                | ** ** | **Protection One,  Inc.** | ** ** | **Protection One  Alarm Monitoring** | ** ** | **Network  Multifamily** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------|------------|---------------------------|------------|--------------------------------------|------------|--------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Revenues:                                                 |       |                      |       |                                 |       |                     |       |                            |       |             |       |             |       |
| Monitoring  and related services                          |       | $                         | —     |                                 | $          | 224,642                  |       | $                               | 36,824     |             | $          | 9,388            |       | $ | — |   | $ | 270,854 |   |
| Other                                                     |       | —                    |       | 18,474                               |       | 1,252                    |       | —                          |       | —           |       | 19,726           |       |
| Total  revenues                                           |       | —                    |       | 243,116                              |       | 38,076                   |       | 9,388                           |       | —           |       | 290,580          |       |
| Cost of  revenues:                                        |       |                      |       |                                 |       |                     |       |                            |       |             |       |             |       |
| Monitoring  and related services                          |       | —                    |       | 66,654                               |       | 8,310                    |       | 3,671                           |       | —           |       | 78,635           |       |
| Other                                                     |       | —                    |       | 28,347                               |       | 6,176                    |       | —                          |       | —           |       | 34,523           |       |
| Total cost  of revenues                                   |       | —                    |       | 95,001                               |       | 14,486                   |       | 3,671                           |       | —           |       | 113,158          |       |
| Gross profit                                              |       | —                    |       | 148,115                              |       | 23,590                   |       | 5,717                           |       | —           |       | 177,422          |       |
| Operating  expenses:                                      |       |                      |       |                                 |       |                     |       |                            |       |             |       |             |       |
| Selling                                                   |       | —                    |       | 25,995                               |       | 2,265                    |       | 347                             |       | —           |       | 28,607           |       |
| General and  administrative                               |       | 6,538                     |       | 68,279                               |       | 9,994                    |       | (434                            | )          | —           |       | 84,377           |       |
| Amortization  and depreciation                            |       | 1                         |       | 76,673                               |       | 5,267                    |       | 499                             |       | —           |       | 82,440           |       |
| Loss on  impairment of customer accounts                  |       | —                    |       | 332,597                              |       | —                   |       | 5,507                           |       | —           |       | 338,104          |       |
| Loss on  impairment of goodwill                           |       | —                    |       | 103,937                              |       | —                   |       | —                          |       | —           |       | 103,937          |       |
| Holding  company allocation                               |       | (7,256                    | )          | 6,022                                |       | 1,234                    |       | —                          |       | —           |       | —           |       |
| Corporate  overhead allocation                            |       | —                    |       | (2,146                               | )          | —                   |       | 2,146                           |       | —           |       | —           |       |
| Aviation  services                                        |       | (2,238                    | )          | —                               |       | —                   |       | 2,238                           |       | —           |       | —           |       |
| Total  operating expense                                  |       | (2,955                    | )          | 611,357                              |       | 18,760                   |       | 10,303                          |       | —           |       | 637,465          |       |
| Operating  income (loss)                                  |       | 2,955                     |       | (463,242                             | )          | 4,830                    |       | (4,586                          | )          | —           |       | (460,043         | )          |
| Other income  (loss):                                     |       |                      |       |                                 |       |                     |       |                            |       |             |       |             |       |
| Interest  income (expense)(a)                             |       | 1,043                     |       | (24,030                              | )          | (5,293                   | )          | 10                              |       | —           |       | (28,270          | )          |
| Related  party interest                                   |       | —                    |       | (14,753                              | )          | —                   |       | —                          |       | —           |       | (14,753          | )          |
| Gain on  retirement of debt                               |       | —                    |       | 19,337                               |       | —                   |       | —                          |       | —           |       | 19,337           |       |
| Other                                                     |       | —                    |       | 598                                  |       | —                   |       | 4                               |       | —           |       | 602              |       |
| Equity  lossin subsidiary                                 |       | (883,524                  | )          | (107,622                             | )          | —                   |       | —                          |       | 991,146          |       | —           |       |
| Loss from  continuing operations before income taxes      |       | (879,526                  | )          | (589,712                             | )          | (463                     | )          | (4,572                          | )          | 991,146          |       | (483,127         | )          |
| Income tax  (expense) benefit                             |       | (1,329                    | )          | 151,545                              |       | (2,075                   | )          | 711                             |       |             |       | 148,852          |       |
| Loss from  continuing operations before accounting change |       | (880,855                  | )          | (438,167                             | )          | (2,538                   | )          | (3,861                          | )          | 991,146          |       | (334,275         | )          |
| Gain (loss)  from discontinued operations                 |       | —                    |       | 482                                  |       | —                   |       | (3,449                          | )          | —           |       | (2,967           | )          |
| Cumulative  effect of accounting change, net of taxes     |       |                      |       |                                 |       |                     |       |                            |       |             |       |             |       |
| Continuing  operations                                    |       | —                    |       | (444,378                             | )          | (96,952                  | )          | —                          |       | —           |       | (541,330         | )          |
| Discontinued  operations                                  |       | —                    |       | —                               |       | —                   |       | (2,283                          | )          | —           |       | (2,283           | )          |
| Net income  (loss)                                        |       | $                         | (880,855   | )                                    | $          | (882,063                 | )          | $                               | (99,490    | )                | $          | (9,593           | )          | $ | 991,146 |   | $ | (880,855 | ) |

 

----

(a) Protection One Alarm Monitoring, Inc. allocated $5,293 ofits interest expense to Network Multifamily

 

32

----

 

