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

FORM 10-K

For the fiscal year ended December 31, 2001

For the transition period from                                     to                                     

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

(None)
(Title of Class)

        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 registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

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

        The aggregate market value of common stock of Protection One, Inc. held by nonaffiliates on March 15, 2002 (based on the last sale price of such shares on the New York Stock Exchange) was $29,566,175.

        As of March 15, 2002, Protection One, Inc. had 97,901,367 shares of Common Stock outstanding, 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 I (1)(a) and (b) for Form 10-K and is therefore filing this form with the reduced disclosure format set forth therein.

DOCUMENTS INCORPORATED BY REFERENCE:

        Portions of Protection One, Inc.'s proxy statement on Schedule 14A to be furnished to stockholders in connection with its Annual Meeting of Stockholders are incorporated by reference in Part III of the Form 10-K. Such proxy statement is expected to be filed with the Commission by April 23, 2002.

TABLE OF CONTENTS

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PART I

FORWARD-LOOKING STATEMENTS

        This Annual Report on Form 10-K (this "Report") and the materials incorporated by reference herein include "forward-looking statements" intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally can be identified as such because the context of the statement includes words such as we "believe," "expect," "anticipate" or other words of similar import. Similarly, statements herein that describe our objectives, plans or goals also are forward-looking statements. Such statements include those made on matters such as our earnings and financial condition, litigation, accounting matters, our business, our efforts to consolidate and reduce costs, our customer account acquisition strategy and attrition, our liquidity and sources of funding and our capital expenditures. All such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Important factors that could cause actual results to differ materially from our expectations include, among others, the factors discussed in the section entitled "Risk Factors." The forward-looking statements included herein are made only as of the date of this Report and we undertake no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.

ITEM 1. BUSINESS

        Unless the context otherwise indicates, all references in 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. ("Protection One Alarm Monitoring") and Protection One Alarm Monitoring's other wholly owned subsidiaries. Protection One's sole asset is, and Protection One operates solely through, Protection One Alarm Monitoring and Protection One Alarm Monitoring's other wholly owned subsidiaries. Each of Protection One and Protection One Alarm Monitoring is a Delaware corporation organized in September 1991.

Overview

        Protection One is a leading provider of property monitoring services, providing electronic monitoring and maintenance of alarm systems to approximately 1.2 million customers as of December 31, 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. At December 31, 2001, our customer base composition was as follows:

        Our company is divided into two business segments:

        Protection One North America ("North America") generated approximately $304.5 million, or 89.3%, of our revenues in 2001 and is comprised of Protection One Alarm Monitoring, our core alarm monitoring business, and our wholesale monitoring business, which provides alarm monitoring services to independent alarm companies.

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        Network Multifamily ("Multifamily") generated approximately $36.5 million, or 10.7%, of our revenues in 2001 and is comprised of our alarm monitoring business servicing apartments, condominiums and other multifamily dwellings.

        Our strategy is to improve returns on invested capital by realizing economies of scale from increasing customer density in the largest urban markets in North America. We plan to accomplish this goal by: (i) retaining our customers by providing superior customer service from our monitoring facilities and our branches; (ii) using our national presence, strategic alliances, and strong local operations to persuade the most desirable residential and commercial prospects to enter into long term agreements with us on terms that permit us to achieve appropriate returns on capital; and (iii) on a limited basis in 2002 or 2003, acquiring alarm companies and portfolios of alarm accounts pursuant to transactions that meet our strategic and financial requirements.

Significant Business Developments

        Management Team.    In 2001, important changes were made in our management team with the addition of four experienced executives with extensive industry experience. Richard Ginsburg joined us as President and Chief Executive Officer in April 2001. In July and August 2001, we added Mack Sands as Executive Vice President and Chief Operating Officer, Darius G. Nevin as Executive Vice President and Chief Financial Officer, and Peter J. Pefanis as Senior Vice President. Additional changes were made throughout the remainder of our management ranks to strengthen our management team. See "Item 10—Directors and Executive Officers of the Registrants."

        Operational Efficiencies.    Our management team made improvements in operational efficiencies one of our key priorities in 2001. We consolidated our monitoring facilities in Hagerstown, Maryland, Beaverton, Oregon, and Irving, Texas, into our monitoring facility in Wichita, Kansas, which currently monitors approximately 650,000 accounts. In January 2002, we completed the installation of our common technology platform for customer service, monitoring, billing and collection functions in all of our residential monitoring facilities outside Canada. In addition, we discontinued our National Accounts and Patrol divisions, sold certain accounts that were not part of our core business, and consolidated additional operational and administrative facilities. These consolidations and other cost reduction initiatives resulted in a total reduction of approximately 600 positions in our work force. See "Centralized Monitoring, Common Technology Platform and Customer Service."

        Attrition and Customer Creation.    In 2001, we had a net loss of 196,357 customers in our customer base. This decline resulted from attrition, the decision to add new customers at reasonable costs through our internal sales force and to focus on operational efficiencies, the disposition of certain accounts, and adjustments related to the conversion of our customer base to our common technology platform. Our customer acquisition strategy for our North America segment relies primarily on our internal sales force, which generated 43,742 accounts in 2001 compared to 27,259 accounts in 2000, and our marketing alliance with BellSouth Telecommunications, Inc. See "Sales and Marketing," "Attrition."

        Impairment Charge.    In the first quarter of 2002, we will record an impairment charge to write-down goodwill and customer accounts to their estimated fair values. The amount of this charge net of tax will be approximately $659.3 million, of which approximately $441.5 million will be related to goodwill and approximately $217.8 million will be related to customer accounts. For further information, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation—Impairment Charge Pursuant to New Accounting Rules" and Note 16 of the "Notes to Consolidated Financial Statements."

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Operations

        Our operations consist principally of alarm monitoring, customer service functions and branch operations.

        Centralized Monitoring, Common Technology Platform and Customer Service

        Customer Security Alarm Systems.    Security alarm systems include many different types of devices installed at customers' premises designed to detect or react to various occurrences or conditions, such as intrusion or the presence of fire or smoke. In general, systems for multi-family and residential applications tend to be smaller in size than those used by commercial customers, and also tend to generate a lower level of alarm signals than in commercial applications. These devices are connected to a computerized control panel that communicates through the phone lines to a monitoring facility. In most systems, control panels can identify the nature of the alarm and the areas within a building where the sensor was activated, and can transmit that information to a central monitoring station.

        Customer Contracts.    Our alarm monitoring customer contracts generally have initial terms ranging from two to ten years in duration, and provide for automatic renewals for a fixed period (typically one year) unless we or the customer elect to cancel the contract at the end of its term. Typically, customers sign alarm monitoring contracts that include a bundled monthly charge for monitoring, extended service protection and a rebate against the homeowners' insurance deductibles in the event of a loss. Extended service protection covers the normal costs of repair of the security system after the expiration of the security system's initial warranty period. Customers may elect to sign an alarm monitoring contract that excludes extended service protection.

        Monitoring Facilities.    We provide monitoring services to our customer base from six monitoring facilities. The table below provides additional detail about our monitoring centers:

(1)

In 2002, Multifamily will move their administrative headquarters and monitoring operations to the Irving, Texas facility formerly utilized by our North America segment for monitoring residential and commercial customers.

        Our monitoring facilities operate 24 hours per day, seven days a week, including all holidays. Each monitoring facility incorporates the use of communications and computer systems that route incoming alarm signals and telephone calls to operators. Each operator within a monitoring facility monitors a computer screen that presents information concerning the nature of the alarm signal, the customer whose alarm has been activated, and the premises on which such alarm is located. Other non-emergency administrative signals are generated by low battery status, arming and disarming of the alarm monitoring system, and test signals, and are processed automatically by computer. Depending upon the type of service for which the customer has contracted, monitoring facility personnel respond to alarms by relaying information to the local fire or police departments, notifying the subscriber, or taking other appropriate action, such as dispatching alarm response personnel to the customer's premises where this service is available.

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        All of our primary monitoring facilities in North America are listed by Underwriters Laboratories, Inc. ("UL") as protective signaling services stations. UL specifications for monitoring facilities include building integrity, back-up computer and power systems, staffing and standard operating procedures. In many jurisdictions, applicable law requires that security alarms for certain buildings be monitored by UL listed facilities. In addition, such listing is required by certain commercial customers' insurance companies as a condition to insurance coverage.

        Common Technology Platform.    In recognition of the strategic importance of serving all our customers on a common database running on an industry standard monitoring automation application, in 2000 we adopted MAS®, from Monitored Automation Systems, of Irvine, California, as the technology platform for our domestic monitoring facilities. MAS® combines customer service, monitoring, billing and collection functions into a single system and is used, to varying extents, by other large companies in the security monitoring industry including ADT Security Services and Brink's (see Competition, below).

        In 2001, our Wichita and Irving monitoring facilities completed their conversions to MAS®^. With the conversion to MAS® of the Portland, Maine facility in January 2002, we serve approximately 94% of our North America residential and commercial customer base by utilizing one common database. We plan to dedicate the Portland monitoring facility to monitoring our new commercial customers whose requirements often exceed those of typical residential customers. We also completed the installation of a new financial system which we began using in January 2001 that can be accessed in all of our locations.

        The conversion to MAS® enabled us to consolidate the number of monitoring facilities we operate, resulting in operational efficiencies and cost savings. During 2001 and early 2002, we completed a series of monitoring facility conversions to MAS and consolidations of monitoring facilities including:

        Wholesale Monitoring.    Through our monitoring facilities in Orlando, Wichita and Vancouver, we provide wholesale monitoring services to independent alarm companies. Under the typical arrangement, alarm companies subcontract monitoring services to us, primarily because they do not have their own monitoring capabilities. We may also provide billing and other services. These independent alarm companies retain ownership of monitoring contracts and are responsible for every other aspect of the relationship with customers, including field repair service.

        Customer Care Services.    Customer care personnel answer non-emergency telephone calls typically regarding service, billing and alarm activation issues. Until late 2001, all customer care personnel were located exclusively in our monitoring facilities. During the last quarter of 2001, we began shifting some business-hours customer care functions to our branches, including responding to routine billing and service inquiries. In 2002, we expect to complete the shifting of most business-hours customer care functions to our branches. During business hours, monitoring facility personnel receive inbound customer calls forwarded from branches when the latter are unable to answer within a specified number of rings. After-hours, all customer calls are forwarded to the monitoring facilities.

