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

INTRODUCTION

In Management's Discussion and Analysis we explain the general financial condition and the operating results for Western Resources, Inc. and its subsidiaries. We explain:

- What factors affect our business
- What our earnings and costs were for the three and twelve month periods ending March 31, 1998 and 1997
- Why these earnings and costs differed from period to period
- How our earnings and costs affect our overall financial condition
- Any other items that particularly affect our financial condition or earnings

The following Management's Discussion and Analysis of Financial Condition and Results of Operations updates the information provided in the 1997 Annual Report on Form 10-K/A and should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in the company's 1997 Annual Report on Form 10-K/A.

FORWARD-LOOKING STATEMENTS: Certain matters discussed here and elsewhere in this Form 10-Q are "forward-looking statements." The Private Securities Litigation Reform Act of 1995 has established that these statements qualify for safe harbors from liability. Forward-looking statements may include words like we "believe," "anticipate," "expect" or words of similar meaning.
Forward-looking statements describe our future plans, objectives, expectations or goals. Such statements address future events and conditions concerning capital expenditures, earnings, litigation, rate and other regulatory matters, possible corporate restructurings, mergers, acquisitions, dispositions, liquidity and capital resources, interest and dividend rates, environmental matters, changing weather, nuclear operations and accounting matters. What happens in each case could vary materially from what we expect because of such things as electric utility deregulation, including ongoing state and federal activities; future economic conditions; legislative developments; our regulatory and competitive markets; and other circumstances affecting anticipated operations, sales and costs.

FINANCIAL CONDITION

GENERAL: Sales, cost of sales, operating expenses, net income and basic earnings per share were significantly reduced for the three months ended March 31, 1998 due to the effects of restructuring our natural gas interests in the strategic alliance with ONEOK as of November 30, 1997. The restructuring reduced first quarter earnings by $0.22 per share when compared to prior year, which we anticipate will be made up by earnings from our ONEOK investment in the second and third quarters. Each quarter, earnings from our 45% ownership in ONEOK will be recorded in our other income section of our Consolidated Statements of Income. Our investment income stream is expected to fluctuate less each quarter without the seasonal swings typical of the natural gas distribution business.

For the three months ended March 31, 1998, sales decreased 39%, net income decreased 26% and basic earnings per share decreased 26%. Sales also decreased 10% for the twelve months ended March 31, 1998 due primarily to the transfer of our natural gas assets to ONEOK.

Net income increased $318 million and basic earnings per share increased $4.96 for the twelve months ended March 31, 1998 due to the pre-tax gain on the sale of the Tyco common stock of $864 million, or $7.97 of basic earnings per share, recorded in the third quarter of 1997. Partially offsetting this increase was the special non-recurring charge in December 1997 to expense $48 million of deferred KCPL Merger costs, the special non-recurring charge in December 1997 of approximately $40 million recorded by Protection One and our reduced electric rates implemented on February 1, 1997.

A quarterly dividend of $0.535 per share was declared in the first quarter of 1998, for an indicated annual rate of $2.14 per share. The book value per share was $30.84 at March 31, 1998, up from $30.79 at December 31, 1997. There were 65,409,603 and 64,807,081 average shares outstanding for the first quarter of 1998 and 1997.

OPERATING RESULTS

The following explains significant changes from prior year results in sales, cost of sales, operating expenses, other income (expense), interest expense, income taxes and preferred and preference dividends.

Energy sales, cost of sales and operating expenses have decreased significantly from prior year due to the transfer of our natural gas business assets to ONEOK Inc. as of November 30, 1997.

SALES: Energy sales include electric sales, power marketing sales, natural gas sales and other insignificant energy-related sales. Certain state regulatory commissions and the FERC authorize rates for our electric sales. Our energy sales vary with levels of energy deliveries. Changing weather affects the amount of energy our customers use. Very hot summers and very cold winters prompt more demand, especially among our residential customers. Mild weather reduces demand.