**ConsolidatingStatement of Assets and Liabilities (Deficiency in Assets)**

**December 31,2004**

**(dollaramounts in thousands)**

 
| ** **                                                                 | ** ** | **Protection  One,  Inc.** | ** ** | **Protection  One  Alarm  Monitoring** | ** ** | **Network  Multifamily** | ** ** | **Subsidiary  Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------------------|------------|--------------------------|------------|----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                                 |       |                       |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Current  Assets                                                            |       |                       |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Cash and  cash equivalents                                                 |       | $                          | —     |                                   | $          | 51,944                   |       | $                                | 159        |             | $          | 425              |       | $ | — |   | $ | 52,528 |   |
| Restricted  cash                                                           |       | —                     |       | 926                                    |       | —                   |       | —                           |       | —           |       | 926              |       |
| Receivables,  net                                                          |       | —                     |       | 20,662                                 |       | 2,176                    |       | 1,381                            |       | —           |       | 24,219           |       |
| Inventories,  net                                                          |       | —                     |       | 3,016                                  |       | 2,212                    |       | —                           |       | —           |       | 5,228            |       |
| Prepaid  expenses                                                          |       | 248                        |       | 4,567                                  |       | 978                      |       | —                           |       | —           |       | 5,793            |       |
| Other  miscellaneous receivables                                           |       | —                     |       | 5,494                                  |       | —                   |       | —                           |       | —           |       | 5,494            |       |
| Other                                                                      |       | —                     |       | 2,336                                  |       | —                   |       | 39                               |       | —           |       | 2,375            |       |
| Total  current assets                                                      |       | 248                        |       | 88,945                                 |       | 5,525                    |       | 1,845                            |       | —           |       | 96,563           |       |
| Property and  equipment, net                                               |       | 14                         |       | 29,061                                 |       | 1,709                    |       | 368                              |       | —           |       | 31,152           |       |
| Customer  accounts, net                                                    |       | —                     |       | 166,542                                |       | 8,781                    |       | 832                              |       | —           |       | 176,155          |       |
| Goodwill                                                                   |       | —                     |       | —                                 |       | 41,847                   |       | —                           |       | —           |       | 41,847           |       |
| Deferred  customer acquisition costs                                       |       | —                     |       | 82,496                                 |       | 24,814                   |       | —                           |       | —           |       | 107,310          |       |
| Other                                                                      |       | —                     |       | 8,017                                  |       | —                   |       | —                           |       | —           |       | 8,017            |       |
| Accounts  receivable (payable) to (from) associated companies (a)          |       | (33,088                    | )          | 85,144                                 |       | (68,321                  | )          | 16,265                           |       | —           |       | —           |       |
| Investment  in POAMI                                                       |       | (141,475                   | )          | —                                 |       | —                   |       | —                           |       | 141,475          |       | —           |       |
| Investment  in Network Multifamily                                         |       | —                     |       | 4,798                                  |       | —                   |       | —                           |       | (4,798           | )          | —           |       |
| Investment  in Non-guarantors                                              |       | —                     |       | 17,940                                 |       | —                   |       | —                           |       | (17,940          | )          | —           |       |
| **Total assets**                                                           |       | $                          | (174,301   | )                                      | $          | 482,943                  |       | $                                | 14,355     |             | $          | 19,310           |       | $ | 118,737 |   | $ | 461,044 |   |
|                                                                       |       |                       |       |                                   |       |                     |       |                             |       |             |       |             |       |
| **Liabilities and Stockholder Equity (Deficiency in Assets)**              |       |
| Current  liabilities:                                                      |       |                       |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Current  portion of long-term debt                                         |       | $                          | —     |                                   | $          | 395,417                  |       | $                                | —     |             | $          | —           |       | $ | — |   | $ | 395,417 |   |
| Accounts  payable                                                          |       | —                     |       | 1,496                                  |       | 770                      |       | —                           |       | —           |       | 2,266            |       |
| Accrued  liabilities                                                       |       | 3,308                      |       | 31,164                                 |       | 2,358                    |       | 258                              |       | —           |       | 37,088           |       |
| Due to  related parties                                                    |       | —                     |       | 335                                    |       | —                   |       | —                           |       | —           |       | 335              |       |
| Deferred  revenue                                                          |       | —                     |       | 32,447                                 |       | 458                      |       | 1,112                            |       | —           |       | 34,017           |       |
| Total  current liabilities                                                 |       | 3,308                      |       | 460,859                                |       | 3,586                    |       | 1,370                            |       | —           |       | 469,123          |       |
| Long-term  debt, net of current portion                                    |       | —                     |       | 110,340                                |       | —                   |       | —                           |       | —           |       | 110,340          |       |
| Deferred  customer acquisition revenue                                     |       | —                     |       | 52,186                                 |       | 5,247                    |       | —                           |       | —           |       | 57,433           |       |
| Other                                                                      |       | —                     |       | 1,033                                  |       | 724                      |       | —                           |       | —           |       | 1,757            |       |
| **Total Liabilities**                                                      |       | 3,308                      |       | 624,418                                |       | 9,557                    |       | 1,370                            |       | —           |       | 638,653          |       |
|                                                                       |       |                       |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Stockholders’  Equity (Deficiency in Assets)                          |       |                       |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Common stock                                                               |       | 26                         |       | 2                                      |       | 1                        |       | —                           |       | (3               | )          | 26               |       |
| Additional  paid in capital                                                |       | 1,380,728                  |       | 1,344,325                              |       | 147,799                  |       | 13,708                           |       | (1,505,832       | )          | 1,380,728        |       |
| Accumulated  other comprehensive income                                    |       | 162                        |       | 162                                    |       | —                   |       | —                           |       | (162             | )          | 162              |       |
| Retained  earnings (deficit)                                               |       | (1,523,913                 | )          | (1,485,964                             | )          | (143,002                 | )          | 4,232                            |       | 1,624,734        |       | (1,523,913       | )          |
| Treasury  stock                                                            |       | (34,612                    | )          | —                                 |       | —                   |       | —                           |       | —           |       | (34,612          | )          |
| **Total stockholders’ equity (deficiency in assets)**                 |       | (177,609                   | )          | (141,475                               | )          | 4,798                    |       | 17,940                           |       | 118,737          |       | (177,609         | )          |
| **Total liabilities and stockholders’ equity (deficiency in assets)** |       | $                          | (174,301   | )                                      | $          | 482,943                  |       | $                                | 14,355     |             | $          | 19,310           |       | $ | 118,737 |   | $ | 461,044 |   |

 

----

(a) Includes $53,873 payable to Protection One Alarm Monitoringfrom Network Multifamily related to allocations of interest charges.

 

33

----

 