        Customer care personnel in our branches and in our monitoring facilities at help desks assist customers in understanding and resolving minor service and operating issues related to security systems. Branch personnel schedule technician appointments. We also operate a dedicated telesales center in

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Wichita to address questions that customers or potential customers have about our services, as well as to perform outbound sales and marketing activities.

        Enhanced Services.    As a means of increasing revenues and enhancing customer satisfaction, we offer customers an array of enhanced security services, including extended service protection, expanded monitoring features, and telephone line security. These services position us as a full service provider and give our sales representatives more features to sell in their solicitation of new customers. Enhanced services include:

•

Extended Service Protection, which covers the normal costs of repairing the system during normal business hours, after the expiration of the initial warranty period.



•

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



•

Wireless Back-Up, which permits the alarm system to send signals over a cellular telephone or dedicated radio system in the event that regular telephone service is interrupted.

Branch Operations

        We maintain approximately 60 service branches in North America from which we provide field repair, customer care, alarm response and sales services, and 7 satellite locations from which we provide field repair services. During the last quarter of 2001, we began shifting some business-hours customer care functions to our branches, including responding to routine billing and service inquiries. In 2002, we expect to complete the shifting of most business-hours customer care functions to our branches by expanding the range of functions provided at our branches to include billing set-up and collections. Our nationwide network of branches operate in some of the largest cities in the United States and Canada and play a critical role in enhancing customer satisfaction, reducing customer loss and building brand awareness.

        Repair services generate revenues primarily through billable field service calls and recurring payments under our extended service protection program. By focusing growth in targeted areas we hope to increase the density of our customer base which will permit more effective scheduling and routing of field service technicians and will create economies of scale.

Sales and Marketing

        Our current customer acquisition strategy for our North America segment relies primarily on internally generated sales. In June 2001, we notified most of our remaining domestic dealers that we were terminating our dealer arrangement with them and therefore would not be extending or renewing their contracts. The number of accounts being purchased through our dealer program decreased from 21,817 in 2000, to 7,501 in 2001. We also discontinued our National Accounts program in 2001.

        Our internal sales program was started in February 2000 on a commission only basis with a goal of creating accounts at a cost lower than our external programs. In 2001, we revised and enhanced our internal sales program and, in early 2002, we introduced modest base compensation. This program utilizes our existing branch infrastructure in approximately 60 markets. The internal sales program generated 43,742 accounts and 27,259 accounts in 2001 and 2000, respectively.

        In late 2001, we entered into a marketing alliance with BellSouth Telecommunications, Inc. ("BellSouth") to offer monitored security services to the residential, single family market in the nine-state BellSouth region. Under this agreement, we operate as "BellSouth Security Systems from

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Protection One" from many of our branches in the nine-state BellSouth region. BellSouth provides us with leads of new owners of single family residences in its territory and of transfers of existing BellSouth customers within its territory. We follow up on the leads and attempt to persuade them to become customers of our monitored security services. We pay BellSouth an upfront royalty for each new contract and a recurring royalty based on a percentage of recurring charges.

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

        We operate a dedicated telesales center ("Telesales") in Wichita to address questions that customers or potential customers have about our services, as well as to perform outbound sales and marketing activities. Outbound Telesales is extensively involved in supporting the alliance with BellSouth by calling the leads provided by BellSouth. Telesales also provides quality control follow-up calls to customers for whom we recently provided installation or maintenance services.

        Our Multifamily segment utilizes a salaried and commissioned sales force to produce new accounts. Multifamily markets its services and products primarily to developers, owners and managers of apartment complexes and other multifamily dwellings. Multifamily sales and marketing activities consist of national and regional advertising, nationwide professional field sales efforts, centralized inbound and outbound sales functions, prospective acquisition marketing efforts and professional industry-related association affiliation. Services are sold directly to the property owner, and payment is based on a monthly price on a per-unit basis. Ongoing service for the duration of the lease includes equipment, maintenance, 24-hour monitoring from our central monitoring station, customer service and individual market support. Property owner contracts generally have initial terms ranging from five to ten years in duration, and provide for automatic renewal for a fixed period (typically five years) unless Multifamily or the subscriber elects to cancel the contract at the end of its term.

        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. We expect to re-enter the market for acquiring alarm account portfolios or alarm companies on a limited basis at some time during 2002 or 2003.

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 the adjustments described below, 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. We expect adjustments to lost accounts for purchase holdbacks will be lower in the future because we are purchasing fewer accounts in the types of transactions that create holdbacks and we have extinguished a substantial portion of our purchase holdback reserve. We do not reduce the gross accounts lost during a period by "move in" accounts, which are accounts where a new customer moves into the premises equipped with the Company's security system and vacated by a prior customer, or "competitive takeover" accounts, which are accounts where the owner of a premise monitored by a competitor requests that we provide monitoring services.

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        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 an 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 years ended December 31, 2001, 2000 and 1999 is summarized below:

(a)

Does not include the Europe segment which we sold in February 2000.

        Attrition increased in our North America Segment in 2001 compared to 2000 for a variety of reasons including:

•

Deteriorating economic conditions which left some customers unable to afford our services.



•

The fourth quarter of 2001 marked the two-year anniversary of the down-sizing of our dealer program. Many customers generated by the dealer program signed two-year agreements and elected not to renew their monitoring agreements with us at the end of their initial contract term.



•

Some former dealers from whom we purchased accounts within the last three to four years entered into funding programs with other sponsors and used their knowledge of our customer base to encourage our customers to cancel service with us.



•

Efforts to identify active customers who had an accounts receivable balance greater than 120 days past due. Such customers were treated as if they were disconnected for purposes of calculating attrition.

Competition

        The security alarm industry is highly competitive. In North America, there are only four alarm companies that offer services across the U.S. and Canada with the remainder being either large regional or small, privately held alarm companies. Based on total annual revenues in 2000, we believe the top four alarm companies in North America are:

•

ADT Security Services, a subsidiary of Tyco International, Inc. ("ADT")



•

Protection One, Inc.



•

Brinks Home Security Inc., a subsidiary of The Pittston Services Group of North America



•

Honeywell Inc.

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        Competition in the security alarm industry is based primarily on market visibility, price, reputation for quality of services and systems, services offered, and the ability to identify and to solicit prospective customers as they move into homes and businesses. We believe that we compete effectively with other national, regional and local security alarm companies due to our ability to offer integrated alarm system installation, monitoring, repair and enhanced services, our reputation for reliable equipment and services, our affinity alliance with BellSouth, and our prominent presence in the areas surrounding our branch offices.

Intellectual Property

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

Regulatory Matters

        A number of local governmental authorities have adopted or are considering various measures aimed at reducing the number of false alarms. Such measures include:

•

permitting of individual alarm systems and the revocation of such permits following a specified number of false alarms;



•

imposing fines on alarm customers for false alarms;



•

imposing limitations on the number of times the police will respond to alarms at a particular location after a specified number of false alarms;



•

requiring further verification of an alarm signal before the police will respond; and



•

subjecting alarm 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 both domestic and foreign federal, state, and local authorities. In certain jurisdictions, we are required to obtain licenses or permits, to comply with standards governing employee selection and training, and to meet certain standards in the conduct of our business.

        The alarm industry is also subject to requirements imposed by various insurance, approval, listing, and standards organizations. Depending upon the type of customer served, the type of security service provided, and the requirements of the applicable local governmental jurisdiction, adherence to the requirements and standards of such organizations is mandatory in some instances and voluntary in others.

        Our advertising and sales practices are regulated in the United States by both the Federal Trade Commission and state consumer protection laws. In addition, certain administrative requirements and laws of the jurisdictions in which we operate also regulate such practices. Such laws and regulations include restrictions on the manner in which we promote the sale of our security alarm systems, the obligation to provide purchasers of our alarm systems with certain rescission rights and certain foreign jurisdictions' restrictions on a company's freedom to contract.

        Our alarm monitoring business utilizes telephone lines and radio frequencies to transmit alarm signals. The cost of telephone lines, and the type of equipment, which may be used in telephone line transmission, are currently regulated by both federal and state governments. The Federal Communications Commission and state public utilities commissions regulate the operation and

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utilization of radio frequencies. In addition, the laws of certain of the foreign jurisdictions in which we operate regulate the telephone communications with the local authorities.

Risk Management

        The nature of the services provided by Protection One potentially exposes us to greater risks of liability for employee acts or omissions, or system failure, than may be inherent in other businesses. Substantially all of our alarm monitoring agreements, and other agreements, pursuant to which we sell our products and services contain provisions limiting liability to customers in an attempt to reduce this risk.

        We carry insurance of various types, including general liability and errors and omissions insurance in amounts management considers adequate and customary for our industry and business. Our loss experience, and the loss experiences at other security service companies, may affect the availability and cost of such insurance. Certain of our insurance policies, and the laws of some states, may limit or prohibit insurance coverage for punitive or certain other types of damages, or liability arising from gross negligence.

Employees

        At December 31, 2001, we had approximately 2,800 full-time employees.

RISK FACTORS

Cautionary Statements Regarding Future Results of Operations

        You should read the following risk factors in conjunction with discussions of factors discussed elsewhere in this and other of our filings with the SEC. These cautionary statements are intended to highlight certain factors that may affect our financial condition and results of operations and are not meant to be an exhaustive discussion of risks that apply to public companies with broad operations, such as us. Like other businesses, we are susceptible to macroeconomic downturns in the United States or abroad that may affect the general economic climate and our performance or that of our customers. Similarly, the price of our securities is subject to volatility due to fluctuations in general market conditions, differences in our results of operations from estimates and projections generated by the investment community and other factors beyond our control.

We have had a history of losses which are likely to continue.

        We incurred net losses of $86.0 million in 2001 (a net loss of $120.5 million excluding extraordinary gains of $34.5 million, net of tax), $57.2 million in 2000 (a net loss of $106.4 million excluding extraordinary gains of $49.3 million, net of tax), $80.7 million in 1999 (a net loss of $91.9 million excluding the effect of the Mobile Services Group gain, net of tax), and $17.8 million in 1998. These losses reflect, among other factors:

•

our customer base and revenues have declined since 1999;



•

substantial charges incurred by us for amortization of purchased customer accounts and goodwill;



•

interest incurred on indebtedness;



•

other charges required to manage operations; and



•

costs associated with the integration of the acquisitions we have made.

