**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-K/A**

 
| **ý**                                       | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE**     |
|--------------------------------------------------|---------------------------------------------------------------|
| ** **                                       | **SECURITIES EXCHANGE ACT OF 1934**                           |
|                                             |                                                          |   |
| **For the  fiscal year ended December 31, 2005** |
| ** **                                       | ** **                                                    | ** ** |
| **OR**                                           |
|                                             |                                                          |   |
| **o**                                            | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE** |
| ** **                                       | **SECURITIES EXCHANGE ACT OF 1934**                           |
|                                                  |                                                               |  |  |  |  |

 

**For the transition period from                     to                    **

 
| **Commission file number: 1-12181-01** |   | **Commission file number: 1-12181** |
|----------------------------------------|--------|-------------------------------------|

 

| **Protection  One, Inc.**                               | ** ** | **Protection  One Alarm Monitoring, Inc.**              |
|---------------------------------------------------------|------------|---------------------------------------------------------|
| (Exact name  of registrant as specified in its charter) |       | (Exact name  of registrant as specified in its charter) |

 

| **Delaware**                                       | ** ** | **93-1063818**       | ** ** | **Delaware**                                     | ** ** | **93-1064579**       |
|----------------------------------------------------|------------|----------------------|------------|--------------------------------------------------|------------|----------------------|
| (State or  other jurisdiction of                   |       | (I.R.S.  Employer    |       | (State or  other jurisdiction of                 |       | (I.R.S.  Employer    |
| incorporation  or organization)                    |       | Identification  No.) |       | incorporation  or organization)                  |       | Identification  No.) |
|                                               |       |                 |       |                                             |       |                 |
| **1035 N.  3rd Street, Suite 101,   Lawrence, KS** |       | **66044**            |       | **1035 N.  3rd Street, Suite 101, Lawrence, KS** |       | **66044**            |
| (Address of  principal executive offices)          |       | (Zip Code)           |       | (Address of  principal executive offices)        |       | (Zip Code)           |

 

**785-856-5500**

(Registrant’s telephone number,including area code)

 

**N/A**

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

 

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, ofProtection One, Inc.

 

**Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.**
| ** ** | ** ** | **Yes****o** | ** ** | **No****ý** |
|------------|------------|--------------|------------|------------------|

 

**Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Exchange Act.**
| ** ** | ** ** | **Yes****o** | ** ** | **No****ý** |
|------------|------------|--------------|------------|------------------|

 

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

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-accelerated filer.See definition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act.
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer ý |
|---------------------------|---------------------|------------------------------|

 

Indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).
|   |   | Yes o |   | No ý |
|--------|--------|-------|--------|-----------|

 

As of June 30, 2005, the aggregate marketvalue of the registrant’s common stock held by non-affiliates of the registrantwas $4,653,564 based on the closing sale price as reported on the OTC BulletinBoard.

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate.

 

 

 

| **Class**                                | ** ** | **Outstanding at March 10, 2006** |
|------------------------------------------|------------|-----------------------------------|
| Common  Stock, $0.01 par value per share |       | 18,238,787  shares                |

 

**DOCUMENTS INCORPORATED BY REFERENCE**
| **Document**                                                                                                                | ** ** | **Parts  Into Which Incorporated** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|
| Information Statement for the Annual Meeting of Stockholders to be  held on or before July 15, 2006 (Information Statement) |       | Part I, II, III and IV             |

 

 

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**EXPLANATORY NOTE**

 

**Thisamended annual report on Form 10-K/A is being filed to correct an error incalculation of depreciation for certain assets revalued as part of the pushdown accounting adjustments described herein. In the original annual report onForm 10-K, which we filed with the Securities and Exchange Commission on March20, 2006, depreciation expense was overstated by approximately $2.1 million,which resulted in reporting a larger net loss for the period February 9, 2005through December 31, 2005, than was actually incurred. This amendment providesthe correct amount of depreciation on the Consolidated Statement of Operationsand Comprehensive Loss for the period February 9, 2005 through December 31,2005, as well as the correct amount of net property and equipment andstockholders’ equity on the Consolidated Balance Sheet as of December 31, 2005.**

** **

**Thisamendment also includes an updated report and consent of the independentregistered public accounting firm as well as updated certifications of ourprincipal executive officer and principal financial officer. Accordingly,pursuant to Rule 12b-15 under the Securities and Exchange Act of 1934, thisamendment contains the complete text of Item 1A, “Risk Factors,” Item 6, “SelectedFinancial Data,” Item 7, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” Item 8, “Financial Statements andSupplementary Data,” Item 9A, “Controls and Procedures” and Item 15, “Exhibits,Financial Statement Schedules,” as amended.**

** **

**SeeNote 17 of the Notes to the Consolidated Financial Statements, “Restatement ofConsolidated Financial Statements,” for detailed information concerning therestatements. In order to preserve the nature and the character of thedisclosures as of March 20, 2006, no attempt has been made in this Form 10-K/Ato modify or update such disclosures except as required to reflect the resultsof the restatement.**

** **

**2**

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** **

**ITEM 1A:  RISKFACTORS**

 

You should read the following risk factors in conjunction withdiscussions of factors discussed elsewhere in this and other of our filingswith the SEC. These cautionary statements are intended to highlight certainfactors that may affect our financial condition and results of operations andare not meant to be an exhaustive discussion of risks that apply to publiccompanies with broad operations, such as us.

 

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

 

Quadrangle owns approximately 97.1% of our outstanding common stock asof March 10, 2006. Pursuant to a stockholder agreement with Quadrangle andsubject to Quadrangle maintaining a certain threshold of ownership in us,Quadrangle will be able to direct the election of three of our directors andexercise a controlling influence over our business and affairs, including anydeterminations with respect to mergers or other business combinations involvingus, appointment of our officers, our acquisition or disposition of materialassets and our incurrence of indebtedness. Similarly, Quadrangle will continueto have the power to determine matters submitted to a vote of our stockholderswithout the consent of other stockholders and to take other actions that mightbe favorable to Quadrangle, whether or not these actions would be favorable tous or to our stockholders in general.

 

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

 

We incurred net losses of $15.6 million in the period February 9, 2005through December 31, 2005, $11.4 million in the period January 1, 2005 throughFebruary 8, 2005, $323.9 million in 2004 and $34.4 million in 2003. Theselosses reflect the following, among other factors:

 

•      our customerbase and revenues have declined every year since 1999;

 

•      substantialcharges incurred by us for amortization of customer accounts;

 

•      a write down ofremaining deferred tax assets in 2004;

 

•      change incontrol and debt restructuring costs in 2004 and for the period January 1, 2005through February 8, 2005;

 

•      interestincurred on indebtedness;

 

•      expansion ofour internal sales and installation efforts; and

 

•      other chargesrequired to manage operations.

 

We will continue to incur a substantial amount of interest expense andamortization of customer accounts and we do not expect to attain profitabilityin the near future.

 

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

 

We have, and will continue to have, a significantamount of indebtedness. As of March 10, 2006, the face value of our totalindebtedness, including capital leases, was approximately $345.2 million. Ourlevel of indebtedness could have important consequences. For example, it could:

 

•       limit ourability to borrow money or sell stock to fund our working capital, capitalexpenditures, acquisitions and debt service requirements;

 

•       limit ourflexibility in planning for, or reacting to, changes in our business and futurebusiness opportunities;

 

•       make usmore vulnerable to a downturn in our business or in the economy or to anincrease in interest rates;

 

•       place usat a disadvantage to some of our competitors, who may be less highly leveragedthan us; and

 

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

 

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

 

***Our business was impacted by Hurricane Katrina and wehave incurred and may continue to incur customer losses related to propertydamage caused by Hurricane Katrina.***

 

We have lost customers due to property damage causedby Hurricane Katrina in August 2005. In September 2005, we suspended billingfor our customers in the areas most heavily affected by Hurricane Katrina. Weare currently attempting to contact each of these customers to determine if ourservices will be needed in the future. As of December 31, 2005, Protection OneMonitoring estimated the loss of 3,117 customers, including 379 wholesalecustomers, and Network Multifamily has estimated the loss of 1,556 customeraccounts. Estimated RMR losses related to these accounts were less than 1% ofour total RMR. Our efforts to contact our customers affected by HurricaneKatrina may not be successful and we may not be able to recapture accounts lostdue to the hurricane.

 

***Restrictive covenants restrict our ability to operateour business and to pursue our business strategies, and our failure to complywith these covenants could result in an acceleration of our indebtedness.***

 

Our senior credit facility and the indenture governingour notes contain covenants that restrict our ability to finance futureoperations or capital needs, to respond to changing business and economicconditions or to engage in other transactions or business activities that maybe important to our growth strategy or otherwise important to us. The seniorcredit facility and the indenture governing our notes restrict, among otherthings, our ability to:

 

•      incuradditional indebtedness or enter into sale and leaseback transactions;

 

•      pay dividendsor make distributions on our capital stock or certain other restricted paymentsor investments;

 

•      purchase orredeem stock;

 

•      issue stock ofour subsidiaries;

 

•      makeinvestments and extend credit;

 

•      engage intransactions with affiliates;

 

•      transfer andsell assets;

 

•      effect aconsolidation or merger or sell, transfer, lease or otherwise dispose of all orsubstantially all of our assets; and

 

•      create liens onour assets to secure debt.

 

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

 

Any breach of the covenants in our senior securedcredit facility or the indenture governing our notes could cause a defaultunder such instruments. If there were an event of default under any of our debtinstruments that was not cured or waived, the holders of the defaulted debtcould cause all amounts outstanding with respect to the debt instrument to bedue and payable immediately. Our assets and cash flow may not be sufficient tofully repay borrowings under our outstanding debt instruments if acceleratedupon an event of default. If, as or when required, we are unable to repay,refinance or restructure our indebtedness under, or amend the covenantscontained in, our senior credit facility, the lenders under our senior creditfacility could institute foreclosure proceedings against the assets securingborrowings under the senior credit facility.

 

***We face increasing competition and pricing pressurefrom other companies in our industry and if we are unable to competeeffectively with these companies, our sales and profitability could beadversely affected.***

 

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

 

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recognition than we do. Inaddition, the innovative nature of our markets may attract new entrants to thefield. We may not be able to compete successfully with the services of othercompanies, which could result in the loss of customers and, as a result,decreased revenue and operating results.

 

***The competitive market for the acquisition andcreation of accounts may affect our future profitability.***

 

Prior to 2000, we grew very rapidly by acquiring portfolios of alarmmonitoring accounts through acquisitions and dealer purchases. Our currentstrategy is to reduce the cost of acquiring new accounts by utilizing othercustomer account acquisition channels such as our internal sales force augmentedby traditional marketing support. The security alarm monitoring industry ishighly competitive and highly fragmented. We compete with several companiesthat have account acquisition and loan programs for independent dealers andsome of those competitors are larger than we are and have more capital than wedo. Increased competition from other alarm monitoring companies could requireus to reduce our prices for installations, decrease the monitoring fees wecharge our customers and take other measures that could reduce our margins. Thesedecreases and other measures could have a material adverse effect on us.

 

***Loss of customer accounts could materially adverselyaffect our operations.***

 

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

 

•      relocation ofcustomers;

 

•      customers’inability or unwillingness to pay our charges;

 

•      adversefinancial and economic conditions;

 

•      the customers’perceptions of value; and

 

•      competitionfrom other alarm service companies.

 

We may experience the loss of newly acquired or created accounts to theextent we do not integrate or adequately service those accounts. Because someacquired accounts are prepaid on an annual, semiannual or quarterly basis,customer loss may not become evident for some time after an acquisition isconsummated. During 2005, we experienced a net loss of 17,316 customers, or a1.7% decrease in our customer base from January 1, 2005. While our attritionrate is decreasing, we continue to lose customers at a rate faster than our rateof adding customers. The net loss of customers was the primary cause of ourdecline in monitoring and related service revenues of $1.6 million in 2005 and$8.8 million in 2004. We expect losses to exceed additions until the efforts weare making to acquire new accounts and further reduce our rate of attritionbecome more successful than they have been to date. Net losses of customeraccounts materially and adversely affect our business, financial condition andresults of operations.

 

***Our customer acquisition strategies may not besuccessful, which would adversely affect our business.***

 

The customer account acquisition strategy we are now employing reliesprimarily on our internal sales force and forming marketing alliances. We havechanged our acquisition strategy several times over the past few yearsattempting to decrease the cost of adding customers and to decrease the rate ofattrition from new accounts. While our present strategy resulted in someimprovement in 2005 and 2004, this strategy may not be successful in the future.If the strategy is not successful, our customer base could continue to decline.If successful, the selling costs related to this strategy will increase ourexpenses and uses of cash. Failure to replace customers lost through attritionor increased cash needs to replace those customers could have a materialadverse effect on our business, financial condition, results of operations andability to service debt obligations.

 

***We rely on a marketing alliance for the generation ofmany new accounts.***

 

***We haveestablished a marketing relationship to offer monitored security services tothe residential, single-family market and to businesses in 17 of the largermetropolitan markets in the southeastern United States. Approximately 25% ofour new accounts created in 2005 and 20% of our new accounts created in each of2004 and 2003 were produced from this arrangement. Termination of thisarrangement could have a short term material adverse effect on our ability togenerate new customers in this territory.***

*** ***

***Increased adoption of “false alarm” ordinances bylocal governments may adversely affect our business.***

 

Anincreasing number of local governmental authorities have adopted, or areconsidering the adoption of laws, regulations or policies aimed at reducing theperceived costs to municipalities of responding to false alarm signals. Suchmeasures could include:

 

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

 

•      imposing fineson alarm customers or alarm monitoring companies for false alarms;

 

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

 

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

 

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

 

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

 

***Increased adoption of statutes and governmentalpolicies purporting to void automatic renewal provisions in our customercontracts, or purporting to characterize certain of our charges as unlawful,may adversely affect our business.***

 

Our customer contracts typically contain provisions automaticallyrenewing the term of the contract at the end of the initial term, unlesscancellation notice is delivered in accordance with the terms of the contract. Ifthe customer cancels prior to the end of the contract term, other than inaccordance with the contract, we may charge the customer the charges that wouldhave been paid over the remaining term of the contract, or charge an earlycancellation fee.

 

Several states have adopted, or are considering the adoption ofstatutes, consumer protection policies or legal precedents which purport tovoid the automatic renewal provisions of our customer contracts, or otherwiserestrict the charges we can impose upon contract cancellation. Such initiativescould compel us to increase the length of the initial term of our contracts,and increase our charges during the initial term, and consequently lead to lessdemand for our services and increase our attrition. Adverse judicialdeterminations regarding these matters could cause us to incur legal exposureto customers against whom such charges have been imposed, and the risk thatcertain of our customers may seek to recover such charges through litigation. Inaddition, the costs of defending such litigation and enforcement actions couldhave an adverse effect on us.

 

***Declines in rents, occupancy rates and newconstruction of multifamily dwellings may affect our sales in this marketplace.***

 

Demand for alarm monitoring services in the Network Multifamily segmentis tied to the general health of the multifamily housing industry. Thisindustry is dependent upon prevailing rent levels and occupancy rates as wellas the demand for construction of new properties. The real estate market ingeneral is cyclical, however, and, in the event of a decline in the marketfactors described above, it is likely that demand for our alarm monitoringservices to multifamily dwellings would also decline, which could negativelyimpact our results of operations.

 

***We could face liability for our failure to respondadequately to alarm activations.***

 

The nature of the services we provide potentially exposes us to greaterrisks of liability for employee acts or omissions or system failures than maybe inherent in other businesses. In an attempt to reduce this risk, our alarmmonitoring agreements and other agreements pursuant to which we sell ourproducts and services contain provisions limiting our liability to customersand third parties. However, in the event of litigation with respect to suchmatters, these limitations may not be enforced. In addition, the costs of suchlitigation could have an adverse effect on us.

 

***Future government regulations or other standards couldhave an adverse effect on our operations.***

 

Our operations are subject to a variety of laws, regulations andlicensing requirements of federal, state and local authorities. In certainjurisdictions, we are required to obtain licenses or permits, to comply withstandards governing employee selection and training and to meet certainstandards in the conduct of our business. The loss of such licenses, or theimposition of conditions to the granting or retention of such licenses, couldhave an adverse effect on us. In the event that these laws, regulations and/orlicensing requirements change, we may be required to modify our operations orto utilize resources to maintain compliance with such rules and regulations. Inaddition, new regulations may be enacted that could have an adverse effect onus.

 

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***The loss of our Underwriters Laboratories listingcould negatively impact our competitive position.***

 

All of our alarm monitoring centers are Underwriters Laboratories (“UL”)listed. To obtain and maintain a UL listing, an alarm monitoring center must belocated in a building meeting UL’s structural requirements, have back-up anduninterruptible power supplies, have secure telephone lines and maintainredundant computer systems. UL conducts periodic reviews of alarm monitoringcenters to ensure compliance with their regulations. Non-compliance couldresult in a suspension of our UL listing. The loss of our UL listing couldnegatively impact our competitive position.

 

***We depend on our relationships with alarm systemmanufacturers and suppliers. If we are not able to maintain or renew thesealliances, our ability to create new customers and to service our existingaccount base could be negatively affected.***

 

We currently have agreements with certain alarm system manufacturersand suppliers of hardware for products that we install in customer locationsfor new systems and to repair existing systems. We may not be able to maintainor renew our existing product sourcing arrangements on terms and conditionsacceptable to us. If we are unable to maintain or renew our existingrelationships, we may incur additional costs creating new customer arrangementsand in servicing existing customers.

 

***We rely on subcontractors in certain markets toinstall, service and repair alarm systems.***

 

We currently have agreements with various subcontractors in order totimely and efficiently install, service and repair alarm systems. We may not beable to maintain or renew our subcontractor arrangements on terms and conditionsacceptable to us. If we are unable to maintain or renew our existingsubcontractor relationships, we may incur additional costs creating newcustomer arrangements and in servicing existing customers and customersatisfaction may suffer, leading to increased attrition. Also, our reliance onsubcontractors increases our costs related to quality assurance and inspectionsand potentially diminishes our brand identity with customers.

 

***We rely on technology that may become obsolete, whichcould require significant capital expenditures.***

 

Our monitoring services depend upon the technology (hardware andsoftware) of security alarm systems. We may be required to upgrade or implementnew technology, which could require significant capital expenditures. We maynot be able to successfully implement new technologies or adapt existingtechnologies to changing market demands. If we are unable to adapt in responseto changing technologies, market conditions or customer requirements in atimely manner, such inability could adversely affect our business.

 

***Most of our customers’ alarm systems communicate withour monitoring center via Public Switched Telephone Network lines, or PSTNlines, provided by an incumbent local exchange carrier, which are losing marketshare to wireless and Internet-based means of communication.***

 

The number of PSTN lines provided by incumbent local exchange carriersdecreased at about a 6% annual rate in 2005 and is projected to continuedecreasing. While we offer alarm systems that can communicate signals to ourcentral stations using various wireless and/or Internet-based communicationtechnologies, such solutions are presently more expensive than traditionalPSTN-based alarm communicators. Higher costs might reduce the market for newcustomers of alarm monitoring services, and the trend away from PSTN lines toalternatives may mean more existing customers will cancel service with us. Inaddition, such shifts to newer communications technologies may increase ourcosts for personnel training.

 

***We are dependent upon our experienced seniormanagement, who would be difficult to replace.***

 

The success of our business is largely dependent upon the activeparticipation of our executive officers, who have extensive experience in theindustry. As a result, we have entered into employment agreements with each ofour executive officers. The loss of the services of one or more of suchofficers for any reason may have an adverse effect on our business.

 

***Due to a concentration of accounts in California andFlorida, we are susceptible to environmental incidents that may negativelyimpact our results of operations.***

 

Almost one-third of our recurring monthly revenue is derived fromcustomers located in California and Florida. A major earthquake, hurricane orsome other environmental disaster in an area of high account concentration forus could disrupt our ability to serve those customers or render those customersuninterested in continuing to retain us to provide alarm monitoring services.

 

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***We have incurred and will continue to incurincreased costs as a result of recently enacted securities laws and regulationsrelating to corporate governance matters and public disclosure.***

 

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

 

We are taking steps to comply with the recently enactedlaws and regulations in accordance with the deadlines by which compliance isrequired, however, our estimate of the amount or timing of additional coststhat we may incur to respond by these deadlines may not be accurate. Furthermore,we may not be able to fully comply with the provisions of Section 404 of theAct regarding management’s assessment of the effectiveness of the Company’sinternal control over financial reporting and the auditor’s attestation to andreport on both management’s assessment and the effectiveness of the Company’sinternal control over financial reporting.

 

**ITEM 6.  SELECTED FINANCIAL DATA**

 

The selected consolidated financial data set forth below should be readin conjunction with Item 7, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and the audited consolidated financialstatements and notes to the financial statements of Protection One, which canbe found in Item 8. Due to the impact of the changes resulting from the pushdown accounting adjustments described in Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—SignificantActivities—*New Basis of Accounting*” below, thestatement of operations data presentation separates our results into twoperiods:  (1) the period prior to theFebruary 8, 2005 consummation of the exchange transaction and (2) the periodbeginning after that date utilizing the new basis of accounting. The resultsare further separated by a heavy black line to indicate the effective date ofthe new basis of accounting. Similarly, the current and prior period amountspresented under consolidated balance sheet data and other operating data areseparated by a heavy black line to indicate the application of a new basis ofaccounting between the periods presented. All amounts are in thousands, exceptper share and customer data, unless otherwise noted.

 

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**SELECTEDCONSOLIDATED FINANCIAL DATA**

 
| ** **                                                                                   | ** ** | **February 9  through  December 31,  2005 (a)** | ** ** | ** ** | **January 1  through  February 8,  2005 (b)**               | ** ** | **Year Ended  December 31,  2004** | ** ** | **Year Ended  December 31,  2003** | ** ** | **Year Ended  December 31,  2002** | ** ** | **Year Ended  December 31,  2001** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------|----------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                   | ** ** | **(As Restated) (f)**                                | ** ** | ** ** | ** **                                                                 | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** **                                   | ** ** | ** **                              | ** ** |
| ** **                                                                                   | ** ** | ** **                                                     | ** ** | ** ** | **(dollar amounts in thousands, except per share amounts)** | ** ** | ** **                                   | ** ** |
| **Statements of operations data**                                                            |       |                                                           |       |       |                                                                       |       |                                         |       |                                         |       |                                         |       |                                    |       |
| Revenues                                                                                     |       | $                                                              | 234,481    |       |                                                                       | $          | 28,543                                       |       | $                                            | 269,259    |                                         | $          | 277,085                                 |       | $ | 290,580 |   | $ | 332,846 |   |
| Cost of revenues                                                                             |       | 81,059                                                         |       |       | 10,714                                                                     |       | 101,579                                      |       | 102,205                                      |       | 113,158                                      |       | 119,074                                 |       |
| Selling, general and administrative  expenses                                                |       | 86,014                                                         |       |       | 12,093                                                                     |       | 104,872                                      |       | 109,261                                      |       | 112,984                                      |       | 126,012                                 |       |
| Change in control, restructuring and  corporate consolidation costs                          |       | 2,339                                                          |       |       | 5,939                                                                      |       | 24,382                                       |       | —                                       |       | —                                       |       | —                                  |       |
| Amortization of intangibles and  depreciation expense                                        |       | 43,742                                                         |       |       | 6,638                                                                      |       | 78,455                                       |       | 80,252                                       |       | 82,440                                       |       | 195,773                                 |       |
| Other charges:                                                                               |       |                                                           |       |       |                                                                       |       |                                         |       |                                         |       |                                         |       |                                    |       |
| Loss on impairment of customer accounts (d)                                                  |       | —                                                         |       |       | —                                                                     |       | —                                       |       | —                                       |       | 338,104                                      |       | —                                  |       |
| Loss on impairment of goodwill (d)                                                           |       | —                                                         |       |       | —                                                                     |       | —                                       |       | —                                       |       | 103,937                                      |       | —                                  |       |
| Operating income (loss)                                                                      |       | 21,327                                                         |       |       | (6,841                                                                     | )          | (40,029                                      | )          | (14,633                                      | )          | (460,043                                     | )          | (108,013                                | )          |
| Interest expense                                                                             |       | (30,634                                                        | )          |       | (4,544                                                                     | )          | (44,398                                      | )          | (40,101                                      | )          | (43,023                                      | )          | (51,737                                 | )          |
| Gain (loss) on retirement of debt                                                            |       | (6,657                                                         | )          |       | —                                                                     |       | (47                                          | )          | —                                       |       | 19,337                                       |       | 53,043                                  |       |
| Other income                                                                                 |       | 688                                                            |       |       | 15                                                                         |       | 147                                          |       | 2,829                                        |       | 602                                          |       | 125                                     |       |
| Loss from continuing operations before  income taxes                                         |       | (15,276                                                        | )          |       | (11,370                                                                    | )          | (84,327                                      | )          | (51,905                                      | )          | (483,127                                     | )          | (106,582                                | )          |
| Income tax benefit (expense) (e)                                                             |       | (312                                                           | )          |       | (35                                                                        | )          | (239,579                                     | )          | 17,494                                       |       | 148,852                                      |       | 21,572                                  |       |
| Loss from continuing operations before accounting  change                                    |       | (15,588                                                        | )          |       | (11,405                                                                    | )          | (323,906                                     | )          | (34,411                                      | )          | (334,275                                     | )          | (85,010                                 | )          |
| Loss from discontinued operations, net of  taxes                                             |       | —                                                         |       |       | —                                                                     |       | —                                       |       | —                                       |       | (2,967                                       | )          | (1,038                                  | )          |
| Cumulative effect of accounting change, net  of taxes                                        |       |                                                           |       |       |                                                                       |       |                                         |       |                                         |       |                                         |       |                                    |       |
| Continuing operations (d)                                                                    |       | —                                                         |       |       | —                                                                     |       | —                                       |       | —                                       |       | (541,330                                     | )          | —                                  |       |
| Discontinued operations (d)                                                                  |       | —                                                         |       |       | —                                                                     |       | —                                       |       | —                                       |       | (2,283                                       | )          | —                                  |       |
| Net loss                                                                                     |       | $                                                              | (15,588    | )          |                                                                       | $          | (11,405                                      | )          | $                                            | (323,906   | )                                            | $          | (34,411                                 | )          | $ | (880,855 | ) | $ | (86,048 | ) |
| Net loss from continuing operations before  accounting changes per share of common stock (c) |       | $                                                              | (0.86      | )          |                                                                       | $          | (5.80                                        | )          | $                                            | (164.78    | )                                            | $          | (17.53                                  | )          | $ | (170.46 | ) | $ | (40.31 | ) |
| Weighted average number of shares of common  stock outstanding (c)                           |       | 18,198,571                                                     |       |       | 1,965,654                                                                  |       | 1,965,654                                    |       | 1,962,587                                    |       | 1,961,424                                    |       | 2,109,172                               |       |
|                                                                                         |       |                                                           |       |       |                                                                       |       |                                         |       |                                         |       |                                         |       |                                    |       |
| **Consolidated balance sheet data**                                                          |       |                                                           |       |       |                                                                       |       |                                         |       |                                         |       |                                         |       |                                    |       |
| Working capital deficit                                                                      |       | $                                                              | (5,067     | )          |                                                                       | $          | (373,052                                     | )          | $                                            | (372,560   | )                                            | $          | (148,957                                | )          | $ | (12,071 | ) | $ | (2,834 | ) |
| Customer accounts, net (a)                                                                   |       | 232,875                                                        |       |       | 170,717                                                                    |       | 176,155                                      |       | 244,744                                      |       | 312,785                                      |       | 719,679                                 |       |
| Goodwill, net (a)                                                                            |       | 12,160                                                         |       |       | 41,847                                                                     |       | 41,847                                       |       | 41,847                                       |       | 41,847                                       |       | 763,449                                 |       |
| Total assets (a)                                                                             |       | 436,302                                                        |       |       | 457,008                                                                    |       | 461,044                                      |       | 809,022                                      |       | 837,572                                      |       | 1,748,938                               |       |
| Long term debt, including capital leases,  net of current portion                            |       | 321,293                                                        |       |       | 110,340                                                                    |       | 110,340                                      |       | 331,874                                      |       | 547,798                                      |       | 584,115                                 |       |
| Total stockholders’ equity (deficiency in  assets)                                      |       | 8,067                                                          |       |       | (183,666                                                                   | )          | (177,609                                     | )          | 146,174                                      |       | 168,147                                      |       | 1,061,776                               |       |
|                                                                                         |       |                                                           |       |       |                                                                       |       |                                         |       |                                         |       |                                         |       |                                    |       |
| **Other operating data**                                                                     |       |                                                           |       |       |                                                                       |       |                                         |       |                                         |       |                                         |       |                                    |       |
| Number of customers at end of period                                                         |       | 1,012,797                                                      |       |       | 1,029,211                                                                  |       | 1,030,113                                    |       | 1,048,320                                    |       | 1,073,698                                    |       | 1,133,323                               |       |
| Cash flows provided by operations                                                            |       | 40,413                                                         |       |       | 3,710                                                                      |       | 61,814                                       |       | 59,035                                       |       | 43,391                                       |       | 36,811                                  |       |
| Cash flows used in investment activities                                                     |       | (24,151                                                        | )          |       | (2,473                                                                     | )          | (30,369                                      | )          | (27,471                                      | )          | (20,943                                      | )          | (7,724                                  | )          |
| Cash flows provided by (used in) financing  activities                                       |       | (50,134                                                        | )          |       | —                                                                     |       | (14,120                                      | )          | 1,865                                        |       | (24,950                                      | )          | (27,879                                 | )          |

 

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(a)SeeItem 7 “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations—Significant Activities—*New Basis of Accounting*”for a discussion on push down accounting in 2005 and the adjusted basis ofcertain assets and liabilities.

(b)Consolidatedbalance sheet data and number of customers are as of January 31, 2005.

(c)Lossper share and weighted average number of shares presented give retroactiveeffect to the one-share-for-fifty shares reverse stock split on February 8,2005.

(d)Impairmentcharges and the cumulative effect of an accounting change are the result of ourJanuary 1, 2002 implementation of SFAS Nos. 142, “Accounting for Goodwill andOther Intangible Assets” and 144, “Accounting for the Impairment and Disposalof Long-Lived Assets.”

(e)SeeItem 7 “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations—Critical Accounting Policies—*Income Taxes*”and Item 7 “Management’s Discussion and Analysis of Financial Condition andResults of Operations—Liquidity and Capital Resources—*Tax Matters*”for discussion of the 2004 income tax expense related to establishment of avaluation allowance for deferred tax assets.

(f)  SeeNote 17 to the Consolidated Financial Statements included in Part II, Item 8.

 

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**ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**Introduction**

 

In this section we explain our general financial condition andoperating results, including:

 

•      what factorsaffect our business;

 

•      what ourearnings and costs were in 2005, 2004 and 2003;

 

•      why theseearnings and costs differ from year to year;

 

•      how ourearnings and costs affect our overall financial condition;

 

•      what we expectour capital expenditures to be for the years 2006 through 2007;

 

•      how we plan topay for these future capital expenditures; and

 

•      other itemsthat materially affect our financial condition, liquidity or earnings.

 

In February 2005, wecompleted a one-share-for-fifty-shares reverse stock split of our outstandingshares of common stock. All prior share and per share amounts included in thisreport give retroactive effect to the reverse stock split.

 

As you read this section,please refer to our Consolidated Statements of Operations and ComprehensiveLoss and accompanying notes found in Item 8. These statements show ouroperating results for the period February 9, 2005 through December 31, 2005,January 1, 2005 through February 8, 2005, and the years ended December 31, 2004and 2003. In this section, we analyze and explain the significant annualchanges of specific line items in the Consolidated Statements of Operations andComprehensive Loss. We also suggest you read Item 1A, “Risk Factors” which willhelp your understanding of our financial condition, liquidity and operations.

 

As discussed in Note 17to the Consolidated Financial Statements, the Company’s 2005 consolidatedfinancial statements have been restated. The accompanying management’sdiscussion and analysis gives effect to the restatement.

 

**Overview**

 

We are a leading national provider of security alarm monitoringservices, providing installation, maintenance and electronic monitoring ofalarm systems to single-family residential, commercial, multifamily andwholesale customers. We monitor signals originating from alarm systems designedto detect burglary, fire, medical, hold-up and environmental conditions, and fromaccess control and CCTV systems. Most of our monitoring services and a largeportion of our maintenance services are governed by multi-year contracts withour customers. These contracts are typically three to five years in durationfor our Protection One Monitoring segment and five to ten years for our NetworkMultifamily segment, have automatic annual renewal provisions where permittedand provide us with RMR.

 

Our business consists of two primary segments, Protection OneMonitoring and Network Multifamily. Protection One Monitoring primarilyprovides residential and commercial electronic security system installationsand alarm monitoring services directly to homeowners and businesses. ProtectionOne Monitoring also provides wholesale alarm monitoring services to independentalarm companies. Network Multifamily provides electronic security systeminstallation and alarm monitoring services to owners and managers ofapartments, condominiums and other multifamily dwellings. We market ourservices to these customer segments through separate internal sales andinstallation branch networks.

 

**Business Strategy**

 

Our overall goal is tostrengthen our leadership position in delivering security monitoring servicesand related installation services in principal markets across the United Statesin order to improve our returns on the capital we invest in creating andserving customers. Specific goals include (i) lowering attrition rates; (ii)reducing acquisition costs for each dollar of RMR created; (iii) increasing RMRadditions, and (iv) increasing the efficiency of our monitoring and serviceactivities. We plan to achieve these objectives by building upon our corestrengths, including our national branch platform, our improving brandrecognition, our internal sales force model and our highly skilled andexperienced management team and workforce.

 

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**Significant Activities**

 

***Change in Majority Owner***

 

On February 17, 2004, our former majority stockholder, WestarIndustries, Inc., a wholly owned subsidiary of Westar Energy, Inc., which werefer to collectively as Westar, consummated the sale of approximately 87% ofour common stock to POI Acquisition I, Inc., which was formed by QuadrangleCapital Partners LP, Quadrangle Select Partners LP, Quadrangle CapitalPartners-A LP and Quadrangle Master Funding Ltd, which we refer to collectivelyas Quadrangle. The transaction also included the assignment of Westar’s rightsand obligations as the lender under our revolving credit facility to POIAcquisition, L.L.C., which subsequently assigned one-third of its interest toQuadrangle Master Funding, Ltd.

 

On November 12, 2004, we 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 16 million shares of our commonstock (on a post-reverse stock split basis). The exchange was completed onFebruary 8, 2005 and was accompanied by a one-share-for-fifty-shares reversestock split of our common stock. The newly issued shares, together with sharesalready owned by Quadrangle, resulted in Quadrangle owning approximately 97.3%of our common stock.

 

***New Basis of Accounting***

 

As a result of Quadrangle’s increased ownership interest from theFebruary 8, 2005 debt-for-equity exchange, we have “pushed down” Quadrangle’sbasis to a proportionate amount of our underlying assets and liabilitiesacquired based on the estimated fair market values of the assets andliabilities. The “push-down” accounting adjustments did not impact cash flows. Theprimary changes to the balance sheet reflect (1) the reduction of deferredcustomer acquisition costs and revenues, which have been subsumed into theestimated fair market value adjustment for customer accounts; (2) adjustmentsto the carrying values of debt to estimated fair market value (or Quadrangle’sbasis in the case of the credit facility); (3) adjustments to historical goodwill to reflect goodwill arising fromthe push down accounting adjustments; (4) the recording of a value for ourtrade names; and (5) an increase to the equity section from these adjustments. Theprimary changes to the income statement include (1) the reduction in otherrevenue due to a lower level of amortization from the reduced amortizable baseof deferred customer acquisition revenues; (2) the reduction in other costs ofrevenue and selling expenses due to a lower level of amortization from thereduced amortizable base of deferred customer acquisition costs; (3) anincrease in interest expense due to amortization of debt discounts arising fromdifferences in fair values and carrying values of our debt instruments; and (4)the reduction in amortization related to the reduction in the amortizable baseof customer accounts.

 

Due to the impact of the changes resulting from the push downaccounting adjustments described above, the income statement presentationseparates our results into two periods: (1) the period prior to the February 8, 2005 consummation of theexchange transaction and (2) the period beginning after that date utilizing thenew basis of accounting. The results are further separated by a heavy blackline to indicate the effective date of the new basis of accounting. Similarly,the current and prior period amounts reported on the balance sheet andstatement of cash flows are separated by a heavy black line to indicate theapplication of a new basis of accounting between the periods presented.

 

***Restructuring***

 

We have improved our capital structure through the debt-for-equityexchange with Quadrangle and by refinancing approximately $242.3 million ofdebt due in 2005 with the bank credit agreement due 2011 (see “Refinancing”discussion below). In connection with the restructuring, we retired anaggregate of approximately of $152.9 million which was outstanding on December31, 2004.

 

*Stockholders Agreement and Composition of OurBoard of Directors.*In connection with therestructuring, we also entered into a stockholders agreement with Quadrangle. Thestockholders agreement contains certain agreements with respect to ourcorporate governance following the restructuring, including, but not limitedto, the composition of our board of directors. The parties to the stockholdersagreement are generally required to use their reasonable best efforts to causeour board of directors to consist of five members.

 

In the event POI Acquisition, L.L.C. or its permitted transferees ownsless than 25% of our common shares issued and outstanding as of therestructuring, POI Acquisition, L.L.C. shall have the right to designate onedirector instead of two. In the event either POI Acquisition, L.L.C. orQuadrangle Master Funding Ltd owns less than 10% of our common shares issuedand outstanding as of the restructuring, such entity will lose the ability todesignate a member to our board of directors. If and for so long as POIAcquisition, L.L.C. owns at least 40% of the outstanding shares of our commonstock, it shall have the right to elect to increase the size of the board byone director, which it shall be entitled to designate.

 

11

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In accordance with the stockholders agreement, we amended our bylawsfollowing the restructuring to prevent us from voluntarily filing forbankruptcy, merging or consolidating with another entity until February 8, 2007or from selling all or substantially all of our assets without the writtenconsent of Quadrangle Master Funding Ltd. The stockholders agreement alsoincludes voting agreements, certain restrictions on the transfer of the ourcommon stock, drag-along rights in favor of POI Acquisition, L.L.C. andtag-along rights in favor of Quadrangle Master Funding Ltd, all upon customaryterms and subject to certain customary exceptions (including exceptions forcertain transfers among affiliates). In addition, the stockholders agreementprovides the Quadrangle parties with the right to participate on a proportionalbasis in any future equity issuance by us, except for issuances pursuant toregistered public offerings, business combination transactions or officer,employee, director or consultant arrangements.

 

*Registration Rights Agreement*.As a condition to the consummation of the debt-for-equity exchange, we enteredinto a registration rights agreement with POI Acquisition, L.L.C. andQuadrangle Master Funding Ltd. The registration rights agreement provides,among other things, that we will register, upon notice, shares of our commonstock owned by such parties. Under the registration rights agreement, POIAcquisition, L.L.C. is permitted up to four demand registrations and QuadrangleMaster Funding Ltd is permitted up to two demand registrations, subject tocertain conditions described in the agreement. POI Acquisition, L.L.C. andQuadrangle Master Funding Ltd also received piggyback registration rightswhereby they shall have the opportunity to register their securities pursuantto any registration statement we may file in the future, subject to certain conditions.We are also obligated to pay certain of their expenses pursuant to theregistration of their securities under the registration rights agreement.

 

*Repurchase of Outstanding 13.625% SeniorSubordinated Discount Notes*. In connection with therestructuring and as required by the indenture governing our outstanding13.625% senior subordinated discount notes, we also initiated a change ofcontrol repurchase offer at 101% for our approximately $29.9 million ofoutstanding 13.625% senior subordinated discount notes. We completed therepurchase of all of these notes on March 11, 2005.

 

***Management Incentive Plan;Retention Bonuses****.*

 

As a condition to the completion of the debt-for-equity exchange, weimplemented a management incentive plan that included an equity investmentopportunity and stock appreciation rights (SARs) for our senior executiveofficers and a new stock option plan.

 

*Equity Investment*. Aspart of the management incentive plan implemented 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. Messrs. Ginsburg, Nevin, Pefanis, Williams andGriffin invested $600,000, $500,000, $250,000, $225,000 and $50,000,respectively, and received 80,000, 66,667, 33,333, 30,000 and 6,667 shares ofour common stock, respectively. 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, transfer restrictions and other provisions.

 

*Stock Appreciation Rights Plan*.Pursuant to the management incentive plan, Messrs. Ginsburg, Nevin, Pefanis,and Williams received an aggregate of approximately 798,473, 532,981, 465,111and 199,618  SARs, respectively, on apost-reverse stock split basis. The SARs vest and become payable upon theearlier of (1) a qualified sale as defined in the SAR Plan, which generally meansQuadrangle’s sale of at least 60% of its equity interest in us, provided thatif the qualified sale is not a permissible distribution event (as defined inthe SAR Plan) the payment will be made, with interest, in connection with asubsequent permissible distribution event, and (2) February 8, 2011. Theexercise price of the SARs is $4.50 and increases by 9% per annum, which werefer to as the fixed return, compounded annually, beginning on February 8,2006. If Quadrangle sells less than 60% of its equity interest in us, theexercise 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 one shareof stock in such qualified sale, or the fair market value of one share of stockif the qualified sale is not a sale to a third party and (2) $7.50, providedthat if a SAR holder’s right to receive stock is converted pursuant to the SARPlan into a right to receive cash from a grantor trust that the Company mayestablish, the amount of cash payable will be credited with interest at 6% perannum, compounded annually, from the date such conversion is effective untilthe applicable payment date. Because payment under the plan will only be madein the event of a qualified sale as defined in the SAR plan, no amounts havebeen accrued as of December 31, 2005.

 

*2004 Stock Option Plan*.The 2004 Stock Option Plan became effective upon the consummation of thedebt-for-equity exchange on February 8, 2005. Under the 2004 Stock Option Plan,certain executive officers and selected management employees were grantedoptions, which are subject to vesting, exercise and delivery restrictiondescribed below, to purchase an aggregate of 1,782,947 shares of common stock,on a post-reverse stock split basis, including 621,035, 388,147, 388,147,199,618 and 10,000 options that were granted to Messrs. Ginsburg, Nevin,Pefanis, Williams and Griffin, respectively. The options initially grantedunder the plan will vest ratably each month during the 48 months after the dateof grant, subject to accelerated vesting, in the case of 

 

12

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certain senior executiveofficers, under certain circumstances following a qualified sale. Under theoption agreements applicable to the options granted, any shares of stockpurchased through the exercise of options generally will be issued anddelivered to the option holder, and any net payment that may be due to suchholder in accordance with the plan, will be paid to such holder upon theearlier of: (1) specified dates following the occurrence of certain permissibledistribution 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.

 

*Retention Bonus Program*.Pursuant to the terms of their new employment agreements, Messrs. Ginsburg,Nevin, Pefanis, Williams, and Griffin were each entitled to receive tworetention bonuses. We accrued $1.9 million as general and administrativeexpense in 2004 and an additional $0.2 million of expense in January 2005 forthese retention bonuses. The first retention bonus was paid on January 5, 2005,and the second was paid in February 2005 upon the completion of thedebt-for-equity exchange. Each retention bonus payment was equal to a specifiedpercentage of each executive officer’s annual base salary at the followingrates:  Richard Ginsburg–75.0%, Darius G.Nevin–72.5%, Peter J. Pefanis–67.5%, Steve V. Williams–67.5%, and J. EricGriffin-50.0%.

 

***Refinancing***

 

On April 18, 2005, we entered into a new credit agreement enabling usto complete a redemption of our 7.375% senior notes due 2005 for approximately$166.3 million plus accrued interest (approximately $164.3 million aggregateprincipal amount outstanding) and repay the Quadrangle credit facility(approximately $78.0 million aggregate principal amount outstanding). The7.375% senior notes due 2005 and the Quadrangle credit facility each had amaturity date of August 15, 2005. We recorded a loss in the second quarter of2005 of approximately $6.1 million associated with this redemption andrepayment.

 

The bank credit agreement provides for a $25.0 million revolving creditfacility and a $250.0 million term loan facility. The revolving credit facilitymatures in 2010 and the term loan matures in 2011, subject to earlier maturityif we do not refinance our 8.125% senior subordinated notes due 2009 beforeJuly 2008. The new revolving credit facility is undrawn as of March 10, 2006. Weintend to use any other proceeds from borrowings under the revolving creditfacility, from time to time, for working capital and general corporate purposes.Letters of credit are also available to us under the bank credit agreement.

 

***Corporate Consolidation***

 

In 2005, we consolidated management and other support functions of ourNetwork Multifamily subsidiary with our Protection One Monitoring segment. Approximatelyforty positions were eliminated, including the President, Senior VicePresident-Sales, Senior Vice President-Legal and Vice President-Finance. Weaccrued approximately $2.3 million for severance and retention expense relatedto this consolidation and paid approximately $2.2 million of this amount as ofDecember 31, 2005. Additional expense of approximately $20.0 thousand wasincurred in January 2006 and the remaining accrued amounts were paid at thattime. For more information regarding this consolidation, see our Current Reporton Form 8-K filed on September 7, 2005.

 

In addition, Network Multifamily has completed a conversion of itsbilling system to Mastermind, which is the billing system used by ProtectionOne Alarm Monitoring, Inc. and its general ledger, inventory management,accounts payable and payroll software to Lawson, which is the same softwarecurrently used by Protection One Alarm Monitoring, Inc.

 

In December 2005, wemoved our commercial monitoring operations from Portland, Maine, to NetworkMultifamily’s monitoring facility in Irving, Texas. Approximately twenty-fourpositions were eliminated related to the consolidation of the Portlandmonitoring center.

 

**Other Significant Activities**

 

***Net Loss***

 

We incurred a net loss of $15.6 million for the period February 9, 2005through December 31, 2005 and $11.4 million for the period January 1, 2005through February 8, 2005. The net loss in the period February 9, 2005 throughDecember 31, 2005 includes $2.3 million in severance and other costs related toour efforts to consolidate operations with our Network Multifamily subsidiary. Thenet loss in the period January 1, 2005 through February 8, 2005 includes $5.9million in charges related to our debt restructuring. The remaining net loss inboth periods reflects a decline in revenue, substantial charges incurred by usfor amortization of customer accounts and interest incurred on indebtedness.

 

13

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**Industry Metrics**

 

***Recurring MonthlyRevenue***

 

At various times during each year, we measure all of the monthlyrevenue we are entitled to receive under contracts with customers in effect atthe end of the period. Our computation of RMR may not be comparable to othersimilarly titled measures of other companies, and RMR should not be viewed byinvestors as an alternative to actual monthly revenue, as determined inaccordance with generally accepted accounting principles.

 

We had approximately $19.9 million of RMR as of December 31 for each ofthe years 2005 and 2004 and $20.1 million of RMR as of December 31, 2003. Theslowing rate of RMR decrease is a result of a reduction in the rate of declineof our customer base. Our customer base reflected a net loss of 17,316 customersduring 2005 compared to a net loss of 18,207 customers during 2004 and a netloss of 25,378 customers during 2003. We expect we will continue to lose moreaccounts than we add until the efforts we are making to acquire new accountsand to reduce our rate of attrition become more successful than they have beento date. Net losses of customer accounts materially and adversely affect ourbusiness, financial condition and results of operations.

 

We believe the presentation of RMR is useful to investors because themeasure is used by investors and lenders to value companies such as ours withrecurring revenue streams. Management monitors RMR, among other things, toevaluate our ongoing performance. The table below reconciles our RMR torevenues reflected on our consolidated statements of operations (informationfor the period January 1, 2005 through February 8, 2005 was not considered tobe material in a comparison of RMR as of fiscal year end and therefore has notbeen presented).

 
| ** **                          | ** ** | **February 9 –  December 31** | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                          | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| ** **                          | ** ** | **(dollar amounts in millions)**   | ** ** |
| RMR at December 31                  |       | $                                                 | 19.9       |                                       |       | $ | 19.9 |   | $ | 20.1 |   |
| Amounts excluded from RMR:          |       |                                              |       |                                       |       |   |   |   |
| Amortization of deferred revenue    |       | 0.5                                               |       |                                       | 0.8        |   | 0.6 |   |
| Other revenues (a)                  |       | 1.9                                               |       |                                       | 1.7        |   | 2.1 |   |
| Revenues (GAAP basis):              |       |                                              |       |                                       |       |   |   |   |
| December                            |       | 22.3                                              |       |                                       | 22.4       |   | 22.8 |   |
| February 9 – November 30, 2005 |       | 212.2                                             |       |                                       | —     |   | — |   |
| January – November             |       | —                                            |       |                                       | 246.9      |   | 254.3 |   |
|                                |       |                                              |       |                                       |       |   |   |   |
| Total period revenue                |       | $                                                 | 234.5      |                                       |       | $ | 269.3 |   | $ | 277.1 |   |

 

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(a) Revenues that are not pursuant to monthly contractual billings.

 

Our RMR includes amounts billable to customers with past due balancesthat we believe are collectible. We seek to preserve the revenue streamassociated with each customer contract, primarily to maximize our return on theinvestment we made to generate each contract. As a result, we actively work tocollect amounts owed to us and to retain the customer at the same time. In someinstances, we may allow up to six months to collect past due amounts, while evaluatingthe ongoing customer relationship. After we have made every reasonable effortto collect past due balances, we will disconnect the customer and include theloss in attrition calculations.

 

The following table identifies RMR by segment and in total for theyears indicated.

 

14

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| ** **                                                            | ** ** | **Year Ended December 31** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                            | ** ** | **Protection  One  Monitoring**           | ** ** | **Network  Multi-family** | ** ** | **Total** | ** ** | **Protection  One  Monitoring** | ** ** | **Network  Multi-family** | ** ** | **Total** | ** ** | **Protection  One  Monitoring** | ** ** | **Network  Multi-  family** | ** ** | **Total** | ** ** |
|                                                                  |       | **(dollar  amounts in thousands)**        |       |
| Beginning RMR  balance (a)                                       |       | $                                         | 17,112     |   | $ | 2,795 |   | $ | 19,907 |   | $ | 17,255 |   | $ | 2,834 |   | $ | 20,089 |   | $ | 18,239 |   | $ | 2,798 |   | $ | 21,037 |   |
| RMR retail  additions                                                 |       | 1,907                                     |       | 91 |   | 1,998 |   | 1,729 |   | 160 |   | 1,889 |   | 1,638 |   | 225 |   | 1,863 |   |
| RMR retail  losses, excluding Hurricane Katrina                       |       | (2,085                                    | )          | (187 | ) | (2,272 | ) | (2,146 | ) | (213 | ) | (2,359 | ) | (2,624 | ) | (185 | ) | (2,809 | ) |
| RMR retail losses  from Hurricane Katrina (b)                    |       | (72                                       | )          | (15 | ) | (87 | ) | — |   | — |   | — |   | — |   | — |   | — |   |
| Price changes and  other                                              |       | 270                                       |       | 40 |   | 310 |   | 222 |   | 14 |   | 236 |   | (42 | ) | (4 | ) | (46 | ) |
| Net change in  wholesale RMR, excluding losses from Hurricane Katrina |       | 19                                        |       | — |   | 19 |   | 52 |   | — |   | 52 |   | 44 |   | — |   | 44 |   |
| RMR wholesale  losses from Hurricane Katrina (b)                 |       | (2                                        | )          | — |   | (2 | ) | — |   | — |   | — |   | — |   | — |   | — |   |
| Ending RMR  balance                                                   |       | $                                         | 17,149     |   | $ | 2,724 |   | $ | 19,873 |   | $ | 17,112 |   | $ | 2,795 |   | $ | 19,907 |   | $ | 17,255 |   | $ | 2,834 |   | $ | 20,089 |   |

 

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(a)   BeginningRMR balance includes $903, $850 and $806 wholesale customer RMR for 2005, 2004and 2003, respectively, in both the Protection One Monitoring segment and intotal. Our Network Multifamily segment RMR does not contain wholesalecustomers.

(b)   InSeptember 2005, we suspended billing for our customers in the areas mostheavily affected by Hurricane Katrina. We are currently attempting to contacteach of these customers to determine if our services will be needed in thefuture. As of December 31, 2005, Protection One Monitoring has estimated theloss of 3,117 customers, including 379 wholesale customers, and Network Multifamilyhas estimated the loss of 1,556 customer accounts. Estimated RMR losses relatedto these accounts were less than 1% of our total RMR.

 

The table below reconciles our recurring monthly revenue by segment torevenues reflected in our segment results of operations (information for theperiod January 1, 2005 through February 8, 2005 was not considered to bematerial in a comparison of RMR as of fiscal year end and therefore has notbeen presented).

 
| ** **                          | ** ** | **February 9 – December 31,** | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                               | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| ** **                          | ** ** | **Protection  One  Monitoring**                        | ** ** | **Network  Multi-  family**                | ** ** | **Total** | ** ** | **Protection  One  Monitoring** | ** ** | **Network  Multi-  family** | ** ** | **Total** | ** ** | **Protection  One  Monitoring** | ** ** | **Network  Multi-  family** | ** ** | **Total** | ** ** |
| ** **                          | ** ** | ** **                                             | ** ** | ** **                                 | ** ** | ** ** | ** ** | **(dollar amounts in millions)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| RMR at December 31                  |       | $                                                      | 17.2       |                                       | $          | 2.7 |   | $ | 19.9 |   |   | $ | 17.1 |   | $ | 2.8 |   | $ | 19.9 |   | $ | 17.3 |   | $ | 2.8 |   | $ | 20.1 |   |
| Amounts excluded from RMR:          |       |                                                   |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Amortization of deferred revenue    |       | 0.5                                                    |       | 0.0                                        |       | 0.5 |   |   | 0.6 |   | 0.2 |   | 0.8 |   | 0.5 |   | 0.1 |   | 0.6 |   |
| Other revenues (a)                  |       | 1.6                                                    |       | 0.3                                        |       | 1.9 |   |   | 1.6 |   | 0.1 |   | 1.7 |   | 1.8 |   | 0.3 |   | 2.1 |   |
| Revenues (GAAP basis):              |       |                                                   |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| December                            |       | 19.3                                                   |       | 3.0                                        |       | 22.3 |   |   | 19.3 |   | 3.1 |   | 22.4 |   | 19.6 |   | 3.2 |   | 22.8 |   |
| February 9 – November 30, 2005 |       | 183.5                                                  |       | 28.7                                       |       | 212.2 |   |   | — |   | — |   | — |   | — |   | — |   | — |   |
| January – November             |       | —                                                 |       | —                                     |       | — |   |   | 212.2 |   | 34.7 |   | 246.9 |   | 219.4 |   | 34.9 |   | 254.3 |   |
| Total period revenue                |       | $                                                      | 202.8      |                                       | $          | 31.7 |   | $ | 234.5 |   |   | $ | 231.5 |   | $ | 37.8 |   | $ | 269.3 |   | $ | 239.0 |   | $ | 38.1 |   | $ | 277.1 |   |

 

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(a) Revenues that are not pursuant to monthlycontractual billings.

 

15

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***Monitoring andRelated Services Margin***

 

In each of the last three years, monitoring and related servicerevenues comprised over 91% of our total revenues. As a result of our decliningcustomer base, these revenues have been decreasing. The rate of revenue declinehas slowed, however, while the gross margin as a percentage of revenues hasremained relatively constant. The table below identifies the monitoring andrelated services gross margin and gross margin percent for the presentedperiods.

 
| ** **                                        | ** ** | **2005**                                         | ** ** | ** **                | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | **February 9-**                             | ** ** | **January 1 -** | ** ** | **Year Ended December 31,** | ** ** |
| ** **                                        | ** ** | **December 31**                             | ** ** | **February 8**       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                        | ** ** | **(dollar amounts in thousands)** | ** ** |
|                                              |       |                                             |       |                      |       |   |   |   |   |
| Monitoring and related services revenues          |       | $                                                | 219,475    |                      | $          | 26,455 |   | $ | 247,498 |   | $ | 256,266 |   |
| Cost of monitoring and related services  revenues |       | 62,243                                           |       | 7,400                     |       | 69,598 |   | 73,205 |   |
| Gross margin                                      |       | $                                                | 157,232    |                      | $          | 19,055 |   | $ | 177,900 |   | $ | 183,061 |   |
|                                              |       |                                             |       |                      |       |   |   |   |   |
| Gross margin %                                    |       | 71.6                                             | %          | 72.0                      | %          | 71.9 | % | 71.4 | % |

 

***Attrition***

 

Customer attrition has a direct impact on our results of operationssince it affects our revenues, amortization expense and cash flow. We defineattrition as a ratio, the numerator of which is the gross number of lostcustomer accounts for a given period, net of the adjustments described below,and the denominator of which is the average number of accounts for a givenperiod. In some instances, we use estimates to derive attrition data. We makeadjustments to lost accounts primarily for the net change, either positive ornegative, in our wholesale base. We do not reduce the gross accounts lostduring a period by “move in” accounts, which are accounts where a new customermoves into a home installed with our security system.

 

Our actual attrition experience shows that the relationship period withany individual customer can vary significantly. Customers discontinue servicewith us for a variety of reasons, including relocation, service issues and cost.A portion of the acquired customer base can be expected to discontinue serviceevery year. Any significant change in the pattern of our historical attritionexperience would have a material effect on our results of operations.

 

We monitor attrition each quarter based on a quarterly annualized andtrailing twelve-month basis. This method utilizes each segment’s averagecustomer account base for the applicable period in measuring attrition. Therefore,in periods of customer account growth, customer attrition may be understatedand in periods of customer account decline, customer attrition may beoverstated.

 

As defined above,customer attrition by business segment for the years ended December 31, 2005,2004 and 2003 is summarized below:

 
| ** **                                               | ** ** | **Customer Account Attrition** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                               | ** ** | **December 31, 2005**          | ** ** | **December 31, 2005,  Excluding Hurricane  Katrina (a)** | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
| ** **                                               | ** ** | **Annualized  Fourth  Quarter**          | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** |
| Protection One Monitoring (a)                       |       | 6.2                                      | %          | 8.3 | % | 7.1 | % | 7.8 | % | 7.8 | % | 8.5 | % | 10.3 | % | 10.5 | % |
| Protection One Monitoring, excluding  wholesale (a) |       | 12.3                                     | %          | 13.3 | % | 12.8 | % | 12.8 | % | 12.3 | % | 12.9 | % | 14.6 | % | 14.5 | % |
| Network Multifamily                                      |       | 3.3                                      | %          | 6.4 | %(b) | 4.5 | % | 5.9 | %(b) | 7.1 | % | 6.4 | % | 6.5 | % | 5.8 | % |
| Total Company (a)                                   |       | 5.3                                      | %          | 7.7 | % | 6.3 | % | 7.2 | % | 7.6 | % | 7.8 | % | 9.1 | % | 9.0 | % |

 

----

(a)   Wehave estimated the loss of our customers in the areas affected by HurricaneKatrina. As of December 31, 2005, Protection One Monitoring has estimated the lossof 3,117 customers, including 379 wholesale customers, and Network Multifamilyhas estimated the loss of 1,556 customers whose homes or businesses have beendamaged beyond repair and will no longer need our monitoring services. We arecurrently attempting to contact each customer in the hurricane damaged areas todetermine if our services will be needed in the future.

(b)   Attritionresults for Network Multifamily exclude the impact on the calculation of ourcustomer base from the conversion of our billing system to our new technologyplatform, MAS. Customers are defined differently in the new system and theresult was a decrease in the number of customers in the new system.

 

Excludingthe impact of Hurricane Katrina, our twelve month trailing attrition rate hasremained level compared to our 2004 rate in our Protection One Monitoringsegment.

 

16

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In the table below we define the denominatorthe same as above but define the numerator as the gross number of lost customeraccounts for a given period reduced by move-in accounts.

 
| ** **                                      | ** ** | **Customer Account Attrition** | ** ** |
|-------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                      | ** ** | **December 31, 2005**          | ** ** | **December 31, 2005,  excluding Hurricane  Katrina (a)** | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
| ** **                                      | ** ** | **Annualized  Fourth  Quarter**          | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** | **Annualized  Fourth  Quarter** | ** ** | **Trailing  Twelve  Month** | ** ** |
|                                            |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Protection One Monitoring                       |       | 4.5                                      | %          | 6.4 | % | 5.3 | % | 6.0 | % | 6.0 | % | 6.6 | % | 8.5 | % | 8.5 | % |
| Protection One Monitoring, excluding  wholesale |       | 10.0                                     | %          | 10.8 | % | 10.4 | % | 10.3 | % | 10.0 | % | 10.4 | % | 12.3 | % | 11.9 | % |
| Network Multifamily                             |       | 3.3                                      | %          | 6.4 | %(b) | 4.5 | % | 5.9 | %(b) | 7.1 | % | 6.4 | % | 6.5 | % | 5.7 | % |
| Total Company                                   |       | 4.1                                      | %          | 6.4 | % | 5.1 | % | 6.0 | % | 6.4 | % | 6.5 | % | 7.8 | % | 7.6 | % |

 

----

(a)   Wehave estimated the loss of our customers in the areas affected by HurricaneKatrina. As of December 31, 2005, Protection One Monitoring has estimated theloss of 3,117 customers, including 379 wholesale customers, and NetworkMultifamily has estimated the loss of 1,556 customers whose homes or businesseshave been damaged beyond repair and will no longer need our monitoring services.We are currently attempting to contact each customer in the hurricane damagedareas to determine if our services will be needed in the future.

(b)   Attritionresults for Network Multifamily excludes the impact on the calculation of ourcustomer base from the conversion of our billing system to our new technologyplatform, MAS. Customers are defined differently in the new system and theresult was a decrease in the number of customers in the new system.

 

The table below shows the change in our total company customer baseincluding customer additions and attrition from 2005 to 2003:

 
| ** **                                               | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                               | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Beginning Balance, January 1,                            |       | 1,030,113                                  |       | 1,048,320 |   | 1,073,698 |   |
| Customer additions, excluding wholesale                  |       | 63,418                                     |       | 68,687 |   | 76,226 |   |
| Customer losses, excluding wholesale (a)                 |       | (90,403                                    | )          | (91,600 | ) | (102,853 | ) |
| Changes in wholesale customer and other  adjustments (b) |       | 9,669                                      |       | 4,706 |   | 1,249 |   |
| Ending Balance, December 31,                             |       | 1,012,797                                  |       | 1,030,113 |   | 1,048,320 |   |

 

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(a)     2005includes estimated customer losses of 4,294 resulting from Hurricane Katrina.

(b)     2005includes estimated wholesale customer losses of 379 resulting from HurricaneKatrina.

 

**Sources of Revenue**

 

For both Protection One Monitoring and Network Multifamily, revenue isprimarily generated from providing monitoring services. Monitoring revenue forresidential, commercial and multifamily segments is generated based oncontracts that we enter into with our customers. The typical initial contractterm is three to five years for Protection One Monitoring customers and five toten years for Network Multifamily customers, with automatic renewal provisionswhere permitted (the renewal terms are longer in the case of NetworkMultifamily). Many of our residential and commercial contracts require us toprovide additional services, such as maintenance services, generatingincremental revenue for us. Other revenue consists primarily of sales ofburglar alarms, closed circuit television systems, fire alarms and card accesscontrol systems to commercial customers.

 

**Costsof Revenues; Expenses**

 

Monitoring andrelated services costs generally relate to the cost of providing monitoringservice and include the costs of monitoring, billing, customer service andfield operations.  Other costs ofrevenues consist primarily of equipment and labor charges to install alarmsystems, closed circuit television systems, fire alarms and card access controlsystems sold to our customers.

 

Sellingexpenses include employee compensation, benefits and recruiting for ourinternal sales force, advertising, customer signage, marketing materials,trade show expense, and amortization of previously deferred sellingcosts.  General and administrativeexpenses include lease expenses on office space, computers and other officeequipment, telecommunications, costs of debt collection

 

17

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efforts, advertising, employeecompensation and benefits, professional service fees and other miscellaneousexpenses.  Amortization of intangiblesand depreciation includes amortization of customer accounts as well as depreciationon property and equipment.

 

**CriticalAccounting Policies**

 

Our discussionand analysis of results of operations and financial condition are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States of America,or GAAP.  The preparation of theseconsolidated financial statements requires us to make estimates and judgmentsthat affect the reported amounts of assets, liabilities, revenues and expenses,and related disclosure of contingent assets and liabilities.  We evaluate our estimates on an on-goingbasis, including those related to bad debts, inventories, investments, customeraccounts, goodwill, intangible assets, income taxes, contingencies and litigation.  We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from these estimates under differentassumptions or conditions.

 

***Push Down Accounting***

 

As describedin “Significant Activities—*New Basis of Accounting*”above, we have ‘‘pushed down’’ Quadrangle’s basis to a proportionate amount of ourunderlying assets and liabilities acquired based on the estimated fair marketvalues of the assets and liabilities.  The“pushed-down” basis at February 8, 2005 was used to value customer accounts,property and equipment, trade name, goodwill, deferred customer acquisitioncosts and revenues, debt, additional paid in capital and deficit as of therestructuring.  Additions of assets orliabilities subsequent to February 8, 2005 are initially valued at cost.

 

***Revenue and ExpenseRecognition***

 

Revenues arerecognized when security services are provided. System installation revenues, sales revenues on equipment upgrades anddirect and incremental costs of installations and sales are deferred forresidential customers with monitoring service contracts.  For commercial customers and our nationalaccount customers, revenue recognition is dependent upon each specific customercontract.  In instances when we passtitle to a system, we recognize the associated revenues and costs related tothe sale of the equipment in the period incurred regardless of whether the saleis accompanied by a service agreement. In cases where we retain title to the system, we defer and amortizerevenues and direct costs.

 

Deferred system and upgrade installation revenues arerecognized over the estimated life of the customer utilizing an acceleratedmethod for our residential and commercial customers and a straight-line methodfor our Network Multifamily customers. Deferred costs in excess of deferred revenues are recognized utilizing astraight-line method over the initial contract term, typically two to threeyears for residential systems, five years for commercial systems and five toten years for Network Multifamily systems. To the extent deferred costs are less than deferred revenues, such costsare recognized over the estimated life of the customer utilizing the samemethod as with the related deferred revenues. Therefore, a change in the estimated life of a customer pool would resultin a change in the amount of previously deferred revenue that would beamortized to income but would also result in a similar change in the amount ofpreviously deferred costs that are amortized to expense.  For example, if we had determined as of February9, 2005 that the estimated life of each pool should be shortened by one year,the amount of previously deferred revenue amortized to revenue for the periodFebruary 9, 2005 through December 31, 2005 would have increased byapproximately $0.4 million.  Similarly,the amount of previously deferred cost of revenues would have increased by $0.4million resulting in no net impact to gross profit.

 

The tablebelow reflects the impact of our accounting policy on the respective line itemsof the Statement of Operations for the periods February 9, 2005 throughDecember 31, 2005 and January 1, 2005 through February 8, 2005 and for theyears ended December 31, 2004 and 2003. The “Total amount incurred” line represents the current amount ofbillings that were made and the current costs that were incurred for theperiod.  We then subtract the deferralamount and add back the amortization of previous deferral amounts to determinethe amount we report in the Statement of Operations.

 

18

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|                                        |   | **February 9 – December 31,** | ** ** | **January 1 – February 8,** | ** ** | **For the Year Ended December 31,** |       |
|---------------------------------------------|--------|--------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                                        |   | **2005**                                               | ** ** | **2005**                                             | ** ** | **2004**                                                     | ** ** | **2003** |   |
|                                        |   | **Revenues-  other**                                   | ** ** | **Cost of  revenues-  other**                   | ** ** | **Selling  expense**                                         | ** ** | **Revenues-  other** | ** ** | **Cost of  revenues-  other** | ** ** | **Selling  expense** | ** ** | **Revenues-  other** | ** ** | **Cost of  revenues-  other** | ** ** | **Selling  expense** | ** ** | **Revenues-  other** | ** ** | **Cost of  revenues-  other** | ** ** | **Selling  expense** |   |
| Protection One  Monitoring segment:         |   |                                                   |       |                                                 |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total amount  incurred                      |   | $                                                      | 35,532     |                                                 | $          | 42,469                                                       |       | $ | 36,359 |   |   | $ | 3,265 |   | $ | 3,663 |   | $ | 3,645 |   | $ | 34,291 |   | $ | 39,207 |   | $ | 33,647 |   | $ | 32,494 |   | $ | 37,643 |   | $ | 34,439 |   |
| Amount deferred                             |   | (24,193                                                | )          | (29,947                                              | )          | (15,309                                                      | )          |   | (2,147 | ) | (2,579 | ) | (1,470 | ) | (20,698 | ) | (25,075 | ) | (14,192 | ) | (18,145 | ) | (23,320 | ) | (14,138 | ) |
| Amount amortized                            |   | 3,579                                                  |       | 5,623                                                |       | 5,893                                                        |       |   | 798 |   | 1,487 |   | 1,550 |   | 6,496 |   | 11,678 |   | 11,575 |   | 4,474 |   | 8,794 |   | 8,554 |   |
| Amount included  in Statement of Operations |   | $                                                      | 14,918     |                                                 | $          | 18,145                                                       |       | $ | 26,943 |   |   | $ | 1,916 |   | $ | 2,571 |   | $ | 3,725 |   | $ | 20,089 |   | $ | 25,810 |   | $ | 31,030 |   | $ | 18,823 |   | $ | 23,117 |   | $ | 28,855 |   |
| Network  Multifamily segment:               |   |                                                   |       |                                                 |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total amount  incurred                      |   | $                                                      | 167        |                                                 | $          | 1,638                                                        |       | $ | 1,912 |   |   | $ | (156 | ) | $ | 169 |   | $ | 237 |   | $ | 695 |   | $ | 3,421 |   | $ | 2,287 |   | $ | 922 |   | $ | 5,262 |   | $ | 2,714 |   |
| Amount deferred                             |   | (167                                                   | )          | (1,579                                               | )          | (27                                                          | )          |   | 156 |   | (160 | ) | (9 | ) | (619 | ) | (3,293 | ) | (160 | ) | (707 | ) | (5,007 | ) | (358 | ) |
| Amount amortized                            |   | 88                                                     |       | 612                                                  |       | 28                                                           |       |   | 172 |   | 734 |   | 36 |   | 1,596 |   | 6,043 |   | 338 |   | 1,781 |   | 5,628 |   | 306 |   |
| Amount included  in Statement of Operations |   | $                                                      | 88         |                                                 | $          | 671                                                          |       | $ | 1,913 |   |   | $ | 172 |   | $ | 743 |   | $ | 264 |   | $ | 1,672 |   | $ | 6,171 |   | $ | 2,465 |   | $ | 1,996 |   | $ | 5,883 |   | $ | 2,662 |   |
| Total Company:                              |   |                                                   |       |                                                 |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total amount  incurred                      |   | $                                                      | 35,699     |                                                 | $          | 44,107                                                       |       | $ | 38,271 |   |   | $ | 3,109 |   | $ | 3,832 |   | $ | 3,882 |   | $ | 34,986 |   | $ | 42,628 |   | $ | 35,934 |   | $ | 33,416 |   | $ | 42,905 |   | $ | 37,153 |   |
| Amount deferred                             |   | (24,360                                                | )          | (31,526                                              | )          | (15,336                                                      | )          |   | (1,991 | ) | (2,739 | ) | (1,479 | ) | (21,317 | ) | (28,368 | ) | (14,352 | ) | (18,852 | ) | (28,327 | ) | (14,496 | ) |
| Amount amortized                            |   | 3,667                                                  |       | 6,235                                                |       | 5,921                                                        |       |   | 970 |   | 2,221 |   | 1,586 |   | 8,092 |   | 17,721 |   | 11,913 |   | 6,255 |   | 14,422 |   | 8,860 |   |
| Amount reported  in Statement of Operations |   | $                                                      | 15,006     |                                                 | $          | 18,816                                                       |       | $ | 28,856 |   |   | $ | 2,088 |   | $ | 3,314 |   | $ | 3,989 |   | $ | 21,761 |   | $ | 31,981 |   | $ | 33,495 |   | $ | 20,819 |   | $ | 29,000 |   | $ | 31,517 |   |

 

***Valuation ofIntangible Assets***

 

As discussedin “—*New Basis of Accounting*” above, becauseQuadrangle acquired substantially all of our common stock, resulting in a newbasis of accounting, new values for intangible assets were recorded in thefirst quarter of 2005 based on estimates of fair market values.  New values were recorded for customeraccounts, trade names and goodwill.

 

Customeraccounts were valued by segment based on a combination of (1) the incomeapproach utilizing our projections of cash flow, operating margins and customerattrition and (2) the market approach based on available industry transactiondata generally expressed as a multiple of recurring monthly revenues.  Trade name values were based on theidentifiable revenues associated with each segment and were valued based on theincome approach.  Goodwill represents theexcess of the purchase price over the fair value of net assets acquired.  Goodwill and trade names are tested forimpairment on at least an annual basis or as circumstances warrant.

 

Customeraccounts are tested on a periodic basis or as circumstances warrant.  For purposes of this impairment testing,goodwill is considered to be directly related to the acquired customeraccounts.  Factors we consider importantthat could trigger an impairment review include the following:

 

·      highlevels of customer attrition;

·      continuingrecurring losses above our expectations; and 

·      adverseregulatory rulings.

 

An impairmenttest of customer accounts would have to be performed when the undiscountedexpected future operating cash flows by asset group, which consists primarilyof capitalized customer accounts and related goodwill, is less than thecarrying value of that asset group.  Animpairment would be recognized if the fair value of the customer accounts isless than the net book value of the customer accounts.

 

19

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We completed our annual impairment testing during the third quarter of2005 and determined that no impairment of our non-amortizable intangible assetswas required as of July 1, 2005. We also determined that no impairment wasrequired due to the impact of Hurricane Katrina. No impairment charge wasrecorded in 2004 or 2003.

 

***Customer AccountAmortization***

 

The choice of an amortization life and method is based on our estimatesand judgments about the amounts and timing of expected future revenues fromcustomer accounts and average customer account life. Amortization methods andselected periods were determined because, in our opinion, they would adequatelymatch amortization cost with anticipated revenue. We periodically performlifing studies on our customer accounts to assist us in determining appropriatelives of our customer accounts. These reviews are performed specifically toevaluate our historic amortization policy in light of the inherent decliningrevenue curve over the life of a pool of customer accounts, and our historicalattrition experience. Prior to adopting a new basis of accounting as describedin “—*New Basis of Accounting*” above, we hadidentified three distinct pools of customer accounts, as shown in the tablebelow, each of which had distinct attributes that effected differing attritioncharacteristics. One of these pools (the acquired Westinghouse customers) wasfully amortized at December 31, 2004. For the Protection One Monitoring pools,the results of the lifing studies indicated to us that we can expect attritionto be greatest in years one through five of asset life and that a decliningbalance (accelerated) method would therefore best match the future amortizationcost with the estimated revenue stream from these customer pools. We switchfrom the declining balance method to the straight-line method in the year thestraight-line method results in greater amortization expense.

 

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

 

| **Pool**                                               | ** ** | **Method**                             |
|--------------------------------------------------------|------------|----------------------------------------|
| New amortization method (post February 8, 2005):       |       |                                   |
| Protection One Monitoring                              |       | Ten–year 135% declining balance   |
| Network Multifamily                                    |       | Nine–year straight-line           |
|                                                   |       |                                   |
| Historical amortization method (pre February 9, 2005): |       |                                   |
| Protection One Monitoring:                             |       |                                   |
| •   Acquired Westinghouse  Customers    |       | Eight–year 120% declining balance |
| •   Other Customers                     |       | Ten–year 135% declining balance   |
| Network Multifamily                                    |       | Nine–year straight-line           |

 

We recorded approximately $32.6 million and $5.6 million of customeraccount amortization for the period February 9, 2005 though December 31, 2005and January 1, 2005 through February 8, 2005, respectively. We recordedapproximately $68.6 million of customer account amortization in the year endedDecember 31, 2004. This amount would change if we changed the estimated life oramortization rate for customer accounts. For example, if we had determined thatthe estimated remaining life as of February 9, 2005 of each customer poolshould be reduced by one year, the amortization expense would have beenapproximately $36.3 million for the period February 9, 2005 through December31, 2005.

 

***Income Taxes***

 

As part of the process of preparing our consolidated financialstatements, we are required to estimate our income taxes in each of thejurisdictions in which we operate. Significant management judgment is requiredin determining our provision for income taxes and our deferred tax assets andliabilities. This process involves us estimating our actual current taxexposure together with assessing temporary differences resulting from differingtreatment of items, such as depreciation and amortization, for tax andaccounting purposes. These differences result in deferred tax assets andliabilities, which are included within our consolidated balance sheet. We mustthen assess the likelihood that our deferred tax assets will be recovered. Tothe extent we believe that recovery is not likely, we must establish avaluation allowance. In the first quarter of 2004, due to Westar’s sale of itsinterest in us, we determined that our deferred tax assets would not berealizable. We recorded a non-cash charge to income in the approximate amountof $285.9 million to establish a valuation allowance equal to the amount of netdeferred tax assets determined not to be realizable.

 

We currently do not expect to be in a position to record tax benefitsfor losses incurred in the future.

 

20

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***New accountingstandards****.*

 

In December 2004, the FASB issued Statement of Financial AccountingStandards No. 123R (revised 2004), “Share-Based Payment” (“SFAS No. 123R”),which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” andsupersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting forStock Issued to Employees.”  SFAS No.123R requires compensation costs related to share-based payment transactions tobe recognized in financial statements based on the fair value on the grant dateof the equity or liability instruments used. Compensation cost will berecognized over the period that an employee provides service for that award,resulting in a decrease in net earnings. We will adopt provisions of thisStatement, as amended, using the modified prospective method beginning infiscal 2006. Compensation costs will be recognized for awards that are issuedbeginning in 2006 and for awards that have been granted prior to December 31,2005 but have yet to reach the end of the requisite service period. The amountof expense to be recognized over the remaining service period as of December31, 2005 is $6.7 million. We will begin expensing these costs over the shorterof the vesting period or the period from the date of grant to the date theemployee becomes eligible for retirement. Based on currently outstandingoptions, we expect to record total expense of approximately $2.1 million during2006.

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes andError**Corrections, a replacement of APBOpinion No. 20 and FASB Statement No. 3,” to change the requirements for theaccounting for and reporting of a change in accounting principle. Theprovisions of the Statement are effective for accounting changes and correctionof errors made in fiscal years beginning after December 21, 2005. This newstandard could have a material impact on the Company’s results of operations,financial position or cash flows if an accounting change or error correctionoccurs.

 

**Results of Operations**

 

***Protection OneConsolidated***

 

As a result of the push down accounting adjustments described in “—*New Basis of Accounting*” above, the activity for the periodFebruary 9, 2005 through December 31, 2005 (the “post-push down” period) isreported under the new basis of accounting while the activity for the periodJanuary 1, 2005 through February 8, 2005 (the “pre-push down” period) isreported on the historical basis of accounting, which was used in 2004 and2003. For the post-push down period, the primary changes to the incomestatement reflect (1) the reduction in amortization related to the reductionsto the amount of deferred acquisition costs and deferred acquisition revenues,(2) an increase in interest expense due to accretion of debt discounts arisingfrom differences in fair values and carrying values of our debt instrumentsthat existed in the pre-push down period and (3) the reduction in amortizationrelated to the reduction in the amortizable base of customer accounts.

 

The income statement presentation separates our results into twoperiods:  (1) the period prior to theFebruary 8, 2005 consummation of the exchange transaction and (2) the periodbeginning after that date utilizing the new basis of accounting. The resultsare further separated by a heavy black line to indicate the effective date ofthe new basis of accounting.

 

For the periods February 9, 2005 through December 31, 2005 and January1, 2005 through February 8, 2005, we incurred consolidated net losses of $15.6million and $11.4 million, respectively, or losses per share of common stock of$0.86 and $5.80 respectively. For the years ended December 31, 2004, and 2003,we incurred consolidated net losses of $323.9 million and $34.4 million,respectively, or losses per share of common stock of $164.78 and $17.53,respectively. We recorded an operating profit for the period February 9, 2005through December 31, 2005 of $21.3 million. This operating profit, which is thefirst in recent history, is primarily the result of reduced amortization ofcustomer accounts related to the pushdown accounting described in “—*New Basis of Accounting*” above, and a reduction in generaland administrative expenses. Interest expense of $30.6 million and a loss onretirement of debt of $6.7 million for the period February 9, 2005 throughDecember 31, 2005 contributed to the net loss for the post-push down period.The net loss in the period January 1, 2005 through February 8, 2005 includes$5.9 million for change in control and debt restructuring costs. The loss in2004 includes net income tax expense of $239.6 million primarily due to avaluation allowance established on our deferred tax assets and also includes$24.4 million in change in control and debt restructuring transaction-relatedcosts and $3.5 million in retention bonuses.

 

Monitoring and related services revenues,which are not impacted by the push down adjustments, decreased slightly (lessthan 1%) in 2005 compared to 2004, primarily as a result of a decline in ourcustomer base, but partially offset by price increases implemented in 2004.Cost of monitoring and related services revenues, which are not impacted by thepush down adjustments, increased slightly (less than 0.1%) in 2005 compared to2004. Monitoring and related services margin as a percentage of relatedrevenues remained above 71% in both 2004 and 2005. Interest expense in 2005decreased primarily due to the debt-for-equity exchange with Quadrangle and theretirement of other debt in conjunction with our 2005 restructuring. Interestexpense in the post-push down period includes approximately $6.4 million ofamortized debt discounts. See “—*Restructuring*”above for additional information.

 

21

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***Protection OneMonitoring***

 

We present the table below to show how Protection One Monitoring’soperating results have changed over the periods presented. Next to eachperiod’s results of operations, we provide the relevant percentage of totalrevenues so that you can make comparisons about the relative change in revenuesand expenses. As a result of the push down accounting adjustments described in“—*New Basis of Accounting*” above, thepost-push down and the pre-push down periods in 2005 and the years ended December31, 2004 and December 31, 2003 information presented in the following tablesmay not be comparable.

 
| ** **                                                                       | ** ** | **February 9 through  December 31,** | ** ** | **January 1 through  February 8,** | ** ** | **For the year ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2003**                                                     | ** ** |
| ** **                                                                       | ** ** | **(dollar amounts in thousands)**    | ** ** |
| Revenues                                                                         |       |                                                |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                  |       | $                                                   | 187,857    |                                              | 92.6       | %                                                            |       | $ | 22,564 |   | 92.2 | % | $ | 211,424 |   | 91.3 | % | $ | 220,176 |   | 92.1 | % |
| Other                                                                            |       | 14,918                                              |       | 7.4                                               |       |                                                         | 1,916      |   | 7.8 |   | 20,089 |   | 8.7 |   | 18,823 |   | 7.9 |   |
| Total Revenues                                                                   |       | 202,775                                             |       | 100.0                                             |       |                                                         | 24,480     |   | 100.0 |   | 231,513 |   | 100.0 |   | 238,999 |   | 100.0 |   |
| Cost of revenues (exclusive of amortization  and depreciation shown below)       |       |                                                |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                  |       | 55,498                                              |       | 27.4                                              |       |                                                         | 6,627      |   | 27.1 |   | 61,762 |   | 26.7 |   | 64,803 |   | 27.1 |   |
| Other                                                                            |       | 18,145                                              |       | 8.9                                               |       |                                                         | 2,571      |   | 10.5 |   | 25,810 |   | 11.1 |   | 23,117 |   | 9.7 |   |
| Total cost of revenues (exclusive of  amortization and depreciation shown below) |       | 73,643                                              |       | 36.3                                              |       |                                                         | 9,198      |   | 37.6 |   | 87,572 |   | 37.8 |   | 87,920 |   | 36.8 |   |
| Operating Expenses                                                               |       |                                                |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |
| Selling expenses                                                                 |       | 26,943                                              |       | 13.3                                              |       |                                                         | 3,725      |   | 15.2 |   | 31,030 |   | 13.4 |   | 28,855 |   | 12.1 |   |
| General and administrative expenses                                              |       | 48,845                                              |       | 24.1                                              |       |                                                         | 6,922      |   | 28.3 |   | 61,096 |   | 26.4 |   | 66,611 |   | 27.9 |   |
| Change in control and debt restructuring  costs                                  |       | —                                              |       | —                                            |       |                                                         | 5,939      |   | 24.3 |   | 22,839 |   | 9.9 |   | — |   | — |   |
| Amortization of intangibles and  depreciation expense                            |       | 37,954                                              |       | 18.7                                              |       |                                                         | 6,112      |   | 24.9 |   | 73,560 |   | 31.8 |   | 75,335 |   | 31.5 |   |
| Total operating expenses                                                         |       | 113,742                                             |       | 56.1                                              |       |                                                         | 22,698     |   | 92.7 |   | 188,525 |   | 81.5 |   | 170,801 |   | 71.5 |   |
| Operating profit (loss)                                                          |       | $                                                   | 15,390     |                                              | 7.6        | %                                                            |       | $ | (7,416 | ) | (30.3 | )% | $ | (44,584 | ) | (19.3 | )% | $ | (19,722 | ) | (8.3 | )% |

 

*2005 Compared to 2004*.We had a net decrease of 4,848 customers in 2005, compared to a net decrease of12,888 customers in 2004. Our net increase of 11,861 in wholesale customers wasexceeded by the net decrease in retail customers, including those lost due toHurricane Katrina. The average customer base was 697,179 for 2005 compared to706,047 for 2004.

 

We expect that the decline in our customer base will continue until theefforts we are making to acquire new accounts and reduce attrition become moresuccessful than they have been to date. Net losses of customer accountsmaterially and adversely affect our financial condition and results ofoperations. We are currently focused on reducing attrition, developing costeffective marketing programs and generating positive cash flow. We are alsosusceptible to macroeconomic downturns that may affect our ability to retainour customers.

 

Further analysis of the change in the Protection One Monitoringcustomer account base is shown in the table below.

 
| ** **                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Beginning Balance, January 1,                            |       | 699,603  |       | 712,491  |       | 743,786  |       |
| Customer additions, excluding wholesale                  |       | 53,974   |       | 52,584   |       | 51,181   |       |
| Customer losses, excluding wholesale (a)                 |       | (69,620  | )          | (70,178  | )          | (83,725  | )          |
| Changes in wholesale customer and other  adjustments (b) |       | 10,798   |       | 4,706    |       | 1,249    |       |
| Ending Balance, December 31,                             |       | 694,755  |       | 699,603  |       | 712,491  |       |
| Twelve month trailing attrition (c)                      |       | 8.3      | %          | 8.5      | %          | 10.5     | %          |

 

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(a)   2005 includes estimated customer losses of 2,738 resulting from HurricaneKatrina

(b)   2005 includes estimated wholesale customer losses of 379 resulting fromHurricane Katrina.

(c)   Annualized attrition excluding the losses from Hurricane Katrina is 7.8%for 2005.

 

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**Monitoring and related service revenues**were not impacted by the push down accounting adjustments and decreased lessthan 1% in 2005 compared to 2004. We believe our focus on customer retentioncoupled with price increases in 2004 and 2005 will result in a slowdown in theloss of monitoring and related service revenues. These revenues consistprimarily of contractual revenue derived from providing monitoring andmaintenance service.

 

**Other revenues** include$3.6 million and $0.8 million in amortization of previously deferred revenuesfor the post-push down and pre-push down periods in 2005, respectively, and$6.5 million for 2004. In 2005, we experienced a $3.3 million increase incommercial lease arrangements in which upfront revenues are deferred and a $1.1million decrease in outright commercial sale arrangements which result inimmediate revenue recognition. Other revenues are generated from our internalinstallations of new alarm systems and consist primarily of sales of burglaralarms, closed circuit television systems, fire alarms and card access controlsystems to commercial customers, as well as amortization of previously deferredrevenues.

 

**Cost of monitoring and related servicesrevenues** were not impacted by the push down accountingadjustments and increased less than 1% in 2005 compared to 2004. These costsgenerally relate to the cost of providing monitoring service and include thecosts of monitoring, billing, customer service and field operations. Costs ofmonitoring and related services revenues as a percentage of the relatedrevenues increased to 29.5% in 2005 from 29.2% in 2004.

 

**Cost of other revenues**include$5.6 million and $1.5 million in amortization of previously deferred customer acquisitioncosts for the post-push down and pre-push down periods in 2005, respectively,and $11.7 million for 2004. We also experienced a $0.5 million decrease in costof other revenues related to the decrease in outright commercial sales in 2005compared to 2004. Cost of other revenues consist primarily of equipment andlabor charges to install alarm systems, CCTV systems, fire alarms and cardaccess control systems sold to our customers, as well as amortization ofpreviously deferred customer acquisition costs.

 

**Selling expenses**include $5.9 million and $1.5 million in amortization of previously deferredcustomer acquisition costs for the post-push down and pre-push down periods in2005, respectively, and $11.6 million for 2004. Other selling expenses haveincreased over 2004 levels by approximately $3.4 million due to increases inwages, benefits, commissions and other expenses related to an increase in thenumber of salespeople.

 

**General and administrative expenses**decreased in 2005, generally due to a $1.6 million reduction in insurancepremiums primarily related to director and officer policies and general andprofessional liability policies and a $2.1 million reduction in system charges.As of December 31, 2004 (with respect to human resources software) and February17, 2005 (with respect to financial systems software), we no longer incursystem processing charges from our former parent company related to our usageof its software. Insurance premium reductions are a result of our improvedfinancial condition, including the debt restructuring activites, which wasfound favorable by insurance markets. The 2005 pre-push down period includes$0.4 million in retention bonus expense and 2004 includes $2.8 million inretention bonus expense.

 

**Changein control****and debtrestructuring costs** for the 2005 pre-push down period include $5.6million in fees paid upon completion of the restructuring as well as legal andother fees related to the debt restructuring. In 2004 we made change of controlpayments to executive officers in the amount of $9.5 million, incurred $1.6million in expenses for the write-off of director and officer insurance uponthe change of control in February 2004, paid $3.5 million to the advisor to ourboard of directors and incurred approximately $8.2 million for legal andadvisory fees related to the sale and restructuring efforts.

 

**Amortization of intangibles and depreciationexpense** for the post-push down period is based on thenewly recorded values of the customer accounts and fixed assets and theirassociated estimated remaining lives, which resulted in a decrease of $31.9million in amortization of customer accounts for 2005. The remaining lives offixed assets were generally decreased which resulted in an increase of $2.4million in depreciation expense in 2005. The customer accounts are amortizedover a ten year life on an accelerated basis while the remaining asset livesfor the components of fixed assets have generally been shortened.

 

*2004 Compared to 2003*.We had a net decrease of 12,888 customers in 2004, as compared to a netdecrease of 31,295 customers in 2003. This decline is the primary reason forthe $7.5 million decline in revenues in 2004. The average customer base was706,047 for 2004 compared to 728,139 for 2003. Although our net customersdecreased for the year, attrition decreased in 2004 compared to 2003 for avariety of reasons including:

 

•      a focus by oursales force on obtaining high quality customers;

 

•      an increase inthe investment required by customers to purchase our systems;

 

•      an emphasis oncustomer service and attrition reduction by branch and monitoring centerpersonnel;

 

•      the passage oftime from the end of the dealer program; and

 

•      legal actiontaken against competitors who illegally solicit our customers.

 

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**Monitoring and related service revenues**for 2004 decreased 4.0% compared to 2003. The decrease is primarily due to thedecline in our customer base, which decreased for the reasons discussed above.The rate of decrease in monitoring and related services revenues slowedcompared to the rate of decrease in 2003 of 5.9% primarily due to improvementsin attrition rates and partially due to rate increases for monitoring services.These revenues consist primarily of contractual revenue derived from providingmonitoring and maintenance service.

 

**Other revenues** for2004 increased 6.7% compared to 2003 primarily due to an increase in theamortization of previously deferred revenues of approximately $2.0 million,partially offset by a reduction in commercial sales of $0.6 million. Theserevenues consist primarily of sales of burglar alarms, closed circuittelevision systems, fire alarms and card access control systems to commercialcustomers as well as amortization of previously deferred revenues.

 

**Cost of monitoring and related servicesrevenues** for 2004 decreased 4.7% compared to 2003.These costs generally relate to the cost of providing monitoring service andinclude the costs of monitoring, billing, customer service and fieldoperations. The decrease is primarily due to the decline in our customer base,which resulted in a decrease in service expense of $1.9 million and a decreasein monitoring expense of $1.1 million. Costs of monitoring and related servicesrevenues as a percentage of the related revenues decreased from 29.4% in 2003to 29.2% in 2004.

 

**Cost of other revenues**for2004 increased 11.6% compared to 2003. These costs consist primarily ofequipment and labor charges to install alarm systems, CCTV systems, fire alarmsand card access control systems sold to our customers and amortization ofinstallation costs previously deferred. The increase is primarily due to anincrease in amortization of deferred customer acquisition costs of $2.9million.

 

**Selling expenses** for2004 increased 7.5%. The increase is due to our continued efforts to generatenew customers through an internal sales force by building the necessary salessupport. As our internal sales force increases its generation of new customers,the amount of direct and incremental selling costs that are deferred alsoincreases. These deferred selling costs are amortized to selling expense over acustomer’s initial contract term, typically a two to three year period, whichresulted in an aggregate increase of $3.0 million in amortization of sellingexpense.

 

**General and administrative expenses**for 2004 decreased 8.3% compared to 2003. This decrease is generally the resultof a $2.1 million decrease in premiums to insurance companies related to ourdirector and officer liability policies and a $3.9 million decrease inadministrative and general salaries and related benefit expenses primarilyrelated to a reduction in retention plan expenses in 2004 and a decrease inmedical and dental plan expenses. As a percentage of total revenues, generaland administrative expenses decreased from 27.9% in 2003 to 26.4% in 2004.

 

**Changein control****and debtrestructuring expenses** for 2004 include expenses for legal andfinancial advisors related to the sale of us by Westar and debt restructuringexpenses incurred subsequent to the sale, as well as change in control paymentsresulting from the sale.

 

**Amortization of intangibles and depreciationexpense** for 2004 decreased 2.4% compared to 2003. Thisdecrease reflects a reduction in customer amortization of $0.1 million and adecrease in depreciation expense of $1.7 million primarily due to a decrease inthe amount of capital purchases from the level of purchases in 1999 and 2000,which assets are becoming fully depreciated.

 

***Network Multifamily***

 

In August 2005, NetworkMultifamily and Protection One began efforts to consolidate management andother functions. Approximately forty positions were eliminated at NetworkMultifamily, including the President, Senior Vice President-Sales, Senior VicePresident-Legal and Vice President-Finance. Approximately $2.3 million inseverance and retention costs were expensed for the year ended December 31,2005. In addition, Network Multifamily completed conversion of its billingsystem to Mastermind, which is the billing system used by Protection One AlarmMonitoring, Inc. and conversion of its general ledger, inventory management,accounts payable and payroll software to Lawson, which is the same softwarecurrently used by Protection One Alarm Monitoring, Inc.

 

The following table provides information for comparison of the NetworkMultifamily operating results for the periods presented. Next to each year’sresults of operations, we provide the relevant percentage of total revenues sothat comparisons about the relative change in revenues and expenses can bemade. As a result of the push down accounting adjustments described in “—

 

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*New Basisof Accounting*” above, the post-push down period andthe pre-push down period in 2005 and the years ended December 31, 2004 andDecember 31, 2003 information presented in the following tables may not becomparable.

 
| ** **                                                                       | ** ** | **February 9 through  December 31,** | ** ** | **January 1 through  February 8,** | ** ** | **For the year ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2003**                                                     | ** ** |
| ** **                                                                       | ** ** | **(dollar amounts in thousands)**    | ** ** |
| Revenues                                                                         |       |                                                |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                  |       | $                                                   | 31,618     |                                              | 99.7       | %                                                            |       | $ | 3,891 |   | 95.8 | % | $ | 36,074 |   | 95.6 | % | $ | 36,090 |   | 94.8 | % |
| Other                                                                            |       | 88                                                  |       | 0.3                                               |       |                                                         | 172        |   | 4.2 |   | 1,672 |   | 4.4 |   | 1,996 |   | 5.2 |   |
| Total Revenues                                                                   |       | 31,706                                              |       | 100.0                                             |       |                                                         | 4,063      |   | 100.0 |   | 37,746 |   | 100.0 |   | 38,086 |   | 100.0 |   |
| Cost of revenues (exclusive of amortization  and depreciation shown below)       |       |                                                |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |
| Monitoring and related services                                                  |       | 6,745                                               |       | 21.3                                              |       |                                                         | 773        |   | 19.0 |   | 7,836 |   | 20.8 |   | 8,402 |   | 22.1 |   |
| Other                                                                            |       | 671                                                 |       | 2.1                                               |       |                                                         | 743        |   | 18.3 |   | 6,171 |   | 16.3 |   | 5,883 |   | 15.4 |   |
| Total cost of revenues (exclusive of  amortization and depreciation shown below) |       | 7,416                                               |       | 23.4                                              |       |                                                         | 1,516      |   | 37.3 |   | 14,007 |   | 37.1 |   | 14,285 |   | 37.5 |   |
| Operating Expenses                                                               |       |                                                |       |                                              |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |
| Selling expenses                                                                 |       | 1,913                                               |       | 6.0                                               |       |                                                         | 264        |   | 6.5 |   | 2,465 |   | 6.5 |   | 2,662 |   | 7.0 |   |
| General and administrative expenses                                              |       | 8,313                                               |       | 26.2                                              |       |                                                         | 1,182      |   | 29.1 |   | 10,281 |   | 27.2 |   | 11,133 |   | 29.2 |   |
| Change in control and debt restructuring  costs                                  |       | —                                              |       | —                                            |       |                                                         | —     |   | — |   | 1,543 |   | 4.1 |   | — |   | — |   |
| Corporate consolidation costs                                                    |       | 2,339                                               |       | 7.4                                               |       |                                                         | —     |   | — |   | — |   | — |   | — |   | — |   |
| Amortization of intangibles and  depreciation expense                            |       | 5,788                                               |       | 18.3                                              |       |                                                         | 526        |   | 12.9 |   | 4,895 |   | 13.0 |   | 4,917 |   | 12.9 |   |
| Total operating expenses                                                         |       | 18,353                                              |       | 57.9                                              |       |                                                         | 1,972      |   | 48.5 |   | 19,184 |   | 50.8 |   | 18,712 |   | 49.1 |   |
| Operating income                                                                 |       | $                                                   | 5,937      |                                              | 18.7       | %                                                            |       | $ | 575 |   | 14.2 | % | $ | 4,555 |   | 12.1 | % | $ | 5,089 |   | 13.4 | % |

 

*2005 Compared to2004*. We had a net decrease of 12,468 customers in2005 compared to a net decrease of 5,319 customers in 2004. This decrease isdue primarily to fewer customer additions. Demand for our services from ownersand managers of multifamily properties has been negatively affected by theincreasing preference of occupants of multifamily units to subscribe only forcellular telephone services and not for traditional telephone service, whichour alarm systems have historically used to transport alarm signals to ourmonitoring center. We are marketing a new product which will allow monitoringof multifamily units without a landline in each unit, which we believe willimprove the rate of site additions. The “Conversion Adjustments” line itemreflects the impact of the 2005 conversion of our billing system to our newtechnology platform, MAS. Customers are defined differently in the new systemand the result was a decrease in the number of customers in the new system. Theaverage customer base was 324,276 for 2005 compared to 333,170 for 2004. Thechange in Network Multifamily’s customer base for the period is shown below.

 
| ** **                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Beginning Balance, January 1        |       | 330,510  |       | 335,829  |       | 329,912  |       |
| Additions                           |       | 9,444    |       | 16,103   |       | 25,045   |       |
| Customer losses (a)                 |       | (20,783  | )          | (21,422  | )          | (19,128  | )          |
| Conversion adjustments              |       | (1,129   | )          | —   |       | —   |       |
| Ending Balance, December 31,        |       | 318,042  |       | 330,510  |       | 335,829  |       |
| Twelve month trailing attrition (b) |       | 6.4      | %          | 6.4      | %          | 5.8      | %          |

 

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(a)   2005includes estimated customer losses of 1,556 resulting from Hurricane Katrina.

(b)   Annualizedattrition excluding the losses from Hurricane Katrina is 5.9% for 2005.

 

**Monitoring and related services revenue**were not impacted by the push down accounting adjustments and decreased 1.6% in2005 compared to 2004. These revenues consist primarily of contractual revenuederived from providing monitoring and maintenance service. The decline was dueto the decrease in the customer base and a decrease in repair billings.

 

**Other revenues**include$0.1 million and $0.2 million in amortization of previously deferred revenuesfor the post-push down and pre-push down periods in 2005, respectively, and$1.6 million for 2004. These revenues consist primarily of amortization ofpreviously deferred revenues associated with the sale of alarm systems andrevenues from the sale of access control systems.

 

25

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**Cost of monitoring and related servicerevenues** were not impacted by the push down accountingadjustments and generally relate to the cost of providing monitoring serviceand include the costs of monitoring, billing, customer service and fieldoperations. These costs decreased approximately 4.1% in 2005 compared to 2004. Costof monitoring and related services revenues as a percentage of the relatedrevenues decreased to 21.2% in 2005 from 21.7% in 2004.

 

**Cost of other revenues**includes $0.6 million and $0.7 million in amortization of previously deferredcustomer acquisition for the post-push down and pre-push down periods in 2005,respectively, and $6.0 million for 2004. These costs also include the costs toinstall access control systems.

 

**Selling expenses**includes approximately $28.0 thousand and $36.0 thousand in amortization ofpreviously deferred customer acquisition costs for the post-push down andpre-push down periods in 2005, respectively, and $0.3 million for 2004. Otherselling expenses in 2005 remained consistent with 2004 expenses.

 

**General and administrative expenses**decreasedin 2005 generally due to consolidation efforts described above.

 

**Change in control and debt restructuringexpenses** for 2004 include change in control paymentsmade as a result of the sale by Westar.

 

**Corporate consolidation costs**for the post-push down period in 2005 include severance and retention paymentsexpense for those employees whose responsibilities were consolidated into theparent company.

 

**Amortization of intangibles and depreciationexpense** for the post-push down period is based on thenewly recorded values of the customer accounts and fixed assets and theirassociated estimated remaining lives. The customer accounts are amortized overa nine year life on a straight-line basis, while the remaining asset lives forthe components of fixed assets have generally been shortened.

 

*2004 Compared to 2003*.We had a net decrease of 5,319 customers in 2004 compared to a net increase of5,917 customers in 2003. The decrease in 2004 is primarily due to a reductionof added accounts of 8,942 or a 36% decrease from 2003 added accounts, which weattribute to a downturn in the multifamily industry and to the uncertainty ofour restructuring efforts in 2004. The average customer base was 333,170 for2004 compared to 332,871 for 2003.

 

**Monitoring and related services revenue**for 2004 remained consistent with 2003. These revenues consist primarily ofcontractual revenue derived from providing monitoring and maintenance service. A$0.4 million decrease in repair billings was offset by an increase in contractbuyouts of $0.3 million and an increase in RMR related to the slightly higheraverage customer base in 2004.

 

**Other revenues**for2004 decreased 16.2% compared to 2003 primarily due to a $0.2 million decreasein the amortization of previously deferred revenue and a $0.1 million decreasein access control system sales revenue. These revenues consist primarily ofamortization of previously deferred revenues associated with the sale of alarmsystems and revenues from the sale of access control systems.

 

**Cost of monitoring and related servicerevenues** for 2004 decreased 6.7% compared to 2003. Thesecosts generally relate to the cost of providing monitoring service and includethe costs of monitoring, customer service and field operations. This decreaseis the result of reduced field service costs of $0.5 million and loweremployment costs of $0.1 million related to an employee retention plan in 2003.Cost of monitoring and related services revenues as a percentage of the relatedrevenues decreased to 21.7% in 2004 from 23.3% in 2003.

 

**Cost of other revenues**for 2004 increased 4.9% compared to 2003. These costs consist primarily ofamortization of installation costs previously deferred and the costs to installaccess control systems. The costs increased primarily due to an increase of$0.4 million in amortization of deferred customer acquisition costs, partiallyoffset by a $0.1 million decrease in access control system installation costs.

 

**Selling expenses** for2004 decreased 7.4% compared to 2003. This decrease is the result of a $0.2million decline in employment costs related to an employee retention plan in2003 and reduced advertising costs of $0.1 million.

 

**General and administrative expenses**for2004 decreased 7.7% compared to 2003. This decrease is primarily due to a $1.0million decrease in management fees allocated from Protection One, lower legalcosts of $0.3 million and reduced telecom costs of $0.2 million. Thesedecreases were partially offset by increased liability insurance costs of $0.5million. As a percentage of total revenues, general and administrative expensesdecreased to 27.2% in 2004 from 29.2% in 2003.

 

26

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**Change in control and debt restructuringexpenses** for 2004 include change in control paymentsmade as a result of the sale by Westar.

 

**Amortization of intangibles and depreciationexpense** for 2004 remained consistent with 2003.

 

**Liquidity and Capital Resources**

 

We have improved our capital structure by reducing the face amount ofoutstanding debt by $161.3 million to $344.2 million at December 31, 2005 from$505.5 million at December 31, 2004, primarily through a $120 milliondebt-for-equity exchange with Quadrangle. We expect to generate operating cashflows in excess of that required for operations and for required principal andinterest payments.

 

On April 18, 2005, we entered into a new credit agreement, whichenabled us to redeem our 7.375% senior notes due 2005 for approximately $166.3million plus accrued interest (approximately $164.3 million aggregate principalamount outstanding) and repay the Quadrangle credit facility (approximately$78.0 million aggregate principal amount outstanding). The 7.375% senior notesand the Quadrangle credit facility would have matured on August 15, 2005. Thebank credit facility provides for a $25.0 million revolving credit facility anda $250.0 million term loan facility. The revolving credit facility matures in2010 and the term loan matures in 2011, subject to earlier maturity if we donot refinance our 8.125% senior subordinated notes due 2009 before July 2008. Thenew revolving credit facility is undrawn as of March 10, 2006 and approximately$24.0 million remains available after reducing total availability byapproximately $1.0 million for outstanding letters of credit. We intend to useany other proceeds from borrowings under the revolving credit facility, fromtime to time, for working capital and general corporate purposes. Letters ofcredit are also available under the bank credit agreement.

 

In an effort to limit our exposure to interest rate risk on ourvariable rate bank credit facility, we purchased interest rate caps in theaggregate amount of $0.9 million during the second quarter of 2005. Ourobjective is to protect against increases in interest expense caused byfluctuation in LIBOR. One interest rate cap provides protection on a $75million tranche of our long term debt over a five-year period if LIBOR exceeds6%. A second interest rate cap provides protection on a separate $75 milliontranche of our long term debt over a three-year period if LIBOR exceeds 5%.

 

Our long-term debt instruments contain restrictions based on “EBITDA.”  EBITDA is generally derived by adding toincome (loss) before income taxes, interest expense, depreciation expense andamortization expense. However, under the indenture related to our 8.125% seniorsubordinated notes and our bank credit facility various and numerous additionaladjustments to EBITDA are sometimes required.

 

The bank credit facility and the indenture relating to our 8.125%senior subordinated notes contain the following financial tests that must besatisfied in order for us to incur additional indebtedness, pay dividends, makeloans or advances and sell assets.

 

| **Debt Instrument**        | ** ** | **Financial Covenant and Current Test**                                                                                                                |
|----------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
| Bank Credit Facility       |       | Consolidated total debt  on last day of period/consolidated EBITDA for most recent four fiscal  quarters less than 5.25 to 1.0                         |
|                       |       |                                                                                                                                                   |
|                       |       | Consolidated EBITDA for  most recent four fiscal quarters/consolidated interest expense for most  recent four fiscal quarters greater than 2.35 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, 2005, we were in compliance with the financialcovenants and tests.

 

These debt instruments also restrict our ability to pay dividends tostockholders, but do not otherwise restrict our ability to fund cashobligations.

 

***Cash Flow***

 

***Operating Cash Flowsfor the Year Ended December 31, 2005***. Ouroperating activities provided net cash flows of $40.4 million and $3.7 millionfor the periods February 9, 2005 through December 31, 2005 and January 1, 2005through February 8, 2005, respectively. Our operating activities provided netcash flows of $61.8 and $59.0 million in 2004 and 2003, respectively. Thedecrease in cash flows from operating activities in 2005 compared to 2004 and2003 is primarily related to the termination of the tax

 

27

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sharing agreement with Westarpartially offset by a reduction of cash interest expense and a decrease inchange in control, debt restructuring, retention and corporate consolidationcosts. We received $45.9 million in cash from Westar under the tax sharingsettlement in 2004 and $20.0 million in tax sharing payments in 2003. Cashinterest expense was $25.2 and $6.5 million for the periods February 9, 2005through December 31, 2005, and January 1, 2005 through February 8, 2005,respectively, compared to $45.0 million and $41.0 million for the years endedDecember 31, 2004 and 2003, respectively. We made corporate consolidation,change in control, debt restructuring and retention and severance payments of$2.3 million and $9.1 million for the periods February 9 through December 31,2005 and January 1, 2005 through February 8, 2005, respectively, compared to$25.1 million and $5.1 million for the years ended December 31, 2004 and 2003,respectively.

 

***Investing Cash Flowsfor the Year Ended December 31, 2005*.**We used anet $24.2 million and $2.5 million for our investing activities in the periodsFebruary 9, 2005 through December 31, 2005 and January 1, 2005 through February8, 2005, respectively. We invested a net $22.5 million in cash to install andacquire new accounts, invested $5.7 million to acquire fixed assets, invested$0.8 million in non-monitored leased equipment, increased restricted cash by$0.6 million and we received an aggregate $5.4 million from the disposition ofmarketable securities and other assets and from the redemption of preferredstock in the period February 9, 2005 through December 31, 2005. We invested anet $2.2 million in cash to install and acquire new accounts and $0.3 millionto acquire fixed assets in the period January 1, 2005 through February 8, 2005.We used a net $30.4 million for our investing activities in 2004. Proceeds fromthe sale of other assets provided cash of $0.4 million. We invested a net $21.4million in cash to install and acquire new accounts and $9.3 million to acquirefixed assets. In 2003, we invested a net $24.3 million in cash to install andacquire new accounts and $7.4 million to acquire fixed assets. The sale of AVONE to Westar in 2003 provided $1.4 million and the sale of other assetsprovided $2.9 million.

 

***Financing Cash Flowsfor the Year Ended December 31, 2005***. Financingactivities used a net $50.1 million in cash in the period February 9, 2005through December 31, 2005. In the period February 9, 2005 through December 31,2005, we used $293.7 million to retire debt, $7.2 million for debt and stockissuance costs and $0.9 million for interest rate caps. We received $250.0million for the new bank credit facility and $1.8 million in proceeds from thesale of common stock in the period February 9, 2005 through December 31, 2005. Financingactivities used net cash flows of $14.1 million in 2004, primarily to retire$14.5 million of our outstanding debt. In 2003, we received $11.9 million forthe sale of parent securities that were held as treasury and $0.5 million forthe sale of our Protection One Europe trademark rights and made payments of$10.2 million on long-term debt.

 

***Capital Expenditures.***We made capitalexpenditures of approximately $31.4 million in 2005. Of such amount, weinvested approximately $24.7 million in customer acquisition costs, $0.8million in non-monitored leased equipment and $5.9 million for fixed assets. Assumingwe have available funds, capital expenditures for 2006 and 2007 are expected tobe approximately $36.4 million and $38.2 million, respectively, of whichapproximately $28.3 million and $31.2 million, respectively, would be used forcustomer acquisition costs, with the balance to be used for fixed assets. Theseestimates are prepared for planning purposes and are revised from time to time.Actual expenditures for these and other items not presently anticipated mayvary materially from these estimates during the course of the years presented.

 

***Tax Matters****.*Due to Westar’s sale of its interests inus in the first quarter of 2004 we are no longer entitled to receive taxsharing payments from Westar. We determined that most of our deferred taxassets would not be realizable, and we recorded a non-cash charge to income inthe first quarter of 2004 in the approximate amount of $285.9 million toestablish a valuation allowance equal to the amount of net deferred tax assetsdetermined not to be realizable. We currently do not expect to be in a positionto record tax benefits for losses incurred in the future.

 

**Off-Balance Sheet Arrangements**

 

We had no off-balance sheet arrangements at December 31, 2005, otherthan as discussed below.

 

**Material Commitments**

 

We have the following future, material, long-term commitments as ofDecember 31, 2005:

 

28

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| ** **                                 | ** ** | **Payment Due by Period**         | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|
| **At December 31, 2005:**   | ** ** | **Total**                                        | ** ** | **Less  than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                                 | ** ** | **(dollar amounts in thousands)** | ** ** |
| **Contractual Obligations**           | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Long-Term Debt Obligations (a)             |       | $                                                | 344,162    |   | $ | 2,356 |   | $ | 231,466 |   | $ | 110,340 |   | $ | — |   |
| Interest Obligations on Long-Term Debt (a) |       | 74,050                                           |       | 26,164 |   | 43,403 |   | 4,483 |   | — |   |
| Operating Leases Obligations               |       | 16,188                                           |       | 4,967 |   | 7,005 |   | 3,097 |   | 1,119 |   |
| Purchase Obligations (b)                   |       | 11,250                                           |       | 3,750 |   | 7,500 | ** ** | **—** |   | — |   |
| Total (c)                                  |       | $                                                | 445,650    |   | $ | 37,237 |   | $ | 289,374 |   | $ | 117,920 |   | $ | 1,119 |   |

 

----

(a)  Assumes(i) payment of 8.125% senior subordinated notes at contractual maturity date ofJanuary 15, 2009; and (ii) bank credit facility subject to early maturity dateof June 30, 2008. Interest rate used to calculate interest obligation onvariable rate bank credit facility is the weighted average rate at December 31,2005.

(b)Contracttariff for telecommunication services.

(c)Wehave a capital lease arrangement with GE Fleet Services for vehicles deliveredin February 2006. Payments under the capital lease provisions for the vehiclesplanned for delivery in 2006 are expected to be $0.2 million in 2006 and $0.3million in each of the years 2007, 2008, and 2009. These expected payments arenot included in the above total contractual obligations at December 31, 2005.

 

The table below shows our total commercial commitments and the expectedexpiration per period:

 
| **At December 31, 2005:**   | ** ** | **Amount of Commitment Expiration Per Period** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Total**                                                               | ** ** | **2006** | ** ** | **2007-2008** | ** ** | **2009-2010** | ** ** | **Thereafter** | ** ** |
| ** **                                 | ** ** | **(dollar amounts in thousands)**                        | ** ** |
| **Other Commercial Commitments** | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Standby letters of credit                  |       | 1,024                                                                   |       | 1,024 |   | — |   | — |   | — |   |
| Total commercial commitments               |       | $                                                                       | 1,024      |   | $ | 1,024 |   | $ | — |   | $ | — |   | $ | — |   |
|                                            |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**CreditRatings**

 

As of March 10, 2006, our public debt was rated as follows:

 
| ** **   | ** ** | **Bank Credit  Facility** | ** ** | **8.125% Senior  Subordinated  Notes Due 2009** | ** ** | **Outlook** | ** ** |
|--------------|------------|--------------------------------|------------|----------------------------------------------------------------|------------|-------------|------------|
| S & P    |       | B+                             |       | B-                                                             |       | Negative    |       |
| Moody’s |       | B2                             |       | Caa1                                                           |       | Stable      |       |

 

**ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK**

 

Our new bank credit facility is a variable rate debt instrument, and asof March 10, 2006, we had borrowings of $233.8 million outstanding. A 100 basispoint change in the debt benchmark rate would affect pretax income byapproximately $2.3 million. Interest rate caps purchased in the second quarterof 2005 cap LIBOR (i) for three years at 5% on a $75.0 million tranche ofborrowings and (ii) for five years at 6% on a separate $75.0 million tranche.

 

29

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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 consolidatedbalance sheets of Protection One, Inc. and subsidiaries (the “Company”) as ofDecember 31, 2005 and 2004, and the related consolidated statements ofoperations and comprehensive loss, stockholders’ equity (deficiency in assets)and cash flows for each of the periods February 9, 2005 through December 31,2005, and January 1, 2005 through February 8, 2005 and each of the years endedDecember 31, 2004 and 2003.  Our audits also included the consolidatedfinancial statement schedule listed in Item 15(a)2.  Theseconsolidated financial statements and the consolidated financial statementschedule are the responsibility of the Company’s management.  Ourresponsibility is to express an opinion on the consolidated financialstatements and the consolidated financial statement schedule based on ouraudits.

 

We conducted our audits in accordance withthe standards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement.  The Company is not required to have, nor were weengaged to perform, an audit of its internal control over financial reporting. Ouraudit included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting.  Accordingly, weexpress no such opinion.  An audit also includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our audits provide a reasonable basis forour opinion.

 

In our opinion, such consolidated financialstatements present fairly, in all material respects, the financial position ofProtection One, Inc. and subsidiaries as of December 31, 2005 and 2004, and theresults of their operations and their cash flows for each of the periodsFebruary 9, 2005 through December 31, 2005, and January 1, 2005 through February8, 2005 and each of the years ended December 31, 2004 and 2003, in conformitywith accounting principles generally accepted in the United States ofAmerica.  Also, in our opinion, such financial statement schedule, whenconsidered in relation to the basic consolidated financial statements taken asa whole, presents fairly in all material respects the information set forththerein.

 

As discussed in Note 17, the consolidatedfinancial statements as of December 31, 2005 and for the period February 9,2005 through December 31, 2005 have been restated.

 
| DELOITTE & TOUCHE LLP |   |
|---------------------------|--------|

 

Kansas City, Missouri

March 16, 2006 (April 10,2006 as to the effects of the restatement discussed in Note 17)

 

30

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                    | ** ** | **December 31,**            | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                    | ** ** | **(As Restated,   See Note 17)** | ** ** | ** ** | ** ** |
| **ASSETS**                                                                                                                                                    |       |                             |       |   |   |   |
| Current assets:                                                                                                                                               |       |                             |       |   |   |   |
| Cash and cash equivalents                                                                                                                                     |       | $                                | 19,893     |   |   | $ | 52,528 |   |
| Restricted cash                                                                                                                                               |       | —                           |       |   | 926 |   |
| Receivables, net                                                                                                                                              |       | 29,861                           |       |   | 24,219 |   |
| Inventories, net                                                                                                                                              |       | 4,466                            |       |   | 5,228 |   |
| Prepaid expenses                                                                                                                                              |       | 3,183                            |       |   | 5,793 |   |
| Other miscellaneous receivables                                                                                                                               |       | 111                              |       |   | 5,494 |   |
| Other                                                                                                                                                         |       | 3,072                            |       |   | 2,375 |   |
| Total current assets                                                                                                                                          |       | 60,586                           |       |   | 96,563 |   |
| Restricted cash                                                                                                                                               |       | 1,597                            |       |   | — |   |
| Property and equipment, net                                                                                                                                   |       | 21,553                           |       |   | 31,152 |   |
| Customer accounts, net                                                                                                                                        |       | 232,875                          |       |   | 176,155 |   |
| Goodwill                                                                                                                                                      |       | 12,160                           |       |   | 41,847 |   |
| Trade name                                                                                                                                                    |       | 25,812                           |       |   | — |   |
| Deferred customer acquisition costs                                                                                                                           |       | 73,198                           |       |   | 107,310 |   |
| Other                                                                                                                                                         |       | 8,521                            |       |   | 8,017 |   |
| Total Assets                                                                                                                                                  |       | $                                | 436,302    |   |   | $ | 461,044 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIENCY IN ASSETS)**                                                                                         | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                                          |       |                             |       |   |   |   |
| Current portion of long-term debt,  including $201,000 due to related party in 2004                                                                           |       | $                                | 2,356      |   |   | $ | 395,417 |   |
| Accounts payable                                                                                                                                              |       | 2,726                            |       |   | 2,266 |   |
| Accrued liabilities                                                                                                                                           |       | 24,100                           |       |   | 37,088 |   |
| Due to related parties                                                                                                                                        |       | —                           |       |   | 335 |   |
| Deferred revenue                                                                                                                                              |       | 36,471                           |       |   | 34,017 |   |
| Total current liabilities                                                                                                                                     |       | 65,653                           |       |   | 469,123 |   |
| Long-term debt, net of current portion                                                                                                                        |       | 321,293                          |       |   | 110,340 |   |
| Deferred customer acquisition revenue                                                                                                                         |       | 39,873                           |       |   | 57,433 |   |
| Other liabilities                                                                                                                                             |       | 1,416                            |       |   | 1,757 |   |
| Total Liabilities                                                                                                                                             |       | 428,235                          |       |   | 638,653 |   |
| Commitments and contingencies (see Note 13)                                                                                                                   |       |                             |       |   |   |   |
| Stockholders’ equity:                                                                                                                                    |       |                             |       |   |   |   |
| Preferred stock, $.10 par value, 5,000,000  shares authorized                                                                                                 |       | —                           |       |   | — |   |
| Common stock, $.01 par value, 150,000,000  shares authorized, 18,198,571 shares issued at December 31, 2005 and  2,562,512 shares issued at December 31, 2004 |       | 182                              |       |   | 26 |   |
| Additional paid-in capital                                                                                                                                    |       | 159,939                          |       |   | 1,380,728 |   |
| Accumulated other comprehensive income  (loss)                                                                                                                |       | (107                             | )          |   | 162 |   |
| Deficit                                                                                                                                                       |       | (151,947                         | )          |   | (1,523,913 | ) |
| Treasury stock, at cost, 596,858 shares at  December 31, 2004                                                                                                 |       | —                           |       |   | (34,612 | ) |
| Total stockholders’ equity (deficiency in  assets)                                                                                                       |       | 8,067                            |       |   | (177,609 | ) |
| Total Liabilities and Stockholders’ Equity  (Deficiency in Assets)                                                                                       |       | $                                | 436,302    |   |   | $ | 461,044 |   |

 

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

 

31

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE LOSS**

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

 
| ** **                                                                      | ** ** | **February 9 – December 31,** | ** ** | **January 1 – February 8,** | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                                               | ** ** | **2004**                                             | ** ** | **2003**                                   | ** ** |
| ** **                                                                      | ** ** | **(As Restated,   See Note 17)**                  | ** ** | ** **                                           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Revenues:                                                                       |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Monitoring and related services                                                 |       | $                                                      | 219,475    |                                                 |       | $                                          | 26,455     |   | $ | 247,498 |   | $ | 256,266 |   |
| Other                                                                           |       | 15,006                                                 |       |                                                 | 2,088      |                                       | 21,761     |   | 20,819 |   |
| Total revenues                                                                  |       | 234,481                                                |       |                                                 | 28,543     |                                       | 269,259    |   | 277,085 |   |
| Cost of revenues (exclusive of amortization  and depreciation shown below):     |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Monitoring and related services                                                 |       | 62,243                                                 |       |                                                 | 7,400      |                                       | 69,598     |   | 73,205 |   |
| Other                                                                           |       | 18,816                                                 |       |                                                 | 3,314      |                                       | 31,981     |   | 29,000 |   |
| Total cost of revenues (exclusive of  amortization and depreciation show below) |       | 81,059                                                 |       |                                                 | 10,714     |                                       | 101,579    |   | 102,205 |   |
| Operating expenses:                                                             |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Selling                                                                         |       | 28,856                                                 |       |                                                 | 3,989      |                                       | 33,495     |   | 31,517 |   |
| General and administrative                                                      |       | 57,158                                                 |       |                                                 | 8,104      |                                       | 71,377     |   | 77,744 |   |
| Change in control and debt restructuring  costs                                 |       | —                                                 |       |                                                 | 5,939      |                                       | 24,382     |   | — |   |
| Corporate consolidation costs                                                   |       | 2,339                                                  |       |                                                 | —     |                                       | —     |   | — |   |
| Amortization and depreciation                                                   |       | 43,742                                                 |       |                                                 | 6,638      |                                       | 78,455     |   | 80,252 |   |
| Total operating expenses                                                        |       | 132,095                                                |       |                                                 | 24,670     |                                       | 207,709    |   | 189,513 |   |
| Operating income (loss)                                                         |       | 21,327                                                 |       |                                                 | (6,841     | )                                          | (40,029    | ) | (14,633 | ) |
| Other expense (income):                                                         |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Interest expense                                                                |       | 28,683                                                 |       |                                                 | 2,602      |                                       | 26,316     |   | 25,087 |   |
| Related party interest                                                          |       | 1,951                                                  |       |                                                 | 1,942      |                                       | 18,082     |   | 15,014 |   |
| Loss on retirement of debt                                                      |       | 6,657                                                  |       |                                                 | —     |                                       | 47         |   | — |   |
| Other                                                                           |       | (688                                                   | )          |                                                 | (15        | )                                          | (147       | ) | (2,829 | ) |
| Total other expense                                                             |       | 36,603                                                 |       |                                                 | 4,529      |                                       | 44,298     |   | 37,272 |   |
| Loss before income taxes                                                        |       | (15,276                                                | )          |                                                 | (11,370    | )                                          | (84,327    | ) | (51,905 | ) |
| Income tax (expense) benefit                                                    |       | (312                                                   | )          |                                                 | (35        | )                                          | (239,579   | ) | 17,494 |   |
| Net loss                                                                        |       | $                                                      | (15,588    | )                                                    |       | $                                          | (11,405    | ) | $ | (323,906 | ) | $ | (34,411 | ) |
| Other comprehensive income (loss), net of  tax:                                 |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Reclassification adjustment for realized gain  on marketable securities         |       | (162                                                   | )          |                                                 | —     |                                       | —     |   | — |   |
| Unrealized gain on marketable securities                                        |       | —                                                 |       |                                                 | —     |                                       | 84         |   | 78 |   |
| Unrealized loss on interest rate cap                                            |       | (107                                                   | )          |                                                 | —     |                                       | —     |   | — |   |
| Comprehensive loss                                                              |       | $                                                      | (15,857    | )                                                    |       | $                                          | (11,405    | ) | $ | (323,822 | ) | $ | (34,333 | ) |
| Basic and diluted per share information:                                        |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Net loss per common share                                                       |       | $                                                      | (0.86      | )                                                    |       | $                                          | (5.80      | ) | $ | (164.78 | ) | $ | (17.53 | ) |

 

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

 

32

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollar amounts in thousands)**

 
| ** **                                                                                          | ** ** | **February 9 – December 31,** | ** ** | **January 1 – February 8,** | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                                               | ** ** | **2004**                                             | ** ** | **2003**                                   | ** ** |
| ** **                                                                                          | ** ** | **(As Restated,   See Note 17)**                       | ** ** | ** **                                           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                               | ** ** | ** **                                             |       |                                                 |       |                                       |       |   |   |   |
| Net loss                                                                                            |       | $                                                      | (15,588    | )                                                    |       | $                                          | (11,405    | ) | $ | (323,906 | ) | $ | (34,411 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities:                    |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Loss on retirement of debt                                                                          |       | 6,657                                                  |       |                                                 | —     |                                       | 47         |   | — |   |
| Senior notes received in tax sharing  settlement                                                    |       | —                                                 |       |                                                 | —     |                                       | (26,640    | ) | — |   |
| (Gain) loss on sale of assets                                                                       |       | (766                                                   | )          |                                                 | 8          |                                       | (93        | ) | (2,092 | ) |
| Amortization and depreciation                                                                       |       | 43,742                                                 |       |                                                 | 6,638      |                                       | 78,455     |   | 80,252 |   |
| Amortization of debt costs, discounts and  premium                                                  |       | 7,524                                                  |       |                                                 | 2          |                                       | 681        |   | 735 |   |
| Amortization of deferred customer  acquisition costs in excess of amortization of deferred revenues |       | 8,489                                                  |       |                                                 | 2,837      |                                       | 21,542     |   | 17,027 |   |
| Deferred income taxes                                                                               |       | —                                                 |       |                                                 | —     |                                       | 286,309    |   | 8,469 |   |
| Provision for doubtful accounts                                                                     |       | 1,664                                                  |       |                                                 | 272        |                                       | 729        |   | 774 |   |
| Other                                                                                               |       | (119                                                   | )          |                                                 | (15        | )                                          | (69        | ) | 2 |   |
| Changes in assets and liabilities, net of  effects of acquisitions and dispositions:                |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Receivables                                                                                         |       | (6,868                                                 | )          |                                                 | (263       | )                                          | (1,278     | ) | 1,637 |   |
| Related party tax receivable                                                                        |       | —                                                 |       |                                                 | —     |                                       | 26,087     |   | (5,343 | ) |
| Other assets                                                                                        |       | 6,050                                                  |       |                                                 | 5,500      |                                       | (3,951     | ) | (175 | ) |
| Accounts payable                                                                                    |       | (4,359                                                 | )          |                                                 | 5,114      |                                       | (3,139     | ) | (683 | ) |
| Deferred revenue                                                                                    |       | 1,007                                                  |       |                                                 | 1,346      |                                       | 638        |   | (2,577 | ) |
| Other liabilities                                                                                   |       | (7,020                                                 | )          |                                                 | (6,324     | )                                          | 6,402      |   | (4,580 | ) |
| Net cash provided by operating activities                                                           |       | 40,413                                                 |       |                                                 | 3,710      |                                       | 61,814     |   | 59,035 |   |
| Cash flows from investing activities:                                                               |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Installations and purchases of new accounts                                                         |       | —                                                 |       |                                                 | —     |                                       | (14        | ) | (311 | ) |
| Deferred customer acquisition costs                                                                 |       | (46,862                                                | )          |                                                 | (4,218     | )                                          | (42,720    | ) | (42,823 | ) |
| Deferred customer acquisition revenue                                                               |       | 24,360                                                 |       |                                                 | 1,991      |                                       | 21,317     |   | 18,852 |   |
| Purchase of rental equipment                                                                        |       | (772                                                   | )          |                                                 | —     |                                       | —     |   | — |   |
| Purchase of property and equipment                                                                  |       | (5,680                                                 | )          |                                                 | (250       | )                                          | (9,323     | ) | (7,450 | ) |
| Net increase in restricted cash                                                                     |       | (631                                                   | )          |                                                 | —     |                                       | —     |   | — |   |
| Proceeds from disposition of marketable  securities                                                 |       | 660                                                    |       |                                                 | —     |                                       | —     |   | — |   |
| Proceeds from redemption of preferred stock                                                         |       | 4,399                                                  |       |                                                 | —     |                                       | —     |   | — |   |
| Proceeds from disposition of assets and  sale of customer accounts                                  |       | 375                                                    |       |                                                 | 4          |                                       | 371        |   | 2,850 |   |
| Sale of AV One, Inc.                                                                                |       | —                                                 |       |                                                 | —     |                                       | —     |   | 1,411 |   |
| Net cash used in investing activities                                                               |       | (24,151                                                | )          |                                                 | (2,473     | )                                          | (30,369    | ) | (27,471 | ) |
| Cash flows from financing activities:                                                               |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Payments on long-term debt                                                                          |       | (212,714                                               | )          |                                                 | —     |                                       | (14,500    | ) | (10,159 | ) |
| Payments on credit facility                                                                         |       | (81,000                                                | )          |                                                 | —     |                                       | —     |   | — |   |
| Proceeds from long-term debt                                                                        |       | 250,000                                                |       |                                                 | —     |                                       | —     |   | — |   |
| Proceeds from sale of common stock                                                                  |       | 1,750                                                  |       |                                                 | —     |                                       | —     |   | — |   |
| Sale of parent company stock held as  treasury                                                      |       | —                                                 |       |                                                 | —     |                                       | —     |   | 11,940 |   |
| Purchase of treasury stock                                                                          |       | —                                                 |       |                                                 | —     |                                       | —     |   | (3 | ) |
| Proceeds from trademark licensing fees                                                              |       | —                                                 |       |                                                 | —     |                                       | 160        |   | 450 |   |
| Stock issuance (costs) proceeds                                                                     |       | (270                                                   | )          |                                                 | —     |                                       | —     |   | 359 |   |
| Payment for interest rate caps                                                                      |       | (922                                                   | )          |                                                 | —     |                                       | —     |   | — |   |
| Debt issue costs                                                                                    |       | (6,978                                                 | )          |                                                 | —     |                                       | —     |   | — |   |
| Funding from (payment to) parent                                                                    |       | —                                                 |       |                                                 | —     |                                       | 220        |   | (722 | ) |
| Net cash provided by (used in) financing  activities                                                |       | (50,134                                                | )          |                                                 | —     |                                       | (14,120    | ) | 1,865 |   |
| Net cash provided by discontinued  operations from operating activities                             |       | —                                                 |       |                                                 | —     |                                       | —     |   | 229 |   |
| Net increase (decrease) in cash and cash  equivalents                                               |       | (33,872                                                | )          |                                                 | 1,237      |                                       | 17,325     |   | 33,658 |   |
| Cash and cash equivalents:                                                                          |       |                                                   |       |                                                 |       |                                       |       |   |   |   |
| Beginning of period                                                                                 |       | 53,765                                                 |       |                                                 | 52,528     |                                       | 35,203     |   | 1,545 |   |
| End of period                                                                                       |       | $                                                      | 19,893     |                                                 |       | $                                          | 53,765     |   | $ | 52,528 |   | $ | 35,203 |   |
| Cash paid for interest                                                                              |       | $                                                      | 25,209     |                                                 |       | $                                          | 6,451      |   | $ | 45,003 |   | $ | 40,989 |   |
| Cash paid for income taxes, exclusive of  benefits received from parent                             |       | $                                                      | 438        |                                                 |       | $                                          | 6          |   | $ | 327 |   | $ | 296 |   |

 

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

 

33

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY (DEFICIENCY IN ASSETS)**

**(Dollar amounts in thousands)**

 
| ** **                                                                                                 | ** ** | **Common Stock** | ** ** | **Treasury** | ** ** | **Additional  Paid –In** | ** ** | **Investment  In Parent** | ** ** | ** **     | ** ** | **Accumulated  Other  Comprehensive ** | ** ** | **Total  Stockholders’  Equity  (Deficiency in** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------|------------|------------------------------------|------------|--------------------------------|------------|----------------|------------|---------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **Shares**            | ** ** | **Amount**   | ** ** | **Stock**                          | ** ** | **Capital**                    | ** ** | **Securities** | ** ** | **Deficit**                                 | ** ** | **Income(Loss)**                                           | ** ** | **Assets)** | ** ** |
| ** **                                                                                                 | ** ** | ** **            | ** ** | ** **   | ** ** | ** **                         | ** ** | ** **                     | ** ** | ** **     | ** ** | **(As  Restated,   See Note 17)**           | ** ** | ** **                                                 | ** ** | **(As Restated,    See Note 17)** | ** ** |
| **Common  Stock**                                                                                          |       |                  |       |         |       |                               |       |                           |       |           |       |                                        |       |                                                       |       |   |   |
| ** **                                                                                                 |       |                  |       |         |       |                               |       |                           |       |           |       |                                        |       |                                                       |       |   |   |
| ***January  1, 2003***                                                                                     |       | 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 | ) |
| Sale of 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 | ) |
| Net loss                                                                                                   |       | —                |       | —       |       | —                             |       | —                         |       | —         |       | (11,405                                     | )          | —                                                     |       | (11,405 | ) |
| ***February  8, 2005***                                                                                    |       | 1,965,654             |       | $            | 26         |                               | $          | (34,612                        | )          | $              | 1,380,728  |                                        |       |                                                       | $          | (1,535,318 | ) | $ | 162 |   | $ | (189,014 | ) |
| Debt for equity  exchange                                                                                  |       | 16,000,000            |       | 160          |       | —                             |       | 119,840                        |       | —         |       | —                                      |       | —                                                     |       | 120,000 |   |
| Stock purchased                                                                                            |       | 232,917               |       | 2            |       | —                             |       | 1,748                          |       | —         |       | —                                      |       | —                                                     |       | 1,750 |   |
| Partial shares  adjustment from reverse stock split                                                        |       | —                |       | (6           | )          | —                             |       | 6                              |       | —         |       | —                                      |       | —                                                     |       | — |   |
| Push down  accounting adjustments                                                                          |       | —                |       | —       |       | 34,612                             |       | (1,342,113                     | )          | —         |       | 1,398,959                                   |       | —                                                     |       | 91,458 |   |
| Stock issuance  costs                                                                                      |       | —                |       | —       |       | —                             |       | (270                           | )          | —         |       | —                                      |       | —                                                     |       | (270 | ) |
| Reclassification  adjustment for realized gains on marketable securities included in net loss,  net of tax |       | —                |       | —       |       | —                             |       | —                         |       | —         |       | —                                      |       | (162                                                       | )          | (162 | ) |
| Unrealized  loss-interest rate caps, net of tax                                                            |       | —                |       | —       |       | —                             |       | —                         |       | —         |       | —                                      |       | (107                                                       | )          | (107 | ) |
| Net loss                                                                                                   |       | —                |       | —       |       | —                             |       | —                         |       | —         |       | (15,588                                     | )          | —                                                     |       | (15,588 | ) |
| ***December  31, 2005***                                                                                   |       | 18,198,571            |       | $            | 182        |                               | $          | —                         |       | $              | 159,939    |                                        | $          | —                                                     |       | $ | (151,947 | ) | $ | (107 | ) | $ | 8,067 |   |

 

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

 

34

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.****             The Company:**

 

Protection One, Inc., referred to as Protection One or theCompany, a Delaware corporation, is a publicly-traded security alarm monitoringcompany. Protection One is principally engaged in the business of providingsecurity alarm monitoring services, which includes sales, installation andrelated servicing of security alarm systems for residential and businesscustomers. 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. BothPOI Acquisition, L.L.C. and POI Acquisition I, Inc. are entities formed byQuadrangle Capital Partners L.P., Quadrangle Select Partners L.P., QuadrangleCapital Partners-A L.P. and Quadrangle Master Funding Ltd, collectivelyreferred to as Quadrangle. Westar retained approximately 1% of the Company’scommon stock, representing shares underlying restricted stock units granted tocurrent 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 anaggregate of approximately $154.7 million to Westar as consideration for boththe common stock and the revolving credit facility, including accrued interestof $2.2 million, with approximately $2.1 million of the payments beingconsideration for the common stock.

 

Upon completion of the Westar sale transaction and as a result ofliquidity problems caused by its significant debt burden and continuing netlosses, the Company retained a financial advisor and began discussionsregarding a potential debt restructuring. In November 2004, the Companyreceived $73.0 million pursuant to a tax sharing settlement agreement withWestar that terminated the Westar tax sharing agreement, generally settled allclaims with Westar relating to the tax sharing agreement and generally settledall claims between Quadrangle and Westar relating to the Westar saletransaction. Contemporaneously, the Company entered into a debt-for-equityexchange agreement with Quadrangle that provided for the principal balanceoutstanding under the Quadrangle credit facility to be reduced by $120.0million in exchange for the issuance to Quadrangle of the equivalent of 16million shares of the Company’s common stock (on a post-reverse stock splitbasis). The exchange was completed on February 8, 2005 and was accompanied by aone-share-for-fifty-shares reverse stock split of the Company’s outstandingshares of common stock. The newly issued shares, together with shares alreadyowned by Quadrangle, resulted in Quadrangle owning approximately 97.3% of theCompany’s common stock.

 

As a result of Quadrangle obtaining control of over 95% of the commonstock of the Company on February 8, 2005, SEC Staff Accounting Bulletin Topic5J requires the acquisition by Quadrangle to be “pushed-down,” meaning thepost-transaction financial statements of the Company reflect a new basis of accounting.

 

The purchase price paid as a result of each transaction described abovehas been allocated to a proportionate amount of the Company’s underlying assetsand liabilities based upon Quadrangle’s acquired interests (86.8% on February17, 2004 and 10.5% on February 8, 2005) in the respective fair market values ofassets and liabilities at the date of each transaction. The followingrepresents the approximate fair values attributable to the assets acquired andliabilities assumed in Quadrangle’s acquisition of substantially all of theCompany’s outstanding common stock. These values exclude the proportionateshare of the historical cost basis attributable to the minority interestholders representing 2.7% of the Company.

 

Allocation of proportionate share to major components of assets andliabilities acquired (dollar amounts in millions):

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

 

35

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The primary changes to the balance sheet reflect (1) the reduction ofdeferred customer acquisition costs and revenues, which have been subsumed intothe estimated fair market value adjustment for customer accounts; (2)adjustments to the carrying values of debt to estimated fair market value (orQuadrangle’s basis in the case of the credit facility); (3) adjustments tohistorical goodwill to reflect goodwill arising from the push down accountingadjustments; (4) the recording of a value for trade names; and (5) an increaseto the equity section from these adjustments. The primary changes to the incomestatement include (1) the reduction in other revenue due to a lower level ofamortization from the reduced amortizable base of deferred customer acquisitionrevenues; (2)  the reduction in othercosts of revenue and selling expenses due to lower level of amortization fromthe reduced amortizable base of deferred customer acquisition costs; (3) anincrease in interest expense due to amortization of debt discounts arising fromdifferences in fair values and carrying values of the Company’s debtinstruments; and (4) the reduction in amortization related to the reduction inthe amortizable base of customer accounts.

 

Due to the impact of the changes resulting from the push downaccounting adjustments described above, the income statement and cash flowspresentations separate the Company’s results into two periods:  (1) the period ending with the February 8,2005 consummation of the exchange transaction and (2) the period beginningafter that date utilizing the new basis of accounting. The results are furtherseparated by a heavy black line to indicate the effective date of the new basisof accounting. Similarly, the current and prior period amounts reported on thebalance sheet are separated by a heavy black line to indicate the applicationof a new basis of accounting between the periods presented.

 

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 prepares its financial statements in conformity withaccounting principles generally accepted in the United States of America, whichrequire management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosures of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates. The accompanying consolidated financial statementsinclude the accounts of Protection One’s wholly owned subsidiaries. Allsignificant intercompany balances have been eliminated in consolidation.

 

* *InAugust 2005, the Company began efforts to consolidate management and othersupport functions with its Network Multifamily subsidiary. Approximately fortypositions were eliminated, including the President, Senior VicePresident-Sales, Senior Vice President-Legal and Vice President-Finance. TheCompany accrued approximately $2.3 million for severance and retention expensesrelated to this consolidation and paid approximately $2.2 million of thisamount as of December 31, 2005. Additional expense of approximately $20.0thousand was incurred in January 2006 and the remaining accrued amounts werepaid at that time.

 

In December 2005,the Company moved its commercial monitoring operations from Portland, Maine, toNetwork Multifamily’s monitoring facility in Irving, Texas. Approximatelytwenty-four positions were eliminated related to the consolidation of the Portlandmonitoring center.

 

**2.****             Summary ofSignificant Accounting Policies:**

 

*(a)**  StockBased Compensation*

 

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 the disclosure requirements of SFAS 123 torequire prominent disclosures in both annual and interim financial statementsabout the method of accounting for stock-based employee compensation and theeffect of the method used on reported results. This statement requires thatcompanies follow the prescribed format and provide the additional disclosuresin their annual reports for fiscal years ending after December 15, 2002. TheCompany applies the recognition and measurement principles of AccountingPrinciples Board, or APB, Opinion No. 25, “Accounting for Stock Issued toEmployees,” as allowed by SFAS Nos. 123 and 148, and related interpretations inaccounting for its stock-based compensation plans, as described in Note 8 ofthe Consolidated Financial 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. Information related to the pro formaimpact on the Company’s earnings and earnings per share follows (dollar amountsin thousands, except earnings per share amounts).

 

36

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| ** **                                                                                                        | ** ** | **February 9 – December 31,** | ** ** | **January 1 – February 8,** | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2005**                                               | ** ** | **2004**                                             | ** ** | **2003**                                   | ** ** |
| ** **                                                                                                        | ** ** | ** **                                             | ** ** | ** **                                           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Loss available for common stock, as  reported                                                                     |       | $                                                      | (15,588    | )                                                    | $          | (11,405                                    | )          | $ | (323,906 | ) | $ | (34,411 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss, net of related taxes               |       | —                                                 |       | —                                               |       | 34                                         |       | 89 |   |
| Deduct: Total stock option expense  determined under fair value method for all awards, net of related tax effects |       | (2,169                                                 | )          | (16                                                  | )          | (672                                       | )          | (676 | ) |
| Loss available for common stock, pro forma                                                                        |       | (17,757                                                | )          | $                                                    | (11,421    | )                                          | $          | (324,544 | ) | $ | (34,998 | ) |
| Net loss per common share (basic and  diluted):                                                                   |       |                                                   |       |                                                 |       |                                       |       |   |   |
| As reported                                                                                                       |       | $                                                      | (0.86      | )                                                    | $          | (5.80                                      | )          | $ | (164.78 | ) | $ | (17.53 | ) |
|                                                                                                              |       |                                                   |       |                                                 |       |                                       |       |   |   |
| Pro forma                                                                                                         |       | (0.98                                                  | )          | $                                                    | (5.81      | )                                          | $          | (165.11 | ) | $ | (17.83 | ) |

 

As described in “New Accounting Standards-Share Based Payment” below,the Company will change its method of accounting for options beginning in 2006.

 

*(b)**          Revenue Recognition*

 

Revenues are recognized when security services are provided. Systeminstallation revenues, sales revenues on equipment upgrades and direct andincremental costs of installations and sales are deferred for residentialcustomers with monitoring service contracts. For commercial customers and ournational account customers, revenue recognition is dependent upon each specificcustomer contract. In instances when the Company passes title to a system, theCompany recognizes the associated revenues and costs related to the sale of theequipment in the period incurred regardless of whether the sale is accompaniedby a service agreement. In cases where the Company retains title to the system,the Company defers 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. Deferred system and upgrade installation revenuesare recognized over the expected life of the customer utilizing an acceleratedmethod for residential and commercial customers and a straight-line method forNetwork Multifamily customers. Deferred costs in excess of deferred revenue arerecognized over the initial contract term, utilizing a straight-line method,typically three years for Protection One Monitoring and five to ten years forNetwork Multifamily systems. To the extent deferred costs are less thandeferred revenues, such costs are recognized over the estimated life of thecustomer.

 

The Company follows SFAS 13, “Accounting for Leases,” for itsarrangements whereby security equipment that does not require monitoring isleased to customers, typically over a five year initial lease term. Thisequipment typically consists of closed circuit television equipment and cardaccess control equipment. The Company records these arrangements as operatingleases and records revenue on a straight line basis over the life of the lease.

 

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. Revenuesfrom monitoring activities are recognized 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 cumulativewrite-downs of $2.5 million and $2.0 million at December 31, 2005 and 2004,respectively. These write-downs are determined based primarily upon currentusage of the individual parts included in inventory.

 

*(d)**          Property and Equipment*

 

Property and equipment are stated at cost or at the fair value atFebruary 8, 2005 to reflect the new basis of accounting and are depreciatedusing the straight-line method over estimated useful lives. Gains or lossesfrom retirements and dispositions of property and equipment are recognized inincome in the period realized. Repair and maintenance costs are expensed asincurred. See Note 4, “Property and Equipment,” for additional informationregarding push down accounting related to property and equipment.

 

37

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Estimated useful lives of property and equipment are as follows:

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

 

*(e)**           Income Taxes*

 

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

 

The Company had a tax sharing agreement with Westar Energy during theperiod that Westar owned a controlling interest in the Company. The tax sharingagreement utilized a parent company down approach in the allocation of incometax expense among members of the consolidated tax group. Pursuant to thisagreement, Westar Energy made payments to the Company for current tax benefitsutilized by Westar Energy in its consolidated tax return irrespective ofwhether the Company would realize these current benefits on a separate returnbasis.

 

The Company currently does not have any taxable earnings and does notexpect to have taxable earnings in the foreseeable future. Income tax expenseshown on the statements of operations represents state taxes paid by theCompany’s subsidiaries.

 

*(f)**            Comprehensive Loss*

 

Comprehensive loss consists of net loss and the unrealized gains andlosses associated with available-for-sale investment securities and interestrate caps.

 

*(g)**          Customer Accounts*

 

Additions to customer accounts are stated at cost and are amortizedover the estimated customer life. Internal costs incurred in support ofacquiring customer accounts are expensed as incurred. Upon adoption ofpush-down accounting as a result of Quadrangle’s increased ownership in theCompany, new values for customer accounts were recorded as of February 8, 2005to reflect the estimated fair value of these accounts.

 

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, inmanagement’s opinion, they would adequately match amortization cost withanticipated revenue. The Company periodically uses an independent appraisalfirm to perform lifing studies on its customer accounts in order to assistmanagement in determining appropriate lives of its customer accounts. Thesereviews are performed specifically to evaluate the Company’s historicamortization policy in light of the inherent declining revenue curve over thelife of a pool of customer accounts, and the Company’s historical attrition experience.The Company had previously identified three distinct pools of customeraccounts, each of which had distinct attributes that effect differing attritioncharacteristics. One of these pools (the acquired Westinghouse customers), wasfully amortized at December 31, 2004. For the Protection One Monitoring pool,the results of lifing studies indicated that the Company can expect attritionto be greatest in years one through five of asset life and that a decliningbalance (accelerated) method would therefore best match the future amortizationcosts with the estimated revenue stream from these customer pools. The Companyswitches from the declining balance method to the straight-line method in theyear the straight-line method results in greater amortization expense.

 

38

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

 
| **Pool**                                                                                           | ** ** | **Method**                              |
|----------------------------------------------------------------------------------------------------|------------|-----------------------------------------|
| New  amortization method (post February 8, 2005):                                                  |       |                                    |
| Protection  One Monitoring                                                                         |       | Ten–year  135% declining balance   |
| Network  Multifamily                                                                               |       | Nine–year  straight-line           |
|                                                                                               |       |                                    |
| Historical  amortization method (pre February 9, 2005):                                            |       |                                    |
| Protection  One Monitoring:                                                                        |       |                                    |
| •           Acquired Westinghouse Customers |       | Eight–year  120% declining balance |
| •           Other Customers                 |       | Ten–year  135% declining balance   |
| Network  Multifamily                                                                               |       | Nine–year  straight-line           |

 

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 of its business or the value of itscustomer accounts that may be incurred prospectively may also requireadditional impairment charges. No impairment charges were recorded in theperiods presented herein.

 

*(h)**          Goodwill and Trade Name*

 

The new basis of accounting resulted in new recorded values for tradenames and for goodwill as of February 8, 2005 to reflect their estimated fairvalues. Neither of these intangible assets is amortizable and they aretherefore subject to annual impairment testing. The Company had establishedJuly 1 as its annual impairment testing date and completed its annualimpairment testing during the third quarter of 2005 and 2004 and determinedthat no impairment of its non-amortizable intangible assets was required as ofeach testing date. An impairment test is also completed if events or changes incircumstances indicate that the assets might be impaired. The Companydetermined that no impairment was required due to the impact of HurricaneKatrina.

 

*(i)**           Cash and CashEquivalents*

 

All highly liquid investments purchased with a remaining maturity ofthree months or less at the date acquired are cash equivalents. Theseinvestments, consisting of money market funds and 30-day certificate ofdeposits, 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 former insurer of theCompany’s workers’ compensation claims and collateral for the Company’s suretybonding requirements. The workers’ compensation collateral is required tosupport reserves established on claims filed during the period covered by theformer insurer. The Company receives interest income earned by the trust. Thesurety bond collateral is required by the Company’s liability insurance carrier.The funds have been deposited into a money market account which earns interestincome.

 

*(k)**          Receivables*

 

Gross receivables, which consist primarily of trade accountsreceivable, of $34.9 million at December 31, 2005 and $29.8 million at December31, 2004 have been reduced by allowances for doubtful accounts of $5.0 millionand $5.6 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. Thispercentage, which is based on the Company’s historical collections experience,is increased as any portion of the receivable ages until it is fully reservedand written off when it is 120 days past due and the account is disconnectedand turned over to a collection agency. Additionally, once the customer’sbalance is greater than 120 days past due, all other receivable balancesassociated with that customer, irrespective of how many days past due, aredeemed to be 120 days past due and fully reserved. In certain instances, basedupon the discretion of the local general manager, credit can be extended andthe account may remain active.

 

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

 

*(l)**           Marketable securities*

 

The Company’s marketablesecurities at December 31, 2004 consisted of 16,168 shares ofavailable-for-sale MetLife stock received as part of MetLife’s demutualization.The securities were recorded at market value with a balance of $0.7 million atDecember 31, 2004, which included $0.2 million of unrealized gains. Thesecurities were sold in the first quarter of 2005.

 

39

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*(m)**          Advertising Costs*

 

Printed materials are expensed as incurred. Broadcast advertising costsare expensed upon the first broadcast of the respective advertisement. Totaladvertising expense was $2.3 million and $0.1 million for the periods February9, 2005 through December 31, 2005, and January 1, 2005 through February 8,2005, respectively. Total advertising expense was $2.5 million and $2.8 millionduring the years ended December 31, 2004, and 2003, respectively.

 

*(n)**          Derivative FinancialInstruments*

 

The Company’s interest rate caps are recorded in the consolidatedbalance sheet at fair value and have been designated as cash flow hedges. Changesin the fair value are recognized in other comprehensive income (loss) until thehedge transaction is recognized in earnings. The unamortized costs of the capagreements are included in other assets. The Company will amortize the costs ofthe interest rate caps to interest expense over the respective lives of theagreements with any ineffectiveness in the hedging relationship recognizedimmediately in earnings. Payments to be received as a result of the capagreements, if any, will be accrued as a reduction of interest expense.

 

*(o)**          Concentrations of CreditRisk*

 

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. The Company extends credit to its customers inthe normal course of business, performs periodic credit evaluations andmaintains allowances for the potential credit losses. The Company has customerslocated throughout the United States. The Company does not believe asignificant risk of loss from a concentration of credit risk exists.

 

*(p)**          Loss Per Share*

 

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

 
| ** **                          | ** ** | **February 9 – December 31,** | ** ** | **January 1 – February 8,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2005**                                               | ** ** | **2004**                                             | ** ** | **2003**              | ** ** |
| Weighted average shares outstanding |       | 18,198,571                                             |       | 1,965,654                                            |       | 1,965,654             |       | 1,962,587 |   |

 

For the period February 9, 2005 through December 31, 2005, the Companyhad outstanding stock options that represented 1.0 million dilutive potentialcommon shares. No outstanding stock options and warrants represent dilutivepotential common shares for the period January 1, 2005 through February 8, 2005or for the year ended December 31, 2004. The Company had outstanding stockoptions and warrants of which approximately 111 represent dilutive potentialcommon shares for the year ended December 31, 2003. These securities were notincluded in the computation of diluted earnings per share since to do so wouldhave been antidilutive for all periods presented.

 

*(q)**          NewAccounting Standards*

 

*Share-Based Payment.*InDecember 2004, the FASB issued Statement of Financial Accounting Standards No.123R (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which replacesSFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedesAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees.”  SFAS No. 123Rrequires compensation costs related to share-based payment transactions to berecognized in financial statements based on the fair value on the grant date ofthe equity or liability instruments used. Compensation cost will be recognizedover the period that an employee provides service for that award, resulting ina decrease in net earnings. The Company will adopt provisions of thisStatement, as amended, using the modified prospective method beginning infiscal 2006. Compensation costs will be recognized for awards that are issuedbeginning in 2006 and for awards that have been granted prior to December 31,2005 but have yet to reach the end of the requisite service period. The amountof expense to be recognized over the remaining service period as of December31, 2005 is $6.7 million. The Company will begin expensing these costs over theshorter of the vesting period or the period from the date of grant to the datethe employee becomes eligible for retirement. Based on currently outstandingoptions, the Company expects to record total expense of approximately $2.1million during 2006.

 

*Accounting Changes and Error Corrections.*InMay 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error**Corrections, a replacement of APB Opinion No. 20 and FASBStatement No. 3,” to change the requirements for the accounting for andreporting of a change in accounting principle. The provisions of the Statementare effective for accounting changes and

 

40

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correction of errors made infiscal years beginning after December 21, 2005. This new standard could have amaterial impact on the Company’s results of operations, financial position orcash flows if an accounting change or error correction occurs.

 

**3.****             AccruedLiabilities:**

 

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

 

| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Accrued interest                                 |       | $                     | 5,342      |   |   | $ | 8,653 |   |
| Accrued vacation pay                             |       | 3,436                 |       |   | 2,624 |   |
| Accrued salaries, bonuses and employee  benefits |       | 5,445                 |       |   | 9,145 |   |
| Other accrued liabilities                        |       | 9,877                 |       |   | 16,666 |   |
| Total accrued liabilities                        |       | $                     | 24,100     |   |   | $ | 37,088 |   |

 

**4.****             Propertyand Equipment:**

 

As discussed in Note 1, “The Company,” because Quadrangle acquiredsubstantially all of the Company’s common stock, a new basis of accounting wasestablished and new values for property and equipment were recorded as ofFebruary 8, 2005. The following reflects the Company’s carrying value inproperty and equipment as of the following periods (dollar amounts inthousands):

 

| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                            | ** ** | ** **            | ** ** | ** ** | ** ** |
| Furniture, fixtures and equipment     |       | $                     | 4,290      |   |   | $ | 8,112 |   |
| Data processing and telecommunication |       | 24,408                |       |   | 75,474 |   |
| Leasehold improvements                |       | 2,762                 |       |   | 3,819 |   |
| Vehicles                              |       | 8,991                 |       |   | 14,501 |   |
| Buildings and other                   |       | 5,473                 |       |   | 6,188 |   |
| Rental equipment                      |       | 772                   |       |   | — |   |
|                                  |       | 46,696                |       |   | 108,094 |   |
| Less accumulated depreciation         |       | (25,143               | )          |   | (76,942 | ) |
| Property and equipment, net           |       | $                     | 21,553     |   |   | $ | 31,152 |   |

 

Depreciation expense was $11.1 million and $1.0 million for the periodsFebruary 9, 2005 through December 31, 2005, and January 1, 2005 throughFebruary 8, 2005, respectively. Depreciation expense was $9.9 million and $11.6million for the years ended December 31, 2004 and 2003, respectively.

 

Rental equipment is comprised of commercial security equipment thatdoes not require monitoring services by the Company and is leased to customers,typically over a 5-year initial lease term. Accumulated depreciation ofapproximately $16.0 thousand has been recorded on these assets as of December31, 2005. The following is a schedule by years of minimum future rentals onnon-cancelable operating leases as of December 31, 2005 (dollar amounts inthousands):

 
| **Year ending December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 2006                                        |       | $          | 159        |   |
| 2007                                        |       | $          | 159        |   |
| 2008                                        |       | $          | 159        |   |
| 2009                                        |       | $          | 159        |   |
| 2010                                        |       | $          | 67         |   |
| Total minimum future rentals                |       | $          | 703        |   |

 

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

 

As discussed in Note 1, “The Company,” because Quadrangle acquiredsubstantially all of the Company’s common stock, a new basis of accounting wasestablished and new values for customer accounts were recorded at February 8,2005. The following reflects the Company’s carrying value in customer accountsas of the following dates (dollar amounts in thousands):

 

41

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| ** **               | ** ** | **Protection One  Monitoring** | ** ** | **Network Multifamily** | ** ** | **Total Company** | ** ** |
|--------------------------|------------|-------------------------------------|------------|-------------------------|------------|-------------------|------------|
| ** **               | ** ** | **12/31/2005**                      | ** ** | **12/31/2004**          | ** ** | **12/31/2005**    | ** ** | **12/31/2004** | ** ** | **12/31/2005** | ** ** | **12/31/2004** | ** ** |
|                     |       |                                |       |                    |       |              |       |   |   |   |   |   |   |
| Customer accounts        |       | $                                   | 260,319    |                    |       | $                 | 646,229    |   | $ | 51,872 |   |   | $ | 34,691 |   | $ | 312,191 |   |   | $ | 680,920 |   |
| Accumulated Amortization |       | $                                   | (68,495    | )                       |       | $                 | (478,856   | ) | $ | (10,821 | ) |   | $ | (25,909 | ) | $ | (79,316 | ) |   | $ | (504,765 | ) |
| Customer accounts, net   |       | $                                   | 191,824    |                    |       | $                 | 167,373    |   | $ | 41,051 |   |   | $ | 8,782 |   | $ | 232,875 |   |   | $ | 176,155 |   |

 

Amortization expense was $32.6 million for the period February 9, 2005through December 31, 2005 and $5.6 million for the period January 1, 2005through February 8, 2005. Amortization expense was $68.6 million for each ofthe years ended December 31, 2004 and 2003. The table below reflects theestimated aggregate customer account amortization for each of the fivesucceeding years on the Company’s existing customer account base as of December31, 2005 (dollar amounts in thousands):

 
| ** **                     | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Estimated amortization expense |       | $        | 32,528     |     | $          | 29,687   |       | $        | 28,726     |     | $          | 28,301 |   | $ | 28,253 |   |
|                                |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

The new basis of accounting also resulted in new recorded values fortrade names and for goodwill as of February 8, 2005 for both segments. Neitherof these intangible assets is amortizable and they are therefore subject toannual impairment testing and when circumstances dictate. The Company completedits annual impairment testing during the third quarter of 2005 and determinedthat no impairment of its non-amortizable intangible assets was required as ofJuly 1, 2005. The Company also determined that no impairment was required dueto the impact of Hurricane Katrina. The following table reflects these amountsas of the following periods (dollar amounts in thousands):

 
| ** ** | ** ** | **Protection One Monitoring** | ** ** | **Network Multifamily** | ** ** | **Total Company** | ** ** |
|------------|------------|-----------------------------------------|------------|------------------------------|------------|------------------------|------------|
| ** ** | ** ** | **12/31/2005**                          | ** ** | **12/31/2004**               | ** ** | **12/31/2005**         | ** ** | **12/31/2004** | ** ** | **12/31/2005** | ** ** | **12/31/2004** | ** ** |
|       |       |                                    |       |                         |       |                   |       |   |   |   |   |   |   |
| Trade name |       | $                                       | 22,987     |                         |       | $                      | —     |   | $ | 2,825 |   |   | $ | — |   | $ | 25,812 |   |   | $ | — |   |
| Goodwill   |       | $                                       | 7,430      |                         |       | $                      | —     |   | $ | 4,730 |   |   | $ | 41,847 |   | $ | 12,160 |   |   | $ | 41,847 |   |

 

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

 

**6.****             Debt:**

 

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

 
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Quadrangle Credit (a)                  |       | $                     | —     |   |   | $ | 201,000 |   |
| Bank Credit Facility (b)               |       | 233,823               |       |   | — |   |
| Senior Subordinated Notes (c)          |       | 89,826                |       |   | 110,340 |   |
| Senior Notes (c)                       |       | —                |       |   | 164,285 |   |
| Senior Subordinated Discount Notes (d) |       | —                |       |   | 30,132 |   |
|                                   |       | 323,649               |       |   | 505,757 |   |
| Less current portion (e)               |       | (2,356                | )          |   | (395,417 | ) |
| Total long-term debt                   |       | $                     | 321,293    |   |   | $ | 110,340 |   |

 

----

(a)   Theweighted-average annual interest rate before fees on borrowings at December 31,2004 was 9.0%. The Quadrangle credit facility was repaid in April 2005 as partof the refinancing described in “Refinancing” below.

(b)   AtDecember 31, 2005, the weighted average annual interest rate before fees was7.4%. See “Bank Credit Facility” below, for additional discussion regarding thematurity date, variable interest rate and applicable margins. The bank creditfacility is secured by substantially all assets of the Company.

 

42

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(c)   See“Valuation of Debt” below regarding the discount amount associated with thedebt instruments. The stated interest rate on December 31, 2004 was 7.375% onthe Senior Notes and was 8.125% on the Senior Subordinated Notes. The effectiverate to the Company due to the accretion of debt discounts was approximately13.2% on the Senior Notes and was approximately 15.9% on the SeniorSubordinated Notes. All outstanding Senior Notes were redeemed in April 2005 aspart of the refinancing described in “Refinancing” below.

(d)   Alloutstanding Senior Subordinated Discount Notes were repurchased at 101% inMarch 2005 pursuant to a change of control repurchase offer. At December 31,2004, the carrying value of the notes included an unamortized premium ofapproximately $0.3 million.

(e)   TheBank Credit Facility requires quarterly principal reduction payments ofapproximately $0.6 million.

 

*Valuation of Debt*

 

As discussed in Note 1, “The Company,” becauseQuadrangle acquired substantially all of the Company’s common stock, a newbasis of accounting was established at February 8, 2005, and new values for theCompany’s debt instruments were determined based on estimated fair marketvalues for debt due to unrelated parties and based on Quadrangle’s cost basisfor the Quadrangle Credit Facility. As of December 31, 2005, the unamortizeddiscount on the 8.125% senior subordinated notes due January 2009 was $20.5million. The discount is being amortized using the effective interest ratemethod over the remaining life of the debt.

 

*Refinancing*

 

On April 18, 2005, the Company entered into a new credit agreementenabling it to complete a redemption of its 7.375% senior notes due 2005 forapproximately $166.3 million plus accrued interest (approximately $164.3million aggregate principal amount outstanding) and the repayment of its Quadranglecredit facility (approximately $78.0 million aggregate principal amountoutstanding). The 7.375% senior notes due 2005 and the Quadrangle creditfacility each had a maturity date of August 15, 2005. The Company recorded aloss in the second quarter of 2005 of approximately $6.1 million associatedwith such redemption and repayment.

 

*Bank Credit Facility*

 

To facilitate the redemption of its 7.375% senior notes due 2005 andthe repayment of its Quadrangle credit facility, the Company entered into a CreditAgreement, dated as of April 18, 2005 (the “bank credit agreement”), with theseveral banks and other financial institutions or entities from time to timeparties to the bank credit agreement.

 

The bank credit agreement provides for a $25.0 million revolving creditfacility and a $250.0 million term loan facility. The revolving credit facilitymatures in 2010 and the term loan matures in 2011, subject to earlier maturity(July 1, 2008) if the Company does not refinance its 8.125% senior subordinatednotes due 2009 before July 2008. Letters of credit are also available to theCompany under the bank credit agreement. The new revolving credit facility isundrawn as of March 10, 2006 and approximately $24.0 million remains availableafter reducing total availability by approximately $1.0 million for outstandingletters of credit. The Company intends to use any other proceeds fromborrowings under the revolving credit facility, from time to time, for workingcapital and general corporate purposes.

 

Pursuant to the Guarantee and Collateral Agreement, dated as of April18, 2005 (the “Guarantee Agreement”), by the Company and its subsidiaries infavor of Bear Stearns Corporate Lending Inc., the new credit facilities areguaranteed by Protection One Systems, Inc., Protection One Data Services, Inc.,Security Monitoring Services, Inc., Protection One Alarm Monitoring of Mass,Inc. and Network Multifamily Security Corporation (collectively with theCompany, the “Guarantors”), the Company’s domestic subsidiaries, and secured bya perfected first priority security interest in substantially all of theCompany’s and the Guarantors’ present and future assets.

 

Borrowings under the bank credit agreement bear interest at a ratecalculated according to a base rate or a Eurodollar rate, at the Company’sdiscretion, plus an applicable margin. The applicable margin with respect tothe term loan is 2.0% for a base rate borrowing and 3.0% for a Eurodollarborrowing. Depending on the Company’s leverage ratio at the time of borrowing,the applicable margin with respect to a revolving loan may range from 1.25% to2.25% for a base rate borrowing and 2.25% to 3.25% for a Eurodollar borrowing.

 

The bank credit agreement required the Company to enter into a hedgeagreement to provide interest rate protection on at least $70.0 million of theterm loans for not less than two years. To satisfy this requirement and tofurther limit its exposure to interest rate risk on the variable rate bankcredit facility, the Company entered into two separate interest rate capagreements in May 2005 for a one-time aggregate cost of approximately $0.9million. The Company’s objective is to protect against increases in interestexpense caused by fluctuation in the LIBOR interest rate. One interest rate capprovides protection on $75 million of the Company’s long term debt over afive-year period if LIBOR exceeds 6%. A second interest rate cap providesprotection on $75 million of the Company’s long term debt over a three-yearperiod if LIBOR exceeds 5%.

 

43

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The unamortized costs of the cap agreements at December 31, 2005 are$0.8 million and are included in other assets. The Company will amortize thecosts of the interest rate caps to interest expense over the respective livesof the agreements. In 2005, no payments were received as a result of the capagreements, no significant amounts were amortized to interest expense and therewas no ineffectiveness in the hedging relationship of the interest rate caps.

 

*Quadrangle Credit Facility*

 

On November 12, 2004, the Company entered into adebt-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 our common stock. The exchange was completed on February 8,2005. As part of the April 2005 refinancing, the $78 million outstandingbalance on the Quadrangle Credit Facility was paid in full.

 

At December 31, 2004 the Quadrangle credit facility provided forborrowings up to $201.0 million with a variable interest rate. Theweighted-average annual interest rate after fees on all borrowings under thefacility was 8.4% for the year ended December 31, 2004.

 

*Senior Subordinated Notes*

 

In 1998, the Company issued $350 million aggregate principal amount ofunsecured 8.125% senior subordinated notes. Interest on these notes is payablesemi-annually on January 15 and July 15. The notes are redeemable at the Company’soption, in whole or in part, at a predefined price.

 

*Senior Notes*

 

In 1998, the Company issued $250 million of 7.375% senior notes. Interestwas payable semi-annually on February 15 and August 15. On November 12, 2004,as part of the Westar tax sharing settlement agreement, Westar transferredapproximately $26.6 million principal of these notes to the Company, which weresubsequently retired. On April 18, 2005, the Company completed a redemption ofits 7.375% senior notes due 2005 for approximately $166.3 million plus accruedinterest (approximately $164.3 million aggregate principal amount outstanding).

 

*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 13.625% which were revalued to reflect an 11.8% effectiveinterest rate in connection with a 1997 business combination. Interest paymentsbegan in 1999 and were payable semi-annually on June 30 and December 31. Aspart of the February 8, 2005 restructuring, the Company initiated the change ofcontrol repurchase offer at 101% for the Company’s approximately $29.9 millionof outstanding 13.625% senior subordinated discount notes. The Companycompleted the repurchase of all of these notes on March 11, 2005.

 

*Debt Maturities*

 

Debt maturities over the succeeding five years and thereafter are asfollows (dollar amounts in thousands):

 
| 2006       |   | $       | 2,356   |   |
|------------|--------|---------|---------|--------|
| 2007       |   | 2,356   |    |
| 2008       |   | 229,111 | (a)     |
| 2009       |   | 110,340 | (b)     |
| 2010       |   | —  |    |
| Thereafter |   | —  |    |
| Total      |   | $       | 344,163 |   |

 

----

(a) Assumes (i) payment of 8.125% seniorsubordinated notes at contractual maturity date of January 15, 2009; and (ii)bank credit facility subject to early maturity date of June 30, 2008. See “BankCredit Facility” above, for additional information regarding its early maturityprovision.

 

(b) The 8.125% senior subordinated notes arelisted at face value in this table.

 

44

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*Financial and operating covenants*

 

The indenture relating to the Company’s 8.125% seniorsubordinated notes due 2009 and the bank credit facility contain certaincovenants and restrictions, including with respect to the Company’s ability toincur debt and pay dividends, based on earnings before interest, taxes,depreciation, and amortization, or EBITDA. Adjustments to EBITDA are requiredby the indenture and the bank credit facility. EBITDA is generally derived byadding to income (loss) before income taxes, the sum of interest expense anddepreciation and amortization expense, including amortization of deferredcustomer acquisition costs and deducting amortization of deferred revenues. However,under the indentures, additional adjustments are sometimes required.

 

The Company’s bank credit facility and the indenturerelating to its 8.125% senior subordinated notes due 2009 contain the financialcovenants and current tests, respectively, summarized below:

 
| **Debt Instrument**              | ** ** | **Financial Covenant and Current Test**                                                                                                                                                                                                                                                               |
|----------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Bank Credit Facility             |       | Consolidated total debt on  last day of period/ consolidated EBITDA for most recent four fiscal  quarters—less than 5.25 to 1.0; and Consolidated EBITDA for most recent four  fiscal quarters/consolidated interest expense for most recent four fiscal  quarters—greater than 2.35 to 1.0 |
|                             |       |                                                                                                                                                                                                                                                                                                  |
| 8.125% Senior Subordinated Notes |       | Current fiscal quarter EBITDA/current fiscal quarter interest  expense—greater than 2.25 to 1.0                                                                                                                                                                                                  |

 

At December 31, 2005, the Company was in compliance with the financialcovenants and tests.

 

**7.****             Related PartyTransactions**

 

**Quadrangle Management Agreements**

 

On April 18, 2005,the Company entered into management agreements with each of Quadrangle AdvisorsLLC (“QA”) and Quadrangle Debt Recovery Advisors LLC (“QDRA,” and together withQA, the “Advisors”), pursuant to which the Advisors, affiliates of Quadrangle,will provide business and financial advisory and consulting services to theCompany in exchange for annual fees of $1.0 million (in the case of QA) and$0.5 million (in the case of QDRA), payable in advance in quarterlyinstallments. The Quadrangle management agreements also provide that when andif the Advisors advise or consult with the Company’s board of directors orsenior executive officers with respect to an acquisition by the Company,divesture (if the Company does not engage a financial advisor with respect tosuch divesture) or financing transaction, they may also invoice the Companyfor, and the Company shall pay, additional fees in connection with any suchtransaction in an amount not to exceed 0.667% (in the case of QA) and 0.333%(in the case of QDRA) of the aggregate value of such transaction. TheQuadrangle management agreements are effective as of February 8, 2005 and shallcontinue in effect from year to year unless amended or terminated by mutualconsent of the parties, subject to automatic termination in certain specifiedsituations and subject to termination at any time upon ninety days notice byeither party. For the period February 9, 2005 through December 31, 2005,approximately $1.4 million was expensed related to these agreements.

 

**Administrative Services and ManagementServices 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, that included accounting, tax, audit, humanresources, legal, purchasing and facilities services. The agreement terminatedeffective February 17, 2005. The Company expensed approximately $0.1 millionfor the period February 9, 2005 through February 17, 2005 and $0.1 million forthe period January 1, 2005 through February 8, 2005. The Company recordedexpense of approximately $3.1 million and $4.3 million for the years endedDecember 31, 2004 and 2003, respectively, and had a net balance due to WestarEnergy of $0.4 million at December 31, 2004, for these services. Prior torelocation of corporate headquarters on November 18, 2004, the Company rentedoffice space for its corporate headquarters from Westar on a month-to-monthbasis. The Company paid approximately $0.4 million and $0.6 million for rentfor the years ended December 31, 2004 and 2003, respectively.

 

Westar Energy has claimed that the Company should reimburse WestarEnergy for as much as $1.2 million for an allocation of the costs incurred byWestar in the development of the application systems shared with the Companyunder the administrative service agreement. See Note 13, “Commitments andContingencies—Administrative Services Agreement,” for further discussionrelated to the claim.

 

45

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**Credit Facility**

 

The Company had outstanding borrowings under thecredit facility with Quadrangle of $201.0 million at December 31, 2004. TheQuadrangle credit facility, with a remaining principal balance of $78 million,was repaid in full on April 18, 2005 in connection with the consummation of thebank credit agreement. The following table indicates the amount of interestaccrued and paid on the credit facility for the periods listed (dollar amountsin millions).

 
| ** **       | ** ** | **2005**                                     | ** ** | **Year Ended December 31,** | ** **                                    |
|------------------|------------|----------------------------------------------|------------|--------------------------------------------|-----------------------------------------------|
| ** **       | ** ** | **February 9 –April 18** | ** ** | ** **                                 | **January 1 –February 8** | ** ** | **2004 (a)** | ** ** | **2003 (b)** | ** ** |
| Interest Accrued |       | $                                            | 1.5        |                                       |                                          | $ | 1.9 |   | $ | 17.2 |   | $ | 12.6 |   |
| Interest Paid    |       | $                                            | 1.5        |                                       |                                          | $ | 1.9 |   | $ | 17.2 |   | $ | 13.1 |   |

 

----

(a)      Interestaccrued and interest paid each include $2.2 million for the period January 1,2004 through February 17, 2004 that the credit facility was held by Westar, theCompany’s former owner.

(b)      Interestaccrued and interest paid in 2003 refers to the Westar Credit Facility.

 

The Company also paid Quadrangle a one-time fee of$1.15 million upon consummation of the debt-for-equity exchange in connectionwith the amendment to the credit facility. See Note 6, “Debt—Refinancing,” forinformation related to the refinancing of the Quadrangle credit facility.

 

**Quadrangle Debt RestructuringReimbursement**

 

In addition tointerest accrued and paid under the Quadrangle credit facility, discussedabove, the Company expensed $0.2 million for legal expenses incurred byQuadrangle for the period January 1, 2005 through February 8, 2005. The Companypaid $0.6 million and owed $0.3 million to Quadrangle for legal expensesincurred by Quadrangle for the year ended December 31, 2004. Pursuant tocontractual requirements, the Company also paid the costs for the financial andlegal advisors for both the senior and subordinated debt holders relating tothe restructuring of the Company’s indebtedness. See Note 6, “Debt,” forinformation relating to the debt restructuring.

 

**Board of Directors and Amended Bylaws**

 

If and for so longas POI Acquisition, L.L.C. owns at least 40% of the outstanding shares of theCompany’s common stock, it shall have the right to elect to increase the sizeof the board by one director, which it shall be entitled to designate.

 

In accordance withthe stockholders agreement, the Company amended its bylaws following therestructuring to prevent it from voluntarily filing for bankruptcy, merging orconsolidating with another entity until February 8, 2007 or from selling all orsubstantially all of its assets without the written consent of QuadrangleMaster Funding Ltd. The stockholders agreement also includes voting agreements,certain restrictions on the transfer of the Company’s common stock, drag-alongrights in favor of POI Acquisition, L.L.C. and tag-along rights in favor ofQuadrangle Master Funding Ltd, all upon customary terms and subject to certaincustomary exceptions (including exceptions for certain transfers amongaffiliates). In addition, the stockholders agreement provides the Quadrangleparties with the right to participate on a proportional basis in any futureequity issuance by the Company, except for issuances pursuant to registeredpublic offerings, business combination transactions or officer, employee,director or consultant arrangements.

 

**Registration Rights Agreement**

 

As a condition to the consummation of the debt-for-equity exchange, theCompany entered into a registration rights agreement with POI Acquisition,L.L.C. and Quadrangle Master Funding Ltd. The registration rights agreementprovides, among other things, that the Company will register, upon notice,shares of its common stock owned by such parties. Under the registration rightsagreement, POI Acquisition, L.L.C. is permitted up to four demand registrationsand Quadrangle Master Funding Ltd is permitted up to two demand registrations,subject to certain conditions described in the agreement. POI Acquisition,L.L.C. and Quadrangle Master Funding Ltd also received piggyback registrationrights whereby they shall have the opportunity to register their securitiespursuant to any registration statement the Company may file in the future,subject to certain conditions. The Company is also obligated to pay certain oftheir expenses pursuant to the registration of their securities under theregistration rights agreement.

 

46

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**Change in Control and Debt RestructuringPayments**

 

Upon the change of control on February 17, 2004, $11.0 million was paidto executive management, $3.5 million was paid to the financial advisor to theCompany’s Special Committee of its board of directors and $1.6 million ofexpense was recorded for director and officer insurance that lapsed upon thechange of control. In addition to its own financial and legal advisors, theCompany also agreed to pay the financial advisory and legal fees incurred onbehalf of Quadrangle and certain holders of the Company’s publicly-held debt. Forthe year ended December 31, 2004 the Company incurred expenses relating to theseadvisors of approximately $8.2 million. For the period from January 1, 2005through February 8, 2005, the Company recorded expense of $5.9 million,including $5.6 million in fees paid on February 8, 2005 upon completion of therestructuring.

 

**8.****             Stock Warrants andOptions:**

 

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.

 

A summary of warrant and option activity for the Company’s common stockfrom December 31, 2002 through December 31, 2005 is as follows:

 
| ** **                       | ** ** | **Warrants  And Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|----------------------------------|------------|--------------------------------|------------|----------------------------------------|------------|
| 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     |   |
| Granted                          |       | 1,782,947                      |       | 7.50                                   |       |
| Exercised                        |       | —                         |       | —                                 |       |
| Surrendered                      |       | (175,030                       | )          | 29.47                                  |       |
| Outstanding at December 31, 2005 |       | 1,693,401                      |       | $                                      | 12.32      |   |

 

47

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The table below summarizes stock options and warrants for the Company’scommon stock outstanding as of December 31, 2005:

 
| **Description**   | ** ** | **Range of  Exercise Price** | ** ** | **Number of  Shares of  Common  Stock** | ** ** | **Weighted-  Average  Remaining  Contractual  Life in years** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-------------------|------------|----------------------------------------|------------|---------------------------------------------------|------------|-------------------------------------------------------------------------|------------|----------------------------------------|------------|
| *Exercisable*     |       |                                   |       |                                              |       |                                                                    |       |                                   |       |
| 1996 Options      |       | $475.00-693.75                         |       | 640                                               |       | < year                                                               |       | $                                      | 516.02     |   |
| 1997 Options      |       | 475.00                                 |       | 360                                               |       | 1 years                                                                 |       | 475.00                                 |       |
| 1998 Options      |       | 428.125-550.00                         |       | 4,672                                             |       | 2 years                                                                 |       | 539.26                                 |       |
| 1999 Options      |       | 262.50-446.375                         |       | 3,314                                             |       | 3 years                                                                 |       | 439.72                                 |       |
| 2000 Options      |       | 65.625-71.875                          |       | 3,743                                             |       | 4 years                                                                 |       | 71.67                                  |       |
| 2001 Options      |       | 43.75-71.00                            |       | 35,800                                            |       | 5 years                                                                 |       | 66.63                                  |       |
| 2001 Warrants     |       | 65.825                                 |       | 5,000                                             |       | 5 years                                                                 |       | 65.83                                  |       |
| 2002 Options      |       | 103.50-137.50                          |       | 10,267                                            |       | 6 years                                                                 |       | 111.66                                 |       |
| 2003 Options      |       | 60.00                                  |       | 400                                               |       | 7 years                                                                 |       | 60.00                                  |       |
| 2005 Options      |       | 7.50                                   |       | 394,866                                           |       | 5 years                                                                 |       | 7.50                                   |       |
|              |       |                                   |       | 459,062                                           |       |                                                                    |       |                                   |       |
| *Not exercisable* |       |                                   |       |                                              |       |                                                                    |       |                                   |       |
| 2003 Options      |       | $60.00                                 |       | 266                                               |       | 7 years                                                                 |       | $                                      | 60.00      |   |
| 2005 Options      |       | 7.50                                   |       | 1,234,073                                         |       | 5 years                                                                 |       | 7.50                                   |       |
|              |       |                                   |       | 1,234,339                                         |       |                                                                    |       |                                   |       |
| *Outstanding*     |       |                                   |       | 1,693,401                                         |       |                                                                    |       |                                   |       |

 

The table below summarizes number of shares of common stock representedby exercisable options and the respective weighted average exercise price forthe common stock for the years presented:

 
| ** **                                                           | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Number of shares of common stock  represented by exercisable options |       | 459,062                                    |       | 81,634 |   | 63,094 |   |
| Weighted average exercise price                                      |       | $                                          | 25.25      |   | $ | 150.28 |   | $ | 175.82 |   |
|                                                                      |            |                                            |            |  |  |  |  |  |  |  |

 

The weighted average fair value of options granted during 2005 and 2003estimated on the date of grant using the Black-Scholes Option Pricing Model was$5.39 and $40.00, respectively. No options were granted in 2004. The fair valuewas calculated using the following assumptions:

 
| ** **                      | ** ** | **Year Ended  December 31,  2005** | ** ** | **Year Ended  December 31,  2003** | ** ** |
|---------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| Expected stock price volatility |       | 82.1                                         | %          | 67.1                                         | %          |
| Risk free interest rate         |       | 3.8                                          | %          | 3.2                                          | %          |
| Expected option life            |       | 6 years                                      |       | 7 years                                      |       |
| Expected dividend yield         |       | —                                       |       | —                                       |       |

 

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 aterm of ten years and vested ratably over the subsequent three years. Thepurchase price of the shares issuable pursuant to the option is $66.00 pershare while the fair market value of the common stock at the date of the optiongrant was $89.50 per share resulting in $0.4 million in deferred compensationexpense amortized over three years. The expense amount was approximately $40.0thousand for the year ended December 31, 2004 and $0.1 million for the yearending December 31, 2003.

 

On April 16, 2001, the Company also granted a warrant to purchase anaggregate of 5,000 shares of its common stock to Guardian International, Inc.(Guardian) in connection with the hiring of Richard Ginsburg as the Company’snew chief executive officer, who was formerly the chief executive officer ofGuardian. The warrant has a term of ten years and vested ratably over threeyears and therefore fully vested in 2004. The purchase price of the sharesissuable pursuant to the option is $66.00 per share while the fair market valueof the common stock at the date of the option grant was $89.50 per shareresulting in $0.4 million expense in 2001.

 

48

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***2004 Stock Option Plan.***

 

The 2004 Stock Option Plan became effective upon the consummation ofthe debt-for-equity exchange on February 8, 2005. Under the 2004 Stock OptionPlan, certain executive officers and selected management employees were grantedoptions, which are subject to vesting, exercise and delivery restrictiondescribed below, to purchase an aggregate of 1,782,947 shares of common stock,including 621,035, 388,147, 388,147, 199,618 and 10,000 options that weregranted to Messrs. Ginsburg, Nevin, Pefanis, Williams and Griffin, respectively.The options initially granted under the plan will vest ratably each month duringthe 48 months after the date of grant, subject to accelerated vesting, in thecase of certain senior executive officers, under certain circumstancesfollowing a qualified sale. Under the option agreements applicable to theoptions granted, any shares of stock purchased through the exercise of optionsgenerally will be issued and delivered to the option holder, and any netpayment that may be due to such holder in accordance with the plan, will bepaid to such holder upon the earlier of: (1) specified dates following theoccurrence of certain permissible distribution events (as defined in the SARPlan) and (2) February 8, 2011, provided that if an option holder’s right toreceive stock is converted pursuant to the plan into a right to receive cash,the amount of cash payable will be credited with interest at 6% per annum,compounded annually, from the date such conversion is effective until theapplicable payment date.

 

***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 key employees. Underthe LTIP, 114,000 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 thegranting of options that qualify as incentive stock options under the InternalRevenue Code and options that do not so qualify.

 

Each option has a term of ten years and typically vests ratably overthree years. The purchase price of the shares issuable pursuant to the optionsis equal to (or greater than) the fair market value of the common stock at thedate 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.

 

***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 the Plan.A total of 26,000 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 Plan provides for thegranting of options that qualify as incentive stock options under the InternalRevenue Code and options that do not so qualify.

 

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 was accelerated on November 24, 1997 and allremaining options are currently exercisable.

 

**9.****             Income Taxes:**

 

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

 
| ** ** | ** ** | **2005**                                              | ** ** | **Year Ended December 31,**          | ** ** |
|------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** ** | ** ** | **February 9 – December 31** | ** ** | **January 1 – February 8** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Federal    |       |                                                  |       |                                                |       |   |   |   |   |   |
| Current    |       | $                                                     | —     |                                                |       | $ | — |   | $ | 46,913 |   | $ | 23,071 |   |
| Deferred   |       | —                                                |       |                                                | —     |   | (286,309 | ) | (7,493 | ) |
| State      |       |                                                  |       |                                                |       |   |   |   |   |   |
| Current    |       | (312                                                  | )          |                                                | (35        | ) | (183 | ) | 2,892 |   |
| Deferred   |       | —                                                |       |                                                | —     |   | — |   | (976 | ) |
| Total      |       | $                                                     | (312       | )                                                   |       | $ | (35 | ) | $ | (239,579 | ) | $ | 17,494 |   |

 

49

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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:

 
| ** **                                                            | ** ** | **February 9- December 31,** | ** ** | **January 1- February 8,** | ** ** | **Year ended  December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                    | ** ** | **2004**                                  | ** ** | **2003**                               | ** ** |
| Federal statutory tax rate                                            |       | 35                                          | %          | 35                                        | %          | 35                                     | %          | 35 | % |
| State income tax benefit, net of federal  expense                     |       | 1                                           |       | 2                                         |       | 4                                      |       | — |   |
| Non-deductible change in control, debt  restructuring costs and other |       | (2                                          | )          | (20                                       | )          | (5                                     | )          | — |   |
| Valuation allowance                                                   |       | (36                                         | )          | (17                                       | )          | (318                                   | )          | — |   |
| Other                                                                 |       | —                                      |       | —                                    |       | —                                 |       | (1 | ) |
|                                                                  |       | (2                                          | )%         | 0                                         | %          | (284                                   | )%         | 34 | % |

 

Management believes theCompany’s net deferred tax assets are not likely realizable and therefore avaluation allowance has been established to fully offset the deferred taxassets, as can be seen in the table below. In assessing whether deferred taxesare realizable, management considers whether it is more likely than not thatsome portion or all deferred tax assets will be realized. The ultimaterealization of deferred tax assets is dependent upon the generation of futuretaxable income during the periods in which those temporary differences becomedeductible. Management considers the projected future taxable income and tax planningstrategies in making this assessment.

 

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

 
| ** **                                             | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deferred tax asset, current:                           |       |       |       |       |       |
| Accrued liabilities                                    |       | $          | 3,178      |       | $          | 5,877 |   |
| Accounts receivable, due to allowance                  |       | 1,872      |       | 1,285      |       |
| Revolving credit facility                              |       | —     |       | 11,150     |       |
| Other                                                  |       | 1,213      |       | (163       | )          |
| Valuation allowance                                    |       | (6,263     | )          | (18,149    | )          |
|                                                   |       | $          | —     |       | $          | — |   |
| Deferred tax asset, noncurrent:                        |       |       |       |       |       |
| Net operating loss carryforwards (a)                   |       | $          | 27,599     |       | $          | 14,371 |   |
| Property & equipment                               |       | 7,140      |       | 2,357      |       |
| Deferred customer acquisition costs (net of  revenues) |       | (12,530    | )          | (21,223    | )          |
| Customer accounts                                      |       | (12,252    | )          | 20,632     |       |
| Goodwill                                               |       | 6,870      |       | 4,699      |       |
| Other intangibles                                      |       | 118        |       | 10,822     |       |
| Debt                                                   |       | (7,411     | )          | —     |       |
| Other                                                  |       | 544        |       | 1,698      |       |
| Valuation allowance                                    |       | (10,078    | )          | (33,356    | )          |
|                                                   |       | $          | —     |       | $          | — |   |

 

----

(a)  Federalnet operating loss carryforwards of $35,496, $17,200 and $20,707 will expire inthe years 2025, 2024 and 2023, respectively. Total state net operating lossesof approximately the same amount have various expiration dates.

 

As discussed in Note 1, “TheCompany,” as part of the February 8, 2005 ownership change, the Company pusheddown Quadrangle’s basis to the underlying assets and liabilities of the Companyresulting in significant adjustments to the historical carrying values of theseassets and liabilities as reflected on the Company’s books. The 2005 deferredtax assets and liabilities reflect significant movement from the 2004 amountsbecause no adjustments were made to the tax bases of the assets and liabilitiesas a result of the February 8, 2005 adoption of a new basis of accounting.

 

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 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 net operating loss carryforwards, no valuation allowancehad been established by the Company because the tax sharing agreement utilizeda parent company down approach in the allocation of income tax expense

 

50

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among members of theconsolidated tax group and, consistent with that approach, no valuationallowance had been allocated to the Company. As a result of the February 17,2004 sale transaction, $285.9 million of the Company’s net deferred tax assetswere not expected to be realizable, and the Company therefore recorded anon-cash charge against income in the first quarter of 2004 to establish avaluation 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 Westar tax sharing settlement, among otherthings, Westar agreed to pay the Company approximately $45.9 million in cashand transfer to it 7.375% senior notes of the Company, due 2005, with aggregateprincipal and accrued interest of approximately $27.1 million for totalconsideration of $73.0 million. As a result of the Westar tax sharingsettlement, the Company recorded a 2004 tax benefit of $46.9 million. The taxsharing settlement also provided for a mutual general release, except withrespect to certain indemnification obligations pursuant to the purchaseagreement between Quadrangle and Westar and certain alarm monitoring and otherservice agreements between the Company and Westar. In addition, Westar and POIAcquisition I, Inc. joined in making Section 338(h)(10) elections under theCode. As part of the settlement, the parties mutually agreed to the purchaseprice allocation 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 todetermine at this time whether Westar will claim any such benefits or, ifWestar were to claim any such benefits, the amount of the benefits that Westarwould claim or when or whether Westar would actually receive any such benefits.Due to the uncertainty, the Company has not recorded any tax benefit withrespect to any such potential contingent payments.

 

**10.****          Employee Benefit 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 the Protection One 401(k) Plan, whichcontributions are allocated among participants based upon the respectivecontributions made by the participants through salary reductions during theapplicable plan year. The Company’s matching contribution may be made in commonstock, in cash or in a combination of both stock and cash. For the periodsFebruary 9, 2005 through December 31, 2005 and January 1, 2005 through February8, 2005 and for the years ended December 31, 2004 and 2003, Protection One madematching cash contributions to the plan of $0.9 million, $0.1 million, $1.0million and $1.0 million, respectively. The funds of the plan are depositedwith a trustee and at each participant’s option in one or more investmentfunds, including a Company stock fund. Contributions to the Company stock fundwere suspended during 2003, and have not resumed as of March 10, 2006. The planwas amended effective January 1, 2001 requiring the Company to match employees’contributions up to specified maximum limits.

 

*Network Multifamily 401(k) Plan*.The Company makes contributions to the Network Multifamily 401(k) Plan, whichcontributions are allocated among participants based upon the respectivecontributions made by the participants through salary reductions during theapplicable plan year. The Company’s matching contribution are made in cash. Forthe period February 9, 2005 through December 31, 2005 and for each of the yearsended December 31, 2004 and 2003, the Company made matching cash contributionsto the plan of $0.2 million. The funds of the plan are deposited with a trusteeand at each participant’s option in one or more investment funds.

 

As part of the corporate consolidation process described in Note 1, “TheCompany,” the Network Multifamily 401(k) plan was merged with the ProtectionOne 401(k) plan as of March 1, 2006.

 

*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 contributedby employees through the ESPP in 2003 were returned in November 2003. Participationin the ESPP was not resumed and the plan terminated on the last business day inSeptember 2005 as set forth in the plan.

 

*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 anticipated restructuring.The previous employment agreements with these senior executives would haveexpired on or about August 17, 2004. The new employment agreements supersedeand replace these previous employment agreements.

 

51

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These employment agreements provide for, among other things, minimumannual 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 undercertain circumstances after a change in control of the Company and in certainother circumstances.

 

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’s indebtedness,the Company’s Board of Directors authorized senior management in June 2004 toimplement 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 new retention agreements superseded andreplaced previous retention agreements which provided additional severance upona change in control. The aggregatepayout under the plan was approximately $3.9 million of which approximately$3.5 million was accrued for and approximately $0.7 million was paid as ofDecember 31, 2004. The remaining $3.2 million was paid in January and Februaryof 2005.

 

*Stock Appreciation Rights Plan*.

 

Pursuant to the management incentive plan, Messrs. Ginsburg, Nevin,Pefanis and Williams received an aggregate of approximately 798,473, 532,981,465,111 and 199,618  SARs, respectively. TheSARs vest and become payable upon the earlier of (1) a qualified sale as definedin the SAR Plan, which generally means Quadrangle’s sale of at least 60% of itsequity interest in the Company, provided that if the qualified sale is not apermissible distribution event (as defined in the SAR Plan) the payment will bemade, with interest, in connection with a subsequent permissible distributionevent, and (2) February 8, 2011. The exercise price of the SARs is $4.50 andincreases by 9% per annum, which is referred to as the fixed return, compoundedannually, beginning on February 8, 2006. If Quadrangle sells less than 60% ofits equity interest in the Company, the exercise price applicable to anequivalent percentage of management’s SARs would be based on the fixed returnthrough the date of such sale. Each SAR that vests and becomes payable inconnection with a qualified sale will generally entitle the holder of a SAR toreceive the difference between the exercise price and the lesser of (1) thevalue of the consideration paid for one share of stock in such qualified sale,or the fair market value of one share of stock if the qualified sale is not asale to a third party and (2) $7.50, provided that if a SAR holder’s right toreceive stock is converted pursuant to the SAR Plan into a right to receivecash from a grantor trust that the Company may establish, the amount of cashpayable will be credited with interest at 6% per annum, compounded annually,from the date such conversion is effective until the applicable payment date. Becausepayment under the plan will only be made in the event of a qualified sale asdefined in the SAR plan, no amounts have been accrued as of December 31, 2005.

 

*Retention Bonus Program*.

 

Included with the retention plan and******pursuantto the terms of their new employment agreements, Messrs. Ginsburg, Nevin,Pefanis, Williams and Griffin were each entitled to receive two retentionbonuses. The Company accrued $1.9 million as general and administrative expensein 2004 and an additional $0.2 million of expense in January 2005 for theseretention bonuses. The first retention bonus was paid on January 5, 2005, andthe second was paid in February 2005 upon the completion of the debt-for-equityexchange. Each retention bonus payment was equal to a specified percentage ofeach executive officer’s annual base salary at the following rates:  Richard Ginsburg–75.0%, Darius G.Nevin–72.5%, Peter J. Pefanis–67.5%, Steve V. Williams–67.5%, and J. EricGriffin–50.0%.

 

**11.          Leases:**

 

The Company leases office facilities for lease terms maturing through2012. Future minimum lease payments under non-cancelable operating leases areas follows (dollar amounts in thousands):

 

| **Year ended December 31,** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|
| 2006                                       |       | $          | 4,966      |   |
| 2007                                       |       | 4,136      |       |
| 2008                                       |       | 2,869      |       |
| 2009                                       |       | 1,748      |       |
| 2010                                       |       | 1,349      |       |
| Thereafter                                 |       | 1,119      |       |
|                                       |       | $          | 16,187     |   |

 

52

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Total rent expense for the periods February 9, 2005 through December31, 2005, and January 1, 2005 through February 8, 2005, and for the years endedDecember 31, 2004 and 2003, was $4.9 million, $0.6 million, $7.2 million and $9.2million respectively.

 

**12.          Fair Market Value ofFinancial 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.

 

The fair value of the Company’s debt instruments are estimated based onquoted market prices except for the Quadrangle credit facility and the bankcredit facility, which had no available quote and was estimated by the Company.Fair value of the bank credit facility is estimated to be face value based onthe terms of the facility and its relatively recent issuance. At December 31,the fair value and carrying amount of the Company’s debt for the yearsindicated were as follows (dollar amounts in thousands):

 
| ** **                                   | ** ** | **Fair Value** | ** ** | **Carrying Value** | ** ** |
|----------------------------------------------|------------|---------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **2005**            | ** ** | **2004**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Quadrangle Credit Facility                   |       | $                   | —     |                    | $          | 201,000 |   | $ | — |   | $ | 201,000 |   |
| Bank Credit Facility                         |       | 233,823             |       | —                  |       | 233,823 |   | — |   |
| Senior Subordinated Notes (8.125%)           |       | 106,478             |       | 105,926                 |       | 89,826 |   | 110,340 |   |
| Senior Notes (7.375%)                        |       | —              |       | 165,928                 |       | — |   | 164,285 |   |
| Senior Subordinated Discount Notes (13.625%) |       | —              |       | 28,677                  |       | — |   | 30,132 |   |
|                                         |       | $                   | 340,301    |                    | $          | 501,531 |   | $ | 323,649 |   | $ | 505,757 |   |

 

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.

 

**13.          Commitments andContingencies:**

 

**Dealer Litigation**

 

The company is a defendant in an arbitration proceeding brought by IraBeer, the owner of two former Protection One dealers, Security Response Networkand Homesafe Security, Inc. Mr. Beer alleges breach of contract, impropercalculation of holdback amounts, and other causes of action. Discovery isongoing in this matter. In late January 2006, after a period of considerableinactivity, the claimants requested an April 2006 arbitration date. Currently,no arbitration date has been established. In the opinion of management, thismatter will not have a material adverse effect on the Company’s consolidatedfinancial 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 receivesnotices of consumer complaints filed with various state agencies. The Companyhas developed a dispute resolution process for addressing these administrativecomplaints. The ultimate outcome of such matters cannot presently bedetermined; however, in the opinion of management, the resolution of suchmatters will not have a material adverse effect upon the Company’s consolidatedfinancial position or results of operations.

 

**Administrative Services Agreement**

 

Westar Energy, the Company’s former majority stockholder, has claimedthat the Company is obligated to 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 administrativeservices agreement. The Company disputes these claims. In the opinion ofmanagement, this matter will not have a material adverse effect on the Company’sconsolidated financial position or results of operations.

 

**Tax SharingAgreement**

 

The Company is potentially entitled to certaincontingent payments, depending on whether Westar claims and receives certainadditional tax benefits in the future with respect to the February 17, 2004sale transaction. While these potential contingent payments, if any, could besignificant, the Company is unable to determine at this time whether Westarwill claim any such benefits or, if Westar were to claim any such benefits, theamount of the benefits that Westar would claim or when or whether Westar would actuallyreceive any such benefits. Due to this uncertainty, the Company has notrecorded any tax benefit with respect to any such potential contingentpayments.

 

53

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**14.          Segment Reporting:**

 

The Company’s operating segments are defined as components for whichseparate financial information is available that is evaluated regularly by thechief operating decision maker. The operating segments are managed separatelybecause each operating segment represents a strategic business unit that servesdifferent markets.

 

Protection One’s reportable segments include Protection One Monitoringand Network Multifamily. Protection One Monitoring provides residential,commercial, and wholesale security alarm monitoring services, which include sales,installation and related servicing of security alarm systems for residentialand business customers in the United States of America. Network Multifamilyprovides security alarm services to apartments, condominiums and othermultifamily dwellings.

 

The accounting policies of the operating segments are the same as thosedescribed in the summary of significant accounting policies. The Companymanages its business segments based on earnings before interest, income taxes,depreciation, amortization (including amortization of deferred customeracquisition costs and revenues) and other items, referred to as AdjustedEBITDA.

 

Reportable segments (dollar amounts in thousands):

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

 

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

 

54

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| ** **                                                                     | ** ** | **For the year ended December 31, 2003** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **Protection  One  Monitoring****(1)**                                 | ** ** | **Network  Multi-  family****(2)** | ** ** | **Adjustments****(3)** | ** ** | **Consolidated** | ** ** |
| 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 |   |
| 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 |   |
|                                                                                |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          Includes allocation of holding companyexpenses reducing Adjusted EBITDA by $3.5 million, $0.3 million, $3.0 millionand $7.0 million for the periods February 9, 2005 through December 31, 2005 andJanuary 1, 2005 through February 8, 2005, and for the years ended December 31,2004 and 2003, respectively.

(2)          Includes allocation of holding companyexpenses reducing Adjusted EBITDA by $0.9 million, $0.1 million, $0.7 millionand $1.8 million for the periods February 9, 2005 through December 31, 2005 andJanuary 1, 2005 through February 8, 2005, and for the years ended December 31,2004 and 2003, respectively.

(3)          Adjustment to eliminate intersegment accountsreceivable.

(4)          Adjusted EBITDA is used by management inevaluating segment performance and allocating resources, and managementbelieves it is used by many analysts following the security industry. Thisinformation should not be considered as an alternative to any measure ofperformance as promulgated under accounting principles generally accepted inthe United States of America (“GAAP”), such as income (loss) before incometaxes or cash flow from operations. Items excluded from Adjusted EBITDA aresignificant components in understanding and assessing the consolidatedfinancial performance of the Company. See the table below for thereconciliation of Adjusted EBITDA to consolidated income (loss) before incometaxes. The Company’s calculation of Adjusted EBITDA may be different from thecalculation used by other companies and comparability may be limited.Management believes that presentation of a non-GAAP financial measure such asAdjusted EBITDA is useful because it allows investors and management toevaluate and compare the Company’s operating results from period to period in ameaningful and consistent manner in addition to standard GAAP financialmeasures.

 
| ** **                                                                     | ** ** | **Consolidated**                             | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                     | ** ** | **(Dollars in thousands)**         | ** ** |
| ** **                                                                     | ** ** | **February 9 -  December 31** | ** ** | **January 1 -  February 8** | ** ** | **Year Ended December 31,** | ** ** |
| ** **                                                                     | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                     | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income (loss) before income taxes                                              |       | $                                            | (15,276    | ) |   | $ | (11,370 | ) | $ | (84,327 | ) | $ | (51,905 | ) |
| Plus:                                                                          |       |                                         |       |   |   |   |   |   |   |   |
| Interest expense                                                               |       | 30,634                                       |       |   | 4,544 |   | 44,398 |   | 40,101 |   |
| Amortization of intangibles and  depreciation expense                          |       | 43,742                                       |       |   | 6,638 |   | 78,455 |   | 80,252 |   |
| Amortization of deferred costs in excess of  amortization of deferred revenues |       | 8,489                                        |       |   | 2,837 |   | 21,542 |   | 17,027 |   |
| Change in control and debt restructuring  costs                                |       | —                                       |       |   | 5,939 |   | 24,382 |   | — |   |
| Key employee retention plan expense (a)                                        |       | —                                       |       |   | 435 |   | 3,466 |   | 6,167 |   |
| Corporate consolidation costs (b)                                              |       | 2,339                                        |       |   | — |   | — |   | — |   |
| Loss on retirement of debt                                                     |       | 6,657                                        |       |   | — |   | 47 |   | — |   |
| Less:                                                                          |       |                                         |       |   |   |   |   |   |   |   |
| Other income                                                                   |       | (688                                         | )          |   | (15 | ) | (147 | ) | (2,829 | ) |
| Adjusted EBITDA                                                                |       | $                                            | 75,897     |   |   | $ | 9,008 |   | $ | 87,816 |   | $ | 88,813 |   |

 

----

(a)          TheCompany entered into agreements with selected individuals to retain theirservices through sale and restructuring activities. The cost of theseagreements is recorded in general and administrative expense.

(b)         Network Multifamily severanceand retention expense related to corporate consolidation.

 

55

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**15.          Summarized Combined FinancialInformation of the Subsidiary Guarantors of Debt:**

** **

Protection One AlarmMonitoring, Inc., a wholly-owned subsidiary of the Company, is the primaryobligor for all outstanding debt securities (see Note 6, “Debt”). These debtsecurities are fully and unconditionally guaranteed by Protection One, Inc. andwholly owned subsidiaries of Protection One Alarm Monitoring, Inc. Thefollowing tables present condensed consolidating financial information forProtection One, Inc., Protection One Alarm Monitoring, Inc., and all othersubsidiaries. Condensed financial information for Protection One, Inc. andProtection One Alarm Monitoring, Inc. on a stand-alone basis is presented usingthe equity method of accounting for subsidiaries in which they own or controltwenty percent or more of the voting shares.

 

56

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**Condensed Consolidating Statement of Operations**

**For the Period February 9, 2005 through December 31, 2005**

**(dollar amounts in thousands)**

 
| ** **                                                    | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| Revenues:                                                     |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Monitoring and related services                               |       | $                              | —     |                                       | $          | 178,346                    |       | $                | 41,129     |             | $          | — |   | $ | 219,475 |   |
| Other                                                         |       | —                         |       | 14,918                                     |       | 88                         |       | —           |       | 15,006           |       |
| Total revenues                                                |       | —                         |       | 193,264                                    |       | 41,217                     |       | —           |       | 234,481          |       |
| Cost of revenues:                                             |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Monitoring and related services                               |       | —                         |       | 51,401                                     |       | 10,842                     |       | —           |       | 62,243           |       |
| Other                                                         |       | —                         |       | 18,145                                     |       | 671                        |       | —           |       | 18,816           |       |
| Total cost of revenues                                        |       | —                         |       | 69,546                                     |       | 11,513                     |       | —           |       | 81,059           |       |
|                                                          |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Operating expenses                                            |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Selling                                                       |       | —                         |       | 26,690                                     |       | 2,166                      |       | —           |       | 28,856           |       |
| General and administrative                                    |       | 4,590                          |       | 43,822                                     |       | 8,746                      |       | —           |       | 57,158           |       |
| Corporate consolidation costs                                 |       | —                         |       | —                                     |       | 2,339                      |       | —           |       | 2,339            |       |
| Amortization and depreciation                                 |       | 4                              |       | 37,140                                     |       | 6,598                      |       | —           |       | 43,742           |       |
| Holding company allocation                                    |       | (4,371                         | )          | 3,497                                      |       | 874                        |       | —           |       | —           |       |
| Corporate overhead allocation                                 |       | —                         |       | (897                                       | )          | 897                        |       | —           |       | —           |       |
| Total operating expenses                                      |       | 223                            |       | 110,252                                    |       | 21,620                     |       | —           |       | 132,095          |       |
| Operating income (loss)                                       |       | (223                           | )          | 13,466                                     |       | 8,084                      |       | —           |       | 21,327           |       |
| Other income (expense)                                        |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Interest expense (a)                                          |       | —                         |       | (27,950                                    | )          | (733                       | )          | —           |       | (28,683          | )          |
| Related party interest                                        |       | —                         |       | (1,951                                     | )          | —                     |       | —           |       | (1,951           | )          |
| Loss on retirement of debt                                    |       | —                         |       | (6,657                                     | )          | —                     |       | —           |       | (6,657           | )          |
| Other                                                         |       | —                         |       | 20,288                                     |       | (34                        | )          | (19,566          | )          | 688              |       |
| Equity earnings in subsidiary                                 |       | 4,201                          |       | 7,005                                      |       | —                     |       | (11,206          | )          | —           |       |
| Income (loss) from continuing operations  before income taxes |       | 3,978                          |       | 4,201                                      |       | 7,317                      |       | (30,772          | )          | (15,276          | )          |
| Income tax expense                                            |       | —                         |       | —                                     |       | (312                       | )          |             |       | (312             | )          |
| Net income (loss)                                             |       | $                              | 3,978      |                                       | $          | 4,201                      |       | $                | 7,005      |             | $          | (30,772 | ) | $ | (15,588 | ) |

 

----

(a)  Protection One Alarm Monitoring, Inc.allocated $740 of its interest expense to Network Multifamily.

 

57

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**Condensed Consolidating Statement of Operations**

**For the Period January 1, 2005 through February 8, 2005**

**(dollar amounts in thousands)**

 
| ** **                                                    | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary   Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------------|------------|------------------|------------|------------------|------------|
| Revenues:                                                     |       |                           |       |                                       |       |                             |       |             |       |             |       |
| Monitoring and related services                               |       | $                              | —     |                                       | $          | 21,455                           |       | $                | 5,000      |             | $          | — |   | $ | 26,455 |   |
| Other                                                         |       | —                         |       | 1,916                                      |       | 172                              |       | —           |       | 2,088            |       |
| Total revenues                                                |       | —                         |       | 23,371                                     |       | 5,172                            |       | —           |       | 28,543           |       |
| Cost of revenues:                                             |       |                           |       |                                       |       |                             |       |             |       |             |       |
| Monitoring and related services                               |       | —                         |       | 6,151                                      |       | 1,249                            |       | —           |       | 7,400            |       |
| Other                                                         |       | —                         |       | 2,571                                      |       | 743                              |       | —           |       | 3,314            |       |
| Total cost of revenues                                        |       | —                         |       | 8,722                                      |       | 1,992                            |       | —           |       | 10,714           |       |
|                                                          |       |                           |       |                                       |       |                             |       |             |       |             |       |
| Operating expenses                                            |       |                           |       |                                       |       |                             |       |             |       |             |       |
| Selling                                                       |       | —                         |       | 3,699                                      |       | 290                              |       | —           |       | 3,989            |       |
| General and administrative                                    |       | 792                            |       | 6,054                                      |       | 1,258                            |       | —           |       | 8,104            |       |
| Change of control and debt restructuring  costs               |       | 5,939                          |       | —                                     |       | —                           |       | —           |       | 5,939            |       |
| Amortization and depreciation                                 |       | —                         |       | 6,058                                      |       | 580                              |       | —           |       | 6,638            |       |
| Holding company allocation                                    |       | (437                           | )          | 350                                        |       | 87                               |       | —           |       | —           |       |
| Corporate overhead allocation                                 |       | —                         |       | (110                                       | )          | 110                              |       | —           |       | —           |       |
| Total operating expenses                                      |       | 6,294                          |       | 16,051                                     |       | 2,325                            |       | —           |       | 24,670           |       |
| Operating income (loss)                                       |       | (6,294                         | )          | (1,402                                     | )          | 855                              |       | —           |       | (6,841           | )          |
| Other income (expense)                                        |       |                           |       |                                       |       |                             |       |             |       |             |       |
| Interest expense (a)                                          |       | —                         |       | (2,499                                     | )          | (103                             | )          | —           |       | (2,602           | )          |
| Related party interest                                        |       | —                         |       | (1,942                                     | )          | —                           |       | —           |       | (1,942           | )          |
| Other                                                         |       | —                         |       | 15                                         |       | —                           |       | —           |       | 15               |       |
| Equity earnings (loss) in subsidiary                          |       | (5,111                         | )          | 717                                        |       | —                           |       | 4,394            |       | —           |       |
| Income (loss) from continuing operations  before income taxes |       | (11,405                        | )          | (5,111                                     | )          | 752                              |       | 4,394            |       | (11,370          | )          |
| Income tax expense                                            |       | —                         |       | —                                     |       | (35                              | )          | —           |       | (35              | )          |
| Net income (loss)                                             |       | $                              | (11,405    | )                                          | $          | (5,111                           | )          | $                | 717        |             | $          | 4,394 |   | $ | (11,405 | ) |

 

----

(a)  Protection One Alarm Monitoring, Inc.allocated $103 of its interest expense to Network Multifamily.

 

58

----

 

**Condensed Consolidating Statement ofOperations**

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

**(dollar amounts in thousands)**

 
| ** **                                           | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| Revenues:                                            |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Monitoring and related services                      |       | $                              | —     |                                       | $          | 201,228                    |       | $                | 46,270     |             | $          | — |   | $ | 247,498 |   |
| Other                                                |       | —                         |       | 20,089                                     |       | 1,672                      |       | —           |       | 21,761           |       |
| Total revenues                                       |       | —                         |       | 221,317                                    |       | 47,942                     |       | —           |       | 269,259          |       |
| Cost of revenues:                                    |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Monitoring and related services                      |       | —                         |       | 57,292                                     |       | 12,306                     |       | —           |       | 69,598           |       |
| Other                                                |       | —                         |       | 25,810                                     |       | 6,171                      |       | —           |       | 31,981           |       |
| Total cost of revenues                               |       | —                         |       | 83,102                                     |       | 18,477                     |       | —           |       | 101,579          |       |
| Operating expenses:                                  |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Selling                                              |       | —                         |       | 30,733                                     |       | 2,762                      |       | —           |       | 33,495           |       |
| General and administrative                           |       | 4,752                          |       | 56,124                                     |       | 10,501                     |       | —           |       | 71,377           |       |
| Change in control and debt restructuring  costs      |       | 22,839                         |       | —                                     |       | 1,543                      |       | —           |       | 24,382           |       |
| Amortization and depreciation                        |       | 2                              |       | 73,046                                     |       | 5,407                      |       | —           |       | 78,455           |       |
| Holding company allocation                           |       | (3,720                         | )          | 2,976                                      |       | 744                        |       | —           |       | —           |       |
| Corporate overhead allocation                        |       | —                         |       | (1,123                                     | )          | 1,123                      |       | —           |       | —           |       |
| Total operating expense                              |       | 23,873                         |       | 161,756                                    |       | 22,080                     |       | —           |       | 207,709          |       |
| Operating income (loss)                              |       | (23,873                        | )          | (23,541                                    | )          | 7,385                      |       | —           |       | (40,029          | )          |
| Other income (loss):                                 |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Interest income (expense) (a)                        |       | —                         |       | (22,744                                    | )          | (3,572                     | )          | —           |       | (26,316          | )          |
| Related party interest                               |       | —                         |       | (18,082                                    | )          | —                     |       | —           |       | (18,082          | )          |
| Loss on retirement of debt                           |       | —                         |       | (47                                        | )          | —                     |       | —           |       | (47              | )          |
| Other                                                |       | —                         |       | 147                                        |       | —                     |       | —           |       | 147              |       |
| Equity loss in subsidiary                            |       | (302,029                       | )          | (231                                       | )          | —                     |       | 302,260          |       | —           |       |
| Loss from continuing operations before  income taxes |       | (325,902                       | )          | (64,498                                    | )          | 3,813                      |       | 302,260          |       | (84,327          | )          |
| Income tax (expense) benefit                         |       | 1,996                          |       | (237,531                                   | )          | (4,044                     | )          |             |       | (239,579         | )          |
| Net income (loss)                                    |       | $                              | (323,906   | )                                          | $          | (302,029                   | )          | $                | (231       | )                | $          | 302,260 |   | $ | (323,906 | ) |

 

----

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

 

59

----

 

# **Condensed**Consolidating Statement of Operations

**For the year ended December 31, 2003**

**(dollar amounts in thousands)**

 
| ** **                                                    | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| Revenues:                                                     |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Monitoring and related services                               |       | $                              | —     |                                       | $          | 210,445                    |       | $                | 45,821     |             | $          | — |   | $ | 256,266 |   |
| Other                                                         |       | —                         |       | 18,823                                     |       | 1,996                      |       | —           |       | 20,819           |       |
| Total revenues                                                |       | —                         |       | 229,268                                    |       | 47,817                     |       | —           |       | 277,085          |       |
| Cost of revenues:                                             |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Monitoring and related services                               |       | —                         |       | 60,667                                     |       | 12,538                     |       | —           |       | 73,205           |       |
| Other                                                         |       | —                         |       | 23,117                                     |       | 5,883                      |       | —           |       | 29,000           |       |
| Total cost of revenues                                        |       | —                         |       | 83,784                                     |       | 18,421                     |       | —           |       | 102,205          |       |
| Operating expenses:                                           |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Selling                                                       |       | —                         |       | 28,563                                     |       | 2,954                      |       | —           |       | 31,517           |       |
| General and administrative                                    |       | 8,798                          |       | 58,423                                     |       | 10,523                     |       | —           |       | 77,744           |       |
| Amortization and depreciation                                 |       | 2                              |       | 74,860                                     |       | 5,390                      |       | —           |       | 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                                    |       | 22,328                     |       | —           |       | 189,513          |       |
| Operating income (loss)                                       |       | 659                            |       | (22,360                                    | )          | 7,068                      |       | —           |       | (14,633          | )          |
| Other income (loss):                                          |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Interest income (expense) (a)                                 |       | 577                            |       | (20,754                                    | )          | (4,910                     | )          | —           |       | (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                                    | )          | 2,158                      |       | 35,345           |       | (51,905          | )          |
| Income tax (expense) benefit                                  |       | (552                           | )          | 21,200                                     |       | (3,154                     | )          |             |       | 17,494           |       |
| Net loss                                                      |       | $                              | (34,411    | )                                          | $          | (34,349                    | )          | $                | (996       | )                | $          | 35,345 |   | $ | (34,411 | ) |
|                                                               |            |                                |            |                                            |            |                            |            |                  |            |                  |            |  |  |  |  |  |  |  |  |  |

 

----

(a)Protection One Alarm Monitoring, Inc. allocated $4,930 of its interest expenseto Network Multifamily

 

60

----

 

**Condensed**Consolidating BalanceSheet

**December 31, 2005**

**(dollar amounts in thousands)**

 
| ** **                                                    | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                    | ** ** | ** **                     | ** ** | ** **                                 | ** ** | ** **                 | ** ** | ** **       | ** ** | ** **       | ** ** |
| **Assets**                                                    |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Current Assets                                                |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Cash and cash equivalents                                     |       | $                              | —     |                                       | $          | 19,468                     |       | $                | 425        |             | $          | — |   | $ | 19,893 |   |
| Receivables, net                                              |       | —                         |       | 23,526                                     |       | 6,335                      |       | —           |       | 29,861           |       |
| Inventories, net                                              |       | —                         |       | 2,790                                      |       | 1,676                      |       | —           |       | 4,466            |       |
| Prepaid expenses                                              |       | 28                             |       | 2,497                                      |       | 658                        |       | —           |       | 3,183            |       |
| Other miscellaneous receivables                               |       | —                         |       | 111                                        |       | —                     |       | —           |       | 111              |       |
| Other                                                         |       | —                         |       | 3,062                                      |       | 10                         |       | —           |       | 3,072            |       |
| Total current assets                                          |       | 28                             |       | 51,454                                     |       | 9,104                      |       | —           |       | 60,586           |       |
| Restricted cash                                               |       | —                         |       | 1,597                                      |       | —                     |       | —           |       | 1,597            |       |
| Property and equipment, net                                   |       | 10                             |       | 19,823                                     |       | 1,720                      |       | —           |       | 21,553           |       |
| Customer accounts, net                                        |       | —                         |       | 187,570                                    |       | 45,305                     |       | —           |       | 232,875          |       |
| Goodwill                                                      |       | —                         |       | 6,142                                      |       | 6,018                      |       | —           |       | 12,160           |       |
| Trade name                                                    |       | —                         |       | 22,987                                     |       | 2,825                      |       |             |       | 25,812           |       |
| Deferred customer acquisition costs                           |       | —                         |       | 66,253                                     |       | 6,945                      |       | —           |       | 73,198           |       |
| Other                                                         |       | —                         |       | 8,518                                      |       | 3                          |       | —           |       | 8,521            |       |
| Accounts receivable (payable) from (to)  associated companies |       | 7,752                          |       | 9,481                                      |       | (17,233                    | )          | —           |       | —           |       |
| Investment in POAMI                                           |       | 1,237                          |       | —                                     |       | —                     |       | (1,237           | )          | —           |       |
| Investment in subsidiary guarantors                           |       | —                         |       | 47,852                                     |       | —                     |       | (47,852          | )          | —           |       |
| Total assets                                                  |       | $                              | 9,027      |                                       | $          | 421,677                    |       | $                | 54,687     |             | $          | (49,089 | ) | $ | 436,302 |   |
|                                                          |       |                           |       |                                       |       |                       |       |             |       |             |       |
| **Liabilities and Stockholder Equity**                        |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Current liabilities:                                          |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Current portion of long-term debt                             |       | $                              | —     |                                       | $          | 2,356                      |       | $                | —     |             | $          | — |   | $ | 2,356 |   |
| Accounts payable                                              |       | —                         |       | 2,601                                      |       | 125                        |       | —           |       | 2,726            |       |
| Accrued liabilities                                           |       | 960                            |       | 21,492                                     |       | 1,648                      |       | —           |       | 24,100           |       |
| Deferred revenue                                              |       | —                         |       | 33,159                                     |       | 3,312                      |       | —           |       | 36,471           |       |
| Total current liabilities                                     |       | 960                            |       | 59,608                                     |       | 5,085                      |       | —           |       | 65,653           |       |
| Long-term debt, net of current portion                        |       | —                         |       | 321,293                                    |       | —                     |       | —           |       | 321,293          |       |
| Deferred customer acquisition revenue                         |       | —                         |       | 38,746                                     |       | 1,127                      |       | —           |       | 39,873           |       |
| Other                                                         |       | —                         |       | 793                                        |       | 623                        |       | —           |       | 1,416            |       |
| Total Liabilities                                             |       | 960                            |       | 420,440                                    |       | 6,835                      |       | —           |       | 428,235          |       |
|                                                          |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Stockholders’ Equity                                     |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Common stock                                                  |       | 182                            |       | 2                                          |       | 1                          |       | (3               | )          | 182              |       |
| Additional paid in capital                                    |       | 159,939                        |       | 1,416,051                                  |       | 202,457                    |       | (1,618,508       | )          | 159,939          |       |
| Accumulated other comprehensive loss                          |       | (107                           | )          | (107                                       | )          | —                     |       | 107              |       | (107             | )          |
| Deficit                                                       |       | (151,947                       | )          | (1,414,709                                 | )          | (154,606                   | )          | 1,569,315        |       | (151,947         | )          |
| Total stockholders’ equity                               |       | 8,067                          |       | 1,237                                      |       | 47,852                     |       | (49,089          | )          | 8,067            |       |
| Total liabilities and stockholders’ equity               |       | $                              | 9,027      |                                       | $          | 421,677                    |       | $                | 54,687     |             | $          | (49,089 | ) | $ | 436,302 |   |

 

61

----

 

**Condensed**Consolidating BalanceSheet

**December 31, 2004**

**(dollar amounts in thousands)**

 
| ** **                                                              | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                              |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Current Assets                                                          |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Cash and cash equivalents                                               |       | $                              | —     |                                       | $          | 51,944                     |       | $                | 584        |             | $          | — |   | $ | 52,528 |   |
| Restricted cash                                                         |       | —                         |       | 926                                        |       | —                     |       | —           |       | 926              |       |
| Receivables, net                                                        |       | —                         |       | 20,662                                     |       | 3,557                      |       | —           |       | 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                                     |       | 7,370                      |       | —           |       | 96,563           |       |
| Property and equipment, net                                             |       | 14                             |       | 29,061                                     |       | 2,077                      |       | —           |       | 31,152           |       |
| Customer accounts, net                                                  |       | —                         |       | 166,542                                    |       | 9,613                      |       | —           |       | 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                                     |       | (52,056                    | )          | —           |       | —           |       |
| Investment in POAMI                                                     |       | (141,475                       | )          | —                                     |       | —                     |       | 141,475          |       | —           |       |
| Investment in subsidiary guarantors                                     |       | —                         |       | 22,738                                     |       | —                     |       | (22,738          | )          | —           |       |
| Total assets                                                            |       | $                              | (174,301   | )                                          | $          | 482,943                    |       | $                | 33,665     |             | $          | 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                                     |       | 2,616                      |       | —           |       | 37,088           |       |
| Due to related parties                                                  |       | —                         |       | 335                                        |       | —                     |       | —           |       | 335              |       |
| Deferred revenue                                                        |       | —                         |       | 32,447                                     |       | 1,570                      |       | —           |       | 34,017           |       |
| Total current liabilities                                               |       | 3,308                          |       | 460,859                                    |       | 4,956                      |       | —           |       | 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                                    |       | 10,927                     |       | —           |       | 638,653          |       |
|                                                                    |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Stockholders’ Equity (Deficiency in Assets)                        |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Common stock                                                            |       | 26                             |       | 2                                          |       | 1                          |       | (3               | )          | 26               |       |
| Additional paid in capital                                              |       | 1,380,728                      |       | 1,344,051                                  |       | 161,232                    |       | (1,505,283       | )          | 1,380,728        |       |
| Accumulated other comprehensive income                                  |       | 162                            |       | 162                                        |       | —                     |       | (162             | )          | 162              |       |
| Deficit                                                                 |       | (1,523,913                     | )          | (1,485,690                                 | )          | (138,495                   | )          | 1,624,185        |       | (1,523,913       | )          |
| Treasury stock                                                          |       | (34,612                        | )          | —                                     |       | —                     |       | —           |       | (34,612          | )          |
| Total stockholders’ equity (deficiency in  assets)                 |       | (177,609                       | )          | (141,475                                   | )          | 22,738                     |       | 118,737          |       | (177,609         | )          |
| Total liabilities and stockholders’ equity  (deficiency in assets) |       | $                              | (174,301   | )                                          | $          | 482,943                    |       | $                | 33,665     |             | $          | 118,737 |   | $ | 461,044 |   |

 

----

(a) Includes $53,873 payable to Protection OneAlarm Monitoring from Network Multifamily related to allocations of interestcharges.

 

62

----

 

**Condensed Consolidating Statement of Cash Flows**

**For the Period February 9, 2005 through December 31, 2005**

**(dollar amounts in thousands)**

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

 

63

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**Condensed Consolidating Statement of Cash Flows**

**For the Period January 1, 2005 through February 8, 2005**

**(dollar amounts in thousands)**

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

** **

**64**

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** **

**Consolidating Condensed Statement of Cash Flows**

**December 31, 2004**

**(dollar amounts in thousands)**

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

 

65

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**Consolidating Condensed Statement of Cash Flows**

**December 31, 2003**

**(dollar amounts in thousands)**

 
| ** **                                                              | ** ** | **Protection  One, Inc.** | ** ** | **Protection  One Alarm  Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                              | ** ** | ** **                     | ** ** | ** **                                 | ** ** | ** **                 | ** ** | ** **       | ** ** | ** **       | ** ** |
| **Net cash provided by operating activities**                           | ** ** | **$**                          | **846**    | ** **                                 | **$**      | **46,841**                 | ** ** | **$**            | **11,348** | ** **       | **$**      | **—** | ** ** | **$** | **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                                     | )          | (1,220                     | )          | —           |       | (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**                                | **)**      | **(5,765**                 | **)**      | **—**       | ** ** | **(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                                     |       | (5,496                     | )          | —           |       | —           |       |
| **Net cash provided by (used in) financing  activities**                | ** ** | **(2,273**                     | **)**      | **9,634**                                  | ** ** | **(5,496**                 | **)**      | **—**       | ** ** | **1,865**        | ** ** |
| Net cash provided by discontinued  operations from operating activities |       | —                         |       | 229                                        |       | —                     |       | —           |       | 229              |       |
| Net increase (decrease) in cash and cash  equivalents                   |       | —                         |       | 33,571                                     |       | 87                         |       | —           |       | 33,658           |       |
| Cash and cash equivalents:                                              |       |                           |       |                                       |       |                       |       |             |       |             |       |
| Beginning of period                                                     |       | —                         |       | 260                                        |       | 1,285                      |       | —           |       | 1,545            |       |
| End of period                                                           |       | $                              | —     |                                       | $          | 33,831                     |       | $                | 1,372      |             | $          | — |   | $ | 35,203 |   |

 

66

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**16.          Unaudited QuarterlyFinancial Information:**

 

The following is a summary of the unaudited quarterly financialinformation for 2005 and 2004, respectively (in thousands, except per shareamounts). The operating results for the quarters ended September 30, 2005 andDecember 31, 2005 have been restated to give effect to the restatement relatedto the over depreciation of property and equipment, as discussed in Note 17.

 
| ** **                                                     | ** ** | **January 1-** | ** ** | **February 9 ** | ** ** | **Quarter Ended** | ** ** |
|----------------------------------------------------------------|------------|---------------------|------------|---------------------------|------------|------------------------|------------|
| ** **                                                     | ** ** | **February 8** | ** ** | **– March 31**  | ** ** | **June 30**       | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                                                     | ** ** | ** **          | ** ** | ** **                | ** ** | ** **             | ** ** | **(As  Originally   Reported)** | ** ** | **(As  Restated)** | ** ** | **(As  Originally   Reported)** | ** ** | **(As  Restated)** | ** ** |
| ***2005***                                                     |       |                |       |                      |       |                   |       |   |   |   |   |   |   |   |   |   |
| Revenues                                                       |       | $                   | 28,543     |                      |       | $                      | 36,911     |   | $ | 65,441 |   | $ | 65,623 |   | $ | 65,623 |   | $ | 66,506 |   | $ | 66,506 |   |
| Net loss                                                       |       | $                   | (11,405    | )                         |       | $                      | (3,242     | ) | $ | (7,891 | ) | $ | (3,285 | ) | $ | (2,212 | ) | $ | (3,317 | ) | $ | (2,243 | ) |
| Basic and diluted income (loss) per share:                     |       |                |       |                      |       |                   |       |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                              |       | $                   | (5.80      | )                         |       | $                      | (0.18      | ) | $ | (0.43 | ) | $ | (0.18 | ) | $ | (0.12 | ) | $ | (0.18 | ) | $ | (0.13 | ) |
| Weighted average number of shares of common  stock outstanding |       | 1,966               |       |                      | 18,199     |                   | 18,199     |   | 18,199 |   | 18,199 |   | 18,199 |   | 18,199 |   |
|                                                           |       |                |       |                      |       |                   |       |   |   |   |   |   |   |   |   |   |

 
| ** **                                                     | ** ** | **Quarter Ended** | ** ** |
|----------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                     | ** ** | **March 31**      | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ***2004***                                                     | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                       |       | $                      | 67,132     |   | $ | 67,274 |   | $ | 67,528 |   | $ | 67,325 |   |
| Net income (loss)                                              |       | $                      | (309,383   | ) | $ | (16,616 | ) | $ | (16,652 | ) | $ | 18,745 |   |
| Basic and diluted 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 |   |

** **

**17. Restatement of Consolidated Financial Statements**

 

Subsequent to the issuance of the December 31, 2005 consolidatedfinancial statements, the Company identified an error in the calculation ofdepreciation expense in the period from February 9, 2005 through December 31,2005. The error resulted in an overstatement of depreciation expense and anoverstatement of net loss by approximately $2.1 million. The correction of thiserror is reflected in the restated results for the period February 9, 2005through December 31, 2005 as follows:

 
| ** **                                      | ** ** | **Amount as  originally  reported**          | ** ** | **Amount as  restated** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **(Dollars amounts in thousands)** | ** ** |
| **Changes to Consolidated Balance Sheet**       | ** ** | ** **                                        | ** ** | ** **                   | ** ** |
| **As of December 31, 2005**                     | ** ** | ** **                                        | ** ** | ** **                   | ** ** |
| Property and equipment, net                     |       | $                                                 | 19,406     |                         | $          | 21,553 |   |
| Total Assets                                    |       | $                                                 | 434,155    |                         | $          | 436,302 |   |
| Deficit                                         |       | $                                                 | (154,094   | )                            | $          | (151,947 | ) |
| Stockholders’ equity                       |       | $                                                 | 5,920      |                         | $          | 8,067 |   |
| Total Liabilities and Stockholders’ equity |       | $                                                 | 434,155    |                         | $          | 436,302 |   |

** **
| ** **                                                                  | ** ** | **Amount as  originally  reported**                                     | ** ** | **Amount as  restated** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                  | ** ** | **(Dollar amounts in thousands,   except per share amounts)** | ** ** |
| **Changes to Consolidated Statement of  Operations and Comprehensive Loss** | ** ** | ** **                                                                   | ** ** | ** **                   | ** ** |
| **For the period February 9, 2005 through  December 31, 2005**         | ** ** | ** **                                                                   | ** ** | ** **                   | ** ** |
| Amortization and depreciation                                               |       | $                                                                            | 45,889     |                         | $          | 43,742 |   |
| Total operating expenses                                                    |       | $                                                                            | 134,242    |                         | $          | 132,095 |   |
| Operating income                                                            |       | $                                                                            | 19,180     |                         | $          | 21,327 |   |
| Loss before income taxes                                                    |       | $                                                                            | (17,423    | )                            | $          | (15,276 | ) |
| Net loss                                                                    |       | $                                                                            | (17,735    | )                            | $          | (15,588 | ) |
| Comprehensive loss                                                          |       | $                                                                            | (18,004    | )                            | $          | (15,857 | ) |
| Net loss per common share, basic and  diluted                               |       | $                                                                            | (0.97      | )                            | $          | (0.86 | ) |

 

67

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**PROTECTION ONE, INC. AND SUBSIDIARIES**

**SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS**

**(Dollar amounts in thousands)**

 
| **Description**                                        | ** ** | **Balance at   Beginning  of period** | ** ** | **Charged to  costs and   expenses** | ** ** | **Deductions (a)** | ** ** | **Balance at  End of Period** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------|------------|----------------------------------------------|------------|
| ** **                                             |       |                                                 |       |                                                |       |                    |       |                                         |       |
| **Year ended December 31, 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 |   |
| **Year ended December 31, 2005**                       |       |                                                 |       |                                                |       |                    |       |                                         |       |
| Allowances deducted from assets for  doubtful accounts |       | $                                                    | 5,576      |                                                | $          | 1,936                   |       | $                                            | (2,533     | ) | $ | 4,979 |   |

 

----

(a)    Results from write-offs and sales ofaccounts receivable.

 

**ITEM9A.  CONTROLS AND PROCEDURES**

 

The Companymaintains disclosure controls and procedures designed to ensure thatinformation required to be disclosed in reports filed under the SecuritiesExchange Act of 1934, as amended, is recorded, processed, summarized andreported within the specified time periods. As of December 31, 2005, the Company’s management, under the supervisionand with the participation of our chief executive officer and our chieffinancial officer, performed an evaluation of the effectiveness of the designand operation of our disclosure controls and procedures.  Based on that evaluation, our chief executiveofficer and chief financial officer concluded that, as of December 31, 2005,our disclosure controls and procedures (a) were effective to ensure thatinformation required to be disclosed by us in reports filed or submitted underthe Exchange Act is timely recorded, processed, summarized and reported, and(b) include, without limitation, controls and procedures designed to ensurethat information required to be disclosed by us in reports filed or submittedunder the Exchange Act is accumulated and communicated to management, includingits chief executive officer and chief financial officer, as appropriate toallow timely decisions regarding required disclosure.  

 

On March 30,2006, we identified a material weakness in our internal control over financialreporting, which we view as an integral part of our disclosure controls andprocedures.  A material weakness is acontrol deficiency, or combination of control deficiencies, that results inmore than a remote likelihood that a material misstatement of the annual orinterim consolidated financial statements will not be prevented or detected.   Specifically, the amount of depreciationcalculated on equipment that had been revalued as part of our push downadjustments was overstated by $2.1 million for the period February 9, 2005through December 31, 2005.  Accordingly,these controls were reevaluated.  

 

On March 30,2006, the Company’s management, under the supervision and with the participationof our chief executive officer and our chief financial officer, concluded thatour disclosure controls and procedures as of December 31, 2005 did not providereasonable assurance of their effectiveness with respect to our accounting fordepreciation of certain equipment because the Company did not adequately designand maintain effective controls over the preparation, review, presentation anddisclosure of the amount of depreciation included in the Company’s ConsolidatedFinancial Statements, which resulted in misstatements therein. 

 

To remediatethis material weakness in the Company’s internal control over financialreporting, in the first quarter of 2006, the Company implemented additionalreview procedures over the calculation of depreciation of assets revalued aspart of the push down accounting adjustments. 

 

During thefourth fiscal quarter ended December 31, 2005, no change in our internalcontrol over financial reporting occurred that, in our judgment, eithermaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.  Duringthe first quarter of 2006, however, we made changes to our internal controlover financial reporting in connection with the preparation, review,presentation and disclosure of the amount of depreciation included in ourConsolidated Financial Statements, which resulted in the discovery of the errordescribed above.

 

Ourmanagement, including our chief executive officer and chief financial officer,recognize that any set of controls and procedures, no matter how well designedand operated, can provide only reasonable assurance of achieving management’scontrol objectives.

 

68

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**PART IV**

 

**ITEM 15. EXHIBITS, FINANCIAL STATEMENT**

 

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

 

Consolidated Balance Sheets

Consolidated Statements of Operations and Comprehensive Loss

Consolidated Statements of Cash Flows

Consolidated Statements of Stockholders’ Equity (Deficiency in Assets)

 

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

 

Schedule II - Valuation and Qualifying Accounts.

 

All other schedules for which provision is made in the applicableaccounting regulations of the Commission are not required under the relatedinstructions or are inapplicable and, therefore, have been omitted.

 

3. The following documents are filed or furnished as a part of thisreport:

 
| **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, as amended (the “Fiscal 2004 Form 10-K, as amended”)).                                                                                                      |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 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 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).                                                                                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                       |
| 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).                                                                                                                                     |

 

69

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|   |   |                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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”)).                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 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 Fiscal 2004 Form 10-K, as amended).*                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 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 L.L.C., POI Acquisition I, Inc. and Quadrangle  Master Limited Funding Ltd (incorporated by reference to Exhibit 10.5 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring for the quarter  ended September 30, 2004).                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.6   |   | 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).                                                                                                                     |

 

70

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| 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).          |
|   |   |                                                                                                                                                                                                                                                                                         |
| 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).*                                                                                                                   |

 

71

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| 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).                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                |
| 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, L.L.C.,  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).*                                                            |

 

72

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| 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).                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                            |
| 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 Fiscal 2004  Form 10-K, as amended).*                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                            |
| 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 Fiscal 2004 Form 10-K, as amended).*                                                                |
|   |   |                                                                                                                                                                                                                                                                                                            |
| 10.60  |   | Senior Management 2005 Short-Term Incentive  Plan (incorporated by reference to Exhibit 10.60 to the Fiscal 2004 Form  10-K, as amended).*                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                            |
| 10.61  |   | First Amendment to Employment Agreement  dated February 8, 2005 between Protection One, Inc., Network Multi-Family  Security Corporation, Protection One Alarm Monitoring, Inc. and Steven V.  Williams (incorporated by reference to Exhibit 10.1 of the Current Report on  Form 8-K dated September 7, 2005). |
|   |   |                                                                                                                                                                                                                                                                                                            |
| 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, 2005).                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                            |
| 23.1   |   | Consent of Deloitte & Touche LLP.+                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                            |
| 31.1   |   | Certification pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002. +                                                                                                                                                                                                                                     |

 

73

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| 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 marked with an asteriskconstitutes a management contract or compensatory plan or arrangement requiredto be filed or incorporated by reference as an Exhibit to this report pursuantto Item 15(c) of Form 10-K.

 

+           Filed or furnished herewith.

 

(b)  The exhibits required by Item 601 ofRegulation S-K are filed or furnished herewith.

 

74

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SIGNATURES

 

Pursuant tothe requirements of Section 13 and 15(d) of the Securities Exchange Act of1934, the Registrants have duly caused this report to be signed on their behalfby the undersigned, thereunto duly authorized.

 
|                  | PROTECTION ONE, INC.                   |
|-----------------------|----------------------------------------|
|                  | PROTECTION  ONE ALARM MONITORING, INC. |
|                  |                                   |
| Date: April  10, 2006 | By:                                    | /s/ DARIUS  G. NEVIN |   |
|                       |                                        |  |  |  |

 

 
|   | Darius G. Nevin              |   |
|--------|------------------------------|--------|
|   | Executive Vice President and |   |
|   | Chief Financial Manager      |   |

 

75

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