**ConsolidatingStatement of Assets and Liabilities**

**December 31,2003**

**(dollaramounts in thousands)**

 
| ** **                                                        | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One  Alarm  Monitoring** | ** ** | **Network  Multifamily** | ** ** | **Subsidiary  Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------|------------|----------------------------------------|------------|--------------------------|------------|----------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                        | ** ** | ** **                     | ** ** | ** **                             | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **       | ** ** | ** **       | ** ** |
| **Assets**                                                        |       |                           |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Current  Assets                                                   |       |                           |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Cash and  cash equivalents                                        |       | $                              | —     |                                   | $          | 33,831                   |       | $                                | 650        |             | $          | 722              |       | $ | — |   | $ | 35,203 |   |
| Restricted  cash                                                  |       | —                         |       | 1,810                                  |       | —                   |       | —                           |       | —           |       | 1,810            |       |
| Receivables,  net                                                 |       | —                         |       | 20,125                                 |       | 2,365                    |       | 1,180                            |       | —           |       | 23,670           |       |
| Inventories,  net                                                 |       | —                         |       | 3,586                                  |       | 2,635                    |       | —                           |       | —           |       | 6,221            |       |
| Prepaid  expenses                                                 |       | 84                             |       | 4,901                                  |       | 537                      |       | —                           |       | —           |       | 5,522            |       |
| Related  party tax receivable                                     |       | —                         |       | 26,088                                 |       | —                   |       | —                           |       | —           |       | 26,088           |       |
| Deferred tax  assets                                              |       | 143                            |       | 33,051                                 |       | 641                      |       | 64                               |       | —           |       | 33,899           |       |
| Other  miscellaneous receivables                                  |       | —                         |       | 1,419                                  |       | —                   |       | —                           |       | —           |       | 1,419            |       |
| Other                                                             |       | —                         |       | 2,536                                  |       | —                   |       | —                           |       | —           |       | 2,536            |       |
| Total  current assets                                             |       | 227                            |       | 127,347                                |       | 6,828                    |       | 1,966                            |       | —           |       | 136,368          |       |
| Property and  equipment, net                                      |       | 3                              |       | 29,572                                 |       | 1,978                    |       | 368                              |       | —           |       | 31,921           |       |
| Customer  accounts, net                                           |       | —                         |       | 230,630                                |       | 12,935                   |       | 1,179                            |       | —           |       | 244,744          |       |
| Goodwill                                                          |       | —                         |       | —                                 |       | 41,847                   |       | —                           |       | —           |       | 41,847           |       |
| Deferred tax  assets, net of current portion                      |       | 1,400                          |       | 250,055                                |       | —                   |       | 956                              |       | —           |       | 252,411          |       |
| Deferred  customer acquisition costs                              |       | —                         |       | 66,482                                 |       | 27,743                   |       | —                           |       | —           |       | 94,225           |       |
| Other                                                             |       | —                         |       | 7,506                                  |       | —                   |       | —                           |       | —           |       | 7,506            |       |
| Accounts  receivable (payable) to (from) associated companies (a) |       | (15,148                        | )          | 62,098                                 |       | (60,693                  | )          | 13,743                           |       | —           |       | —           |       |
| Investment  in POAMI                                              |       | 160,471                        |       | —                                 |       | —                   |       | —                           |       | (160,471         | )          | —           |       |
| Investment  in Network Multifamily                                |       | —                         |       | 19,483                                 |       | —                   |       | —                           |       | (19,483          | )          | —           |       |
| Investment  in Non-guarantors                                     |       | —                         |       | 16,868                                 |       | —                   |       | —                           |       | (16,868          | )          | —           |       |
| **Total assets**                                                  |       | $                              | 146,953    |                                   | $          | 810,041                  |       | $                                | 30,638     |             | $          | 18,212           |       | $ | (196,822 | ) | $ | 809,022 |   |
|                                                              |       |                           |       |                                   |       |                     |       |                             |       |             |       |             |       |
| **Liabilities and Stockholder Equity**                            |       |                           |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Current  liabilities:                                             |       |                           |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Current  portion of long-term debt                                |       | $                              | —     |                                   | $          | 215,500                  |       | $                                | —     |             | $          | —           |       | $ | — |   | $ | 215,500 |   |
| Accounts  payable                                                 |       | —                         |       | 3,890                                  |       | 1,151                    |       | —                           |       | —           |       | 5,041            |       |
| Accrued  liabilities                                              |       | 726                            |       | 27,935                                 |       | 2,308                    |       | 289                              |       | —           |       | 31,258           |       |
| Due to  related parties                                           |       | 53                             |       | 220                                    |       | —                   |       | —                           |       | —           |       | 273              |       |
| Deferred  revenue                                                 |       | —                         |       | 31,522                                 |       | 676                      |       | 1,055                            |       | —           |       | 33,253           |       |
| Total  current liabilities                                        |       | 779                            |       | 279,067                                |       | 4,135                    |       | 1,344                            |       | —           |       | 285,325          |       |
| Long-term  debt, net of current portion                           |       | —                         |       | 331,874                                |       | —                   |       | —                           |       | —           |       | 331,874          |       |
| Deferred  customer acquisition revenue                            |       | —                         |       | 37,986                                 |       | 6,223                    |       | —                           |       | —           |       | 44,209           |       |
| Other                                                             |       | —                         |       | 643                                    |       | 797                      |       | —                           |       | —           |       | 1,440            |       |
| **Total Liabilities**                                             |       | 779                            |       | 649,570                                |       | 11,155                   |       | 1,344                            |       | —           |       | 662,848          |       |
|                                                              |       |                           |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Stockholders’  Equity                                        |       |                           |       |                                   |       |                     |       |                             |       |             |       |             |       |
| Common stock                                                      |       | 26                             |       | 2                                      |       | 1                        |       | —                           |       | (3               | )          | 26               |       |
| Additional  paid in capital                                       |       | 1,380,689                      |       | 1,202,627                              |       | 161,181                  |       | 13,433                           |       | (1,377,241       | )          | 1,380,689        |       |
| Accumulated  other comprehensive income                           |       | 78                             |       | 78                                     |       | —                   |       | —                           |       | (78              | )          | 78               |       |
| Retained  earnings (deficit)                                      |       | (1,200,007                     | )          | (1,042,236                             | )          | (141,699                 | )          | 3,435                            |       | 1,180,500        |       | (1,200,007       | )          |
| Treasury  stock                                                   |       | (34,612                        | )          | —                                 |       | —                   |       | —                           |       | —           |       | (34,612          | )          |
| **Total stockholders’ equity**                               |       | 146,174                        |       | 160,471                                |       | 19,483                   |       | 16,868                           |       | (196,822         | )          | 146,174          |       |
| **Total liabilities and stockholders’ equity**               |       | $                              | 146,953    |                                   | $          | 810,041                  |       | $                                | 30,638     |             | $          | 18,212           |       | $ | (196,822 | ) | $ | 809,022 |   |

 

----

(a) Includes $50,297 payable to Protection One Alarm Monitoringfrom Network Multifamily related to allocations of interest charges.

 

34

----

 

**ConsolidatingCondensed Statement of Cash Flows**

**December 31,2004**

**(dollaramounts in thousands)**

 
| ** **                                                         | ** ** | **Protection  One,  Inc.** | ** **  | **Protection  One Alarm  Monitoring** | ** ** | **Network  Multifamily** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------|-------------|---------------------------------------|------------|--------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net cash provided by (used in) operating activities**            | ** ** | **$**                      | **(17,875** | **)**                                 | **$**      | **68,750**               | ** ** | **$**                             | **8,548**  | ** **       | **$**      | **2,391**        | ** ** | **$** | **—** | ** ** | **$** | **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                                | )          | (493                     | )          | (151                              | )          | —           |       | (9,323           | )          |
| Proceeds  from disposition of assets and sale of customer accounts |       | —                     |        | 329                                   |       | 42                       |       | —                            |       | —           |       | 371              |       |
| **Net cash used in investing activities**                          | ** ** | **(13**                    | **)**       | **(26,907**                           | **)**      | **(3,284**               | **)**      | **(165**                          | **)**      | **—**       | ** ** | **(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                                | )          | (5,755                   | )          | (2,523                            | )          | —           |       | —           |       |
| **Net cash provided by (used in) financing activities**            | ** ** | **17,888**                 | ** **  | **(23,730**                           | **)**      | **(5,755**               | **)**      | **(2,523**                        | **)**      | **—**       | ** ** | **(14,120**      | **)**      |
| Net increase  (decrease) in cash and cash equivalents              |       | —                     |        | 18,113                                |       | (491                     | )          | (297                              | )          | —           |       | 17,325           |       |
| Cash and  cash equivalents:                                        |       |                       |        |                                  |       |                     |       |                              |       |             |       |             |       |
| Beginning of  period                                               |       | —                     |        | 33,831                                |       | 650                      |       | 722                               |       | —           |       | 35,203           |       |
| End of  period                                                     |       | $                          | —      |                                  | $          | 51,944                   |       | $                                 | 159        |             | $          | 425              |       | $ | — |   | $ | 52,528 |   |

 

35

----

 

**ConsolidatingCondensed Statement of Cash Flows**

**December 31,2003**

**(dollar amounts in thousands)**

 
| ** **                                                         | ** ** | **Protection  One,  Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Network  Multifamily** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|--------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net cash provided by operating activities**                      | ** ** | **$**                      | **846**    | ** **                            | **$**      | **46,841**               | ** ** | **$**                             | **9,382**  | ** **       | **$**      | **1,966**        | ** ** | **$** | **—** | ** ** | **$** | **59,035** | ** ** |
| Cash flows  from investing activities:                             |       |                       |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Installation  and purchases of new accounts                        |       | —                     |       | (296                                  | )          | —                   |       | (15                               | )          | —           |       | (311             | )          |
| Deferred  customer acquisition costs                               |       | —                     |       | (37,457                               | )          | (5,366                   | )          | —                            |       | —           |       | (42,823          | )          |
| Deferred  customer acquisition revenue                             |       | —                     |       | 18,145                                |       | 707                      |       | —                            |       | —           |       | 18,852           |       |
| Purchase of  property and equipment                                |       | (3                         | )          | (6,227                                | )          | (897                     | )          | (323                              | )          | —           |       | (7,450           | )          |
| Sale of  AV-One, Inc.                                         |       | 1,411                      |       | —                                |       | —                   |       | —                            |       | —           |       | 1,411            |       |
| Proceeds  from disposition of assets and sale of customer accounts |       | 19                         |       | 2,702                                 |       | 129                      |       | —                            |       | —           |       | 2,850            |       |
| **Net cash provided by (used in) investing activities**            | ** ** | **1,427**                  | ** ** | **(23,133**                           | **)**      | **(5,427**               | **)**      | **(338**                          | **)**      | **—**       | ** ** | **(27,471**      | **)**      |
| Cash flows  from financing activities:                             |       |                       |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Payment on  long-term debt                                         |       | —                     |       | (10,159                               | )          | —                   |       | —                            |       | —           |       | (10,159          | )          |
| Sale of  parent company stock held as treasury                     |       | 11,940                     |       | —                                |       | —                   |       | —                            |       | —           |       | 11,940           |       |
| Purchase of  treasury stock                                        |       | (3                         | )          | —                                |       | —                   |       | —                            |       | —           |       | (3               | )          |
| Proceeds  from sale of trademark                                   |       | —                     |       | 450                                   |       | —                   |       | —                            |       | —           |       | 450              |       |
| Issuance  costs and other                                          |       | 285                        |       | 74                                    |       | —                   |       | —                            |       | —           |       | 359              |       |
| Funding from  Westar                                               |       | 599                        |       | (1,321                                | )          | —                   |       | —                            |       | —           |       | (722             | )          |
| Due to  (from) related companies                                   |       | (15,094                    | )          | 20,590                                |       | (4,085                   | )          | (1,411                            | )          | —           |       | —           |       |
| **Net cash provided by (used in) financing activities**            | ** ** | **(2,273**                 | **)**      | **9,634**                             | ** ** | **(4,085**               | **)**      | **(1,411**                        | **)**      | **—**       | ** ** | **1,865**        | ** ** |
| Net cash  provided by discontinued operations                      |       | —                     |       | 229                                   |       | —                   |       | —                            |       | —           |       | 229              |       |
| Net increase  (decrease) in cash and cash equivalents              |       | —                     |       | 33,571                                |       | (130                     | )          | 217                               |       | —           |       | 33,658           |       |
| Cash and  cash equivalents:                                        |       |                       |       |                                  |       |                     |       |                              |       |             |       |             |       |
| Beginning of  period                                               |       | —                     |       | 260                                   |       | 780                      |       | 505                               |       | —           |       | 1,545            |       |
| End of  period                                                     |       | $                          | —     |                                  | $          | 33,831                   |       | $                                 | 650        |             | $          | 722              |       | $ | — |   | $ | 35,203 |   |