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        We will continue to incur substantial interest expense unless we significantly reduce our debt which is unlikely given our expected cash flow. We do not expect to attain profitable operations in the foreseeable future.

We will record an impairment charge in the first quarter of 2002. Additional charges may be recorded in the future.

        In the first quarter of 2002, we will record an impairment charge to write-down goodwill and customer accounts to their estimated fair values. The amount of this charge net of tax will be approximately $659.3 million, of which approximately $441.5 million will be related to goodwill and approximately $217.8 million will be related to customer accounts. For further information on the impairment charge, see Note 16 of the "Notes to Consolidated Financial Statements." After this write-down is recorded, we will still have material amounts of goodwill and customer accounts recorded on our balance sheet. The remaining amount of goodwill will be required to be tested annually for impairment. Customer accounts will be required to be tested upon certain triggering events, which include recurring operating losses, adverse business conditions, declines in market values and other matters that negatively impact value. If we fail future impairment tests for either goodwill or customer accounts, we will be required to recognize additional impairment charges on these assets in the future.

The impact of class action litigation may be material.

        We, Protection One Alarm Monitoring, Westar Industries, Inc. ("Westar Industries"), Western Resources, Inc. ("Western Resources") and certain of our present and former officers and directors are defendants in a purported class action litigation pending in the United States District Court for the Central District of California brought on behalf of our shareholders. The plaintiffs are seeking unspecified compensatory damages based on allegations that various statements concerning our financial results and operations for 1997, 1998, 1999 and the first three quarters of 2000 were false and misleading. We cannot currently predict the impact of this litigation which could be material. See "Item 3. Legal Proceedings".

The competitive market for the acquisition and creation of accounts may affect our future profitability.

        Prior to 2000, we grew very rapidly by acquiring portfolios of alarm monitoring accounts through acquisitions and dealer purchases. Our current strategy is to reduce the cost of acquiring new accounts by utilizing other customer account acquisition channels such as our internal sales force augmented by traditional marketing support. We expect to re-enter the market for acquiring alarm account portfolios or alarm companies on a limited basis at some time during 2002 or 2003. We compete with major companies, some of which have greater financial resources than we do, or may be willing to offer higher prices than we might be prepared to offer to purchase subscriber accounts. The effect of competition may be to reduce the purchase opportunities available to us, or to increase the price we pay for subscriber accounts, which could have a material adverse effect on our return on investment in such accounts, and on our results of operations, financial condition, and ability to service debt.

We may experience difficulty integrating businesses we acquire.

        We expect to reenter the acquisition market on a limited basis in 2002 or 2003. An important aspect of an acquisition program is the integration of customer accounts into our operations after purchase. Risks typically associated with acquisitions include, without limitation, the following:

•

the possibility of unanticipated problems not discovered prior to the acquisition;



•

additional expenses required to integrate the acquired company's systems;



•

higher than expected customer losses resulting in lower than expected revenues;

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•

the significant demands placed on management to resolve issues arising from acquisitions; and



•

for acquisitions that are structured as stock purchases of other companies, the assumption of unexpected liabilities and losses from the disposition of unnecessary or undesirable assets of the acquired companies.

We will need additional funding to finance our future growth.

        Prior to 2000, our purchases of customer accounts and acquisitions of portfolios of customer accounts and new lines of business required cash in amounts that exceeded the net cash provided by our operating activities. In 2001, our principal focus was on improving our service, reducing attrition of current customers and integrating and building infrastructure. As a result, our cash requirements were less in 2001 than those in 2000 and 1999. In 2002, while continuing our focus on customer care to lower attrition, we intend to pursue customer account growth through our internal sales program and, eventually and on a limited basis, through acquisitions. Should we resume an acquisition program in 2002, we expect that our cash requirements will exceed cash flows from operations. Under this circumstance, funding from additional borrowings under our Senior Credit Facility or through the sale of assets would be required. As of March 25, 2002, we had $34.5 million of remaining availability under our $180 million Senior Credit Facility. Our credit ratings were downgraded in March 2000 and again in March 2001 which will make obtaining additional funding more difficult and costly.

        Any inability to obtain funding through external financing could adversely affect our ability to increase our customers, revenues and cash flows from operations. There can be no assurance that we will be able to obtain external funding on favorable terms or at all.

We have a substantial amount of debt, which could constrain our growth.

        We have, and will likely continue to have, a large amount of consolidated indebtedness. The terms of various indentures and credit agreements governing our indebtedness limit our ability to incur additional indebtedness that we might need in the future in order to fund acquisitions of subscriber accounts.

        Additionally, please be aware that:

•

As of December 31, 2001, we had outstanding total indebtedness of $584.8 million, of which $584.1 million was long-term indebtedness.



•

As of December 31, 2001, we had $137.5 million of debt outstanding under our $155 million Senior Credit Facility bearing interest at a weighted average floating interest rate before fees of 5.8%. As of March 15, 2002 we had $145.5 million of debt outstanding under our $180 million Senior Credit Facility bearing interest at a weighted average floating interest rate before fees of 5.6%. Our Senior Credit Facility is provided by Westar Industries, Inc., our 87% parent, and matures on January 3, 2003.



•

Our Convertible Senior Subordinated Notes, which represent $23.8 million of our long-term indebtedness, mature in September 2003.

        Our present high level of indebtedness could have negative consequences on, without limitation:

•

our ability to obtain additional financing in the future for working capital, acquisitions or creation of subscriber accounts, capital expenditures, general corporate purposes or other purposes;



•

our ability to withstand a downturn in our business or the economy generally; and



•

our ability to compete against other less leveraged companies.

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        The indentures governing all of our debt securities require that we offer to repurchase the securities in certain circumstances following a change of control.

We will need to refinance our Senior Credit Facility.

        Our ability to refinance our Senior Credit Facility and satisfy any payment obligations will depend, in large part, on our performance, which will ultimately be affected by general economic and business factors, many of which will be outside management's control. We believe that our cash flow from operations combined with borrowings under the Senior Credit Facility and asset sales will be enough to meet our expenses and interest obligations through at least January 1, 2003. In the event our parent, Westar Industries, does not extend our Senior Credit Facility beyond that date on its present terms and we are required to seek such financing from unaffiliated third parties, we may not be able to do so on terms as economically favorable as those under our present Senior Credit Facility or at all. 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. Western Resources has filed for approval a financial plan with the Kansas Corporation Commission which provides that Westar Industries will use the funds from some of its other interests in a manner other than the funding of such obligations. The Company would face significant liquidity issues if Westar Industries was unable to fund its obligations under the Senior Credit Facility. We were unsuccessful in refinancing our Senior Credit Facility with unaffiliated third parties on satisfactory terms in 2000 and 2001. If payment obligations cannot be satisfied, we will be forced to find alternative sources of funds by selling assets, restructuring, refinancing debt or seeking additional equity capital. There can be no assurance that any of these alternative sources would be available on satisfactory terms or at all.

Our debt agreements impose operational restrictions on us.

        The indentures governing our public indebtedness require us to satisfy certain financial covenants in order to borrow additional funds. The most restrictive of these covenants are set forth below:

•

Total debt to annualized EBITDA for the most recent quarter must be less than 6.0 to 1;



•

EBITDA to interest expense for the most recent quarter must be greater than 2.25 to 1; and



•

Senior debt to annualized EBITDA for the most recent quarter must be less than 4.0 to 1.

        In each case, the ratio reflects the impact of acquisitions and other capital investments for the entire period covered by the calculation.

        The indentures contain other covenants that impose operational restrictions on us which are not as burdensome to us as those listed above and none are based on credit ratings. A violation of these restrictions would result in an event of default which would allow the lenders to declare all amounts outstanding immediately due and payable.

We lose some of our customers over time.

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

•

relocation of customers;



•

adverse financial and economic conditions;



•

competition from other alarm service companies; and



•

customer service and operational difficulties with integration of acquired or created customers.

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        We may experience the loss of newly acquired or created accounts to the extent we do not integrate or adequately service those accounts. Because some acquired accounts are prepaid on an annual, semiannual or quarterly basis, customer loss may not become evident for some time after an acquisition is consummated. An increase in the rate of customer loss could have a material adverse effect on our results of operations and financial condition.

        When acquiring accounts, we seek under terms of the purchase agreement to withhold a portion of the purchase price as a partial reserve against a greater than expected loss of customers. If the actual rate of customer loss for the accounts acquired is greater than the assumed rate at the time of the acquisition, and damages cannot be recouped from the portion of the purchase price held back from the seller, the loss of customers could have a material adverse effect on our results of operations and financial condition. Moreover, we may not be able to obtain purchase price holdbacks in future acquisitions, particularly acquisitions of large portfolios and rates of customer losses for acquired accounts may be greater than the rate we have assumed or historically incurred. Moreover, we cannot predict the impact acquired accounts will have on the overall rate of attrition.

        During 2001, attrition, our change in focus from growth to strengthening our operations, the disposition of certain accounts and adjustments related to the conversion of our customer base to our common technology platform resulted in a net loss of 196,357 customers or an 14.3% decrease in our customer base from January 1, 2001. We explain some of the reasons for the increase in attrition in 2001 in "Attrition," above. This was the primary cause of our $59.9 million decline in monitoring and related service revenues in the North America segment from 2000 to 2001. We expect this trend will continue until the efforts we are making to acquire new accounts and reduce our rate of 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.

Our customer acquisition strategies may not be successful.

        Our customer account acquisition strategy primarily relies on our internal sales force. We have changed our acquisition strategy several times over the past few years attempting to decrease the cost of adding customers and decrease the rate of attrition. There can be no assurance that this strategy will be successful. If the strategy is not successful, our customer base could continue to decline. If successful, the selling costs related to this strategy will increase our expenses and use of cash. Failure to economically replace customers lost though attrition or increased cash needs could have a material adverse effect on our business, financial condition, results of operations, and ability to service debt obligations.

Declines in new construction of multi-family dwellings may affect our sales in this marketplace.