Many things will affect our future energy sales. They include:

- The weather
- Our electric rates
- Competitive forces
- Customer conservation efforts
- Wholesale demand
- The overall economy of our service area

Electric sales increased 13.8% for the three months ended March 31, 1998 because of revenues of $47 million from the expansion of power marketing activity in 1997. Our involvement in electric power marketing takes advantage of increased competitive opportunities in the wholesale electric utility industry. We are involved in both the marketing of electricity and risk management services to wholesale electric customers and the purchase of electricity for our retail customers. Our margin from power marketing activity is significantly less than our margins on other energy sales. Our power marketing activity has resulted in energy purchases and sales made in areas outside of our historical marketing

territory. Through March 31, 1998, this additional power marketing activity has had an insignificant effect on operating income. This sales increase was partially offset by a 25.7% decrease in traditional wholesale sales and our reduced electric rates implemented February 1, 1997. Reduced electric rates lowered first quarter 1998 sales by an estimated $5 million.

Electric sales increased 5.9% for the twelve months ended March 31, 1998 because of $117 million included from our power marketing activity. This increase was partially offset by decreases in sales from all customer classes because of our reduced electric rates implemented February 1, 1997.

The following table reflects the increases in electric energy deliveries for retail customers for the three and twelve months ended March 31, 1998 from the comparable periods of 1997.

                              3 Months          12 Months
                                ended             ended
Residential                     1.7%              1.6%
Commercial                      3.6%              3.0%
Industrial                      2.9%              3.1%
Other                           2.2%              1.2%
  Total retail                  2.7%              2.6%

For the three and twelve months ended March 31, 1998, natural gas sales have significantly decreased due to the transfer of our natural gas business assets to ONEOK on November 30, 1997.

Security alarm monitoring business sales increased $45 million for the three months ended March 31, 1998 and $157 million for the twelve months ended March 31, 1998. This increase is primarily because of our purchase of the assets of Westinghouse Security Systems on December 30, 1996, our acquisition of Network Multi-Family in September 1997, our acquisition of Protection One on November 24, 1997, and Protection One's acquisitions of Multimedia Security and Comsec in the first quarter of 1998.

COST OF SALES: Items included in energy cost of sales are fuel expense, purchased power expense (electricity we purchase from others for resale), power marketing expense and natural gas purchased. Items included in security alarm monitoring cost of sales are the cost of direct monitoring and the cost of installing security monitoring equipment that is not capitalized.

Energy business cost of sales were 64% lower for the three months ended March 31, 1998 and 18% lower for the twelve months ended March 31, 1998 primarily due to the transfer of our natural gas business assets to ONEOK on November 30, 1997. Partially offsetting these decreases was increased power marketing expense of $47 million and $118 million for the three and twelve month periods ending March 31, 1998.

Security alarm monitoring cost of sales increased 26% and 94% for the three and twelve month periods ending March 31, 1998. The increase is primarily a result of the purchase of the assets of Westinghouse Security Systems on December 30, 1996, our acquisition of Network Multi-Family in September 1997 and our acquisition of Protection One on November 24, 1997. Security alarm monitoring cost of sales also increased for the three months ended March 31, 1998 due to the addition of several service centers resulting from acquisition activity and additional installation activities from Protection One's first quarter acquisitions.

OPERATING EXPENSES

OPERATING AND MAINTENANCE EXPENSE: Total operating and maintenance expense decreased 18% for the three months ended March 31, 1998 due to the transfer of our natural gas business assets to ONEOK on November 30, 1997. Partially offsetting this decrease was increased operating and maintenance expense for our electric business. Operating and maintenance expense decreased three percent for the twelve months ended March 31, 1998.

