Protection One Alarm Monitoring 10Q 2001 Q2 Quarterly report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

/x/	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2001

/ /	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

0-24780 (Commission File Number)		33-73002-01 (Commission File Number)
PROTECTION ONE, INC. (Exact Name of Registrant As Specified In its Charter)		PROTECTION ONE ALARM MONITORING, INC. (Exact Name of Registrant As Specified In its Charter)
Delaware (State or Other Jurisdiction Of Incorporation or Organization)		Delaware (State of Other Jurisdiction Of Incorporation or Organization)
93-1063818 (I.R.S. Employer Identification No.)		93-1064579 (I.R.S. Employer Identification No.)
818 S. Kansas Avenue Topeka, Kansas 66612 (Address of Principal Executive Offices, Including Zip Code)		818 S. Kansas Avenue Topeka, Kansas 66612 (Address of Principal Executive Offices, Including Zip Code)
(785) 575-1707 (Registrant's Telephone Number, Including Area Code)		(785) 575-1707 (Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether each of the registrants (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that such registrants were required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /

As of August 3, 2001, Protection One, Inc. had outstanding 100,368,301 shares of Common Stock, par value $0.01 per share. As of such date, Protection One Alarm Monitoring, Inc. had outstanding 110 shares of Common Stock, par value $0.10 per share, all of which shares were owned by Protection One, Inc. Protection One Alarm Monitoring, Inc. meets the conditions set forth in General Instructions H(1)(a) and (b) for Form 10-Q and is therefore filing this form with the reduced disclosure format set forth therein.

FORWARD-LOOKING STATEMENTS

Certain matters discussed in this Form 10-Q are forward-looking statements. The Private Securities Litigation Reform Act of 1995 has established that these statements qualify for safe harbors from liability. Forward-looking statements may include words like we believe, anticipate, expect or words of similar meaning. Forward-looking statements describe our future plans, objectives, expectations, or goals. All such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Please refer to "Risk Factors" in our Form 10-K for the year ended December 31, 2000 with respect to such risks and uncertainties. Such statements address future events and conditions concerning capital expenditures, earnings, restructuring our customer acquisition channels, litigation, possible corporate restructurings, mergers, acquisitions, dispositions, liquidity and capital resources, compliance with debt and other restrictive covenants, interest, ability to enter new markets successfully and capitalize on growth opportunities, and accounting matters. What happens in each case could vary materially from what we expect because of such things as future economic conditions; changes in accounting requirements; litigation; legislative developments; competitive markets; changes in Western Resources' strategic plans including its proposed merger with PNM and separation of its unregulated businesses (including Westar Industries and us) from its regulated utility business; and other circumstances affecting anticipated operations, revenues and costs. Any forward-looking statement speaks only as of the date such statement was made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement was made.

Unless the context otherwise indicates, all references in this Report on Form 10-Q (this "Report") to the "Company," "Protection One," "we," "us" or "our" or similar words are to Protection One, Inc., its direct wholly owned subsidiary, Protection One Alarm Monitoring, Inc. ("Monitoring") and Monitoring's wholly owned subsidiaries. Protection One's sole asset is, and Protection One operates solely through, Monitoring and Monitoring's wholly owned subsidiaries. Both Protection One and Monitoring are Delaware corporations organized in September 1991.

PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PROTECTION ONE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)
(Unaudited)

			June 30, 2001			December 31, 2000
ASSETS
Current assets:
	Cash and cash equivalents		$	5,151		$	2,740
	Restricted cash			1,716			779
	Receivables, net			31,295			37,826
	Inventories, net			11,381			11,129
	Prepaid expenses			3,851			2,652
	Related party tax receivable & current deferred tax assets			35,840			31,347
	Other			3,952			1,050

		Total current assets		93,186			87,523

Property and equipment, net				52,455			49,884
Customer accounts, net				829,971			900,314
Goodwill, net				793,285			829,145
Other				66,593			63,261

	Total assets		$	1,835,490		$	1,930,127

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Current portion of long-term debt		$	110,241		$	530
	Accounts payable			4,432			7,164
	Accrued liabilities			71,725			60,448
	Deferred revenue			46,213			46,704

		Total current liabilities		232,611			114,846

Long-term debt, net of current portion				487,111			637,181
Other liabilities				496			645

	Total liabilities			720,218			752,672

Commitments and contingencies (Note 5)
Stockholders' equity:
	Preferred stock, $0.10 par value, 5,000,000 authorized			—			—
	Commonstock, $0.01 par value, 150,000,000 shares authorized, 100,420,801 shares and 120,207,987 shares issued and outstanding at June 30, 2001 and December 31, 2000 respectively			1,272			1,270
	Additional paid-in capital			1,381,660			1,380,774
	Accumulated other comprehensive income, net			(1,240	)		(564	)
	Retained losses			(238,284	)		(198,693	)
	Treasury Stock, at cost, 26,759,772 and 6,826,813 shares at June 30, 2001 and December 31, 2000 respectively			(28,136	)		(5,332	)

		Total stockholders' equity		1,115,272			1,177,455

	Total liabilities and stockholders' equity		$	1,835,490		$	1,930,127

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

PROTECTION ONE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands, except for per share amounts)
(Unaudited)

			Six Months Ended June 30,
			2001			2000
Revenues:
	Monitoring and related services		$	171,992		$	212,986
	Other			7,961			22,965

		Total revenues		179,953			235,951
Cost of revenues:
	Monitoring and related services			55,167			62,978
	Other			7,028			13,409

		Total cost of revenues		62,195			76,387

		Gross profit		117,758			159,564
Operating expenses:
	Selling			9,406			11,086
	General and administrative			54,816			65,621
	Amortization and depreciation			101,392			118,059
	Severance and other			4,695			3,050

Total operating expenses				170,309			197,816

		Operating loss		(52,551	)		(38,252	)
Other (income) expense:
	Interest, net			22,407			28,490
	Related party interest, net			5,480			4,601
	Other			478			(291	)

Loss before income taxes & extraordinary gain				(80,916	)		(71,052	)
Income tax benefit				17,154			17,983

Loss before extraordinary item				(63,762	)		(53,069	)
Extraordinary gain, net of tax effect of $(13,015) and $(26,531)				24,171			49,273

	Net loss		$	(39,591	)	$	(3,796	)

Other comprehensive income (loss), net of tax
	Unrealized loss on marketable securities, arising during the period		$	—		$	(1,202	)

	Reclassification adjustment for losses included in sale of European operations			—			2,830

		Net change in unrealized loss on marketable securities		—			1,628

	Foreign currency translation loss			(675	)		(1,681	)
	Reclassification adjustment for losses included in sale of European operations			—			2,421

		Net change in foreign currency translation loss		(675	)		740

	Income tax expense			—			(929	)

Total other comprehensive income (loss), net of tax				(675	)		1,439

Comprehensive income (loss):			$	(40,266	)	$	2,357

	Loss per common share		$	(0.57	)	$	(0.41	)

	Extraordinary gain per common share		$	0.21		$	0.38

	Net income (loss) per common share		$	(0.36	)	$	0.03

	Weighted average common shares outstanding (in thousands)			111,065			126,970

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

PROTECTION ONE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands, except for per share amounts)
(Unaudited)

			Three Months Ended June 30,
			2001			2000
Revenues:
	Monitoring and related services		$	84,199		$	96,815
	Other			3,926			4,413

		Total revenues		88,125			101,228
Cost of revenues:
	Monitoring and related services			27,455			29,216
	Other			3,006			3,299

		Total cost of revenues		30,461			32,515

		Gross profit		57,664			68,713
Operating expenses:
	Selling			4,661			2,719
	General and administrative			27,994			28,581
	Amortization and depreciation			50,919			56,551
	Severance and other			4,276			—

Total operating expenses				87,850			87,851

		Operating income (loss)		(30,186	)		(19,138	)
Other (income) expense:
	Interest, net			10,517			12,521
	Related party interest, net			3,079			1,089
	Other			498			(8	)

		Loss before income taxes & extraordinary gain		(44,280	)		(32,740	)
Income tax benefit				7,339			8,557

Loss before extraordinary item				(36,941	)		(24,183	)
Extraordinary gain, net of tax effect of $(3,137) and $(9,340)				5,826			17,347

		Net loss	$	(31,115	)	$	(6,836	)

Other comprehensive income (loss), net of tax
	Unrealized foreign currency translation			934			(267	)
Comprehensive loss			$	(30,181	)	$	(7,103	)

	Loss per common share		$	(0.35	)	$	(0.18	)

	Extraordinary gain per common share		$	0.06		$	0.13

	Net loss per common share		$	(0.29	)	$	(0.05	)

	Weighted average common shares outstanding (in thousands)			105,907			126,952

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

PROTECTION ONE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)
(Unaudited)

			Six Months Ended June 30,
			2001			2000
Cash flow from operating activities:
Net loss			$	(39,591	)	$	(3,796	)
Adjustments to reconcile net loss to net cash provided by operating activities:
	Extraordinary gain			(24,171	)		(49,273	)
	Loss on sale of certain customer accounts			428			—
	Amortization and depreciation			101,392			118,059
	Amortization of debt costs and premium			662			(2,469	)
	Deferred income taxes			(11,144	)		(18,524	)
	Provision for doubtful accounts			3,580			10,592
	Other			310			(3,512	)
Changes in assets and liabilities, net of effects of acquisitions and dispositions:
	Receivables, net			1,556			3,980
	Other assets			(16,522	)		(10,212	)
	Accounts payable			(2,628	)		(133	)
	Other liabilities			13,099			(11,216	)

		Net cash provided by operating activities		26,971			33,496

Cash flows from investing activities:
	Installations and purchases of new accounts, net			(13,920	)		(20,943	)
	Purchase of property and equipment, net			(3,918	)		(7,591	)
	Proceeds from sale of certain customer accounts			19,165			—
	Related party sale of European operations			—			183,025

		Net cash provided by investing activities		1,327			154,491

Cash flows from financing activities:
	Payments on long-term debt			(67,622	)		(46,518	)
	Proceeds from long term-debt			495			6,087
	Borrowings from (repayments on) Senior Credit Facility			66,000			(155,000	)
	Purchase of Treasury Stock			(22,804	)		(801	)
	Issuance costs and other			(1,049	)		160
	Funding from parent			(536	)		3,473

		Net cash used in financing activities		(25,516	)		(192,599	)

Effect of exchange rate changes on cash and equivalents				(371	)		183

		Net increase (decrease) in cash and cash equivalents		2,411			(4,429	)
Cash and cash equivalents:
	Beginning of period			2,740			7,658

	End of period		$	5,151		$	3,229

Cash paid for interest			$	31,040		$	40,469

Cash paid for taxes			$	92		$	293

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:

In the first quarter of 2000, the Company sold its European operations for $225.0 million and certain investments for $19.0 million to Westar Industries, Inc. In exchange, the Company received $183.0 million in cash and $61.0 million market value of its outstanding bonds. Also in the first quarter of 2000, the Company received $15.0 million market value of its bonds and a $14.2 million note receivable from Westar Industries for payment of the Company's 1998 income tax receivable of $20.3 million and an intercompany receivable of $8.9 million. Westar Industries repaid all but $0.2 million of the note by delivering $14.0 million in market value of the Company's debt securities in March and April of 2000. The balance of the note was repaid in April 2000.

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

PROTECTION ONE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Consolidation and Interim Financial Information:

Protection One, Inc., a Delaware corporation ("Protection One" or the "Company") is a publicly traded security alarm monitoring company. Protection One is principally engaged in the business of providing security alarm monitoring services, which include sales, installation and related servicing of security alarm systems for residential and small business customers. Westar Industries, Inc. ("Westar Industries"), a wholly owned subsidiary of Western Resources, Inc. ("Western Resources"), owns approximately 87% of the Company's common stock.

The Company's unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and in accordance with the instructions to Form 10-Q. Accordingly, certain information and footnote disclosures normally included in financial statements presented in accordance with generally accepted accounting principles have been condensed or omitted. These financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2000, included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC").

In the opinion of management of the Company, all adjustments considered necessary for a fair presentation of the financial statements have been included. The results of operations for the three and six months ended June 30, 2001 are not necessarily indicative of the results to be expected for the full year.

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

2. Related Party Transactions

The Company had outstanding borrowings under the Senior Credit Facility with Westar Industries of $110.0 million and $44.0 million at June 30, 2001 and December 31, 2000, respectively. In the second quarter of 2001, the Company requested and Westar Industries agreed to modifications to the Senior Credit Facility which excluded from EBITDA the costs associated with certain work force reductions and office consolidations. In addition, the leverage ratio was amended to increase the maximum ratio to 5.75 to 1.0 and the interest coverage ratio was amended to decrease the minimum ratio to 2.1 to 1.0.

The Company accrued interest expense of $2.8 million and $4.5 million and made interest payments of $2.9 million and $4.4 million on borrowings under the facility for the three and six months ended June 30, 2001, compared to interest expense of $1.1 million and $4.6 million for the three and six months ended June 30, 2000.

In the first quarter of 2001, the Company purchased from Westar Industries $66.1 million face value of the Company's bonds for $45.2 million. As a result of this transaction, an extraordinary gain of $13.4 million, net of tax was recognized.

The Company acquired 3,149,255 shares of its common stock at market prices from Westar Industries in the second quarter of 2001 for $3.9 million and acquired 14,681,359 shares of its common stock at market prices from Westar Industries in the six months ended June 30, 2001 for $16.5 million. The Company reports these shares as treasury stock, at cost, in the equity section of the accompanying balance sheet. Following the purchases from Westar Industries in June 2001, the shares of the

Company's common stock owned by Westar Industries represented approximately 87% of the outstanding shares. In June 2001, the Company and Western Resources amended the Contribution Agreement dated as of July 30, 1997 to permit the ownership of the Company's outstanding common stock to exceed 85% to the extent necessary for Western Resources' beneficial ownership to represent up to but not exceeding 81% of the outstanding shares on a fully diluted basis.

The Company had a receivable balance of $9.4 million and $3.2 million at June 30, 2001 and December 31, 2000, respectively, relating to a tax sharing agreement with Western Resources. During 2000, the Company received $20.3 million and $28.6 million from Western Resources under the tax sharing agreement for the tax years 1998 and 1999, respectively. See Note 7 for further discussion relating to income taxes.

Western Resources provides administrative services to the Company pursuant to services agreements, including accounting, tax, audit, human resources, legal, facilities and technology services. Charges of approximately $2.8 million and $5.2 million were incurred for the three and six months ended June 30, 2001, compared to charges of approximately $1.6 million and $2.4 million for the three and six months ended June 30, 2000. The Company had a net intercompany balance due to Western Resources primarily for these services of $0.9 million and $1.2 million at June 30, 2001 and December 31, 2000, respectively.

On February 29, 2000, the Company sold its European operations and certain investments to Westar Industries. The consideration received was approximately $244.0 million, comprised of approximately $183.0 million in cash and certain outstanding debt securities of the Company acquired by Westar Industries in open market purchases. In separate transactions, additional outstanding debt securities of the Company were acquired from Westar Industries at market value.

Since Westar Industries is a related party, no gain or loss was recorded on the sale of the Company's European operations and investments. The Company increased Additional Paid-In Capital $25.6 million to reflect the excess of the transaction price over book value on the sale of the European operations. The Company reduced Additional Paid-In Capital $16.7 million to reflect the excess of book value of the investments over the transaction price.

Recognition of gain or loss on the acquisition and retirement of the Company's debt securities from Westar Industries was also impacted because the parties were related. The Company increased Additional Paid-In Capital $12.8 million in 2000 and $0.4 million for the six months ended June 30, 2001, to reflect the change in the amount that would have been considered a gain had the parties not been related.

3. Customer Accounts:

The following reflects the changes in the Company's investment in customer accounts (at cost) for the following periods (in thousands):

	Six Months Ended June 30, 2001			Year Ended December 31, 2000
Beginning customer accounts, net	$	900,314		$	1,122,585
Acquisition of customer accounts, net		6,970			45,588
Amortization of customer accounts, net		(68,980	)		(147,871	)
Sale of European operations		—			(107,806	)
Sale of accounts		(7,353	)		—
Purchase holdbacks and other		(980	)		(12,182	)

Total customer accounts	$	829,971		$	900,314

Accumulated amortization of the investment in customer accounts at June 30, 2001 and December 31, 2000 was $512.7 million and $447.7 million respectively.

4. Debt:

During the first six months of 2001, the Company's borrowings under the Senior Credit Facility increased by $66.0 million and the Company's other outstanding long-term debt decreased by $106.1 million. The Company used available cash along with the $66.0 million in borrowings to purchase outstanding long-term debt for $67.3 million, acquire additional treasury stock for $22.8 million and make interest payments of approximately $31.0 million during the six months ended June 30, 2001. Extraordinary gain from extinguishment of debt securities was $24.2 million, net of tax of $13.0 million and $49.3 million, net of tax of $26.5 million for the first six months of 2001 and 2000, respectively.

As of June 30, 2001, and December 31, 2000, total borrowings under the Senior Credit Facility were $110.0 million and $44.0 million, respectively. The remaining availability under this facility as of June 30, 2001 and December 31, 2000 was $45.0 million and $71.0 million, respectively. The Senior Credit Facility currently expires on January 2, 2002. The Company expects to renew the facility with Westar Industries unless efforts to replace the facility with financing from an unaffiliated third party lender are successful. The success of these efforts will depend on improvements in the Company's financial performance. The Kansas Corporation Commission has issued an order prohibiting Western Resources from borrowing to make loans or capital contributions to Westar Industries. This order limits the resources available to Westar Industries for funding its obligations under the Senior Credit Facility. The Company would face significant liquidity issues if it were unable to renew the Senior Credit Facility with Westar Industries or if Westar Industries was unable to fund its obligations under the Senior Credit Facility.

The Company's ability to borrow under the facility is subject to compliance with certain financial covenants including a leverage ratio of 5.75 to 1.0 and an interest coverage ratio of 2.10 to 1.0. At June 30, 2001, the ratios were approximately 4.8 to 1.0 and 2.3 to 1.0, respectively.

The indentures governing the Company's outstanding senior and subordinated notes contain similar covenants with different calculations relating to the Company's ability to incur indebtedness. The Company is in compliance with all covenants contained in these indentures.

5. Commitments and Contingencies:

The Company, its subsidiary Protection One Alarm Monitoring, and certain present and former officers and directors of Protection One are defendants in a purported class action litigation pending in the United States District Court for the Central District of California,Alec Garbini, et al v. Protection One, Inc., et al., No CV 99-3755 DT (RCx). Pursuant to an Order dated August 2, 1999, four pending purported class actions were consolidated into a single action. On February 27, 2001, plaintiffs filed a Third Consolidated Amended Class Action Complaint ("Amended Complaint"). Plaintiffs purport to bring the action on behalf of a class consisting of all purchasers of publicly traded securities of Protection One, including common stock and notes, during the period of February 10, 1998 through February 2, 2001. The Amended Complaint asserts claims under Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 against Protection One, Monitoring, and certain present and former officers and directors of Protection One based on allegations that various statements concerning Protection One's financial results and operations for 1997, 1998, 1999 and the first three quarters of 2000 were false and misleading and not in compliance with generally accepted accounting principles. Plaintiffs allege, among other things, that former employees of Protection One have reported that Protection One lacked adequate internal accounting controls and that certain accounting information was unsupported or manipulated by management in order to avoid disclosure of

accurate information. The Amended Complaint further asserted claims against Western Resources and Westar Industries as controlling persons under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. A claim was also asserted under Section 11 of the Securities Act of 1933 against Protection One's auditor, Arthur Andersen LLP. The Amended Complaint sought an unspecified amount of compensatory damages and an award of fees and expenses, including attorneys' fees. On June 4, 2001, the District Court dismissed plaintiff's claims under Section 10(b) and 20(a) of the Securities Exchange Act. The Court granted plaintiffs leave to replead such claims. The Court also dismissed all claims brought on behalf of bondholders with prejudice. The Court also dismissed plaintiff's claims against Arthur Andersen. The plaintiffs subsequently moved for reconsideration of the Court's order insofar as it did not give plaintiffs permission to replead their claims against Arthur Andersen. After that motion is decided by the Court, plaintiffs will file a new amended complaint. The Company intends to vigorously defend against this action. The Company cannot predict the impact of this litigation which could be material.

Six former Protection One dealers have filed a class action lawsuit in the U. S. District Court for the Western District of Kentucky alleging breach of contract because of the Company's interpretation of their dealer contracts. The action is styledTotal Security Solutions, Inc., et al. v. Protection One Alarm Monitoring, Inc., Civil Action No. 3:99CV-326-H (filed May 21, 1999). In September 1999, the Court granted Protection One's motion to stay the proceeding pending the individual plaintiff's pursuit of arbitration as required by the terms of their agreements. On June 23, 2000, the Court denied plaintiffs' motion to have collective arbitration. On or about October 4, 2000, notwithstanding the Court's denial of plaintiffs' motion to have collective arbitration, the six former dealers filed a Motion to Compel Consolidated Arbitration with the American Arbitration Association ("AAA"). On November 21, 2000, the AAA denied the dealers' motion and advised they would proceed on only one matter at a time. As of July 31, 2001, no dealer has proceeded with arbitration.

An arbitration was commenced against Protection One and Monitoring by Ralph Apa in December, 2000 alleging common law fraud, negligent misrepresentation and Oregon Blue Sky law claims based on the allegedly inflated stock price of the shares of Protection One stock received in connection with Protection One's acquisition of his alarm monitoring business on October 1, 1998. Mr. Apa also alleges breach of contract, breach of the covenant of good faith and fair dealing and conversion arising from the transaction. The statement of claim seeks undisclosed compensatory and punitive damages, interest and attorneys fees and costs. An arbitration date has not yet been set.

On April 2, 2001, Monitoring was served with a demand for arbitration by Cynthia L. Russell and Active Alert Security, Inc. ("Claimants") before the AAA wherein Claimants are seeking approximately $1.0 million, additional unspecified amounts for lost profits, interest and attorneys fees, due to alleged defaults by Monitoring under one or more dealer agreements. The matter is awaiting arbitration.

Other Protection One dealers have filed or threatened litigation or arbitration based upon a variety of theories surrounding calculations of holdback and other payments. The Company believes it has complied with the terms of these contracts and although the Company believes that no individual such claim will have a material adverse effect, the Company cannot predict the aggregate impact of these disputes with dealers which could be material.

On October 2, 2000, the Company, as successor-in-interest to Centennial Security, Inc., was served with a demand for arbitration by Crimebusters, Inc. before the AAA wherein Crimebusters is seeking $7.0 million in damages due to alleged defaults by the Company under an asset purchase agreement between Crimebusters,et al and Centennial Security, Inc.

On October 6, 2000, the Company filed claims alleging fraud, willful misconduct and breach of contract against Crimebusters,et al in the United States District Court for the District of Connecticut,Protection One Alarm Monitoring, Inc. v Crimebusters, Inc., First Federal Security Systems, Inc. and Anthony Perrotti, Jr., Civil Action No. 300CV-1932DJS. On May 29, 2001, the District Court dismissed

the lawsuit. The Company has appealed the dismissal order, and the appeal is presently pending before the United States Court of Appeals for the Second Circuit (No. 01-7786). The Company has requested the arbitration action be dismissed or indefinitely stayed pending the resolution of this litigation. The ultimate outcome cannot presently be determined and the Company cannot currently predict the impact of this litigation which could be material.

The Company is a party to claims and matters of litigation incidental to the normal course of its business. Additionally, the Company receives notices of consumer complaints filed with various state agencies. The Company has developed a dispute resolution process for addressing these administrative complaints. The ultimate outcome of such matters cannot presently be determined; however, in the opinion of management of the Company, the resolution of such matters will not have a material adverse effect upon the Company's consolidated financial position or results of operations.

Potential impairment charge relating to the planned adoption on January 1, 2002 of a new statement regarding a new accounting standard for the treatment of goodwill in a business combination. The Financial Accounting Standards Board issued SFAS No. 142, "Goodwill and Other Intangible Assets" which establishes a new accounting standard for the treatment for goodwill. The new standard continues to require recognition of goodwill as an asset in a business combination but does not permit amortization as currently required by APB Opinion No. 17, "Intangible Assets." Effective January 1, 2002 the new standard requires that goodwill be separately tested for impairment using a fair-value based approach as opposed to the undiscounted cash flow approach used under current accounting standards. If goodwill is found to be impaired the Company would be required to record a non-cash charge against income which would be recorded as the cumulative effect of a change in accounting principle. The impairment charge would be equal to the amount by which the carrying amount of the goodwill exceeds its estimated fair value. Also effective January 1, 2002, goodwill will no longer be amortized as is required under current accounting standards. Under the new standard any subsequent impairment test on the Company's customer accounts will be performed on the customer accounts alone rather than in conjunction with goodwill utilizing an undiscounted cash flow test pursuant to SFAS No. 121.

At June 30, 2001, the Company's intangible assets included $793.3 million in goodwill and $830.0 million in customer accounts. These intangible assets together represented 88.4% of the book value of its total assets. The Company recorded $24.6 million and $27.1 million in goodwill amortization expense for the six-months ended June 30, 2001 and 2000, respectively.

The Company has not yet performed tests for impairment under the new standard. When tests are performed, the Company believes it is probable that it will be required to record a non-cash impairment charge. The amount will not be known until the tests are performed, but the Company believes the amount will be material and could be a substantial portion of its intangible assets. This impairment charge will have a material adverse effect on the Company's results of operation and could have a material adverse effect on its business and financial condition.

6. Segment Reporting:

The Company's reportable segments include North America and Multifamily. North America provides residential, commercial and wholesale security alarm monitoring services, which include sales, installation and related servicing of security alarm systems in the United States and Canada. Multifamily provides security alarm services to apartments, condominiums and other multi-family dwellings.

The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies in the Company's Form 10-K for the year ended December 31, 2000. The Company manages its business segments based on earnings before interest, income taxes, depreciation and amortization ("EBITDA").

Six Months Ended June 30, 2001
(Dollars in thousands)

	North America⁽¹⁾			Multifamily		Consolidated
Revenues	$	162,073		$	17,880	$	179,953
EBITDA		44,957			8,579		53,536
Amortization and depreciation expense		93,356			8,036		101,392
Severance and other expense		4,695			—		4,695
Operating income (loss)		(53,094	)		543		(52,551	)
Capital expenditures for new accounts		11,347			2,573		13,920

Six Months Ended June 30, 2000
(Dollars in thousands)

	North America⁽¹⁾			Multifamily		Europe⁽²⁾		Consolidated
Revenues	$	188,456		$	19,591	$	27,904	$	235,951
EBITDA		68,220			8,237		6,400		82,857
Amortization and depreciation expense		104,920			7,719		5,420		118,059
Severance and other expense		3,050			—		—		3,050
Operating income (loss)		(39,750	)		518		980		(38,252	)
Capital expenditures for new accounts		15,622			3,010		2,311		20,943

Three Months Ended June 30, 2001
(Dollars in thousands)

	North America⁽³⁾			Multifamily		Consolidated
Revenues	$	79,077		$	9,048	$	88,125
EBITDA		20,760			4,249		25,009
Amortization and depreciation expense		46,884			4,035		50,919
Severance and other expense		4,276			—		4,276
Operating income (loss)		(30,400	)		214		(30,186	)
Capital expenditures for new accounts		6,363			1,207		7,570

Three Months Ended June 30, 2000
(Dollars in thousands)

	North America⁽³⁾			Multifamily		Consolidated
Revenues	$	91,777		$	9,451	$	101,228
EBITDA		33,297			4,116		37,413
Amortization and depreciation expense		52,666			3,885		56,551
Severance and other expense		—			—		—
Operating income (loss)		(19,369	)		231		(19,138	)
Capital expenditures for new accounts		5,799			1,964		7,763

⁽¹⁾: Includes allocation of holding company expenses reducing EBITDA by $2.7 million and $3.2 million for the six months ended June 30, 2001 and 2000, respectively.
⁽²⁾: The European operations were sold to Westar Industries on February 29, 2000. See Note 2, "Related Party Transactions."

⁽³⁾: Includes allocation of holding company expenses reducing EBITDA by $1.2 million and $1.6 million for the three months ended June 30, 2001 and 2000, respectively.

7. Income Taxes:

The income tax benefit recorded for the six-month period ended June 30, 2001 is approximately 21% of the pre-tax loss. The difference between the expected annual effective rate and the federal statutory rate of 35% is primarily attributable to non-deductible goodwill. The Company has a tax sharing agreement with Western Resources which allows it to be reimbursed for tax deductions utilized by Western Resources in its consolidated tax return. If Western Resources were to complete its proposed transaction with Public Service Company of New Mexico, including the split-off of Westar Industries, the Company would no longer be able to file taxes on a consolidated basis with Western Resources. As a result, a substantial portion of the Company's net deferred tax assets of $83.0 million at June 30, 2001 would likely not be realizable and the Company would likely not be in a position to record a tax benefit for losses incurred. The Company would be required to record a non-cash charge against income for the portion of its net deferred tax assets determined not to be realizable. This charge could be material.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management's Discussion and Analysis of Financial Condition and Results of Operations updates the information provided in and should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2000.

Overview

Protection One is a leading provider of property monitoring services, providing electronic monitoring and maintenance of alarm systems to approximately 1.3 million customers as of June 30, 2001. Our revenues are generated primarily from recurring monthly payments for monitoring and maintaining the alarm systems that are installed in our customers' homes and businesses. We provide our services to residential (both single family and multifamily residences), commercial and wholesale customers.

Summary of Significant Matters

Net Loss. We incurred a net loss of $57.2 million for the year ended December 31, 2000 and a net loss of $39.6 million in the first six-months of 2001. This net loss reflects a decline in revenues and substantial charges incurred by us for amortization of customer accounts and goodwill and interest incurred on indebtedness. We do not expect to have earnings in the foreseeable future.

Potential impairment charge relating to the planned adoption on January 1, 2002, of a new accounting standard for treatment of goodwill in a business combination. The Financial Accounting Standards Board issued SFAS No. 142, "Goodwill and Other Intangible Assets" which establishes a new accounting standard for the treatment for goodwill. The new standard continues to require recognition of goodwill as an asset in a business combination but does not permit amortization as currently required by APB Opinion No. 17, "Intangible Assets." Effective January 1, 2002 the new standard requires that goodwill be separately tested for impairment using a fair-value based approach as opposed to the undiscounted cash flow approach used under current accounting standards. If goodwill is found to be impaired we would be required to record a non-cash charge against income which would be recorded as the cumulative effect of a change in accounting principle. The impairment charge would be equal to the amount by which the carrying amount of the goodwill exceeds its estimated fair value. Also effective January 1, 2002, goodwill will no longer be amortized as is required under current accounting

standards. Under the new standard any subsequent impairment test on our customer accounts will be performed on the customer accounts alone rather than in conjunction with goodwill utilizing an undiscounted cash flow test pursuant to SFAS No. 121.

At June 30, 2001, our intangible assets included $793.3 million in goodwill and $830.0 million in customer accounts. These intangible assets together represented 88.4% of the book value of our total assets. We recorded $24.6 million and $27.1 million in goodwill amortization expense for the six-months ended June 30, 2001 and 2000, respectively.

We have not yet performed tests for impairment under the new standard. When tests are performed, we believe it is probable that we will be required to record a non-cash impairment charge. The amount will not be known until the tests are performed, but we believe the amount will be material and could be a substantial portion of our intangible assets. This impairment charge will have a material adverse effect on our results of operation and could have a material adverse effect on our business and financial condition.

Streamlining of operations. We continue our efforts to streamline our business operations and improve operating efficiencies. We merged our Hagerstown, Maryland customer service center which monitored nearly 60,000 customers and our Beaverton, Oregon customer service center which monitored nearly 300,000 customers into our Wichita, Kansas customer service center during the first six-months of 2001. The Wichita customer service center now monitors approximately 520,000 customers. Additionally, in May we discontinued our National Accounts and Patrol divisions both of which had been operating at a loss. In June, we sold certain customer accounts which we believed were not part of our core business. In June, we also eliminated 180 positions from a variety of departments. These consolidations and other cost cutting measures resulted in a total reduction of approximately 400 positions. For the three and six-months ended June 30, 2001, we incurred $4.3 million and $4.7 million in nonrecurring costs relating primarily to these actions.

Western Resources Transactions. On November 9, 2000, Western Resources announced that it had entered into an agreement with Public Service Company of New Mexico providing for the purchase of Western Resources' electric utility business in a stock-for-stock transaction. Immediately prior to the consummation of this transaction, Western Resources would split-off its then interest in Westar Industries to its shareholders. Westar Industries' is principally engaged in the monitored security business through its approximate 87% ownership interest in us and its 100% ownership interest in Protection One Europe (formerly our Europe segment). Westar Industries also holds an approximate 45% ownership interest in ONEOK, Inc., a Tulsa-based natural gas company, a receivable from Western Resources in the amount of $117.5 million at June 30, 2001, an approximate 17% common stock interest in Western Resources and other investments.

In May 2001, the Kansas Corporation Commission opened an investigation into the split-off of Westar Industries from Western Resources and a proposed rights offering by Westar Industries for shares of its common stock. In July 2001, the Kansas Corporation Commission issued an order which, among other things, prohibited the rights offering and raised questions as to the status of the proposed split-off of Westar Industries, although the Kansas Corporation Commission noted that it was not disapproving the Public Service Company of New Mexico transaction or a split-off of Westar Industries. On July 26, 2001, Public Service Company of New Mexico and Western Resources issued a joint press release announcing their belief that, if recent orders issued by the Kansas Corporation Commission remained in place, the proposed transaction would be difficult to complete as presently structured and that they intend to meet to discuss possible modifications to the transaction that will make it possible to obtain necessary regulatory approvals. On August 13, 2001 PNM issued a press release announcing that Western Resources had discontinued discussions and stating that an order issued by the Kansas Corporation Commission reducing Western Resources' rates could result in the failure of a significant condition to the transaction. Western Resources disagrees with these statements.

We are unable to predict the outcome of these discussions or whether or when the proposed transactions may occur.

Potential write down of deferred tax assets. Western Resources makes payments to us for current tax benefits utilized by Western Resources in its consolidated tax return pursuant to a tax sharing agreement. If Western Resources completes its proposed transaction with Public Service Company of New Mexico, including the split-off of Westar Industries, we would no longer be able to file taxes on a consolidated basis with Western Resources. As a result, a substantial portion of our net deferred tax assets of $83.0 million at June 30, 2001 would likely not be realizable and we would likely not be in a position to record a tax benefit for losses incurred. We would be required to record a non-cash charge against income for the portion of our net deferred tax assets we determine not to be realizable. This charge could be material and could have a material adverse effect on our business, financial condition and results of operations.

Registration of Senior Subordinated Notes. As a result of the completion of a registered offer to exchange a new series of 8¹/8% Series B Senior Subordinated Notes for a like amount of our outstanding 8¹/8% Senior Subordinated Notes, effective June 1, 2001 the annual interest rate on all of such outstanding notes decreased from 8⁵/8% to 8¹/8%. At the time of the exchange, the resulting annual interest savings would be $1.2 million.

Amendment to Senior Credit Facility.. In the second quarter of 2001, we requested and Westar Industries agreed to modifications to the Senior Credit Facility which excluded from EBITDA the costs associated with certain work force reductions and office consolidations. In addition, the leverage ratio was amended to increase the maximum ratio to 5.75 to 1.0 and the interest coverage ratio was amended to decrease the minimum ratio to 2.1 to 1.0.

Retirement of Additional Debt.. In the first quarter of 2001, we purchased $83.6 million face value of our bonds for $54.8 million. As a result, an extraordinary gain of $18.3 million, net of tax was recognized. In the second quarter of 2001, we purchased $21.8 million face value of our bonds in the open market for $12.5 million resulting in an extraordinary gain of $5.8 million, net of tax. In July 2001, we purchased an additional $5 million of our bonds in the open market for $2.9 million resulting in an extraordinary gain of $1.3 million, net of tax.

Share Repurchase. In the first quarter of 2001, we purchased 13,712,704 shares of our common stock for $15.0 million, of which 11,532,104 shares were purchased from Westar Industries for $12.6 million. In the second quarter of 2001, we purchased 6,220,255 shares of our common stock for $7.8 million, of which 3,149,255 shares were purchased from Westar Industries for $3.9 million. In July 2001, we purchased an additional 52,500 shares of our common stock in open market purchases. As of August 6, 2001, we had authority from our board of directors to purchase an additional approximately 11.2 million shares of our common stock. The purchases from Westar Industries mainatain its proportionate ownership interest in our common stock. See Note 2 of the Notes to Consolidated Financial Statements.

Customer Creation and Marketing. For the three and six months ended June 30, 2001, our North America segment added 14,348 and 29,530 accounts, respectively, although our net number of accounts decreased by 54,753 and 84,627 accounts, respectively. These decreases include 7,878 accounts that were included in the sale of certain customer accounts and 1,562 accounts that were part of our Patrol business that we discontinued in May 2001. These decreases also reflect 15,532 accounts that were combined with related existing accounts in the conversion of our Beaverton, Oregon customer service center. Our Beaverton billing and monitoring systems reported accounts based on number of contracts. Our new billing and monitoring system, referred to as MAS®, or Monitored Automation Systems, reports sites for which we provide service regardless of whether we have separate contracts to provide multiple services at that site. For the three and six months ended June 30, 2000, our North America

segment added 11,259 and 24,988 accounts, respectively, and our net number of accounts decreased by 35,866 and 62,112 accounts, respectively. Multifamily added 6,810 and 20,087 accounts for the three and six-months ended June 30, 2001, respectively, with its net number of accounts increasing by 2,966 accounts and 11,358 accounts, respectively. For the three and six months ended June 30, 2000, Multifamily added 11,252 and 19,120 accounts, respectively, and its net number of accounts decreased by 665 accounts and increased by 1,378 accounts, respectively.

Our current customer acquisition strategy relies primarily on internally generated sales and occasional "tuck-in" acquisitions. In June, we notified our remaining dealers that we are discontinuing our dealer program and therefore will not be extending or renewing their contracts. The number of accounts being purchased through our dealer program decreased from 14,334 in the first six-months of 2000, to 4,777 in the first six-months of 2001. In the first six-months of 2000, the dealer program accounted for 57% of all customer additions compared to 16% in the first six-months of 2001. In February 2000, we started a commission only internal sales program with a goal of acquiring accounts at a cost lower than our external programs. We currently have a commissioned sales force of over 400 persons. This program utilizes our existing branch infrastructure in approximately 70 markets. The internal sales program generated 19,581 accounts and 10,237 accounts in the first six-months of 2001 and 2000, respectively. Our Multifamily segment utilizes a salaried and commissioned sales force to produce new accounts. We continually evaluate our customer creation and marketing strategy, including evaluating each respective channel for economic returns, volume and other factors and may shift our strategy or focus, including the elimination of a particular channel.

Attrition. Subscriber attrition has a direct impact on our results of 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 of lost customer accounts for a given period, net of certain adjustments, and the denominator of which is the average number of accounts for a given period. In some instances, we use estimates to derive attrition data. We make adjustments to lost accounts primarily for the net change, either positive or negative, in our wholesale base and for accounts which are covered under a purchase price holdback and are "put" back to the seller. We reduce the gross accounts lost during a period by the amount of the guarantee provided for in the purchase agreements with sellers. In some cases, the amount of the purchase holdback may be less than actual attrition experience. For the quarter ended June 30, 2001 we further reduced gross accounts lost for account dispositions and for adjustments resulting from the conversion of accounts to MAS®. We do not reduce the gross accounts lost during a period by "move in" accounts, which are accounts where a new customer moves into a home installed with our security system and vacated by a prior customer, or "competitive takeover" accounts, which are accounts where the owner of a residence monitored by a competitor requests that we provide monitoring services.

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

We monitor attrition each quarter based on a quarterly annualized and trailing twelve-month basis. This method utilizes each segment's average customer account base for the applicable period in measuring attrition. Therefore, in periods of customer account growth, customer attrition may be understated and in periods of customer account decline, customer attrition may be overstated.

Customer attrition by business segment for the three months ended June 30, 2001 and 2000 is summarized below:

	Customer Account Attrition
	June 30, 2001				June 30, 2000
	Annualized Second Quarter		Trailing Twelve Month		Annualized Second Quarter		Trailing Twelve Month
North America	14.5	%	16.7	%	14.2	%	15.5	%
Multifamily	4.8	%	5.8	%	16.1	%	9.9	%
Total Company*	12.2	%	14.2	%	14.6	%	14.4	%

*: Does not include Europe segment which was sold February 29, 2000.

Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000

We separate our business into two reportable segments: North America and Multifamily. North America provides security alarm monitoring services, which include sales, installation and related servicing of security alarm systems in the United States and Canada. Multifamily provides security alarm services to apartments, condominiums and other multi-family dwellings.

North America Segment

We present the table below for comparison of our North America operating results for the periods presented. Next to each period's results of operations, we provide the relevant percentage of total revenues so you can make comparisons about the relative change in revenues and expenses.

		Six Months Ended June 30,
		2001					2000
		(dollars in thousands)
Revenues:
	Monitoring and related services	$	154,434		95.3	%	$	181,291		96.2	%
	Other		7,639		4.7			7,165		3.8

	Total revenues		162,073		100.0			188,456		100.0
Cost of revenues:
	Monitoring and related services		51,200		31.6			55,365		29.4
	Other		6,644		4.1			5,793		3.1

	Total cost of revenues		57,844		35.7			61,158		32.5

	Gross profit		104,229		64.3			127,298		67.5
Selling expense			8,453		5.2			3,301		1.7
General and administrative expense			47,515		29.3			49,318		26.2
Acquisition and transition expense			3,304		2.0			6,459		3.4
Amortization and depreciation expense			93,356		57.6			104,920		55.7
Severance and other expense			4,695		2.9			3,050		1.6

Operating income (loss)		$	(53,094	)	(32.7	)%	$	(39,750	)	(21.1	)%

2001 Compared to 2000. We had a net decrease of 84,627 customers in the first half of 2001, including 21,652 customers related to dispositions and conversions, as compared to a net decrease of 62,112 customers in the first half of 2000. We expect that this trend will continue until the efforts we are making to acquire new accounts and reduce attrition become more successful than they have been to date. Until we are able to reverse this trend, net losses of customer accounts will materially and adversely affect our business, financial condition and results of operations. We are currently focused on

the completion of our current infrastructure projects, cost reductions, the development of cost effective marketing programs, and the generation of positive cash flow.

Further analysis of the change in the North American account base between the two periods is shown in the table below. The "Conversion adjustments" line item reflects the impact on the calculation of our customer base from the conversion of our Wichita, Hagerstown and Beaverton monitoring and billing systems to our new technology platform, MAS®. These conversion adjustments relate to how a customer is defined and the transition of that definition from one system to another. We anticipate further such adjustments, which could be either positive or negative, from the conversion of our Irving, Texas monitoring station to MAS® later this year.

	Six Months Ended June 30,
	2001		2000
Beginning Balance, January 1	1,063,115		1,204,642
Additions	29,530		24,988
Conversion adjustments	(12,212	)	—
Customer losses from dispositions	(9,440	)	—
Customer losses not guaranteed with holdback put backs	(78,956	)	(76,612	)
Customer losses guaranteed with holdback put backs and other	(13,549	)	(10,488	)

Ending Balance, June 30	978,488		1,142,530

Monitoring and related service revenues decreased approximately $26.9 million in the first six months of 2001 as compared to the first six months of 2000 primarily due to the decline in our customer base. These revenues consist primarily of contractual revenue derived from providing monitoring and maintenance service.

Other revenues increased by $0.4 million or 6.6% to $7.6 million in 2001 from $7.2 million in 2000. These revenues consist primarily of sales of burglar alarms, closed circuit televisions, fire alarms and card access control systems to commercial customers.

Cost of monitoring and related services revenues for the first six months of 2001 decreased by $4.2 million, or 7.5%, to $51.2 million from $55.4 million for the first six months of 2000. These costs generally relate to the cost of providing monitoring service and include the costs of monitoring, billing, customer service and field operations. The decrease is primarily due to the discontinuation of our Patrol services in May, the decline in our customer base and a reduction of telecommunication costs. Costs of monitoring and related services revenues as a percentage of the related revenues increased to 33.2% in the first six months of 2001 from 30.5% in the first six months of 2000. Although we have reduced certain costs we have not been able to achieve cost reductions at the same rate as our decline in revenues.

Cost of other revenues increased by $0.8 million from $5.8 million in the first six months of 2000 to $6.6 million in the first six months of 2001. These costs consist primarily of equipment and labor charges to install alarm systems, closed circuit televisions, fire alarms and card access control systems sold to our customers. These costs as a percentage of other revenues were approximately 87.0% for the first six months of 2001 as compared to approximately 80.9% for the first six months of 2000.

Selling expenses increased $5.1 million or 156.1% to $8.4 million in the first six months of 2001 from $3.3 million in 2000. The increase is due to our increased efforts to generate new customers through an internal sales force. Our internal sales force has grown from approximately 100 salespersons at June 30, 2000 to over 400 salespersons at June 30, 2001.

General and administrative expenses decreased $1.8 million or 4.3% from $49.3 million to $47.5 million in the first half of 2001. The decrease is generally comprised of reductions in bad debt

expense of approximately $4.6 million primarily due to increased collection efforts and $0.5 million in telecommunications expense. These decreases were partially offset by increases in outside services of $1.3 million primarily due to additional costs of converting our billing and monitoring systems, $0.8 million in costs associated with the closing of our dealer program and $1.5 million for lease expense relating to computer equipment and software. Our prior practice was to purchase our computer equipment and software and depreciate and amortize accordingly. We now generally lease our computer equipment and certain software and incur lease charges. As a percentage of total revenues, general and administrative expenses increased in the first six months of 2001 because the decrease in expenses was proportionately less than the decrease in revenues.

Acquisition and transition expenses decreased $3.2 million in the first half of 2001 from $6.5 million to $3.3 million. The decrease is generally due to the reduced level of account acquisitions in the first six months of 2001 as compared to 2000.

Amortization and depreciation expense for the first six months of 2001 decreased by $11.6 million, or 11.0%, to $93.3 million from $104.9 million. This decrease reflects a reduction in depreciation expense of $7.5 million primarily related to the accelerated depreciation of the billing and general ledger system used in 2000, and a reduction in subscriber amortization expense of $3.1 million related to the declining balance method of amortization utilized. The remaining $1.0 million decrease is from goodwill amortization and is due to adjustments made to goodwill in 2000 to reflect utilization of tax net operating losses.

Severance and other expense increased $1.7 million, or 53.9%, from $3.0 million to $4.7 million in the first half of 2000 and 2001, respectively. This expense for 2001 is primarily for severance charges incurred in the closing of our Beaverton and Hagerstown customer service centers, the reduction of 180 positions, the discontinuation of the National Accounts and Patrol divisions and the relocation of certain departments. Also included are certain other costs incurred with the closure of facilities. In 2000, these costs were comprised of $1.5 million in officer severance and $1.5 million for costs incurred in the sale of our European operations.

Multifamily Segment

We present the table below for comparison of the Multifamily operating results for the periods presented. Next to each period's results of operations, we provide the relevant percentage of total revenues so that you can make comparisons about the relative change in revenues and expenses.

		Six Months Ended June 30,
		2001				2000
		(dollars in thousands)
Revenues:
	Monitoring and related services	$	17,558	98.2	%	$	17,379	88.7	%
	Other		322	1.8			2,212	11.3

	Total revenues		17,880	100.0			19,591	100.0
Cost of revenues:
	Monitoring and related services		3,967	22.2			3,911	20.0
	Other		384	2.1			2,112	10.8

	Total cost of revenues		4,351	24.3			6,023	30.8

	Gross profit		13,529	75.7			13,568	69.2
Selling expense			953	5.3			1,315	6.7
General and administrative expenses			3,997	22.4			4,016	20.5
Amortization and depreciation expense			8,036	45.0			7,719	39.4

Operating income		$	543	3.0	%	$	518	2.6	%

2001 Compared to 2000. We had a net increase of 11,358 customers in the first six months of 2001 as compared to a net increase of 1,378 customers in 2000. The average customer base was 313,636 for the first six months of 2001 compared to 295,649 for the first six months of 2000. The change in Multifamily's customer base for the period is shown below.

	Six Months Ended June 30,
	2001		2000
Beginning Balance, January 1,	307,957		294,960
Additions, net of holdback put backs	20,087		19,120
Customer losses, net of holdback put backs	(8,729	)	(17,742	)

Ending Balance	319,315		296,338

Monitoring and related services revenues was $17.6 million in 2001 compared to $17.4 million in 2000. The average customer base increase of 6.0% was offset by a decrease in our recurring monthly revenue ("RMR") per customer. The decrease in RMR per customer is partly due to an increase in the number of our customers added during 2000 through outright sales of security systems with lower RMR than our standard contracts which include an additional monthly charge for equipment rental and maintenance. The remaining decline in RMR per customer is primarily related to an increasing number of contract renewals which provide for significant contract term extensions and lower RMR.

Installation and other revenues decreased by $1.9 million or 85.4% to $0.3 million in 2001 from $2.2 million in 2000 primarily due to a $1.3 million decrease in revenue resulting from fewer outright sales and revenue deferrals of $0.6 million.

Cost of monitoring and related revenues for the first six months of 2001 remained consistent with costs incurred in the first six months of 2000. This cost as a percentage of associated revenues also remained consistent at 22.5% with the respective periods.

Cost of installation and other revenues decreased by $1.7 million, or 81.8% to $0.4 million in 2001 from $2.1 million in 2000 due to the decline in the number of outright sales and the deferral of $0.6 million in costs.

Selling expense decreased $0.4 million, or 27.5%, to $0.9 million in 2001 from $1.3 million in 2000 due to a temporary decline in the sales force and a decrease in commission expense resulting from a decline in contract executions.

General and administrative expenses for the first six months of 2001 remained consistent with the first six months of 2000.

Amortization and depreciation expense for 2001 increased by $0.3 million, or 4.1% to $8.0 million from $7.7 million in 2000. This increase is the result of the increasing customer base being amortized.

Three Months Ended June 30, 2001 Compared to Three Months Ended June 30, 2000

North America Segment

		Three Months Ended June 30,
		2001					2000
		(dollars in thousands)
Revenues:
	Monitoring and related services	$	75,330		95.3	%	$	88,124		96.0	%
	Other		3,747		4.7			3,653		4.0

	Total revenues		79,077		100.0			91,777		100.0
Cost of revenues:
	Monitoring and related services		25,412		32.1			27,240		29.7
	Other		2,783		3.6			2,569		2.8

	Total cost of revenues		28,195		35.7			29,809		32.5

	Gross profit		50,882		64.3			61,968		67.5
Selling expense			4,183		5.3			2,080		2.3
General and administrative expense			24,244		30.6			23,711		25.8
Acquisition and transition expense			1,695		2.1			2,880		3.1
Amortization and depreciation expense			46,884		59.3			52,666		57.4
Severance and other expense			4,276		5.4			—		—

Operating income (loss)		$	(30,400	)	(38.4	)%	$	(19,369	)	(21.1	)%

2001 Compared to 2000. We had a net decrease of 54,753 customers in the second quarter of 2001, including 24,972 customers related to dispositions and conversions, as compared to a net decrease of 35,866 customers in the second quarter of 2000. The average customer base for the second quarter of 2001 and 2000 was 1,005,865 and 1,160,463, respectively, or a decrease of 154,598 customers. The number of customers decreased primarily because our customer acquisition strategies were not able to generate accounts in a sufficient volume at acceptable cost to replace accounts lost through attrition. We expect that this trend will continue until the efforts we are making to acquire new accounts and reduce attrition become more successful than they have been to date. Until we are able to reverse this trend, net losses of customer accounts will materially and adversely affect our business, financial condition and results of operations. We are currently focused on the completion of our current

infrastructure projects, cost reductions, the development of cost effective marketing programs, and the generation of positive cash flow.

	Three Months Ended June 30,
	2001		2000
Beginning Balance, April 1	1,033,241		1,178,396
Additions	14,348		11,259
Conversion adjustments	(15,532	)	—
Customer losses from dispositions	(9,440	)	—
Customer losses not guaranteed with holdback put backs	(36,469	)	(41,086	)
Customer losses guaranteed with holdback put backs and other	(7,660	)	(6,039	)

Ending Balance, June 30	978,488		1,142,530

Annualized quarterly attrition	14.5	%	14.2	%

Monitoring and related service revenues decreased approximately $12.8 million or 14.5% in the second quarter of 2001 compared to the second quarter of 2000. This is primarily due to the decline in our customer base.

Other revenues consist primarily of revenues generated from our internal installations of new alarm systems. These revenues were comparable for the quarters ended June 30, 2001 and 2000.

Cost of monitoring and related services revenues for the second quarter of 2001 decreased by $1.8 million, or 6.7%, to $25.4 million from $27.2 million for the second quarter of 2001. The decrease is primarily due to the discontinuation of our Patrol services in May and the decline in our customer base. Costs of monitoring and related services revenues as a percentage of the related revenues increased to 33.7% in the second quarter of 2001 from 30.9% in the second quarter of 2000. Although we have reduced certain costs we have not been able to achieve cost reductions at the same rate as our decline in revenues.

Cost of other revenues was comparable for the quarters ended June 30, 2001 and 2000.

Selling expenses increased $2.1 million from $2.1 million in the second quarter of 2000 to $4.2 million in the second quarter of 2001. The increase is generally due to an increase in the internal sales force and the resulting increase in sales commissions, wages and benefits and support costs.

General and administrative expenses increased $0.5 million from $23.7 million in the second quarter of 2000 to $24.2 million in the second quarter of 2001. The increase in 2001 is comprised generally of a $1.4 million increase in outside services primarily relating to the conversion of our billing and monitoring systems, a $1.0 million increase in costs associated with the closing of our dealer program and a $0.7 million increase in computer equipment and software lease expense. These increases were partially offset by a $2.1 million decrease in bad debt expense primarily related to increased collection efforts. As a percentage of total revenues, general and administrative expenses increased in the second quarter of 2001 because the decrease in expenses was proportionately less than the decrease in revenues.

Acquisition and expenses decreased $1.2 million or 41.1% for the second quarter of 2001 compared to the second quarter of 2000. Fewer accounts have been acquired through the dealer program in 2001.

Amortization and depreciation expense for the second quarter of 2001 decreased by $5.8 million, or 10.9%, to $46.9 million from $52.7 million in the second quarter of 2000. This decrease reflects a reduction in depreciation expense of $3.6 million primarily related to the accelerated depreciation of the billing and general ledger system used in 2000, and a reduction in subscriber amortization expense of $1.6 million related to the declining balance method of amortization utilized. The remaining $0.5 million decrease is from goodwill amortization.

Severance and other expense of $4.3 million in the second quarter of 2001 consisted primarily of severance charges incurred in the closing of our Beaverton customer service center, the reduction of 180 positions, the discontinuation of the National Accounts and Patrol divisions and the relocation of certain departments. Also included are certain other costs incurred with the closure of facilities. There were no such charges in the second quarter of 2000.

Multifamily Segment

		Three Months Ended June 30,
		2001				2000
		(dollars in thousands)
Revenues:
	Monitoring and related services	$	8,869	98.0	%	$	8,691	92.0	%
	Other		179	2.0			760	8.0

	Total revenues		9,048	100.0			9,451	100.0
Cost of revenues:
	Monitoring and related services		2,043	22.6			1,976	20.9
	Other		223	2.4			730	7.8

	Total cost of revenues		2,266	25.0			2,706	28.7

	Gross profit		6,782	75.0			6,745	71.3
Selling expense			478	5.3			639	6.8
General and administrative expenses			2,055	22.7			1,990	21.0
Amortization and depreciation expense			4,035	44.6			3,885	41.1

Operating income		$	214	2.4	%	$	231	2.4	%

2001 Compared to 2000. We had a net increase of 2,966 customers in the second quarter of 2001 as compared to a net decrease of 665 customers in 2000. The average customer base was 317,832 for

the second quarter of 2001 compared to 296,671 for the second quarter of 2000. The change in Multifamily's customer base for the period is shown below.

	Three Months Ended June 30,
	2001		2000
Beginning Balance, April 1	316,349		297,003
Additions, net of holdback put backs	6,810		11,252
Customer losses, net of holdback put backs	(3,844	)	(11,917	)

Ending Balance, June 30	319,315		296,338

Annualized quarterly attrition	4.8	%	16.1	%

Monitoring and related services revenues was $8.9 million in the second quarter 2001 compared to $8.7 million in 2000. The average customer base increase of 7.1% was offset by a decrease in our recurring monthly revenue ("RMR") per customer. The decrease in RMR per customer is partly due to an increase in the number of our customers added during 2000 through outright sales of security systems with lower RMR than our standard contracts which include an additional monthly charge for equipment rental and maintenance. The remaining decline in RMR per customer is primarily related to an increasing number of contract renewals which provide for significant contract term extensions and lower RMR.

Installation and other revenues decreased by $0.6 million or 76.4% to $0.2 million in 2001 from $0.8 million in 2000 primarily due to a $0.3 million decrease in revenue resulting from fewer outright sales and revenue deferrals of $0.3 million.

Cost of monitoring and related revenues for the second quarter of 2001 remained consistent with the costs incurred in the second quarter of 2000. This cost as a percentage of associated revenues increased slightly to 23.0% for the second quarter of 2001 compared to 22.7% in 2000.

Cost of installation and other revenues decreased by $0.5 million or 69.5% to $0.2 million from $0.7 million in 2000 due to the decrease in the number of outright sales and the deferral of $0.3 million in costs.

Selling expense decreased $0.2 million or 25.2% to $0.5 million in 2001 from $0.7 million in 2000 generally due to a decrease in commission expense resulting from a decline in contract executions.

General and administrative expenses for the second quarter of 2001 remained consistent with the second quarter of 2000.

Amortization and depreciation expense for 2001 increased by $0.1 million, or 3.9% to $4.0 million from $3.9 million in 2000. This increase is the result of the increasing customer base being amortized.

Liquidity and Capital Resources

We believe we will have sufficient cash to fund future operations of our business through July 1, 2002 from a combination of cash flow from our security monitoring customer base which generated $53.5 million of positive EBITDA in the first six months of 2001, possible asset sales and borrowings under our existing Senior Credit Facility with Westar Industries, which had approximately $19 million of availability at July 31, 2001.

The Senior Credit Facility currently expires on January 2, 2002. We expect to renew the facility with Westar Industries unless efforts to replace the facility with financing from an unaffiliated third party lender are successful. The success of these efforts will depend on improvements in our financial performance. The Kansas Corporation Commission has issued an order prohibiting Western Resources

from borrowing to make loans or capital contributions to Westar Industries. This order limits the resources available to Westar Industries for funding its obligations under the Senior Credit Facility. We would face significant liquidity issues if we were unable to renew the Senior Credit Facility with Westar Industries or if Westar Industries was unable to fund its obligations under the Senior Credit Facility.

Our ability to borrow under the facility is subject to compliance with certain financial covenants including a leverage ratio of 5.75 to 1.0 and an interest coverage ratio of 2.10 to 1.0. At June 30, 2001, the ratios were approximately 4.8 to 1.0 and 2.3 to 1.0, respectively.

EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, should not be construed as an alternative to operating income and is indicative neither of operating performance nor cash flows available to fund our cash needs. Items excluded from EBITDA are significant components in understanding and assessing our financial performance. We believe that presentation of EBITDA enhances an understanding of our financial condition, results of operations and cash flows because EBITDA is used to satisfy our debt service obligations and our capital expenditures and other operational needs as well as to provide funds for growth. In addition, EBITDA is used by senior lenders and subordinated creditors and the investment community to determine the current borrowing capacity and to estimate the long-term value of companies with recurring cash flows from operations. Our computation of EBITDA may not be comparable to other similarly titled measures of other companies.

Operating Cash Flows for the Six Months Ended June 30, 2001. Our operating activities provided net cash flows of $27.0 million for the first six months of 2001. Other liabilities increased by $13.1 million primarily due to a $16.5 million liability incurred with the purchase of additional shares of our outstanding debt and equity securities. This liability was paid in early July. Our net tax assets increased by $4.3 million due for tax benefits resulting from our net loss and accrued interest decreased by $3.8 million due to a reduction of our outstanding debt. Deferred revenue on recurring billings also decreased by $4.3 primarily due to an overall decrease in our customer base.

Investing Cash Flows for the Six Months Ended June 30, 2001. Our investing activities provided net cash flows of $1.3 million in the first six months of 2001. Proceeds from the sale of certain customer accounts provided cash of $19.2 million. We used $13.9 million in cash to install and acquire new accounts and $3.9 million to acquire fixed assets including $1.6 million of new service vehicles.

Financing Cash Flows for the Six Months Ended June 30, 2001. We used a net $25.5 million in cash for financing activities in the first six months of 2001. We increased our borrowings under the Senior Credit Facility by $66.0 million. We used cash to purchase $105.4 million in face value of our outstanding debt for $67.3 million and to acquire 19,932,959 shares of our outstanding stock for $22.8 million. At June 30, 2001, the Senior Credit Facility had a weighted average interest rate of 7.95% and an outstanding balance of $110.0 million.

Debt and Equity Repurchase Plans. We may from time to time purchase our debt and equity securities in the open market or through negotiated transactions. The timing and terms of purchases, and the amount of debt or equity actually purchased will be determined based on market conditions and other factors. As of August 6, 2001, we had authority from our board of directors to purchase an additional approximately 11.2 million shares of our common stock.

Material Commitments. We have future, material, long-term commitments made in the past several years in connection with our growth. We believe these commitments will be met through a combination

of borrowings under our Senior Credit Facility, refinancings and positive operating cash flows. The following reflects these commitments as of June 30, 2001:

Debt Security	Maturity Date	Amount
		(in thousands)
Convertible Senior Subordinated Notes (a)	September 2003	$	23,785
Senior Subordinated Discount Notes	June 2005		39,761
Senior Unsecured Notes	August 2005		204,650
Senior Subordinated Notes	January 2009		216,440
Senior Credit Facility	January 2002		110,000

		$	594,636

(a): These notes are convertible into Protection One common stock at a price of $11.19 per share, which is above the price at which our shares are traded in the public stock markets.

We are in compliance with the financial covenants under the Senior Credit Facility and the indentures for the second quarter of 2001.

Credit Ratings. As of August 3, 2001, the major rating agencies carried the following ratings on our outstanding public debt:

	Senior Unsecured Debt	Senior Subordinated Unsecured Debt	Outlook
S & P	B+	B-	Negative
Moody's	B3	Caa2	Negative
Fitch	B	CCC+	Negative

In general, declines in our credit ratings make debt financing more costly and more difficult to obtain on terms which are economically favorable to us.

Capital Expenditures. We anticipate making capital expenditures of approximately $20 million to acquire customer accounts and to purchase fixed assets for the remainder of 2001. We are evaluating our estimated capital expenditures for 2002 and 2003 previously discussed in our Form 10-K for the year ended December 31, 2000. We currently do not have new estimates, however, we anticipate such estimates will be reduced upon the completion of our evaluation. These estimates are prepared for planning purposes and are revised from time to time. Actual expenditures for these and possibly other items not presently anticipated will vary from these estimates during the course of the years presented. We believe that our capital requirements will be met in 2001 through the use of internally generated funds and drawings under our Senior Credit Facility. In subsequent years, we anticipate that these capital requirements will be met through the use of internally generated funds, asset sales, the Senior Credit Facility or external financings. See "Liquidity and Capital Resources" above.

Tax Matters

We have a tax sharing agreement with Western Resources which allows us to be reimbursed for tax deductions utilized by Western Resources in its consolidated tax return. If Western Resources were to complete its proposed transaction with Public Service Company of New Mexico, including the split-off of Westar Industries, we would no longer be able to file taxes on a consolidated basis with Western Resources. As a result, a substantial portion of our net deferred tax assets of $83.0 million at June 30, 2001 would likely not be realizable and we would likely not be in a position to record a tax benefit for losses incurred. We would be required to record a non-cash charge against income for the portion of our net deferred tax assets determined not to be realizable. This charge could be material.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company has not experienced any significant changes in its exposure to market risk since December 31, 2000. For additional information on the Company's market risk, see Item 7A of the Form 10-K for the year ended December 31, 2000.

The Company expects to adopt the following pending accounting pronouncements:

SFAS No. 142, "Goodwill and Other Intangible Assets" effective January 1, 2002. See Note 5 for additional information regarding this pronouncement and the potential impact on upon adoption.

SFAS No. 143, "Accounting for Asset Retirement Obligations." The Company is evaluating the impact and expects to adopt this Statement by January 1, 2003.

PART II

OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

Information relating to legal proceedings is set forth in Note 5 of the Notes to Consolidated Financial Statements included in Part I of this report, which information is incorporated herein by reference.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS.

The 2001 annual meeting of Protection One, Inc.'s stockholders (the "Annual Meeting") was held on May 24, 2001. All directors nominated were elected at the Annual Meeting. For the election of directors, the results were as follows:

Nominee	Votes For	Votes Withheld
Annette M. Beck	104,917,791	74,746
Gene A. Budig	104,931,656	60,881
Howard A. Christensen	104,929,656	62,881
Maria de Lourdes Duke	104,933,311	59,226
Ben M. Enis	104,929,656	62,881
Richard Ginsburg	104,928,101	64,436
Donald A. Johnston	104,931,156	61,381
Carl M.Koupal, Jr.	104,930,031	62,506
Douglas T. Lake	104,931,764	60,773
Rita A. Sharpe	104,930,169	62,368
Steven V. Williams	104,933,158	59,379
James Q. Wilson	104,932,656	59,881

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a): Exhibits. The following exhibits are filed with this Quarterly Report on Form 10-Q or incorporated by reference.

Exhibit Number		Exhibit Description
10.1		Fifth Amendment of Credit Agreement effective as of June 30, 2001 between Protection One Alarm Monitoring, Inc. and Westar Industries, Inc.
10.2		Amendment No. 3 to Contribution Agreement between Protection One Inc. and Western Resources, Inc.

(b): During the quarter ended June 30, 2001, the Company filed one Current Report on Form 8-K dated April 18, 2001, reporting that Richard Ginsburg was named the new Chief Executive Officer of the Company.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized.

Date: August 14, 2001		PROTECTION ONE, INC. PROTECTION ONE ALARM MONITORING, INC.
		By:		/s/ DARIUS G. NEVIN Darius G. Nevin Executive Vice President and Chief Financial Officer

Exhibit List

Exhibit Number		Exhibit Description
10.1		Fifth Amendment of Credit Agreement effective as of June 30, 2001 between Protection One Alarm Monitoring, Inc. and Westar Industries, Inc.
10.2		Amendment No. 3 to Contribution Agreement between Protection One Inc. and Western Resources, Inc.