        Demand for alarm monitoring services in the multi-family alarm monitoring market is tied to the construction of new multi-family structures. We believe that developers of multi-family dwellings view the provision of alarm monitoring services as an added feature that can be used in marketing newly developed condominiums, apartments and other multi-family structures. Accordingly, we anticipate that the growth in the multi-family alarm monitoring market will continue so long as there is a demand for new multi-family dwellings. However, the real estate market in general is cyclical and, in the event of a decline in the market for new multi-family dwellings, it is likely that demand for our alarm monitoring services to multi-family dwellings would also decline, which could negatively impact our results of operations.

Westar Industries is our principal stockholder and senior lender.

        Westar Industries owned approximately 87% of the outstanding common stock of Protection One as of December 31, 2001. As long as Westar Industries continues to beneficially own in excess of 50%

15

of the shares of Protection One common stock outstanding, Westar Industries will be able to direct the election of all directors of Protection One and exercise a controlling influence over our business and affairs, including any determinations with respect to mergers or other business combinations involving Protection One, our acquisition or disposition of material assets and our incurrence of indebtedness. Similarly, Westar Industries will continue to have the power to determine matters submitted to a vote of Protection One's stockholders without the consent of other stockholders, to prevent or cause a change in control of Protection One and to take other actions that might be favorable to Western Resources and Westar Industries, whether or not these actions would be favorable to Protection One or its stockholders generally. In addition, Westar Industries is also our senior lender under our Senior Credit Facility as discussed above.

Western Resources is engaged in regulatory proceedings which could adversely effect us.

        Western Resources presently owns all of Westar Industries' stock. Western Resources is a public electric utility regulated by the Kansas Corporation Commission. The Kansas Corporation Commission has issued orders and is holding proceedings which directly impact on the ability of Westar Industries to fund its obligation under our Senior Credit Facility or make any other investment in us, including an order which prohibits Western Resources from borrowing to make loans or capital contribution to Westar Industries. In response to a Kansas Corporation Commission order to submit a plan to reduce its outstanding debt, Western Resources has proposed (and may be required) to sell part or all of its interest in Westar Industries. Reference is made to Western Resources Form 10-K and Forms 10-Q filed with the Securities and Exchange Commission (File No. 1-3523) for further information on these orders and proceedings, which may adversely impact on us.

We obtain administrative services from Western Resources.

        Western Resources provides us certain administrative services pursuant to a services agreement including accounting, human resources, legal, facilities and technology services. Western Resources has proposed to separate Westar Industries (including us) from Western Resources. If a separation occurs, Westar Industries will enter into a services agreement with Western Resources pursuant to which Western Resources will continue to provide Westar Industries (including us) the services currently provided to us, but Western Resources will have the right to terminate this agreement beginning two years after the closing subject to providing one years' advance notice of termination. If the services agreement is terminated, our cost of obtaining such services from either a third party or by hiring sufficient staff to perform those services internally may increase.

We have deferred tax assets we may not utilize.

        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 separation of Westar Industries (including us) from Western Resources in a transaction that results in Westar Industries no longer being able to file taxes on a consolidated basis with Western Resources our net deferred tax assets of $88.4 million at December 31, 2001 might not be realizable and we might 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. The amount of our deferred taxes will increase by approximately $173.7 million upon our recording of an impairment charge in the first quarter of 2002 as discussed above. In addition, as a result of a separation, we would no longer receive payments from Western Resources for current tax benefits utilized by Western Resources. In 2001 and 2000, we received aggregate payments from Western Resources of $19.1 million and $48.9 million, respectively. The loss of these payments would have a material adverse effect on our cash flow.

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ITEM 2. PROPERTIES

        We maintain our executive offices at 818 S. Kansas Avenue, Topeka, Kansas 66612. We operate primarily from the following facilities, although we also lease office space for our approximate 60 service branch offices and 7 satellite branches in North America.

(1)

In 2002, Multifamily will move their administrative headquarters and monitoring operations to the Irving, Texas facility.

ITEM 3. LEGAL PROCEEDINGS

        Protection One, 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 ("Third Amended Complaint"). Plaintiffs purported 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 Third Amended Complaint asserted claims under Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 against Protection One, Protection One Alarm 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 alleged, 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 Third 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 Third 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 plaintiffs' claims under Sections 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 plaintiffs' claims against Arthur Andersen, and plaintiffs have appealed that dismissal. On February 22, 2002, plaintiffs filed a Fourth Consolidated Amended Class Action Complaint. The new complaint realleges claims on behalf of purchasers of common stock under Sections 11 and 15 of

17

the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The defendants have until April 5, 2002 to respond to the new complaint. 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 styled Total 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 plaintiffs' 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 for collective arbitration, the six former dealers filed a Motion to Compel Consolidation 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 March 3, 2002, one dealer (Masterguard) proceeded with arbitration. On March 8, 2002, Masterguard's claims against the Company were settled by a mutual agreement of the parties.

        An arbitration was commenced against Protection One and Protection One Alarm 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 been set for May 28, 2002. The Company cannot predict the impact of this arbitration which could be material.

        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. 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 in excess of $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 cannot predict the impact of this arbitration and 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.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS

        No matters were submitted to Protection One's stockholders following our annual meeting in 2001.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Price Information

        Our common stock is listed on the New York Stock Exchange under the symbol "POI". The table below sets forth for each of the calendar quarters indicated, the high and low sales prices per share of our common stock, as reported by the New York Stock Exchange. All prices are as reported by the National Quotation Bureau, Incorporated.

Dividend Information

        Holders of Protection One common stock are entitled to receive only dividends declared by the board of directors from funds legally available for dividends to stockholders.

        Other than a $7.00 cash distribution paid to holders of record of Protection One common stock as of November 24, 1997, to holders of outstanding options to purchase Protection One common stock and to holders of warrants exercisable for Protection One common stock, all in connection with the combination of the Protection One and Western Resources' security businesses in November 1997, Protection One has never paid any cash dividends on its common stock and does not intend to pay any cash dividends in the foreseeable future. The indentures governing the 8¹/8% Senior Subordinated Notes due 2009, the 13⁵/8% Senior Subordinated Discount Notes due 2005, and the credit agreement relating to its Senior Credit Facility restrict Protection One Alarm Monitoring's ability to pay dividends or to make other distributions to its corporate parent. Consequently, these agreements restrict our ability to declare or pay any dividend on, or make any other distribution in respect of, our capital stock.

Number of Stockholders

        As of March 15, 2002, there were approximately 139 stockholders of record who held shares of our common stock.

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ITEM 6. SELECTED FINANCIAL DATA

        The selected consolidated financial data set forth below should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation" and the audited consolidated financial statements and notes to the financial statements of Protection One. All amounts are in thousands, except per share and customer data, unless otherwise noted. Prior to November 24, 1997, Protection One was a stand-alone security business. On November 24, 1997, pursuant to a contribution agreement dated July 30, 1997, between Protection One and Western Resources, Protection One acquired WestSec, Inc. and Westar Security, Inc., which together were the Western Resources security businesses ("WRSB"), and Centennial Security Holdings, Inc. ("Centennial"). As a result of the November 1997 business combination, Western Resources, through its wholly owned subsidiary Westar Industries owned approximately 85% of Protection One at December 31, 1997.

        The November 1997 business combination was accounted for as a reverse purchase acquisition which treats WRSB as the accounting acquiror. Accordingly, the results of operations of Protection One and Centennial have been included in the consolidated financial data only since November 24, 1997.

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SELECTED CONSOLIDATED FINANCIAL DATA

(a)

We derive earnings before interest, taxes, depreciation and amortization (EBITDA) by adjusting loss before income taxes and extraordinary gain, net of taxes by adding: (i) interest expense, net (ii) amortization of intangibles and depreciation expense, and (iii) other charges; and by subtracting other income as set forth in the table below.

(b)

Includes results of the European segment (that was acquired between May and September 1998 and sold to Westar Industries on February 29, 2000) for the period it was owned by us.

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        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 the cash needs of Protection One. Items excluded from EBITDA are significant components in understanding and assessing the financial performance of Protection One. Protection One believes presentation of EBITDA enhances an understanding of financial condition, results of operations and cash flows because EBITDA is used by Protection One to satisfy its debt service obligations and its capital expenditure 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. Protection One's computation of EBITDA may not be comparable to other similarly titled measures of other companies.

        The following table provides a calculation of EBITDA for each of the periods presented above:

(a)

Other charges in 2001 consist of severance charges of $4.8 million and facility closure costs of $4.9 million incurred in connection with our efforts to improve efficiency of our monitoring facilities and branch operations. Other charges in 2000 represents severance charges of $1.5 million, charges incurred relating to the sale of our European business of $1.6 million and transition costs of $1.3 million for the closure of our Culver City and Chatsworth facilities. Other charges in 1999 represents severance charges of $3.2 million and transition costs of $2.6 million relating to the move of the finance and accounting offices from Irving, Texas to Topeka, Kansas. Other charges in 1998 represents severance and relocation payments of $3.4 million related to our 1998 reorganization and costs of $5.3 million incurred to replace signage for WRSB after the merger of WRSB with Protection One in 1998. Other charges in 1997 represent merger costs.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

Introduction

        In Management's Discussion and Analysis we explain our general financial condition and operating results, including:

•

what factors impact our business,



•

what our earnings and costs were in 2001, 2000, and 1999,



•

why these earnings and costs differed from year to year,



•

how our earnings and costs affect our overall financial condition,



•

what we expect our capital expenditures to be for the years 2002 through 2004,



•

how we plan to pay for these future capital expenditures, and



•

other items that materially affect our financial condition or earnings.

        As you read Management's Discussion and Analysis, please refer to our Consolidated Statements of Operations and Comprehensive Loss. These statements show our operating results for 2001, 2000 and 1999. In Management's Discussion and Analysis, we analyze and explain the significant annual changes of specific line items in the Consolidated Statements of Operations and Comprehensive Loss.

Summary of Significant Activities

        Impairment Charge Pursuant to New Accounting Rules.    Effective January 1, 2002, we adopted the new accounting standards SFAS No. 142, "Accounting for Goodwill and Other Intangible Assets," and SFAS No. 144, "Accounting for the Impairment and Disposal of Long-Lived Assets." SFAS No. 142 establishes new standards for accounting for goodwill. SFAS No. 142 continues to require the recognition of goodwill as an asset, but discontinues amortization of goodwill. In addition, annual impairment tests must be performed using a fair-value based approach as opposed to an undiscounted cash flow approach required under prior standards.