DEPRECIATION AND AMORTIZATION EXPENSE: Depreciation and amortization expense increased two percent for the three months and 20% for the twelve months ending March 31, 1998. The increase for the twelve months is primarily attributable to the amortization of capitalized security alarm monitoring accounts and goodwill for our security alarm monitoring business.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE: Selling, general and administrative expense has decreased 11% for the three months ended March 31, 1998 due to the transfer of our natural gas business assets to ONEOK Inc. as of November 30, 1997 and due to lower selling, general and administrative expense for our electric business. Partially offsetting these decreases was increased selling, general and administrative expense from Protection One due primarily to our purchase of the assets of Westinghouse Security Systems on December 30, 1996, our acquisition of Network Multi-Family in September 1997, our acquisition of Protection One on November 24, 1997 and Protection One's acquisitions of Multimedia Security and Comsec in the first quarter of 1998.

Higher security alarm monitoring business selling, general and administrative expense caused a 51% increase in total selling general and administrative expense for the twelve months ended March 31, 1998. The security alarm monitoring business increase is primarily because of security business acquisitions discussed in the previous paragraph. Partially offsetting this increase was decreased selling, general and administrative expense due to the transfer of our natural gas business assets to ONEOK as of November 30, 1997.

OTHER: Two additional items affected total operating expenses for the twelve months ended March 31, 1998. We recorded a special non-recurring charge in December 1997 to expense $48 million of deferred KCPL Merger costs.

Protection One recorded a special non-recurring charge of approximately $40 million in December 1997, to reflect the phase out of certain business activities which are no longer of continuing value to Protection One, to eliminate redundant facilities and activities and to bring all customers under the Protection One brand.

OTHER INCOME (EXPENSE)

Other income (expense) includes miscellaneous income and expenses not directly related to our operations. Other income increased approximately $13 million for the three months ended March 31, 1998. Other income for that quarter included investment earnings of approximately $15 million from our 45% ownership in ONEOK. Other income for the first quarter of 1997 included investment earnings of approximately $11 million primarily from our investment in ADT which was converted to Tyco stock and sold in the third quarter of 1997. The gain on the sale of Tyco common stock increased other income $864 million for the twelve months ended March 31, 1998.

INTEREST EXPENSE

Interest expense includes the interest we paid on outstanding debt. Interest expense increased two percent for the three months and 15% for the twelve months ended March 31, 1998. Interest recorded on long-term debt increased $32 million or 31% for the twelve months ended March 31, 1998 due to the issuance of $520 million in senior unsecured notes. A decline in short-term debt interest expense in the second half of 1997 partially offset the increase in long-term debt interest expense. We used the proceeds from the sale of Tyco common stock and the $520 million in senior unsecured notes to reduce our short-term debt balance.

INCOME TAXES

Income tax expense for the twelve months ended March 31, 1998 increased $282 million due to the gain from the sale of Tyco common stock. Partially offsetting this increase was lower operating income. Income taxes for the three months ended March 31, 1998 decreased $14 million or 60%.

PREFERRED AND PREFERENCE DIVIDENDS

Preferred and preference dividends decreased 61% for the twelve months ended March 31, 1998 because we redeemed all of our 8.50% preference stock due 2016 on July 1, 1996.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 1998, we had $14 million in cash and cash equivalents. We consider highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Our cash and cash equivalents decreased $63 million from December 31, 1997, due to a decrease in cash held by Protection One. Protection One used its cash for security alarm monitoring business acquisitions. Other than operations, our primary source of short-term cash is from short-term bank loans, unsecured lines of credit and the sale of commercial paper. At March 31, 1998, we had approximately $462 million of short-term debt outstanding, of which $397 million was commercial paper. An additional $357 million of short-term debt was available from committed credit arrangements.

On April 1, 1998, we redeemed our 7.58% Preference Stock due 2007 at a premium, including dividends, for $53 million.

Net cash flows from operating activities increased $98 million due primarily to receivables associated with our natural gas business as part of the strategic alliance with ONEOK.

On April 17, 1998, Protection One filed with the SEC a shelf registration on Form S-3 related to $400 million of equity and/or debt securities to be issued by Protection One from time to time as determined by market conditions.