 

36

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**ConsolidatingCondensed Statement of Cash Flows**

**December 31,2002**

**(dollaramounts in thousands)**

 
| ** **                                                         | ** ** | **Protection  One,  Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Network  Multifamily** | ** ** | **Subsidiary  Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|--------------------------|------------|----------------------------------|------------|------------------|------------|------------------|------------|
| **Net cash provided by operating activities**                      | ** ** | **871**                    | ** ** | **33,063**                            | ** ** | **9,116**                | ** ** | **341**                          | ** ** | **—**       | ** ** | **43,391**       | ** ** |
| Cash flows  from investing activities:                             |       |                       |       |                                  |       |                     |       |                             |       |             |       |             |       |
| Installation  and purchases of new accounts                        |       | —                     |       | (1,766                                | )          | 156                      |       | (43                              | )          | —           |       | (1,653           | )          |
| Deferred  customer acquisition costs                               |       | —                     |       | (39,144                               | )          | (6,389                   | )          | —                           |       | —           |       | (45,533          | )          |
| Deferred  customer acquisition revenue                             |       | —                     |       | 16,424                                |       | 644                      |       | —                           |       | —           |       | 17,068           |       |
| Purchase of  property and equipment                                |       | 29                         |       | (7,075                                | )          | (1,010                   | )          | —                           |       | —           |       | (8,056           | )          |
| Purchase of  parent company bonds                                  |       | —                     |       | (67,492                               | )          | —                   |       | —                           |       | —           |       | (67,492          | )          |
| Proceed from  sale of parent company bonds                         |       | —                     |       | 67,492                                |       | —                   |       | —                           |       | —           |       | 67,492           |       |
| Purchase of  AV-One, Inc.                                     |       | (1,378                     | )          | —                                |       | —                   |       | —                           |       | —           |       | (1,378           | )          |
| Proceeds  from disposition of assets and sale of customer accounts |       | —                     |       | 17,893                                |       | 712                      |       | 4                                |       |             |       | 18,609           |       |
| **Net cash used in investing activities**                          | ** ** | **(1,349**                 | **)**      | **(13,668**                           | **)**      | **(5,887**               | **)**      | **(39**                          | **)**      | **—**       | ** ** | **(20,943**      | **)**      |
| Cash flows  from financing activities:                             |       |                       |       |                                  |       |                     |       |                             |       |             |       |             |       |
| Payment on  long-term debt                                         |       | —                     |       | (84,032                               | )          | —                   |       | —                           |       | —           |       | (84,032          | )          |
| Proceeds  from long-term debt                                      |       | —                     |       | 44                                    |       | —                   |       | —                           |       | —           |       | 44               |       |
| Borrowings  from revolving credit facility                         |       | —                     |       | 78,000                                |       | —                   |       | —                           |       | —           |       | 78,000           |       |
| Purchase of  parent company stock held as treasury                 |       | (13,537                    | )          | —                                |       | —                   |       | —                           |       | —           |       | (13,537          | )          |
| Purchase of  treasury stock                                        |       | (2,178                     | )          | —                                |       | —                   |       | —                           |       | —           |       | (2,178           | )          |
| Issuance  costs and other                                          |       | 462                        |       | (2,403                                | )          | —                   |       | —                           |       | —           |       | (1,941           | )          |
| Funding from  Westar                                               |       | (2,638                     | )          | 1,332                                 |       | —                   |       | —                           |       | —           |       | (1,306           | )          |
| Due to  (from) related companies                                   |       | 18,369                     |       | (14,232                               | )          | (2,611                   | )          | (1,526                           | )          | —           |       | —           |       |
| **Net cash provided by (used in) financing activities**            | ** ** | **478**                    | ** ** | **(21,291**                           | **)**      | **(2,611**               | **)**      | **(1,526**                       | **)**      | **—**       | ** ** | **(24,950**      | **)**      |
| Net cash  provided by discontinued operations                      |       | —                     |       | 376                                   |       | —                   |       | —                           |       | —           |       | 376              |       |
| Net increase  (decrease) in cash and cash equivalents              |       | —                     |       | (1,520                                | )          | 618                      |       | (1,224                           | )          | —           |       | (2,126           | )          |
| Cash and  cash equivalents:                                        |       |                       |       |                                  |       |                     |       |                             |       |             |       |             |       |
| Beginning of  period                                               |       | —                     |       | 1,780                                 |       | 162                      |       | 1,729                            |       | —           |       | 3,671            |       |
| End of  period                                                     |       | —                     |       | 260                                   |       | 780                      |       | 505                              |       | —           |       | 1,545            |       |

 

37

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**17.****                               DiscontinuedOperations:**

 

During the second quarter of 2002, theCompany entered into negotiations for the sale of its Canadian business, whichwas included in its Protection One Monitoring segment. The sale was consummatedon July 9, 2002. The Company recorded a pretax impairment loss ofapproximately $2.0 million and an after tax loss of approximately $1.3 millionin the second quarter of 2002 as a result of the sale.

 

The net operating losses of the Canadianoperations are included in the consolidated statements of operations under “discontinuedoperations.” The net operating loss for the year ended December 31, 2002of $1.6 million includes an impairment loss on customer accounts ofapproximately $1.9 million. An impairment charge of $2.3 million relating tothe Canadian operations’ goodwill is reflected in the consolidated statement ofoperations as a cumulative effect of accounting change on discontinuedoperations. Revenues from these operations were $4.2 million for the periodended July 9, 2002 compared to $8.2 million for the year ended December 31,2001.

 

In June 2002, the Company formed awholly owned subsidiary named Protection One Data Services, Inc., known asPODS, and on July 1, 2002 transferred to it approximately 42 of itsInformation Technology employees. Effective July 1, 2002, PODS enteredinto an outsourcing agreement with Westar Energy pursuant to which PODSprovided Westar Energy information technology services. As a condition of theagreement, PODS offered employment to approximately 100 Westar EnergyInformation Technology employees. Operation of the subsidiary and the supply ofsuch services to Westar Energy were discontinued as of December 31, 2002. Theapproximately 142 Information Technology employees that had accepted employmentwith PODS returned to their respective companies as of the end of the year. Thenet income of PODS operations of approximately $0.3 million is included in theconsolidated statements of operations under “discontinued operations.” Revenuesfrom these operations totaled $11.2 million for the six months of theiroperation ending December 31, 2002. PODS had $1.1 million in receivablesfrom Westar Energy and $0.4 million in accounts payable as of December 31,2002.