        SFAS No. 144 establishes a new approach to determining whether our customer account asset is impaired. The approach no longer permits the company to evaluate its customer account asset for impairment based on the net undiscounted cash flow stream obtained over the remaining life of goodwill associated with the customer accounts being evaluated. Rather, the cash flow stream to be used under SFAS No. 144, is limited to future estimated undiscounted cash flows from existing customer accounts. Additionally, the new rule no longer permits us to include estimated cash flows from forecasted customer additions. If the undiscounted cash flow stream from existing customer accounts is less than the combined book value of customer accounts and goodwill, an impairment charge would be required.

        The new rule substantially reduces the net undiscounted cash flows used for impairment evaluation purposes as compared to the previous accounting rules. The undiscounted cash flow stream has been reduced from the 16 year remaining life of the goodwill to the 9 year remaining life of customer accounts for impairment evaluation purposes and does not include estimated cash flows from forecasted customer additions.

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        To implement the new standards, we engaged an appraisal firm to help us estimate the fair values of goodwill and customer accounts. Based on this analysis, we will record a non-cash charge of approximately $659.3 million in the first quarter of 2002. The charge is detailed as follows:

        The impairment charge for goodwill will be reflected in the consolidated statement of income as a cumulative effect of a change in accounting principle. The impairment charge for customer accounts will be reflected in the consolidated statement of income as an operating cost. These impairment charges will reduce the recorded value of these assets to their estimated fair values at January 1, 2002.

        A deferred tax asset in the amount of $173.7 million will be recorded in the first quarter of 2002 for the tax benefit estimated above. However, if Western Resources were to own less than 80% of Westar Industries voting stock or if Westar Industries were to own less than 80% of our voting stock, we would no longer file on a consolidated basis with Western Resources. As a result, we would not be in a position to utilize the deferred tax asset and we would record a charge to earnings to establish a valuation allowance.

        In 2001, we recorded approximately $48.9 million of goodwill amortization. Because we have adopted the new rule for goodwill, we will no longer be permitted to amortize goodwill to income. In 2001, we recorded approximately $137.7 million of customer account amortization expense. After the customer impairment charge, customer account amortization expense in 2002 is expected to decrease to approximately $80 million. This amount would increase if we change the estimated life or amortization rate for customer accounts in 2002. See "Estimated Lives of Customer Accounts May Change Based on Customer Account Lifing Study Results."

        We will be required to perform impairment tests for long-lived assets prospectively as long as we continue to incur recurring losses or for other matters that may negatively impact our business. Goodwill will be required to be tested each year for impairment. Declines in market values of our business or the value of our customer accounts that may occur in the future may require additional write-down of these assets in the future.

        Estimated Lives of Customer Accounts May Change Based on Customer Account Lifing Study Results.    We are currently evaluating the estimated life and amortization rates for customer accounts in our North America and Multifamily customer pools, given the results of a lifing study performed by a third party appraisal firm in the first quarter of 2002. Any change in our amortization rate or estimated life will be determined in the first quarter of 2002 and accounted for prospectively as a change in estimate.

        Net Loss.    We incurred a net loss of $86.0 million in 2001 (a net loss of $120.5 million excluding extraordinary gains of $34.5 million, net of tax). This net loss reflects a decline in revenues caused by our declining North American account base and substantial charges incurred by us for amortization of customer accounts and goodwill, interest incurred on indebtedness and our consolidations and cost reduction efforts. We do not expect to have earnings in the foreseeable future.

        Streamlining of Operations.    To ensure that our variable and fixed costs decreased while our North American account base declined, we streamlined our business operations and improved operating efficiencies. During 2001, we merged our Hagerstown, Maryland, our Beaverton, Oregon and our Irving, Texas monitoring facilities into our Wichita, Kansas customer service center. The Wichita

24

customer service center now monitors approximately 650,000 customers. Additionally, we discontinued our National Accounts and Patrol divisions and sold certain customer accounts which we believed were not part of our core business. In June, we eliminated 180 positions from a variety of departments. In September, we consolidated additional operational and administrative facilities. These consolidations and other cost cutting measures resulted in a total reduction of nearly 600 positions in 2001. We incurred $9.7 million in severance and facility closure costs relating primarily to these actions in 2001.

        Extinguishment of Debt and Extraordinary Gain.    During 2001, we acquired $146.0 million of our bonds for $91.7 million resulting in an extraordinary gain of $34.5 million, net of tax. During 2000, we acquired $224.8 million of our bonds for $136.2 million resulting in an extraordinary gain of $49.3 million, net of tax. In some cases these debt securities were acquired from Westar Industries limiting the amount of extraordinary gain and resulting in adjustments to Additional Paid-In Capital. See Note 6, "Related Party Transactions" for further discussion.

        Amendment to Credit Agreement with Westar Industries.    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.

        On November 1, 2001, we entered into a further amendment to the Senior Credit Facility with Westar Industries which extended the maturity date to January 3, 2003, and fixed base rate borrowings at the prime rate plus 2.75% and Eurodollar borrowings at the London interbank offered rate (LIBOR) plus 3.75%. In addition, we paid an amendment fee equal to 0.5% of the commitment. We have also entered into an agreement pursuant to which we will pay to Westar Industries, beginning with the quarter ending March 31, 2002, a management fee, payable quarterly, equal to 0.125% of our consolidated total assets at the end of each quarter. The agreement also provides access, at our option, to aviation services. This agreement was approved by the independent members of our board of directors. On March 25, 2002, we entered into a further amendment to the Senior Credit Facility which increased the amount of the facility to $180 million.

        Share Repurchases.    During 2001, we purchased 5,911,700 shares of our common stock in the open market for $7.6 million, and we purchased 16,101,892 shares from Westar Industries at then current market prices for $19.5 million. From January 1, 2002 through March 15, 2002, we purchased 1,000,000 shares of our common stock in the open market for $2.2 million.

Monthly Recurring Revenue.    At various times during each year, we measure all of the monthly revenue we are entitled to receive under contracts with customers in effect at the end of the period. We had approximately $23.4 million and $29.6 million of monthly recurring revenue as of December 31, 2001 and 2000, respectively. The decrease is a result of our net loss of 196,357 customers during 2001. In 2001, we experienced a steady decline in our customer base. We expect this trend will continue until the efforts we are making to acquire new accounts and to reduce our rate of 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 unable to predict the amount of acquired monthly recurring revenue that will be realized in future periods or the impact of the losses of acquired accounts on our overall rate of customer loss. Our computation of monthly recurring revenue may not be comparable to other similarly titled measures of other companies and monthly recurring revenue should not be viewed by investors as an alternative to actual monthly revenue, as determined in accordance with generally accepted accounting principles.

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        Our monthly recurring revenue includes amounts billable to customers with past due balances which we believe are collectible. We seek to preserve the revenue stream associated with each customer contract, primarily to maximize our return on the investment we made to generate each contract. As a result, we actively work to collect amounts owed to us and to retain the customer at the same time. In some instances, we may allow up to six months to collect past due amounts, while evaluating the ongoing customer relationship. After we have made every reasonable effort to collect past due balances, we will disconnect the customer and include the loss in attrition calculations.

Customer Creation and Marketing.    For the year ended December 31, 2001, our North America segment added 51,910 accounts although our net number of accounts decreased by 214,949 accounts. This decrease included 10,086 accounts that were sold during the year and 2,526 accounts that were part of our Patrol business which we discontinued in May 2001. The decrease also includes 62,443 accounts that were combined with related existing accounts in the conversion of our Wichita, Beaverton, Irving and Hagerstown customer monitoring facilities. Our new billing and monitoring system, referred to as MAS®, or Monitored Automation Systems, reports numbers of accounts on the basis of one account for every location we provide service even if we have separate contracts to provide multiple services at that location. Previously, we were utilizing several different billing and monitoring software programs, some of which would count each separate contract for service as a separate account regardless of the location. For the year ended December 31, 2000, our North America segment added 67,160 accounts and our net number of accounts decreased by 141,527 accounts (net of 17,342 accounts acquired in the PowerCall acquisition). Multifamily added 38,492 accounts for the year ended December 31, 2001, with its net number of accounts increasing by 18,592 accounts. For the year ended December 31, 2000, Multifamily added 39,855 accounts, with its net number increasing by 12,997 accounts.

        Our current customer acquisition strategy for our North America segment relies primarily on internally generated sales. In June 2001, we notified most of our remaining domestic dealers that we were terminating our dealer arrangements with them and therefore would not be extending or renewing their contracts. The number of accounts purchased through our dealer program decreased from 21,817 in 2000, to 7,501 in 2001. We currently have a salaried and commissioned sales force that utilizes our existing branch infrastructure in approximately 60 markets. The internal sales program generated 43,742 accounts and 27,259 accounts in 2001 and 2000, respectively. Our Multifamily segment also utilizes a salaried and commissioned sales force to produce new accounts.

        In late 2001, we entered into a marketing alliance with BellSouth Telecommunications, Inc. ("BellSouth") to offer monitored security services to the residential, single family market in the nine-state BellSouth region. Under this agreement, we operate as "BellSouth Security Systems from Protection One" from many of our branches in the nine-state BellSouth region. BellSouth provides us with leads of new owners of single family residences in its territory and of transfers of existing BellSouth customers within its territory. We follow up on the leads and attempt to persuade them to become customers of our monitored security services. We pay BellSouth an upfront royalty for each new contract and a recurring royalty based on a percentage of recurring charges.

        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 the adjustments described below, 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

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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. 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.

        For the period ended December 31, 2001, our total company quarterly annualized and trailing twelve month attrition rates were 18.1% and 15.2%, respectively. The table below shows the change in our total company customer base including customer additions and attrited customers from 2001 to 1999. The "Conversion adjustments" line item reflects the impact on the calculation of our customer base from the conversion of our Wichita, Hagerstown, Beaverton and Irving 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 as described under "Customer Creation and Marketing" above.

(1)

Excludes customer base from the Europe segment which was sold to Westar Industries on February 29, 2000.