MERGERS AND ACQUISITIONS

MERGER AGREEMENT WITH KANSAS CITY POWER & LIGHT COMPANY: On February 7, 1997, the company signed a merger agreement with KCPL by which KCPL would be merged with and into the company in exchange for company stock. In December 1997, representatives of the company's financial advisor indicated that they believed it was unlikely that they would be in a position to issue a fairness opinion required for the merger on the basis of the previously announced terms.

On March 18, 1998, we and KCPL agreed to a restructuring of our February 7, 1997, merger agreement which will result in the formation of Westar Energy, a new regulated electric utility company. Under the terms of the merger agreement, our electric utility operations will be transferred to KGE, and KCPL and KGE will be merged into NKC, Inc., a subsidiary of the company. NKC, Inc. will be renamed Westar Energy. In addition, under the terms of the merger agreement, KCPL shareowners will receive $23.50 of Western Resources common stock per KCPL share, subject to a collar mechanism, and one share of Westar Energy common stock per KCPL share. Upon consummation of the combination, we will own approximately 80.1% of the outstanding equity of Westar Energy and KCPL shareowners will own approximately 19.9%. As part of the combination, Westar Energy will assume all of the electric utility related assets and liabilities of Western Resources, KCPL and KGE.

Westar Energy will assume $2.7 billion in debt, consisting of $1.9 billion of indebtedness for borrowed money of Western Resources and KGE, and $800 million of debt of KCPL. Long-term debt of Western Resources and KGE was $2.1 billion at March 31, 1998. Under the terms of the merger agreement, it is intended that we will be released from our obligations with respect to our debt to be assumed by Westar Energy.

Pursuant to the merger agreement, we have agreed, among other things, to call for redemption all outstanding shares of our 4 1/2% Series Preferred Stock, par value $100 per share, 4 1/4% Series Preferred Stock, par value $100 per share, and 5% Series Preferred Stock, par value $100 per share.

Consummation of the merger is subject to customary conditions including obtaining the approval of our and KCPL's shareowners and various regulatory agencies. We estimate the transaction to close by mid-1999, subject to receipt of all necessary approvals.

KCPL is a public utility company engaged in the generation, transmission, distribution, and sale of electricity to customers in western Missouri and eastern Kansas. We, KCPL and KGE have joint interests in certain electric generating assets, including Wolf Creek. Following the closing of the combination, Westar Energy is expected to have approximately one million electric utility customers in Kansas and Missouri, approximately $8.2 billion in assets and the ability to generate more than 8,000 megawatts of electricity.

On March 23, 1998 we and KCPL filed a letter informing the FERC that we had signed a revised merger agreement, dated March 18, 1998. We sent similar letters on March 24, 1998 to the KCC and the MPSC. We and KCPL will submit appropriate modifications to the merger filings at FERC, the KCC and the MPSC as soon as practicable.

SECURITY ALARM MONITORING BUSINESS PURCHASES: Effective January 1, 1998, Protection One acquired the stock of Network Holdings, Inc., the parent company of Network Multi-Family, from the company for approximately $180 million. Protection One borrowed money under a revolving credit agreement provided by Westar Capital, a subsidiary of the company, to purchase Network Multi-Family.

On March 2, 1998, Protection One acquired the assets comprising the monitored security alarm business of Multimedia Security for approximately $233 million in cash. Multimedia Security has approximately 140,000 subscribers concentrated primarily in California, Florida, Kansas, Oklahoma and Texas.

On March 17, 1998, Protection One acquired the stock of Comsec for approximately $45 million in cash and assumed approximately $15 million in debt. Comsec has approximately 30,000 subscribers located primarily in Connecticut, Maine, Massachusetts, and New Hampshire.

The acquisitions of Multimedia Security and Comsec have been accounted for as purchases. Preliminary allocations of the purchase price for each acquisition have been made based on the estimated fair value of the net assets acquired. These acquisitions do not materially impact the company's financial position or results of operations.

WESTERN RESOURCES, INC.