**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**

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

**Forthe fiscal year ended December 31, 2005**

**OR**

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

**Forthe transition period from                         to                         **

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

 

**785-856-5500**

(Registrant’s telephonenumber, including area code)

**N/A**

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

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

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

 

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

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

 

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

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

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

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

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes x   No o

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

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

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

 

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

Yes o   No x

As ofJune 30, 2005, the aggregate market value of the registrant’s common stockheld by non-affiliates of the registrant was $4,653,564 based on the closingsale price as reported on the OTC Bulletin Board.

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

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

 

**DOCUMENTS INCORPORATED BYREFERENCE**

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

 

 

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**TABLE OF CONTENTS**

|          | ** ** | ** **                                                                                                             | ** ** | **Page** | ** ** |
|----------|------------|------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|     | ** ** | **PART I**                                                                                                        |       |     |       |   |   |
| Item 1.  |       | Business                                                                                                               |       |     | 4          |   |   |
| Item 1A. |       | Risk Factors                                                                                                           |       |     | 11         |   |   |
| Item 1B. |       | Unresolved Staff Comments                                                                                              |       |     | 17         |   |   |
| Item 2.  |       | Properties                                                                                                             |       |     | 18         |   |   |
| Item  3. |       | Legal  Proceedings                                                                                                     |       |     | 18         |   |   |
| Item 4.  |       | Submission of  Matters to a Vote of Security Holders                                                                   |       |     | 18         |   |   |
|     | ** ** | **PART II**                                                                                                       |       |     |       |   |   |
| Item 5.  |       | Market for Registrant’s  Common Equity and Related Stockholder Matters and Issuer Purchases of Equity  Securities |       |     | 19         |   |   |
| Item 6.  |       | Selected Financial  Data                                                                                               |       |     | 20         |   |   |
| Item 7.  |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       |       |     | 22         |   |   |
| Item 7A. |       | Qualitative and Quantitative Disclosure About Market  Risk                                                             |       |     | 46         |   |   |
| Item 8.  |       | Financial  Statements and Supplementary Data                                                                           |       |     | 47         |   |   |
| Item 9.  |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                             |       |     | 91         |   |   |
| Item 9A. |       | Controls and  Procedures                                                                                               |       |     | 91         |   |   |
| Item 9B. |       | Other Information                                                                                                      |       |     | 91         |   |   |
|     | ** ** | **PART III**                                                                                                      |       |     |       |   |   |
| Item 10. |       | Directors and  Executive Officers of the Registrants                                                                   |       |     | 92         |   |   |
| Item 11. |       | Executive  Compensation                                                                                                |       |     | 92         |   |   |
| Item 12. |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                       |       |     | 92         |   |   |
| Item 13. |       | Certain  Relationships and Related Transactions                                                                        |       |     | 92         |   |   |
| Item 14. |       | Principal  Accountant Fees and Services                                                                                |       |     | 92         |   |   |
|     | ** ** | **PART IV**                                                                                                       |       |     |       |   |   |
| Item 15. |       | Exhibits,  Financial Statement Schedules                                                                               |       |     | 93         |   |   |

 

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**PART I**

**FORWARD-LOOKING STATEMENTS**

This Annual Report on Form 10-K and thematerials incorporated by reference herein include “forward-looking statements”intended to qualify for the safe harbor from liability established by thePrivate Securities Litigation Reform Act of 1995. These forward-lookingstatements generally can be identified as such because the context of thestatement includes words such as we “believe,” “expect,” “anticipate,” “will,” “should”or other words of similar import. Similarly, statements herein that describeour objectives, plans or goals also are forward-looking statements. Suchstatements include those made on matters such as our earnings and financialcondition, litigation, accounting matters, our business, our efforts toconsolidate and reduce costs, our customer account acquisition strategy andattrition, our liquidity and sources of funding and our capital expenditures. Allforward-looking statements are subject to certain risks and uncertainties thatcould cause actual results to differ materially from those in theforward-looking statements. The forward-looking statements included herein aremade only as of the date of this report and we undertake no obligation topublicly update such forward-looking statements to reflect subsequent events orcircumstances. Certain factors that could cause actual results to differinclude: our history of losses, which are likely to continue; principal andinterest payment requirements of our indebtedness; competition, includingcompetition from companies that are larger than we are and have greaterresources than we do; losses of our customers over time and difficultyacquiring new customers; changes in technology that may make our services lessattractive or obsolete; the development of new services or service innovationsby our competitors; potential liability for failure to respond adequately toalarm activations; changes in management; the potential for environmental orman-made catastrophes in areas of high customer account concentration; changesin conditions affecting the economy or security alarm monitoring serviceproviders generally; and changes in federal, state or local government or otherregulations or standards affecting our operations.

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

**INTRODUCTION**

Unless the context otherwise indicates, all referencesin this report to the “Company,” “Protection One,” “we,” “us” or “our” orsimilar words are to Protection One, Inc., its direct wholly ownedsubsidiary, Protection One Alarm Monitoring, Inc. and Protection One AlarmMonitoring’s wholly owned subsidiaries. Protection One’s sole asset is ProtectionOne Alarm Monitoring and Protection One Alarm Monitoring’s wholly ownedsubsidiaries, and accordingly, there are no separate financial statements forProtection One Alarm Monitoring, Inc. Each of Protection One andProtection One Alarm Monitoring is a Delaware corporation organized in September 1991.

In February 2005, we completed aone-share-for-fifty-shares reverse stock split of our outstanding shares ofcommon stock. All prior share and per share amounts included in this reportgive retroactive effect to the reverse stock split.

As a result of Quadrangle’s increased ownershipinterest from the February 8, 2005 debt-for-equity exchange, we have ‘‘pusheddown’’ Quadrangle’s basis to a proportionate amount of our underlying assetsand liabilities acquired based on the estimated fair market values of theassets and liabilities. Due to the impact of the changes resulting from thepush down accounting adjustments, the statement of operations data presentationseparates our results into two periods:  (1) theperiod prior to the February 8, 2005 consummation of the exchangetransaction and (2) the period beginning after that date utilizing the newbasis of accounting. See Item 7, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” for a discussion of the changein majority owner of the company in February 2004 and the new basis ofaccounting adopted in February 2005.

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

**ITEM 1.**                BUSINESS

**Overview**

We are a leading national provider of security alarmmonitoring services, providing installation, maintenance and electronicmonitoring of alarm systems to single-family residential, commercial,multifamily and wholesale customers. We monitor signals originating from alarmsystems designed to detect burglary, fire, medical, hold-up and environmentalconditions, and from access control and closed-circuit-television (CCTV)systems. Most of our monitoring services and a large portion of the maintenanceservices we provide our customers are governed by multi-year contracts withautomatic renewal provisions that provide us with recurring monthly revenue, orRMR. As of December 31, 2005, we had more than one million customers. Basedon information provided by a leading industry publication, we are the thirdlargest provider of electronic security monitoring services in the UnitedStates based on RMR.

Our businessconsists of two segments, Protection One Monitoring and Network Multifamily. ProtectionOne Monitoring primarily provides residential and commercial electronicsecurity system installation and alarm monitoring services directly tohomeowners and businesses. Protection One Monitoring also provides wholesalealarm monitoring services to independent alarm companies. Network Multifamilyprovides electronic security system installation and alarm monitoring servicesto owners and managers of apartments, condominiums and other multifamilydwellings. We market our services to customers within these segments throughseparate internal sales and installation branch networks. Our monitoring andrelated services revenue for the period February 9, 2005 through December 31,2005 and customer base compositions at December 31, 2005 were as follows:

| ** **                       | ** ** | ** ** | ** ** | **Percentage of Total**                   | ** ** |
|----------------------------------|------------|------------|------------|-----------------------------------------------------|------------|
| **Market**                       | ** ** | ** ** | ** ** | **Monitoring  and Related  Services  Revenue** | ** ** | **Sites** | ** ** |
| Single family and  commercial    |       |       | 81.1       | %                                                   |       | 50.9 | % |
| Wholesale                        |       |       | 4.5        |                                                |       | 17.7 |   |
| Protection One  Monitoring Total |       |       | 85.6       | %                                                   |       | 68.6 | % |
| Network  Multifamily Total       |       |       | 14.4       |                                                |       | 31.4 |   |
| Total                            |       |       | 100.0      | %                                                   |       | 100.0 | % |

 

For the periods February 9, 2005 through December 31,2005, and January 1, 2005 through February 8, 2005, we generatedconsolidated revenue of $234.5 million and $28.5 million, respectively. For theperiod February 9, 2005 through December 31, 2005, Protection OneMonitoring accounted for 86.5% of consolidated revenues, or $202.8 million,while Network Multifamily accounted for the 13.5% of consolidated revenues, or$31.7 million. For the period January 1, 2005 through February 8,2005, Protection One Monitoring accounting for 85.8% of consolidated revenues,or $24.5 million, while Network Multifamily accounted for 14.2% of consolidatedrevenues, or $4.0 million.

Financial information forthe past three years for each of our business segments is presented in Item 7,“Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Results of Operations” and in Item 8, Note 14 “SegmentReporting,” and is incorporated herein by reference.

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**Protection One Monitoring**

Protection One Monitoring provides installation,maintenance and monitoring of electronic security systems to single-familyresidential and commercial customers (our retail customers), and alarmmonitoring services to independent alarm companies (our wholesale customers). ProtectionOne Monitoring serves approximately 516,000 retail customers with no singlecustomer comprising more than 1% of our total consolidated revenue. ProtectionOne Monitoring serves retail customers from 63 field locations and threecentralized monitoring centers.

Currently, our new retail customers are generatedorganically through our internal sales force. Our reliance on an internal salesforce enables us to control the sales process from inception and to manage thelevel of customer care afforded.

Our wholesale businessserves approximately 860 independent alarm monitoring companies representingapproximately 179,000 customers. Typically, we act as the sole provider ofmonitoring services to independent monitoring companies. For the periods February 9,2005 through December 31, 2005, and January 1, 2005 through February 8,2005, our wholesale business accounted for 4.2% and 4.1%, respectively, of our consolidatedrevenue.

**Network Multifamily**

Network Multifamilyprovides alarm monitoring service to owners and managers of apartments,condominiums and other multifamily dwellings. We believe Network Multifamily isthe leading national provider of alarm monitoring services to the multifamilysector, with approximately 318,000 units in 602 cities.

**Sources of Revenue**

For both Protection One Monitoring and NetworkMultifamily, revenue is primarily generated from providing monitoring services.For the periods February 9, 2005 through December 31, 2005, and January 1,2005 through February 8, 2005, revenue generated from monitoring andrelated services accounted for 93.6% and 92.7%, respectively, of our totalrevenue.

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

For the periods February 9,2005 through December 31, 2005, and January 1, 2005 through February 8,2005, other revenues, derived principally from the sale of electronic securitysystems, contributed 6.4% and 7.3%, respectively, of our total revenue. Electronicsecurity systems typically are provided at a loss in connection with generatingnew contracts for recurring monitoring services.

**Recent Developments**

In August 2005, we began efforts to consolidatemanagement and other functions with our Network Multifamily subsidiary. Approximatelyforty positions were eliminated, including the President, Senior VicePresident-Sales, Senior Vice President-Legal and Vice President-Finance. Approximately$2.3 million in severance and retention costs were accrued and approximately$2.2 million were paid in the year ended December 31, 2005. In the fourthquarter of 2005, Network Multifamily converted its billing system toMastermind, which is the same billing system used by Protection One AlarmMonitoring, Inc. and as of January 1, 2006 Network Multifamily hadalso converted its general ledger, inventory management, 

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accounts payable andpayroll software to the same software currently used by Protection One AlarmMonitoring, 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.

**Industry and Competition**

According to an industry publication, the market forelectronic security system sales, leasing, installation, monitoring and servicetotaled approximately $27.0 billion in 2005. Over the past 10 years, theindustry has grown at an estimated compounded annual rate of 8.5%. Factorsdriving this growth include heightened security awareness, demographic changes,an increase in dual income households, as well as improved capital spendingdynamics for businesses.

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

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

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

·       MonitronicsInternational, Inc.; and

·       SecurityCo, Inc.,dba HSM, formerly called Honeywell Security Monitoring.

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

**Operations**

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

**CentralizedMonitoring, Common Technology Platform and Customer Service**

***Customer Security Alarm Systems***

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

***Customer Contracts***

Our existing alarmmonitoring customer contracts generally have initial terms ranging from threeto ten years in duration, and, in most states, provide for automatic renewalsfor a fixed period (typically one year) unless we or the customer elect tocancel the contract at the end of its term. Since 2002, most new single-familyresidential customers have entered into contracts with an initial term of threeyears, and most new commercial customers have entered into contracts with aninitial term of five years. Network Multifamily contracts have initial termsthat range from five to ten years. Typically, customers sign alarm 

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monitoringcontracts that include a bundled monthly charge for monitoring and extendedservice protection, which covers the normal costs of repair of the securitysystem. Customers may elect to sign an alarm monitoring contract providing fora reduced monthly charge that excludes extended service protection. Asignificant percentage of new residential and commercial customers also electto include line security based on cellular technology in their service bundle.

**MonitoringFacilities**

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

| **Location** | ** ** | ** ** | ** ** | **Approximate Number of   Customers Monitored** | ** ** | **Primary Markets** |
|--------------|------------|------------|------------|-------------------------------------------------|------------|---------------------|
| Irving, TX   |       | 365,000    |       | Multifamily/Commercial/  Residential            |
| Longwood, FL |       | 167,000    |       | Wholesale/Residential                           |
| Wichita, KS  |       | 481,000    |       | Residential/Commercial/ Wholesale               |

 

Our monitoring facilitiesoperate 24 hours per day, seven days a week, including all holidays. Eachmonitoring facility incorporates the use of communications and computer systemsthat route incoming alarm signals and telephone calls to operators. Eachoperator within a monitoring facility monitors a computer screen that presentsinformation concerning the nature of the alarm signal, the customer whose alarmhas been activated and the premises at which such alarm is located. Othernon-emergency administrative signals are generated by low battery status,arming and disarming of the alarm monitoring system and test signals, and suchsignals are processed automatically by computer. Depending upon the type ofservice for which the customer has contracted, monitoring facility personnelrespond to alarms by relaying information to local fire or police departments,notifying the customer, or taking other appropriate action, such as dispatchingalarm response personnel to the customers’ premises where this service isavailable.

All of our primarymonitoring facilities are listed by Underwriters Laboratories, Inc., orUL, as protective signaling services stations. UL specifications for monitoringfacilities include building integrity, back-up computer and power systems,staffing and standard operating procedures. In many jurisdictions, applicablelaw requires that security alarms for certain buildings be monitored by ULlisted facilities. In addition, such listing is required by certain commercialcustomers’ insurance companies as a condition to insurance coverage.

***Backup Facility***

Our backup facility is inWichita, Kansas and is a highly secure concrete building. This fully operable resourcehas the ability to backup all mission critical operations normally performed atour primary retail monitoring center. The structure is equipped with diversevoice and data telecommunication paths, backup power that includes standbyuninterruptible power supplies, access control, video surveillance and datavaults. In addition, we have deployed hot redundancy for our entire complementof equipment essential in the remote monitoring of the retail security systemswe offer. Furthermore, we have replicated the computer systems that are used tomaintain our mission critical applications. This facility was purchased withthe ability to be expanded for future internal growth and is actively used forother business-related operations.

***WholesaleMonitoring***

Through our Longwood andWichita monitoring facilities, we provide wholesale monitoring services toindependent alarm companies. Under the typical arrangement, alarm companiessubcontract monitoring services to us, primarily because they cannotcost-effectively provide their own monitoring 

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service.We may also provide billing and other services. These independent alarmcompanies retain ownership of monitoring contracts and are responsible forevery other aspect of the relationship with customers, including field repairservice.

***Customer Care Services***

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

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

***Enhanced Services***

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

·       *Extended Service Protection*, which coversthe normal costs of repair of the security system during regular businesshours.

·       *Supervised Monitoring Service*, whichallows the alarm system to send various types of signals containing informationon the use of the system, such as which users armed or disarmed the system andat what time of the day. This information is supplied to customers for use inconnection with the management of their households or businesses. Supervisedmonitoring service can also include a daily automatic test feature.

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

**Branch Operations**

We maintain approximately63 field locations in the United States from which we provide some or all ofthe following services:  field repair,customer care, alarm response and sales services. Our nationwide network ofbranches operates in some of the largest cities in the United States and playsa critical role in enhancing customer satisfaction, reducing customer loss andbuilding brand awareness. Repair services generate revenues primarily throughbillable field service calls and recurring payments under our extended serviceprotection program. By focusing growth in targeted areas, we hope to increasethe density of our customer base, which will permit more effective schedulingand routing of field service technicians and will create economies of scale.

**Sales and Marketing**

Our current customer acquisition strategy for ourProtection One Monitoring retail segment relies primarily on internallygenerated sales. Our internal sales program for our Protection One Monitoring 

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segment was started in February 2000on a commission-only basis with a goal of creating accounts at a cost lowerthan our external programs. This program utilizes our existing branchinfrastructure. The internal sales program for our Protection One Monitoringsegment generated 53,974 accounts, 52,584 accounts and 50,731 accounts in 2005,2004 and 2003, respectively. We operate a dedicated telesales center from whichwe respond to questions that customers or potential customers have about ourservices, support a marketing alliance with BellSouth Corporation (“BellSouth”)and provide quality control follow-up calls to customers for whom we recentlyprovided installation or maintenance services.

We are a partner in a marketing alliance withBellSouth to offer monitored security services to the residential,single-family market and to businesses in 17 of the larger metropolitan marketsin the nine-state BellSouth region. Under this agreement, we operate as “BellSouthSecurity Systems from Protection One” from our branches in the nine-stateBellSouth region. BellSouth provides us with information about new owners ofsingle-family residences and businesses in its territory and of transfers ofexisting BellSouth customers within its territory. We follow up on theinformation to create leads for our sales force. We pay BellSouth an upfrontroyalty for each new contract and a recurring royalty based on a percentage ofrecurring charges. Approximately one-fourth of our new accounts created in 2005and one-fifth of our new accounts created in 2004 and 2003 were produced fromthis arrangement. The marketing alliance agreement may be terminated by eitherparty upon 180 days’ notice or earlier upon occurrence of certain events.

Our retail sales professionals are responsible foridentifying new prospects and closing new sales of monitoring systems and services.The sales force also generates revenue from selling equipment upgrades andadd-ons to existing customers and by competing for those customers who areterminating their relationships with our competitors.

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

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

**Attrition**

See Item 7,  “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Attrition,” which is incorporatedherein by reference, for more information regarding attrition calculations, theimpact of attrition on our operating results and customer attrition by businesssegment.

**Intellectual Property**

We own trademarks relatedto the name and logo for Protection One and Network Multifamily Security aswell as a variety of trade and service marks related to individual services weprovide. While we believe our trademarks and service marks and proprietaryinformation are important to our business, we 

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do notbelieve our inability to use any one of them, other than the trademarks we ownin our name and logo, would have a material adverse effect on our business as awhole.

**Regulatory Matters**

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

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

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

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

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

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

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

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

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

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

**Risk Management**

The nature of the services we provide potentiallyexposes us to greater risks of liability for employee acts or omissions, orsystem failure, than may be inherent in other businesses. Substantially all ofour alarm monitoring agreements, and other agreements, pursuant to which wesell our products and services contain provisions limiting liability tocustomers in an attempt to reduce this risk.

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

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**Employees**

At December 31, 2005,we had approximately 2,400 full and part time employees. Our workforce is notunionized.