Critical Accounting Policies

        Our discussion and analysis of results of operations and financial condition are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to bad debts, inventories, investments, customer accounts, goodwill, intangible assets, income taxes, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about

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the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

        Note 2 of the "Notes to Consolidated Financial Statements" includes a summary of the significant accounting policies and methods used in the preparation of our consolidated financial statements. The following is a brief description of the more significant accounting policies and methods we use.

        Revenue Recognition.    Revenues are recognized when security services are provided. Installation revenue, sales revenues on equipment upgrades and direct costs of installations and sales are deferred for residential customers with service contracts. For commercial customers and national account customers, revenue recognition is dependent upon each specific customer contract. In instances when the company sells the equipment outright, revenues and costs are recognized in the period incurred. In cases where there is no outright sale, revenues and direct costs are deferred and amortized.

        Deferred installation revenues and system sales revenues will be recognized over the expected useful life of the customer. Deferred costs in excess of deferred revenues will be recognized over the contract life. To the extent deferred costs are less than deferred revenues, such costs are recognized over the customers' estimated useful life.

        Deferred revenues also result from customers who are billed for monitoring, extended service protection and patrol and response services in advance of the period in which such services are provided, on a monthly, quarterly or annual basis.

        Valuation of Customer Account Intangible Assets.    Customer accounts are stated at cost. Goodwill represents the excess of the purchase price over the fair value of net assets acquired by us. These assets are tested for impairment on a periodic basis or as circumstances warrant. For purposes of this impairment testing, goodwill is considered to be directly related to the acquired customer accounts. Factors we consider important that could trigger an impairment review include the following:

•

high levels of customer attrition;




•

continuing recurring losses; and




•

declines in the market value of our publicly traded equity and debt securities.

        An impairment would be recognized when the undiscounted expected future operating cash flows by customer pool derived from customer accounts is less than the carrying value of capitalized customer accounts and related goodwill. We performed impairment tests on our customer account assets and goodwill as of December 31, 2001. These tests have indicated that future estimated undiscounted cash flows exceeded the sum of the recorded balances for customer accounts and goodwill. See "Summary of Significant Activities—Impairment Charge Pursuant to New Accounting Rules" for a discussion of the impairment recorded on these assets in the first quarter of 2002 pursuant to the adoption of new accounting rules.

        Customer Account Amortization.    Prior to the third quarter of 1999, we amortized our customer accounts by using the straight-line method over a ten-year life, except for accounts acquired from Westinghouse for which an eight-year 120% declining balance has been applied. The choice of an amortization life was based on our estimates and judgments about the amounts and timing of expected future revenues from these assets and average customer account life. Selected periods were determined because, in our opinion, they would adequately match amortization cost with anticipated revenue.

        We conducted a comprehensive review of our amortization policy during the third quarter of 1999. As part of this review, we hired an independent appraisal firm to perform a lifing study on our customer accounts. This review was performed specifically to evaluate the historic amortization policy in light of the inherent declining revenue curve over the life of a pool of customer accounts, and our historical attrition experience. After completing the review, we identified three distinct pools, each of

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which has distinct attributes that effect differing attrition characteristics. The pools corresponded to our North America, Europe (which was sold to Westar Industries on February 29, 2000) and Multifamily business segments. Separate pools for North America and Multifamily will be used going forward. For the North America and Europe pools, the results of the lifing study indicated to us that we can expect attrition to be greatest in years one through five of asset life and that a change from a straight-line to a declining balance (accelerated) method would more closely match future amortization cost with the estimated revenue stream from these assets. We elected to change to that method for all customer accounts in the North America and Europe pools, except for accounts acquired in the Westinghouse acquisition which are utilizing an eight-year accelerated method. No change was made in the method used for the Multifamily pool.

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

        Adoption of the declining balance method effectively shortens the estimated expected average customer life for these customer pools, and does so in a way that does not make it possible to distinguish the effect of a change in method (straight-line to declining balance) from the change in estimated lives. In such cases, generally accepted accounting principles require that the effect of such a change be recognized in operations in the period of the change, rather than as a cumulative effect of a change in accounting principle. We changed to the declining balance method in the third quarter of 1999 for European and North American customers which had been amortized on a straight-line basis. Accordingly, the effect of the change in accounting principle increased amortization expense reported in the third quarter of 1999 by approximately $40 million. Accumulated amortization recorded on the balance sheet would have been approximately $34 million higher through the end of the second quarter of 1999 if the Company had historically used the declining balance method.

        We are currently evaluating the estimated life and amortization rates for customer accounts in our North America and Multifamily customer pools, given the results of a lifing study performed by a third party appraisal firm in the first quarter of 2002. Any change in our amortization rate or estimated life will be determined in the first quarter of 2002 and accounted for prospectively as a change in estimate.

        We recorded approximately $147.9 million and $137.7 million of customer account amortization expense in 2000 and 2001, respectively. After the customer impairment charge, customer account amortization expense in 2002 is expected to decrease to approximately $80 million. This amount would increase if we change the estimated life or amortization rate for customer accounts in 2002. See "Estimated Lives of Customer Accounts May Change Based on Customer Account Lifing Study Results."

        Income Taxes.    As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. Significant management judgment is required in determining our provision for income taxes and our deferred tax assets and liabilities. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as depreciation and amortization, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered. To the extent we believe that recovery is not likely, we must establish a valuation allowance.

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        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 separation of Westar Industries (including us) from Western Resources in a transaction (or enters into any other transaction) that results in Westar Industries no longer being able to file taxes on a consolidated basis with Western Resources (which would happen when Western Resources owns less than 80% of Westar Industries stock), our net deferred tax assets of $88.4 million at December 31, 2001 might not be realizable and we might 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. The amount of our deferred taxes will increase by approximately $173.7 million upon our recording of an impairment charge in the first quarter of 2002 as discussed above. In addition, as a result of a separation, we would no longer receive payments from Western Resources for current tax benefits utilized by Western Resources. In 2001 and 2000 we received aggregate payments from Western Resources of $19.1 million and $48.9 million, respectively. The loss of these payments would have a material adverse effect on our cash flow.

Results of Operation

        For the years ended December 31, 2001, 2000 and 1999, we incurred consolidated net losses before extraordinary gains of $120.5 million, $106.4 million and $79.0 million, respectively, or losses per share of common stock of $(1.14), $(0.84) and $(0.62), respectively. From May 2000 through December 2001 we purchased 28,840,405 of our shares which resulted in a decrease in our weighted average shares outstanding used in calculating our consolidated loss per share before extaordinary gains. Our weighted average shares outstanding for the years ended December 31, 2001, 2000 and 1999 were 105,458,601 shares, 126,550,059 shares and 126,889,802 shares.

        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.

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North America Segment

        We present the table below to show how the North America operating results have changed over the past three years. Next to each year's results of operation, we provide the relevant percentage of total revenues so that you can make comparisons about the relative change in revenues and expenses.

(1)

Includes $3.8 million, $6.5 million and $7.8 million of corporate expenses for 2001, 2000 and 1999, respectively.

(2)

Includes $4.2 million of corporate expenses relating to a failed merger attempt in 1999.

        2001 Compared to 2000.    We had a net decrease of 214,949 customers in 2001, including 75,055 customers related to dispositions and conversions, as compared to a net decrease of 141,527 customers (net of 17,342 customers acquired in the acquisition of PowerCall) in 2000. This decline is the primary reason for the $59.9 million decline in revenues in 2001. The average customer base was 955,641 for 2001 compared to 1,133,879 for 2000. Attrition increased in 2001 compared to 2000 for a variety of reasons including:

•

Deteriorating economic conditions left some customers unable to afford our services.



•

The fourth quarter of 2001 marked the two-year anniversary of the down-sizing of our dealer program. Many customers generated by the dealer program signed two-year agreements and elected not to renew their monitoring agreements with us at the end of their initial contract term.



•

Some former dealers from whom we purchased accounts within the last three to four years entered into funding programs with other sponsors and used their knowledge of our customer base to encourage our customers to cancel service with us.



•

Efforts to identify active customers who had an accounts receivable balance greater than 120 days past due. Such customers were treated as if they were disconnected for purposes of calculating attrition.

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        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, reducing attrition, development of cost effective marketing programs, as well as the generation of positive cash flow.

        Further analysis of the change in the North American account base between the two years 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, Beaverton and Irving monitoring and billing systems to our new technology platform, MAS® discussed under "Customer Creation and Marketing" above.

        Monitoring and related service revenues for 2001 decreased by $59.9 million, or 17.2%, to $288.8 million from $348.8 million for 2000. The decrease is 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 remained constant at $15.7 million in 2001, compared to $15.7 million in 2000. These revenues consist primarily of sales of burglar alarms, closed circuit television systems, fire alarms and card access control systems to commercial customers.

        Cost of monitoring and related services revenues for 2001 decreased by $21.0 million, or 18.0%, to $95.4 million from $116.4 million for 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 discontinuation of our Patrol services in May of 2001, the decline in our customer base, a reduction of telecommunication costs, and consolidation of monitoring and customer service functions. Costs of monitoring and related services revenues as a percentage of the related revenues decreased from 33.4% in 2000 to 33.0% in 2001.

        Cost of other revenues for 2001 increased by $3.2 million, or 27.8%, to $14.7 million from $11.5 million in 2000. 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. This increase is primarily related to costs incurred by our PowerCall branches which were acquired in December 2000. These costs as a percentage of other revenues were approximately 93.2% in 2001 compared to approximately 72.9% in 2000.

        Selling, general and administrative expenses for 2001 decreased by $3.0 million, or 2.8%, to $101.0 million from $104.0 million in 2000. This decrease is generally comprised of reductions in bad debt expense and collection costs of approximately $6.9 million primarily due to increased collection efforts, $2.5 million decrease in corporate marketing expense, $1.3 million reduction in professional fees and outside services, and $1.2 million decrease in wage expense. These decreases were partially offset by a

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$6.7 million increase in selling expense due to our increased efforts to generate new customers through an internal sales force and the associated expenses. We believe our selling costs will continue to increase as we continue to grow our internal sales force. Additionally, lease expense relating to computer equipment and software increased $2.0 million. Our prior practice was to purchase our computer equipment and software and depreciate and amortize accordingly. In 2001, we procured most new computer equipment and certain software with lease financing and, as a result, incur lease charges. As a percentage of total revenues, selling, general and administrative expenses increased from 28.5% in 2000 to 33.2% in 2001 because the decrease in expenses was proportionately less than the decrease in revenues.