 

**18.****                               SubsequentEvents:**

 

On February 8, 2005, the Company andQuadrangle completed a restructuring which was initiated on November 12,2004 upon the Company’s execution of the tax sharing settlement with Westar,which settlement was facilitated by the Company’s contemporaneous execution ofa debt-for-equity exchange agreement with Quadrangle that provided for theprincipal balance outstanding under the Quadrangle credit facility to bereduced by $120.0 million in exchange for the issuance to Quadrangle of 16million shares of the Company’s common stock on a post-reverse stock splitbasis. Other aspects of the restructuring included a one-share-for-fifty-sharesreverse stock split of the Company’s outstanding shares of common stock and theimplementation of a management incentive plan. The newly issued shares,together with the shares currently owned by Quadrangle, resulted in Quadrangle’sowning approximately 97.3% of the Company’s common stock as of the closing ofthe debt-for-equity exchange. In connection with the closing, the Company also amendedits certificate of incorporation, entered into an amended and restated creditfacility, stockholders agreement and registration rights agreement withQuadrangle, implemented a management incentive plan and will consider adoptionof push down accounting.

 

*Amendment ofCertificate of Incorporation*. In connection with thedebt-for-equity exchange, following stockholder approval on February 8,2005, the Company amended and restated its certificate of incorporation toprovide for a one-share-for-fifty-shares reverse stock split of the Company’soutstanding shares of common stock, the elimination of its Series F and Series Hpreferred stock and an election not to be governed by Section 203 of theDelaware Corporation Law, which section potentially restricts transactionsinvolving certain integrated stockholders.

 

*Amendment of theQuadrangle Credit Facility*. Pursuant to the exchangeagreement entered into in connection with the restructuring, Quadrangle agreedto extend the final maturity on the Quadrangle credit facility and to otherwiseamend and restate the Quadrangle credit facility. See Note 5 “Debt” for furtherdiscussion.

 

*StockholdersAgreement and Composition of Board of Directors*. Inconnection with the restructuring, the Company also entered into a stockholdersagreement with Quadrangle. The stockholders agreement contains certainagreements with respect to corporate governance following the restructuring,including, but not limited to, the composition of the Company’s board ofdirectors. The parties to the stockholders agreement are generally required touse their reasonable best efforts to cause the board of directors to consist offive members immediately following the completion of the debt-for-equityexchange, comprised as follows:

 

•                  three members designated byQuadrangle (two directors designated by POI Acquisition, L.L.C. and onedirector designated by Quadrangle Master Funding Ltd);

 

•                  the Company’s President and ChiefExecutive Officer, Richard Ginsburg; and

 

•                  one independent director selected bya majority of the other directors.

 

In connection with the closing of thedebt-for-equity exchange, the size of the board of directors was increased tofour directors, and David Tanner, Steven Rattner and Michael Weinstock,managing principals of Quadrangle, were appointed to the board.

 

38

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Ben M. Enis, a Company director since 1994, and James Q. Wilson, aCompany director since 1996, resigned from the Board to accommodate theseadditions. The Company’s President and Chief Executive Officer, RichardGinsburg, continues to serve as a director. At the March 11, 2005 meetingof the board of directors, Robert J. McGuire was appointed to the board as theindependent director and was selected as chairman of the board’s auditcommittee.

 

In the event POI Acquisition, L.L.C. or itsaffiliates owns less than 25% of the Company’s common shares issued andoutstanding as of the restructuring, POI Acquisition, L.L.C. shall have theright to designate one director instead of two. In the event either POIAcquisition, L.L.C. or Quadrangle Master Funding Ltd owns less than 10% of ourcommon shares issued and outstanding as of the restructuring, such entity willlose the ability to designate a member to the board of directors. If and for solong as POI Acquisition, L.L.C. owns at least 40% of the outstanding shares ofour common stock, it shall have the right to elect to increase the size of theboard by one director, which it shall be entitled to designate.

 

In accordance with the stockholdersagreement, the Company amended its bylaws following the restructuring toprevent the Company from voluntarily filing for bankruptcy, merging orconsolidating with another entity until February 8, 2007 or from sellingall or substantially all of its assets without written consent of QuadrangleMaster Funding Ltd.****Thestockholders agreement also includes voting agreements, certain restrictions onthe transfer of the Company’s common stock, drag-along rights in favor of POIAcquisition, L.L.C. and tag-along rights in favor of Quadrangle Master FundingLtd, all upon customary terms and subject to certain customary exceptions(including exceptions for certain transfers among affiliates). In addition, thestockholders agreement provides the Quadrangle parties with the right toparticipate on a proportional basis in any future equity issuance by theCompany, except for issuances pursuant to registered public offerings, businesscombination transactions or officer, employee, director or consultantarrangements.

 

*Registration RightsAgreement*. As a condition to the consummation of thedebt-for-equity exchange, the Company entered into a registration rightsagreement with POI Acquisition, L.L.C. and Quadrangle Master Funding Ltd. Theregistration rights agreement provides, among other things, that the Companywill register, upon notice, shares of its common stock owned by such parties. Underthe registration rights agreement, POI Acquisition, L.L.C. is permitted up tofour demand registrations and Quadrangle Master Funding Ltd is permitted up totwo demand registrations, subject to certain conditions described in theagreement. POI Acquisition, L.L.C. and Quadrangle Master Funding Ltd alsoreceived piggyback registration rights whereby they shall have the opportunityto register their securities pursuant to any registration statement the Companymay file in the future, subject to certain conditions. The Company is alsoobligated to pay certain of their expenses pursuant to the registration of theirsecurities under the registration rights agreement.

 

*Repurchase ofOutstanding 135/8% Senior Subordinated Discount Notes*.In connection with the restructuring and as required by the indenture governingthe Company’s outstanding 135/8% senior subordinateddiscount notes, the Company also initiated a change of control repurchase offerat 101% for the approximately $29.9 million of outstanding 135/8%senior subordinated discount notes. The Company completed the repurchase of allof these notes on March 11, 2005.

 

*Management Incentive Plan.*As a condition to the completion of the debt-for-equity exchange, the Companyimplemented a management incentive plan that included an equity investmentopportunity for its executive officers, stock appreciation rights (SARs) forits senior executive officers and a new stock option plan.

 

*Equity Investment*.As part of the management incentive plan offered in connection with therestructuring, certain members of management invested an aggregate of $1.75million and received an aggregate of 233,334 shares of common stock on apost-reverse stock split basis. The shares were purchased pursuant to amanagement shareholders’ agreement entered into among the Company, Quadrangleand the management stockholder. The agreement contains tag-along, drag-along,piggyback registration rights and other provisions.

 

*Stock AppreciationRights Plan*. Pursuant to the management incentiveplan, Messrs. Ginsburg, Nevin, Pefanis and Williams received an aggregateof approximately 2.0 million SARs, on a post-reverse stock split basis. TheSARs vest 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 the Company, provided that if the qualified saleis not a permissible distribution event (as defined in the SAR Plan) thepayment will be made, with interest, in connection with a subsequentpermissible distribution event, and (2) February 8, 2011. Theexercise price of the SARs is $4.50 and increases by 9% per annum, which theCompany refers to as the fixed return, compounded annually, beginning on February 8,2006. If Quadrangle sells less than 60% of its equity interest in the Company,the exercise price applicable to an equivalent percentage of management’s SARswould be based on the fixed return through the date of such sale. Each SAR thatvests and becomes payable in connection with a qualified sale will generallyentitle the holder of a SAR to receive the difference between the exerciseprice and the lesser of (1) the value of the consideration paid for oneshare of stock in such qualified sale, or the fair market value of one share ofstock if the qualified sale is not a sale to a third party and (2) $7.50,provided that if a SAR holder’s right to receive stock is converted pursuant tothe SAR Plan into a right to receive cash from a grantor trust that the Companymay establish, the amount of cash payable will be credited with interest at 6%per annum, compounded annually, from the date such conversion is effectiveuntil the applicable payment date.