**Access to Company Information**

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

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

**ITEM 1A:**       RISKFACTORS

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

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

Quadrangle ownsapproximately 97.1% of our outstanding common stock as of March 10, 2006. Pursuantto a stockholder agreement with Quadrangle and subject to Quadranglemaintaining a certain threshold of ownership in us, Quadrangle will be able todirect the election of three of our directors and exercise a controllinginfluence over our business and affairs, including any determinations withrespect to mergers or other business combinations involving us, appointment ofour officers, our acquisition or disposition of material assets and ourincurrence of indebtedness. Similarly, Quadrangle will continue to have thepower to determine matters submitted to a vote of our stockholders without theconsent of other stockholders and to take other actions that might be favorableto Quadrangle, whether or not these actions would be favorable to us or to ourstockholders in general.

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

We incurred netlosses of $17.7 million in the period February 9, 2005 through December 31,2005, $11.4 million in the period January 1, 2005 through February 8,2005, $323.9 million in 2004 and $34.4 million in 2003. These losses reflectthe following, among other factors:

·       ourcustomer base and revenues have declined every year since 1999;

·       substantialcharges incurred by us for amortization of customer accounts;

·       awrite down of remaining deferred tax assets in 2004;

·       changein control and debt restructuring costs in 2004 and for the period January 1,2005 through February 8, 2005;

·       interestincurred on indebtedness;

·       expansionof our internal sales and installation efforts; and

·       othercharges required to manage operations.

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

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

We have, and willcontinue to have, a significant amount of indebtedness. As of March 10,2006, the face value of our total indebtedness, including capital leases, was approximately$345.2 million. Our level of indebtedness could have important consequences. Forexample, it could:

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

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

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

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

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

One or a combination ofthese factors could adversely affect our financial condition. Subject torestrictions in the indenture governing our notes and our senior secured creditfacility, we may incur additional indebtedness, which could increase the risksassociated with our already substantial indebtedness.

***Our business wasimpacted by Hurricane Katrina and we have incurred and may continue to incurcustomer losses related to property damage caused by Hurricane Katrina.***

We have lost customers dueto property damage caused by Hurricane Katrina in August 2005. In September 2005,we suspended billing for our customers in the areas most heavily affected byHurricane Katrina. We are currently attempting to contact each of thesecustomers to determine if our services will be needed in the future. As of December 31,2005, Protection One Monitoring estimated the loss of 3,117 customers,including 379 wholesale customers, and Network Multifamily has estimated theloss of 1,556 customer accounts. Estimated RMR losses related to these accountswere less than 1% of our total RMR. Our efforts to contact our customersaffected by Hurricane Katrina may not be successful and we may not be able torecapture accounts lost due to the hurricane.

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

Our senior creditfacility and the indenture governing our notes contain covenants that restrictour ability to finance future operations or capital needs, to respond tochanging business and economic conditions or to engage in other transactions orbusiness activities that may be important to our growth strategy or otherwiseimportant to us. The senior credit facility and the indenture governing ournotes restrict, among other things, our ability to:

·       incuradditional indebtedness or enter into sale and leaseback transactions;

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

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·       purchaseor redeem stock;

·       issuestock of our subsidiaries;

·       makeinvestments and extend credit;

·       engagein transactions with affiliates;

·       transferand sell assets;

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

·       createliens on our assets to secure debt.

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

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

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

We compete with a numberof major domestic security monitoring services companies, as well as a largenumber of smaller, regional competitors. Due to this fierce competition, wehave experienced high rates of customer attrition and have been subjected tocontinual and significant pricing pressures. Some of our competitors, eitheralone or in conjunction with their respective parent corporate groups, arelarger than we are and have greater financial resources, sales, marketing oroperational capabilities or brand recognition than we do. In addition, theinnovative nature of our markets may attract new entrants to the field. We maynot be able to compete successfully with the services of other companies, whichcould result in the loss of customers and, as a result, decreased revenue andoperating results.

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

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

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

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

·       relocationof customers;

·       customers’inability or unwillingness to pay our charges;

·       adversefinancial and economic conditions;

·       thecustomers’ perceptions of value; and

·       competitionfrom other alarm service companies.

We may experience the lossof newly acquired or created accounts to the extent we do not integrate oradequately service those accounts. Because some acquired accounts are prepaidon an annual, semiannual or quarterly basis, customer loss may not becomeevident for some time after an acquisition is consummated. During 2005, weexperienced a net loss of 17,316 customers, or a 1.7% decrease in our customerbase from January 1, 2005. While our attrition rate is decreasing, wecontinue to lose customers at a rate faster than our rate of adding customers. Thenet loss of customers was the primary cause of our decline in monitoring and relatedservice revenues of $1.6 million in 2005 and $8.8 million in 2004. We expectlosses to exceed additions until the efforts we are making to acquire newaccounts and further reduce our rate of attrition become more successful thanthey have been to date. Net losses of customer accounts materially andadversely affect our business, financial condition and results of operations.

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

The customer account acquisitionstrategy we are now employing relies primarily on our internal sales force andforming marketing alliances. We have changed our acquisition strategy severaltimes over the past few years attempting to decrease the cost of addingcustomers and to decrease the rate of attrition from new accounts. While ourpresent strategy resulted in some improvement in 2005 and 2004, this strategy maynot be successful in the future. If the strategy is not successful, our customerbase could continue to decline. If successful, the selling costs related tothis strategy will increase our expenses and uses of cash. Failure to replacecustomers lost through attrition or increased cash needs to replace thosecustomers could have a material adverse effect on our business, financialcondition, results of operations and ability to service debt obligations.

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

We have established amarketing relationship to offer monitored security services to the residential,single-family market and to businesses in 17 of the larger metropolitan marketsin the southeastern United States. Approximately 25% of our new accountscreated in 2005 and 20% of our new accounts created in each of 2004 and 2003were produced from this arrangement. Termination of this arrangement could havea short term material adverse effect on our ability to generate new customersin this territory.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

All of our alarmmonitoring centers are Underwriters Laboratories (“UL”) listed. To obtain andmaintain a UL listing, an alarm monitoring center must be located in a buildingmeeting UL’s structural requirements, have back-up and uninterruptible powersupplies, have secure telephone lines and maintain redundant computer systems. ULconducts periodic reviews of alarm monitoring centers to ensure compliance withtheir regulations. Non-compliance could result in a suspension of our ULlisting. The loss of our UL listing could negatively impact our competitiveposition.

***We depend on our relationshipswith alarm system manufacturers and suppliers. If we are not able to maintainor renew these alliances, our ability to create new customers and to serviceour existing account base could be negatively affected.***

We currently haveagreements with certain alarm system manufacturers and suppliers of hardwarefor products that we install in customer locations for new systems and torepair existing systems. We may not be able to maintain or renew our existingproduct sourcing arrangements on terms and conditions acceptable to us. If weare unable to maintain or renew our existing relationships, we may incuradditional costs creating new customer arrangements and in servicing existingcustomers.

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

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

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

Our monitoring servicesdepend upon the technology (hardware and software) of security alarm systems.We may be required to upgrade or implement new technology, which could requiresignificant capital expenditures. We may not be able to successfully implementnew technologies or adapt existing technologies to changing market demands. Ifwe are unable to adapt in response to changing technologies, market conditionsor customer requirements in a timely manner, such inability could adverselyaffect our business.

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***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 linesprovided by incumbent local exchange carriers decreased at about a 6% annualrate in 2005 and is projected to continue decreasing. While we offer alarmsystems that can communicate signals to our central stations using variouswireless and/or Internet-based communication technologies, such solutions arepresently more expensive than traditional PSTN-based alarm communicators. Highercosts might reduce the market for new customers of alarm monitoring services,and the trend away from PSTN lines to alternatives may mean more existingcustomers will cancel service with us. In addition, such shifts to newercommunications technologies may increase our costs for personnel training.

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

The success of ourbusiness is largely dependent upon the active participation of our executiveofficers, who have extensive experience in the industry. As a result, we haveentered into employment agreements with each of our executive officers. Theloss of the services of one or more of such officers for any reason may have anadverse 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 ourrecurring monthly revenue is derived from customers located in California andFlorida. A major earthquake, hurricane or some other environmental disaster inan area of high account concentration for us could disrupt our ability to servethose customers or render those customers uninterested in continuing to retainus to provide alarm monitoring services.

***We have incurred and will continue to incur increasedcosts as a result of recently enacted securities laws and regulations relatingto corporate governance matters and public disclosure.***

The Sarbanes-Oxley Act of 2002 and the SEC rules implementingthat Act have required changes in some of our corporate governance practicesand may require further changes. These 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 tocomply with the recently enacted laws and regulations in accordance with thedeadlines by which compliance is required, however, our estimate of the amountor timing of additional costs that we may incur to respond by these deadlinesmay not be accurate. Furthermore, we may not be able to fully comply with theprovisions of Section 404 of the Act regarding management’s assessment ofthe effectiveness of the Company’s internal control over financial reportingand the auditor’s attestation to and report on both management’s assessment andthe effectiveness of the Company’s internal control over financial reporting.

**ITEM1B.**       UNRESOLVED STAFF COMMENTS

We have no unresolvedstaff comments as of March 10, 2006.

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**ITEM 2.**                PROPERTIES

Wemaintain our executive offices at 1035 N. 3rd Street, Suite 101, Lawrence,Kansas 66044. We operate primarily from the following facilities, although wealso lease office space for our approximately 63 field locations.

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

 

**ITEM 3.**                LEGALPROCEEDINGS

Information on our legalproceedings is set forth in Item 8, Note 13 “Commitments and Contingencies” ofthe Notes to Consolidated Financial Statements, which are incorporated hereinby reference.

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

No matters were submitted to Protection One’sstockholders during the fourth quarter of 2005.

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**PART II**

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

**Market Price Information**

Ourcommon stock was listed on the New York Stock Exchange under the symbol “POI”until the fourth quarter of 2003. Because our stock was trading below $1.00 (ona pre-reverse stock split basis), we did not meet listing requirements of theNew York Stock Exchange. Since December 4, 2003, our stock has traded onthe OTC Bulletin Board.  The table belowsets forth for each of the calendar quarters indicated the high and low salesprices per share of our common stock, as reported by the OTC Bulletin Board. Thequotations reflect inter-dealer prices, without retail mark-up, mark-down orcommission and may not represent actual transactions. On February 8, 2005we effectuated a one-share-for-fifty shares reverse stock split. On February 9,2005, our common stock symbol changed from “POIX” to “PONN.”

| ** **     | ** ** | **High(a)** | ** ** | **Low(a)** | ** ** |
|----------------|------------|-------------|------------|------------|------------|
| **2004:**      |       |        |       |       |       |
| First Quarter  |       | $           | 36.00      |       | $          | 13.00 |   |
| Second Quarter |       | 25.00       |       | 9.00       |       |
| Third Quarter  |       | 15.00       |       | 6.00       |       |
| Fourth Quarter |       | 18.50       |       | 8.00       |       |
| **2005:**      |       |        |       |       |       |
| First Quarter  |       | $           | 28.50      |       | $          | 13.50 |   |
| Second Quarter |       | 28.75       |       | 18.05      |       |
| Third Quarter  |       | 18.10       |       | 13.85      |       |
| Fourth Quarter |       | 17.95       |       | 15.80      |       |

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

**Dividend Information**

Holders of Protection One common stock are entitled toreceive only dividends declared by the board of directors from funds legallyavailable for dividends to stockholders. We did not declare or pay anydividends for the years ending December 31, 2005 or 2004.

The indentures governingthe 8.125%senior subordinated notes due in 2009 and the bank credit facility restrictProtection One Alarm Monitoring’s ability to pay dividends or to makeother distributions to its corporate parent. Consequently, these agreementsrestrict our ability to declare or pay any dividend on, or make any otherdistribution in respect of, our capital stock unless we satisfy the financialand other tests set forth in such agreements.

**Number of Stockholders**

As of March 10, 2006,there were approximately 852 stockholders of record who held shares of ourcommon stock.

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

The information called for by the item relating to “SecuritiesAuthorized for Issuance Under Equity Compensation Plans” is set forth underthat heading in Item 12, “Security Ownership of Certain Beneficial Owners andManagement and Related Stockholder Matters” and is incorporated herein byreference.

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**ITEM 6.**                SELECTEDFINANCIAL DATA

Theselected consolidated financial data set forth below should be read inconjunction with Item 7, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and the audited consolidated financialstatements and notes to the financial statements of Protection One, which canbe found in Item 8. Due to the impact of the changes resulting from the pushdown accounting adjustments described in Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—SignificantActivities—*New Basis of Accounting*” below, thestatement of operations data presentation separates our results into twoperiods:  (1) the period prior tothe February 8, 2005 consummation of the exchange transaction and (2) theperiod beginning after that date utilizing the new basis of accounting. Theresults are further separated by a heavy black line to indicate the effectivedate of the new basis of accounting. Similarly, the current and prior periodamounts presented under consolidated balance sheet data and other operatingdata are separated by a heavy black line to indicate the application of a newbasis of accounting between the periods presented. All amounts are inthousands, except per share and customer data, unless otherwise noted.

| ** **                                                          | ** ** | **SELECTED CONSOLIDATED 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** | ** ** |
| ** **                                                          | ** ** | **(dollar amounts in thousands)**            | ** ** |
| **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                |       |                                                        | 45,889     |   |   |   |   |   | 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)                                             |       |                                                        | 19,180     |   |   |   |   |   | (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                 |       |                                                        | (17,423    | ) |   |   |   |   | (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           |       |                                                        | (17,735    | ) |   |   |   |   | (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                                                            |       |                                                        | $          | (17,735 | ) |   |   |   |   | $ | (11,405 | ) |   |   | $ | (323,906 | ) |   |   | $ | (34,411 | ) |   |   | $ | (880,855 | ) |   |   | $ | (86,048 | ) |   |
| Net loss per share of common stock(c)                               |       |                                                        | $          | (0.97 | ) |   |   |   |   | $ | (5.80 | ) |   |   | $ | (164.78 | ) |   |   | $ | (17.53 | ) |   |   | $ | (449.09 | ) |   |   | $ | (40.80 | ) |   |
| 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 |   |   |

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| **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)                                                   |   |   | 434,155   |   |   |   |   |   | 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)           |   |   | 5,920     |   |   |   |   |   | (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)              See Item 7 “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Significant Activities—*New Basis of Accounting*” for a discussion on push downaccounting in 2005 and the adjusted basis of certain assets and liabilities.

(b)             Consolidated balance sheet data and number of customersare as of January 31, 2005.

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

(d)             Impairment charges and the cumulative effect of anaccounting change are the result of our January 1, 2002 implementation ofSFAS Nos. 142, “Accounting for Goodwill and Other Intangible Assets” and144, “Accounting for the Impairment and Disposal of Long-Lived Assets.”

(e)              See Item 7 “Management’s Discussion and Analysisof Financial Condition and Results of Operations—Critical Accounting Policies—*Income Taxes*” and Item 7 “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Liquidity and CapitalResources—*Tax Matters*” for discussion of the 2004income tax expense related to establishment of a valuation allowance fordeferred tax assets.

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

**Introduction**

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

·       whatfactors affect our business;

·       whatour earnings and costs were in 2005, 2004 and 2003;

·       whythese earnings and costs differ from year to year;

·       howour earnings and costs affect our overall financial condition;

·       whatwe expect our capital expenditures to be for the years 2006 through 2007;

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

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

In February 2005, we completed aone-share-for-fifty-shares reverse stock split of our outstanding shares ofcommon stock. All prior share and per share amounts included in this reportgive 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 31,2004 and 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.

**Overview**

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

Our business consists oftwo primary segments, Protection One Monitoring and Network Multifamily. ProtectionOne Monitoring primarily provides residential and commercial electronicsecurity system installations and alarm monitoring services directly tohomeowners and businesses. Protection One Monitoring also provides wholesalealarm monitoring services to independent alarm companies. Network Multifamilyprovides electronic security system installation and alarm monitoring servicesto owners and managers of apartments, condominiums and other multifamilydwellings. We market our services to these customer segments through separateinternal sales and installation 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 

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rates; (ii) reducingacquisition costs for each dollar of RMR created; (iii) increasing RMRadditions, and (iv) increasing the efficiency of our monitoring andservice activities. We plan to achieve these objectives by building upon ourcore strengths, including our national branch platform, our improving brandrecognition, our internal sales force model and our highly skilled andexperienced management team and workforce.

**Significant Activities**

***Change in Majority Owner***

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

On November 12, 2004,we entered into a debt-for-equity exchange agreement with Quadrangle thatprovided for the principal balance outstanding under the Quadrangle creditfacility to be reduced by $120.0 million in exchange for the issuance toQuadrangle of 16 million shares of our common stock.  The exchange was completed on February 8,2005 and was accompanied by a one-share-for-fifty-shares reverse stock split ofour common stock. The newly issued shares, together with shares already ownedby Quadrangle, resulted in Quadrangle owning approximately 97.3% of our commonstock.

***New Basis of Accounting***

As a result of Quadrangle’s increased ownershipinterest from the February 8, 2005 debt-for-equity exchange, we have ‘‘pusheddown’’ Quadrangle’s basis to a proportionate amount of our underlying assetsand liabilities acquired based on the estimated fair market values of theassets and liabilities. The “push-down” accounting adjustments did not impactcash flows.  The primary changes to thebalance sheet reflect (1) the reduction of deferred customer acquisitioncosts and revenues, which have been subsumed into the estimated fair marketvalue adjustment for customer accounts; (2) adjustments to the carryingvalues of debt to estimated fair market value (or Quadrangle’s basis in thecase of the credit facility);  (3) adjustmentsto historical goodwill to reflect goodwill arising from the push downaccounting adjustments; (4) the recording of a value for our trade 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 othercosts of revenue and selling expenses due to a 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 our debt instruments; and (4) thereduction in amortization related to the reduction in the amortizable base ofcustomer accounts.

Due to the impact of thechanges resulting from the push down accounting adjustments described above,the income statement presentation separates our results into two periods:  (1) the period prior to the February 8,2005 consummation of the exchange transaction and (2) the period beginningafter that date utilizing the new basis of accounting. The results are furtherseparated by a heavy black line to indicate the effective date of the new basisof accounting. Similarly, the current and prior period amounts reported on thebalance sheet and statement of cash flows are separated by a heavy black lineto indicate the application of a new basis of accounting between the periodspresented.

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***Restructuring***

We have improved our capital structure through thedebt-for-equity exchange with Quadrangle and by refinancing approximately$242.3 million of debt due in 2005 with the bank credit agreement due 2011 (see“Refinancing” discussion below). In connection with the restructuring, weretired an aggregate of approximately of $152.9 million which was outstandingon December 31, 2004.

*StockholdersAgreement and Composition of Our Board 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 permittedtransferees owns less than 25% of our common shares issued and outstanding asof the restructuring, POI Acquisition, L.L.C. shall have the right to designateone director 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.

In accordance with the stockholders agreement, weamended our bylaws following the restructuring to prevent us from voluntarilyfiling for bankruptcy, merging or consolidating with another entity until February 8,2007 or 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.

*RegistrationRights Agreement.*   As a condition to theconsummation of the debt-for-equity exchange, we entered into a registrationrights agreement with POI Acquisition, L.L.C. and Quadrangle Master Funding Ltd.The registration rights agreement provides, among other things, that we willregister, upon notice, shares of our common stock owned by such parties. Underthe registration rights agreement, POI Acquisition, L.L.C. is permitted up tofour demand registrations and Quadrangle Master Funding Ltd is permitted up totwo demand registrations, subject to certain conditions described in theagreement. POI Acquisition, L.L.C. and Quadrangle Master Funding Ltd alsoreceived piggyback registration rights whereby they shall have the opportunityto register their securities pursuant to any registration statement we may filein the future, subject to certain conditions. We are also obligated to pay certainof their expenses pursuant to the registration of their securities under theregistration rights agreement.

*Repurchase of Outstanding13.625% Senior Subordinated Discount Notes.*   Inconnection with the restructuring and as required by the indenture governingour outstanding 13.625% senior subordinated discount notes, we also initiated achange of control repurchase offer at 101% for our approximately $29.9 millionof outstanding 13.625% senior subordinated discount notes. We completed therepurchase of all of these notes on March 11, 2005.

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

As a condition to the completion of thedebt-for-equity exchange, we implemented a management incentive plan thatincluded an equity investment opportunity and stock appreciation rights (SARs)for our senior executive officers and a new stock option plan.

*EquityInvestment.*   As part of the management incentiveplan implemented in connection with the restructuring, certain members ofmanagement invested an aggregate of $1.75 million and received an aggregate of233,334 shares of common stock on a post-reverse stock split basis.Messrs. Ginsburg, Nevin, Pefanis, Williams and Griffin 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 of our common stock, respectively. Theshares were purchased pursuant to a management shareholders’ agreement enteredinto among the Company, Quadrangle and the management stockholder. Theagreement contains tag-along, drag-along, piggyback registration rights,transfer restrictions and other provisions.

*StockAppreciation Rights Plan.*   Pursuant to themanagement incentive plan, Messrs. Ginsburg, Nevin, Pefanis, and Williamsreceived an aggregate of approximately 798,473, 532,981, 465,111 and199,618  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, whichgenerally means Quadrangle’s sale of at least 60% of its equity interest in us,provided that if the qualified sale is not a permissible distribution event (asdefined in the SAR Plan) the payment will be made, with interest, in connectionwith a subsequent permissible distribution event, and (2) February 8,2011. The exercise price of the SARs is $4.50 and increases by 9% per annum,which we refer 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 oneshare of stock in such qualified sale, or the fair market value of one share ofstock if the qualified sale is not a sale to a third party and (2) $7.50,provided that if a SAR holder’s right to receive stock is converted pursuant tothe SAR Plan into a right to receive cash from a grantor trust that the Companymay establish, the amount of cash payable will be credited with interest at 6%per annum, compounded annually, from the date such conversion is effectiveuntil the applicable payment date. Because payment under the plan will only bemade in the event of a qualified sale as defined in the SAR plan, no amountshave been accrued as of December 31, 2005.

*2004Stock Option Plan.*   The 2004 Stock Option Planbecame effective upon the consummation of the debt-for-equity exchange on February 8,2005. Under the 2004 Stock Option Plan, certain executive officers and selectedmanagement employees were granted options, which are subject to vesting,exercise and delivery restriction described below, to purchase an aggregate of1,782,947 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 weregranted to Messrs. Ginsburg, Nevin, Pefanis, Williams and Griffin,respectively.  The options initiallygranted under the plan will vest ratably each month during the 48 months afterthe date of grant, subject to accelerated vesting, in the case of certainsenior executive officers, under certain circumstances following a qualifiedsale. Under the option agreements applicable to the options granted, any sharesof stock purchased through the exercise of options generally will be issued anddelivered to the option holder, and any net payment that may be due to suchholder in accordance with the plan, will be paid to such holder upon theearlier of: (1) specified dates following the occurrence of certainpermissible distribution events (as defined in the SAR Plan) and (2) February 8,2011, provided that if an option holder’s right to receive stock is converted pursuantto the plan into a right to receive cash, the amount of cash payable will becredited with interest at 6% per annum, compounded annually, from the date suchconversion is effective until the applicable payment date.

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*Retention Bonus Program.*   Pursuantto the terms of their new employment agreements, Messrs. Ginsburg, Nevin,Pefanis, Williams, and Griffin were each entitled to receive two retentionbonuses. We accrued $1.9 million as general and administrative expense in 2004and an additional $0.2 million of expense in January 2005 for theseretention 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 creditagreement enabling us to complete a redemption of our 7.375% senior notes due2005 for approximately $166.3 million plus accrued interest (approximately$164.3 million aggregate principal amount outstanding) and repay the 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. We recorded a lossin the second quarter of 2005 of approximately $6.1 million associated withthis redemption and repayment.

The bank credit agreementprovides for a $25.0 million revolving credit facility and a $250.0 millionterm loan facility. The revolving credit facility matures in 2010 and the termloan matures in 2011, subject to earlier maturity if we do not refinance our8.125% senior subordinated notes due 2009 before July 2008. The newrevolving credit facility is undrawn as of March 10, 2006. We intend to use any other proceeds from borrowingsunder the revolving credit facility, from time to time, for working capital andgeneral corporate purposes. Letters of credit are also available to us underthe bank credit agreement.

***Corporate Consolidation***

In 2005, we consolidated management and other supportfunctions of our Network Multifamily subsidiary with our Protection OneMonitoring segment.  Approximately fortypositions were eliminated, including the President, Senior VicePresident-Sales, Senior Vice President-Legal and Vice President-Finance.  We accrued approximately $2.3 million forseverance and retention expense related to this consolidation and paidapproximately $2.2 million of this amount as of December 31, 2005. Additionalexpense of approximately $20.0 thousand was incurred in January 2006 andthe remaining accrued amounts were paid at that time. For more informationregarding this consolidation, see our Current Report on Form 8-Kfiled on September 7, 2005.

In addition, Network Multifamily has completed aconversion of its billing system to Mastermind, which is the billing systemused by Protection One Alarm Monitoring, Inc. and its general ledger,inventory management, accounts payable and payroll software to Lawson, which isthe same software currently 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$17.7 million for the period February 9, 2005 through December 31,2005 and $11.4 million for the period January 1, 2005 through February 8,2005. The net loss in the period February 9, 2005 through December 31,2005 includes $2.3 million in severance and other costs related to our effortsto consolidate operations with our Network Multifamily subsidiary. The net lossin the period 

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January 1,2005 through February 8, 2005 includes $5.9 million in charges related toour debt restructuring. The remaining net loss in both periods reflects adecline in revenue, substantial charges incurred by us for amortization ofcustomer accounts and interest incurred on indebtedness.

**Industry Metrics**

***Recurring Monthly Revenue***

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

We had approximately $19.9 million of RMR as of December 31for each of the years 2005 and 2004 and $20.1 million of RMR as of December 31,2003. The slowing rate of RMR decrease is a result of a reduction in the rateof decline of our customer base. Our customer base reflected a net loss of 17,316customers during 2005 compared to a net loss of 18,207 customers during 2004and a net loss of 25,378 customers during 2003. We expect we will continue tolose more accounts than we add until the efforts we are making to acquire newaccounts and to reduce our rate of attrition become more successful than theyhave been to date. Net losses of customer accounts materially and adverselyaffect our business, financial condition and results of operations.

Webelieve the presentation of RMR is useful to investors because the measure isused by investors and lenders to value companies such as ours with recurringrevenue streams. Management monitors RMR, among other things, to evaluate ourongoing performance. The table below reconciles our RMR to revenues reflectedon our consolidated statements of operations.

| ** **                               | ** ** | **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 notpursuant to monthly contractual billings.

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

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Thefollowing table identifies RMR by segment and in total for the years indicated.

| ** **                                                                      | ** ** | **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)    In September 2005, we suspended billing for ourcustomers in the areas most heavily affected by Hurricane Katrina. We arecurrently attempting to contact each of these customers to determine if ourservices will be needed in the future. As of December 31, 2005, ProtectionOne Monitoring has estimated the loss of 3,117 customers, including 379wholesale customers, and Network Multifamily has estimated the loss of 1,556customer accounts. Estimated RMR losses related to these accounts were lessthan 1% of our total RMR.

Thetable below reconciles our recurring monthly revenue by segment to revenuesreflected in our segment results of operations.

| ** ** | ** ** | **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.

***Monitoring and Related Services Margin***

Ineach of the last three years, monitoring and related service revenues comprisedover 91% of our total revenues. As a result of our declining customer base,these revenues have been decreasing. The rate of revenue decline has slowed,however, while the gross margin as a percentage of revenues has remained 

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relatively constant. The table below identifies themonitoring and related services gross margin and gross margin percent for thepresented periods.

| ** **                                        | ** ** | **2005**                                         | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                        | ** ** | **February 9 -  December 31**     | ** ** | **January 1 -  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 resultsof operations since it affects our revenues, amortization expense and cash flow.We define attrition as a ratio, the numerator of which is the gross number oflost customer accounts for a given period, net of the adjustments describedbelow, and the denominator of which is the average number of accounts for agiven period. In some instances, we use estimates to derive attrition data. Wemake adjustments to lost accounts primarily for the net change, either positiveor negative, in our wholesale base. 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 therelationship period with any individual customer can vary significantly. Customersdiscontinue service with us for a variety of reasons, including relocation,service issues and cost. A portion of the acquired customer base can beexpected to discontinue service every year. Any significant change in thepattern of our historical attrition experience would have a material effect onour results of operations.

We monitor attrition each quarter based on a quarterlyannualized and trailing twelve-month basis. This method utilizes each segment’saverage customer account base for the applicable period in measuring attrition.Therefore, in periods of customer account growth, customer attrition may beunderstated and in periods of customer account decline, customer attrition maybe overstated.

Asdefined 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 | % |   |

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(a)              We have estimated the loss of our customers in theareas affected by Hurricane Katrina. As of December 31, 2005, ProtectionOne Monitoring has estimated the loss of 3,117 customers, including 379wholesale customers, and Network Multifamily has estimated the loss of 1,556customers whose homes or businesses have been damaged beyond repair and will nolonger need our monitoring services. We are currently attempting to contacteach customer in the hurricane damaged areas to determine if our services willbe needed in the future.

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(b)             Attrition results for Network Multifamily exclude theimpact on the calculation of our customer base from the conversion of ourbilling system to our new technology platform, MAS. Customers are defineddifferently in the new system and the result was a decrease in the number ofcustomers in the new system.

Excluding the impact of Hurricane Katrina, our twelvemonth trailing attrition rate has remained level compared to our 2004 rate inour Protection One Monitoring segment.

In thetable below we define the denominator the same as above but define thenumerator as the gross number of lost customer accounts for a given periodreduced by move-in accounts.

| ** **                                     | ** ** | **Customer Account Attrition** | ** ** |
|------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                     | ** ** | **December 31, 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 | % |   |

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(a)              We have estimated the loss of our customers in theareas affected by Hurricane Katrina. As of December 31, 2005, ProtectionOne Monitoring has estimated the loss of 3,117 customers, including 379wholesale customers, and Network Multifamily has estimated the loss of 1,556customers whose homes or businesses have been damaged beyond repair and will nolonger need our monitoring services. We are currently attempting to contacteach customer in the hurricane damaged areas to determine if our services willbe needed in the future.

(b)             Attrition results for Network Multifamily excludes theimpact on the calculation of our customer base from the conversion of ourbilling system to our new technology platform, MAS. Customers are defineddifferently in the new system and the result was a decrease in the number ofcustomers in the new system.

Thetable below shows the change in our total company customer base includingcustomer 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)           2005 includes estimatedcustomer 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 OneMonitoring and Network Multifamily, revenue is primarily generated fromproviding monitoring services. Monitoring revenue for residential, commercialand multifamily segments is generated based on contracts that we enter intowith our customers. The typical initial contract term is three to five yearsfor Protection One Monitoring customers and five to ten years for NetworkMultifamily customers, with automatic renewal provisions where permitted (therenewal terms are longer in the case of Network Multifamily). Many of ourresidential and commercial contracts require us to provide additional services,such as maintenance services, generating incremental revenue for us. Otherrevenue consists 

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primarilyof sales of burglar alarms, closed circuit television systems, fire alarms andcard access control systems to commercial customers.

**Costs of Revenues; Expenses**

Monitoring and related services costs generally relateto the cost of providing monitoring service and include the costs ofmonitoring, billing, customer service and field operations. Other costs 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.

Selling expenses includeemployee compensation, benefits and recruiting for our internal salesforce, advertising, customer signage, marketing materials, trade showexpense, and amortization of previously deferred selling costs. Generaland administrative expenses include lease expenses on office space, computersand other office equipment, telecommunications, costs of debt collectionefforts, advertising, employee compensation and benefits, professional servicefees and other miscellaneous expenses. Amortization of intangibles anddepreciation includes amortization of customer accounts as well as depreciationon property and equipment.

**Critical Accounting Policies**

Our discussion andanalysis of results of operations and financial condition are based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America, orGAAP. The preparation of these consolidated financial statements requires us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. We evaluate our estimates on an on-going basis, includingthose related to bad debts, inventories, investments, customer accounts,goodwill, intangible assets, income taxes, contingencies and litigation. Webase our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions.

***Push Down Accounting***

As described in “SignificantActivities—*New Basis of Accounting*” above, we have ‘‘pusheddown’’ Quadrangle’s basis to a proportionate amount of our underlying assetsand liabilities acquired based on the estimated fair market values of theassets and liabilities. The “pushed-down” basis at February 8, 2005 wasused to value customer accounts, property and equipment, trade name, goodwill,deferred customer acquisition costs and revenues, debt, additional paid incapital and deficit as of the restructuring. Additions of assets or liabilitiessubsequent to February 8, 2005 are valued at cost.

***Revenue and Expense Recognition***

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

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method for our NetworkMultifamily customers. Deferred costs in excess of deferred revenues arerecognized utilizing a straight-line method over the initial contract term,typically two to three years for residential systems, five years for commercialsystems and five to ten years for Network Multifamily systems. To the extentdeferred costs are less than deferred revenues, such costs are recognized overthe estimated life of the customer utilizing the same method as with therelated deferred revenues. Therefore, a change in the estimated life of acustomer pool would result in a change in the amount of previously deferredrevenue that would be amortized to income but would also result in a similarchange in the amount of previously deferred costs that are amortized to expense.For example, if we had determined as of February 9, 2005 that theestimated life of each pool should be shortened by one year, the amount ofpreviously 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 costof revenues would have increased by $0.4 million resulting in no net impact togross profit.

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Thetable below reflects the impact of our accounting policy on the respective lineitems of the Statement of Operations for the periods February 9, 2005through December 31, 2005 and January 1, 2005 throughFebruary 8, 2005 and for the years ended December 31, 2004 and 2003.The “Total amount incurred” line represents the current amount of billings thatwere made and the current costs that were incurred for the period. We thensubtract the deferral amount and add back the amortization of previous deferralamounts to determine the amount we report in the Statement of Operations.

| ** ** | ** ** | **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** | ** ** |
| ** ** | ** ** | **(dollar  amounts in thousands)**            | ** ** |
|            |            |                                               |            |                                         |            |                                             |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

| 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 |   |

 

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***Valuation of Intangible Assets***

As discussed in “—*New Basis of Accounting*”above, because Quadrangle acquired substantially all of our common stock,resulting in a new basis of accounting, new values for intangible assets wererecorded in the first quarter of 2005 based on estimates of fair market values.New values were recorded for customer accounts, trade names and goodwill.

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

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

·       highlevels of customer attrition;

·       continuingrecurring losses above our expectations; and

·       adverseregulatory rulings.

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

We completed our annualimpairment testing during the third quarter of 2005 and determined that noimpairment of our non-amortizable intangible assets was required as ofJuly 1, 2005. We also determined that no impairment was required due tothe impact of Hurricane Katrina. No impairment charge was recorded in 2004 or2003.

***Customer Account Amortization***

The choice of an amortization life and method is basedon our estimates and judgments about the amounts and timing of expected futurerevenues from customer accounts and average customer account life. Amortizationmethods and selected periods were determined because, in our opinion, theywould adequately match amortization cost with anticipated revenue. Weperiodically perform lifing studies on our customer accounts to assist us indetermining appropriate lives of our customer accounts. These reviews areperformed specifically to evaluate our historic amortization policy in light ofthe inherent declining revenue curve over the life of a pool of customeraccounts, and our historical attrition experience. Prior to adopting a newbasis of accounting as described in “—*New Basis of Accounting*”above, we had identified three distinct pools of customer accounts, as shown inthe table below, each of which had distinct attributes that effected differingattrition characteristics. One of these pools (the acquired Westinghousecustomers) was fully amortized at December 31, 2004. For the ProtectionOne Monitoring pools, the results of the lifing studies indicated to us that wecan expect attrition to be greatest in years one through five of asset life andthat a declining balance (accelerated) method would therefore best match thefuture amortization cost with the estimated revenue stream from these customerpools. We switch from the declining balance method to the straight-line methodin the year the straight-line method results in greater amortization expense.

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**Ouramortization rates consider the average estimated remaining life and historicaland projected attrition rates. The amortization method for each customer poolis 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 customer account amortization for the period February 9,2005 though December 31, 2005 and January 1, 2005 through February 8,2005, respectively. We recorded approximately $68.6 million of customer accountamortization in the year ended December 31, 2004. This amount would changeif we changed the estimated life or amortization rate for customer accounts. Forexample, if we had determined that the estimated remaining life as of February 9,2005 of each customer pool should be reduced by one year, the amortizationexpense would have been approximately $36.3 million for the period February 9,2005 through December 31, 2005.

***Income Taxes***

As part of the process of preparing our consolidatedfinancial statements, we are required to estimate our income taxes in each ofthe jurisdictions in which we operate. Significant management judgment isrequired in determining our provision for income taxes and our deferred taxassets and liabilities. This process involves us estimating our actual currenttax exposure together with assessing temporary differences resulting fromdiffering treatment of items, such as depreciation and amortization, for taxand accounting purposes. These differences result in deferred tax assets andliabilities, which are included within our consolidated balance sheet. We mustthen assess the likelihood that our deferred tax assets will be recovered. Tothe extent we believe that recovery is not likely, we must establish avaluation allowance. In the first quarter of 2004, due to Westar’s  sale of its interest in us, we determined thatour deferred tax assets would not be realizable. We recorded a non-cash chargeto income in the approximate amount of $285.9 million to establish a valuationallowance equal to the amount of net deferred tax assets determined not to berealizable.

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

***New Accounting Standards.***

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No. 123R (revised 2004), “Share-BasedPayment” (“SFAS No. 123R”), which replaces SFAS No. 123, “Accountingfor Stock-Based Compensation,” and supersedes Accounting Principles Board(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” SFASNo. 123R requires compensation costs related to share-based paymenttransactions to be recognized in financial statements based on the fair value onthe grant date of the equity or liability instruments used. Compensation costwill be recognized over the period that an employee provides service for thataward, resulting in a decrease in net earnings. We will adopt provisions ofthis Statement, as amended, using the modified prospective method beginning infiscal 2006. 

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Compensation costs will berecognized for awards that are issued beginning in 2006 and for awards thathave been granted prior to December 31, 2005 but have yet to reach the endof the requisite service period. The amount of expense to be recognized overthe remaining service period as of December 31, 2005 is $6.7 million.We will begin expensing these costs over the shorter of the vesting period orthe period from the date of grant to the date the employee becomes eligible forretirement. Based on currently outstanding options, we expect to record totalexpense of approximately $2.1 million during 2006.

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error**Corrections,a replacement of APB Opinion No. 20 and FASB Statement No. 3,” tochange the requirements for the accounting for and reporting of a change inaccounting principle. The provisions of the Statement are effective foraccounting changes and correction of errors made in fiscal years beginningafter December 21, 2005. This new standard could have a material impact onthe Company’s results of operations, financial position or cash flows if anaccounting change or error correction occurs.

**Results of Operations**

***Protection One Consolidated***

As a result of the push down accounting adjustmentsdescribed in “—*New Basis of Accounting*” above,the activity for the period February 9, 2005 through December 31,2005 (the “post-push down” period) is reported under the new basis ofaccounting while the activity for the period January 1, 2005 through February 8,2005 (the “pre-push down” period) is reported on the historical basis of accounting,which was used in 2004 and 2003. For the post-push down period, the primarychanges to the income statement reflect (1) the reduction in amortizationrelated to the reductions to the amount of deferred acquisition costs anddeferred acquisition revenues, (2) an increase in interest expense due toaccretion of debt discounts arising from differences in fair values andcarrying values of our debt instruments that existed in the pre-push downperiod and (3) the reduction in amortization related to the reduction inthe amortizable base of customer accounts.

The income statement presentation separates ourresults into two periods:  (1) theperiod prior to the February 8, 2005 consummation of the exchangetransaction and (2) the period beginning after that date utilizing the newbasis of accounting. The results are further separated by a heavy black line toindicate the effective date of the new basis of accounting.

For the periods February 9, 2005 through December 31,2005 and January 1, 2005 through February 8, 2005, we incurredconsolidated net losses of $17.7 million and $11.4 million, respectively, orlosses per share of common stock of $0.97 and $5.80 respectively. For the yearsended December 31, 2004, and 2003, we incurred consolidated net losses of$323.9 million and $34.4 million, respectively, or losses per share of commonstock of $164.78 and $17.53, respectively. We recorded an operating profit forthe period February 9, 2005 through December 31, 2005 of $19.2million. This operating profit, which is the first in recent history, isprimarily the result of reduced amortization of customer accounts related tothe pushdown accounting described in “—*New Basis of Accounting*”above, and a reduction in general and administrative expenses. Interest expenseof $30.6 million and a loss on retirement of debt of $6.7 million for theperiod February 9, 2005 through December 31, 2005 contributed to thenet 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 controland debt restructuring costs. The loss in 2004 includes net income tax expenseof $239.6 million primarily due to a valuation allowance established on ourdeferred tax assets and also includes $24.4 million in change in control anddebt restructuring transaction-related costs and $3.5 million in retentionbonuses.

Monitoring and relatedservices revenues, which are not impacted by the push down adjustments,decreased slightly (less than 1%) in 2005 compared to 2004, primarily as aresult of a decline in our customer base, but partially offset by priceincreases implemented in 2004. Cost of monitoring and related 

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servicesrevenues, which are not impacted by the push down adjustments, increasedslightly (less than 0.1%) in 2005 compared to 2004. Monitoring and relatedservices margin as a percentage of related revenues remained above 71% in both2004 and 2005. Interest expense in 2005 decreased primarily due to thedebt-for-equity exchange with Quadrangle and the retirement of other debt inconjunction with our 2005 restructuring. Interest expense in the post-push downperiod includes approximately $6.4 million of amortized debt discounts. See“—*Restructuring*” above for additionalinformation.

***Protection One Monitoring***

Wepresent the table below to show how Protection One Monitoring’s operatingresults have changed over the periods presented. Next to each period’s resultsof operations, we provide the relevant percentage of total revenues so that youcan make comparisons about the relative change in revenues and expenses. As aresult of the push down accounting adjustments described in “—*New Basis of Accounting*” above, the post-push down and thepre-push down periods in 2005 and the years ended December 31, 2004 and December 31,2003 information presented in the following tables may 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 debtrestructuring costs                                    |       | —                                           |       | —     |       |                                          |       | 5,939                                                        |       | 24.3 |   | 22,839 |   | 9.9 |   | — |   | — |   |
| Amortization of intangibles and depreciation expense                             |       | 40,101                                           |       | 19.8       |       |                                          |       | 6,112                                                        |       | 24.9 |   | 73,560 |   | 31.8 |   | 75,335 |   | 31.5 |   |
| Total operating expenses                                                         |       | 115,889                                          |       | 57.2       |       |                                          |       | 22,698                                                       |       | 92.7 |   | 188,525 |   | 81.5 |   | 170,801 |   | 71.5 |   |
| Operating profit  (loss)                                                         |       | $                                                | 13,243     |       | 6.5        | %                                             |       |                                                         | $          | (7,416 | ) | (30.3 | )% | $ | (44,584 | ) | (19.3 | )% | $ | (19,722 | ) | (8.3 | )% |

 

*2005Compared to 2004.*   We had a net decrease of 4,848customers in 2005, compared to a net decrease of 12,888 customers in 2004. Ournet increase of 11,861 in wholesale customers was exceeded by the net decreasein retail customers, including those lost due to Hurricane Katrina. The averagecustomer base was 697,179 for 2005 compared to 706,047 for 2004.

We expect that the decline in our customer base willcontinue until the efforts we are making to acquire new accounts and reduceattrition become more successful than they have been to date. Net losses ofcustomer accounts materially and adversely affect our financial condition andresults of operations. We are currently focused on reducing attrition,developing cost effective marketing programs and generating positive cash flow.We are also susceptible to macroeconomic downturns that may affect our abilityto retain our customers.

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Furtheranalysis of the change in the Protection One Monitoring customer account baseis 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 estimatedcustomer losses of 2,738 resulting from Hurricane Katrina

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

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

**Monitoringand related service revenues** were not impacted by thepush down accounting adjustments and decreased less than 1% in 2005 compared to2004. We believe our focus on customer retention coupled with price increasesin 2004 and 2005 will result in a slowdown in the loss of monitoring andrelated service revenues. These revenues consist primarily of contractual revenuederived from providing monitoring and maintenance service.

**Otherrevenues** include $3.6 million and $0.8 million inamortization of previously deferred revenues for the post-push down andpre-push down periods in 2005, respectively, and $6.5 million for 2004. In2005, we experienced a $3.3 million increase in commercial lease arrangementsin which upfront revenues are deferred and a $1.1 million decrease in outrightcommercial sale arrangements which result in immediate revenue recognition.Other revenues are generated from our internal installations of new alarmsystems and 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.

**Costof monitoring and related services revenues** were notimpacted by the push down accounting adjustments and increased less than 1% in2005 compared to 2004. These costs generally relate to the cost of providingmonitoring service and include the costs of monitoring, billing, customerservice and field operations. Costs of monitoring and related services revenuesas a percentage of the related revenues increased to 29.5% in 2005 from 29.2%in 2004.

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

**Sellingexpenses** include $5.9 million and $1.5 million inamortization of previously deferred customer acquisition costs for thepost-push down and pre-push down periods in 2005, respectively, and $11.6million for 2004. Other selling expenses have increased over 2004 levels byapproximately $3.4 million due to increases in wages, benefits, commissions andother expenses related to an increase in the number of salespeople.

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

**Changein control and debt restructuring costs** for the 2005pre-push down period include $5.6 million in fees paid upon completion of therestructuring as well as legal and other fees related to the debt restructuring.In 2004 we made change of control payments to executive officers in the amountof $9.5 million, incurred $1.6 million in expenses for the write-off ofdirector and officer insurance upon the change of control in February 2004,paid $3.5 million to the advisor to our board of directors and incurredapproximately $8.2 million for legal and advisory fees related to the sale andrestructuring efforts.

**Amortizationof intangibles and depreciation expense** for thepost-push down period is based on the newly recorded values of the customeraccounts and fixed assets and their associated estimated remaining lives, whichresulted in a decrease of $31.9 million in amortization of customer accountsfor 2005. The remaining lives of fixed assets were generally decreased whichresulted in an increase of $4.5 million in depreciation expense in 2005. Thecustomer accounts are amortized over a ten year life on an accelerated basiswhile the remaining asset lives for the components of fixed assets have generallybeen shortened.

*2004 Compared to 2003.*   Wehad a net decrease of 12,888 customers in 2004, as compared to a net decreaseof 31,295 customers in 2003. This decline is the primary reason for the $7.5million decline in revenues in 2004. The average customer base was 706,047 for2004 compared to 728,139 for 2003. Although our net customers decreased for theyear, attrition decreased in 2004 compared to 2003 for a variety of reasonsincluding:

·       afocus by our sales force on obtaining high quality customers;

·       anincrease in the investment required by customers to purchase our systems;

·       anemphasis on customer service and attrition reduction by branch and monitoringcenter personnel;

·       thepassage of time from the end of the dealer program; and

·       legalaction taken against competitors who illegally solicit our customers.

**Monitoringand related service revenues** for 2004 decreased 4.0%compared to 2003. The decrease is primarily due to the decline in our customerbase, which decreased for the reasons discussed above. The rate of decrease inmonitoring and related services revenues slowed compared to the rate ofdecrease in 2003 of 5.9% primarily due to improvements in attrition rates andpartially due to rate increases for monitoring services. These revenues consistprimarily of contractual revenue derived from providing monitoring andmaintenance service.

**Otherrevenues** for 2004 increased 6.7% compared to 2003primarily due to an increase in the amortization of previously deferredrevenues of approximately $2.0 million, partially offset by a reduction incommercial sales of $0.6 million. These revenues consist primarily of sales ofburglar alarms, closed circuit television systems, fire alarms and card accesscontrol systems to commercial customers as well as amortization of previouslydeferred revenues.

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**Costof monitoring and related services revenues** for 2004decreased 4.7% compared to 2003. These costs generally relate to the cost ofproviding monitoring service and include the costs of monitoring, billing, customerservice and field operations. The decrease is primarily due to the decline inour customer base, which resulted in a decrease in service expense of $1.9million and a decrease in monitoring expense of $1.1 million. Costs ofmonitoring and related services revenues as a percentage of the relatedrevenues decreased from 29.4% in 2003 to 29.2% in 2004.

**Costof 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.

**Sellingexpenses** for 2004 increased 7.5%. The increase is dueto our continued efforts to generate new customers through an internal salesforce by building the necessary sales support. As our internal sales forceincreases its generation of new customers, the amount of direct and incrementalselling costs that are deferred also increases. These deferred selling costsare amortized to selling expense over a customer’s initial contract term,typically a two to three year period, which resulted in an aggregate increaseof $3.0 million in amortization of selling expense.

**Generaland administrative expenses** for 2004 decreased 8.3%compared to 2003. This decrease is generally the result of a $2.1 milliondecrease in premiums to insurance companies related to our director and officerliability policies and a $3.9 million decrease in administrative and generalsalaries and related benefit expenses primarily related to a reduction inretention plan expenses in 2004 and a decrease in medical and dental planexpenses. As a percentage of total revenues, general and administrativeexpenses decreased from 27.9% in 2003 to 26.4% in 2004.

**Changein control and debt restructuring expenses** for 2004include expenses for legal and financial advisors related to the sale of us byWestar and debt restructuring expenses incurred subsequent to the sale, as wellas change in control payments resulting from the sale.

**Amortization ofintangibles and depreciation expense** for 2004decreased 2.4% compared to 2003. This decrease reflects a reduction in customeramortization of $0.1 million and a decrease in depreciation expense of $1.7million primarily due to a decrease in the amount of capital purchases from thelevel of purchases in 1999 and 2000, which assets are becoming fully depreciated.

***Network Multifamily***

In August 2005, Network Multifamily andProtection One began efforts to consolidate management and other functions. Approximatelyforty positions were eliminated at Network Multifamily, including thePresident, Senior Vice President-Sales, Senior Vice President-Legal and VicePresident-Finance. Approximately $2.3 million in severance and retention costswere expensed for the year ended December 31, 2005. In addition, NetworkMultifamily completed conversion of its billing system to Mastermind, which isthe billing system used by Protection One Alarm Monitoring, Inc. andconversion of its general ledger, inventory management, accounts payable andpayroll software to Lawson, which is the same software currently used byProtection One Alarm Monitoring, Inc.

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Thefollowing table provides information for comparison of the Network Multifamilyoperating results for the periods presented. Next to each year’s results ofoperations, we provide the relevant percentage of total revenues so that comparisonsabout the relative change in revenues and expenses can be made. As a result ofthe push down accounting adjustments described in “—*New Basis ofAccounting*” above, the post-push down period and the pre-push downperiod in 2005 and the years ended December 31, 2004 and December 31,2003 information presented in the following tables may 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                                            |       |                                             | $          | 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 to 2004.*   Wehad a net decrease of 12,468 customers in 2005 compared to a net decrease of5,319 customers in 2004. This decrease is due primarily to fewer customeradditions. Demand for our services from owners and managers of multifamilyproperties has been negatively affected by the increasing preference ofoccupants of multifamily units to subscribe only for cellular telephoneservices and not for traditional telephone service, which our alarm systemshave historically used to transport alarm signals to our monitoring center. Weare marketing a new product which will allow monitoring of multifamily unitswithout a landline in each unit, which we believe will improve the rate of siteadditions. The “Conversion Adjustments” line item reflects the impact of the2005 conversion of our billing system to our new technology platform, MAS. Customersare defined differently in the new system and the result was a decrease in thenumber of customers in the new system. The average customer base was 324,276for 

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2005 compared to 333,170 for 2004. The change inNetwork 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      | %          |

----

(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.

**Monitoringand related services revenue** were not impacted by thepush down accounting adjustments and decreased 1.6% in 2005 compared to 2004. Theserevenues consist primarily of contractual revenue derived from providingmonitoring and maintenance service. The decline was due to the decrease in thecustomer base and a decrease in repair billings.

**Otherrevenues******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.

**Costof monitoring and related service revenues** were notimpacted by the push down accounting adjustments and generally relate to thecost of providing monitoring service and include the costs of monitoring,billing, customer service and field operations.  These costs decreased approximately 4.1% in2005 compared to 2004. Cost of monitoring and related services revenues as apercentage of the related revenues decreased to 21.2% in 2005 from 21.7% in2004.

**Costof other revenues** includes $0.6 million and $0.7million in amortization of previously deferred customer acquisition for thepost-push down and pre-push down periods in 2005, respectively, and $6.0million for 2004. These costs also include the costs to install access controlsystems.

**Sellingexpenses** includes approximately $28.0 thousand and$36.0 thousand in amortization of previously deferred customer acquisitioncosts for the post-push down and pre-push down periods in 2005, respectively,and $0.3 million for 2004. Other selling expenses in 2005 remained consistentwith 2004 expenses.

**Generaland administrative expenses******decreased in 2005 generally due to consolidation effortsdescribed above.

**Changein control and debt restructuring expenses** for 2004include change in control payments made as a result of the sale by Westar.

**Corporateconsolidation costs** for the post-push down period in2005 include severance and retention payments expense for those employees whoseresponsibilities were consolidated into the parent company.

**Amortizationof intangibles and depreciation expense** for thepost-push down period is based on the newly recorded values of the customeraccounts and fixed assets and their associated estimated remaining lives. Thecustomer accounts are amortized over a nine year life on a straight-line basis,while the remaining asset lives for the components of fixed assets havegenerally been shortened.

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*2004Compared to 2003.*   We had a net decrease of 5,319customers in 2004 compared to a net increase of 5,917 customers in 2003. Thedecrease in 2004 is primarily due to a reduction of added accounts of 8,942 ora 36% decrease from 2003 added accounts, which we attribute to a downturn inthe multifamily industry and to the uncertainty of our restructuring efforts in2004. The average customer base was 333,170 for 2004 compared to 332,871 for2003.

**Monitoringand related services revenue**for 2004 remainedconsistent with 2003. These revenues consist primarily of contractual revenuederived from providing monitoring and maintenance service. A $0.4 milliondecrease in repair billings was offset by an increase in contract buyouts of$0.3 million and an increase in RMR related to the slightly higher averagecustomer base in 2004.

**Otherrevenues**for 2004 decreased 16.2% compared to 2003primarily due to a $0.2 million decrease in the amortization of previouslydeferred revenue and a $0.1 million decrease in access control system salesrevenue. These revenues consist primarily of amortization of previouslydeferred revenues associated with the sale of alarm systems and revenues fromthe sale of access control systems.

**Costof monitoring and related service revenues**for 2004decreased 6.7% compared to 2003. These costs generally relate to the cost ofproviding monitoring service and include the costs of monitoring, customerservice and field operations. This decrease is the result of reduced fieldservice costs of $0.5 million and lower employment costs of $0.1 millionrelated to an employee retention plan in 2003. Cost of monitoring and relatedservices revenues as a percentage of the related revenues decreased to 21.7% in2004 from 23.3% in 2003.

**Costof other revenues**for 2004 increased 4.9% compared to2003. These costs consist primarily of amortization of installation costspreviously deferred and the costs to install access control systems. The costsincreased primarily due to an increase of $0.4 million in amortization ofdeferred customer acquisition costs, partially offset by a $0.1 milliondecrease in access control system installation costs.

**Sellingexpenses**for 2004 decreased 7.4% compared to 2003. Thisdecrease is the result of a $0.2 million decline in employment costs related toan employee retention plan in 2003 and reduced advertising costs of $0.1million.

**Generaland administrative expenses**for 2004 decreased 7.7%compared to 2003. This decrease is primarily due to a $1.0 million decrease inmanagement fees allocated from Protection One, lower legal costs of $0.3million and reduced telecom costs of $0.2 million. These decreases werepartially offset by increased liability insurance costs of $0.5 million. As apercentage of total revenues, general and administrative expenses decreased to27.2% in 2004 from 29.2% in 2003.

**Changein control and debt restructuring expenses**for 2004include change in control payments made as a result of the sale by Westar.

**Amortization ofintangibles and depreciation expense**for 2004 remainedconsistent with 2003.

**Liquidity and Capital Resources**

We have improved our capital structure by reducing theface amount of outstanding debt by $161.3 million to $344.2 million at December 31,2005 from $505.5 million at December 31, 2004, primarily through a $120million debt-for-equity exchange with Quadrangle. We expect to generateoperating cash flows in excess of that required for operations and for requiredprincipal and interest payments.

On April 18, 2005, we entered into a new creditagreement, which enabled us to redeem our 7.375% senior notes due 2005 forapproximately $166.3 million plus accrued interest (approximately $164.3million aggregate principal amount outstanding) and repay the Quadrangle creditfacility (approximately $78.0 million aggregate principal amount outstanding). The7.375% senior notes and the Quadrangle credit facility would have matured on August 15,2005. The bank credit facility provides for a $25.0 million 

43

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revolving credit facilityand a $250.0 million term loan facility. The revolving credit facility maturesin 2010 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.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 under the bank credit agreement.

In an effort to limit our exposure to interest raterisk on our variable rate bank credit facility, we purchased interest rate capsin the aggregate 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 restrictionsbased on “EBITDA.” EBITDA is generally derived by adding to income (loss)before income taxes, interest expense, depreciation expense and amortizationexpense. However, under the indentures related to our 8.125% seniorsubordinated notes and our bank credit facility, various and numerousadditional adjustments to EBITDA are sometimes required.

The bankcredit facility and the indenture relating to our 8.125% senior subordinatednotes contain the following financial tests that must be satisfied in order forus to incur additional indebtedness, pay dividends, make loans or advances andsell 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 withthe financial covenants and tests.

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

***Cash Flow***

***Operating CashFlows for 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 1,2005 through February 8, 2005, respectively. Our operating activitiesprovided net cash flows of $61.8 and $59.0 million in 2004 and 2003,respectively. The decrease in cash flows from operating activities in 2005compared to 2004 and 2003 is primarily related to the termination of the tax sharingagreement with Westar partially offset by a reduction of cash interest expenseand a decrease in change in control, debt restructuring, retention andcorporate consolidation costs. We received $45.9 million in cash fromWestar under the tax sharing settlement in 2004 and $20.0 million in taxsharing payments in 2003.  Cash interestexpense 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 theyears ended December 31, 2004 and 2003, respectively. We made corporateconsolidation, change in control, debt restructuring and retention andseverance payments of $2.3 million and $9.1 million for the periodsFebruary 9 through December 31, 2005 and January 1, 2005 through 

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February 8, 2005,respectively, compared to $25.1 million and $5.1 million for theyears ended December 31, 2004 and 2003, respectively.

***Investing CashFlows for the Year Ended December 31, 2005.*****  **We used a net $24.2 million and $2.5 million for ourinvesting activities in the periods February 9, 2005 through December 31,2005 and January 1, 2005 through February 8, 2005, respectively. Weinvested a net $22.5 million in cash to install and acquire new accounts,invested $5.7 million to acquire fixed assets, invested $0.8 million innon-monitored leased equipment, increased restricted cash by $0.6 million andwe received an aggregate $5.4 million from the disposition of marketablesecurities and other assets and from the redemption of preferred stock in theperiod February 9, 2005 through December 31, 2005. We invested a net$2.2 million in cash to install and acquire new accounts and $0.3 million toacquire 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. Proceedsfrom the sale of other assets provided cash of $0.4 million. We invested a net$21.4 million in cash to install and acquire new accounts and $9.3 million toacquire fixed assets. In 2003, we invested a net $24.3 million in cash toinstall and acquire new accounts and $7.4 million to acquire fixed assets.The sale of AV ONE to Westar in 2003 provided $1.4 million and the sale ofother assets provided $2.9 million.

***Financing CashFlows for 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. Financing activities 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 for the sale of parent securities that were held as treasuryand $0.5 million for the sale of our Protection One Europe trademarkrights and made payments of $10.2 million on long-term debt.

***CapitalExpenditures.******  ***Wemade capital expenditures of approximately $31.4 million in 2005. Of suchamount, we invested approximately $24.7 million in customer acquisition costs,$0.8 million in non-monitored leased equipment and $5.9 million for fixedassets. Assuming we have available funds, capital expenditures for 2006 and2007 are expected to be approximately $36.4 million and 38.2 million,respectively, of which approximately $28.3 million and $31.2 million,respectively, would be used for customer acquisition costs, with the balance tobe used for fixed assets. These estimates are prepared for planning purposesand are revised from time to time. Actual expenditures for these and otheritems not presently anticipated may vary materially from these estimates duringthe course of the years presented.

***Tax Matters.****  *Due to Westar’s sale of itsinterests in us in the first quarter of 2004 we are no longer entitled toreceive tax sharing payments from Westar. We determined that most of ourdeferred tax assets would not be realizable, and we recorded a non-cash chargeto income in the first quarter of 2004 in the approximate amount of $285.9million to establish a valuation allowance equal to the amount of net deferredtax assets determined not to be realizable. We currently do not expect to be ina position to record tax benefits for losses incurred in the future.

**Off-BalanceSheet Arrangements**

We had no off-balancesheet arrangements at December 31, 2005, other than as discussed below.

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**MaterialCommitments**

We have the followingfuture, material, long-term commitments as of December 31, 2005:

| ** **                                | ** ** | **Payment Due by Period**         | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                | ** ** | **Total**                                        | ** ** | **Less  than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More  than  5 years** | ** ** |
| ** **                                | ** ** | **(dollar amounts in thousands)** | ** ** |
| **At December 31, 2005:**  |       |                                             |       |   |   |   |   |   |   |   |   |
| **Contractual Obligations**          |       |                                             |       |   |   |   |   |   |   |   |   |
| Long-Term Debt Obligations                |       | $                                                | 344,162    |   | $ | 2,356 |   | $ | 4,712 |   | $ | 115,052 |   | $ | 222,042 |   |
| Interest Obligations on Long-Term Debt(a) |       | 120,550                                          |       | 26,164 |   | 51,807 |   | 37,663 |   | 4,916 |   |
| Operating Leases Obligations              |       | 16,188                                           |       | 4,967 |   | 7,005 |   | 3,097 |   | 1,119 |   |
| Purchase Obligations(b)                   |       | 11,250                                           |       | 3,750 |   | 7,500 | ** ** | — |   | — |   |
| Total(c)                                  |       | $                                                | 492,150    |   | $ | 37,237 |   | $ | 71,024 |   | $ | 155,812 |   | $ | 228,077 |   |

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(a)           Representscontractual interest obligations assuming all long-term debt obligations remainoutstanding until maturity. Interest rate used to calculate interest obligationon variable 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 thevehicles planned for delivery in 2006 are expected to be $0.2 million in 2006and $0.3 million in each of the years 2007, 2008, and 2009. These expectedpayments are not included in the above total contractual obligations at December 31,2005.

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

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

 

**Credit Ratings**

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      |       |

 

**ITEM7A.**        QUALITATIVE ANDQUANTITATIVE DISCLOSURE ABOUT MARKET RISK

Our new bank credit facility is a variable rate debtinstrument, and as of March 10, 2006, we had borrowings of $233.8 millionoutstanding. A 100 basis point change in the debt benchmark rate would affectpretax income by approximately $2.3 million. Interest rate caps purchased inthe second quarter of 2005 cap LIBOR (i) for three years at 5% on a $75.0million tranche of borrowings and (ii) for five years at 6% on a separate$75.0 million tranche.

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**ITEM8.     FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Stockholders of Protection One, Inc.:

We have audited the accompanying consolidated balancesheets of Protection One, Inc. and subsidiaries (the “Company”) as of December 31,2005 and 2004, and the related consolidated statements of operations andcomprehensive loss, stockholders’ equity (deficiency in assets) and cash flowsfor each of the periods February 9, 2005 through December 31, 2005, andJanuary 1, 2005 through February 8, 2005 and each of the years ended December 31,2004 and 2003. Our audits also included the consolidated financial statementschedule listed in Item 15(a)2. These consolidated financial statementsand the consolidated financial statement schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on the consolidatedfinancial statements and the consolidated financial statement schedule based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of material misstatement.The Company is not required to have, nor were we engaged to perform, an auditof its internal control over financial reporting. Our audit includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Protection One, Inc. and subsidiaries as of December 31,2005 and 2004, and the results of their operations and their cash flows foreach of the periods February 9, 2005 through December 31, 2005, and January 1,2005 through February 8, 2005 and each of the years ended December 31, 2004 and 2003, in conformity withaccounting principles generally accepted in the United States of America. Also,in our opinion, such financial statement schedule, when considered in relationto the basic consolidated financial statements taken as a whole, presentsfairly in all material respects the information set forth therein.

/s/ DELOITTE & TOUCHE LLP

Kansas City, MissouriMarch 16, 2006

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**PROTECTION ONE, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(Dollar amounts in thousands, except for per share amounts)**

| ** **                                                                                                                                                              | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                              | ** ** | **2005**              | ** ** | ** ** | ** ** | **2004** | ** ** |
| **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                                                                                                                                            |       | 19,406                |       |   |   | 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                                                                                                                                                            |       | $                     | 434,155    |   |   |   | $ | 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                                                                                                                                                                 |       | (154,094              | )          |   |   | (1,523,913 | ) |
| Treasury stock, at  cost, 596,858 shares at December 31, 2004                                                                                                      |       | —                |       |   |   | (34,612 | ) |
| Total stockholders’ equity (deficiency in assets)                                                                                                                  |       | 5,920                 |       |   |   | (177,609 | ) |
| Total Liabilities and  Stockholders’ Equity (Deficiency in Assets)                                                                                                 |       | $                     | 434,155    |   |   |   | $ | 461,044 |   |

 

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

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**PROTECTION ONE, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF OPERATIONS AND COMPREHENSIVE LOSS(Dollar amounts in thousands, except for per share amounts)**

| ** **                                                                      | ** ** | **February 9-  December 31,** | ** ** | ** ** | ** ** | **January 1-  February 8,** | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|------------|------------|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                                | ** ** | **2004**   | ** ** | **2003**                              | ** ** |
| 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                                                   |       |                                    | 45,889     |       |       |                                  |       |                                       | 6,638      |   |   | 78,455 |   | 80,252 |   |
| Total operating  expenses                                                       |       |                                    | 134,242    |       |       |                                  |       |                                       | 24,670     |   |   | 207,709 |   | 189,513 |   |
| Operating income (loss)                                                         |       |                                    | 19,180     |       |       |                                  |       |                                       | (6,841     | ) |   | (40,029 | ) | (14,633 | ) |
| Other (income) expense                                                          |       |                                    |       |       |       |                                  |       |                                       |       |   |   |   |   |   |   |
| 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 | ) |
| Loss before income taxes                                                        |       |                                    | (17,423    | )          |       |                                  |       |                                       | (11,370    | ) |   | (84,327 | ) | (51,905 | ) |
| Income tax  (expense) benefit                                                   |       |                                    | (312       | )          |       |                                  |       |                                       | (35        | ) |   | (239,579 | ) | 17,494 |   |
| Net loss                                                                        |       |                                    | $          | (17,735    | )          |                                  |       |                                       |       | $ | (11,405 | ) |   | $ | (323,906 | ) | $ | (34,411 | ) |
| Other comprehensive  income (loss), net of tax:                                 |       |                                    |       |       |       |                                  |       |                                       |       |   |   |   |   |   |   |
| Unrealized gain (loss) on marketable securities                                 |       |                                    | (162       | )          |       |                                  |       |                                       | —     |   |   | 84 |   | 78 |   |
| Unrealized loss on interest rate cap                                            |       |                                    | (107       | )          |       |                                  |       |                                       | —     |   |   | — |   | — |   |
| Comprehensive  loss                                                             |       |                                    | $          | (18,004    | )          |                                  |       |                                       |       | $ | (11,405 | ) |   | $ | (323,822 | ) | $ | (34,333 | ) |
| Basic and diluted per  share information:                                       |       |                                    |       |       |       |                                  |       |                                       |       |   |   |   |   |   |   |
| Net loss per common  share                                                      |       |                                    | $          | (0.97      | )          |                                  |       |                                       |       | $ | (5.80 | ) |   | $ | (164.78 | ) | $ | (17.53 | ) |

 

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

49

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**PROTECTION ONE, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Dollar amounts in thousands)**

| ** **                                                                                           | ** ** | **February 9 -   December 31,** | ** ** | ** **                                                           | ** ** | **January 1 -   February 8,**                    | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2005**                                            | ** ** | **     2004     ** | ** ** | **     2003     ** | ** ** |
| Cash flows from operating activities:                                                                |       |                                                |       |                                                                 |       |                                                                 |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                             |       |                                                | $          | (17,735                                                              | )          |                                                                 |       |                                       |       | $ | (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                                                                       |       |                                                | 45,889     |                                                                 |       |                                                                 |       |                                       | 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 |   |   |
| Issuance costs and  other                                                                            |       |                                                | (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  taxes, exclusive of benefits received from parent                                     |       |                                                | $          | 438                                                                  |       |                                                                 |       |                                       |       | $ | 6 |   |   |   | $ | 327 |   |   |   | $ | 296 |   |   |

 

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

50

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**PROTECTION ONE, INC. AND SUBSIDIARIESCONSOLIDATED 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)** | ** ** |
| **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 | ) |   |
| Investment in parent securities                    |       | —                |       |         | —     |                    |       | —                         |       | (3,010         | )          |                                  | 14,950     |                                                             |       | — |   |   | — |   |   |   | 11,940 |   |   |
| Net loss                                           |       | —                |       |         | —     |                    |       | —                         |       | —         |       |                                  | —     |                                                             |       | (34,411 | ) |   | — |   |   |   | (34,411 | ) |   |
| ***December 31, 2003***                       |       | 1,965,654             |       |         | $          | 26                      |       |                           | $          | (34,612        | )          | $                                     | 1,380,689  |                                                             |       | $ | — |   |   | $ | (1,200,007 | ) |   | $ | 78 |   |   |   | $ | 146,174 |   |   |
| Exercise of options and warrants                   |       | —                |       |         | —     |                    |       | —                         |       | 39             |       |                                  | —     |                                                             |       | — |   |   | — |   |   |   | 39 |   |   |
| Unrealized gain-marketable  securities        |       | —                |       |         | —     |                    |       | —                         |       | —         |       |                                  | —     |                                                             |       | — |   |   | 84 |   |   |   | 84 |   |   |
| Net loss                                           |       | —                |       |         | —     |                    |       | —                         |       | —         |       |                                  | —     |                                                             |       | (323,906 | ) |   | — |   |   |   | (323,906 | ) |   |
| ***December 31, 2004***                       |       | 1,965,654             |       |         | $          | 26                      |       |                           | $          | (34,612        | )          | $                                     | 1,380,728  |                                                             |       | $ | — |   |   | $ | (1,523,913 | ) |   | $ | 162 |   |   |   | $ | (177,609 | ) |   |
| Net loss                                           |       | —                |       |         | —     |                    |       | —                         |       | —         |       |                                  | —     |                                                             |       | (11,405 | ) |   | — |   |   |   | (11,405 | ) |   |
| ***February 8, 2005***                        |       | 1,965,654             |       |         | $          | 26                      |       |                           | $          | (34,612        | )          | $                                     | 1,380,728  |                                                             |       |   |   |   | $ | (1,535,318 | ) |   | $ | 162 |   |   |   | $ | (189,014 | ) |   |
| Debt for equity exchange                           |       | 16,000,000            |       |         | 160        |                    |       | —                         |       | 119,840        |       |                                  | —     |                                                             |       | — |   |   | — |   |   |   | 120,000 |   |   |
| Stock purchased                                    |       | 232,917               |       |         | 2          |                    |       | —                         |       | 1,748          |       |                                  | —     |                                                             |       | — |   |   | — |   |   |   | 1,750 |   |   |
| Partial shares adjustment from reverse stock split |       | —                |       |         | (6         | )                       |       | —                         |       | 6              |       |                                  | —     |                                                             |       | — |   |   | — |   |   |   | — |   |   |
| Push down accounting adjustments                   |       | —                |       |         | —     |                    |       | 34,612                         |       | (1,342,113     | )          |                                  | —     |                                                             |       | 1,398,959 |   |   | — |   |   |   | 91,458 |   |   |
| Stock issuance costs                               |       | —                |       |         | —     |                    |       | —                         |       | (270           | )          |                                  | —     |                                                             |       | — |   |   | — |   |   |   | (270 | ) |   |
| Unrealized loss-marketable  securities, net of tax |       | —                |       |         | —     |                    |       | —                         |       | —         |       |                                  | —     |                                                             |       | — |   |   | (162 | ) |   |   | (162 | ) |   |
| Unrealized loss-interest rate caps, net of tax     |       | —                |       |         | —     |                    |       | —                         |       | —         |       |                                  | —     |                                                             |       | — |   |   | (107 | ) |   |   | (107 | ) |   |
| Net loss                                           |       | —                |       |         | —     |                    |       | —                         |       | —         |       |                                  | —     |                                                             |       | (17,735 | ) |   | — |   |   |   | (17,735 | ) |   |
| ***December 31,  2005***                      |       | 18,198,571            |       |         | $          | 182                     |       |                           | $          | —         |       | $                                     | 159,939    |                                                             |       | $ | — |   |   | $ | (154,094 | ) |   | $ | (107 | ) |   |   | $ | 5,920 |   |   |

 

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

51

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

**1. TheCompany:**

Protection One, Inc., referred to as ProtectionOne or the Company, a Delaware corporation, is a publicly-traded security alarmmonitoring company. Protection One is principally engaged in the business ofproviding security alarm monitoring services, which includes sales,installation and related servicing of security alarm systems for residentialand business customers. On February 17, 2004, the Company’s formermajority owner, Westar Industries, Inc., a Delaware corporation, referredto as Westar Industries, a wholly owned subsidiary of Westar Energy, Inc.,which together with Westar Industries is referred to as Westar, soldapproximately 87% of the issued and outstanding shares of the Company’s commonstock, par value $0.01 per share to POI Acquisition I, Inc., a whollyowned subsidiary of POI Acquisition, L.L.C. Both POI Acquisition, L.L.C. andPOI Acquisition I, Inc. are entities formed by Quadrangle Capital PartnersL.P., Quadrangle Select Partners L.P., Quadrangle Capital Partners-A L.P. andQuadrangle Master Funding Ltd, collectively referred to as Quadrangle. Westarretained approximately 1% of the Company’s common stock, representing sharesunderlying restricted stock units granted to current and former employees ofWestar. As part of the sale transaction, Westar Industries also assigned itsrights and obligations as the lender under the revolving credit facility to POIAcquisition, L.L.C. Quadrangle paid an aggregate of approximately $154.7million to Westar as consideration for both the common stock and the revolvingcredit facility, including accrued interest of $2.2 million, with approximately$2.1 million of the payments being consideration for the common stock.

Upon completion of the Westar sale transaction and asa result of liquidity problems caused by its significant debt burden andcontinuing net losses, the Company retained a financial advisor and begandiscussions regarding a potential debt restructuring. In November 2004,the Company received $73.0 million pursuant to a tax sharing settlementagreement with Westar that terminated the Westar tax sharing agreement,generally settled all claims with Westar relating to the tax sharing agreementand generally settled all claims between Quadrangle and Westar relating to theWestar sale transaction. Contemporaneously, 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 theequivalent of 16 million shares of the Company’s common stock (on apost-reverse stock split basis).  Theexchange 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 over95% of the common stock of the Company on February 8, 2005, SEC StaffAccounting Bulletin Topic 5J requires the acquisition by Quadrangle to be“pushed-down,” meaning the post-transaction financial statements of the Companyreflect a new basis of accounting.

The purchase price paid as a result of eachtransaction described above has been allocated to a proportionate amount of theCompany’s underlying assets and liabilities based upon Quadrangle’s acquiredinterests (86.8% on February 17, 2004 and 10.5% on February 8, 2005) inthe respective fair market values of assets and liabilities at the date of eachtransaction.  The following representsthe approximate fair values attributable to the assets acquired and liabilitiesassumed in Quadrangle’s acquisition of substantially all of the Company’soutstanding common stock.  These valuesexclude the proportionate share of the historical cost basis attributable tothe minority interest holders representing 2.7% of the Company.

52

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| Allocation of  proportionate share to major components of assets and liabilities acquired  (dollar amounts in millions): |   |   |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Current assets, net of current liabilities                                                                               |   | $      | 24.9   |   |
| Property and  equipment                                                                                                  |   | 29.6   |   |
| Customer accounts                                                                                                        |   | 293.7  |   |
| Goodwill                                                                                                                 |   | 11.0   |   |
| Trade name                                                                                                               |   | 25.8   |   |
| Other long term  assets                                                                                                  |   | 12.1   |   |
| Long term debt                                                                                                           |   | (274.9 | )      |
| Total  consideration paid for equity interests                                                                           |   | $      | 122.2  |   |

 

The primary changes to the balance sheet reflect (1) thereduction of deferred customer acquisition costs and revenues, which have beensubsumed into the estimated fair market value adjustment for customer accounts;(2) adjustments to the carrying values of debt to estimated fair marketvalue (or Quadrangle’s basis in the case of the credit facility); (3) adjustmentsto historical goodwill to reflect goodwill arising from the push downaccounting adjustments; (4) the recording of a value for trade names; and (5) anincrease to the equity section from these adjustments. The primary changes tothe income statement include (1) the reduction in other revenue due to alower level of amortization from the reduced amortizable base of deferredcustomer acquisition revenues; (2)  the reduction in other costs ofrevenue and selling expenses due to 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 the Company’s debtinstruments; and (4) the reduction in amortization related to thereduction in the amortizable base of customer accounts.

Due to the impact of the changes resulting from thepush down accounting adjustments described above, the income statement and cashflows presentations 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 the balancesheet are separated by a heavy black line to indicate the application of a newbasis of accounting between the periods presented.

All prior share and per share amounts included in thefinancial statements 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 inconformity with accounting principles generally accepted in the United Statesof America, which require management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosures ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period. Actualresults could differ from those estimates. The accompanying consolidatedfinancial statements include the accounts of Protection One’s wholly ownedsubsidiaries. All significant intercompany balances have been eliminated inconsolidation.

In August 2005, the Company began efforts toconsolidate management and other support functions with its Network Multifamilysubsidiary.  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 amountswere paid at that time.

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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 thePortland monitoring center.

**2. Summaryof Significant Accounting Policies:**

*(a) Stock BasedCompensation*

In December 2002, the Financial Accounting StandardsBoard, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure,” whichamends SFAS No. 123, “Accounting for Stock-Based Compensation.”  SFAS No. 148 provides alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation. In addition, it amends thedisclosure requirements of SFAS 123 to require prominent disclosures in bothannual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults. This statement requires that companies follow the prescribed formatand provide the additional disclosures in their annual reports for fiscal yearsending after December 15, 2002. The Company applies the recognition andmeasurement principles of Accounting Principles Board, or APB, Opinion No. 25,“Accounting for Stock Issued to Employees,” as allowed by SFAS Nos. 123 and148, and related interpretations in accounting for its stock-based compensationplans, as described in Note 8 of the Consolidated Financial Statements “StockWarrants and Options.”  The Company hasadopted the disclosure requirements of SFAS No. 148.

Forpurposes 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).

| ** **                                                                                                         | ** ** | **February 9 -   December 31,** | ** ** | **January 1 -   February 8,** | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **2005**                                       | ** ** | **2004**                                     | ** ** | **2003**                                   | ** ** |
| Loss available  for common stock, as reported                                                                      |       |                                           | $          | (17,735                                      | )          |                                       |       | $ | (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                                                                   |       |                                           | (19,904    | )                                            |       |                                       | $          | (11,421 | ) |   | $ | (324,544 | ) | $ | (34,998 | ) |
| Net loss per  common share (basic and diluted):                                                                    |       |                                           |       |                                         |       |                                       |       |   |   |   |   |   |   |
| As reported                                                                                                        |       |                                           | $          | (0.97                                        | )          |                                       |       | $ | (5.80 | ) |   | $ | (164.78 | ) | $ | (17.53 | ) |
| Pro forma                                                                                                          |       |                                           | (1.09      | )                                            |       |                                       | $          | (5.81 | ) |   | $ | (165.11 | ) | $ | (17.83 | ) |

 

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Asdescribed in “New Accounting Standards-Share Based Payment” below, the Companywill change its method of accounting for options beginning in 2006.

*(b) RevenueRecognition*

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

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

The Company follows SFAS 13, “Accounting for Leases,”for its arrangements whereby security equipment that does not requiremonitoring is leased to customers, typically over a five year initial leaseterm. This equipment typically consists of closed circuit television equipmentand card access control equipment. The Company records these arrangements asoperating leases and records revenue on a straight line basis over the life ofthe lease.

Deferredrevenues also result from customers who are billed for monitoring and extendedservice protection in advance of the period in which such services areprovided, on a monthly, quarterly or annual basis. Revenues from monitoringactivities are recognized in the period such services are provided.

*(c) Inventories*

Inventories,primarily comprised of alarm systems and parts, are stated at the lower ofaverage cost or market. Inventory is shown net of an obsolescence reserve of$2.5 million and $2.0 million at December 31, 2005 and 2004, respectively.This reserve is determined based primarily upon current usage of the individualparts included in inventory.

*(d) Property andEquipment*

Property and equipment are stated at cost or at thefair value at February 8, 2005 to reflect the new basis of accounting andare depreciated using the straight-line method over estimated useful lives. Gainsor losses from retirements and dispositions of property and equipment arerecognized in income in the period realized. Repair and maintenance costs areexpensed as incurred. See Note 4, “Property and Equipment,” for additionalinformation regarding push down accounting related to property and equipment.

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

The Company had a tax sharing agreement with WestarEnergy during the period that Westar owned a controlling interest in the Company.The tax sharing agreement utilized a parent company down approach in theallocation of income tax expense among members of the consolidated tax group. Pursuantto this agreement, Westar Energy made payments to the Company for current taxbenefits utilized by Westar Energy in its consolidated tax return irrespectiveof whether the Company would realize these current benefits on a separatereturn basis.

The Company currently doesnot have any taxable earnings and does not expect to have taxable earnings inthe foreseeable future. Income tax expense shown on the statements ofoperations represents state taxes paid by the Company’s subsidiaries.

*(f) ComprehensiveLoss*

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

*(g) CustomerAccounts*

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

The choice of an amortization life is based onestimates and judgments about the amounts and timing of expected futurerevenues from customer accounts and average customer account life. Selectedperiods were determined because, in management’s opinion, they would adequatelymatch amortization cost with anticipated revenue. The Company periodically usesan independent appraisal firm to perform lifing studies on its customer accountsin order to assist management in determining appropriate lives of its customeraccounts. These reviews are performed specifically to evaluate the Company’shistoric amortization policy in light of the inherent declining revenue curveover the life of a pool of customer 

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accounts, and the Company’shistorical attrition experience. The Company had previously identified threedistinct pools of customer accounts, each of which had distinct attributes thateffect differing attrition characteristics. One of these pools (the acquiredWestinghouse customers), was fully amortized at December 31, 2004. For theProtection One Monitoring pool, the results of lifing studies indicated thatthe Company can expect attrition to be greatest in years one through five of assetlife and that a declining balance (accelerated) method would therefore bestmatch the future amortization costs with the estimated revenue stream fromthese customer pools. The Company switches from the declining balance method tothe straight-line method in the year the straight-line method results ingreater amortization expense.

Theamortization rates consider the average estimated remaining life and historicaland projected attrition rates. The amortization method for each customer poolis 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 toperform impairment tests for long-lived assets prospectively when the Companydetermines that indicators of impairment are present. Declines in market valueof its business or the value of its customer accounts that may be incurredprospectively may also require additional impairment charges. Any such impairmentcharges could be material.

*(h) Goodwill andTrade Name*

The new basis ofaccounting resulted in new recorded values for trade names and for goodwill asof February 8, 2005 to reflect their estimated fair values. Neither ofthese intangible assets is amortizable and they are therefore subject to annualimpairment testing. The Company had established July 1 as its annualimpairment testing date and completed its annual impairment testing during thethird quarter of 2005 and 2004 and determined that no impairment of itsnon-amortizable intangible assets was required as of each testing date. Animpairment test is also completed if events or changes in circumstancesindicate that the assets might be impaired. The Company determined that noimpairment was required due to the impact of Hurricane Katrina.

*(i) Cash and CashEquivalents*

All highly liquidinvestments purchased with a remaining maturity of three months or less at thedate acquired are cash equivalents. These investments, consisting of money marketfunds and 30-day certificate of deposits, are stated at cost, whichapproximates market.

*(j) Restricted Cash*

Restricted cash on theaccompanying balance sheet represents a trust account established as collateralfor the benefit of the former insurer of the Company’s workers’ compensationclaims and collateral for the Company’s surety bonding requirements. Theworkers’ compensation collateral is required to support 

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reservesestablished on claims filed during the period covered by the former insurer. TheCompany receives interest income earned by the trust. The surety bondcollateral is required by the Company’s liability insurance carrier. The fundshave been deposited into a money market account which earns interest income.

*(k) Receivables*

Gross receivables, which consist primarily of tradeaccounts receivable, of $34.9 million at December 31, 2005 and $29.8million at December 31, 2004 have been reduced by allowances for doubtfulaccounts of $5.0 million and $5.6 million, respectively.

The Company’s policy for Protection One Monitoring isto establish a reserve for a percentage of a customer’s total receivablebalance when any portion of that receivable balance is greater than 30 dayspast due. This percentage, which is based on the Company’s historical collectionsexperience, is increased as any portion of the receivable ages until it isfully reserved and written off when it is 120 days past due and the account isdisconnected and turned over to a collection agency. Additionally, once thecustomer’s balance is greater than 120 days past due, all other receivablebalances associated with that customer, irrespective of how many days past due,are deemed to be 120 days past due and fully reserved. In certain instances,based upon the discretion of the local general manager, credit can be extendedand the account may remain active.

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

*(l) Marketablesecurities*

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 marketvalue with a balance of $0.7 million at December 31, 2004, which included$0.2 million of unrealized gains. The securities were sold in the first quarterof 2005.

*(m) AdvertisingCosts*

Printed materials areexpensed as incurred. Broadcast advertising costs are expensed upon the firstbroadcast of the respective advertisement. Total advertising expense was $2.3million and $0.1 million for the periods February 9, 2005 throughDecember 31, 2005, and January 1, 2005 through February 8, 2005,respectively. Total advertising expense was $2.5 million and $2.8 millionduring the years ended December 31, 2004, and 2003, respectively.

*(n) DerivativeFinancial Instruments*

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

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*(o) Concentrationsof Credit Risk*

Financial instrumentswhich potentially subject the Company to concentrations of credit risk consistprincipally of trade receivables from a large number of customers, includingboth residential and commercial, dispersed across a wide geographic base. TheCompany extends credit to its customers in the normal course of business,performs periodic credit evaluations and maintains allowances for the potentialcredit losses. The Company has customers located throughout the United States.The Company does not believe a significant risk of loss from a concentration ofcredit risk exists.

*(p) Loss Per Share*

Lossper share is presented in accordance with SFAS No. 128 “Earnings PerShare.”  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 Company had outstanding stock optionsthat represented 1.0 million dilutive potential common shares. No outstandingstock options and warrants represent dilutive potential common shares for theyear ended December 31, 2004. The Company had outstanding stock optionsand warrants of which approximately 111 represent dilutive potential commonshares 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) New AccountingStandards*

*Share-BasedPayment.**  *In December 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. 123R requires compensation costs related toshare-based payment transactions to be recognized in financial statements basedon the fair value on the grant date of the equity or liability instruments used.Compensation cost will be recognized over the period that an employee providesservice for that award, resulting in a decrease in net earnings. The Companywill adopt provisions of this Statement, as amended, using the modifiedprospective method beginning in fiscal 2006. Compensation costs will berecognized for awards that are issued beginning in 2006 and for awards thathave been granted prior to December 31, 2005 but have yet to reach the endof the requisite service period. The amount of expense to be recognized overthe remaining service period as of December 31, 2005 is $6.7 million. TheCompany will begin expensing these costs over the shorter of the vesting periodor the period from the date of grant to the date the employee becomes eligiblefor retirement. Based on currently outstanding options, the Company expects torecord total expense of approximately $2.1 million during 2006.

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*Accounting Changes andError Corrections.**  *In May 2005,the FASB issued SFAS No. 154, “Accounting Changes and Error**Corrections, a replacement of APB Opinion No. 20 andFASB Statement No. 3,” to change the requirements for the accounting forand reporting of a change in accounting principle. The provisions of theStatement are effective for accounting changes and correction of errors made infiscal years beginning after December 21, 2005. This new standard couldhave a material impact on the Company’s results of operations, financialposition or cash flows if an accounting change or error correction occurs.

**3.**   Accrued Liabilities:

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 |   |
| Miscellaneous  accrued liabilities |       | 4,033                 |       |   |   | 14,198 |   |
| Other accrued  liabilities         |       | 11,289                |       |   |   | 11,613 |   |
| Total accrued  liabilities         |       | $                     | 24,100     |   |   |   | $ | 37,088 |   |

** **

**4.**   Property and Equipment:

As discussed in Note 1, “TheCompany,” because Quadrangle acquired substantially all of the Company’s commonstock, a new basis of accounting was established and new values for propertyand equipment were recorded as of February 8, 2005. The following reflectsthe Company’s carrying value in property and equipment as of the followingperiods (dollar amounts in thousands):

| ** **                             | ** ** | **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         |       | (27,290               | )          |   |   | (76,942 | ) |
| Property and equipment,  net           |       | $                     | 19,406     |   |   |   | $ | 31,152 |   |

 

Depreciation expense was $13.3 million and $1.0million for the periods February 9, 2005 through December 31, 2005,and January 1, 2005 through February 8, 2005, respectively. Depreciationexpense was $9.9 million and $11.6 million for the years ended December 31,2004 and 2003, respectively.

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Rentalequipment is comprised of commercial security equipment that does not requiremonitoring services by the Company and is leased to customers, typically over a5-year initial lease term. Accumulated depreciation of approximately$16.0 thousand has been recorded on these assets as of December 31, 2005. Thefollowing is a schedule by years of minimum future rentals on non-cancelableoperating leases as of December 31, 2005 (dollar amounts in thousands):
| 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:

Asdiscussed in Note 1, “The Company,” because Quadrangle acquired substantiallyall of the Company’s common stock, a new basis of accounting was establishedand new values for customer accounts were recorded at February 8, 2005. Thefollowing reflects the Company’s carrying value in customer accounts as of thefollowing dates (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** | ** ** |
| 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 |   |

 

Amortizationexpense was $32.6 million for the period February 9, 2005 through December 31,2005 and $5.6 million for the period January 1, 2005 through February 8,2005. Amortization expense was $68.6 million for each of the years ended December 31,2004 and 2003. The table below reflects the estimated aggregate customeraccount amortization for each of the five succeeding years on the Company’sexisting customer account base as of December 31, 2005 (dollar amounts inthousands):

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

 

Thenew basis of accounting also resulted in new recorded values for trade namesand for goodwill as of February 8, 2005 for both segments. Neither ofthese intangible assets is amortizable and they are therefore subject to annualimpairment testing and when circumstances dictate. The Company completed itsannual impairment testing during the third quarter of 2005 and determined thatno impairment of its non-amortizable intangible assets was required as of July 1,2005. The Company also determined that no impairment was required due to theimpact of Hurricane Katrina. The following table reflects these amounts as ofthe 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 |   |   |

 

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Therewere no changes in carrying amounts of goodwill for the year ended December 31,2004.

**6.**   Debt:

Long-termdebt and the fixed or weighted average interest rates are as follows (dollaramounts 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 |   |

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(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 aspart of the refinancing described in “Refinancing” below.

(b)          AtDecember 31, 2005, the weighted average annual interest rate before feeswas 7.4%. See “Bank Credit Facility” below, for additional discussion regardingthe maturity date, variable interest rate and applicable margins. The bankcredit facility is secured by substantially all assets of the Company.

(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%on the Senior Notes and was 8.125% on the Senior Subordinated Notes. Theeffective rate to the Company due to the accretion of debt discounts wasapproximately 13.2% on the Senior Notes and was approximately 15.9% on theSenior Subordinated Notes. All outstanding Senior Notes were redeemed in April 2005as part of the refinancing described in “Refinancing” below.

(d)          Alloutstanding Senior Subordinated Discount Notes were repurchased at 101% in March 2005pursuant 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, “TheCompany,” because Quadrangle acquired substantially all of the Company’s commonstock, a new basis of accounting was established at February 8, 2005, andnew values for the Company’s debt instruments were determined based onestimated fair market values for debt due to unrelated parties and based onQuadrangle’s cost basis for the Quadrangle Credit Facility. As of December 31,2005, the unamortized discount on the 8.125% senior subordinated notes due January 2009was $20.5 million. The discount is being amortized using the effective interestrate method over the remaining life of the debt.

*Refinancing*

On April 18,2005, the Company entered into a new credit agreement enabling it to complete aredemption of its 7.375% senior notes due 2005 for approximately $166.3 millionplus accrued interest 

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(approximately $164.3 million aggregate principal amountoutstanding) and the repayment of its Quadrangle credit facility (approximately$78.0 million aggregate principal amount outstanding). The 7.375% senior notesdue 2005 and the Quadrangle credit facility each had a maturity date of August 15,2005. The Company recorded a loss in the second quarter of 2005 ofapproximately $6.1 million associated with such redemption and repayment.

*Bank CreditFacility*

To facilitate the redemption of its 7.375% seniornotes due 2005 and the repayment of its Quadrangle credit facility, the Companyentered into a Credit Agreement, dated as of April 18, 2005 (the “bankcredit agreement”), with the several banks and other financial institutions orentities from time to time parties to the bank credit agreement.

The bank credit agreement provides for a $25.0 millionrevolving credit facility and a $250.0 million term loan facility. Therevolving credit facility matures in 2010 and the term loan matures in 2011,subject to earlier maturity (July 1, 2008) if the Company does notrefinance its 8.125% senior subordinated notes due 2009 before July 2008. Thenew revolving credit facility is undrawn as of March 10, 2006. The Companyintends 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 the Company under the bank creditagreement.

Pursuant to the Guarantee and Collateral Agreement,dated as of April 18, 2005 (the “Guarantee Agreement”), by the Company andits subsidiaries in favor of Bear Stearns Corporate Lending Inc., the newcredit facilities are guaranteed by Protection One Systems, Inc.,Protection One Data Services, Inc., Security Monitoring Services, Inc.,Protection One Alarm Monitoring of Mass, Inc. and Network MultifamilySecurity Corporation (collectively with the Company, the “Guarantors”), theCompany’s domestic subsidiaries, and secured by a perfected first prioritysecurity interest in substantially all of the Company’s and the Guarantors’present and future assets.

Borrowings under the bank credit agreement bearinterest at a rate calculated according to a base rate or a Eurodollar rate, atthe Company’s discretion, plus an applicable margin. The applicable margin withrespect to the term loan is 2.0% for a base rate borrowing and 3.0% for aEurodollar borrowing. Depending on the Company’s leverage ratio at the time ofborrowing, the applicable margin with respect to a revolving loan may rangefrom 1.25% to 2.25% for a base rate borrowing and 2.25% to 3.25% for aEurodollar borrowing.

The bank credit agreement required the Company toenter into a hedge agreement to provide interest rate protection on at least$70.0 million of the term loans for not less than two years. To satisfy thisrequirement and to further limit its exposure to interest rate risk on thevariable rate bank credit facility, the Company entered into two separateinterest rate cap agreements in May 2005 for a one-time aggregate cost ofapproximately $0.9 million. The Company’s objective is to protect againstincreases in interest expense caused by fluctuation in the LIBOR interest rate.One interest rate cap provides protection on $75 million of the Company’slong term debt over a five-year period if LIBOR exceeds 6%. A second interestrate cap provides protection on $75 million of the Company’s long term debtover a three-year period if LIBOR exceeds 5%.

The unamortized costs ofthe cap agreements at December 31, 2005 are $0.8 million and are includedin other assets. The Company will amortize the costs of the interest rate capsto interest expense over the respective lives of the agreements. In 2005, nopayments were received as a result of the cap agreements, no significantamounts were amortized to interest expense and there was no ineffectiveness inthe hedging relationship of the interest rate caps.

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*Quadrangle CreditFacility*

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 millionoutstanding balance on the Quadrangle Credit Facility was paid in full.

At December 31, 2004the Quadrangle credit facility provided for borrowings up to $201.0 millionwith a variable interest rate. The weighted-average annual interest rate afterfees on all borrowings under the facility was 8.4% for the year ended December 31,2004.

*Senior SubordinatedNotes*

In 1998, the Companyissued $350 million aggregate principal amount of unsecured 8.125% seniorsubordinated notes. Interest on these notes is payable semi-annually on January 15and July 15. The notes are redeemable at the Company’s option, in whole orin part, at a predefined price.

*Senior Notes*

In 1998, the Companyissued $250 million of 7.375% senior notes. Interest was payable semi-annuallyon February 15 and August 15. On November 12, 2004, as part ofthe Westar tax sharing settlement agreement, Westar transferred approximately$26.6 million principal of these notes to the Company, which were subsequentlyretired. On April 18, 2005, the Company completed a redemption of its7.375% senior notes due 2005 for approximately $166.3 million plus accruedinterest (approximately $164.3 million aggregate principal amount outstanding).

*Senior SubordinatedDiscount Notes*

In 1995, a predecessor tothe Company issued $166 million aggregate principal amount of unsecured seniorsubordinated discount notes with a fixed interest rate of 13.625% which wererevalued to reflect an 11.8% effective interest rate in connection with a 1997business combination. Interest payments began in 1999 and were payablesemi-annually on June 30 and December 31. As part of the February 8,2005 restructuring, the Company initiated the change of control repurchaseoffer at 101% for the Company’s approximately $29.9 million of outstanding13.625% senior subordinated discount notes. The Company completed therepurchase of all of these notes on March 11, 2005.

*Debt Maturities*

Debtmaturities over the succeeding five years and thereafter are as follows (dollaramounts in thousands):

| 2006       |   | 2,356   |    |   |
|------------|--------|---------|---------|--------|
| 2007       |   | 2,356   |    |   |
| 2008       |   | 112,696 | (a)     |   |
| 2009       |   | 2,356   |    |   |
| 2010       |   | 2,356   |    |   |
| Thereafter |   | 222,043 |    |   |
| Total      |   | $       | 344,163 |   |   |
|            |        |         |         |        |  |

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(a)           Assumesrefinancing of 8.125% senior subordinated notes prior to their maturity date sothat the bank credit facility is not subject to early maturity. See “BankCredit Facility” above, for additional information regarding its early maturityprovision. The 8.125% senior subordinated notes are listed at face value inthis table.

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*Financial andoperating 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.

TheCompany’s bank credit facility and the indenture relating to its 8.125% seniorsubordinated notes due 2009 contain the financial covenants 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 financial covenants and tests.

**7. Related Party Transactions**

**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 andshall continue in effect from year to year unless amended or terminated bymutual consent of the parties, subject to automatic termination in certainspecified situations and subject to termination at any time upon ninety daysnotice by either party. For the period February 9, 2005 through December 31,2005, approximately $1.4 million was expensed related to these agreements.

**AdministrativeServices and Management Services Agreements**

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

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through February 17,2005 and $0.1 million for the period January 1, 2005 throughFebruary 8, 2005. The Company recorded expense of approximately $3.1million and $4.3 million for the years ended December 31, 2004 and 2003,respectively, and had a net balance due to Westar Energy of $0.4 million atDecember 31, 2004, for these services. Prior to relocation of corporateheadquarters on November 18, 2004, the Company rented office space for itscorporate headquarters from Westar on a month-to-month basis. The Company paidapproximately $0.4 million and $0.6 million for rent for the years endedDecember 31, 2004 and 2003, respectively.

Westar Energy has claimedthat the Company should reimburse Westar Energy for as much as $1.2 million foran allocation of the costs incurred by Westar in the development of theapplication systems shared with the Company under the administrative serviceagreement. See Note 13, “Commitments and Contingencies—Administrative ServicesAgreement,” for further discussion related to the claim.

**Credit Facility**

The Company had outstanding borrowings under thecredit facility with Quadrangle of $201.0 million at December 31, 2004.The Quadrangle credit facility, with a remaining principal balance of $78million, was repaid in full on April 18, 2005 in connection with theconsummation of the bank credit agreement. The following table indicates theamount of interest accrued and paid on the credit facility for the periodslisted (dollar amounts in 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)           Interest accrued andinterest paid each include $2.2 million for the period January 1, 2004through February 17, 2004 that the credit facility was held by Westar, theCompany’s former owner.

(b)          Interest accrued andinterest paid in 2003 refers to the Westar Credit Facility.

The Company also paidQuadrangle a one-time fee of $1.15 million upon consummation of thedebt-for-equity exchange in connection with the amendment to the creditfacility. See Note 6, “Debt—Refinancing,” for information related to therefinancing of the Quadrangle credit facility.

**QuadrangleDebt Restructuring Reimbursement**

In addition to interestaccrued and paid under the Quadrangle credit facility, discussed above, theCompany expensed $0.2 million for legal expenses incurred by Quadrangle for theperiod January 1, 2005 through February 8, 2005. The Company paid$0.6 million and owed $0.3 million to Quadrangle for legal expenses incurred byQuadrangle for the year ended December 31, 2004. Pursuant to contractualrequirements, the Company also paid the costs for the financial and legaladvisors for both the senior and subordinated debt holders relating to therestructuring of the Company’s indebtedness. See Note 6, “Debt,” forinformation relating to the debt restructuring.

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**Boardof Directors and Amended Bylaws**

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

In accordance with thestockholders agreement, the Company amended its bylaws following therestructuring to prevent it from voluntarily filing for bankruptcy, merging orconsolidating with another entity until February 8, 2007 or from sellingall or substantially all of its assets without the written consent ofQuadrangle Master Funding Ltd. The stockholders agreement also includes votingagreements, certain restrictions on the transfer of the Company’s common stock,drag-along rights in favor of POI Acquisition, L.L.C. and tag-along rights infavor of Quadrangle Master Funding Ltd, all upon customary terms and subject tocertain customary exceptions (including exceptions for certain transfers amongaffiliates). In addition, the stockholders agreement provides the Quadrangleparties with the right to participate on a 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 theconsummation of the debt-for-equity exchange, the Company entered into aregistration rights agreement with POI Acquisition, L.L.C. and Quadrangle MasterFunding Ltd. The registration rights agreement provides, among other things,that the Company will register, upon notice, shares of its common stock ownedby such parties. Under the registration rights agreement, POI Acquisition,L.L.C. is permitted up to four demand registrations and Quadrangle MasterFunding Ltd is permitted up to two demand registrations, subject to certainconditions described in the agreement. POI Acquisition, L.L.C. and QuadrangleMaster Funding Ltd also received piggyback registration rights whereby theyshall have the opportunity to register their securities pursuant to anyregistration statement the Company may file in the future, subject to certainconditions. The Company is also obligated to pay certain of their expensespursuant to the registration of their securities under the registration rightsagreement.

**Changein Control and Debt Restructuring Payments**

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

**8. Stock Warrants and Options:**

The Company accounts for employee stock options inaccordance with Accounting Principles Board, or APB, Opinion No. 25, “Accountingfor Stock Issued to Employees.”  UnderAPB No. 25, the Company recognizes no compensation expense related toemployee stock options that are granted with an exercise price at or greaterthan the market price on the day of grant.

A summary of warrant and option activity for theCompany’s common stock from December 31, 2002 through December 31,2005 is as follows:

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| ** **                             | ** ** | **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 |   |

 

The table below summarizes stock options and warrantsfor the Company’s common 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                              |       |                                              |       |                                                                    |       |                                   |       |   |   |

 

Thetable below summarizes number of shares of common stock represented byexercisable options and the respective weighted average exercise price for the commonstock 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 |   |
|                                                                      |            |                                            |            |  |  |  |  |  |  |  |

 

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Theweighted average fair value of options granted during 2005 and 2003 estimatedon the date of grant using the Black-Scholes Option Pricing Model was $5.39 and$40.00, respectively.  No options weregranted in 2004. The fair value was 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 |   |   |

 

On April 16, 2001, the Company granted an optionto purchase an aggregate of 17,500 post-reverse split shares of its commonstock to Richard Ginsburg as part of his employment agreement with the Company.The option has a term of ten years and vested ratably over the subsequent threeyears. The purchase price of the shares issuable pursuant to the option is$66.00 per share while the fair market value of the common stock at the date ofthe option grant was $89.50 per share resulting in $0.4 million in deferredcompensation expense amortized over three years. The expense amount wasapproximately $40.0 thousand for the year ended December 31, 2004 and $0.1million for the year ending December 31, 2003.

On April 16, 2001,the Company also granted a warrant to purchase an aggregate of 5,000 shares ofits common stock to Guardian International, Inc. (Guardian) in connectionwith the hiring of Richard Ginsburg as the Company’s new chief executiveofficer, who was formerly the chief executive officer of Guardian. The warranthas a term of ten years and vested ratably over three years and therefore fullyvested in 2004. The purchase price of the shares issuable pursuant to theoption is $66.00 per share while the fair market value of the common stock atthe date of the option grant was $89.50 per share resulting in $0.4 millionexpense in 2001.

***2004 Stock Option Plan.***

The 2004 Stock Option Planbecame effective upon the consummation of the debt-for-equity exchange on February 8,2005. Under the 2004 Stock Option Plan, certain executive officers and selectedmanagement employees were granted options, which are subject to vesting,exercise and delivery restriction described below, to purchase an aggregate of1,782,947 shares of common stock, including 621,035, 388,147, 388,147, 199,618and 10,000 options that were granted to Messrs. Ginsburg, Nevin, Pefanis,Williams and Griffin, respectively. The options initially granted under theplan will vest ratably each month during the 48 months after the date of grant,subject to accelerated vesting, in the case of 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 certainpermissible distribution events (as defined in the SAR Plan) and (2) February 8,2011, provided that if an option holder’s right to receive stock is convertedpursuant to the plan into a right to receive cash, the amount of cash payablewill be credited with interest at 6% per annum, compounded annually, from thedate such conversion is effective until the applicable payment date.

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

The 1997 Long-TermIncentive Plan, which is referred to as the LTIP, approved by the ProtectionOne stockholders on November 24, 1997, provides for the award of incentivestock options to directors, officers and key employees. Under the LTIP, 114,000shares are reserved for issuance, subject to such adjustment as may benecessary to reflect changes in the number or kinds of shares of common stockor 

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othersecurities of Protection One. The LTIP provides for the granting of optionsthat qualify as incentive stock options under the Internal Revenue Code andoptions that do not so qualify.

Each option has a term often years and typically vests ratably over three years. The purchase price ofthe shares issuable pursuant to the options is equal to (or greater than) thefair market value of the common stock at the date of the option grant.

The vesting of optionsgranted to our senior management was accelerated because of the change incontrol of the Company when Westar sold its interest in the Company toQuadrangle.

***1994 Stock Option Plan***

The 1994 Stock Option Plan, which is referred to asthe Plan, approved by the Protection One stockholders in June 1994, providesfor the award of incentive stock options to directors, officers and keyemployees under the Plan. A total of 26,000 shares are reserved for issuance,subject to such adjustment as may be necessary to reflect changes in the numberor kinds of shares of common stock or other securities of Protection One. ThePlan provides for the granting of options that qualify as incentive stockoptions under the Internal Revenue Code and options that do not so qualify.

The purchase price of theshares issuable pursuant to the options is equal to (or greater than) the fairmarket value of common stock at the date of option grant. The vesting periodwas accelerated on November 24, 1997 and all remaining options arecurrently exercisable.

**9. Income Taxes:**

Components of income tax (expense) benefit are asfollows (dollar amounts 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 |   |

 

The difference between the income tax (expense)benefit at the federal statutory rate and income tax (expense) benefit in theaccompanying statements of 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 | % |   |

 

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Management believes the Company’s net deferred taxassets are not likely realizable and therefore a valuation allowance has beenestablished to fully offset the deferred tax assets, as can be seen in thetable below. In assessing whether deferred taxes are realizable, managementconsiders whether it is more likely than not that some portion or all deferredtax assets will be realized. The ultimate realization of deferred tax assets isdependent upon the generation of future taxable income during the periods inwhich those temporary differences become deductible. Management considers theprojected future taxable income and tax planning strategies in making thisassessment.

Deferred income tax assets and liabilities were composedof the following (dollar amounts in thousands):

| ** **                                            | ** ** | **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                         |       | 7,948    |       | 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                                   |       | (10,886  | )          | (33,356  | )          |
|                                                  |       | $        | —     |     | $          | — |   |

----

(a)           Federal net operatingloss carryforwards of $35,496, $17,200 and $20,707 will expire in the years2025,  2024 and 2023, respectively. Totalstate net operating losses of approximately the same amount have variousexpiration dates.

As discussed in Note 1, “The Company,” as part of the February 8,2005 ownership change, the Company pushed down Quadrangle’s basis to theunderlying assets and liabilities of the Company resulting in significantadjustments to the historical carrying values of these assets and liabilitiesas reflected on the Company’s books. The 2005 deferred tax assets andliabilities reflect significant movement from the 2004 amounts because noadjustments were made to the tax bases of the assets and liabilities as aresult of the February 8, 2005 adoption of a new basis of accounting.

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

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and the Company thereforerecorded a non-cash charge against income in the first quarter of 2004 toestablish a valuation allowance for these assets.

On November 12, 2004, the Company entered into atax sharing settlement agreement with Westar and Quadrangle that, among otherthings, terminated the Westar tax sharing agreement and settled all of itsclaims with Westar relating to the tax sharing agreement. In accordance withthe Westar tax sharing settlement, among other things, Westar agreed to pay theCompany approximately $45.9 million in cash and transfer to it 7.375% seniornotes of the Company, due 2005, with aggregate principal and accrued interestof approximately $27.1 million for total consideration of $73.0 million. As aresult of the Westar tax sharing settlement, the Company recorded a 2004 tax benefitof $46.9 million. The tax sharing settlement also provided for a mutual generalrelease, except with respect to certain indemnification obligations pursuant tothe purchase agreement between Quadrangle and Westar and certain alarmmonitoring and other service agreements between the Company and Westar. Inaddition, Westar and POI Acquisition I, Inc. joined in making Section 338(h)(10) electionsunder the Code. As part of the settlement, the parties mutually agreed to thepurchase price 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 unableto determine 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.**          EmployeeBenefit Plans:

*401(k) Plans*

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

*ProtectionOne 401(k) Plan.*   The Company makescontributions to the Protection One 401(k) Plan, which contributions areallocated among participants based upon the respective contributions made bythe participants through salary reductions during the applicable plan year. TheCompany’s matching contribution may be made in common stock, in cash or in acombination of both stock and cash. For the periods February 9, 2005through December 31, 2005 and January 1, 2005 throughFebruary 8, 2005 and for the years ended December 31, 2004 and 2003,Protection One made matching cash contributions to the plan of $0.9 million,$0.1 million, $1.0 million and $1.0 million, respectively. The funds of theplan are deposited with a trustee and at each participant’s option in one ormore investment funds, including a Company stock fund. Contributions to theCompany stock fund were suspended during 2003, and have not resumed as ofMarch 10, 2006. The plan was amended effective January 1, 2001requiring the Company to match employees’ contributions up to specified maximumlimits.

*NetworkMultifamily 401(k) Plan.*   The Company makescontributions to the Network Multifamily 401(k) Plan, which contributionsare allocated among participants based upon the respective contributions madeby the participants through salary reductions during the applicable plan year. TheCompany’s matching contribution are made in cash. For the periodFebruary 9, 2005 through December 31, 2005 and for each of the yearsended December 31, 2004 and 2003, the Company made matching cashcontributions to the plan of $0.2 million. The funds of the plan are depositedwith a trustee and at each participant’s option in one or more investmentfunds.

As part of the corporateconsolidation process described in Note 1, “The Company,” the NetworkMultifamily 401(k) plan was merged with the Protection One 401(k) planas of March 1, 2006.

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*Employee StockPurchase Plan*

Participation in theEmployee Stock Purchase Plan, which is referred to as the ESPP, was suspendedduring 2003 due to the sales process associated with Westar selling itsownership interest in the Company. All amounts contributed by employees throughthe ESPP in 2003 were returned in November 2003. Participation in the ESPPwas not resumed and the plan terminated on the last business day in September 2005as set forth in the plan.

*ManagementEmployment Agreements and Key Employee Retention Plan*

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

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

In order to retain theservices of senior management and selected key employees who may have feltuncertain about the Company’s future ownership and direction due to theprevious discussions with the Company’s creditors regarding the restructuringof the Company’s indebtedness, the Company’s Board of Directors authorizedsenior management in June 2004 to implement a new key employee retentionplan. The new retention plan applied to approximately 30 senior managers andselected key employees and provided incentives for such individuals to remainwith the Company through the restructuring. These new retention agreementssuperseded and replaced previous retention agreements which provided additionalseverance upon a change in control. The aggregate payout under the plan wasapproximately $3.9 million of which approximately $3.5 million was accrued forand approximately $0.7 million was paid as of December 31, 2004. Theremaining $3.2 million was paid in January and February of 2005.

*Stock AppreciationRights Plan.*

Pursuant to the managementincentive plan, Messrs. Ginsburg, Nevin, Pefanis and Williams received anaggregate of approximately 798,473, 532,981, 465,111 and 199,618  SARs, respectively. The SARs vest and becomepayable upon the earlier of (1) a qualified sale as defined in the SARPlan, which generally means Quadrangle’s sale of at least 60% of its equityinterest 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 and increases by 9% per annum, which is referred to as the fixed return,compounded annually, beginning on February 8, 2006. If Quadrangle sellsless than 60% of its equity interest in the Company, the exercise priceapplicable to an equivalent percentage of management’s SARs would be based onthe fixed return through the date of such sale. Each SAR that vests and becomespayable in connection with a qualified sale will generally entitle the holderof a SAR to receive the difference between the exercise price and the lesser of(1) the value of the consideration paid for one share of stock in suchqualified sale, or the fair market value of one share of stock if the qualifiedsale is not a sale to a third party and (2) $7.50, provided that if a SARholder’s right to receive stock is converted 

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pursuantto the SAR Plan into a right to receive cash from a grantor trust that theCompany may establish, the amount of cash payable will be credited withinterest at 6% per annum, compounded annually, from the date such conversion iseffective until the applicable payment date. Because payment under the planwill only be made in the event of a qualified sale as defined in the SAR plan,no amounts have been accrued as of December 31, 2005.

*Retention BonusProgram.*

Includedwith 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 retention bonuses.The Company accrued $1.9 million as general and administrative expense in 2004and an additional $0.2 million of expense in January 2005 for theseretention 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%.

**11.**          Leases:

TheCompany leases office facilities for lease terms maturing through 2012. Futureminimum lease payments under non-cancelable operating leases are as 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 |   |

 

Totalrent expense for the periods February 9, 2005 through December 31,2005, and January 1, 2005 through February 8, 2005, and for the yearsended December 31, 2004 and 2003, was $4.9 million, $0.6 million, $7.2million and $9.2 million respectively.

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

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

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Thefair value of the Company’s debt instruments are estimated based on quotedmarket prices except for the Quadrangle credit facility and the bank creditfacility, which had no available quote and was estimated by the Company. Fairvalue of the bank credit facility is estimated to be face value based on theterms of the facility and its relatively recent issuance.   At December 31, the fair value andcarrying amount of the Company’s debt for the years indicated 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 |   |

 

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

**13.**          Commitmentsand Contingencies:

**Dealer Litigation**

The company is a defendantin an arbitration proceeding brought by Ira Beer, the owner of two formerProtection One dealers, Security Response Network and Homesafe Security, Inc.Mr. Beer alleges breach of contract, improper calculation of holdbackamounts, and other causes of action. Discovery is ongoing in this matter. Inlate January 2006, after a period of considerable inactivity, theclaimants requested an April 2006 arbitration date. Currently, noarbitration 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 toclaims and matters of litigation incidental to the normal course of itsbusiness. Additionally, the Company receives notices of consumer complaintsfiled with various state agencies. The Company has developed a disputeresolution process for addressing these administrative complaints. The ultimateoutcome of such matters cannot presently be determined; however, in the opinionof management, the resolution of such matters will not have a material adverseeffect upon the Company’s consolidated financial position or results ofoperations.

**Administrative Services Agreement**

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

**Tax Sharing Agreement**

TheCompany is potentially entitled to certain contingent payments, depending onwhether Westar claims and receives certain additional tax benefits in thefuture with respect to the February 17, 2004 sale transaction. While thesepotential contingent payments, if any, could be significant, the Company isunable 

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to determine at this time whether Westar will claimany such benefits or, if Westar were to claim any such benefits, the amount ofthe 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.

**14.   Segment Reporting:**

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

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

The accounting policies of the operating segments arethe same as those described in the summary of significant accounting policies. TheCompany manages its business segments based on earnings before interest, incometaxes, depreciation, amortization (including amortization of deferred customeracquisition costs and revenues) and other items, referred to as AdjustedEBITDA.

Reportablesegments (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                           |       |                                         | 40,101     |   |   |   |   |   | 6,112 |   |   |   | 5,788 |   |   |   |   |   | 526 |   |   |   |   |   |   |   | 45,889 |   |   |   |   |   | 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                                                                 |       |                                         | 386,860    |   |   |   |   |   | — |   |   |   | 64,529 |   |   |   |   |   | — |   |   |   | (17,234 | ) |   |   | 434,155 |   |   |   |   |   | — |   |   |
| 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 |   |   |

 

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| ** **                                                                     | ** ** | **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 | ** ** |   |
|                                                                                |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                                     | ** ** | **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 |   |   |
|                                                                                |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Includes allocation ofholding company expenses reducing Adjusted EBITDA by $3.5 million, $0.3million, $3.0 million and $7.0 million for the periods February 9, 2005through December 31, 2005 and January 1, 2005 through February 8,2005, and for the years ended December 31, 2004 and 2003, respectively.

(2)          Includes allocation ofholding company expenses reducing Adjusted EBITDA by $0.9 million, $0.1million, $0.7 million and $1.8 million for the periods February 9, 2005through December 31, 2005 and January 1, 2005 through February 8,2005, and for the years ended December 31, 2004 and 2003, respectively.

(3)          Adjustment to eliminateintersegment accounts receivable.

(4)          Adjusted EBITDA is usedby management in evaluating segment performance and allocating resources, andmanagement believes it is used by many analysts following the security industry.This information 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 

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Company’s operatingresults from period to period in a meaningful and consistent manner in additionto standard GAAP financial measures.

| ** **                                                                     | ** ** | **Consolidated**                             | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                     | ** ** | **(Dollars in thousands)**         | ** ** |
| ** **                                                                     | ** ** | **February 9 -  December 31** | ** ** | ** ** | ** ** | **January 1 -  February 8** | ** ** | **Year Ended  December 31,** | ** ** |
| ** **                                                                     | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| Income (loss)  before income taxes                                             |       |                                         | $          | (17,423 | ) |   |   |   |   | $ | (11,370 | ) |   | $ | (84,327 | ) | $ | (51,905 | ) |
| Plus:                                                                          |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense                                                               |       |                                         | 30,634     |   |   |   |   |   | 4,544 |   |   | 44,398 |   | 40,101 |   |
| Amortization of  intangibles and depreciation expense                          |       |                                         | 45,889     |   |   |   |   |   | 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)           The Company enteredinto agreements with selected individuals to retain their services through saleand restructuring activities. The cost of these agreements is recorded ingeneral and administrative expense.

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

**15.   Summarized Combined Financial Information ofthe Subsidiary Guarantors of Debt:**

Protection One Alarm Monitoring, Inc., awholly-owned subsidiary of the Company, is the primary obligor for alloutstanding debt securities (see Note 6, “Debt”). These debt securities arefully and unconditionally guaranteed by Protection One, Inc. and whollyowned subsidiaries of Protection One Alarm Monitoring, Inc. The followingtables present condensed consolidating financial information for ProtectionOne, 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 presentedusing the equity method of accounting for subsidiaries in which they own orcontrol twenty percent or more of the voting shares.

78

----

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

| ** **                                                    | ** ** | **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          |                                           |       |                       | 39,287     |             |       |             | 6,598      |   |   |   | — |   |   |   | 45,889 |   |   |
| Holding company allocation                                    |       |                           | (4,371     | )                                              |       |                       | 3,497      |             |       |             | 874        |   |   |   | — |   |   |   | — |   |   |
| Corporate overhead allocation                                 |       |                           | —     |                                           |       |                       | (897       | )                |       |             | 897        |   |   |   | — |   |   |   | — |   |   |
| Total operating expenses                                      |       |                           | 223        |                                           |       |                       | 112,399    |             |       |             | 21,620     |   |   |   | — |   |   |   | 134,242 |   |   |
| Operating income  (loss)                                      |       |                           | (223       | )                                              |       |                       | 11,319     |             |       |             | 8,084      |   |   |   | — |   |   |   | 19,180 |   |   |
| 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                                 |       |                           | 2,054      |                                           |       |                       | 7,005      |             |       |             | —     |   |   |   | (9,059 | ) |   |   | — |   |   |
| Income (loss)  from continuing operations before income taxes |       |                           | 1,831      |                                           |       |                       | 2,054      |             |       |             | 7,317      |   |   |   | (28,625 | ) |   |   | (17,423 | ) |   |
| Income tax  expense                                           |       |                           | —     |                                           |       |                       | —     |             |       |             | (312       | ) |   |   |   |   |   |   | (312 | ) |   |
| Net income (loss)                                             |       |                           | $          | 1,831                                          |       |                       |       | $                | 2,054      |             |       |   | $ | 7,005 |   |   |   | $ | (28,625 | ) |   |   | $ | (17,735 | ) |   |

----

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

79

----

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

| ** **                                                    | ** ** | **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 AlarmMonitoring, Inc. allocated $103 of its interest expense to NetworkMultifamily.

80

----

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

| ** **                                           | ** ** | **Protection  One, Inc.** | ** ** | **Protection One  Alarm Monitoring** | ** ** | **Subsidiary  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|--------------------------------|------------|------------------------------------------------|------------|----------------------------|------------|------------------|------------|------------------|------------|
| 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 AlarmMonitoring, Inc. allocated $3,576 of its interest expense to NetworkMultifamily.

81

----

**Consolidating Statement of OperationsFor 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 AlarmMonitoring, Inc. allocated $4,930 of its interest expense to NetworkMultifamily

82

----

**Consolidating Statement of Assets and Liabilities(Deficiency in Assets)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                             |       | 17,676                                     |       | 1,720                      |       | —           |       |             | 19,406     |   |   |
| 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                                                    |       | (910                           | )          | —                                     |       | —                     |       | 910              |       |             | —     |   |   |
| Investment in  subsidiary guarantors                                    |       | —                         |       | 47,852                                     |       | —                     |       | (47,852          | )          |             | —     |   |   |
| Total assets                                                            |       | $                              | 6,880      |                                       | $          | 419,530                    |       | $                | 54,687     |             | $          | (46,942 | ) |   | $ | 434,155 |   |   |
| **Liabilities and Stockholder  Equity (Deficiency in Assets)**          |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |
| 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  (Deficiency in Assets)                       |       |                           |       |                                       |       |                       |       |             |       |             |       |   |   |
| 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                                                                 |       | (154,094                       | )          | (1,416,856                                 | )          | (154,606                   | )          | 1,571,462        |       |             | (154,094   | ) |   |
| Total  stockholders’ equity (deficiency in assets)                 |       | 5,920                          |       | (910                                       | )          | 47,852                     |       | (46,942          | )          |             | 5,920      |   |   |
| Total liabilities and  stockholders’ equity (deficiency in assets) |       | $                              | 6,880      |                                       | $          | 419,530                    |       | $                | 54,687     |             | $          | (46,942 | ) |   | $ | 434,155 |   |   |

 

83

----

**ConsolidatingStatement of Assets and Liabilities (Deficiency in Assets)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 $53,873payable to Protection One Alarm Monitoring from Network Multifamily related toallocations of interest charges.

84

----

**Condensed Consolidating Statement of Cash Flows**

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

**(dollar amounts inthousands)**

**(Unaudited)**

| ** **                                                           | ** ** | **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 |   |   |   |

 

85

----

**CondensedConsolidating Statement of Cash Flows**

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

**(dollar amounts inthousands)**

**(Unaudited)**

| ** **                                                         | ** ** | **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 |   |   |

 

86

----

**Consolidating Condensed Statement of Cash Flows**

**December 31,2004**

**(dollaramounts 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 |   |   |

 

87

----

 

**Consolidating Condensed Statement of Cash Flows**

**December 31,2003**

**(dollaramounts 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 |   |   |

 

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**16.   Unaudited Quarterly Financial Information:**

The following is a summary of the unaudited quarterlyfinancial information for 2005 and 2004, respectively:.

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

 

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

| **Description**                                        | ** ** | ** ** | ** ** | **Balance at  Beginning  of period** | ** ** | **Charged to  costs and  expenses** | ** ** | **Deductions(a)** | ** ** | **Balance at  End of Period** | ** ** |
|--------------------------------------------------------|------------|------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|-------------------|------------|----------------------------------------------|------------|
| **Year ended December 31,  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-offsand sales of accounts receivable.

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

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

**ITEM 9A.**        CONTROLSAND PROCEDURES

As of December 31, 2005, the end of the periodcovered by this report, the Company’s management, under the supervision andwith the participation of our chief executive officer and our chief financialofficer, performed an evaluation of the effectiveness of the design andoperation of our disclosure controls and procedures. Based on this evaluation,our chief executive officer and chief financial officer concluded that, as ofsuch date, our disclosure controls and procedures  (a) were effective to ensure thatinformation required to be disclosed by us in reports filed or submitted underthe Exchange Act is timely recorded, processed, summarized and reported and (b) include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by us in reports filed or submitted under the ExchangeAct is accumulated and communicated to management, including its chiefexecutive officer and chief financial officer, as appropriate to allow timelydecisions regarding required disclosure. Our management, including our chiefexecutive officer and chief financial officer, recognize that any set ofcontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving management’s control objectives.

During the fourth fiscalquarter ended December 31, 2005, no change in our internal control overfinancial reporting occurred that, in our judgment, either materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

**ITEM 9B.**       OTHERINFORMATION

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

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**PART III**

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

Information relating toour directors, nominees for directors and executive officers is set forth underthe heading “Election of Directors” in the Proxy Statement or InformationStatement relating to the Annual Meeting of Stockholders to be held in 2006,which will be filed with the Securities and Exchange Commission no later than April 30,2006, and which is incorporated herein by reference.

**ITEM 11.**         EXECUTIVECOMPENSATION

Information relating toour executive officers and executive compensation is set forth under theheading “Executive Officers; Executive Compensation and Related Information” inthe Proxy Statement or Information Statement relating to the Annual Meeting ofStockholders to be held in 2006, which will be filed with the Securities andExchange Commission no later than April 30, 2006, and which isincorporated herein by reference.

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

Information relating tothe security ownership of certain beneficial owners and management is set forthunder the heading “Security Ownership of Certain Beneficial Owners,” “SecurityOwnership of Management and Directors” and “Equity Compensation PlanInformation” in the Proxy Statement or Information Statement relating to theAnnual Meeting of Stockholders to be held in 2006, which will be filed with theSecurities and Exchange Commission no later than April 30, 2006, and whichis incorporated herein by reference.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

Information relating tocertain relationships and related transactions concerning directors andexecutive officers is set forth under the heading “Certain Relationships andRelated Transactions” in the Proxy Statement or Information Statement relatingto the Annual Meeting of Stockholders to be held in 2006, which will be filedwith the Securities and Exchange Commission no later than April 30, 2006,and which is incorporated herein by reference.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

Information relating to our principal accountant feesand services is set forth under the heading “Relationship with IndependentPublic Accountants” in the Proxy Statement or Information Statement relating tothe Annual Meeting of Stockholders to be held in 2006, which will be filed withthe Securities and Exchange Commission no later than April 30, 2006, andwhich is incorporated herein by reference.

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**PART IV**

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

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

Consolidated BalanceSheets

Consolidated Statements ofOperations and Comprehensive Loss

Consolidated Statements ofCash Flows

Consolidated Statements ofStockholders’ Equity (Deficiency in Assets)

2. The followingfinancial statement schedule is included in Item 8, “Financial Statements andSupplementary Data.”

Schedule II - Valuation and Qualifying Accounts.

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

3. The following documents are filed or furnished as apart of this report:

| Exhibit No. | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                                                                                                                                                        |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |       | Amended and Restated Certificate of Incorporation,  effective as of February 8, 2005 (incorporated by reference to  Exhibit 3.1 to the Annual Report on Form 10-K filed by POI  and Monitoring for the year ended December 31, 2004, 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)).                                                                                                                                                                                               |

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| 4.4   |   | Third Supplemental Indenture dated as of  February 14, 2000 among Monitoring as Issuer, POI inter alia, as  Guarantor and SSBTC as Trustee (incorporated by reference to Exhibit 4.4  to the Annual Report on Form 10-K filed by POI and Monitoring for  the year ended December 31, 2000 (the “Fiscal 2000 Form 10-K”)).                                                                 |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.5   |   | Indenture, dated as of August 17, 1998, among  Monitoring, as issuer, POI as guarantor, and The Bank of New York, as trustee  (incorporated by reference to Exhibit 4.1 to the Registration Statement  on Form S-4 filed by POI and Monitoring on September 22,  1998).                                                                                                                                  |
| 4.6   |   | Indenture, dated as of December 21, 1998, among  Monitoring, as issuer, POI, as guarantor, and The Bank of New York, as  trustee (incorporated by reference to Exhibit 4.8 to the Annual Report  on Form 10-K filed by POI and Monitoring for the year ended  December 31, 1998 (the “Fiscal 1998 Form 10-K”)).                                                                           |
| 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).                                                                                                                                                 |

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| 10.13 |   | Fifth Amendment of Credit Agreement effective as of  June 30, 2001 between Protection One Alarm Monitoring, Inc. and  Westar Industries, Inc. (incorporated by reference to Exhibit 10.1  to the Current Report on Form 8-K filed by POI and Monitoring  dated August 15, 2001).             |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14 |   | Sixth Amendment of Credit Agreement effective as of  November 1, 2001 between Protection One Alarm Monitoring, Inc. and  Westar Industries, Inc. (incorporated by reference to Exhibit 10.1  to the Current Report on Form 8-K filed by POI and Monitoring  dated November 14, 2001).        |
| 10.15 |   | Seventh Amendment to Credit Agreement effective  March 25, 2002 between Protection One Alarm Monitoring, Inc. and  Westar Industries, Inc. (incorporated by reference to Exhibit 10.19  to the Fiscal 2001 Form 10-K).                                                                            |
| 10.16 |   | Eighth Amendment of Credit Agreement effective as of  June 3, 2002 between Protection One Alarm Monitoring, Inc. and  Westar Industries, Inc. (incorporated by reference to Exhibit 10.2  to the Quarterly Report on Form 10-Q filed by POI and Monitoring  dated August 13, 2002).          |
| 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).*                                                                                                                               |

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| 10.28 |   | Employment Agreement dated March 18, 2003  between Protection One, Inc. and Peter J. Pefanis (incorporated by  reference to Exhibit 10.27 to the Fiscal 2002 Form 10-K).*                                                                                                                                                                      |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.29 |   | Employment Agreement dated March 18, 2003  between Protection One, Inc. and Mack Sands (incorporated by reference  to Exhibit 10.28 to the Fiscal 2002 Form 10-K).*                                                                                                                                                                            |
| 10.30 |   | Employment Agreement dated March 18, 2003  between Protection One, Inc. and Steve V. Williams (incorporated by  reference to Exhibit 10.29 to the Fiscal 2002 Form 10-K).*                                                                                                                                                                     |
| 10.31 |   | Letter Agreement dated November 1, 2001 between  Westar Industries, Inc. and POI regarding management fee and financial  advisory services (incorporated by reverence to Exhibit 10.23 to the  Fiscal 2001 Form 10K).                                                                                                                          |
| 10.32 |   | Outsourcing Agreement between Westar  Energy, Inc. and Protection One Data Services, Inc. dated  July 1, 2002 (incorporated by reference to Exhibit 10.4 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated  August 13, 2002).                                                                                  |
| 10.33 |   | Westar Aviation, Inc. Stock Purchase Agreement  dated as of June 5, 2002 by and between Westar Industries, Inc. and  Protection One, Inc. (incorporated by reference to Exhibit 10.5 to  the Quarterly Report on Form 10-Q filed by POI and Monitoring  dated August 13, 2002).                                                 |
| 10.34 |   | Aircraft Reimbursement Agreement dated as of  June 5, 2002 between AV ONE, Inc. (f/k/a Westar  Aviation, Inc.) and Westar Industries (incorporated by reference to  Exhibit 10.6 to the Quarterly Report on Form 10-Q filed by  POI and Monitoring dated August 13, 2002).                                                           |
| 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).                                                                                                                                            |

96

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| 10.46 |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  Richard Ginsburg (incorporated by reference to Exhibit 10.1 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated  August 16, 2004).*                                            |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.47 |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  Darius G. Nevin (incorporated by reference to Exhibit 10.1 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated  August 16, 2004).*                                             |
| 10.48 |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  Peter J. Pefanis (incorporated by reference to Exhibit 10.1 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated  August 16, 2004).*                                            |
| 10.49 |   | Employment Agreement dated July 23, 2004  between Protection One, Inc., Protection One Alarm Monitoring, Inc and  Steve V. Williams (incorporated by reference to Exhibit 10.1 to the  Quarterly Report on Form 10-Q filed by POI and Monitoring dated  August 16, 2004).*                                           |
| 10.50 |   | Stockholders Agreement, dated as of February 8,  2005, by and between the Company and Quadrangle (incorporated by reference to  Exhibit 10.1 of the Current Report on Form 8-K dated  February 8, 2005).                                                                                                                  |
| 10.51 |   | Registration Rights Agreement, dated as of  February 8, 2005, by and between the Company and Quadrangle  (incorporated by reference to Exhibit 10.2 of the Current Report on  Form 8-K dated February 8, 2005).                                                                                                           |
| 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.+                                                                                                                                                                                                                                                                                                          |
| 23.1  |   | Consent of Deloitte & Touche LLP.+                                                                                                                                                                                                                                                                                                   |

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| 31.1 |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.+                                                                                     |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 |   | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.+                                                                                     |
| 32.1 |   | Certification of Principal Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.+ |
| 32.2 |   | Certification of Principal Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.+ |

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*                    EachExhibit marked with an asterisk constitutes a management contract orcompensatory plan or arrangement required to be filed or incorporated byreference as an Exhibit to this report pursuant to Item 15(c) of Form 10-K.

+                Filedor furnished herewith.

(b)   The exhibits required by Item 601 of Regulation S-K are filed orfurnished herewith.

98

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**SIGNATURES**

Pursuant to therequirements of Section 13 and 15(d) of the Securities Exchange Actof 1934, the Registrants have duly caused this report to be signed on theirbehalf by the undersigned, thereunto duly authorized.

PROTECTION ONE, INC.

PROTECTION ONE ALARM MONITORING, INC.

 

| Date:  March 20, 2006 | By:    | /s/ DARIUS G. NEVIN                                   |
|---------------------------------|--------|-------------------------------------------------------|
|                            |   | Darius G. Nevin,                                      |
|                            |   | Executive Vice  President and Chief Financial Officer |

 

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

|                       | **Signature** | ** **                                            | ** ** |                      | **Title** | ** ** | ** ** |  | **Date** | ** ** | ** ** |
|-----------------------|---------------|-------------------------------------------------------|------------|----------------------|-----------|------------|------------|--|----------|------------|------------|
|                  |          |                                                  |       |                 |      |
| /s/ RICHARD GINSBURG  |          | President,  Chief Executive Officer and Director      |       | March 20,  2006 |      |
| Richard Ginsburg      |          |                                                  |       |                 |      |
|                  |          |                                                  |       |                 |      |
| /s/ DARIUS G. NEVIN   |          | Executive  Vice President and Chief Financial Officer |       | March 20,  2006 |      |
| Darius G. Nevin       |          |                                                  |       |                 |      |
|                  |          |                                                  |       |                 |      |
| /s/ ERIC A. DEVIN     |          | Vice  President, Treasurer, Controller and Assistant  |       | March 20,  2006 |      |
| Eric A. Devin,        |          | Secretary                                             |       |                 |      |
|                  |          |                                                  |       |                 |      |
| /s/ ROBERT J. MCGUIRE |          | Director                                              |       | March 20,  2006 |      |
| Robert J. McGuire     |          |                                                  |       |                 |      |
|                  |          |                                                  |       |                 |      |
| /s/ STEVEN RATTNER    |          | Director                                              |       | March 20,  2006 |      |
| Steven Rattner        |          |                                                  |       |                 |      |
|                  |          |                                                  |       |                 |      |
| /s/ DAVID A. TANNER   |          | Director                                              |       | March 20,  2006 |      |
| David A. Tanner       |          |                                                  |       |                 |      |
|                  |          |                                                  |       |                 |      |
| /s/ MICHAEL WEINSTOCK |          | Director                                              |       | March 20,  2006 |      |
| Michael Weinstock     |          |                                                  |       |                 |      |

 

 

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