        Acquisition expenses for 2001 decreased by $5.6 million, or 48.7%, to $5.9 million from $11.5 million in 2000. The decrease is generally due to the reduced level of account acquisitions in 2001 as compared to 2000. During 2001 we increased emphasis on our internal sales force as the primary means of acquiring new customers.

        Amortization of intangibles and depreciation expense for 2001 decreased by $15.2 million, or 7.5%, to $186.8 million from $202.0 million in 2000. This decrease reflects a reduction in depreciation expense of $6.1 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 $7.4 million related to the declining balance method of amortization utilized. The remaining $1.7 million decrease is from goodwill amortization and is due to adjustments made to goodwill in 2000 to reflect utilization of tax net operating losses. With the implementation of SFAS No. 142 and SFAS No. 144 on January 1, 2002, we will no longer amortize goodwill and the balance of customer accounts to be amortized will be reduced by approximately 45% after an impairment charge resulting in significantly lower amortization in 2002.

        Other charges for 2001 increased $4.8 million, or 109.6%, to $9.2 million from $4.4 million in 2000. Other charges in 2001 were primarily for severance and facility closure costs related to the closure of our Irving, Texas, Beaverton, Oregon, and Hagerstown, Maryland monitoring facilities as well as severance expenses related to the elimination of certain business lines, such as our national accounts and patrol divisions. In 2000, other charges were comprised of $1.5 million in officer severance, $1.6 million for expenses relating to the sale of the European operations, and $1.3 million in costs relating to the closing of our Chatsworth, California and Culver City, California offices. We expect these expenses will decline in 2002 as we completed most of our consolidation efforts in 2001.

        Interest expense, net for 2001 and 2000 was $51.7 million and $59.0 million, respectively. This decrease is primarily a result of the reduction of approximately $474.9 million in outstanding debt during 2000 and an additional reduction of approximately $52.9 million in 2001. Approximately $0.6 million of the reduction is due to the registration of the Senior Subordinated Notes on June 1, 2001 which reduced the interest rate on the outstanding notes from 8⁵/8% to 8¹/8%.

        2000 Compared to 1999. We had a net decrease of 141,527 customers (net of 17,342 customers acquired in the acquisition of PowerCall) in 2000, as compared to a net increase of 8,595 customers in 1999. The average customer base was 1,133,879 for 2000 compared to 1,200,345 for 1999. 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.

        Monitoring and related service revenues for 2000 decreased by $33.1 million, or 8.7%, to $348.8 million from $381.9 million for 1999. The decrease is primarily due to the decline in our customer base. These revenues consist primarily of contractual revenue derived from providing monitoring and maintenance service.

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        Other revenues increased by 2.8% to $15.7 million in 2000, compared to $15.3 million in 1999. These revenues consist primarily of sales of burglar alarms, closed circuit television systems, fire alarms and card access control systems to commercial customers.

        Cost of monitoring and related services revenues for 2000 increased by $12.2 million, or 11.7%, to $116.4 million from $104.2 million for 1999. Cost of monitoring and related services revenues as a percentage of the related revenues increased from 27.3% in 1999 to 33.4% in 2000. Compensation costs for the monitoring stations increased by approximately $4.9 million due primarily to an increase in personnel. In addition, parts and materials costs increased by $5.5 million and vehicle costs increased $1.7 million. These costs generally relate to the cost of providing monitoring service and include the costs of monitoring, billing, customer service and field operations.

        Cost of other revenues for 2000 decreased by $1.1 million, or 8.6%, to $11.5 million from $12.6 million in 1999. Parts and materials decreased by $2.8 million and labor costs increased by $1.7 million. These costs consist primarily of equipment and labor charges to install alarm systems, closed circuit televisions, fire alarms and card access control systems sold outright to our customers.

        Selling, general and administrative expenses for 2000 decreased by $1.2 million, or 1.1%, to $104.0 million from $105.2 million in 1999, but increased as a percentage of total revenues from 26.4% in 1999 to 28.5% in 2000. Selling expense increased $3.1 million to $8.7 million in 2000 from $5.6 million in 1999. This increase is primarily due to an increase in sales commissions stemming from our increased emphasis on internal account growth. Bad debt and collection expenses decreased approximately $7.9 million primarily due to increased collection efforts in 2000. Subcontract expense for outside information technology support increased approximately $4.3 million due primarily to work performed in connection with the implementation of our new billing, collection and monitoring software.

        Acquisition expenses for 2000 decreased by $14.9 million, or 56.3%, to $11.5 million from $26.4 million in 1999. Third party monitoring costs decreased by $4.8 million, signs and decals expense decreased by $1.9 million, printing expense decreased by $1.7 million and compensation expense decreased by $1.0 million. These decreases are a direct result of the significant decline in the number of new accounts acquired from 223,093 in 1999 to 67,160 accounts acquired in 2000. This decline is primarily due to the restructuring of our dealer program. The decrease in third party monitoring expense and associated increase in reprogramming expense are a result of our concentrated effort in late 1999 to move such accounts to our own monitoring stations. Additionally, in the third quarter of 1999, $3.7 million of costs relating to the termination of the Lifeline merger were expensed.

        Amortization of intangibles and depreciation expense for 2000 increased by $7.1 million, or 3.6%, to $202.0 million from $194.9 million in 1999. Subscriber amortization for 2000 and 1999 was $139.0 million and $159.8 million respectively, a decrease of $20.8 million. We changed the amortization method on most of our customer base from a 10-year straight line method to a 10-year declining balance method as of the third quarter in 1999. The cumulative effect of this change in accounting principle was approximately $28.6 million including approximately $20.2 million of additional amortization from the effect of the change on amortization in years prior to 1999. This change does not include our Westinghouse customer pool for which we adopted an 8-year accelerated amortization method from the date of the WSS acquisition.

        On January 1, 2000, we changed our estimate of the useful life of goodwill from 40 years to 20 years. As a result, our goodwill amortization expense increased $21.0 million from $20.3 million in 1999 to $41.3 million in 2000. Additionally, in 2000, depreciation expense increased $6.9 million from $14.7 million in 1999 to $21.6 million. This increase is due to accelerated depreciation of the general ledger and accounts receivable systems installed in 1999. In 2000, we moved to another general ledger and accounts receivable system better suited to meet our needs.

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        Other charges for 1999 consisted of officers' severance costs of $3.2 million and $2.6 million in non recurring costs incurred to transition certain back office functions from Irving, Texas to Topeka, Kansas. For 2000 these charges consist of $1.5 million for officers' severance, $1.6 million for expenses relating to the sale of the European operations, and $1.3 million in costs relating to the closing of our Chatsworth, California and Culver City, California offices.

        Interest expense, net for 2000 and 1999 was $59.0 million and $76.1 million, respectively. This decrease is primarily a result of the reduction of approximately $474.9 million in outstanding debt during 2000.

Multifamily Segment

        The following table provides information 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 comparisons about the relative change in revenues and expenses can be made.

        2001 Compared to 2000.    We had a net increase of 18,592 customers in 2001 as compared to a net increase of 12,997 customers in 2000. The average customer base was 317,253 for 2001 compared to 301,459 for 2000. The change in Multifamily's customer base for the period is shown below.

        The attrition rate for Multifamily in 2000 reflects approximately 7,000 subscribers related to one developer cancelled due to nonpayment. Had these accounts not attrited, the annualized attrition would

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have been approximately 6.6%. The Company is pursuing contractual remedies for the nonpayment of these accounts.

        Monitoring and related services revenues was $35.9 million for 2001 compared to $35.2 million in 2000. The average customer base increase of 5.2% 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 and 2001 through outright sales of security systems with lower RMR than our standard contracts, which include an additional monthly charge for equipment. The remaining decline in RMR per customer is primarily related to an increasing number of contract renewals, which provide for significant contract term extensions at a reduced RMR, and contract cancellations, which are terminating at higher RMR rates to due annual rate escalations.

        Other revenues decreased by $3.5 million, or 84.9%, to $0.6 million in 2001 from $4.1 million in 2000 primarily due to a $2.3 million decrease in revenue resulting from fewer outright sales. We also deferred $1.2 million in installation revenues pursuant to Staff Accounting Bulletin (SAB) 101, which requires deferral of revenue over the life of the customer along with deferral of associated direct and incremental costs.

        Cost of monitoring and related service revenues for 2001 remained consistent with costs for 2000.

        Cost of other revenues decreased by $2.9 million or 79.6% to $0.7 million in 2001 from $3.6 million in 2000 due to the decline in the number of outright sales and $1.0 million in deferrals of costs related to the $1.2 million in revenue deferrals pursuant to SAB 101.

        Selling, general and administrative expenses for 2001 increased $1.7 million to $11.6 million from $9.9 million in 2000. This 17.6% increase is primarily the result of management fees allocated from Protection One and increased legal fees.

        Other expense of $0.5 million in 2001 consists of lease obligations related to Multifamily's corporate office relocation to Protection One's Irving facility.

        Amortization of intangibles and depreciation expense for 2001 increased by $0.2 million, or 1.4% to $15.8 million from $15.6 million in 2000. This increase is the result of a larger customer base being amortized.

        2000 Compared to 1999.    We had a net increase of 12,997 customers in 2000 as compared to a net increase of 9,006 customers in 1999. The average customer base was 301,459 for 2000 compared to 290,457 for 1999. We had an increase in the attrition rate for Multifamily in 2000 due to nonpayment of approximately 7,000 subscribers related to one developer. Had these accounts not attrited, the annualized attrition would have been approximately 6.6% instead of 8.9%. This compares to 7.6% in 1999.

        Monitoring and related services revenues for 2000 increased by $0.9 million, or 2.7%, to $35.2 million from $34.3 million for 1999. Multifamily's additional revenues in 2000 were primarily attributable to the increase in the subscriber base. These revenues consist primarily of contractual revenue derived from providing monitoring and maintenance service.