 

*2004 Stock OptionPlan*. The 2004 Stock Option Plan became effective uponthe consummation of the debt-for-equity exchange on February 8, 2005. Underthe 2004 Stock Option Plan, certain executive officers and selected managementemployees

 

39

----

 

were granted options to purchase an aggregate of 1,792,947 shares ofcommon stock, on a post-reverse stock split basis. The options initiallygranted under the plan will vest ratably each month during the 48 months afterthe date of grant, subject to accelerated vesting, in the case of certainsenior executive officers, under certain circumstances following a qualifiedsale. Under the option agreements applicable to the options granted, any sharesof stock purchased 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 plan, will be paid to such holder upon theearlier of: (1) specified dates following the occurrence of a certainpermissible distribution events (as defined in the SAR Plan) and (2) February 8,2011, provided that if an option holder’s right to receive stock is convertedpursuant to the plan into a right to receive cash, the amount of cash payablewill be credited with interest at 6% per annum, compounded annually, from thedate such conversion is effective until the applicable payment date.

 

*Push Down Accounting.*The Company is currentlyevaluating whether it will be required to adopt a new basis of accounting as aresult of Quadrangle’s increased ownership following the debt-for-equityexchange. In accordance with SEC Staff Accounting Bulletin Topic 5J, theCompany may be required to “push down” Quadrangle’s cost of acquiring its 97.3%interest in the Company to the Company’s assets and liabilities. If adopted,the “push-down” accounting adjustments will not impact cash flows. The primaryimpact of the adjustments will be to the carrying values of certain long-termassets and liabilities as well as to shareholders’ equity.

 

**19.**                               Unaudited QuarterlyFinancial Information:

 

The following is a summary of the unauditedquarterly financial information for 2004 and 2003 respectively.

 
| ** **                                                     | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
|----------------------------------------------------------------|------------|-------------------|------------|------------------|------------|-----------------------|------------|----------------------|------------|
| ***2004***                                                     |       |              |       |             |       |                  |       |                 |       |
| Revenues                                                       |       | $                 | 67,132     |             | $          | 67,274                |       | $                    | 67,528     |   | $ | 67,325 |   |
| Gross profit                                                   |       | 42,320            |       | 42,535           |       | 41,741                |       | 41,084               |       |
| Net income  (loss)                                             |       | (309,383          | )          | (16,616          | )          | (16,652               | )          | 18,745               |       |
| Basic and  diluted income (loss) per share:                    |       |              |       |             |       |                  |       |                 |       |
| Net income  (loss)                                             |       | (157.37           | )          | (8.45            | )          | (8.47                 | )          | 9.53                 |       |
| Weighted  average number of shares of common stock outstanding |       | 1,966             |       | 1,966            |       | 1,966                 |       | 1,966                |       |
|                                                           |       |              |       |             |       |                  |       |                 |       |
| ***2003***                                                     |       |              |       |             |       |                  |       |                 |       |
| Revenues                                                       |       | $                 | 70,086     |             | $          | 68,942                |       | $                    | 69,758     |   | $ | 68,299 |   |
| Gross profit                                                   |       | 44,075            |       | 43,619           |       | 44,434                |       | 42,752               |       |
| Net loss                                                       |       | (9,317            | )          | (7,990           | )          | (8,664                | )          | (8,440               | )          |
| Basic and  diluted loss per share:                             |       |              |       |             |       |                  |       |                 |       |
| Net loss                                                       |       | (4.75             | )          | (4.07            | )          | (4.42                 | )          | (4.30                | )          |
| Weighted  average number of shares of common stock outstanding |       | 1,962             |       | 1,962            |       | 1,962                 |       | 1,964                |       |

 

40

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**PROTECTIONONE, INC. AND SUBSIDIARIES**

**SCHEDULE II—VALUATIONAND QU****ALIFYINGACCOUNTS**

**(Dollaramounts in thousands)**

 
| **Description**                                        | ** ** | **Balance at  Beginning  of period** | ** ** | **Charged to  costs and  expenses** | ** ** | **Deductions  (a)** | ** ** | **Balance at  End of Period** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|---------------------|------------|-------------------------------|------------|
|                                                   |       |                                 |       |                                |       |                |       |                          |       |
| **Year ended December 31, 2002**                  |       |                                 |       |                                |       |                |       |                          |       |
| Allowances  deducted from assets for doubtful accounts |       | 6,572                                |       | 4,566                               |       | (4,868              | )          | 6,270                         |       |
| **Year ended December 31, 2003**                  |       |                                 |       |                                |       |                |       |                          |       |
| Allowances  deducted from assets for doubtful accounts |       | 6,270                                |       | 774                                 |       | (145                | )          | 6,899                         |       |
| **Year ended December 31, 2004**                  |       |                                 |       |                                |       |                |       |                          |       |
| Allowances  deducted from assets for doubtful accounts |       | 6,899                                |       | 729                                 |       | (2,052              | )          | 5,576                         |       |

 

----

(a)          Results from write-offsand sales of accounts receivable.

 

41

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**PART IV**

 

**ITEM 15.****                                              EXHIBITS,FINANCIAL STATEMENT SCHEDULES**

 

(a)                                  1.The following financial statements are included in Item 8, “FinancialStatements and Supplementary Data.”

 

Consolidated Balance Sheets

Consolidated Statements of Operations andComprehensive Loss

Consolidated Statements of Cash Flows

Consolidated Statements of Stockholders’Equity (Deficiency in Assets)

 

2.               The following financial statement schedule isincluded in Item 8, “Financial Statements and Supplementary Data.”

 

Schedule II - Valuation and Qualifying Accounts.

 

All other schedules for which provision ismade in the applicable accounting regulations of the Commission are notrequired under the related instructions or are inapplicable and, therefore,have been omitted.

 

3.               Thefollowing documents are filed or furnished as a part of this report:

 
| **Exhibit No.** | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                                                                                                                                                        |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                  |       | Amended and Restated Certificate of  Incorporation, 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 (the “Fiscal  2004 Form 10-K”)).                                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.2                  |       | Certificate of Incorporation of 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 May 17, 1995,  among Monitoring, as Issuer, POI, inter alia, as Guarantor, and The First  National Bank of Boston (“FNBB”), as Trustee (incorporated by reference to Exhibit 4.1  to the Registration Statement on Form S-4 (Registration No. 33-94684)  originally filed by POI and, inter alia, Monitoring on July 18, 1995  (the “1995 Form S-4”)).      |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.2                  |       | First Supplemental Indenture dated as of July 26,  1996, among Monitoring, as Issuer, POI, inter alia, as Guarantor and State  Street Bank and Trust Company (“SSBTC”) as successor to FNBB as Trustee  (incorporated by reference to Exhibit 4.2 to the Annual Report on Form 10-K  filed by POI and Monitoring of the year ended September 30, 1996 (the “Fiscal  1996 Form 10-K”)). |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.3                  |       | Second Supplemental Indenture dated as of October 28,  1996, among Monitoring as Issuer, POI inter alia, as Guarantor and SSBTC as  Trustee (incorporated by reference to Exhibit 4.3 to the Fiscal 1996 Form 10-K)).                                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.4                  |       | Third Supplemental Indenture dated as of February 14,  2000 among Monitoring as Issuer, POI inter alia, as Guarantor and SSBTC as  Trustee (incorporated by reference to Exhibit 4.4 to the Annual Report  on Form 10-K filed by POI and Monitoring for the year ended December 31,  2000 (the “Fiscal 2000 Form 10-K”)).                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.5                  |       | Indenture, dated as of August 17,  1998, among Monitoring, as issuer, POI as guarantor, and The Bank of New  York, as trustee (incorporated by reference to Exhibit 4.1 to the  Registration Statement on Form S-4 filed by POI and Monitoring on September 22,  1998).                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.6                  |       | 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”)).                                                                                  |

 

42

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| 10.1   |   | Warrant Agreement dated as of May 17,  1995, between POI and The First National Bank of Boston, as Warrant Agent  (incorporated by reference to Exhibit 10.40 to the 1995 Form S-4).                                                                                                                                                                                                                          |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.2   |   | 1994 Stock Option Plan of POI, as amended  (incorporated by reference to Exhibit 10.23 to the Fiscal 1996 Form 10-K).*                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.3   |   | 1997 Long-Term Incentive Plan of POI, as  amended (incorporated by reference to Exhibit 10.3 to the Annual Report  on Form 10-K filed by POI and Monitoring for the year ended December 31,  2004 (the “Fiscal 2004 Form 10-K”)).*                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.4   |   | 2004 Stock Option Plan (incorporated by  reference to Exhibit 10.3 to the Current Report on Form 8-K  filed by POI and Monitoring dated February 8, 2005).*                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.5   |   | Exchange Agreement dated as of November 12,  2004 by and among the Company, POI Acquisition LLC, 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).                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.6   |   | Registration Rights Agreement, dated December 21,  1998, among Monitoring, POI and various subsidiary guarantors and Morgan  Stanley & Co. Incorporated, Chase Securities Inc, First Union  Capital Markets, NationsBanc Montgomery Securities LLC and TD Securities  (USA), Inc. (the “Placement Agents”) (incorporated by reference to Exhibit 99.2  to the Fiscal 1998 Form 10-K). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.7   |   | Notes Registration Rights Agreement dated  as of May 17, 1995, among POI, Monitoring, Morgan Stanley &  Co., Incorporated and Montgomery Securities (incorporated by reference to Exhibit 4.2  to the 1995 Form S-4).                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.8   |   | Revolving Credit Agreement among  Monitoring, borrower, NationsBank, N.A., administrative agent, First Union  National Bank, syndication agent, Toronto Dominion (Texas), Inc.,  documentation agent, and Lenders named therein, dated December 21, 1998  (the “Revolving Credit Agreement”) (incorporated by reference to Exhibit 10.11  to the Fiscal 1998 Form 10-K).                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.9   |   | First Amendment to the Revolving Credit  Agreement, dated as of February 26, 1999 (incorporated by reference to Exhibit 10.12  to the Fiscal 1998 Form 10-K).                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.10  |   | Second Amendment of Credit Agreement,  effective as of February 29, 2000, between Monitoring and Westar  Industries, Inc., as Administrative Agent and a Lender (incorporated by  reference to Exhibit 10.3 to the Current Report on Form 8-K  filed by POI and Monitoring dated February 29, 2000).                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.11  |   | Third Amendment to the Revolving Credit  Agreement, dated as of January 2, 2001, between Monitoring and Westar  Industries, Inc., as Administrative Agent and as a Lender (incorporated  by reference to Exhibit 10.15 to the Fiscal 2000 Form 10-K).                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.12  |   | Fourth Amendment to the Revolving Credit  Agreement, dated as of February 28, 2001, between Monitoring and Westar  Industries, Inc., as Administrative Agent and as a Lender (incorporated  by reference to Exhibit 10.16 to the Fiscal 2000 Form 10-K).                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.13  |   | Fifth Amendment of Credit Agreement  effective as of June 30, 2001 between Protection One Alarm Monitoring, Inc.  and Westar Industries, Inc. (incorporated by reference to Exhibit 10.1  to the Current Report on Form 8-K filed by POI and Monitoring  dated August 15, 2001).                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.14  |   | Sixth Amendment of Credit Agreement  effective as of November 1, 2001 between Protection One Alarm Monitoring, Inc.  and Westar Industries, Inc. (incorporated by reference to Exhibit 10.1  to the Current Report on Form 8-K filed by POI and Monitoring  dated November 14, 2001).                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.15  |   | Seventh Amendment to Credit Agreement  effective March 25, 2002 between Protection One Alarm Monitoring, Inc.  and Westar Industries, Inc. (incorporated by reference to Exhibit 10.19  to the Fiscal 2001 Form 10-K).                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.16  |   | Eighth Amendment of Credit Agreement  effective as of June 3, 2002 between Protection One Alarm Monitoring, Inc.  and Westar Industries, Inc. (incorporated by reference to Exhibit 10.2  to the Quarterly Report on Form 10-Q filed by POI and Monitoring  dated August 13, 2002).                                                                                                            |

 

43

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| 10.17  |   | Ninth Amendment of Credit Agreement  effective as of June 26, 2002 between Protection One Alarm Monitoring, Inc.  and Westar Industries, Inc. (incorporated by reference to Exhibit 10.3  to the Quarterly Report on Form 10-Q filed by POI and Monitoring  dated August 13, 2002).          |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.19  |   | Tenth Amendment of Credit Agreement  effective as of July 25, 2002 between Protection One Alarm Monitoring, Inc.  and Westar Industries, Inc. (incorporated by reference to Exhibit 10.1  to the Quarterly Report on Form 10-Q filed by POI and Monitoring  dated November 14, 2002).        |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.20  |   | Eleventh Amendment of Credit Agreement  effective as of August 26, 2002 between Protection One Alarm Monitoring, Inc.  and Westar Industries, Inc. (incorporated by reference to Exhibit 10.2  to the Quarterly Report on Form 10-Q filed by POI and Monitoring  dated November 14, 2002).   |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.21  |   | Twelfth Amendment of Credit Agreement  effective as of September 11, 2002 between Protection One Alarm  Monitoring, Inc. and Westar Industries, Inc. (incorporated by  reference to Exhibit 10.3 to the Quarterly Report on Form 10-Q  filed by POI and Monitoring dated November 14, 2002). |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.22  |   | Thirteenth Amendment of Credit Agreement  effective as of March 11, 2003 between Protection One Alarm Monitoring, Inc.  and Westar Industries, Inc. (incorporated by reference to Exhibit 10.1  to the Current Report on Form 8-K filed by POI and Monitoring  dated June 26, 2003).         |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.23  |   | Fourteenth Amendment of Credit Agreement  effective as of June 20, 2003 between Protection One Alarm Monitoring, Inc.  and Westar Industries, Inc. (incorporated by reference to Exhibit 10.2  to the Current Report on Form 8-K filed by POI and Monitoring  dated June 26, 2003).          |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.24  |   | Fifteenth Amendment of Credit Agreement  effective as of March 23, 2004 between Protection One Alarm Monitoring, Inc.  and POI Acquisition, L.L.C. (incorporated by reference to Exhibit 10.1  to the Quarterly Report on Form 10-Q filed by POI and Monitoring  dated May 13,2004).              |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.25  |   | Employment Agreement dated as of April 16,  2001 between Protection One, Inc. and Richard Ginsburg (incorporated by  reference to Exhibit 10.1 to the Current Report on Form 8-K  filed by POI and Monitoring dated May 15, 2001).*                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.26  |   | Employment Agreement dated March 18,  2003 between Protection One, Inc. and Richard Ginsburg (incorporated by  reference to Exhibit 10.25 to the Annual Report on Form 10-K  filed by POI and Monitoring for the year ended December 31, 2002 (the “Fiscal  2002 Form 10-K”).*     |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.27  |   | Employment Agreement dated March 18,  2003 between Protection One, Inc. and Darius G. Nevin (incorporated by  reference to Exhibit 10.26 to the Fiscal 2002 Form 10-K).*                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.28  |   | Employment Agreement dated March 18,  2003 between Protection One, Inc. and Peter J. Pefanis (incorporated by  reference to Exhibit 10.27 to the Fiscal 2002 Form 10-K).*                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.29  |   | Employment Agreement dated March 18,  2003 between Protection One, Inc. and Mack Sands (incorporated by  reference to Exhibit 10.28 to the Fiscal 2002 Form 10-K).*                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.30  |   | Employment Agreement dated March 18,  2003 between Protection One, Inc. and Steve V. Williams (incorporated by  reference to Exhibit 10.29 to the Fiscal 2002 Form 10-K).*                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.31  |   | Letter Agreement dated November 1,  2001 between Westar Industries, Inc. and POI regarding management fee  and financial advisory services (incorporated by reverence to Exhibit 10.23  to the Fiscal 2001 Form 10K).                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.32  |   | Outsourcing Agreement between Westar Energy, Inc.  and Protection One Data Services, Inc. dated July 1, 2002  (incorporated by reference to Exhibit 10.4 to the Quarterly Report on Form 10-Q  filed by POI and Monitoring dated August 13, 2002).                                           |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.33  |   | Westar Aviation, Inc. Stock Purchase  Agreement dated as of June 5, 2002 by and between Westar Industries, Inc.  and Protection One, Inc. (incorporated by reference to Exhibit 10.5  to the Quarterly Report on Form 10-Q filed by POI and Monitoring  dated August 13, 2002).         |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 10.34  |   | Aircraft Reimbursement Agreement dated as  of June 5, 2002 between AV ONE, Inc. (f/k/a Westar Aviation, Inc.)  and Westar Industries (incorporated by reference to Exhibit 10.6 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated August 13,  2002).                   |

 

44

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| 10.35  |   | Kansas Corporation Commission Order dated November 8,  2002 (incorporated by reference to Exhibit 99.2 to our Quarterly Report  on Form 10-Q dated November 14, 2002).                                                                                                                                                                        |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.36  |   | Kansas Corporation Commission Order No. 55  dated December 23, 2002 (filed as Exhibit 99.1 to our December 30,  2002 Form 8-K).                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.37  |   | Limited Stipulation and Agreement dated February 11,  2003, with the Staff of the Kansas Corporation Commission, Westar Energy, Inc.,  Westar Industries, Inc., Citizens’ Utility Ratepayer Board, MBIA  Insurance Corporation and the Kansas Industrial Consumers (filed as Exhibit 99.1  to our February 11, 2003 Form 8-K). |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.38  |   | Kansas Corporation Commission Order dated February 10,  2003 (filed as Exhibit 99.1 to our February 14, 2003 Form 8-K).                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.39  |   | Partial Stipulation and Agreement dated February 25,  2003, with the Staff of the Kansas Corporation Commission, Westar Energy, Inc.,  Westar Industries, Inc. and MBIA Insurance Corporation (filed as Exhibit 99.1  to our February 25, 2003 Form 8-K).                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.40  |   | Kansas Corporation Commission Order No. 62  approving Limited Stipulation and Agreement dated February 14, 2003  (incorporated by reference to Exhibit 10.39 to the Fiscal 2002 Form 10-K).                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.41  |   | Kansas Corporation Commission Order No. 65  dated March 11, 2003 (filed as Exhibit 99.1 to our March 14,  2003 Form 8-K).                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.42  |   | Letter dated March 19, 2003 from J.  Eric Griffin of Protection One, Inc. to the Kansas Corporation  Commission accepting the conditions of Kansas Corporation Commission Order No. 65.  (incorporated by reference to Exhibit 10.41 to the Fiscal 2002 Form 10-K).                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.43  |   | Letter dated March 19, 2003 from J.  Eric Griffin of Protection One, Inc. to Martin J. Bregman of Westar  Energy pursuant to Kansas Corporation Commission Order No. 65  (incorporated by reference to Exhibit 10.42 to the Fiscal 2002 Form 10-K).                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.44  |   | Revolving Credit Facility Standstill  Agreement dated as of February 17, 2004, among POI Acquisition, LLC,  Protection One, Inc., Protection One Alarm Monitoring, Inc. and  Network Multi-Family Security Corporation (filed as Exhibit 10.43 to our  February 18, 2004 Form 8-K).                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.45  |   | Equity Standstill Agreement dated as of February 17,  2004, by and between Protection One, Inc. and POI Acquisition I, Inc.  (filed as Exhibit 10.44 to our February 18, 2004 Form 8-K).                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.46  |   | 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).*                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.47  |   | 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).*                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.48  |   | 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).*                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.49  |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  Steve V. Williams (incorporated by reference to Exhibit 10.1 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated August 16,  2004).*                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.50  |   | 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).                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                              |
| 10.51  |   | 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).                                                                                                                               |

 

45

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| 10.52  |   | Form of Award Agreement under 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).*                                                                                                                                                             |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.53  |   | Form of Award Agreement under 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).*                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.54  |   | Stock Appreciation Rights Plan  (incorporated by reference to Exhibit 10.6 of the Current Report on Form 8-K  dated February 8, 2005).*                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.55  |   | 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).*                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.56  |   | 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).*                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.57  |   | Senior Management 2004 Short-Term Incentive  Plan, as amended (incorporated by reference to Exhibit 10.9 of the  Current Report on Form 8-K dated February 8, 2005).*                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.58  |   | 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  Annual Report on Form 10-K filed by POI and Monitoring for the  year ended December 31, 2004 (the “Fiscal 2004 Form 10-K”)).*                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.59  |   | 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 Annual Report on Form 10-K filed by POI and Monitoring for  the year ended December 31, 2004 (the “Fiscal 2004 Form 10-K”)).* |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 10.60  |   | Senior Management 2005 Short-Term Incentive  Plan (incorporated by reference to Exhibit 10.60 to the Annual Report on  Form 10-K filed by POI and Monitoring for the year ended December 31,  2004 (the “Fiscal 2004 Form 10-K”)).*                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 12.1   |   | Statement regarding Computation of Earnings  to Fixed Charges (incorporated by reference to Exhibit 12.1 to the  Annual Report on Form 10-K filed by POI and Monitoring for the  year ended December 31, 2004 (the “Fiscal 2004 Form 10-K”)).                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 16.1   |   | Letter from Arthur Andersen LLP to the  Securities and Exchange Commission re: Change in Certifying Accountant  (incorporated by reference to Exhibit 16 to our Current Report on Form 8-K  dated May 30, 2002).                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 21.1   |   | Subsidiaries of POI and Monitoring  (incorporated by reference to Exhibit 21.1 to the Annual Report on Form 10-K  filed by POI and Monitoring for the year ended December 31, 2004 (the “Fiscal  2004 Form 10-K”)).                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
| 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. +                                                                                                                                                                                                              |

 

----

*           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)  The exhibits required by Item 601of Regulation S-K are filed or furnished herewith.

 

46

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**SIGNATURES**

 

Pursuant to the requirements of Section 13and 15(d) of the Securities Exchange Act of 1934, the Registrants haveduly caused this amended report to be signed on their behalf by theundersigned, thereunto duly authorized.

 
|                                              |   | PROTECTION ONE, INC.                  |
|---------------------------------------------------|--------|---------------------------------------|
|                                              |   | PROTECTION ONE ALARM MONITORING, INC. |
|                                              |   |                                  |   |
| Date:    March 24,  2005 | By:    | /s/ DARIUS  G. NEVIN                  |   |
|                                              |   |                                  | Darius G.  Nevin, |   |
|                                              |   |                                  | Executive  Vice President and |   |
|                                              |   |                                  | Chief  Financial Officer |   |

 

47

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