        Other revenues decreased by $.5 million or 10.4% to $4.1 million in 2000 from $4.6 million in 1999 primarily due to a decrease in the number of outright sales installations.

        Cost of monitoring and related service revenues for 2000 increased by $0.6 million, or 8.7%, to $8.2 million from $7.6 million for 1999. Monitoring and related service expenses, as a percentage of monitoring and related service revenues, increased to 23.3% for 2000 from 22.0% for 1999. This increase is primarily related to increased employment costs caused by a more competitive labor market and an increase in claims experience on a self-funded medical insurance plan.

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        Cost of other revenues decreased by $0.6 million or 13.1% to $3.6 million from $4.2 million in 1999. Other cost of revenues, as a percentage of other revenues, decreased to 88.2% in 2000 from 90.9% in 1999. This decline is principally due to an increase in sales of access control contracts with greater installation margins than the standard alarm sale and the access control sales installed in 1999.

        Selling, general and administrative expenses decreased $0.7 million or 6.7% to $9.9 million in 2000 from $10.6 million in 1999 primarily due to a temporary decline in the sales force.

        Amortization of intangibles and depreciation expense for 2000 increased by $6.1 million, or 64.0% to $15.6 million from $9.5 million in 1999. This increase is primarily due to the change in estimate of goodwill life from 40 years to 20 years resulting in an increase in goodwill amortization expense of $5.0 million. Subscriber amortization increased by $1.0 million due to the larger customer base being amortized.

Liquidity and Capital Resources

        We believe we will have sufficient cash to fund future operations of our business through January 3, 2003 from a combination of cash flow from our security monitoring customer base which generated $43.6 million of positive cash flow from operations in 2001, possible asset sales and borrowings under our existing Senior Credit Facility with Westar Industries, which had approximately $34.5 million of availability at March 25, 2002. We have sought to obtain a third party source of funds to replace those provided by Westar Industries under our Senior Credit Facility. We have not been able to obtain another lender or lenders on terms or at a cost acceptable to us or Westar Industries. We can give no assurance that we would be able to obtain adequate financing from third party sources should that become necessary.

        The Senior Credit Facility currently expires on January 3, 2003. 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 Kansas Corporation Commission also ordered Western Resources to submit a financial plan to reduce the amount of its outstanding debt. The financial plan proposed by Western Resources contemplates the sale of some or all of Westar Industries stock with the proceeds being used for that purpose. The plan also provides for Westar Industries to apply revenue it derives from certain sources to the reduction of Western Resources debt. We would face significant liquidity issues if Westar Industries were unable to fund its obligations under the Senior Credit Facility and we can give no assurance that the KCC actions will not adversely impact the ability of Westar Industries to fund these obligations.

        Our ability to borrow under the facility is subject to compliance with certain financial covenants including a leverage ratio, total debt to EBITDA as defined in the Senior Credit Facility, of 5.75 to 1.0 and an interest coverage ratio, interest expense to EBITDA, of 2.10 to 1.0. At December 31, 2001, the ratios were approximately 5.0 to 1.0 and 2.3 to 1.0, respectively.

        Operating Cash Flows for the Year Ended December 31, 2001.    Our operating activities provided net cash flows of $43.6 million in 2001 compared to $101.5 million in 2000, a decrease of $57.9 million. This decrease was primarily due to an additional net loss before extraordinary gain of $14.1 million coupled with a decrease in depreciation and amortization expense of $20.3 million in 2001 compared to 2000. Additionally, we received $29.8 million less in tax benefit payments from Western Resources as compared to 2000.

        Investing Cash Flows for the Year Ended December 31, 2001.    We used a net $15.5 million for our investing activities in 2001. Proceeds from the sale of customer accounts provided cash of $20.9 million. We used $27.7 million in cash to install and acquire new accounts, $7.4 million to acquire fixed assets

37

and invested $1.4 million in marketable securities. In 2000, we used $47.3 million in cash to install and acquire new accounts and $18.6 million to acquire fixed assets.

        Financing Cash Flows for the Year Ended December 31, 2001.    We used a net $26.5 million in cash for financing activities in 2001. We increased our borrowings under the Senior Credit Facility by $93.5 million. We used cash to purchase $146.0 million in face value of our outstanding debt for $91.7 million, to make principal payments of $0.5 million on capital leases and to acquire 22,013,592 shares of our outstanding stock for $27.1 million. At December 31, 2001, the Senior Credit Facility had a weighted average annual interest rate before fees of 5.8% and an outstanding balance of $137.5 million. In 2000, we used a net $223.8 million in financing activities. Borrowings under our Senior Credit Facility decreased by $181.0 million. We used the $183.0 million in cash received from the sale of our European operations and other investments to reduce borrowings under our Senior Credit Facility. We paid an additional $46.9 million to retire $69.1 million carrying amount of other outstanding debt. We also purchased $5.3 million of common stock during the year. At December 31, 2000 the facility had a weighted average annual interest rate of 9.0% and an outstanding balance of $44.0 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, the availability of funds and other factors. From January 1, 2002 through March 15, 2002, we purchased 1,000,000 shares of our common stock for $2.2 million. As of March 15, 2002, we had authority from our board of directors to purchase an additional approximately 8.2 million shares of our common stock.

        In the latter part of 2001 through March 15, 2002, we purchased in the open market, approximately $2.0 million in Western Resources preferred stock, approximately $9.7 million of Western Resources 6.25% notes, approximately $0.1 million in ONEOK common stock and approximately $3.0 million of Western Resources common stock. At December 31, 2001, our total investment in these Western Resources securities was approximately $1.4 million and is included as part of Other assets on the balance sheet.

        On March 25, 2002, we sold our investments in the ONEOK stock and the Western Resources 6.25% notes to Western Resources for approximately $9.8 million. On that same date, we purchased from Westar Industries approximately $8.3 million (face amount) of our Senior Subordinated Discount Notes for approximately $7.5 million and $6.5 million (face amount) of our Senior Subordinated Notes for approximately $4.5 million. The Company will record a $2.0 million extraordinary gain, net of tax, in the first quarter of 2002, as a result of the retirement of this debt.

        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

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of borrowings under our Senior Credit Facility, refinancings and positive operating cash flows. The following reflects our commitments as of December 31, 2001:

(a)

Contract tariff for telecommunication services.

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

        Most of the long-term debt instruments contain restrictions based on "EBITDA". The definition of EBITDA varies among the various indentures and the Senior Credit Facility. EBITDA is generally derived by adding to income (loss) before income taxes, interest expense and depreciation and amortization expense. However, under the varying definitions of the indentures, various and numerous additional adjustments are sometimes required.

        Our Senior Credit Facility and the indentures relating to our other indebtedness contain the financial covenants summarized below:

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        At December 31, 2001, we were in compliance with the covenants under these debt instruments.

        These debt instruments also restrict our ability to pay dividends to stockholders, but do not otherwise restrict our ability to fund cash obligations.

        Credit Ratings.    As of March 15, 2002, public debt was rated as follows:

        In general, revenue declines and reductions in operating margin leave our credit ratings susceptible to further downgrades which 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 $40 million in 2002. Of such amount, we plan to invest approximately $30 million to acquire customer accounts and $10 million for fixed assets. Capital expenditures for 2003 and 2004 are expected to be approximately $45 million and $50 million, respectively. Of these amounts approximately $35 million and $40 million would be to acquire accounts with the balance for fixed assets. 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 through the use of internally generated funds, asset sales, the Senior Credit Facility or external financings. See "Liquidity and Capital Resources" above.

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

        We are exposed to market risk, including changes in the market price, foreign currency exchange rates, equity instrument investment prices, as well as interest rates.

        Foreign currency exchange rates.    During 1998, we acquired Canadian operations with a functional currency other than the US dollar. As of December 31, 2001, the unrealized loss on currency translation, presented as a separate component of stockholders' equity and reported within other comprehensive income was approximately $2.4 million net of tax. A 10% change in the currency exchange rates would have an immaterial effect on other comprehensive loss.

        Interest Rate Exposure.    We have approximately $137.5 million of long-term variable rate debt as of December 31, 2001. A 100 basis point change in the debt benchmark rate would impact net income before tax by approximately $1.4 million.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        Our consolidated financial statements and supplementary data, together with the reports of Arthur Andersen LLP, independent public accountants, are included elsewhere herein. See "Index to Financial Statements" on page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

        None.

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS

        Information relating to our directors, nominees for directors and executive officers is set forth under the heading "Election of Directors" in the Proxy Statement relating to the Annual Meeting of Stockholders to be held May 23, 2002, which will be filed with the Securities and Exchange Commission by April 23, 2002, and which is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

        Information relating to our executive officers and executive compensation is set forth under the heading "Executive Officers; Executive Compensation and Related Information" in the Proxy Statement relating to the Annual Meeting of Stockholders to be held May 23, 2002, which will be filed with the Securities and Exchange Commission by April 23, 2002, and which is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        Information relating to the security ownership of certain beneficial owners and management is set forth under the headings "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management and Directors" in the Proxy Statement relating to the Annual Meeting of Stockholders to be held May 23, 2002 which will be filed with the Securities and Exchange Commission by April 23, 2002, and which is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        Information relating to certain relationships and related transactions concerning directors and executive officers is set forth under the heading "Certain Relationships and Related Transactions" in the Proxy Statement relating to the Annual Meeting of Stockholders to be held May 23, 2002, which will be filed with the Securities and Exchange Commission by April 23, 2002, and which is incorporated herein by reference.

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PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)

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



1.

The financial statements and financial statement schedules listed on the accompanying Index to Financial Statements.



2.

The following Exhibits:

42

43

44

*

Each Exhibit marked with an asterisk constitutes a management contract or compensatory plan or arrangement required to be filed or incorporated by reference as an Exhibit to this report pursuant to Item 14(c) of Form 10-K.

+

Filed herewith.

(b)

During the last quarter of the fiscal year covered by this Report, POI and Monitoring filed one Report on Form 8-K. A Current Report on Form 8-K dated December 5, 2001 reported David C. Wittig, the Chairman of the Board and Chief Executive Officer of Western Resources, Inc., was appointed to our board of directors. Westar Industries, Inc., a wholly owned subsidiary of Western Resources, Inc., owns approximately 87% of the Company's outstanding stock.

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PROTECTION ONE, INC. AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS