10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2002

or

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

For the transition period from            to           

1-12181-01	1-12181
(Commission File Number)	(Commission File Number)
PROTECTION ONE, INC.	PROTECTION ONE ALARM MONITORING, INC.
(Exact Name of Registrant As Specified In its Charter)	(Exact Name of Registrant As Specified In its Charter)
Delaware	Delaware
(State or Other Jurisdiction Of Incorporation or Organization)	(State of Other Jurisdiction Of Incorporation or Organization)
93-1063818	93-1064579
(I.R.S. Employer Identification No.)	(I.R.S. Employer Identification No.)
818 S. Kansas Avenue Topeka, Kansas 66612	818 S. Kansas Avenue Topeka, Kansas 66612
(Address of Principal Executive Offices, Including Zip Code)	(Address of Principal Executive Offices, Including Zip Code)
(785) 575-1707	(785) 575-1707
(Registrant’s Telephone Number, Including Area Code)	(Registrant’s Telephone Number, Including Area Code)

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

As of November 8, 2002, Protection One, Inc. had outstanding 97,955,007 shares of Common Stock, par value $0.01 per share. As of such date, Protection One Alarm Monitoring, Inc. had outstanding 110 shares of Common Stock, par value $0.10 per share, all of which shares were owned by Protection One, Inc. Protection One Alarm Monitoring, Inc. meets the conditions set forth in General Instructions II(1)(a) and (b) for Form 10-Q and is therefore filing this form with the reduced disclosure format set forth therein.

FORWARD-LOOKING STATEMENTS

Certain matters discussed in this Form 10-Q are forward-looking statements 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, the impact on us of the recent order of the Kansas Corporation Commission requiring the financial and corporate restructuring of Westar Energy, 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. Please refer to “Risk Factors” in our Form 10-K for the year ended December 31, 2001 with respect to such risks and uncertainties as well as certain important factors, among others, that could cause actual results to differ materially from our expectations.

Unless the context otherwise indicates, all references in this Report on Form 10-Q (this “Report”) to the “Company,” “Protection One,” “we,” “us” or “our” or similar words are to Protection One, Inc., its direct wholly owned subsidiaries, Protection One Alarm Monitoring, Inc. (“Monitoring”) including Monitoring’s wholly owned subsidiaries and AV ONE, Inc.  Protection One’s sole assets are Monitoring and AV ONE, Inc.  Both Protection One and Monitoring are Delaware corporations organized in September 1991.

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PART I

FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

PROTECTION ONE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

	September 30, 2002			December 31, 2001
ASSETS
Current assets:
Cash and cash equivalents	$	500		$	3,671
Restricted cash	2,603			—
Receivables, net	28,554			35,972
Inventories, net	7,471			8,043
Prepaid expenses	5,210			2,487
Related party tax receivable	24,317			1,655
Deferred tax assets	9,205			8,783
Other	8,916			4,744
Total current assets	86,776			65,355
Property and equipment, net	60,919			54,341
Customer accounts, net	357,904			746,574
Goodwill, net	145,784			763,449
Deferred tax assets, net of current portion	259,232			79,612
Other	25,092			18,082
Assets of discontinued operations	—			22,938
Total assets	$	935,707		$	1,750,351
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	10,242		$	688
Accounts payable	6,810			5,617
Accrued liabilities	32,099			40,543
Due to related parties	4,986			1,875
Deferred revenue	38,176			41,370
Total current liabilities	92,313			90,093
Long-term debt, net of current portion	546,896			584,115
Other liabilities	21,124			11,590
Liabilities of discontinued operations	—			1,364
Total liabilities	660,333			687,162
Commitments and contingencies (Note 5)
Stockholders’ equity:
Preferred stock, $0.10 par value, 5,000,000 authorized	—			—
Common stock, $0.01 par value, 150,000,000 shares authorized, 127,794,512 shares and 127,245,891 shares issued at September 30, 2002 and December 31, 2001 respectively	1,278			1,272
Additional paid-in capital	1,381,980			1,381,450
Accumulated other comprehensive loss	—			(2,361		)
Deficit	(1,058,031		)	(284,741		)
Investment in parent stock-held in treasury	(15,244		)	—
Treasury Stock, at cost, 29,840,405 and 28,840,405 shares at September 30, 2002 and December 31, 2001 respectively	(34,609		)	(32,431		)
Total stockholders’ equity	275,374			1,063,189
Total liabilities and stockholders’ equity	$	935,707		$	1,750,351

The accompanying notes are an integral part of these

consolidated financial statements.

3

PROTECTION ONE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS

(Dollars in thousands, except for per share amounts)

(Unaudited)

	Nine Months Ended September 30,
	2002			2001
Revenues:
Monitoring and related services	$	205,012		$	245,316
Other	13,996			10,599
IT services revenue from related party	5,799			—
Total revenues	224,807			255,915
Cost of revenues (exclusive of depreciation and amortization shown below):
Monitoring and related services	60,007			76,134
Other	13,342			9,909
IT services cost of revenue	4,798			—
Total cost of revenues	78,147			86,043
Gross profit (exclusive of depreciation and amortization shown below)	146,660			169,872
Operating expenses:
Selling	17,276			13,149
General and administrative	63,684			79,117
Amortization and depreciation	66,359			149,786
Loss on impairment	338,104			—
Severance and other	1,613			6,512
Total operating expenses	487,036			248,564
Operating loss	(340,376		)	(78,692		)
Other (income) expense:
Interest expense	24,042			31,987
Related party interest	8,183			8,447
Gain on retirement of debt	(19,285		)	(40,272		)
Other	(667		)	432
Loss from continuing operations before income taxes	(352,649		)	(79,286		)
Income tax benefit	126,191			14,944
Loss from continuing operations before accounting change	(226,458		)	(64,342		)
Loss from discontinued operations, net of taxes	(3,219		)	(404		)
Cumulative effect of accounting change, net of taxes
Continuing operations	(541,330		)	—
Discontinued operations	(2,283		)	—
Net loss	(773,290		)	(64,746		)
Other comprehensive loss
Foreign currency translation loss	—			(1,619		)
Comprehensive loss	$	(773,290	)	$	(66,365	)
Basic and diluted per share information:
Loss from continuing operations per common share	$	(2.31	)	$	(0.60	)
Loss from discontinued operations per common share	$	(0.03	)	$	—
Cumulative effect of accounting change on continuing operations per common share	$	(5.52	)	$	—
Cumulative effect of accounting change on discontinued operations per common share	$	(0.02	)	$	—
Net loss per common share	$	(7.88	)	$	(0.60	)
Weighted average common shares outstanding (in thousands)	98,110			107,465

The accompanying notes are an integral part of these

consolidated financial statements.

4

PROTECTION ONE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS

(Dollars in thousands, except for per share amounts)

(Unaudited)

	Three Months Ended September 30,
	2002			2001
Revenues:
Monitoring and related services	$	66,808		$	77,053
Other	5,212			3,048
IT services revenue from related party	5,799			—
Total revenues	77,819			80,101
Cost of revenues (exclusive of depreciation and amortization shown below):
Monitoring and related services	19,539			22,019
Other	4,955			3,217
IT services cost of revenue	4,798			—
Total cost of revenues	29,292			25,236
Gross profit (exclusive of depreciation and amortization shown below)	48,527			54,865
Operating expenses:
Selling	6,473			3,816
General and administrative	21,011			25,620
Amortization and depreciation	22,170			49,952
Severance and other	1,063			1,817
Total operating expenses	50,717			81,205
Operating loss	(2,190		)	(26,340		)
Other (income) expense:
Interest expense	7,220			9,569
Related party interest	3,368			2,967
Gain on retirement of debt	(2,550		)	(3,086		)
Other	(785		)	(46		)
Loss from continuing operations before income taxes	(9,443		)	(35,744		)
Income tax benefit	3,589			10,758
Loss from continuing operations before accounting change	(5,854		)	(24,986		)
Loss from discontinued operations net of tax	(207		)	(168		)
Net loss	(6,061		)	(25,154		)
Other comprehensive loss:
Foreign currency translation loss	—			(944		)
Comprehensive loss	$	(6,061	)	$	(26,098	)
Basic and diluted per share information:
Loss from continuing operations per common share	$	(0.06	)	$	(0.25	)
Loss from discontinued operations per common share	$	—		$	—
Net loss per common share	$	(0.06	)	$	(0.25	)
Weighted average common shares outstanding (in thousands)	97,944			100,383

The accompanying notes are an integral part of these
consolidatedfinancialstatements.

5

PROTECTION ONE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

	Nine Months Ended September 30,
	2002			2001
Cash flow from operating activities:
Net loss	$	(773,290	)	$	(64,746	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Gain on retirement of debt	(19,285		)	(40,272		)
Loss on discontinued operations, net of taxes	3,219			404
Cumulative effect of accounting change, net of taxes	543,613			—
Loss on impairment of subscriber accounts	338,104			—
Gain (loss) on sale of certain customer accounts	(722		)	428
Amortization and depreciation	66,359			149,786
Amortization of debt costs and premium	1,225			869
Deferred income taxes	(102,821		)	880
Provision for doubtful accounts	3,948			5,036
Other	161			392
Changes in assets and liabilities, net of effects of acquisitions and dispositions:
Receivables, net	3,410			(5,543		)
Related party tax receivable	(22,662		)	(15,969		)
Other assets	(2,683		)	(5,479		)
Accounts payable	3,746			(2,483		)
Deferred revenue	(3,965		)	(2,306		)
Other liabilities	(7,315		)	(19,080		)
Net cash provided by operating activities	31,042			1,917
Cash flows from investing activities:
Installations and purchases of new accounts	(17,372		)	(18,527		)
Deferred customer acquisition costs	(14,381		)	(6,364		)
Deferred customer acquisition revenue	10,639			8,207
Purchase of property and equipment	(5,805		)	(5,502		)
Purchase of AV ONE	(1,378		)	—
Proceeds from disposition of assets and sale of customer accounts	18,609			19,165
Net cash used in investing activities	(9,688		)	(3,021		)
Cash flows from financing activities:
Payments on long-term debt	(83,504		)	(72,469		)
Proceeds from long term-debt	44			495
Borrowings from Senior Credit Facility	76,500			94,000
Purchase of parent company stock-held as treasury	(13,831		)	—
Purchase of Treasury Stock	(2,178		)	(22,899		)
Issuance costs and other	(1,948		)	(1,049		)
Funding from parent	62			1,138
Net cash used in financing activities	(24,855		)	(784		)
Net cash provided by (used in) discontinued operations	330			(179		)
Net decrease in cash and cash equivalents	(3,171		)	(2,067		)
Cash and cash equivalents:
Beginning of period	3,671			2,610
End of period	$	500		$	543
Cash paid for interest	$	40,149		$	54,023
Cash paid for taxes	$	184		$	105

The accompanying notes are an integral part of these

consolidated financial statements.

6

PROTECTION ONE, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.Basis of Consolidation and Interim Financial Information:

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

The Company’s unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q.  Accordingly, certain information and footnote disclosures normally included in financial statements presented in accordance with generally accepted accounting principles have been condensed or omitted. These financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2001, included in the Company’s Annual Report on Form 10–K filed with the Securities and Exchange Commission (the “SEC”).

In the opinion of management of the Company, all adjustments considered necessary for a fair presentation of the financial statements have been included. The results of operations for the three and nine months ended September 30, 2002 are not necessarily indicative of the results to be expected for the full year.

Restricted cash on the accompanying balance sheet represents a trust account established as collateral for the benefit of the insurer of the Company’s workers’ compensation claims.  The Company receives interest income earned by the trust.

The Company has issued stock options and warrants of which approximately 1.8 million represent dilutive potential common shares.  These securities were not included in the computation of diluted earnings per share since to do so would have been antidilutive for all periods presented.

Certain reclassifications, including those discussed in Note 11, have been made to prior year information to conform with the current year presentation.

2.Impairment Charge Pursuant to New Accounting Rules:

Effective January 1, 2002, the Company 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 the Company’s 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 customer accounts.  If the undiscounted cash flow stream from 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 remaining life of customer accounts for impairment evaluation purposes.

7

To implement the new standards, the Company engaged an appraisal firm to help management estimate the fair values of goodwill and customer accounts.  Based on this analysis, the Company recorded a non-cash net charge of approximately $765.2 million in the first quarter of 2002.  The charge is detailed as follows:

	Goodwill			Customer			Total
				(in millions)
North America Segment:
Impairment charge - continuing operations	$	509.4		$	338.1		$	847.5
Impairment charge - discontinued operations	2.3			1.9			4.2
Estimated income tax benefit	(65.1		)	(118.4		)	(183.5		)
Net charge	$	446.6		$	221.6		$	668.2
Multifamily Segment:
Impairment charge	$	104.2		$	—		$	104.2
Estimated income tax benefit	(7.2		)	—			(7.2		)
Net charge	$	97.0		$	—		$	97.0
Total Company:
Impairment charge	$	615.9		$	340.0		$	955.9
Estimated income tax benefit	(72.3		)	(118.4		)	(190.7		)
Net charge	$	543.6		$	221.6		$	765.2

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

A deferred tax asset in the amount of $190.7 million was recorded in the first quarter of 2002 for the tax benefit shown above.  The total net deferred tax asset was $268.4 million at September 30, 2002.  If Westar Energy were to own less than 80% of Westar Industries voting stock, or if Westar Industries were to own less than 80% of the Company’s voting stock, the Company would no longer file its tax return on a consolidated basis with Westar Energy.  As a result, the Company would be required to record a non-cash charge against income to establish a valuation allowance for the portion of its net deferred tax assets determined not to be realizable. This charge could be material.

Because the Company adopted the new rule for goodwill, it is no longer amortizing goodwill to income.  The following tables reflect the Company’s results for the three and nine months ended September 30, 2001, calculated using the new accounting treatment discussed above, as compared to the Company’s results for the three and nine months ended September 30, 2002.

	Nine Months ended September 30,
	2002			2001
	(in thousands, except per share amounts)
Reported net loss	$	(773,290	)	$	(64,746	)
Add back: Goodwill amortization	—			32,277
Adjusted net loss	$	(773,290	)	$	(32,469	)
Basic earnings per share:
Reported net loss	$	(7.88	)	$	(0.60	)
Add back: Goodwill amortization	—			0.30
Adjusted net loss	$	(7.88	)	$	(0.30	)

8

	Three Months ended September 30,
	2002			2001
	(in thousands, except per share amounts)
Reported net loss	$	(6,061	)	$	(25,154	)
Add back: Goodwill amortization	—			10,661
Adjusted net loss	$	(6,061	)	$	(14,493	)
Basic earnings per share:
Reported net loss	$	(0.06	)	$	(0.25	)
Add back:  Goodwill amortization	—			0.11
Adjusted net loss	$	(0.06	)	$	(0.14	)

Goodwill will be required to be tested each year for impairment. The Company has established July 1 as its annual impairment testing date.  The Company completed this testing during the third quarter of 2002 and determined that no additional impairment is required as of July 1, 2002. The Company will be required to perform impairment tests for long-lived assets prospectively if it incurs recurring losses in excess of expectations or for other matters that may negatively impact its business.  Declines in market values of its business or the value of its customer accounts that may be incurred prospectively may also require additional impairment charges. Any such impairment charges could be material.

3.Change in Estimate of Customer Life:

The results of a lifing study performed by a third party appraisal firm in the first quarter of 2002 showed a deterioration in the average remaining life of customer accounts.  The report showed the Company’s North America customer pool can expect a declining revenue stream over the next 30 years with an estimated average remaining life of 9 years.  The Company’s Multifamily pool can expect a declining revenue stream over the next 30 years with an estimated average remaining life of 10 years.  Taking into account the results of the lifing study, the Company adjusted the amortization of customer accounts for its North America and Multifamily customer pools to better match the rate and period of amortization expense with the expected decline in revenues.  In the first quarter of 2002, the Company changed its amortization rate for its North America pool to a 10-year 135% declining balance method from a 10-year 130% declining balance method.  For the Multifamily pool the Company reduced its estimated customer life from 10 to 9 years and will continue to amortize on a straight-line basis.  The Company accounts for these amortization changes prospectively as a change in estimate.  These changes in estimates increased amortization expense for the three and nine months ended September 30, 2002 on a pre-tax basis by approximately $0.3 million and $1.0 million, respectively and on an after tax basis by approximately $0.2 million and $0.6 million, respectively.  The change in estimate had no significant impact on reported earnings per share.

4.Discontinued Operations – Sale of Canadian Operations:

During the second quarter of 2002 the Company entered into negotiations for the sale of its Canadian business which was included in its North American segment.  The sale was consummated on July 9, 2002.  The Company recorded a pretax impairment loss of approximately $2.0 million and an after tax loss of approximately $1.3 million in the second quarter of 2002 as a result of the sale.

The net operating losses of the Canadian operations are included in the consolidated statements of operations under “discontinued operations.”  The net operating loss for the nine months ended September 30, 2002 of $1.6 million includes an impairment loss on customer accounts of approximately $1.9 million.   An impairment charge of $2.3 million relating to the Canadian operations’ goodwill is reflected in the consolidated statement of operations as a cumulative effect of accounting change on discontinued operations.  No revenue from these operations was recorded in the three months ended September 30, 2002.  Revenues from these operations were $4.2 million for the nine months ended September 30, 2002, compared to $2.1 million and $6.3 million for the three and nine months ended September 30, 2001.

9

The major classes of assets and liabilities of the Canadian operations are as follows (in thousands):

	December 31, 2001
Assets:
Current	$	478
Property and equipment	571
Customer accounts, net	16,992
Goodwill	4,842
Other	55
Total assets	$	22,938
Current liabilities	$	1,364

5.Customer Accounts:

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

	Nine Months Ended September 30, 2002			Three Months Ended September 30, 2002			Year Ended December 31, 2001
Beginning customer accounts, net	$	746,574		$	375,618		$	881,726
Acquisition of customer accounts	5,428			1,673			11,556
Amortization of customer accounts	(54,624		)	(18,251		)	(135,197		)
Sale of accounts	(760		)	(712		)	(8,769		)
Purchase holdbacks and other	(610		)	(424		)	(2,742		)
Impairment	(338,104		)	—			—
Total customer accounts, net	$	357,904		$	357,904		$	746,574

The investment at cost in customer accounts at September 30, 2002 and December 31, 2001 was $982.5 million and $1,317.5 million respectively. Accumulated amortization of the investment in customer accounts at September 30, 2002 and December 31, 2001 was $624.6 million and $570.9 million respectively.  The table below reflects the estimated aggregate customer account amortization expense for 2002 and each of the four succeeding fiscal years on the existing customer account base as of September 30, 2002.

	2002		2003		2004		2005		2006
	(Dollars in thousands)
Estimated amortization expense	$	72,850	$	72,565	$	72,460	$	56,208	$	55,847

6.Debt:

During the first nine months of 2002, the Company’s borrowings under the Senior Credit Facility increased by $76.5 million and the Company’s other outstanding long-term debt decreased by $104.2 million. Gain from extinguishment of debt securities was $19.3 million and $40.3 million for the first nine months of 2002 and 2001, respectively.  Accrued interest under the Senior

10

Credit Facility and public indentures was $5.2 million and $7.3 million on September 30, 2002 and on September 30, 2001, respectively.

As of September 30, 2002, and December 31, 2001, total borrowings under the Senior Credit Facility were $214.0 million and $137.5 million, respectively.  The remaining availability under this facility as of September 30, 2002 and December 31, 2001 was $66.0 million and $17.5 million, respectively. The Senior Credit Facility currently expires on January 5, 2004.  The Company expects to renew the facility with Westar Industries unless efforts to replace the facility with financing from an unaffiliated third party lender are successful, which they have not been to date. The success of these efforts will depend on improvements in the Company’s financial performance. The Kansas Corporation Commission (KCC) has issued an order prohibiting Westar Energy from making loans or capital contributions to Westar Industries without KCC approval and which may require Westar Industries to transfer certain assets to Westar Energy.  This order limits the resources available to Westar Industries for funding its obligations under the Senior Credit Facility.  See further discussion in Note 7, “Related Party Transactions.”  The Company would face significant liquidity issues if it were unable to renew the Senior Credit Facility with Westar Industries or if Westar Industries were unable to fund its obligations under the Senior Credit Facility. In this event, the Company would take appropriate measures to manage its cash flow, including but not limited to decreasing investments in new subscribers, curtailing other capital expenditures, evaluating assets for sale and seeking to replace the Senior Credit facility with a third party lender. The Company can give no assurances or guarantees that these measures would be sufficient to maintain its liquidity.

The Company’s ability to borrow under the facility is subject to compliance with certain financial covenants including a leverage ratio of 5.75 to 1.0 and an interest coverage ratio of 2.10 to 1.0.  At September 30, 2002, the ratios were approximately 4.9 to 1.0 and 2.7 to 1.0, respectively.

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

7.Related Party Transactions

The Company had outstanding borrowings under the Senior Credit Facility with Westar Industries of $214.0 million and $137.5 million at September 30, 2002 and December 31, 2001, respectively.  The Senior Credit facility has been amended to increase the capacity from $155 million to $280 million during the first nine months of 2002.  On August 26, 2002 the Senior Credit Facility was further amended to extend the maturity date to January 5, 2004.  The Company incurred amendment fees totaling $2.4 million for these amendments.  At November 8, 2002, the Company had outstanding borrowings of $215.5 million and $64.5 million of remaining capacity.

The Company accrued interest expense of $3.4 million and $8.2 million and made interest payments of $2.8 million and $7.0 million on borrowings under the facility for the three and nine months ended September 30, 2002, compared to interest expense of $3.0 million and $8.4 million for the three and nine months ended September 30, 2001.

In the first nine months of 2002 and 2001, the Company purchased from Westar Industries $83.9 million and $66.1 million face value of the Company’s bonds for $66.8 million and $45.2 million, respectively.  These bonds were purchased at Westar Industries’ cost which approximated fair value.  As a result of these transactions, a gain of $16.6 million and $20.6 million was recognized in the first nine months of 2002 and 2001, respectively.

During the first nine months in 2002 the Company acquired in open market purchases approximately $41.2 million of Westar Energy 6.25% notes, approximately $21.6 million of Westar Energy 6.875% notes and approximately $4.6 million of Westar Energy 7.125% notes.  All of these notes were subsequently sold at cost to Westar Energy prior to September 30, 2002. During the first nine months in 2002 the Company acquired in open market purchases approximately $12.6 million of Westar Energy common stock and approximately $1.8 million of Westar Energy preferred stock. At September 30, 2002, the Company held 850,000 shares of Westar Energy common stock at a cost of approximately $13.2 million and 34,213 shares of Westar Energy preferred stock at a cost of approximately $2.0 million for a combined cost of approximately $15.2 million which is reflected in the equity section of the Company’s balance sheet.  During the first nine months of 2002, the Company received dividends of approximately $0.1 million and $0.2 million on Westar Energy preferred stock and common stock, respectively.  The dividends are recorded as a reduction in basis in Westar Energy equity securities.  The Company’s board of directors has authorized the purchase of up to an additional  $16.9 million in Westar Energy debt and equity securities.

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In the second quarter of 2002, the Company exercised its option to buy an office building located in downtown Wichita, Kansas, from Kansas Gas and Electric Company, a wholly owned subsidiary of Westar Energy, for approximately $0.5 million.

On June 21, 2001, the Company entered into an amendment to the Contribution Agreement dated as of July 30, 1997 between the Company and Westar Energy.  This amendment permitted Westar Energy’s beneficial ownership of the Company’s outstanding common stock to exceed 85% provided that its beneficial ownership on a fully diluted basis does not exceed 81% of the outstanding shares. In March, 2002 the Company and Westar Energy entered into a Consent and Limited Waiver Agreement whereby the Company consented to Westar’s ownership interest in the Company exceeding the ceiling set forth in the amended Contribution Agreement for the period commencing on March 11, 2002 and ending on July 1, 2002. On July 1, 2002, the Company and Westar entered into a second Consent and Limited Waiver Agreement whereby the Company consented to Westar’s ownership interest in the Company exceeding the ceiling for the period commencing on July 1, 2002 and ending on March 31, 2003. The amendment to the Contribution Agreement and the Consent and Limited Waiver Agreements were each approved by the Company’s continuing directors as required by the terms of the Contribution Agreement.

The Company had a receivable balance of $24.3 million and $1.7 million at September 30, 2002 and December 31, 2001, respectively, relating to a tax sharing agreement with Westar Energy.   In February 2002, the Company received $1.7 million from Westar Energy for payment of the tax receivable at December 31, 2001. See Note 10 for further discussion relating to income taxes.

Westar Energy provides administrative services at cost to the Company pursuant to services agreements, including accounting, tax, audit, human resources, legal, purchasing and facilities services.  Charges of approximately $0.6 million and $3.6 million were incurred for the three and nine months ended September 30, 2002, compared to charges of approximately $2.4 million and $6.7 million for the three and nine months ended September 30, 2001.  The Company had a net intercompany balance due to Westar Energy primarily for these services of $3.9 million and $1.7 million at September 30, 2002 and December 31, 2001, respectively.

In November 2001, the Company entered into an agreement pursuant to which it pays to Westar Industries, beginning with the quarter ended March 31, 2002, a financial advisory fee, payable quarterly, equal to 0.125% of the Company’s consolidated total assets at the end of each quarter.  The Company incurred $1.3 million and $4.0 million of expense for the three months and nine months ended September 30, 2002, respectively for the financial advisory fee which is included in general and administrative expenses on the income statement.  The Company paid the second quarter fee of $1.3 million to Westar Industries in the third quarter and will pay the third quarter fee of $1.3 million in the fourth quarter.

On June 5, 2002, the Company acquired the stock of a wholly owned subsidiary of Westar Industries named Westar Aviation, Inc. for approximately $1.4 million.  The Company subsequently changed the name of the newly acquired corporation to AV ONE, Inc. (“AV ONE”) and entered into an Aircraft Reimbursement Agreement with Westar Industries.  Under this agreement, Westar Industries agrees to reimburse AV ONE for certain costs and expenses relating to its operations.   Through September 30, 2002, AV One incurred approximately $1.4 million in expenses for which the Company received reimbursement from Westar Industries in October 2002.

On September 17, 2002, Westar Energy was served with a federal grand jury subpoena by the United States Attorney’s Office concerning, among other things, the use of aircraft leased by our parent, Westar Industries, and by AV ONE.  Since that date, the United States Attorney’s Office has served additional information requests on Westar Energy and certain of its personnel.  The Company is cooperating with Westar Energy in connection with such requests.

In June 2002, the Company formed a wholly owned subsidiary named Protection One Data Services, Inc. (“PODS”) and on July 1, 2002 transferred to it approximately 42 of its Information Technology employees.   Effective July 1, 2002, PODS entered into an outsourcing agreement with Westar Energy pursuant to which PODS provides Westar Energy information technology services.  As a condition of the agreement, PODS offered employment to approximately 100 Westar Energy Information Technology employees.  PODS performs the information technology services and functions for a fixed annual fee of $20.9 million subject to adjustment.  No assets were transferred to PODS, but PODS has access to Westar Energy’s equipment, software and facilities to provide the information technology services.  The term of the outsourcing agreement expires December 31, 2005, subject to the right of either party to terminate the agreement on six months prior written notice, provided that notice of termination may not be given prior to June 30, 2003.  As of September 30, 2002, the Company’s Data Services segment recorded revenues of $5.8 million and cost of revenues of $4.8 million.

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On November 8, 2002, the Kansas Corporation Commission issued an Order which requires Westar Energy to initiate a corporate and financial restructuring, reverse specified accounting transactions described in the Order, review, improve and/or develop, where necessary, methods and procedures for allocating costs between utility and non-utility businesses for KCC approval, refrain from any action that would result in its electric businesses subsidizing non-utility businesses, reduce outstanding debt giving priority to reducing utility debt and pending the corporate and financial restructuring imposes limitations on Westar Energy’s ability to finance non-utility businesses such as ours. Westar Energy must charge interest to non-utility affiliates at the incremental costs of their debt. In addition, the Order suggests that the sale by Westar Energy of the Company’s stock should be explored, along with other alternatives, as a possible source of cash to be used to reduce Westar Energy debt.  Westar Energy has a period of 90 days from the date of the Order to submit a plan for such corporate restructuring, although other provisions of the Order take effect immediately or within 30 days.

Among the provisions of the Order effective immediately is one which requires Westar Energy to seek the approval of the KCC before Westar Energy makes any loan to, investment in or transfer of cash to a non-utility affiliate in an amount in excess of $100,000. The Company does not believe this provision prohibits the Company from borrowing under its Senior Credit Facility with Westar Industries since the restriction applies only to Westar Energy and its Kansas Gas & Electric Company subsidiary. In addition, Westar Energy has advised the Company that Westar Energy does not believe this provision prohibits it from making payments to the Company pursuant to agreements between them, such as the outsourcing agreement and Aircraft Reimbursement Agreement discussed above, or the tax sharing agreement discussed below. Another provision effective immediately requires Westar Energy to seek the approval of the KCC before Westar Energy or any affiliate, which term includes the Company, invests more than $100,000 in existing or new non-utility business. Westar Energy has advised the Company that Westar Energy does not believe this provision prohibits the Company from making investments in its business based upon other language in the Order. This provision and others which may require Westar Industries to transfer certain assets to Westar Energy may limit the resources available to Westar Industries for funding its obligations under the Company’s Senior Credit Facility. See Note 6 above. Westar Energy has advised the Company that Westar Energy intends to file a motion for reconsideration or clarification of these and possibly other provisions, of the Order.

The Company and Westar Energy are in the process of reviewing and assessing the Order and its potential impact, which could be material, on the Company’s operations, prospects, liquidity, borrowing costs, financial condition and financial results.  Since the Order was issued recently and the Company and Westar Energy are still assessing it, there may be additional issues arising from the Order not mentioned here, but which may have a similar impact on the Company.

8.Commitments and Contingencies:

The Company, its subsidiary Protection One Alarm Monitoring, Inc. (“Monitoring”) and certain present and former officers and directors of the Company were 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).  On August 20, 2002, the parties filed a Stipulation of Settlement which provides for, among other things, no finding of wrongdoing on the part of any of the defendants, or any other finding that the claims alleged had merit, and a $7.5 million payment to the plaintiffs, which has been fully funded by the Company’s existing insurance.  On November 4, 2002, the District Court approved the settlement and entered an Order and Final Judgment. The court certified a class for settlement purposes consisting of all persons and entities who purchased or otherwise acquired the common stock of the Company during the time period beginning and including February 10, 1998 through February 2, 2001. The Order and Final Judgment provides for, among other things, dismissal with prejudice and release of all Class members’ claims against the Company, Monitoring, and the present and former officers and directors of the Company.

In 1999, six former Protection One dealers filed a class action lawsuit against Monitoring in the U. S. District Court for the Western District of Kentucky alleging breach of contract arising out of a disagreement over the interpretation of certain provisions 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-II (filed May 21, 1999).  In September 1999, the Court granted Monitoring’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 for 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. Initially, only Masterguard Alarms proceeded with arbitration. On March 8, 2002, Masterguard’s claims against the Company were settled by the mutual agreement of the parties. On July 25, 2002, Complete Security, Inc., a dealer which was among the original plaintiffs in the Total Security Solutions court proceeding, initiated arbitration proceedings against Monitoring, alleging breach of contract, misrepresentation, consumer fraud and franchise law violations. Three other dealers, not plaintiffs in the original Total Security Solutions litigation — Sentralarms, Inc., Security Response Network, Inc. and Homesafe Security, Inc. (the latter two of which are associated with Ira R. Beer), have similar claims in arbitration pending against the Company. The Company believes it has complied with the terms of its contracts with these former dealers, and intends to aggressively defend against these claims. In the opinion of management, none of these pending dealer claims, either alone or in the aggregate, will have a material adverse effect upon the Company’s consolidated financial position or results of operations.

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Other Protection One dealers have threatened, and may bring, claims against the Company based upon a variety of theories surrounding calculations of holdback and other payments, or based on other theories of liability.  The Company believes it has materially complied with the terms of its contracts with dealers.  The Company cannot predict the aggregate impact of these potential disputes with dealers which could be material.

On August 2, 2002, Protection One Alarm Monitoring, Inc. (“Monitoring”), Westar Energy, Inc. and certain former employees of Monitoring, as well as certain third parties, were sued in the District Court of Jefferson County, Texas, by Regina Rogers, a resident of Beaumont, Texas (Case No. D167654). Ms. Rogers has asserted various claims due to casualty losses and property damage she allegedly suffered as a result of a fire to her residence. In her complaint, Ms. Rogers alleges that Protection One and certain of its employees were negligent, grossly negligent and malicious in allegedly failing to properly service and monitor the alarm system at the residence. The complaint also alleges various violations of the Texas Deceptive Trade Practices Act (“DTPA”), fraud and breach of contract. Relief sought under the complaint includes actual, exemplary and treble damages under the DTPA, plus attorneys’ fees. Although the complaint does not specify the amount of damages sought, counsel for the plaintiff has previously alleged actual damages of approximately $7.5 million. The Company believes it has adequate insurance coverage with respect to any potential liability. The Company’s primary insurance carrier is providing defense of the action, and the excess carrier is proceeding under a reservation of rights. In the opinion of management the outcome will not have a material adverse effect upon the Company’s consolidated financial position or results of operations.

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.

The Company, Westar Energy and their former independent auditor, Arthur Andersen LLP, have been advised by the Staff of the Securities and Exchange Commission that the Staff will be inquiring into the practices of the Company and Westar Energy with respect to the restatement of their first and second quarter 2002 financial statements announced in November 2002 and the related announcement that the 2000 and 2001 financial statements of the Company and Westar Energy will be reaudited.  The Company intends to cooperate with the Staff in connection with such inquiry.

9.Segment Reporting:

The Company’s reportable segments include North America, Multifamily and Data Services.  North America provides residential, commercial and wholesale security alarm monitoring services, which include sales, installation and related servicing of security alarm systems in the United States.  Multifamily provides security alarm services to apartments, condominiums and other multi-family dwellings.   Data Services provides information technology services to Protection One, Westar Energy, and Westar Industries.

The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies in the Company’s Form 10-K for the year ended December 31, 2001.  One of the financial measurements the Company uses to manage its business segments is earnings before interest, income taxes, depreciation and amortization (“EBITDA”) which we derive by adjusting income (loss) from continuing operations before income taxes by adding:  (i) interest expense  (ii) amortization of intangibles and depreciation expense, (iii) loss on impairment, (iv) other charges, (v) other income and expenses, and (vi) gain on retirement of debt as set forth in the table below.

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

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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 tables provide a calculation of EBITDA for each of the periods presented in the segment tables:

	Nine Months Ended September 30, 2002										Nine Months Ended September 30, 2001
	(Dollars in thousands)										(Dollars in thousands)
	North America			Multi- family		Data Services		Consolidated			North America			Multi- family			Data Services	Consolidated
Income (loss) from continuing operations before income taxes	$	(354,063	)	$	964	$	450	$	(352,649	)	$	(74,407	)	$	(4,879	)	—	$	(79,286	)
Plus:
Interest expense	28,317			3,908		—		32,225			34,705			5,729			—	40,434
Loss on impairment	338,104			—		—		338,104			—			—			—	—
Amortization of intangibles and depreciation expense	60,132			6,227		—		66,359			137,675			12,111			—	149,786
Other charges(a)	1,613			—		—		1,613			6,512			—			-—	6,512
Other (income) expense(b)	(667		)	—		—		(667		)	432			—			—	432
Gain on retirement of debt	(19,285		)	—		—		(19,285		)	(40,272		)	—			—	(40,272		)
EBITDA	$	54,151		$	11,099	$	450	$	65,700		$	64,645		$	12,961		—	$	77,606

	Three Months Ended September 30, 2002										Three Months Ended September 30, 2001
	(Dollars in thousands)										(Dollars in thousands)
	North America			Multi- family		Data Services		Consolidated			North America			Multi- family			Data Services	Consolidated
Income (loss) from continuing operations before income taxes	$	(10,810	)	$	917	$	450	$	(9,443	)	$	(34,285	)	$	(1,459	)	—	$	(35,744	)
Plus:
Interest expense	9,380			1,208		—		10,588			10,771			1,765			—	12,536
Amortization of intangibles and depreciation expense	20,033			2,137		—		22,170			45,876			4,076			—	49,952
Other charges(a)	1,063			—		—		1,063			1,817			—			—	1,817
Other income(b)	(785		)	—		—		(785		)	(46		)	—			—	(46		)
Gain on retirement of debt	(2,550		)	—		—		(2,550		)	(3,086		)	—			—	(3,086		)
EBITDA	$	16,331		$	4,262	$	450	$	21,043		$	21,047		$	4,382		—	$	25,429

(a)Other charges in 2002 and 2001 consist of severance, relocation and facility closure costs incurred in connection with our efforts to consolidate and improve efficiency of our monitoring facilities and branch operations and to reduce costs.

(b)Other (income) expense in 2002 and 2001 includes gain or loss on sale of assets.

	Nine Months Ended September 30, 2002
	(Dollars in thousands)
	North America(1)			Multifamily(2)		Data Services		Consolidated
Revenues	$	190,946		$	28,062	$	5,799	$	224,807
EBITDA	54,151			11,099		450		65,700
Amortization and depreciation expense	60,132			6,227		—		66,359
Loss on impairment	338,104			—		—		338,104
Severance and other expense	1,613			—		—		1,613
Operating income (loss)	(345,698		)	4,872		450		(340,376		)
Segment assets	890,368			44,134		1,205		935,707
Capital expenditures for new accounts	12,923			4,449		—		17,372

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	Nine Months Ended September 30, 2001
	(Dollars in thousands)
	North America(1)			Multifamily		Data Services	Consolidated
Revenues	$	228,952		$	26,963	—	$	255,915
EBITDA	64,645			12,961		—	77,606
Amortization and depreciation expense	137,675			12,111		149,786
Severance and other expense	6,512			—		—	6,512
Operating income (loss)	(79,542		)	850		—	(78,692		)
Segment assets	1,650,991			169,440		—	1,820,431
Capital expenditures for new accounts	14,363			4,164		—	18,527

	Three Months Ended September 30, 2002
	(Dollars in thousands)
	North America(3)			Multifamily(2)		Data Services		Consolidated
Revenues	$	62,383		$	9,637	$	5,799	$	77,819
EBITDA	16,331			4,262		450		21,043
Amortization and depreciation expense	20,033			2,137		—		22,170
Severance and other expense	1,063			—		—		1,063
Operating income (loss)	(4,765		)	2,125		450		(2,190		)
Capital expenditures for new accounts	5,001			1,368		—		6,369

	Three Months Ended September 30, 2001
	(Dollars in thousands)
	North America(3)			Multifamily		Data Services	Consolidated
Revenues	$	71,017		$	9,084	—	$	80,101
EBITDA	21,047			4,382		—	25,429
Amortization and depreciation expense	45,876			4,076		—	49,952
Severance and other expense	1,817			—		—	1,817
Operating income (loss)	(26,646		)	306		—	(26,340		)
Capital expenditures for new accounts	4,129			1,591		—	5,720

(1)  Includes allocation of holding company and corporate overhead expenses reducing EBITDA and operating income (loss) by $5.0 million and $3.9 million for the nine months ended September 30, 2002 and 2001, respectively.

(2)  Includes allocation of holding company expenses reducing EBITDA and operating income (loss) by $0.3 million and $1.1 million for the three and nine months ended September 30, 2002, respectively.

(3)  Includes allocation of holding company and corporate overhead expenses reducing EBITDA and operating income (loss) by $1.2 million and $1.2 million for the three months ended September 30, 2002 and 2001, respectively.

10.Income Taxes:

The difference between the expected annual effective rate and the federal statutory rate of 35% is primarily attributable to a tax benefit of approximately $2.7 million associated with the sale of the Canadian operations. The Company has a tax sharing agreement with Westar Energy, which allows it to be reimbursed for tax deductions utilized by Westar Energy in its consolidated tax return.  If Westar Energy were to own less than 80% of Westar Industries voting stock, or if Westar Industries were to own less than 80% of the Company’s voting stock, the Company would no longer file its tax return on a consolidated basis with Westar Energy.  As a result, a substantial portion of the Company’s net deferred tax assets of $268.4 million at September 30, 2002 would likely not be realizable and the Company would likely not be in a position to record a tax benefit for losses incurred. Accordingly, the Company would not be in a position to utilize the deferred tax asset and it would record a charge to earnings to establish a valuation allowance.  This charge could be material. See Note 7 for a discussion of the financial and corporate restructuring of Westar Energy recently ordered by the KCC.

11.Gain on retirement of debt:

The Company purchased its bonds from Westar Industries and in the open market and recognized gains on the retirement of these debt securities.  Prior to July 1, 2002, these gains were recognized as extraordinary gains.  Effective July 1, 2002, the Company adopted SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13,

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and Technical Corrections.”  This standard limits the income statement classification of gains and losses from extinguishment of debt as extraordinary to those transactions meeting the criteria of Accounting Principles Board (APB) Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.”  SFAS No. 145 prohibits treating gains and losses associated with extinguishments resulting from a company’s risk management strategy as extraordinary.  Under SFAS 145, current gains and losses from the extinguishment of debt are reported as other income.  Gains or losses in prior periods that were previously classified as extraordinary that do not meet the APB Opinion No. 30 criteria have been reclassified to other income.  The adoption of this standard did not impact the Company’s net income or financial condition.

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

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations updates the information provided in and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2001.

Overview

Protection One is a leading provider of property monitoring services, providing electronic monitoring and maintenance of alarm systems to approximately 1.1 million customers as of September 30, 2002.  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.  In July 2002, we commenced providing information technology services to Westar Energy.

Summary of Significant Matters

Net Loss.  We incurred a net loss of $86.0 million for the year ended December 31, 2001 and a net loss of $773.3 million in the first nine months of 2002.  The net loss in 2001 reflects a decline in revenues and substantial charges incurred by us for amortization of customer accounts and goodwill and interest incurred on indebtedness.   Approximately $765.2 million of the net loss in the first nine months of 2002 is related to an impairment charge as discussed below.  In addition to the impairment charge in 2002, this net loss reflects a decline in revenue, substantial charges incurred by us for amortization of customer accounts, and interest incurred on indebtedness.  We do not expect to have earnings in the foreseeable future.

Kansas Corporation Commission Order.  On November 8, 2002, the Kansas Corporation Commission issued an Order which requires Westar Energy to initiate a corporate and financial restructuring, reverse specified accounting transactions described in the Order, review, improve and/or develop, where necessary, methods and procedures for allocating costs between utility and non-utility businesses, refrain from any action that would result in its electric businesses subsidizing non-utility businesses for KCC approval, reduce outstanding debt giving priority to reducing utility debt and pending the corporate and financial restructuring imposes limitations on Westar Energy’s ability to finance non-utility businesses such as ours. Westar Energy must charge interest to non-utility affiliates at the incremental costs of their debt. In addition, the Order suggests that the sale by Westar Energy of our stock should be explored, along with other alternatives, as a possible source of cash to be used to reduce Westar Energy debt. Westar Energy has a period of 90 days from the date of the Order to submit a plan for such corporate restructuring, although other provisions of the Order take effect immediately or within 30 days. 

Among the provisions of the Order effective immediately is one which requires Westar Energy to seek the approval of the KCC before Westar Energy makes any loan to, investment in or transfer of cash to a non-utility affiliate in an amount in excess of $100,000. We do not believe this provision prohibits us from borrowing under our Senior Credit Facility with Westar Industries since the restriction applies only to Westar Energy and its Kansas Gas & Electric Company subsidiary. In addition, Westar Energy has advised us that Westar Energy does not believe this provision prohibits it from making payments to us pursuant to agreements between us, such as the outsourcing agreement and Aircraft Reimbursement Agreement discussed in Note 7 of the Notes to the Consolidated Financial Statements, or the tax sharing agreement discussed in Note 10 of the Notes to the Consolidated Financial Statements. Another provision effective immediately requires Westar Energy to seek the approval of the KCC before Westar Energy or any affiliate, which term includes us, invests more than $100,000 in an existing or new non-utility business. Westar Energy has advised us that Westar Energy does not believe this provision prohibits us from making investments in our business based upon other language in the Order. This provision and others which may require Westar Industries to transfer certain assets to Westar Energy may limit the resources available to Westar Industries for funding its obligations under our Senior Credit Facility. See Note 6 of the Notes to the Consolidated Financial Statements. Westar Energy has advised us that Westar Energy intends to file a motion for reconsideration or clarification of these and possibly other provisions, of the Order.

We and Westar Energy are in the process of reviewing and assessing the Order and its potential impact, which could be material, on our operations, prospects, liquidity, borrowing costs, financial condition and financial results.  Since the Order was issued recently and we and Westar are still assessing it, there may be additional issues arising from the Order not mentioned here, but which may have a similar impact on us.  A copy of the KCC Order has been filed as an exhibit to this report.

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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 us 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 customer accounts.  If the undiscounted cash flow stream from 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 remaining life of customer accounts for impairment evaluation purposes.

To implement the new standards, we engaged an appraisal firm to help management estimate the fair values of goodwill and customer accounts.  Based on this analysis, we recorded a non-cash net charge of approximately $765.2 million in the first quarter of 2002.  The charge is detailed as follows:

	Goodwill			Customer			Total
	(in millions)
North America Segment:
Impairment charge - continuing operations	$	509.4		$	338.1		$	847.5
Impairment charge - discontinued operations	2.3			1.9			4.2
Estimated income tax benefit	(65.1		)	(118.4		)	(183.5		)
Net charge	$	446.6		$	221.6		$	668.2
Multifamily Segment:
Impairment charge	$	104.2		$	—		$	104.2
Estimated income tax benefit	(7.2		)	—			(7.2		)
Net charge	$	97.0		$	—		$	97.0
Total Company:
Impairment charge	$	615.9		$	340.0		$	955.9
Estimated income tax benefit	(72.3		)	(118.4		)	(190.7		)
Net charge	$	543.6		$	221.6		$	765.2

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

We are no longer permitted to amortize goodwill to income because of the adoption of SFAS No. 142.  The following table reflects our results for the three and nine months ended September 30, 2001, calculated using the new accounting standard for goodwill, compared to our results for the three and nine months ended September 30, 2002.

	Nine Months ended September 30,
	2002			2001
	(in thousands, except per share amounts)
Reported net loss	$	(773,290	)	$	(64,746	)
Add back: Goodwill amortization	—			32,277
Adjusted net loss	$	(773,290	)	$	(32,469	)
Basic earnings per share:
Reported net loss	$	(7.88	)	$	(0.60	)
Add back: Goodwill amortization	—			0.30
Adjusted net loss	$	(7.88	)	$	(0.30	)

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	Three Months ended September 30,
	2002			2001
	(in thousands, except per share amounts)
Reported net loss	$	(6,061	)	$	(25,154	)
Add back: Goodwill amortization	—			10,661
Adjusted net loss	$	(6,061	)	$	(14,493	)
Basic earnings per share:
Reported net loss	$	(0.06	)	$	(0.25	)
Add back: Goodwill amortization	—			0.11
Adjusted net loss	$	(0.06	)	$	(0.14	)

Goodwill will be required to be tested each year for impairment. We have established July 1 as our annual impairment testing date.  We completed this testing during the third quarter of 2002 and determined that no additional impairment is required as of July 1, 2002. We will be required to perform impairment tests for long-lived assets prospectively if we incur recurring losses in excess of expectations or for other matters that may negatively impact our business.  Declines in market values of our business or the value of our customer accounts that may be incurred prospectively may also require additional impairment charges. Any such impairment charges could be material.

Securities and Exchange Commission Inquiry.  We, Westar Energy and our former independent auditor, Arthur Andersen LLP, have been advised by the Staff of the Securities and Exchange Commission that the Staff will be inquiring into the practices of us and Westar Energy with respect to the restatement of our first and second quarter 2002 financial statements announced in November 2002 and the related announcement that the 2000 and 2001 financial statements of us and Westar Energy will be reaudited.  We intend to cooperate with the Staff in connection with such inquiry.

Estimated Lives of Customer Accounts Changed Based on Customer Account Lifing Study Results.  The results of a lifing study performed by a third party appraisal firm in the first quarter of 2002 showed a deterioration in the average remaining life of customer accounts.  The report showed our North America customer pool can expect a declining revenue stream over the next 30 years with an estimated average remaining life of 9 years.  Our Multifamily pool can expect a declining revenue stream over the next 30 years with an estimated average remaining life of 10 years.  Taking into account the results of the lifing study, we adjusted the amortization of customer accounts for our North America and Multifamily customer pools to better match the rate and period of amortization expense with the expected decline in revenues.  In the first quarter of 2002, we changed our amortization rate for our North America pool to a 10-year 135% declining balance method from a 10-year 130% declining balance method.  For the Multifamily pool we reduced our estimated customer life from 10 to 9 years and will continue to amortize on a straight-line basis.  We account for these amortization changes prospectively as a change in estimate.  These changes in estimates increased amortization expense for the three and nine months ended September 30, 2002 on a pre-tax basis by approximately $0.3 million and $1.0 million, respectively and on an after tax basis by approximately $0.2 million and $0.6 million, respectively.  The change in estimate had no significant impact on reported earnings per share.

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Discontinued Operations – Sale of Canadian Operations.  During the second quarter of 2002 we entered into negotiations for the sale of our Canadian business which was included in our North American segment.  The sale was consummated on July 9, 2002.  We recorded a pretax impairment loss of approximately $2.0 million and an after tax loss of approximately $1.3 million in the second quarter of 2002 as a result of the sale.

The net operating losses of these operations are included in the consolidated statements of operations under “discontinued operations.”  The net operating loss for the nine months ended September 30, 2002 of $1.6 million includes an impairment loss on customer accounts of approximately $1.9 million.   An impairment charge of $2.3 million relating to the Canadian operations’ goodwill is reflected in the consolidated statement of operations as a cumulative effect of accounting change on discontinued operations.  No revenue from these operations was recorded in the three months ended September 30, 2002.  Revenues from these operations were $4.2 million for the nine months ended September 30, 2002, compared to $2.1 million and $6.3 million for the three and nine months ended September 30, 2001.

The major classes of assets and liabilities of the Canadian operations are as follows (in thousands):

	December 31, 2001
Assets:
Current	$	478
Property and equipment	571
Customer accounts, net	16,992
Goodwill	4,842
Other	55
Total assets	$	22,938
Current liabilities	$	1,364

Potential write down of deferred tax assets. We have a tax sharing agreement with Westar Energy which allows us to be reimbursed for tax deductions utilized by Westar Energy in its consolidated tax return.  If Westar Energy 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 our tax return on a consolidated basis with Westar Energy.  As a result, a substantial portion of our net deferred tax assets of $268.4 million at September 30, 2002 would likely not be realizable and we would likely not be in a position to record a tax benefit for losses incurred. Accordingly, 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.

Amendments to the Senior Credit Facility.  Our Senior Credit facility with Westar Industries has been amended to increase the capacity from $155 million to $280 million during the first nine months of 2002.  On August 26, 2002 the Senior Credit Facility was further amended to extend the maturity date to January 5, 2004.  We incurred amendment fees totaling $2.4 million for these amendments.  At November 8, 2002, we had outstanding borrowings of $215.5 million and $64.5 million of remaining capacity.

Retirement of Additional Debt.   In the first nine months of 2002, we purchased at cost, which approximated fair value, $83.9 million face value of our bonds from Westar Industries and $18.9 million face value of our bonds in the open market for a total of $82.9 million.  As a result of these transactions, we recognized a gain of $19.3 million.

Prior to July 1, 2002, these gains were recognized as extraordinary gains.  Effective July 1, 2002, we adopted SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.”  This standard limits the income statement classification of gains and losses from extinguishment of debt as extraordinary to those transactions meeting the criteria of Accounting Principles Board (APB) Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.”  SFAS No. 145 prohibits treating gains and losses associated with extinguishments resulting from a company’s risk management strategy as extraordinary.  Under SFAS 145, current gains and losses from the

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extinguishment of debt are reported as other income.  Gains or losses in prior periods that were previously classified as extraordinary that do not meet the APB Opinion No. 30 criteria have been reclassified to other income.  The adoption of this standard did not impact our net income or financial condition.

Share Repurchase. In the first quarter of 2002, we purchased 1,000,000 shares of our common stock in the open market for $2.2 million. As of November 8, 2002, we had authority from our board of directors to purchase an additional approximately 8.2 million shares of our common stock.

Customer Creation and Marketing.   For the three and nine months ended September 30, 2002, our North America segment added 12,660 and 33,606 accounts, respectively, although our net number of accounts decreased by 11,407 and 45,090 accounts, respectively. For the three and nine months ended September 30, 2001, our North America segment added 11,223 and 37,520 accounts, respectively, and our net number of accounts decreased by 34,597 and 119,620 accounts, respectively.  Multifamily added 6,607 and 18,989 accounts for the three and nine months ended September 30, 2002, respectively, with its net number of accounts increasing by 1,331 and 3,330 accounts for the three and nine months ended September 30, 2002, respectively.  For the three and nine months ended September 30, 2001, Multifamily added 8,111 and 28,198 accounts, respectively, and its net number of accounts increasing by 3,204 accounts and 14,562 accounts, respectively.

Our current customer acquisition strategy for our North America segment relies primarily on internally generated sales.  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 32,715 accounts and 34,067 accounts in the nine months ended September 30, 2002 and 2001, 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 all 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 revenues.

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.

Recurring monthly revenue.  A common measure of value in the alarm industry is recurring monthly revenue (“RMR”), as alarm companies are generally valued at multiples of RMR. RMR represents the amount of revenue under contract at a given point in time for monitoring and service. As of September 30, 2002 the North America RMR excluding wholesale accounts was approximately $17.6 million and the Multifamily RMR was approximately $2.8 million.

Attrition.  Subscriber attrition has a direct impact on our results of operations since it affects our revenues, amortization expense and cash flow.  We define attrition as a ratio, the numerator of which is the gross number of lost customer accounts for a given period, net of certain adjustments, and the denominator of which is the average number of accounts for a given period.  In some instances, we use estimates to derive attrition data.  We make adjustments to lost accounts primarily for the net change, either positive or negative, in our wholesale base and for accounts which are covered under a purchase price holdback and are “put” back to the seller.  We reduce the gross accounts lost during a period by the amount of the guarantee provided for in the purchase agreements with sellers.  In some cases, the amount of the purchase holdback may be less than actual attrition experience.

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.

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

Customer attrition by business segment for the three months ended September 30, 2002 and 2001 is summarized below:

	Customer Account Attrition
	September 30, 2002				September 30, 2001
	Annualized Third Quarter		Trailing Twelve Month		Annualized Third Quarter		Trailing Twelve Month
North America(1)	11.8	%	14.9	%	19.7	%	17.0	%
Multifamily	6.4	%	6.7	%	6.1	%	5.9	%
Total Company	10.2	%	12.6	%	16.2	%	14.4	%

(1)  Excludes Canadian operations which were sold in July 2002.

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, customer accounts, goodwill, income taxes, 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 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” of our 2001 Form 10-K 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 and Expense Recognition. Revenues are recognized when security services are provided.  Installation revenue, sales revenues on equipment upgrades, direct costs of installations and direct and incremental selling costs 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, which is a 10 year period, utilizing a 135% accelerated method for North America and a 9 year period, utilizing a straight line method for Multifamily.  To the extent deferred costs are less than deferred revenues, such costs are also recognized over the customers’ estimated useful life.  Deferred costs in excess of deferred revenues will be recognized on a straight line method over the contract life, usually 3 years for North America and 5 to 10 years for Multifamily.  The table below reflects the impact of

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this accounting policy on the respective line items of the Statement of Operations for the nine months ended September 30, 2002.  The “Total Amount Incurred” column represents the current amount of billings that were made and the current costs that were incurred for the period.  We then subtract the deferral amount and add back the amortization of previous deferral amounts to determine the amount we report in the Statement of Operations.

	Total Amount Incurred		North America			Multifamily			Accrual Amount Per Statement Of Operations
			Deferral Amount		Amortization Amount	Deferral Amount		Amortization Amount
	(dollars in thousands)
Revenues - Other	$	24,635	(11,859	)	1,632	(465	)	53	$	13,996
Cost of Revenues - Other	$	19,397	(6,188	)	551	(476	)	58	$	13,342
Selling Expense	$	25,602	(9,591	)	1,290	(27	)	2	$	17,276

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 and Amortization of Customer Account Intangible Assets.These assets are tested for impairment as circumstances warrant.  Factors we consider important that could trigger an impairment review include the following:

•high levels of customer attrition;

•continuing recurring losses in excess of expectations; 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 the asset groups associated with the customer accounts and the fair value of customer accounts is less than the carrying value.  See “Impairment Charge Pursuant to New Accounting Rules” for a more complete discussion of our policy and of the impairment recorded on these assets in the first quarter of 2002 pursuant to the adoption of new accounting rules.

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:

Pool	Method
North America
-Acquired Westinghouse Customers	Eight-year 120% declining balance
-Other Customers	Ten-year 135% declining balance
Multifamily	Nine-year straight-line

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.

Operating Results

We separate our business into three reportable segments: North America, Multifamily, and Data Services.  North America provides security alarm monitoring services, which include sales, installation and related servicing of security alarm systems.

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As discussed above, we sold our Canadian operations in July 2002 which previously had been included in our North America segment.  We are therefore excluding the impact of the Canadian operations in the following analyses.  Multifamily provides security alarm services to apartments, condominiums and other multi-family dwellings.   Data Services provides information technology services to Westar Energy.

Nine Months Ended September 30, 2002 Compared to Nine Months Ended September 30, 2001

Protection One Consolidated

Revenues decreased approximately $31.1 million primarily due to the decline in our customer base.  Cost of revenues decreased approximately $7.9 million and general and administrative costs decreased approximately $15.4 million primarily due to the consolidation of our call centers, downsizing efforts and other cost reduction initiatives.  Selling costs increased approximately $4.1 million primarily due to increased efforts to generate new customers through our internal sales force. Interest expense decreased by approximately $8.2 million primarily due to a reduction in debt.

North America Monitoring Segment

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

	Nine Months Ended September 30,
	2002					2001
	(dollars in thousands)
Revenues:
Monitoring and related services	$	177,247		92.8	%	$	218,841		95.6	%
Other	13,699			7.2		10,111			4.4
Total revenues	190,946			100.0		228,952			100.0
Cost of revenues:
Monitoring and related services	53,686			28.1		70,153			30.6
Other	12,971			6.8		9,364			4.1
Total cost of revenues	66,657			34.9		79,517			34.7
Gross profit	124,289			65.1		149,435			65.3
Selling expense	15,717			8.2		11,738			5.1
General and administrative expense	54,421			28.5		73,052			31.9
Amortization and depreciation expense	60,132			31.5		137,674			60.1
Severance and other expense	1,613			0.8		6,512			2.9
Loss on impairment	338,104			177.1		—			0.0
Operating income (loss)	$	(345,698	)	(181.0	)%	$	(79,541	)	(34.7	)%

2002 Compared to 2001.  We had a net decrease of 45,090 customers in the first nine months of 2002, as compared to a net decrease of 119,620 customers in the first nine months of 2001.  Further analysis of the change in the North American account base between the two periods is shown in the table below.  The “Conversion adjustments” line item reflects the impact on the calculation of our customer base from the conversion of our Wichita, Hagerstown, 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.

Our customer base will continue to decline until our programs to acquire and create new accounts generate the volume of accounts required to equal or exceed those lost due to attrition.  We are also investing considerable effort to reduce attrition.  While net losses have decreased significantly, until we achieve equilibrium between additions and attrition, net losses of customer

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accounts will materially and adversely affect our business, financial condition and results of operations. We are currently focused on reducing attrition, developing cost effective marketing programs, and generating positive cash flow.

	Nine Months Ended September 30,
	2002		2001
Beginning Balance, January 1	806,774		1,023,023
Additions	33,606		37,520
Conversion adjustments	—		(15,180	)
Customer losses from dispositions	—		(9,440	)
Customer losses not guaranteed with holdback put backs	(75,504	)	(122,427	)
Customer losses guaranteed with holdback put backs and other	(3,192	)	(10,093	)
Ending Balance, September 30	761,684		903,403

Monitoring and related services revenues decreased approximately $41.6 million in the first nine months of 2002 as compared to the first nine months of 2001 primarily due to the decline in our customer base. These revenues consist primarily of contractual revenue derived from providing monitoring and maintenance service.

Other revenues increased in the first nine months by $3.6 million or 35.5% to $13.7 million in 2002 from $10.1 million in 2001 primarily due to the completion in 2002 of large system integration projects that were commenced or sold in late 2001. These revenues consist primarily of sales of burglar alarms, closed circuit televisions, fire alarms and card access control systems to commercial customers.

Cost of monitoring and related services revenues for the first nine months of 2002 decreased by $16.5 million, or 23.5%, to $53.7 million from $70.2 million for the first nine months of 2001. 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 a reduction of telecommunication costs and wage expense associated with the consolidation of our call centers and other cost reduction initiatives.  Costs of monitoring and related services revenues as a percentage of the related revenues decreased to 30.3% in the first nine months of 2002 from 32.1% in the first nine months of 2001.  This improvement arises from the percentage reduction in monitoring and related costs exceeding the percentage reduction in related revenues.

Cost of other revenues increased by $3.6 million from $9.4 million in the first nine months of 2001 to $13.0 million in the first nine months of 2002 primarily due to the completion in 2002 of large system integration projects that were commenced or sold in late 2001 and resulted in little or no profit margin. These costs consist primarily of equipment and labor charges to install alarm systems, closed circuit televisions, fire alarms and card access control systems sold to our customers.  These costs as a percentage of other revenues were approximately 94.7% for the first nine months of 2002 as compared to approximately 92.6% for the first nine months of 2001.

Selling expenses increased $4.0 million or 33.9% to $15.7 million in the first nine months of 2002 from $11.7 million in 2001.  The increase is due to our increased efforts to generate new customers through an internal sales force.

General and administrative expenses decreased $18.6 million or 25.5% from $73.0 million to $54.4 million in the first nine months of 2002.  The decrease is generally comprised of reductions in outside services primarily due to completion of special software projects and a reduction in wages and related benefits due to a reduction in workforce.  Other decreases include a reduction in professional fees, collection agency expense, rents and telecommunication expense.  These decreases are partially offset by a $4.0 million expense for a management fee to Westar Industries beginning in 2002.  As a percentage of total revenues, general and administrative expenses decreased to 28.5% for the first nine months of 2002 from 31.9% for the first nine months of 2001 because the percentage reduction in these costs exceeded the percentage decline in revenues.

Amortization and depreciation expense for the first nine months of 2002 decreased by $77.6 million, or 56.3%, to $60.1 million from $137.7 million. This decrease reflects a reduction in subscriber amortization of $48.1 million primarily related to the

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impairment charge and a decrease in goodwill amortization of $29.3 million due to implementation of SFAS No. 142.  The remaining $0.2 million decrease is from depreciation expense.

Severance and other expense decreased $4.9 million, or 75.2%, from $6.5 million to $1.6 million in the first nine months of 2002.  This expense for 2002 consisted primarily of severance and relocation costs related to the consolidation of our monitoring operations.  This expense for 2001 is primarily for severance charges incurred in the closing of our Beaverton and Hagerstown customer service centers, the reduction of 180 positions, the discontinuation of the National Accounts and Patrol divisions and the relocation of certain departments, as well as other costs incurred with the closure of facilities.

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 you can make comparisons about the relative change in revenues and expenses.

	Nine Months Ended September 30,
	2002				2001
	(dollars in thousands)
Revenues:
Monitoring and related services	$	27,765	98.9	%	$	26,428	98.0	%
Other	297		1.1		535		2.0
Total revenues	28,062		100.0		26,963		100.0
Cost of revenues:
Monitoring and related services	6,321		22.5		5,981		22.2
Other	371		1.3		546		2.0
Total cost of revenues	6,692		23.8		6,527		24.2
Gross profit	21,370		76.2		20,436		75.8
Selling expense	1,559		5.6		1,411		5.2
General and administrative expenses	8,712		31.0		6,064		22.5
Amortization and depreciation expense	6,227		22.2		12,111		44.9
Operating income	$	4,872	17.4	%	$	850	3.2	%

2002 Compared to 2001.  We had a net increase of 3,330 customers in the first nine months of 2002 as compared to a net increase of 14,562 customers in 2001.  The average customer base was 328,214 for the first nine months of 2002 compared to 315,238 for the first nine months of 2001.  The change in Multifamily’s customer base for the period is shown below.

	Nine Months Ended September 30,
	2002		2001
Beginning Balance, January 1,	326,549		307,957
Additions, net of holdback put backs	18,989		28,198
Customer losses, net of holdback put backs	(15,659	)	(13,636	)
Ending Balance	329,879		322,519
Annualized Attrition	6.4	%	5.8	%

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Monitoring and related services revenues were $27.8 million in 2002 compared to $26.4 million in 2001. This 5.1% increase was primarily the result of an increase in the average customer base of 4.1% and increased repair billings and contract buyouts.  This increase was partially offset by a decline in our recurring monthly revenue (“RMR”) per customer primarily due to an increasing number of renewals which provide for significant extensions at a reduced RMR.

Other revenues decreased slightly to $0.3 million in 2002 from $0.5 million in 2001 primarily due to a decrease in outright sales of access control systems.

Cost of monitoring and related services revenues for the first nine months of 2002 increased $0.3 million to $6.3 million in 2002 from $6.0 million in 2001.  This 5.7% increase is primarily the result of the increase in the subscriber base and increased field service costs.

Cost of other revenues decreased by $0.1 million, or 32.1% to $0.4 million from $0.5 million in 2001 due to the decline in outright sales of access control systems.

Selling expense in 2002 increased slightly to $1.6 million from $1.4 million in 2001.  This increase is primarily due to an increase in the sales force.

General and administrative expenses for the first nine months of 2002 increased $2.6 million to $8.7 million from $6.1 million in 2001.  This 43.7% increase is primarily due to the allocation of holding company expenses which were not allocated in 2001 until the fourth quarter, the deferral of certain costs in 2001 and increased facility and insurance costs offset by lower professional fees.

Amortization and depreciation expense for 2002 decreased by $5.9 million, or 48.6%, to $6.2 million from $12.1 million in 2001.  This decrease is due to the elimination of goodwill amortization totaling $7.2 million resulting from a change in accounting principle offset by an increase in subscriber amortization resulting from a change in estimate of the subscriber life from 10 years to 9 years and the increasing customer base being amortized.

Data Services Segment

In June 2002, the Company formed a wholly owned subsidiary named Protection One Data Services, Inc. (“PODS”) and on July 1, 2002 transferred to it approximately 42 of its Information Technology employees.   Effective July 1, 2002, PODS entered into an outsourcing agreement with Westar Energy pursuant to which PODS provides Westar Energy information technology services.  As a condition of the agreement, PODS offered employment to approximately 100 Westar Energy Information Technology employees.  PODS performs the information technology services and functions for a fixed annual fee of $20.9 million subject to adjustment.  No assets were transferred to PODS, but PODS has access to Westar Energy’s equipment, software and facilities to provide the information technology services.  The term of the outsourcing agreement expires December 31, 2005, subject to the right of either party to terminate the agreement on six months prior written notice, provided that notice of termination may not be given prior to June 30, 2003.  As of September 30, 2002, Data Services recorded revenues of $5.8 million and cost of revenues of $4.8 million.

Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001

Protection One Consolidated

Monitoring and related services revenues decreased approximately $10.2 million for the three months ended September 30, 2002 compared to the three months ended September 30, 2001 primarily due to the decline in our customer base.  This decrease in monitoring revenue was partially offset by a $2.2 million increase in other revenue and the addition of $5.8 million of revenue from our Data Services segment resulting in a decrease in total revenues of $2.3 million.  Cost of monitoring and related services revenues decreased approximately $2.5 million primarily due to the consolidation of our call centers.  Total cost of revenues increased $4.0 million due to an increase in outright sales of equipment and the addition of our Data Services segment.  General and administrative costs decreased approximately $4.6 million due to downsizing efforts and other cost reduction initiatives.  Selling costs increased approximately $2.7 million primarily due to increased efforts to generate new customers through our internal sales force.  Interest expense decreased by approximately $1.9 million primarily due to a reduction in debt.

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North America Monitoring Segment

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

	Three Months Ended September 30,
	2002					2001
	(dollars in thousands)
Revenues:
Monitoring and related services	$	57,325		91.9	%		$	68,152		96.0	%
Other	5,058			8.1			2,865			4.0
Total revenues	62,383			100.0			71,017			100.0
Cost of revenues:
Monitoring and related services	17,547			28.1			20,005			28.2
Other	4,750			7.6			3,055			4.3
Total cost of revenues	22,297			35.7			23,060			32.5
Gross profit	40,086			64.3			47,957			67.5
Selling expense	5,952			9.5			3,357			4.7
General and administrative expense	17,803			28.6			23,553			33.2
Amortization and depreciation expense	20,033			32.1			45,876			64.6
Severance and other expense	1,063			1.7			1,817			2.6
Operating income (loss)	$	(4,765	)	(7.6	)%		$	(26,646	)	(37.6	)%

2002 Compared to 2001.   We had a net decrease of 11,407 customers in the third quarter of 2002 as compared to a net decrease of 34,597 customers in the third quarter of 2001. Further analysis of the change in the North American account base between the two periods is shown in the table below.  The “Conversion adjustments” line item reflects the impact on the calculation of our customer base from the conversion of our Irving monitoring and billing system to MAS®.  These conversion adjustments relate to how a customer is defined and the transition of that definition from one system to another.

Our customer base will continue to decline until our programs to acquire and create new accounts generate the volume of accounts required to equal or exceed those lost due to attrition.  We are also investing considerable effort to reduce attrition.  While net losses have decreased significantly, until we achieve equilibrium between additions and attrition, net losses of customer accounts will materially and adversely affect our business, financial condition and results of operations. We are currently focused on reducing attrition, developing cost effective marketing programs, and generating positive cash flow.

	Three Months Ended September 30,
	2002		2001
Beginning Balance, July 1	773,091		938,000
Additions	12,660		11,223
Conversion adjustments	—		(2,968	)
Customer losses not guaranteed with holdback put backs	(22,676	)	(45,423	)
Customer losses guaranteed with holdback put backs and other	(1,391	)	2,571
Ending Balance, September 30	761,684		903,403
Annualized quarterly attrition	11.8	%	19.7	%

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Monitoring and related services revenues decreased approximately $10.8 million or 15.9% in the third quarter of 2002 compared to the third quarter of 2001.  This is primarily due to the decline in our customer base.

Other revenues consist primarily of revenues generated from our internal installations of new alarm systems. These revenues increased $2.2 million or 76.5% in the third quarter of 2002 compared to the third quarter of 2001.

Cost of monitoring and related services revenues for the third quarter of 2002 decreased by $2.5 million, or 12.3%, to $17.5 million from $20.0 million for the third quarter of 2001. 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 a reduction of telecommunication costs and wage expense associated with the consolidation of our call centers and other cost reduction initiatives.  Costs of monitoring and related services revenues as a percentage of the related revenues increased to 30.6% in the third quarter of 2002 from 29.4% in the third quarter of 2001.

Cost of other revenues increased $1.7 million to $4.7 million or 55.5% for the third quarter of 2002 compared to the third quarter of 2001.

Selling expenses increased $2.6 million from $3.4 million in the third quarter of 2001 to $6.0 million in the third quarter of 2002.  The increase is generally due to an increase in the internal sales force and the resulting increase in sales commissions, wages and benefits, and support costs.

General and administrative expenses decreased $5.8 million from $23.6 million in the third quarter of 2001 to $17.8 million in the third quarter of 2002. The decrease in 2002 is comprised generally of a $1.8 million decrease in outside services primarily relating to the conversion of our billing and monitoring systems, and a $1.5 million reduction in wages and related benefits.  Other decreases include a reduction in professional fees, rents, corporate advertising, bad debts, telecommunication, and other general expense. These decreases were partially offset by a $1.3 million expense for the third quarter of 2002 related to the financial advisory fee to Westar Industries and an increase in our directors’ and officers’ insurance premiums.  As a percentage of total revenues, general and administrative expenses decreased in the third quarter of 2002 compared to the third quarter of 2001 because the percentage reduction in these costs exceeded the percentage decline in revenues.

Amortization and depreciation expense for the third quarter of 2002 decreased by $25.9 million, or 56.3%, to $20.0 million from $45.9 million in the third quarter of 2001.  This decrease reflects a reduction in subscriber amortization expense of $16.0 million related to the impairment charge and a $9.7 million decrease in goodwill amortization due to the implementation of SFAS No. 142.  The remaining decrease of $0.2 million is attributable to depreciation.

Severance and other expense decreased $0.7 million in the third quarter of 2002 to $1.1 million compared to $1.8 million in the third quarter of 2001.  The expenses consisted primarily of severance charges incurred in the reduction of our workforce and certain other costs incurred with the closure of facilities.

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 you can make comparisons about the relative change in revenues and expenses.

	Three Months Ended September 30,
	2002				2001
	(dollars in thousands)
Revenues:
Monitoring and related services	$	9,483	98.4	%	$	8,871	97.7	%
Other	154		1.6		213		2.3
Total revenues	9,637		100.0		9,084		100.0
Cost of revenues:
Monitoring and related services	1,994		20.7		2,014		22.2
Other	204		2.1		162		1.8
Total cost of revenues	2,198		22.8		2,176		24.0
Gross profit	7,439		77.2		6,908		76.0
Selling expense	522		5.4		458		5.0
General and administrative expenses	2,655		27.6		2,068		22.8
Amortization and depreciation expense	2,137		22.2		4,076		44.9
Operating income	$	2,125	22.0	%	$	306	3.3	%

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2002 Compared to 2001.  We had a net increase of 1,331 customers in the third quarter of 2002 as compared to an increase of 3,204 customers in 2001.  The average customer base was 329,214 for the third quarter of 2002 compared to 320,917 for the third quarter of 2001.  The change in Multifamily’s customer base for the period is shown below.

	Three Months Ended September 30,
	2002		2001
Beginning Balance, July 1	328,548		319,315
Additions, net of holdback put backs	6,607		8,111
Customer losses, net of holdback put backs	(5,276	)	(4,907	)
Ending Balance, September 30	329,879		322,519
Annualized attrition	6.4	%	6.1	%

Monitoring and related services revenues was $9.5 million in the third quarter 2002 compared to $8.9 million in 2001 resulting from an increase in the average customer base and increased repair billings and contract buyouts.  This increase was partially offset by a decline in our recurring monthly revenue (“RMR”) per customer due primarily to an increasing number of renewals which provide for significant contract extensions at a reduced RMR.

Other revenues in the third quarter of 2002 remained consistent with the third quarter of 2001 at $0.2 million.

Cost of monitoring and related services revenues for the third quarter of 2002 and 2001 was $2.0 million.  Costs of monitoring and related revenues as a percentage of related revenues decreased slightly to 21.0% in the third quarter of 2002 from 22.7% in the third quarter of 2001 primarily as a result of increased contract buyout revenue.

Cost of other revenues remained consistent in the third quarter of 2002 compared to 2001 at $0.2 million.

Selling expense in the third quarter of 2002 remained consistent with the third quarter of 2001 at $0.5 million.

General and administrative expenses for the third quarter of 2002 increased to $0.6 million to $2.7 million in 2002 from $2.1 million in the third quarter of 2001.  This 28.4% increase is primarily due to the allocation of holding company expenses which were not allocated in 2001 until the fourth quarter and the deferral of certain costs in 2001.

Amortization of intangibles and depreciation expense for the third quarter of 2002 decreased by $2.0 million, or 47.6% to $2.1 million from $4.1 million in 2001.  This decrease is due to the elimination of goodwill amortization totaling $2.4 million resulting from a change in accounting principle offset by an increase in subscriber amortization resulting from a change in estimate of the subscriber life from 10 years to 9 years and the increasing customer base being amortized.

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Data Services Segment

For the third quarter of 2002, Data Services recorded revenues of $5.8 million and cost of revenues of $4.8 million as described above.

Liquidity and Capital Resources

We believe we will have sufficient cash to fund future operations of our business in 2003 from a combination of cash flow from our security monitoring customer base which generated $31.0 million from operating activities in the first nine months of 2002, possible asset sales and borrowings under our existing Senior Credit Facility with Westar Industries, which had approximately $64.5 million of availability at November 8, 2002.  We have sought to obtain a third party source of funds to replace those provided by Westar Industries under our Senior Credit Facility. The Kansas Corporation Commission has issued an order prohibiting Westar Energy from making 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 and which may require Westar Industries to transfer certain assets to Westar Energy. We have not been able to obtain another lender or lenders on terms or at a cost acceptable to us or Westar Industires.  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 5, 2004. We expect to renew the facility with Westar Industries unless efforts to replace the facility with financing from an unaffiliated third party lender are successful.  The success of these efforts will depend on improvements in our operating and financial performance.  We would face significant liquidity issues if we were unable to renew the Senior Credit Facility with Westar Industries or if Westar Industries were unable to fund its obligations under the Senior Credit Facility. In this event, we would take appropriate measures to manage our cash flow, including but not limited to decreasing investments in new subscribers, curtailing other capital expenditures, evaluating assets for sale and seeking to replace the Senior Credit Facility with a third party lender. We can give no assurances or guarantees that these measures would be sufficient to maintain our liquidity.

Our ability to borrow under the facility is subject to compliance with certain financial covenants including a leverage ratio of 5.75 to 1.0 and an interest coverage ratio of 2.10 to 1.0.  At September 30, 2002, the ratios were approximately 4.9 to 1.0 and 2.7 to 1.0, respectively.

Operating Cash Flows for the Nine Months Ended September 30, 2002.  Our operating activities provided net cash flows of $31.0 million for the first nine months of 2002.

Investing Cash Flows for the Nine Months Ended September 30, 2002. We used a net $9.7 million for our investing activities in the first nine months of 2002.  We used $17.4 million in cash to install and acquire new accounts, $5.8 million to acquire fixed assets and $1.4 million to acquire AV ONE, Inc. from Westar Industries.  We received $18.6 million from the disposition of assets and sale of customer accounts.

Financing Cash Flows for the Nine Months Ended September 30, 2002.  We used a net $24.9 million in cash for financing activities in the first nine months of 2002.  We used $13.8 million to purchase stock of Westar Energy.  We increased our borrowings under the Senior Credit Facility by $76.5 million.  We used cash to purchase $102.8 million in face value of our outstanding debt for $82.9 million and to acquire 1,000,000 shares of our outstanding stock for $2.2 million.  At September 30, 2002, the Senior Credit Facility had a weighted average interest rate of 5.6% and an outstanding balance of $214.0 million.

Debt and Equity Repurchase Plans.  We may from time to time purchase our debt and equity securities as well as Westar Energy’s debt and equity securities in the open market or through negotiated transactions.  The timing and terms of purchases, and the amount of debt or equity actually purchased will be determined based on market conditions and other factors.  As of November 8, 2002, we had authority from our board of directors to purchase an additional approximately 8.2 million shares of our common stock.  Our board of directors has also authorized the purchase of up to an additional $16.9 million in Westar Energy debt and equity securities.

Material Commitments.  We have future, material, long–term commitments made in the past several years in connection with our growth. We believe these commitments will be met through a combination of borrowings under our Senior Credit Facility,

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refinancings and positive operating cash flows. The following reflects our commitments as of September 30, 2002:

	Payment Due by Period
	2002		2003 - 2004		2005 - 2006		Thereafter		Total
	(Dollars in thousands)
At September 30, 2002:
Contractual Cash Obligations
Long-term debt(a)	$	—	$	9,725	$	221,172	$	110,340	$	341,237
Capital lease obligations	89		552		—		—		641
Operating leases	3,360		16,104		7,054		6,350		32,868
Unconditional purchase obligations(b)	1,015		6,090		—		—		7,105
Other long-term obligations	—		—		—		—		—
Total contractual cash obligations	$	4,464	$	32,471	$	228,226	$	116,690	$	381,851

(a)Excludes $1.4 million premium which is being amortized to income.

(b)Contract tariff for telecommunication services.

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

	Amount of Commitment Expiration Per Period
	2002		2003 - 2004		2005 - 2006		Thereafter		Total
	(Dollars in thousands)
At September 30, 2002:
Other Commercial Commitments
Line of credit	$	—	$	214,000	$	—	$	—	$	214,000
Standby letters of credit	1,000		2,000		—		—		3,000
Guarantees	—		—		—		—		—
Standby repurchase obligations	—		—		—		—		—
Other commercial commitments	—		—		—		—		—
Total commercial commitments	$	1,000	$	216,000	$	—	$	—	$	217,000

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:

Debt Instrument	Financial Covenant
Senior Credit Facility	Total consolidated debt/annualized most recent quarter EBITDA less than 5.75 to 1.0
	Consolidated annualized most recent quarter EBITDA/latest four fiscal quarters interest expense greater than 2.10 to 1.0
Senior Subordinated Notes	Current fiscal quarter EBITDA/current fiscal quarter interest expense greater than 2.25 to 1.0
Senior Subordinated Discount Notes	Total debt/annualized current quarter EBITDA less than 6.0 to 1.0
	Senior debt/annualized current quarter EBITDA less than 4.0 to 1.0

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At September 30, 2002, we were in compliance with the covenants under these debt instruments and we expect to remain in compliance for the remainder of the year.

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 November 8, 2002, the major rating agencies carried the following ratings on our outstanding public debt:

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

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

Capital Expenditures.  We anticipate making capital expenditures of approximately $35 million in 2002, of which $25 million has been expended.  Of the $35 million, we plan to invest approximately $10 million for fixed assets and $25 million to create customer accounts.  Capital expenditures for 2003 and 2004 are expected to be approximately $40 million and $45 million, respectively.  Of these amounts, approximately $30 million and $35 million would be to create accounts with the balance for fixed assets in 2003 and 2004, respectively.  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 for the balance of 2002 through the use of internally generated funds, asset sales, the Senior Credit Facility or external financings.  See “Liquidity and Capital Resources” above.

Tax Matters

We have a tax sharing agreement with Westar Energy which allows us to be reimbursed for tax deductions utilized by Westar Energy in its consolidated tax return.  If Westar Energy 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 our tax return on a consolidated basis with Westar Energy.  As a result, a substantial portion of our net deferred tax assets of $268.4 million at September 30, 2002 would likely not be realizable and we would likely not be in a position to record a tax benefit for losses incurred.  Accordingly, 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.  In addition, as a result of a separation, we would no longer receive payments from Westar Energy for current tax benefits utilized by Westar Energy.  In February 2002, we received a payment of approximately $1.7 million and in 2001 and 2000, we received aggregate payments from Westar Energy of $19.1 million and $48.9 million, respectively.  We do not expect to receive any payments from Westar Energy for our 2002 tax benefit prior to the first quarter of 2003. See Note 7 of the Notes to Consolidated Financial Statements for a discussion of the KCC Order requiring Westar Energy to initiate a corporate and financial restructuring.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company has not experienced any significant changes in its exposure to market risk since December 31, 2001.  For additional information on the Company’s market risk, see Item 7A of the Form 10-K for the year ended December 31, 2001.

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ITEM 4.  CONTROLS AND PROCEDURES

Within the 90-day period prior to the date of this report, an evaluation was carried out, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective, in all material respects, with respect to the recordings, processing, summarizing and reporting, within the time periods specified in the SEC’s rules and forms, of information required to be disclosed by us in the reports that we file or submit under the Exchange Act.

There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date of the evaluation described above.

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PART II

OTHER INFORMATION

ITEM 1.   LEGAL PROCEEDINGS.

Information relating to legal proceedings is set forth in Note 8 of the Notes to Consolidated Financial Statements included in Part I of this report, which information is incorporated herein by reference.

ITEM 2.   CHANGES IN SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3.   DEFAULTS UPON SENIOR SECURITIES.

None.

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

None.

ITEM 5.   OTHER INFORMATION.

None.

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

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

Exhibit Number	Exhibit Description
10.1	Tenth Amendment of Credit Agreement effective as of July 25, 2002 between Protection One Alarm Monitoring, Inc. and Westar Industries, Inc.
10.2	Eleventh Amendment of Credit Agreement effective as of August 26, 2002 between Protection One Alarm Monitoring, Inc. and Westar Industries, Inc.
10.3	Twelfth Amendment of Credit Agreement effective as of September 11, 2002 between Protection One Alarm Monitoring, Inc. and Westar Industries, Inc.
10.4	Consent and Limited Waiver Agreement dated July 1, 2002 between Protection One, Inc. and Westar Energy, Inc.
99.1	Certification pursuant to Section 906 of the Sarbanes - Oxley Act of 2002
99.2	The State Corporation Commission of the State of Kansas Order Requiring Financial and Corporate Restructuring by Western Resources, Inc. issued November 8, 2002.

(b)   During the quarter ended September 30, 2002, the Company filed one Current Report on Form 8-K dated September 27, 2002, announcing that on September 17, 2002 our indirect parent, Westar Energy, Inc., was served with a federal grand jury subpoena by the United States Attorney’s Office concerning the use of aircraft leased by our parent, Westar Industries, Inc., and our subsidiary AV One, Inc. and inquiries relating to annual shareholder meetings of Westar Energy Inc.

35

SIGNATURES

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

Date:	November 14, 2002	PROTECTION ONE, INC.
		PROTECTION ONE ALARM MONITORING, INC.
		By:	/s/	Darius G. Nevin
		Darius G. Nevin
		Executive Vice President and Chief Financial Officer

36

CERTIFICATION PURSUANT TO
RULE 13a-14 UNDER THE
SECURITIES EXCHANGE ACT OF 1934

I, Richard Ginsburg, certify that:

1.I have reviewed this quarterly report for the period ended September 30, 2002 on Form 10-Q of Protection One, Inc. and Protection One Alarm Monitoring, Inc.;

2.Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrants as of, and for, the periods presented in this quarterly report;

4.The registrants’ other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a.designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.evaluated the effectiveness of the registrants’ disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c.presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.The registrants’ other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants’ auditors and the audit committee of registrants’ board of directors (or persons performing the equivalent functions):

a.all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants’ ability to record, process, summarize and report financial data and have identified for the registrants’ auditors any material weaknesses in internal controls; and

b.any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants’ internal controls; and

6.The registrants’ other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date:	November 14, 2002	By:	/s/  Richard Ginsburg
			Richard Ginsburg
			President and Chief Executive Officer

37

CERTIFICATION PURSUANT TO
RULE 13a-14 UNDER THE
SECURITIES EXCHANGE ACT OF 1934

I, Darius G. Nevin, certify that:

1.I have reviewed this quarterly report for the period ended September 30, 2002 on Form 10-Q of Protection One, Inc. and Protection One Alarm Monitoring, Inc.;

2.Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrants as of, and for, the periods presented in this quarterly report;

4.The registrants’ other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a.designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.evaluated the effectiveness of the registrants’ disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c.presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.The registrants’ other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants’ auditors and the audit committee of registrants’ board of directors (or persons performing the equivalent functions):

a.all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants’ ability to record, process, summarize and report financial data and have identified for the registrants’ auditors any material weaknesses in internal controls; and

b.any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants’ internal controls; and

6.The registrants’ other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date:	November 14, 2002	By:	/s/  Darius G. Nevin
			Darius G. Nevin
			Executive Vice President and Chief Financial Officer

38

Exhibit List

Exhibit Number	Exhibit Description
10.1	Tenth Amendment of Credit Agreement effective as of July 25, 2002 between Protection One Alarm Monitoring, Inc. and Westar Industries, Inc.
10.2	Eleventh Amendment of Credit Agreement effective as of August 26, 2002 between Protection One Alarm Monitoring, Inc. and Westar Industries, Inc.
10.3	Twelfth Amendment of Credit Agreement effective as of September 11, 2002 between Protection One Alarm Monitoring, Inc. and Westar Industries, Inc.
10.4	Consent and Limited Waiver Agreement dated July 1, 2002 between Protection One, Inc. and Westar Energy, Inc.
99.1	Certification pursuant to Section 906 of the Sarbanes – Oxley Act of 2002
99.2	The State Corporation Commission of the State of Kansas Order Requiring Financial and Corporate Restructuring by Western Resources, Inc. issued November 8, 2002.

39

EX-10.1

Exhibit 10.1

TENTH AMENDMENT OF CREDIT AGREEMENT

THIS TENTH AMENDMENT OF CREDIT AGREEMENT (this “Amendment”) is entered into, effective as of July 25, 2002, between PROTECTION ONE ALARM MONITORING, INC., a Delaware corporation (“Borrower”), each of the Persons which is a signatory to this Amendment (collectively, “Lenders”), and WESTAR INDUSTRIES, INC., as Administrative Agent for the Lenders (in such capacity, together with its successors in such capacity, “Administrative Agent”).

R E C I T A L S

A.            Borrower, Lenders and Administrative Agent entered into the Credit Agreement dated as of December 21, 1998 (as renewed, extended, modified, and amended from time to time, the “Credit Agreement”; capitalized terms used herein shall, unless otherwise indicated, have the respective meanings set forth in the Credit Agreement), providing for a revolving credit facility in the original maximum principal amount of $500,000,000.

B.            Pursuant to a letter agreement dated as of September 30, 1999, Borrower reduced the Total Commitment to $250,000,000.

C.            The Lenders and the Administrative Agent entered into that certain Assignment and Acceptance dated December 17, 1999 wherein the Administrative Agent and the Lenders assigned all of their rights and obligations under the Credit Agreement to Westar Industries, Inc. (f/k/a Westar Capital, Inc.).

D.            Borrower, Lender and Administrative Agent entered into a Second Amendment of Credit Agreement effective as of February 29, 2000, a Third Amendment of Credit Agreement effective as of January 2, 2001, a Fourth Amendment of Credit Agreement effective as of March 2, 2001, a Fifth Amendment to Credit Agreement effective as of June 30, 2001, a Sixth Amendment of Credit Agreement effective as of November 1, 2001, a Seventh Amendment of Credit Agreement effective as of March 25, 2002, an Eighth Amendment of Credit Agreement effective as of June 3, 2002, and a Ninth Amendment of Credit Agreement effective as of June 26, 2002, pursuant to which certain provisions of the Credit Agreement were amended.

E.             Borrower, Lender, and Administrative Agent desire to further modify certain provisions contained in the Credit Agreement to increase the amount of the Committed Sum (as defined herein), subject to the terms and conditions set forth herein.

NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Borrower, Lender, and Administrative Agent agree as follows:

1.             Amendments to the Credit Agreement.  Schedule 2.1 is hereby deleted and replaced with Schedule 2.1 attached hereto.

2.             Amendment of Credit Agreement and Other Loan Documents. All references in the Loan Documents to the Credit Agreement shall henceforth include references to the Credit Agreement as modified and amended by this Amendment, and as may, from time to time, be further modified, amended, restated, extended, renewed, and/or increased.

3.             Ratifications. Borrower (a) ratifies and confirms all provisions of the Loan Documents as amended by this Amendment, (b) ratifies and confirms that all guaranties, assurances, and Liens, if any, granted, conveyed, or assigned to the Credit Parties under the Loan Documents are not released, reduced, or otherwise adversely affected by this Amendment and continue to guarantee, assure, and secure full payment and performance of the present and future Obligation, and (c) agrees to perform such acts and duly authorize, execute, acknowledge, deliver, file, and record such additional documents, and certificates as the Credit Parties may reasonably request in order to create, perfect, preserve, and protect those guaranties, assurances, and Liens.

4.             Representations. Borrower represents and warrants to the Credit Parties that as of the date of this Amendment: (a) this Amendment has been duly authorized, executed, and delivered by Borrower and each of the other Obligors that are parties to this Amendment; (b) no action of, or filing with, any Governmental Authority is required to authorize, or is otherwise required in connection with, the execution, delivery, and performance by Borrower or any other Obligor of this Amendment; (c) the Loan Documents, as amended by this Amendment, are valid and binding upon Borrower and the other Obligors and are enforceable against Borrower and the other Obligors in accordance with their respective terms, except as limited by Debtor Relief Laws and general principles of equity; (d) the execution, delivery, and performance by Borrower and the other Obligors of this Amendment do not require the consent of any other Person and do not and will not constitute a violation of any Governmental Requirement, order of any Governmental Authority, or material agreements to which Borrower or any other Obligor is a party thereto or by which Borrower or any other Obligor is bound; (e) all representations and warranties in the Loan Documents are true and correct in all material respects on and as of the date of this Amendment, except to the extent that (i) any of them speak to a different specific date, or (ii) the facts on which any of them were based have been changed by transactions contemplated or permitted by the Credit Agreement; and (f) both before and after giving effect to this Amendment, no Potential Default or Default exists.

5.             Conditions. This Amendment shall not be effective unless and until:

(a)           this Amendment has been executed by Borrower, the other Obligors, Administrative Agent, and the Required Lenders;

(b)           Borrower shall have delivered to Administrative Agent such documents satisfactory to Administrative Agent as it may request evidencing the authorization and execution of this Agreement, and any other documents executed and delivered in connection herewith (collectively, the “Amendment Documents”); and

2

(c)           Borrower shall have paid to the Administrative Agent, for the account of the Credit Parties as Administrative Agent shall determine, an amendment fee in an amount equal to 1% of the increase in the Total Commitment made effective on the effective date of this Amendment ($250,000).

6.             Continued Effect. Except to the extent amended hereby or by any documents executed in connection herewith, all terms, provisions, and conditions of the Credit Agreement and the other Loan Documents, and all documents executed in connection therewith, shall continue in full force and effect and shall remain enforceable and binding in accordance with their respective terms.

7.             Miscellaneous. Unless stated otherwise (a) the singular number includes the plural and vice versa and words of any gender include each other gender, in each case, as appropriate, (b) headings and captions may not be construed in interpreting provisions, (c) this Amendment shall be construed and its performance enforced, under Texas law, (d) if any part of this Amendment is for any reason found to be unenforceable, all other portions of it nevertheless remain enforceable, and (e) this Amendment may be executed in any number of counterparts with the same effect as if all signatories had signed the same document, and all of those counterparts must be construed together to constitute the same document.

8.             Parties. This Amendment binds and inures to Borrower and the Credit Parties and their respective successors and permitted assigns.

9.             Entireties. The Credit Agreement and the other loan documents, as amended by this amendment and the other amendment documents, represent the final agreement between the parties about the subject matter of the credit agreement and may not be contradicted by evidence of prior, contemporaneous, or subsequent oral agreements of the parties.  there are no unwritten oral agreements between the parties.

[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK]

3

SIGNATURE PAGE TO TENTH AMENDMENT OF

CREDIT AGREEMENT AMONG

PROTECTION ONE ALARM MONITORING, INC., AS BORROWER,

WESTAR INDUSTRIES, INC., AS ADMINISTRATIVE AGENT

AND

THE LENDERS NAMED HEREIN

EXECUTED on and effective as of the date first above written.

PROTECTION ONE ALARM MONITORING, INC., a Delaware corporation, as Borrower
By:	/s/ Darius Nevin
	Name: Darius Nevin
	Title: Executive Vice President and Chief Financial Officer

4

SIGNATURE PAGE TO TENTH AMENDMENT OF

CREDIT AGREEMENT AMONG

PROTECTION ONE ALARM MONITORING, INC., AS BORROWER,

WESTAR INDUSTRIES, INC., AS ADMINISTRATIVE AGENT,

AND

THE LENDERS NAMED HEREIN

EXECUTED on and effective as of the date first above written.

WESTAR INDUSTRIES, INC., as Administrative Agent and a Lender
By:	/s/ Paul R. Geist
	Name: Paul R. Geist
	Title: President

5

To induce the Credit Parties to enter into this Amendment, each of the undersigned (a) consents and agrees to the Amendment Documents’ execution and delivery, (b) ratifies and confirms that all guaranties, assurances, and Liens, if any, granted, conveyed, or assigned to the Credit Parties under the Loan Documents are not released, diminished, impaired, reduced, or otherwise adversely affected by the Amendment Documents and continue to guarantee, assure, and secure the full payment and performance of all present and future Obligations (except to the extent specifically limited by the terms of such guaranties, assurances, or Liens), (c) agrees to perform such acts and duly authorize, execute, acknowledge, deliver, file, and record such additional guaranties, assignments, security agreements, deeds of trust, mortgages, and other agreements, documents, instruments, and certificates as the Credit Parties may reasonably deem necessary or appropriate in order to create, perfect, preserve, and protect those guaranties, assurances, and Liens, and (d) waives notice of acceptance of this consent and agreement, which consent and agreement binds the undersigned and its successors and permitted assigns and inures to the Credit Parties and their respective successors and permitted assigns.

EXECUTED on and effective as of the date first above written.

PROTECTION ONE, INC., a Delaware corporation
By:	/s/ Darius Nevin
	Name: Darius Nevin
	Title: Executive Vice President and Chief Financial Officer
NETWORK MULTI-FAMILY SECURITY CORPORATION, a Delaware corporation
By:	/s/ Anthony D. Somma
	Name: Anthony D. Somma
	Title: Assistant Treasurer

6

SCHEDULE 2.1

PARTIES, ADDRESSES, COMMITMENTS, AND WIRING INFORMATION

Borrower

Protection One Alarm Monitoring, Inc.
818 South Kansas Avenue
Topeka, KS  66612
Attention: Tony Somma

Administrative Agent

Westar Industries, Inc.
818 South Kansas Avenue
Topeka, KS  66612
Attention: Paul R. Geist

Wiring Instructions:

Bank of America, Dallas, Texas
Reference: Protection One Alarm Monitoring, Inc.
Attention: Carolyn Starkey

7

Lenders	Committed Sum			Pro Rata Part of the Commitments
Westar Industries, Inc. 818 South Kansas Avenue Topeka, KS  66612 Attn: Paul R. Geist	$	255,000,000	(1)	100	%
Wiring Instructions:
Bank of America, Dallas, Texas
Reference: Protection One Alarm Monitoring, Inc.
Attention: Carolyn Starkey

(1) Including increase previously requested by Borrower and approved by Administrative Agent pursuant to Section 2.5.

8

EX-10.2

Exhibit 10.2

ELEVENTH AMENDMENT OF CREDIT AGREEMENT

THIS ELEVENTH AMENDMENT OF CREDIT AGREEMENT (this “Amendment”) is entered into, effective as of August 26, 2002, between PROTECTION ONE ALARM MONITORING, INC., a Delaware corporation (“Borrower”), each of the Persons which is a signatory to this Amendment (collectively, “Lenders”), and WESTAR INDUSTRIES, INC., as Administrative Agent for the Lenders (in such capacity, together with its successors in such capacity, “Administrative Agent”).

R E C I T A L S

A.            Borrower, Lenders and Administrative Agent entered into the Credit Agreement dated as of December 21, 1998 (as renewed, extended, modified, and amended from time to time, the “Credit Agreement”; capitalized terms used herein shall, unless otherwise indicated, have the respective meanings set forth in the Credit Agreement), providing for a revolving credit facility in the original maximum principal amount of $500,000,000.

B.            Pursuant to a letter agreement dated as of September 30, 1999, Borrower reduced the Total Commitment to $250,000,000.

C.            The Lenders and the Administrative Agent entered into that certain Assignment and Acceptance dated December 17, 1999 wherein the Administrative Agent and the Lenders assigned all of their rights and obligations under the Credit Agreement to Westar Industries, Inc. (f/k/a Westar Capital, Inc.).

D.            Borrower, Lender and Administrative Agent entered into a Second Amendment of Credit Agreement effective as of February 29, 2000, a Third Amendment of Credit Agreement effective as of January 2, 2001, a Fourth Amendment of Credit Agreement effective as of March 2, 2001, a Fifth Amendment to Credit Agreement effective as of June 30, 2001, a Sixth Amendment of Credit Agreement effective as of November 1, 2001, a Seventh Amendment of Credit Agreement effective as of March 25, 2002, an Eighth Amendment of Credit Agreement effective as of June 3, 2002, a Ninth Amendment of Credit Agreement effective as of June 26, 2002, and a Tenth Amendment of Credit Agreement effective as of July 25, 2002, pursuant to which certain provisions of the Credit Agreement were amended.

E.             Borrower, Lender, and Administrative Agent desire to further modify certain provisions contained in the Credit Agreement to extend the Termination Date (as defined herein), subject to the terms and conditions set forth herein.

NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Borrower, Lender, and Administrative Agent agree as follows:

1.             Amendments to the Credit Agreement. Section 1.1 is hereby amended to delete the definition of “Termination Date” in its entirety and replace such definition with the following:

Termination Date means the earlier of (a) January 5, 2004, and (b) the effective date of any other termination or cancellation of Lenders’ commitments to lend under, and in accordance with, this Agreement.

2.             Amendment of Credit Agreement and Other Loan Documents. All references in the Loan Documents to the Credit Agreement shall henceforth include references to the Credit Agreement as modified and amended by this Amendment, and as may, from time to time, be further modified, amended, restated, extended, renewed, and/or increased.

3.             Ratifications. Borrower (a) ratifies and confirms all provisions of the Loan Documents as amended by this Amendment, (b) ratifies and confirms that all guaranties, assurances, and Liens, if any, granted, conveyed, or assigned to the Credit Parties under the Loan Documents are not released, reduced, or otherwise adversely affected by this Amendment and continue to guarantee, assure, and secure full payment and performance of the present and future Obligation, and (c) agrees to perform such acts and duly authorize, execute, acknowledge, deliver, file, and record such additional documents, and certificates as the Credit Parties may reasonably request in order to create, perfect, preserve, and protect those guaranties, assurances, and Liens.

4.             Representations. Borrower represents and warrants to the Credit Parties that as of the date of this Amendment: (a) this Amendment has been duly authorized, executed, and delivered by Borrower and each of the other Obligors that are parties to this Amendment; (b) no action of, or filing with, any Governmental Authority is required to authorize, or is otherwise required in connection with, the execution, delivery, and performance by Borrower or any other Obligor of this Amendment; (c) the Loan Documents, as amended by this Amendment, are valid and binding upon Borrower and the other Obligors and are enforceable against Borrower and the other Obligors in accordance with their respective terms, except as limited by Debtor Relief Laws and general principles of equity; (d) the execution, delivery, and performance by Borrower and the other Obligors of this Amendment do not require the consent of any other Person and do not and will not constitute a violation of any Governmental Requirement, order of any Governmental Authority, or material agreements to which Borrower or any other Obligor is a party thereto or by which Borrower or any other Obligor is bound; (e) all representations and warranties in the Loan Documents are true and correct in all material respects on and as of the date of this Amendment, except to the extent that (i) any of them speak to a different specific date, or (ii) the facts on which any of them were based have been changed by transactions contemplated or permitted by the Credit Agreement; and (f) both before and after giving effect to this Amendment, no Potential Default or Default exists.

5.             Conditions. This Amendment shall not be effective unless and until:

(a)           this Amendment has been executed by Borrower, the other Obligors, Administrative Agent, and the Required Lenders;

2

(b)           Borrower shall have delivered to Administrative Agent such documents satisfactory to Administrative Agent as it may request evidencing the authorization and execution of this Agreement, and any other documents executed and delivered in connection herewith (collectively, the “Amendment Documents”); and

(c)           Borrower shall have paid to the Administrative Agent, for the account of the Credit Parties as Administrative Agent shall determine, an amendment fee in an amount equal to 0.50% of the Total Commitment on the effective date of this Amendment ($1,275,000).

6.             Continued Effect. Except to the extent amended hereby or by any documents executed in connection herewith, all terms, provisions, and conditions of the Credit Agreement and the other Loan Documents, and all documents executed in connection therewith, shall continue in full force and effect and shall remain enforceable and binding in accordance with their respective terms.

7.             Miscellaneous. Unless stated otherwise (a) the singular number includes the plural and vice versa and words of any gender include each other gender, in each case, as appropriate, (b) headings and captions may not be construed in interpreting provisions, (c) this Amendment shall be construed and its performance enforced, under Texas law, (d) if any part of this Amendment is for any reason found to be unenforceable, all other portions of it nevertheless remain enforceable, and (e) this Amendment may be executed in any number of counterparts with the same effect as if all signatories had signed the same document, and all of those counterparts must be construed together to constitute the same document.

8.             Parties. This Amendment binds and inures to Borrower and the Credit Parties and their respective successors and permitted assigns.

9.             Entireties. The Credit Agreement and the other loan documents, as amended by this amendment and the other amendment documents, represent the final agreement between the parties about the subject matter of the credit agreement and may not be contradicted by evidence of prior, contemporaneous, or subsequent oral agreements of the parties.  there are no unwritten oral agreements between the parties.

[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK]

3

SIGNATURE PAGE TO ELEVENTH AMENDMENT OF

CREDIT AGREEMENT AMONG

PROTECTION ONE ALARM MONITORING, INC., AS BORROWER,

WESTAR INDUSTRIES, INC., AS ADMINISTRATIVE AGENT

AND

THE LENDERS NAMED HEREIN

EXECUTED on and effective as of the date first above written.

PROTECTION ONE ALARM MONITORING, INC., a Delaware corporation, as Borrower
By:	/s/ Anthony D. Somma
	Name: Anthony D. Somma
	Title: Senior Vice President

4

SIGNATURE PAGE TO ELEVENTH AMENDMENT OF

CREDIT AGREEMENT AMONG

PROTECTION ONE ALARM MONITORING, INC., AS BORROWER,

WESTAR INDUSTRIES, INC., AS ADMINISTRATIVE AGENT,

AND

THE LENDERS NAMED HEREIN

EXECUTED on and effective as of the date first above written.

WESTAR INDUSTRIES, INC., as Administrative Agent and a Lender
By:	/s/ Paul R. Geist
	Name: Paul R. Geist
	Title: President

5

To induce the Credit Parties to enter into this Amendment, each of the undersigned (a) consents and agrees to the Amendment Documents’ execution and delivery, (b) ratifies and confirms that all guaranties, assurances, and Liens, if any, granted, conveyed, or assigned to the Credit Parties under the Loan Documents are not released, diminished, impaired, reduced, or otherwise adversely affected by the Amendment Documents and continue to guarantee, assure, and secure the full payment and performance of all present and future Obligations (except to the extent specifically limited by the terms of such guaranties, assurances, or Liens), (c) agrees to perform such acts and duly authorize, execute, acknowledge, deliver, file, and record such additional guaranties, assignments, security agreements, deeds of trust, mortgages, and other agreements, documents, instruments, and certificates as the Credit Parties may reasonably deem necessary or appropriate in order to create, perfect, preserve, and protect those guaranties, assurances, and Liens, and (d) waives notice of acceptance of this consent and agreement, which consent and agreement binds the undersigned and its successors and permitted assigns and inures to the Credit Parties and their respective successors and permitted assigns.

EXECUTED on and effective as of the date first above written.

PROTECTION ONE, INC., a Delaware corporation
By:	/s/ Anthony D. Somma
	Name: Anthony D. Somma
	Title: Senior Vice President
NETWORK MULTI-FAMILY SECURITY CORPORATION, a Delaware corporation
By:	/s/ Anthony D. Somma
	Name: Anthony D. Somma
	Title: Assistant Treasurer

6

SCHEDULE 2.1

PARTIES, ADDRESSES, COMMITMENTS, AND WIRING INFORMATION

Borrower

Protection One Alarm Monitoring, Inc.
818 South Kansas Avenue
Topeka, KS  66612
Attention: Tony Somma

Administrative Agent

Westar Industries, Inc.
818 South Kansas Avenue
Topeka, KS  66612
Attention: Paul R. Geist

Wiring Instructions:

Bank of America, Dallas, Texas
Reference: Protection One Alarm Monitoring, Inc.
Attention: Carolyn Starkey

7

Lenders	Committed Sum			Pro Rata Part of the Commitments
Westar Industries, Inc. 818 South Kansas Avenue Topeka, KS  66612 Attn: Paul R. Geist	$	255,000,000	(1)	100	%
Wiring Instructions:
Bank of America, Dallas, Texas Reference: Protection One Alarm Monitoring, Inc. Attention: Carolyn Starkey

(1) Including increase previously requested by Borrower and approved by Administrative Agent pursuant to Section 2.5.

8

EX-10.3

Exhibit 10.3

TWELFTH AMENDMENT OF CREDIT AGREEMENT

THIS TWELFTH AMENDMENT OF CREDIT AGREEMENT (this “Amendment”) is entered into, effective as of September 11, 2002, between PROTECTION ONE ALARM MONITORING, INC., a Delaware corporation (“Borrower”), each of the Persons which is a signatory to this Amendment (collectively, “Lenders”), and WESTAR INDUSTRIES, INC., as Administrative Agent for the Lenders (in such capacity, together with its successors in such capacity, “Administrative Agent”).

R E C I T A L S

A.            Borrower, Lenders and Administrative Agent entered into the Credit Agreement dated as of December 21, 1998 (as renewed, extended, modified, and amended from time to time, the “Credit Agreement”; capitalized terms used herein shall, unless otherwise indicated, have the respective meanings set forth in the Credit Agreement), providing for a revolving credit facility in the original maximum principal amount of $500,000,000.

B.            Pursuant to a letter agreement dated as of September 30, 1999, Borrower reduced the Total Commitment to $250,000,000.

C.            The Lenders and the Administrative Agent entered into that certain Assignment and Acceptance dated December 17, 1999 wherein the Administrative Agent and the Lenders assigned all of their rights and obligations under the Credit Agreement to Westar Industries, Inc. (f/k/a Westar Capital, Inc.).

D.            Borrower, Lender and Administrative Agent entered into a Second Amendment of Credit Agreement effective as of February 29, 2000, a Third Amendment of Credit Agreement effective as of January 2, 2001, a Fourth Amendment of Credit Agreement effective as of March 2, 2001, a Fifth Amendment to Credit Agreement effective as of June 30, 2001, a Sixth Amendment of Credit Agreement effective as of November 1, 2001, a Seventh Amendment of Credit Agreement effective as of March 25, 2002, an Eighth Amendment of Credit Agreement effective as of June 3, 2002, a Ninth Amendment of Credit Agreement effective as of June 26, 2002, a Tenth Amendment of Credit Agreement effective as of July 25, 2002, and an Eleventh Amendment of Credit Agreement effective as of August 26, 2002, pursuant to which certain provisions of the Credit Agreement were amended.

E.             Borrower, Lender, and Administrative Agent desire to further modify certain provisions contained in the Credit Agreement to increase the amount of the Committed Sum (as defined herein), subject to the terms and conditions set forth herein.

NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Borrower, Lender, and Administrative Agent agree as follows:

1.             Amendment to the Credit Agreement. Schedule 2.1 is hereby deleted and replaced with Schedule 2.1 attached hereto.

2.             Amendment of Credit Agreement and Other Loan Documents. All references in the Loan Documents to the Credit Agreement shall henceforth include references to the Credit Agreement as modified and amended by this Amendment, and as may, from time to time, be further modified, amended, restated, extended, renewed, and/or increased.

3.             Ratifications. Borrower (a) ratifies and confirms all provisions of the Loan Documents as amended by this Amendment, (b) ratifies and confirms that all guaranties, assurances, and Liens, if any, granted, conveyed, or assigned to the Credit Parties under the Loan Documents are not released, reduced, or otherwise adversely affected by this Amendment and continue to guarantee, assure, and secure full payment and performance of the present and future Obligation, and (c) agrees to perform such acts and duly authorize, execute, acknowledge, deliver, file, and record such additional documents, and certificates as the Credit Parties may reasonably request in order to create, perfect, preserve, and protect those guaranties, assurances, and Liens.

4.             Representations. Borrower represents and warrants to the Credit Parties that as of the date of this Amendment: (a) this Amendment has been duly authorized, executed, and delivered by Borrower and each of the other Obligors that are parties to this Amendment; (b) no action of, or filing with, any Governmental Authority is required to authorize, or is otherwise required in connection with, the execution, delivery, and performance by Borrower or any other Obligor of this Amendment; (c) the Loan Documents, as amended by this Amendment, are valid and binding upon Borrower and the other Obligors and are enforceable against Borrower and the other Obligors in accordance with their respective terms, except as limited by Debtor Relief Laws and general principles of equity; (d) the execution, delivery, and performance by Borrower and the other Obligors of this Amendment do not require the consent of any other Person and do not and will not constitute a violation of any Governmental Requirement, order of any Governmental Authority, or material agreements to which Borrower or any other Obligor is a party thereto or by which Borrower or any other Obligor is bound; (e) all representations and warranties in the Loan Documents are true and correct in all material respects on and as of the date of this Amendment, except to the extent that (i) any of them speak to a different specific date, or (ii) the facts on which any of them were based have been changed by transactions contemplated or permitted by the Credit Agreement; and (f) both before and after giving effect to this Amendment, no Potential Default or Default exists.

5.             Conditions. This Amendment shall not be effective unless and until:

(a)           this Amendment has been executed by Borrower, the other Obligors, Administrative Agent, and the Required Lenders;

(b)           Borrower shall have delivered to Administrative Agent such documents satisfactory to Administrative Agent as it may request evidencing the authorization and

2

execution of this Agreement, and any other documents executed and delivered in connection herewith (collectively, the “Amendment Documents”); and

(c)           Borrower shall have paid to the Administrative Agent, for the account of the Credit Parties as Administrative Agent shall determine, an amendment fee in an amount equal to .5% of the increase in the Total Commitment made effective on the effective date of this Amendment ($125,000).

6.             Continued Effect. Except to the extent amended hereby or by any documents executed in connection herewith, all terms, provisions, and conditions of the Credit Agreement and the other Loan Documents, and all documents executed in connection therewith, shall continue in full force and effect and shall remain enforceable and binding in accordance with their respective terms.

7.             Miscellaneous. Unless stated otherwise (a) the singular number includes the plural and vice versa and words of any gender include each other gender, in each case, as appropriate, (b) headings and captions may not be construed in interpreting provisions, (c) this Amendment shall be construed and its performance enforced, under Texas law, (d) if any part of this Amendment is for any reason found to be unenforceable, all other portions of it nevertheless remain enforceable, and (e) this Amendment may be executed in any number of counterparts with the same effect as if all signatories had signed the same document, and all of those counterparts must be construed together to constitute the same document.

8.             Parties. This Amendment binds and inures to Borrower and the Credit Parties and their respective successors and permitted assigns.

9.             Entireties. The Credit Agreement and the other loan documents, as amended by this amendment and the other amendment documents, represent the final agreement between the parties about the subject matter of the credit agreement and may not be contradicted by evidence of prior, contemporaneous, or subsequent oral agreements of the parties.  there are no unwritten oral agreements between the parties.

[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK]

3

SIGNATURE PAGE TO TWELFTH AMENDMENT OF

CREDIT AGREEMENT AMONG

PROTECTION ONE ALARM MONITORING, INC., AS BORROWER,

WESTAR INDUSTRIES, INC., AS ADMINISTRATIVE AGENT

AND

THE LENDERS NAMED HEREIN

EXECUTED on and effective as of the date first above written.

PROTECTION ONE ALARM MONITORING, INC., a Delaware corporation, as Borrower
By:	/s/ Anthony D. Somma
	Name: Anthony D. Somma
	Title: Senior Vice President

4

SIGNATURE PAGE TO TWELFTH AMENDMENT OF

CREDIT AGREEMENT AMONG

PROTECTION ONE ALARM MONITORING, INC., AS BORROWER,

WESTAR INDUSTRIES, INC., AS ADMINISTRATIVE AGENT,

AND

THE LENDERS NAMED HEREIN

EXECUTED on and effective as of the date first above written.

WESTAR INDUSTRIES, INC., as Administrative Agent and a Lender
By:
	Name: Paul R. Geist
	Title: President

5

To induce the Credit Parties to enter into this Amendment, each of the undersigned (a) consents and agrees to the Amendment Documents’ execution and delivery, (b) ratifies and confirms that all guaranties, assurances, and Liens, if any, granted, conveyed, or assigned to the Credit Parties under the Loan Documents are not released, diminished, impaired, reduced, or otherwise adversely affected by the Amendment Documents and continue to guarantee, assure, and secure the full payment and performance of all present and future Obligations (except to the extent specifically limited by the terms of such guaranties, assurances, or Liens), (c) agrees to perform such acts and duly authorize, execute, acknowledge, deliver, file, and record such additional guaranties, assignments, security agreements, deeds of trust, mortgages, and other agreements, documents, instruments, and certificates as the Credit Parties may reasonably deem necessary or appropriate in order to create, perfect, preserve, and protect those guaranties, assurances, and Liens, and (d) waives notice of acceptance of this consent and agreement, which consent and agreement binds the undersigned and its successors and permitted assigns and inures to the Credit Parties and their respective successors and permitted assigns.

EXECUTED on and effective as of the date first above written.

PROTECTION ONE, INC., a Delaware corporation
By:
	Name: Anthony D. Somma
	Title: Senior Vice President
NETWORK MULTI-FAMILY SECURITY CORPORATION, a Delaware corporation
By:
	Name: Anthony D. Somma
	Title: Assistant Treasurer

6

SCHEDULE 2.1

PARTIES, ADDRESSES, COMMITMENTS, AND WIRING INFORMATION

Borrower

Protection One Alarm Monitoring, Inc.
818 South Kansas Avenue
Topeka, KS  66612
Attention: Tony Somma

Administrative Agent

Westar Industries, Inc.
818 South Kansas Avenue
Topeka, KS  66612
Attention: Paul R. Geist

Wiring Instructions:

Bank of America, Dallas, Texas
Reference: Protection One Alarm Monitoring, Inc.
Attention: Carolyn Starkey

7

Lenders	Committed Sum			Pro Rata Part of the Commitments
Westar Industries, Inc. 818 South Kansas Avenue Topeka, KS  66612 Attn: Paul R. Geist	$	280,000,000	(1)	100	%
Wiring Instructions:
Bank of America, Dallas, Texas Reference: Protection One Alarm Monitoring, Inc. Attention: Carolyn Starkey

(1) Including increase previously requested by Borrower and approved by Administrative Agent pursuant to Section 2.5.

8

EX-10.4

Exhibit 10.4

CONSENT AND LIMITED WAIVER AGREEMENT

THIS CONSENT AND LIMITED WAIVER AGREEMENT (this “Waiver”), is made and entered into effective as of July 1, 2002, by and between WESTAR ENERGY, INC. (f/k/a WESTERN RESOURCES, INC.), a Kansas corporation (“Westar”) and PROTECTION ONE, INC., a Delaware corporation (“Protection One”).  Unless otherwise defined herein, all capitalized terms used herein shall have the respective meanings provided such terms in the Contribution Agreement referred to below.

W I T N E S S E T H :

WHEREAS, Section 3.18(c) of the Contribution Agreement dated as of July 30, 1997 between Westar and Protection One (as amended, the “Contribution Agreement”) provides that the percentage of Protection One Voting Securities beneficially owned by Westar on a fully diluted basis may not in the aggregate exceed 81% of the Voting Securities issued and outstanding at any one time (the “Ownership Ceiling”); and

WHEREAS, due to the expiration of options held by former Protection One employees and due to Westar’s having acquired certain Convertible Senior Subordinated Notes issued by Protection One, Westar’s beneficial ownership of Protection One Voting Securities exceeds 81% of the Voting Securities issued and outstanding; and

WHEREAS, pursuant to a Consent and Limited Waiver Agreement dated March 18, 2002, Protection One consented to Westar’s lack of compliance with the Ownership Ceiling for a period ending on July 1, 2002, and waived any breach or default that could be asserted by Protection One under the Contribution Agreement solely as a result of Westar’s lack of compliance with Section 3.18(c) of the Contribution Agreement during the Waiver Period (as defined therein); and

WHEREAS, Protection One desires to extend the period for which it has consented to Westar’s lack of compliance with the Ownership Ceiling and waived any breach or default for Westar’s lack of compliance with Section 3.18(c) of the Contribution Agreement as more particularly provided herein; and

WHEREAS, pursuant to Section 6.2 of the Contribution Agreement, Protection One may not amend, supplement or otherwise modify any provision of the Contribution Agreement, and Protection One may not waive any provision thereof, unless such amendment, supplement, modification or waiver shall have been approved by the affirmative vote of a majority of the Continuing Directors; and

WHEREAS, Mr. Ben M. Enis and Mr. James Q. Wilson (collectively, the “Continuing Directors”) constitute all of the Continuing Directors and desire to authorize Protection One to grant the Waiver as contemplated herein;

WHEREAS, subject to the terms and conditions set forth herein, the parties hereto agree as follows;

NOW, THEREFORE, it is agreed:

1.             CONSENT:  Protection One hereby consents, on a one-time basis, to Westar’s lack of compliance with Section 3.18(c) of the Contribution Agreement in respect to the Ownership Ceiling; provided, however, the one-time consent set forth in this Section 1 shall apply only Westar’s lack of compliance with the Ownership Ceiling during the period commencing on July 1, 2002 (the “Waiver Effective Date”) and ending on March 31, 2003 (and with such period being referred to herein as the “Waiver Period”).

2.             LIMITED WAIVER:  Protection One hereby waives, on a one-time basis, any breach or default that could otherwise be asserted by Protection One under the Contribution Agreement solely as a result of Westar’s lack of compliance with Section 3.18(c) of the Contribution Agreement in respect to the Ownership Ceiling; provided, however, the one-time waiver set forth in this Section 2 shall apply only to such breach or default that could otherwise be or have been asserted by Protection One due to Westar’s lack of compliance with the Ownership Ceiling during the Waiver Period.

3.             MISCELLANEOUS:

(a)           This Waiver is limited as specified and shall not constitute a modification, acceptance or waiver of any other provision of the Contribution Agreement or any other agreement or document.

(b)           This Waiver may be executed in any number of counterparts and by the different parties hereto on separate counterparts, each of which counterparts when executed and delivered shall be an original, but all of which shall together constitute one and the same instrument.

4.             GOVERNING LAW.  THIS WAIVER AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAW OF THE STATE OF DELAWARE.

5.             REPRESENTATIONS OF WESTAR.  In order to induce the Protection One to enter into this Waiver, Westar hereby represents and warrants that after giving effect to this Waiver as of the Waiver Effective Date, (i) there is no material breach of Westar’s obligations under the Contribution Agreement, and (ii) all representations and warranties contained in the Contribution Agreement are true and correct in all material respects.

6.             EFFECTIVE DATE OF WAIVER.  This Waiver shall become effective on the Waiver Effective Date.

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7.             CONTRIBUTION AGREEMENT. From and after the Waiver Effective Date, all references in the Contribution Agreement and any other document referring to the Contribution Agreement shall be deemed to be references to the Contribution Agreement after giving effect to this Waiver.

8.             APPROVAL OF CONTINUING DIRECTORS.  The Continuing Directors have executed this Waiver solely to reflect their approval hereof, in accordance with Section 6.2 of the Contribution Agreement.

IN WITNESS WHEREOF, each of the parties hereto has caused a counterpart of this Waiver to be duly executed and delivered as of the date first above written.

PROTECTION ONE, INC.
By:
Name:	Darius G. Nevin
Title:	Executive Vice President and Chief Financial Officer
WESTAR ENERGY, INC.
(f/k/a WESTERN RESOURCES, INC.)
By:
Name:		Paul R. Geist
Title:		Senior Vice President and Chief Financial Officer
Ben M. Enis
James Q. Wilson

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EX-99.1

Exhibit 99.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES - OXLEY ACT OF 2002

In connection with the Quarterly Report of Protection One, Inc. and Protection One Alarm Monitoring, Inc. (the “Companies”) on Form 10-Q for the quarterly period ended September 30, 2002  (the “Report”) which this certification accompanies, Richard Ginsburg, in my capacity as President and Chief Executive Officer of the Companies, and Darius G. Nevin, in my capacity as Executive Vice President and Chief Financial Officer of the Companies, certify that the Report fully complies with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) and that information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Companies.

Date: November 14, 2002	/s/ Richard Ginsburg
	Richard Ginsburg
	President and Chief Executive Officer, Protection One, Inc. and Protection One Alarm Monitoring, Inc.
Date: November 14, 2002	/s/ Darius G. Nevin
	Darius G. Nevin
	Executive Vice President and Chief Financial Officer Protection One, Inc. and Protection One Alarm Monitoring. Inc.

The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes – Oxley Act of 2002 and shall not be deemed filed by the Company as part of the Report or as a separate disclosure document for purposes of Section 18 or any other provision of the Securities Exchange Act of 1934, as amended.

EX-99.2

Exhibit 99.2

THE STATE CORPORATION COMMISSION

OF THE STATE OF KANSAS

Before Commissioners:	John Wine, Chair
	Cynthia L. Claus
	Brian J. Moline

In the Matter of the Investigation of Actions of Western Resources, Inc. to Separate its Jurisdictional Electric Utility Business from its Unregulated Businesses. )
)
)
)
Docket No. 01-WSRE-949-GIE

No. 51

ORDER REQUIRING FINANCIAL

AND CORPORATE RESTRUCTURING BY WESTERN RESOURCES, INC.

TABLE OF CONTENTS

I.	Introduction and Overview
II.	Procedural Summary
III.	The Commission Rejects WRI’s Financial Plan Because It Compounds, Rather Than Addresses, WRI’s Underlying Problems
	A.	WRI’s Plan
	B.	The Commission’s July 20, 2001 Order
	C.	Permanent Misallocation of Assets and Debt
	D.	Undue Ratepayer Risk and Substantial Uncertainty
	E.	Commission Inaction Not Supported by WRI’s Arguments
IV.	WRI Must Reallocate and Reapportion Debts and Assets Equitably Within the WRI Corporate Family and Separately Incorporate the Jurisdictional Electric Operations as a Subsidiary of WRI
	A.	The Commission’s Authority and Responsibility to Fashion a Remedy To Protect Utility Interests

1.	The Legal Context
2.	The Factual Context
B.	WRI Must Reverse Certain Intercompany Transactions
C.	WRI’s Regulated Electric Utility Operations Must Be Separately Incorporated as a Subsidiary of WRI
1.	Overview
2.	Cost Allocation Manual
3.	Reporting Requirements
4.	Reasons for the Requirement of Moving the KPL Utility Business to a Utility-Only Subsidiary
a.	The Requirement That WRI Electric Operations Be Placed in a Separate Subsidiary or Subsidiaries Will Permit and Provide for an Allocation of Debt That Reflects Appropriate Cash Flow Needs
b.	The Location of WRI’s Electric Operations in Separate Corporate Entities Enhances Monitoring and Accounting for Interaffiliate Transactions
	i.	WRI’s Current Accounting, Reporting, and Related Monitoring Are Inadequate to Protect the Interests of the Public Utility and its Customers in the Context of a Diversified Company
	ii.	The Requirement that WRI Electric Operations be Placed in a Separate Subsidiary or Subsidiaries Will Improve the Ability to Detect the Use of Electric Utility Operations to Further Nonutility Activities
D.	Directive and Guidance on the Restructuring Plans
E.	WRI Shall Reduce Debt By Employing Measures Shown By the Record to be Appropriate
1.	WRI Must Undertake Requisite Debt Reduction Measures, the Mix of Which the Commission Will Leave to WRI Discretion, Initially

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	2.	WRI’s Debt Reduction Measures Shall Consider and Implement Those Measures Shown By the Record to be Appropriate
V.	WRI Shall Refrain from Any Action that Results, Directly or Indirectly, in its Electric Utilities Subsidizing Nonutility Business Activities
	A.	Initiation of Additional Proceedings to Determine Standards and Guidelines for Affiliate Relations within the WRI Corporate Family
	B.	Interim Standstill Protections
VI.	Conclusion

The State Corporation Commission of the State of Kansas (Commission) finds that financial and corporate restructuring of Western Resources, Inc. (WRI)(1) is necessary to: (1) achieve a balanced capital structure within the public utility business controlled by or affiliated with WRI; (2) reduce the excessive debt accumulated due to investment in nonutility business ventures; (3) prevent interaffiliate accounting practices and relations that are harmful to WRI’s public utility business; and (4) protect ratepayers from the risks of WRI’s nonutility business ventures in the corporate family controlled by WRI.

(1)All references to WRI refer to the entity now known as Westar Energy, Inc. All references to Westar Industries refer to Westar Industries, Inc. a wholly owned subsidiary of WRI.

By this Order, the Commission (1) rejects the plan proposed by WRI; (2) directs WRI to reverse certain accounting transactions; (3) directs WRI to transfer its KPL utility division to a utility-only subsidiary of WRI, after Commission review and approval of a plan to be submitted by WRI within 90 days of this Order; (4) institutes interim standstill protections to prevent harm to WRI’s utility businesses as a result of their affiliation with WRI’s nonutility businesses pending adoption of final requirements relating to such affiliation; and (5) institutes an

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investigation into the appropriate type, quantity, structure and regulation of the nonutility businesses with which WRI’s utility businesses may be affiliated.

I.Introduction and Overview

1.WRI is a holding company, providing electric service and owning stock in utility and nonutility businesses. At the holding company level, WRI provides retail electric service in parts of Kansas as KPL. WRI also provides retail electric service through its wholly owned subsidiary, Kansas Gas & Electric Company (KG&E). In total, WRI, including its subsidiary KG&E, provides retail electric service to approximately 636,000 customers in the state of Kansas. WRI and KG&E are both certificated electric public utilities subject to the jurisdiction of the Commission pursuant to K.S.A. 66-104 and 66-131. Collectively, WRI’s electric businesses have been referred to in this proceeding as Western Resources Electric Business or WREB. WRI also owns 100 percent of Westar Industries, Inc., a holding company which owns several nonutility businesses, most prominently ONEOK and Protection One.(2)

(2)Additional information on WRI’s corporate structure is contained in this Commission’s Order of July 20, 2001.

2.Prior to 1996, WRI was almost exclusively an electric and natural gas public utility. As of December 31, 1995, WRI employed approximately $3.4 billion in total capital. WRI’s capitalization at that time consisted of long-term debt in the amount of $1.4 billion, short-term debt in the amount of $0.2 billion and $0.1 billion in quarterly income preferred securities (QUIPs).(3) At that time, WRI had equity of $1.7 billion, which represented approximately 50 percent of its total capital structure. Proctor Direct at 7, 12-13, 20 and Staff Exhibit No. JMP-5.

(3)QUIPs are obligations to securities holders which have both debt and preferred equity characteristics. For example, WRI may deduct for income tax purposes the dividends payable to the securities holder as interest expense.

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3.Since 1996, WRI has employed incremental capital to invest in nonutility businesses. As of December 31, 2001, after taking into consideration and adjusting for an impairment charge of $0.65 billion during the first quarter of 2002 for two of its nonutility subsidiaries, Protection One, Inc. (Protection One) and Protection One, Europe, WRI’s consolidated debt and equity were $3.6 billion and $1.2 billion, respectively, for a total of $4.8 billion in capital. Without the impairment charge, WRI’s total capital would have been $5.4 billion, including $1.8 billion of equity. Consequently, the equity component of WRI, on a consolidated basis, fell to approximately 25 percent of total capital. Proctor Direct at 7, 12-13, 20 and Staff Exhibit No. JMP-6.

4.WRI currently files consolidated financial statements that include the results and standing of Westar Industries, one of WRI’s wholly-owned subsidiaries which currently holds WRI’s investments in most of its nonutility businesses. Both WRI’s regulated electric utility operations and its nonutility business ventures are represented in its consolidated financial statements. WRI also prepares consolidated financial statements for Westar Industries, consisting of the financial results and standing for its investment in ONEOK, Inc. (ONEOK), Protection One and other miscellaneous nonutility investments.

5.In Westar Industries’ consolidated financial statements, as of December 31, 2001, WRI attributed only $0.5 billion of its $3.6 billion of consolidated debt to nonutility businesses. Proctor Direct at 9 and Staff Exhibit No. JMP-6. However, Commission Staff witness James Proctor found that only $1.5 billion of WRI’s $3.6 billion consolidated debt was necessary to finance WRI’s electric utility operations. He came to this conclusion by employing recognized financial techniques to estimate sources and uses of cash. The remaining $2.1 billion of consolidated debt, he found, was incurred and used to finance WRI’s nonutility investments.

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Thus, a large amount of debt sits on the books of WRI (which is the corporation in which the KPL utility division is located) that is properly attributable to Westar Industries and its nonutility businesses.

6.Under these circumstances, if there were a corporate reorganization in which Westar Industries was separated from WRI, the present allocation of debt and equity between the two entities would become permanent. The capital structure of WRI’s nonutility businesses would have received $1.6 billion of equity from WRI’s regulated electric utility operations. Conversely, WRI’s actions would have resulted in $1.6 billion of consolidated debt attributable to nonutility businesses being charged to the regulated utility operations. Proctor Direct at 6-7 and Staff Exhibit No. JMP-1.

7.These were the circumstances, among others described in detail in the Commission’s Order of July 20, 2001, that led the Commission to expand the scope of its investigation and require WRI to file a new financial plan, aimed at reducing debt, correcting the misallocation of debt between the utility and nonutility businesses, and reforming the manner in which WRI’s affiliates interact.

II.Procedural Summary

8.On May 8, 2001, the Commission entered its Order Initiating Investigation. The investigation would address

whether the participation by WRI and its affiliates in the transactions and relationships described herein, and any other transactions or relationships which may emerge from the investigation, is consistent with Kansas law, including WRI’s and KG&E’s statutory obligations to provide efficient and reliable service to Kansas customers at just and reasonable rates.

May 8, 2001 Order at 18.

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9.On July 20, 2001, the Commission entered its Order that determined that WRI’s participation in certain restructuring transactions described in that Order was not consistent with the public interest and contrary to Kansas law. The Commission made permanent the prohibition on consummating those transactions through a “Rights Offering” that would result in a permanent misallocation of the debt and assets within the WRI corporate family as set forth in the Commission’s July 20, 2001 Order at 13-20. The Commission specifically declared that the Asset Allocation and Separation Agreement (Asset Allocation Agreement) between WRI and its wholly-owned subsidiary, Westar Industries, through which the misallocation of assets and debt was established was null and void. July 20, 2001 Order at Ordering ¶¶ (B)-(F).

10.The Commission’s July 20, 2001 Order further required WRI to submit a financial plan to restore WRI to financial health, to achieve a balanced capital structure and to protect ratepayers from the risks of nonutility investments. July 20, 2001 Order at Ordering ¶ G. In judging the reasonableness of a proposed financial plan, the Commission proposed to evaluate not only financial plans but also accounting practices under the following two important criteria. That is, WRI and any financial plan must:

i.include an equitable allocation of assets and liabilities among WRI, WREB and WRI’s other unregulated businesses based on principles consistent with the manner in which electric and non-electric assets and operations were funded historically; and,

ii.protect WREB’s utility customers from harm caused by WRI’s investment in unregulated businesses.

11.On November 6, 2001, WRI filed a Financial Plan in response to the July 20, 2001 Order. WRI amended the Financial Plan on January 29, 2002. During the same time, WRI sought judicial review of the July 20, 2001 Order and the October 3, 2001 Order on

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Reconsideration in the District Court of Shawnee County, Kansas. Case Nos. 01-C1190 and 01- C1387.

12.On January 8, 2002, the Commission expressly expanded its inquiry to assess the impact of and risks associated with WRI’s interest in or affiliations with nonutility business activities on WRI’s jurisdictional electric utility business. The Commission invited comments on whether the Commission should adopt standards or guidelines for affiliate relationships to avoid subsidization of nonutility services or products by the regulated operations. The Commission also sought information on whether accounting guidelines or criteria can effectively evaluate, measure and monitor the impact of the financial condition of the holding company on the regulated electric operations (termed WREB); whether accounting procedures and practices are in place to correctly and equitably record and disclose affiliate transactions; whether accounting procedures and practices are in place to accurately report assets owned and liabilities attributable to the electric operations. The January 8, 2002 Order authorized discovery to facilitate the investigation and provide Commission staff (Staff) and other intervening parties a meaningful opportunity to participate.

13.On February 12, 2002, the Commission, noting the Shawnee County District Court’s dismissal of WRI’s petitions for judicial review and remand, established a procedural schedule for the investigation. The Commission reiterated its two main concerns: First, WRI’s assignment to the electric business of debt used for financing of nonutility business investments and operations creates a misallocation of debt between WRI’s electric business and its nonutility businesses. Second, WRI’s diversification and affiliation with nonutility businesses having stranded investments and other operating difficulties can harm WRI’s ability to provide sufficient and efficient electric service at just and reasonable rates. The Commission also

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directed WRI to explain whether recent actions taken by WRI to pledge KG&E assets as security for WRI debt and to sell or transfer significant utility assets violate the restrictions of the July 20, 2001 Order that WRI refrain from taking any actions that increase the share of debt attributable to WRI’s electric businesses, including entering into any affiliate agreements which violate this principle.

14.On March 26, 2002, the Commission issued an Order that WRI had violated the July 20, 2001 Order by selling the KG&E office building located in Wichita, Kansas, to an affiliate at below book value contrary to Ordering Clauses (B), (C) and (D), of the July 20, 2001 Order. The Commission required WRI to accrue estimated cost of service savings that WRI attributed to the sale of the building. The Commission reserved the appropriate rate treatment for final determination in a subsequent WRI rate proceeding.

15.On April 19, 2002, WRI submitted prefiled written direct testimony for Messrs. David C. Wittig, Paul R. Geist and Arthur H. Tildesley addressing a proposed rights offering, as presented in its amended Financial Plan. On May 23, 2002, Staff submitted prefiled direct testimony for Messrs. James M. Proctor and Jeffrey D. McClanahan; the Citizens’ Utility

Ratepayer Board (CURB) submitted prefiled direct testimony for Messrs. Stephen G. Hill, J. Randall Woolridge and Ms. Andrea C. Crane; Kansas Industrial Consumers (KIC) submitted prefiled direct testimony for Messrs. John C. Dunn and James R. Dittmer; and MBIA Insurance Corporation (MBIA) submitted prefiled direct testimony for Ms. Kara Silva and Messrs. Frank D. Stern, Louis G. Dudney, Steven T. Almrud, and Thomas B. Hensley, Jr. On June 18, 2002, WRI submitted prefiled rebuttal testimony of Mssers. Wittig, Geist, Tildesley, Michael J. Stadler, Richard A. Dixon, Greg A. Greenwood and Ms. Peggy S. Loyd. On the same date,

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several witnesses on behalf of Staff, CURB, KIC and MBIA submitted prefiled cross answering and rebuttal testimony.

16.On July 2, 3, 5, and 8-11, 2002, the Commission conducted hearings. The following appearances were entered: Ms. Susan B. Cunningham, General Counsel, and Ms. Anne Bos, Assistant General Counsel on behalf of Staff; Messrs. Martin J. Bregman, Executive Director, Law, Westar Energy, Inc., Larry M. Cowger, Director, Law, Westar Energy, Inc. and Michael C. Lennen on behalf of WRI; Mr. Walker Hendrix and Ms. Niki Christopher, Consumer Counsel, on behalf of CURB; Messrs. Joe Allen Lang, First Assistant City Attorney and Jay Hinkle on behalf of the City of Wichita, Kansas (Wichita); Ms. Sarah J. Loquist on behalf of Unified School District 259, Wichita, Kansas (U.S.D. 259); Mr. James P. Zakoura of behalf of KIC; Messrs. Karl Zobrist, J. Dale Young and Ms. Glenda Cafer on behalf of MBIA; Mr. James G. Flaherty on behalf of Aquila, Inc. and Messrs. James G. Flaherty, Eric Grimshaw, Vice President and Associate General Counsel, ONEOK, Inc. and John P. DeCoursey, Director of Law, Kansas Gas Service Company, a division of ONEOK, Inc. on behalf of ONEOK, Inc. (ONEOK).

17.On July 2, 2002, ONEOK, WRI, Westar Industries, Staff, CURB and MBIA (collectively referred to as Movants) filed a Joint Motion Approving Partial Stipulation and Agreement. The Movants requested the Commission to issue an order authorizing WRI/Westar Industries to sell its ONEOK Stock in accordance with the terms of the Shareholder Agreement between ONEOK and WRI and authorizing ONEOK, should it elect to do so, to purchase the ONEOK stock from WRI/Westar Industries. On July 9, 2002, the Commission asserted jurisdiction over the subject matter of the Partial Stipulation and Agreement and conditionally approved the Partial Stipulation and Agreement. The Commission’s approval was conditioned

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on WRI’s commitment that the proceeds from any sale of the ONEOK stock held by Westar Industries to ONEOK or to any other third party, be in cash and that such cash proceeds be used to decrease WRI’s consolidated debt without WRI incurring any intercompany payable to Westar Industries.

III.The Commission Rejects WRI’s Financial Plan Because it Compounds, Rather Than Addresses, WRI’s Underlying Problems.

18.The July 20, 2001 Order rejected, as unlawful and contrary to the public interest, WRI’s proposed Asset Allocation Agreement, the rights offering for Westar Industries’ stock and the split-off of Westar Industries (which at the time held WRI’s interest in nonutility businesses) from WRI to WRI shareholders. The Commission found that the effects of these proposals would be to burden WRI (which after the split-off of Westar Industries to WRI shareholders would consist only of WRI’s electric business) with substantial debt related to nonutility, business activities for which debt WRI would be legally responsible. After the split-off of Westar Industries, WRI would then be burdened with the large debt related to its investments held in Westar Industries and be unable to avail itself of Westar Industries’ assets to retire the Westar Industries-related debt held by WRI. July 20, 2001 Order at ¶¶ 25-28.

19.Distinct from the problems posed by the proposed split-off, the Commission found that WRI’s “junk bond” credit rating was inconsistent with its public service obligations and that the situation required more than mere improvement to “investment grade.” July 20, 2001 Order at ¶¶ 42, 58, 64, 85. The Commission stated “[f]ailure to achieve a bond rating similar to comparable utilities will mean higher interest rates.” Id. at ¶ 42.

20.In rejecting WRI’s proposal due to the potential for harm to ratepayers and the public interest, the Commission explained that it was not obligated by statute to wait for

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ratepayer harm to occur before acting. July 20, 2001 Order at ¶ 26. The July 20, 2001 Order therefore directed WRI to present a plan, consistent with the prohibitions and parameters set forth in that Order, to restore WRI to financial health, to achieve a balanced capital structure and to protect ratepayers from the risks of the nonutility business. July 20, 2001 Order at 1.

21.WRI did submit a proposal, which is the subject of the instant proceeding. The Commission finds that this new proposal reasserts WRI’s design and intent to separate Westar Industries and WRI in a manner harmful to the utility business and its ratepayers. This ill-designed separation would leave WRI with the electric utility business encumbered by $1.6 billion dollars in nonutility debt incurred for the benefit of the nonutility investments of Westar Industries. In its July 20, 2001 Order the Commission found, inter alia, that “[t]he resulting debt-equity imbalance in WRI harms WREB and its customers.” July 20, 2001 Order at ¶ 1. As explained further below, WRI’s present plan does not address the harm which the Commission ordered WRI to avoid, but confirms WRI’s intent to proceed in a manner that the Commission has already found to be harmful and contrary to the public interest.

A.WRI’s Plan

22.WRI’s Plan encompasses two stages. Wittig Direct at 3-4. In the first stage, WRI would offer each WRI shareholder the right to purchase one share of Westar Industries’ common stock for every three shares of WRI’s stock held on the date of the offering (the “rights offering”). The shares to be sold would range from a minimum of 4.14 million shares (approximately 5.1 percent of outstanding Westar Industries shares) to a maximum of 19.1 million shares (approximately 19.9 percent of outstanding Westar Industries shares). Wittig Direct at 3. The proceeds from the rights offering would be used by Westar Industries to purchase currently outstanding WRI or KG&E debt securities in the market. Wittig Direct at 6.

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23.In the second stage, WRI proposed to use its “best efforts” to sell the Westar Industries shares it owns, shares of WRI stock, or a combination of these types of shares, in order to reduce WRI’s short and long term debt to $1.8 billion. Wittig Direct at 4. The sale of equities would be triggered if Westar Industries’ shares close for 45 consecutive trading days at a price that is 15 percent above the price necessary to reduce the debt to an amount less than $1.8 billion based on the debt reported in the most recent SEC Form 10-K or 10-Q. This sale would not occur prior to February 2003. Id.

24.WRI states that two features of the plan reduce the price for Westar Industries stock that would be necessary to trigger the sales obligation: (1) the level to which WRI’s consolidated debt would need to be reduced in order to trigger the second stage of the plan would be increased by $100 million on each anniversary of Westar Industries’ rights offering; and (2) WRI commits to reduce its debt by $100 million provided by cash flow each year following the completion of the rights offering until the separation of Westar Industries is consummated. Wittig Direct at Exhibit DCW-1; Exhibit A; Amended and Restated Financial Plan at 15. This latter debt reduction would be in addition to the debt reduction effected by Westar Industries’ rights offering and the second-stage equity sales. Id.

B.The Commission’s July 20, 2001 Order

25.In the July 20, 2001 Order, the precursor to the instant proceeding, the Commission considered WRI’s actions to separate the nonutility business activities of WRI through a rights offering for stock in Westar Industries and a subsequent distribution or “split-off” of Westar Industries through WRI’s distribution of its shares in Westar Industries to WRI’s shareholders. As part of that plan, WRI transferred assets to Westar Industries without allocation of all debt related to the funding of those assets. After completion of WRI’s planned rights

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offering and subsequent distribution of Westar Industries’ common stock to WRI shareholders, Westar Industries would have owned a substantial interest in WRI common stock. WRI would then have been left essentially with only an electric utility business and all of the consolidated debt issued by WRI for funding the utility and nonutility businesses.

26.The July 20, 2001 Order found that a fundamental problem with WRI’s plan was that the rights offering for and subsequent split-off of Westar Industries from WRI was based upon a misallocation of assets and debt as required by the Asset Allocation Agreement between WRI/Westar Industries and the Public Service Company of New Mexico (PNM). However, as the Order explained, the assignment of assets and debt within WRI’s consolidated group might not have a deleterious effect on the regulated electric utility operations since, without a rights offering for and split-off of Westar Industries, WRI would continue to own 100 percent of Westar Industries’ common stock. However, WRI’s planned rights offering for and split-off of Westar Industries’ stock would have rendered the misallocation of assets and debt permanent. The July 20, 2001 Order summarized the inherent problem of the misallocation of assets and debt and the unjust enrichment of Westar Industries at ¶ 24:

In sum, all of the Transactions are designed to ensure that at the time of the split off, WRI’s electric business will hold significant debt but no Westar [Westar Industries] assets, while Westar will own all of WRI’s unregulated assets but will not be responsible for WRI’s long-term debt used to acquire them.

27.The Order further explained why such a misallocation of debt would harm WRI’s ability to perform its public utility obligations under Kansas law. July 20, 2001 Order at ¶¶ 25-30. The Commission therefore ordered WRI to, inter alia,

submit a financial plan to restore WRI’s financial ratings to the investment grade level of similarly situated electric public utilities. This restoration will require WRI to address the various

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causes of the problem, including the financial difficulties created by its unregulated businesses.

Id. at ¶ 85. The Commission further specified at ¶ 85 that the plan must be directed to restoring “WRI’s financial ratings to an investment grade level of similarly situated public utilities.”

C.Permanent Misallocation of Assets and Debt

28.WRI’s allocation of assets and debt to Westar Industries — which the July 20, 2001 Order found contrary to the public interest — would not be corrected by the new plan. To the contrary, WRI’s new plan, like the original plan, would make this misallocation permanent.

29.Under the November 6, 2001 Financial Plan, as amended, WRI proposes that Westar Industries make a rights offering of its common stock to WRI’s shareholders. The rights offering would initiate events that would ultimately confirm, and make permanent, the misallocation of assets and debt to Westar Industries. The execution of WRI’s present proposal would result in a separation of Westar Industries from WRI, with a misallocation of debt and assets substantially identical to the misallocation of assets and debt provided in the Asset Allocation Agreement. Yet, the July 20, 2001 Order rejected the Asset Allocation Agreement and its misallocation of assets and debt as contrary to WRI’s public service obligations.

30.As shown by the analysis of Staff witness Proctor, as of year end 2001, WRI attributed to Westar Industries approximately $0.48 billion (17 percent) debt and $2.30 billion (83 percent) equity. Proctor Direct at 9 and Staff Exhibit No. JMP-1. Based on data provided by WRI, Proctor found that this would leave WREB, as a stand alone company, with a capital structure containing $3.11 billion (117 percent) debt and negative $0.45 billion (negative 17 percent) equity as of December 31, 2001. Proctor Direct at 14.

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31.However, applying appropriate discounted cash flow analyses and equity funding analyses to the allocation of debt from WRI to Westar Industries demonstrates that WRI should attribute approximately $1.47 billion of debt to WREB. Proctor Direct at 14-15, Staff Exhibit No. JMP-2, Schedule No. 3. Based on this testimony, the Commission therefore finds that WRI failed to properly allocate the assets and debt within the WRI corporate family, and has attempted through its Financial Plan to assign approximately $1.63 billion of debt attributable to nonutility business activities to WRI’s regulated utility operations. Leaving this $1.63 billion of debt with WRI after the proposed rights offering for and subsequent sale of Westar Industries’ stock (the second stage of WRI’s Financial Plan) would mean that WRI’s electric business (the only WRI assets remaining) would become financially responsible for debt incurred to finance the nonutility business investments transferred to Westar Industries. To make WRI’s electric utility operations carry this $1.63 billion of debt burden, used to fund Westar Industries’ nonutility business activities, is not consistent with WRI’s public service obligations. Proctor Direct at 14.

32.Put in terms of the capital structure, WRI’s misallocation of debt and assets would leave WRI’s electric utility business, if viewed as a stand-alone company, with a capital structure ratio of 117 percent debt and negative 17 percent equity. Conversely, WRI’s proposed capital structure for Westar Industries is unjustly enriched with 83 percent equity. Such a capital structure does not accurately represent the negative effects of deficient cash flow related to WRI’s unprofitable investment in Protection One. Proctor Direct at 11. For example, in the first quarter of 2002, WRI’s equity was decreased by approximately $0.65 billion because of an impairment charge (equity write-off) for Protection One and Protection One Europe. Proctor Direct at 22.

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33.Had the allocation within the WRI corporate family been made consistent with historic financial requirements of the business operations, WRI’s electric utility business would have a capital ratio of 55 percent debt ($1.47 billion) and 45 percent equity ($1.18 billion). WRI’s electric utility business, at the rates legally established by this Commission and by the Federal Energy Regulatory Commission, without any misallocation of assets and debt between the utility and nonutility affiliates, generated sufficient cash that the proper capital structure to attribute to WRI’s electric utility business is the one described by Proctor, not the one proposed by WRI in its Financial Plan. Proctor Direct at 11, 13-15. The Commission finds that the capital ratio presented by Staff witness Proctor is an accurate representation of WRI’s actual operational experience for its regulated electric businesses.

34.WRI asserts that Proctor’s “allocation of debt will be arbitrary since the legal obligation to repay any particular loan instrument will not change.” WRI Initial Brief at 64. WRI misunderstands the point. The Commission does not view Proctor’s cash flow analyses as intended to suggest a change in the legal location of the indebtedness. Rather, Proctor’s analysis explains how this very legal location represents the misallocation of debt and assets within the WRI corporate family under WRI’s proposed plan.

35.WRI, through the testimony of its witness Paul Geist, takes issue with Proctor’s cash flow analyses. Geist testified that one cannot “...trace the money...” or “...track the flow of funds.from source to use...” Geist Rebuttal at 5 and 7. However, Geist misstates or misunderstands Proctor’s analyses. Proctor agreed that analysts cannot track the specific source for one dollar to its specific use in a diversified corporation, and he did not purport to have done so. Proctor Direct at 14. Proctor explained, however, that it is not necessary to do so to estimate

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the sources and uses of cash funds within a diversified company in an aggregated and ultimately, disaggregated basis. Proctor Direct at 14.

36.In support of this position, Proctor explained that diversified companies such as WRI receive funding from multiple sources (e.g., customer payments, stock offers, debt issuances) and use the funding for multiple purposes (e.g., purchasing supplies, investing in capital assets, providing customer service —and all for more than one business activity). It is difficult or impossible to know whether, for example, a particular dollar raised from a particular debt issuance or customer payment went, to the purchase of a particular supply item or the investment in a particular piece of equipment. However, companies can determine the total amounts of funding received from each source (e.g., customer payments, debt and stock issuances) and the total amount expended on objects of expenditure (e.g., supplies, customer service, investment, operating expenses). In fact, cash flow analyses are regularly and routinely employed by corporate finance experts to perform such tasks or analyses in evaluating businesses and business investments. Proctor Direct at 14-15.

37.Proctor further explained that WRI itself performs cash flow analyses on a consolidated and deconsolidated basis. In order for WRI to prepare cash flow statements for Westar Industries, it needs to separate the sources and uses of WRI’s consolidated cash flow between WRI and Westar Industries. Proctor makes clear that the separation of the sources and uses of WRI’s consolidated cash flow between WRI and Westar Industries is the same task that he performed for this proceeding. Proctor Direct at 14-15. In addition, Proctor explained, as shown in Staff Exhibit No. JMP-2, that a cash flow analysis for WRI’s electric business is the difference between the cash flow analysis for WRI and the one for Westar Industries.

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38.The Commission concludes that Proctor’s approach is reasonable and appropriate for evaluating the capital structures proposed under WRI’s plan. In short, because WRI has, as discussed herein and in the July 20, 2001 Order, placed the nonutility activities in Westar Industries and left WRI with the electric operations, the construction of a cash flow analysis for WRI’s electric operations, can be derived from a comparison of the data available for WRI with that of Westar Industries.

39.WRI further argues that it was arbitrary for Proctor to begin the cash flow analyses with the calendar year 1998. Geist Direct at 12. Proctor explained that he had reviewed the capital structure for WRI’s electric operations as of December 31, 1997, in a prior docket, and found the capital structure at that time to be representative for WRI’s electric utility business, as a stand-alone company. Proctor Direct at 12. Proctor checked his cash flow analysis with an alternative, an equity funding method that employed financial data back to 1995. Proctor Direct at 17-21. Proctor’s alternative analysis resulted in an estimated $1.56 billion for the amount of debt incurred by WRI for the benefit of Westar Industries, compared to the $1.63 billion estimate derived by his discounted cash flow analyses. Proctor Direct at 17. Proctor stated that the results are sufficiently close to lend support to the discounted cash flow analyses. The Commission agrees and concludes that Proctor’s cash flow analyses presented reasonable and accurate representations of what the capital structure would have been for WRI’s electric utility operations, as a stand alone company, absent the misallocation of assets and debt through interaffiliate transactions.

40.In sum, the Commission must reject any proposal that is based and perpetuates the misallocation of debt and assets between utility and nonutility businesses.

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41.WRI seeks to justify its Financial Plan, as amended, in terms of the debt reduction potential. But the Plan would obtain that debt reduction using the very devices that make the misallocation permanent: Westar Industries’ rights offering and WRI’s subsequent sale of WRI’s investment in Westar Industries’ stock. There is substantial uncertainty as to whether the rights offering by Westar Industries and subsequent sale by WRI of its investment in Westar Industries’ stock will produce the cash envisioned by WRI. That is, WRI cannot guarantee that the market value for Westar Industries’ stock will generate sufficient proceeds to reduce WRI’s consolidated debt to an appropriate level.

42.In contrast to the uncertainty over the amount of debt reduction, there is certainty that Westar Industries’ rights offering and WRI’s subsequent sale of WRI’s investment in Westar Industries’ stock will make permanent the present misallocation of assets and debt. Only if the cash proceeds envisioned by WRI are achieved will that misallocation be decreased. WRI’s Financial Plan, if successful, requires it to decrease debt to $1.8 billion. However, WRI’s Financial Plan would still leave WRI and its utility businesses with $0.3 billion greater debt than appropriate. The Commission may not adopt a plan that subjects WRI to definite adversity, in the hopes that this adversity will be overcome by uncertain cash flow from a rights offering and sale of Westar Industries’ stock. For this reason alone, the Commission must reject WRI’s debt reduction plan. The facts on which the Commission bases its findings of uncertainty as to the cash proceeds are discussed next.

D.Undue Ratepayer Risk and Substantial Uncertainty

43.As the Commission’s July 20, 2001 Order stated, restoration of WRI’s financial health means not merely a bond rating of investment grade, but a bond rating comparable to utilities facing similar utility-related risks. July 20, 2001 Order at ¶¶ 42 and 85. The record

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shows that WRI’s rights offering plan will, assuming it is successful as proposed, still leave WRI with too much debt.

44.WRI’s Financial Plan, as amended, proposes a reduction of debt to $1.8 billion which, because it does not include all of WRI’s consolidated debt (the QUIPs obligation to securities holders of $0.2 billion was omitted), is properly seen as a reduction to $2 billion in consolidated debt. Proctor Direct at 48. Even if WRI’s plan, with its proposed reduction to $2 billion in debt, were achieved, WRI would have a capital structure of more than 68 percent debt, and less than 32 percent equity. Proctor Direct at 48 and Staff Exhibit No. JMP-10, Schedule No. 2. This ratio is well above the debt to equity ratio typical for an electric public utility. Dittmer Direct at 10. The average common equity ratio for electric public utilities located in the Midwest is approximately 44.5 percent. Dittmer Direct at 10, citing Value Line Investment Survey for 2002, Central Electric Utility Group, April 5, 2002, at 695. Moreover, successful implementation would, in fact, decrease WRI’s cash flow for the years 2003 and 2004 by $27.6 million and $66.5 million, respectively. Proctor Direct at fns. 56-57, Staff Exhibit No. JMP-10, Schedule No. 1.

45.The record shows that WRI’s plan — even if it works as WRI states — would fall hundreds of millions of dollars short of the debt reduction embodied in alternative proposals presented to the Commission. Furthermore, WRI’s plan would likely result in a capital ratio still excessively weighted with debt, as compared to other proposals. Because there are other alternatives working in combination, as discussed below, that are substantially more likely to produce the required results, and substantially less likely to fall short and thereby perpetuate the ongoing damage to the public interest, the Commission must reject WRI’s Financial Plan, as amended.

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46.In summary: Adopting WRI’s Plan would subject ratepayers to substantial risk and uncertainty that WRI will ever resolve its financial problems, while impairing its ability to provide sufficient and efficient electric service at just and reasonable rates. Even if WRI’s Financial Plan, as amended, meets its stated goals, the Plan would neither achieve debt reduction sufficient to correct the misallocation of debt and assets, nor bring WRI’s debt-equity ratio in line with that of other public utilities. These deficiencies, as well as the permanent misallocation of assets and debt within the WRI corporate family described above, require the Commission to reject the proposed plan as inconsistent with WRI’s public service obligations.

E.Commission Inaction Not Supported by WRI’s Arguments

47.According to WRI, the record demonstrates that WRI has not been imprudent, that there are no parties asserting that WRI has engaged in fraud, that WRI has reduced rates in recent years, that WRI’s embedded cost of debt has not increased, that there is no credible evidence of cross-subsidization, that WRI’s stock has outperformed the Dow Jones Utilities average (and Empire District Electric Company, Great Plains Energy, and Aquila) in the last two years, and that electric service has been provided reliably and will be provided reliably in the foreseeable future. WRI Initial Brief at 1-3, 16-18, 33-47, and 64-68; WRI Reply Brief at 1-5, 21-25,28-29, and 36-46. WRI states that: “[t]here simply is no evidence in this record upon which the Commission can base a proper finding…that any customer or creditor of the Company has been harmed in any way.” WRI Reply Brief at 5.

48.These arguments do not address the circumstances that require Commission action; nor do these arguments address the factual underpinnings of the July 20, 2001 Order. As stated above, it is undisputed that WRI’s debt is excessive and its credit deficient. The record demonstrates that the adverse financial condition in which the electric utility businesses find

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themselves was caused by WRI’s nonutility investments and use of the regulated utility to support nonutility activities. These realities, again, underlay the Commission’s July 20, 2001 Order, which directed WRI to

present a plan, consistent with the foregoing prohibitions and parameters set forth in this Order, to restore WRI to financial health, to achieve a balanced capital structure, and to protect ratepayers from the risks of the nonutility business.

July 20, 2001 Order at ¶ 42.

49.The Commission need not wait for harm to occur in the form of increases in rates or decreases in reliability. The Commission instead can draw reasonable inferences from the facts in the record. It can reasonably conclude, and does so here, that a capital structure with excess debt, in place for well over a year, in a context where the company not only has not corrected the situation but has proposed measures which are likely to leave the debt problems on the books of the utility, will cause harm to the electric utility business and its customers.

50.WRI also argues that it recently refinanced some of its debt without increasing its embedded cost of debt. WRI Initial Brief at 35. But a refinancing that did not result in an increase in embedded debt cost is not surprising where interest rates have declined to the lowest levels in years. The embedded cost could have and should have been lower if WRI’s credit rating had been better. Dunn Direct at 11-12.

51.Also, WRI states that its Protection One subsidiary has experienced positive cash flows in the past two years. WRI Initial Brief at 18. However, the Commission believes that merely examining Protection One’s cash flow for the past two years does not provide a complete understanding of the negative effect of Protection One’s historic, deficient cash flow and operating losses on WRI. According to KIC Exhibit No. 23 (Protection One SEC Form 10-K for

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period ending December 31, 2001, at 16), Protection One had losses in 1997 of $42.3 million; in 1998 of $17.8 million; in 1999 of $80.7 million; in 2000 of $57.2 million; and in 2001 of $86.0 million. As evidenced by Protection One’s historic operating losses for 1997 through 2001 and by Protection One’s equity write-off in the first quarter of 2002, WRI’s investment in Protection One has had a substantial negative impact on WRI’s capital structure.

52.In sum, the record compels rejection of WRI’s proposed plan, and the Commission hereby does so. The Commission is statutorily obligated to protect the public interest in reliable, safe, and efficient electric operations at just and reasonable rates. The continued existence of the conditions identified in the July 20, 2001 Order precludes any finding that WRI’s current conduct is consistent with its statutory obligations to serve the public. Further, the continued existence of the misallocation of debt and assets among the WRI corporate family would unjustly enrich the nonutility businesses of Westar Industries at the expense of WRI’s regulated electric operations and continues to provide WRI with incentive to propose financial plans inconsistent with the public interest and contrary to the directives of the July 20, 2001 Order.

IV.WRI Must Reallocate and Reapportion Debts and Assets Equitably Within the WRI Corporate Family and Separately Incorporate the Jurisdictional Electric Operations as a subsidiary of WRI.

A.The Commission’s Authority and Responsibility to Fashion a Remedy To Protect Utility Interests

53.An understanding of the Commission’s legal authority and responsibility to respond to the WRI problems presented by this record is best obtained by reviewing first the legal context, and then the factual context. Each is discussed next.

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1.The Legal Context

54.Kansas law provides the Commission with broad authority and obligation to oversee and protect the integrity of utilities that serve Kansas ratepayers. Pursuant to K.S.A. 66-101, the Commission “is given full power, authority and jurisdiction to supervise and control the electric public utilities . . . doing business in Kansas and is empowered to do all things necessary and convenient for the exercise of such power, authority and jurisdiction.” K.S.A. 66-101(d) provides the Commission with investigatory powers: “If after investigation and hearing it is found that any regulation, measurement, practice, act or service complained of is unjust, unreasonable, unreasonably inefficient or insufficient, unduly preferential, unjustly discriminatory, or otherwise in violation of this act or of the orders of the commission ... the commission shall have the power to substitute therefore such other regulations, measurements, practices, services or acts, and to make such order respecting any such changes in such regulations, measurements, practices, services or acts as are just and reasonable.” K.S.A. 66-101(h) provides that the Commission “shall have general supervision of all electric public utilities doing business in this state and shall inquire into any neglect or violations of the laws of this state.” The section further provides that, “the commission shall carefully examine and inspect the condition of each electric public utility, its equipment, the manner of its conduct and its management with reference to the public safety and convenience.” K.S.A. Section 66-101(g) provides that “the provisions of this act and all grants of power, authority, and jurisdiction herein made to the commission, shall be liberally construed, and all incidental powers necessary to carry into effect the provisions of this act are expressly granted and conferred upon the commission.” This statutory authority supports the Commission’s actions taken in this order.

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55.WRI, in contrast, argues that: (1) the existence of statutory provisions addressing affiliated interests, as set forth in the Holding Company Act and K.S.A. 66-125, shows that Commission authority does not extend to securities issuances of nonutility subsidiaries of public utilities, Initial Brief at 20, 24; (2) Commission action to prohibit the rights offering is “an inappropriate invasion of management prerogative and authority,” Initial Brief at 26; (3) the Commission does not have broad jurisdiction over transactions that “may affect” jurisdictional utilities, Initial Brief at 29; and (4) the Commission has no authority to invite third party intervenors to propose business plans for WRI, Initial Brief at 32.

56.WRI’s argument distills to the following principle: The Commission has no authority to protect a jurisdictional utility from harm where the source of that harm consists of activities of the utility’s affiliates or its holding company, even where utility and nonutility activities are under identical management and even where that management has a history of putting the utility’s financial condition at risk by proposing to shift utility equity to the nonutility businesses and leaving the utility with an equity-debt ratio which deviates severely from the utility’s historic capital structure and the capital structure of typical utilities. The Commission disagrees. The Commission’s statutory power and obligation to assure service is sufficient and efficient at just and reasonable rates does not allow the Commission to look away from this situation, out of respect for a “management prerogative” not specified in statute. Under WRI’s statutory reading, a utility could defeat the Commission’s comprehensive regulatory authority by arranging relations with a holding company and affiliates such that the harm which the Commission is required to prevent, pursuant to its statutory duty to assure just and reasonable, efficient and sufficient service, has as its source a nonutility entity.

57.WRI argues, Initial Brief at 9-25, that the Commission’s authority under K.S.A

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Section 66-101 is limited by further statutory provisions. WRI focuses on K.S.A. 66-125 (issuance of securities); K.S.A. 66-1401 (jurisdiction over holding companies; affiliated interests defined); K.S.A. 66-136 (franchise transfers); K.S.A. 66-1402 (submission of contracts with affiliated interests); and K.S.A. 66-1214 (dividend payments). See also WRI Reply Brief at 9-10. WRI does not show where and how the broad authority and statutory obligations stated in K.S.A. 66-101 are diminished by statutory language that clearly supplements, rather than supplants, Commission authority. Under WRI’s reading, the Commission must look the other way when the cause of harm to the utility is an activity or entity regulated by another provision, even when the activity or entity is controlled by the same management that controls the utility. The statutory language does not support this reading. K.S.A. 66-1401 and 66-1402 are reporting requirements intended to supplement the Commission’s authority and assist the Commission in stopping abusive inter-affiliate relations that are harmful to the public interest. Similarly, K.S.A. 66-1214 does not limit the Commission’s authority to prohibit dividends, but rather, states the procedures to be employed in doing so. Likewise, K.S.A. 66-125 is a reporting provision intended to accommodate the faster-paced financing transactions in today’s business world while providing the Commission financial information about the public utility.

58.Finally, with regard to K.S.A. 66-136, a statute that provides the Commission broad authority over all matters affecting the provision of utility service, WRI argues that case law has limited the applicability of the statute. Citing Kansas Electric Utilities Company v. Kansas City, Kaw Valley & Western Railway Company 108 Kan. 285, 289 (1921)(Kaw Valley), WRI argues that the statute does not extend the Commission’s approval authority to contracts that “may affect” the public utility. However, in that case, the contract at issue involved an unaffiliated business, and not, as here, an affiliated company. Kaw Valley did not involve

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circumstances where, as here, all the relevant entities are affiliates; nor did it address entities and their managements that mixed utility and nonutility interests to the detriment of the public utility. Even so, the decision on rehearing in Kaw Valley shows that the outcome might have been different had further factual showing been made regarding the effect on the regulated entity. The majority court stated that the trial court’s factual determination on whether K.S.A. 66-1336 was triggered was correct. Id. at 292. On rehearing, the majority court summarized its understanding of the facts, finding that the “contract carries into effect the defendant’s franchise and does not assign, transfer, or lease it, nor any part of it, nor refer to or affect it, nor modify, restrict, or defeat its operation.” Id. at 299. The point is further illustrated from the dissenting opinion where the dissenting court argued that the majority court’s decision was based upon a misconception of the facts that would have required Commission approval under K.S.A. 66-136. Id. at 301. There was no disagreement between the majority and dissenting court on whether the public utility had the right to harm its ability to perform its public service obligations. No such right existed. Id. at 301.

59.WRI further argues, Initial Brief at 26, that Commission action to remedy the financial difficulties of record here would “fundamentally constitute[s] an inappropriate invasion of management prerogative and responsibility.” Regulatory deference to a management decision might be appropriate where the management decision at issue is: (i) a reasonable response to the utility’s obligation to provide just and reasonable, efficient and sufficient service, and (ii) not subject to a conflict in goals between utility and nonutility activities. As the Commission explained above, these conditions do not exist here.

60.In support of its “management prerogative” argument, WRI, Initial Brief at 26, relies on Wichita Gas Co. v. Public Service Commission, 126 Kan. 220, 268 P. 111 (1928) and

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Sekan Electric Cooperative Association, Inc. v. State Corp. Commission, 4 Kan. App. 2d 477, 480, 609 P.2d 188 (1980). Neither of these cases, or any of the further cases cited by WRI, involved showings that utility operations were prejudiced or harmed by management’s operations from nonutility affiliates.

61.Wichita was a rate dispute in which the Court rejected the views of the Commission’s expert as to the time period over which an item should be expensed. Wichita did not address circumstances where utility financing was distorted to benefit nonutility activities; nor did it address circumstances where management (of both utility and nonutility activities) persists in decisions that are shown to be contrary to the utility interest. In Wichita, in regard to Commission argument that the utility overpaid for gas from an affiliated entity, the Court noted that, “[i]t is impossible to declare, on the meager record in this case, either agency or abuse of corporate privilege, in the relation between the Kansas gas companies and the parent organization.” Wichita, 126 Kan. at 230.

62.In Sekan Electric, another rate case, the court upheld the authority of the Commission to adopt a hypothetical equity ratio for purposes of establishing the utility’s rate of return. In doing so, as WRI notes, it cited a public utility treatise, which explained that it was management prerogative “to say how much debt should be incurred or common stock issued.” However, the language cited by WRI is dicta. Moreover, Sekan did not involve or address circumstances where: (i) a utility (such as WRI’s KPL division) does not have a separate capital structure from the parent holding company that is also used to fund nonutility businesses; (ii) the utility’s effective capital structure is established not by independent utility management whose sole allegiance is to the utility, but by management which also has responsibility for nonutility affiliates, thus creating an incentive and opportunity to misuse the utility’s financial strength to

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support the nonutility affiliates; and (iii) management has responded to this incentive and opportunity by taking actions which are detrimental to the utility’s financial strength. There is no prerogative to behave in this manner.

2.The Factual Context

63.The Commission’s obligation to protect the public utility from investment in nonutility businesses is triggered when there is a causal connection between the nonutility activities and a substantial likelihood of harm to the regulated public utility. Here, the record shows that: (i) WRI’s excess debt is detrimental to WRI’s utility activities, (ii) the excess debt was incurred by management’s use of the utility to benefit nonutility activities; and (iii) WRI management—which manages both the utility and nonutility activities—proposes to address the excess utility debt problems caused by its investment in nonutility activities with a plan that puts the utility at further risk of being left holding obligations to repay debt incurred to further nonutility activities.

64.The following facts and patterns of fact provide material support for the Commission’s authority to act here to protect the interest of WRI’s utility operations:

(a)WRI operates the KPL electric business as a division within a holding company structure. Within that holding company structure, human and capital resources are combined. This fact supports the Commission’s actions here because this corporate structure allows the holding company to draw on the utility’s human and capital resources for use in nonutility business ventures.

(b)Westar Industries, which houses the nonutility ventures, is a holding company owned exclusively by WRI, with which Westar Industries shares

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top management. Westar Industries has no assets except those conveyed to it by WRI. This fact supports the Commission’s exercise of its authority because, in contrast to a context in which utility management is responsible solely for the interests of the regulated entity, utility management here is simultaneously responsible for an entity comprised of nonutility activities, whose interests may be, and have been, in conflict with those of the utility.

(c)WRI has a level of debt well in excess of equity, and a credit rating below investment grade. WRI’s debt problem arises because of its financing of nonutility activities. As noted in the opening sections of this Order, in 1995, WRI, then almost exclusively a public utility company, had a total company debt of $1.7 billion. In 2002, after WRI invested in nonutility activities, WRI’s total debt climbed to $3.6 billion. In 2001, $2.1 billion of the debt was attributable to nonutility business activities, and only $1.47 billion could reasonably be said to be required for utility operations. Proctor Direct at 17-21; Staff Exhibit No. JMP-1. The excess debt supports the Commission’s exercise of its authority here because it increases the borrowing costs of WRI, who may need to seek recovery of those costs from its utility ratepayers, Dunn Direct at 11-12, and because WRI will likely continue to seek to use utility cash flow to make good on part or all of its obligation to repay the debt and interest expense on that debt. See Part III of this decision. WRI’s retained earnings subsidy for Westar Industries consists of subsidized interest expense payments of

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approximately $257.6 million for the years 2000 and 2001. Proctor Direct at 18.

(d)WRI’s proposed remedy to WRI’s debt problem includes a “rights offering” of Westar Industries stock. In the July 20, 2001 Order, the Commission found that this rights offering, if effectuated, would have substantial detrimental effects on the electric operations. Notwithstanding the July 20, 2001 finding, WRI again proposed the use of a Westar Industries’ rights offering as the first stage of a plan to remedy financial problems affecting the public utility. The Commission finds here that this renewed proposal would also be detrimental to the interests of the regulated utility operations. See Part III of this decision. These facts support the Commission’s exercise of its authority to promulgate standards and guidelines to govern affiliate relations within the WRI corporate family because they strongly indicate that WRI management will seek to use utility operations and resources as a vehicle to resolve WRI’s financial problems caused by its nonutility businesses, along with its nonutility investment objectives, in a manner that will place the regulated utility at further risk..

65.WRI identifies a series of facts which it states are material to the determination of the Commission’s authority here. WRI Initial Brief at 13-18; Reply Brief at 9-10. But as explained next, the facts on which WRI proposes to rely, like the legal precedent on which it relies, vary materially to the circumstances here. Thus:

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(a)First, WRI states that relevant actions of its nonutility activities do not affect or are isolated from regulated activities. The Commission concludes that the record shows otherwise. For example, WRI states that the rights offering that was previously rejected by the Commission in the July 20, 2001 Order was for the issuance of securities by a WRI nonutility subsidiary, and therefore fell outside of the Commission’s lawful concern. WRI Initial Brief at part IIB. This previously rejected proposal is not before us now; however, as the July 20, 2001 Order explained, the rights offering was part of an integrated plan to merge with the PNM. As explained in that order, the combination of transactions—rights offering, split-off, Asset Allocation Agreement, along with the excess debt and misallocation of debt and equity between WRI and Westar Industries—had direct consequences for the regulated utility operations.(4) Similarly, with regard to the Asset Allocation Agreement, WRI states (in boldface) that “nor has Westar Energy assumed debt of Westar Industries.” Id. This wordplay ignores the facts. WRI incurred debt on behalf of nonutility activities in the first instance. Similarly, WRI states that the “the asset allocation agreement did not in any way affect the public utility franchise of WE [WRI].” Id. at 16. However, the Commission found in the July 20, 2001 Order that the Asset Allocation Agreement would have locked in the

(4)See July 20, 2001 Order, at Part I: “The Commission finds that the split-off, the asset allocation agreement, the rights offering, the intercompany receivables and the ownership of WRI common stock by Westar [Westar Industries], are interdependent and considered collectively, are contrary to the public interest and pose substantial risk of harm to Kansas electric customers.”

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obligation of WRI (and its electric businesses), to repay the debt incurred to benefit nonutility businesses and investments.

(b)Second, WRI directs the Commission to evidence presented by its witness Richard Dixon that its utility operations are functioning well and asserts therefore that the utility has not been adversely affected by nonutility business activities. See WRI Initial Brief at part III, as well as part IIB. However, WRI does not address the debt problem faced by WRI and, by consequence, its electric business. As stated above, the record shows that this debt problem was caused by WRI’s funding of unregulated business activities, including funding secured by WRI’s utility operations activities. The record further shows that the utility is burdened by the debt problem by increasing the utility’s cost to borrow money. Dunn Direct at 11-12. In addition, WRI’s regulated electric business has paid $257.6 million of interest expense for the years 2000 and 2001 on debt properly attributable to Westar Industries and the unregulated investments now housed within that WRI affiliate. Proctor Direct at 18.

(c)Third, WRI urges that its nonutility activities are now doing better, so there can be no future deleterious effect on electric activities. Thus, WRI states that: “Westar Energy’s unregulated businesses, including Protection One, do not have a negative cash flow impact on Westar Industries or on Westar Energy.” WRI Initial Brief at part IIB. However, the record confirms that: (1) in the five year period of 1997 through 2001, WRI’s nonutility businesses had losses and diminution in value that exceeded

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$1.7 billion and (2) Protection One continues to be unprofitable. CURB Exhibit No. 9 at 20, KIC Exhibit No. 1 at 4 and 7, KIC Exhibit Nos. 6-8 and KIC Exhibit No. 11. In addition, Westar Industries extends credit to Protection One through a senior credit facility at a subsidized rate of interest. KIC Exhibit No. 3 at 19, KIC Exhibit No. 5 at 3, KIC Exhibit Nos. 23 at 23 and 33, and MBIA Exhibit No. 7.

66.In sum, the Commission finds that the authority and obligations conferred upon it by statute to oversee and protect the integrity of utility operations provide ample basis and obligation for it to act to assure that WRI’s ability and obligation to provide utility service on a basis that is just and reasonable, efficient and sufficient, is not compromised by management actions that place the utility at risk for the benefit of nonutility business ventures. The electric franchise received by WRI to provide electric utility service in its given certificated service territories within the state of Kansas as monopoly provider carries with it a public trust to operate in the best interests of its captive customers. The public utility possesses no unqualified right to engage in other nonutility businesses to the extent harm to the public utility results or is likely to result. Under the facts and circumstances of this case, the Commission’s statutory authority and duty obligates the Commission to continue its work towards improving the financial and corporate restructuring of WRI. This work will require reversal of certain intercompany transactions that contributed to the present misallocation of debt and assets, movement of WRI’s utility operations to a new utility-only subsidiary, and promulgation of standards or guidelines on interaffiliate relations to protect the public utility from harm in the context of WRI’s current mix of utility and nonutility business activities. Each of these items is discussed next.

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B.WRI Must Reverse Certain Intercompany Transactions

67.Prior to WRI’s creation of Westar Industries in February 2000, WRI funded nonutility investments and operations largely by making loans to Westar Industries which were recorded by WRI as intercompany receivables due WRI from Westar Industries. Proctor Direct at 36. During calendar year 2000, WRI converted notes receivable of $1.06 billion owed by Westar Industries to WRI, into an equity investment by WRI in Westar Industries. Id. at 36 Westar Industries, in turn, eliminated its notes payable to WRI by $1.06 billion and credited its paid in equity account for the same amount. Proctor Direct at f.n. 29.

68.Proctor explained that, as of December 31, 2001, WRI had contributed approximately $1.95 billion in capital to Westar Industries, including $1.8 billion to its paid—in equity account and $0.15 billion to its retained earnings account. In addition to the series of accounting entries comprising the $1.06 billion intercompany receivable, three further components of the accounting transactions comprising the $1.8 billion at issue are capital contributions provided to Westar Industries related to: (i) the transfer of WRI’s investment in ONEOK to Westar Industries; (ii) the transferring of miscellaneous other WRI investments to Westar Industries; and (iii) additional cash investments from WRI to Westar Industries. Proctor Direct at 19; Staff Exhibit No. JMP-4. Finally, WRI’s capital contribution of $0.15 billion to Westar Industries retained earnings account relates to the after-tax impact from WRI paying $0.26 billion of interest expense in years 2000 and 2001 on debt used to finance the nonutility investments held by Westar Industries. Proctor Direct at 18.

69.These accounting entries as now recorded by WRI do not fairly represent the economic substance of transactions initially recorded as loans from WRI to Westar Industries. In its July 20, 2001 Order the Commission found that these transactions “taken as a whole, had an

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asymmetrical result, benefiting Westar Industries at the expense of WRI.” July 20, 2001 Order at ¶ 88. The Commission found that they:

have no purpose related to WRI’s obligation to provide utility service. Whatever corporate goal WRI was seeking to attain, it could have done so in a symmetrical manner that did not disfavor the utility.

Id. at ¶ 89. The July 20, 2001 Order then concluded:

At this time, the Commission will not require the dividending by Westar [Westar Industries] to WRI of the intercompany receivable or of Westar’s ownership of WRI stock. The harm from these two features of the present WRI-Westar Industries relationship stems from their relationship to the rights offering, the Asset Allocation Agreement and the split-off. Because the Order prohibits the rights offering, the Asset Allocation Agreement and the split-off, the Commission does not need to require the dividending of the intercompany receivable and the WRI stock at this time. Should the Commission observe, however, activities relating to these two elements that would cause harm, the Commission will revisit this judgment.

Id. at ¶ 90.

70.The accounting entries, considered alone, do not appear to violate financial accounting standards. Proctor Direct at 36. In the case of a company unaffiliated with a regulated utility, they might be innocent. But the context here is different. Westar Industries is a wholly owned affiliate of WRI. The July 20, 2001 Order found that WRI’s regulated utility has been adversely affected by the drain on utility resources by the nonutility business activities conducted within Westar Industries.

71.In the interim since the July 20, 2001 Order WRI has not, as discussed herein, taken action, including action directed by the Commission in the July 20, 2001 Order, to undo the actual and prevent the potential damage to the utility caused by WRI’s investment in nonutility activities.

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72.In sum, WRI’s conduct in the interim since the July 20, 2001 Order compels the Commission to conclude that, as long as the means and incentive remain available, WRI will continue to pursue the very type of separation between utility and nonutilty businesses that the Commission has found to be contrary to the public interest. WRI must cease the use of interaffiliate financing transactions that produce a financial picture which departs from the historic funding of the regulated and unregulated activities, but has been used by WRI as an accounting convention to facilitate and continue its effort to expand nonutility activities. The Commission therefore directs WRI to reverse the interaffiliate transactions described more fully above and in Staff Exhibit No. JMP-4. That is, WRI is ordered to:

(a)reverse the transactions funding Westar Industries’ equity with $1.95 billion by debiting Westar Industries’ equity and crediting Westar Industries’ intercompany payable to WRI by the same amount;

(b)reverse all transactions recorded during 2002 comprising the equity investments from WRI to Westar Industries to reflect such transactions as intercompany payables to WRI from Westar Industries;(5)

(5)The reversal of the accounting entries for the transactions funding Westar Industries’ equity account will require WRI to debit its intercompany receivable from Westar Industries by the aggregate amount of all entries recorded to Westar Industries intercompany payable account.

(c)provide the Commission with copies of journal entries recorded subsequent to year 2001 comprising all equity contributions from WRI to Westar Industries; and

(d)make a report, within 30 days of this Order, submitted under oath by its Chief Financial Officer, describing WRI’s compliance with these requirements.

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C.WRI’s regulated electric utility operations must be separately incorporated as a subsidiary of WRI.

1.Overview

73.The record in this proceeding, as discussed above, shows that WRI has burdened utility assets with debt commitments devoted to unsuccessful nonutility ventures, and that its present plan, like the plan discussed in the July 20, 2001 Order, again favors the interests of Westar Industries over the utility businesses of WRI. The record also shows that WRI’s corporate structure makes it difficult, time consuming and costly to monitor, prevent, and correct intercompany transactions that are detrimental to utility activities.

74.Also, while the Commission’s requirement that WRI reverse accounting entries that operate to the detriment of the utility operations addresses the past abuses, they do not prevent or protect against future ones. The reversals, by themselves, do not prevent WRI from continuing its efforts to further nonutility business ventures to the continued detriment of the regulated utility operations. Nor do the reversals provide incremental protection to the utility operations from the $1.6 billion of debt issuances whose proceeds were used to serve the unregulated business ventures because WRI, an electric public utility, is still the obligor on that debt not Westar Industries.

75.To prevent WRI’s continued misuse of the regulated utility operations to benefit nonutility business ventures, CURB has recommended the complete split-off of management control over electric operations from control over nonutility activities. See, e.g., Crane Direct at 7. However, as CURB itself acknowledges, to require a total split-off at this point would leave the electric utility operations burdened with nonutility debt. The Commission, therefore, cannot find that the type of separation called for by CURB is presently in the public interest.

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76.Nonetheless, the Commission does agree with CURB that further insulation of the electric utility operations from other WRI operations are needed to: (i) minimize the burden that WRI’s nonutility debt places on the electric operations, and (ii) maximize the likelihood that efforts to exploit utility operations on behalf of unregulated activities are prevented, or, if not prevented, detected and corrected. It is essential that WRI’s corporate structure be such that the utility subsidiaries be aligned with the debt issued to fund such utility activities. In the absence of a proper alignment, management has incentive to favor and enrich Westar Industries at the expense of the regulated utility operations.

77.Toward these ends, the Commission concludes that it is necessary to direct WRI to provide, within 90 days of this Order, a proposal, which will be subject to hearing and approval by the Commission, to restructure its corporation so that the KPL electric division is placed in a separate subsidiary of WRI. (KG&E is already located in a separate subsidiary.) That new electric utility subsidiary of WRI could be a subsidiary separate from KG&E, or it could be a subsidiary which holds both KG&E and the KPL electric operations. There is no suggestion that this separation will have any adverse effect on WRI since WRI and its regulated electric businesses are and will remain part of a consolidated group immediately after separate electric utility subsidiary or subsidiaries are formed.

78.This corporate restructuring is necessary to protect the public interest. Accompanying the movement of the KPL utility business to a new subsidiary must be a new cost allocation manual, and specific reporting requirements. These two requirements are discussed next, followed by an explanation of the reasons for the necessity of moving the KPL utility business to a new subsidiary.

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2.Cost Allocation Manual

79.As explained throughout this Order, the Commission has concerns about the steps WRI has taken to subsidize and enrich its nonutility business and investments to the detriment of the electric utility and its ratepayers. To resolve these concerns, there must be proper identification of costs and investments attributable to regulated utility and nonutility activities and allocation of common costs and investments between them.

80.Therefore, the Commission directs WRI to review and improve its methodology for documenting and reporting of costs attributable to regulated utility operations and nonutilty business activities and for allocating joint and common costs and investments among the WRI businesses. As recommended by Staff witness McClanahan (McClanahan Direct at 20) and KIC witness Dittmer (Dittmer Direct at 24), WRI shall develop proposed CAM procedures to reflect its proposed corporate structure that follows from this Order. The CAM shall provide the allocation procedures proposed by WRI to allocate joint and common overhead costs and investments to the regulated electric utility subsidiary or subsidiaries and WRI’s other affiliates. The proposed CAM shall also fully explain the reasoning for and determination of allocation methods and ratios employed and why they are appropriate. WRI shall provide the proposed CAM to the Commission for review and approval along with the corporate restructuring plan that assigns WRI’s electric utility assets and related liabilities to the newly created electric subsidiary or subsidiaries, as required below.

81.Further, subsequent to the Commission’s approval of WRI’s new CAM, WRI must update and revise the CAM annually. The CAM revisions and updates should reflect changes in the relationship between causation and benefits attributed to WRI’s costs and investments. Annual maintenance of a CAM would require WRI’s management and the

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Commission to review the reasonableness of various cost assignment and allocation schemes in place. As KIC witness Dittmer explains: “In other words, by consciously reviewing existing policies and considering changed circumstances before committing procedures ‘to writing’ within the CAM, management would be indirectly encouraged to review the adequacy, equity and reasonableness of cost assignment/distribution policies in place...” Dittmer Direct at 30.

3.Reporting Requirements

82.Once a Commission order is issued approving a new CAM and the assignment of assets and liabilities from WRI to the newly created electric subsidiary or subsidiaries, the jurisdictional electric utility operations shall fully disclose its affiliate relations with the parent company and other nonutility affiliates and comply with certain financial reporting requirements. Those financial reporting requirements shall include the quarterly filing of income statements, statements of financial position (balance sheets) and statements of cash flow for the electric utility subsidiary or subsidiaries and its holding company parent, WRI. The affiliate reporting requirement proposed in the January 8, 2002 Order should be adopted and implemented for the electric utility subsidiary or subsidiaries required by this Order.

83.The provision of separate financial statements substantially enhances the Commission’s ability to properly monitor and control the effects on ratepayers’ rates and on the regulated electric subsidiary or subsidiaries’ capital structure of WRI’s affiliate transactions and WRI’s corporate funding for utility and nonutilty investments. See Proctor Direct at 34. Under cross-examination, WRI witness Geist conceded that the Commission might benefit from a review of periodically filed income statements, balance sheets and cash-flow statements. Geist, Tr. at 435-36.

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4.Reasons for the Requirement of Moving the KPL Utility Business to a Utility-Only Subsidiary

a.The Requirement That WRI Electric Operations Be Placed in a Separate Subsidiary or Subsidiaries Will Permit and Provide for an Allocation of Debt That Reflects Appropriate Cash Flow Needs

84.The creation of a separate subsidiary will significantly, though not completely, reduce the misallocation of debt to the electric utility activities. As already discussed, WRI is presently obligated to repay approximately $1.6 billion in debt that is related to nonutility businesses, and not utility operations. At present KG&E is a subsidiary within WRI; however, the KPL electric operations are an unincorporated component of WRI. As such, KPL operations will continue to be directly and primarily exposed to the repayment of debt and of interest expense on debt incurred for the unregulated enterprises. The relocation of the KPL operations into a separate subsidiary will permit the allocation to the new subsidiary of debt that is solely attributable to the utility’s operations.

85.The Commission recognizes that utility assets may have been used to secure debt in excess of that debt attributable to utility operations —  i.e., that utility assets secure debt incurred to finance nonutility activities. It is not the Commission's intent that its directive to move the KPL utility operations into a subsidiary of WRI be in conflict with such security commitments. The Commission therefore will require WRI to provide direct evidence of any such commitments, along with a narrative explanation. If the amount of WRI’s consolidated debt currently secured with either WRI’s or KG&E’s electric utility assets exceeds the $1.5billion of debt correctly attributable to the electric businesses, and if that excess debt must remain in the same corporation as the utility assets, then it may be necessary for the electric subsidiary or subsidiaries to hold debt in excess of the amount properly attributable to the utility

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business, based on Mr. Proctor's cash flow analyses. Again, if WRI proposes such a result it must provide clear evidence of its necessity. If the necessity does not exist, then the amount of debt for which the utility subsidiary or subsidiaries is responsible should not exceed $1.47 billion attributed to it by Proctor. Proctor Direct at 14.

86.Should it be necessary for the electric utility subsidiary or subsidiaries to hold more debt than is properly attributable to it, due to a contractual requirement that debt follow assets, the Commission requires WRI to take action to assure that debt initially assigned to the electric subsidiary or subsidiaries is reduced expeditiously by that amount of debt secured by utility assets but used to fund nonutility business ventures. The record shows that such expeditious reduction in debt is possible. Specifically, the testimony of Staff witness Proctor shows that the cash flow from the electric operations is sufficient to permit at least $100 million per year to be set aside for the reduction of debt. Staff Exhibit No. JMP-17. According to the forecasted cash flow estimates presented in Staff Exhibit No. JMP-17, Schedule Nos. 2 and 3 for the years 2003 and 2004, WRI’s electric utility operations will provide $344.0 million and $306.4 million cash flow from operating activities, respectively. The Commission, therefore, directs that, for the two years beginning on the date WRI submits the plans required by this Order, WRI shall reduce secured utility debt by at least $100 million per year from cash flow. At or prior to the expiration of this two-year period, the Commission will review the need for, and the measure of, continuing cash flow commitments in light of the evidence of WRI’s financial condition available at that time. WRI or the electric utilities shall file quarterly reports on its progress on retiring debt secured with utility assets, beginning with the quarter ending December 31, 2002.

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b.The Location of WRI’s Electric Operations in Separate Corporate Entities Enhances Monitoring and Accounting for Interaffiliate Transactions

i.WRI’s Current Accounting, Reporting, and Related Monitoring Are Inadequate to Protect the Interests of the Public Utility and its Customers in the Context of a Diversified Company.

87.The record in this, and related, Commission proceedings, confirms the inadequacy of WRI’s accounting and recordkeeping in regard to the interaffiliate relations between electric utility and nonutility businesses.

88.Staff witness McClanahan noted that in Docket No. 01-WSRE-436-RTS, the Commission found that WRI’s cost allocation manual (CAM) was inadequate for allocating costs for a company diversified in utility and nonutility business activities. That is, WRI’s CAM was last revised in 1992, well prior to WRI’s foray into nonutility business ventures. McClanahan Direct at 13, 15-16 and 20. Staff witness McClanahan summarized:

Through the discovery process, parties requested WRI to provide descriptions and documentation of policies, procedures, and practices that govern the company’s accounting for affiliate transactions [as contained in Attachment No. 1 to the McClanahan Direct Testimony]. The majority of these responses include only a very brief description of accounting practices and in most cases includes no documentation and supporting policies and procedures.

McClanahan Direct at 9.

89.WRI argues that recordkeeping procedures are adequate because they are kept in compliance with Generally Acceptable Accounting Principles (GAAP). However, the testimony of WRI’s own external auditor, James Edwards, an accountant with Arthur Anderson, shows that GAAP does not address the concerns about interaffiliate relations that are the subject of this

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proceeding. Edwards explained that in reviewing books pursuant to GAAP, auditors review financial data on a consolidated basis. They do not address allocations between or among affiliates:

Consolidated financial statements are meant to report the financial position and results of operations of a reporting entity that comprises a parent and its consolidated subsidiaries essentially as if all of their assets, liabilities, and activities were held, incurred, and conducted by a single entity.

Edwards Direct at 11.

90.Elaborating on this distinction, Staff witness McClanahan stated that:

cross-subsidy issues between regulated and nonregulated subsidiaries, such as assignments of assets or liabilities that may be to the detriment of the utility subsidiary, are of little or no concern to a holding company’s external auditors. However, these cross-subsidy issues are very much a concern to public utility commissions.

McClanahan Direct at 7.

91.Similarly, WRI’s argument that it is, or will be, subject to sufficient “corporate governance” requirements is not responsive. WRI contends that, in light of failures at Enron, WorldCom, and elsewhere “corporate governance” requirements are now imposed by statute and, therefore, WRI is already required to comply with “corporate governance” protocol. WRI Reply Brief at 42-44. However, the new corporate governance requirements WRI refers to do not address the special circumstances of regulated utilities that diversify into nonutility business ventures.

ii.The Requirement that WRI Electric Operations be Placed in a Separate Subsidiary or Subsidiaries Will Improve the Ability to Detect the Use of Electric Utility Operations to Further Nonutility Activities.

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92.The separation of the jurisdictional utility operations into their own subsidiary or subsidiaries will substantially improve the Commission's ability to oversee transactions between utility and nonutility operations. With the electric utilities in their own subsidiaries, better and more timely monitoring of dealings between regulated utility and nonutility activities should be available because: (1) cash flow analyses for the regulated electric utility activities, which WRI presently states is impossible or difficult to provide for its electric businesses, would be routinely and readily forthcoming; (2) the relationship between utility operations and debt issuances will be clearer because electric subsidiaries may seek authority to issue debt directly; (3) the Commission will be able to monitor how cash transactions are recorded for accounting purposes between the electric affiliates and the holding company; and (4) the Commission will be better able to monitor operating expenses and capital investments related to activities serving utility and nonutility activities.

93.WRI argues that it cannot prepare and file periodic financial statements for the electric businesses showing cash flow, income and financial position because the electric business is not a separate legal entity. WRI states that in order to produce separate income and balance sheets for Westar Industries and WRI’s electric utility businesses, “it would require certain assumptions concerning what assets comprise the electric utility business and what percent debt and interest expense should be allocated to which business at a particular point in time.” WRI Initial Brief at 64. In addition, WRI argues it is not possible “to trace the money” for purposes of determining cash flow statements separately for Westar Industries and WRI’s electric business. Id. at 66. As discussed above in Part III of this decision, WRI’s arguments are not credible. However, if WRI lacks the skills or resources to compile such reports because of its present corporate structure, the corporate restructuring required by this Order will enable them

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to compile such reports with the skills and resources now available. WRI's witness Geist admitted that such reports would be helpful and useful to the Commission. Geist, Tr. Vol. 2 at 435.

94.The improved quality and availability of monitoring data means that better information will be available to those with responsibility for regulating the utility and that information is more likely to be available before damage to the utility occurs. The increased monitoring should, in turn, deter WRI management from continued efforts to use electric operations to prefer or subsidize nonutility ventures, and provide management with incentive to focus on the electric business. Finally, time and resources now devoted to overseeing WRI’s continuing difficulties will be available (to the Commission and WRI management) for more productive tasks, such as achieving excellence in all aspects of utility service.

D.Directive and Guidance on the Restructuring Plans

95.Within 90 days from the date of this Order, the Commission directs WRI to provide a plan to separate the jurisdictional electric utility business currently operating as a division of WRI into a subsidiary corporation of WRI. In connection with the filing of this plan, WRI shall file testimony which covers, at least the following issues:

1.the description of the process or procedure for the corporate restructuring, including the basis and results of the allocations of WRI’s assets and liabilities to the electric utility subsidiary or subsidiaries and description of the accounting entries necessary to implement the process or procedure;

2.a statement, with documented and analytical support, as to whether the restructuring described here is consistent with WRI's present indenture agreements, and, where not consistent, what actions WRI would have to

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take to obtain necessary amendments to the debt indenture agreements to proceed with the restructuring; and

3.a statement explaining how the corporate restructuring plan is consistent with the principles outlined in this Order and in the July 20, 2001 Order.

96.Any party may file comments or responsive testimony to WRI’s testimony concerning its corporate restructuring plan and proposed CAM required by this Order. The Commission will determine whether a hearing and further argument is necessary upon review of the prefiled testimony.

97.The Commission understands that Sections 9 and 10 of the Public Utility Holding Company Act, 15 U.S.C. §§ 79i and 79j, will require WRI to obtain approval from the U.S. Securities and Exchange Commission (SEC) before creating the new utility subsidiary. The Commission knows of no legal reason why SEC approval of the transaction should not occur, and directs WRI to provide to this Commission, along with its plan, a draft application to the SEC. WRI's plan shall describe the steps and provisions WRI is taking to meet these requirements.

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E.WRI Shall Reduce Debt By Employing Measures Shown By the Record to Be Appropriate.

1.WRI Must Undertake Requisite Debt Reduction Measures, The Mix of Which the Commission Will Leave to WRI Discretion, Initially.

98.By itself, separation of all WRI's utility businesses into an electric subsidiary or subsidiaries, along with the debt secured by those utility assets, will not eliminate fully the problems now plaguing the utility, because WRI's consolidated debt will remain excessive relative to its equity. Although much of WRI’s consolidated debt will not be housed in the electric subsidiary or subsidiaries, the excess debt which today exists in WRI and which will remain, after the transfer, at the WRI level, still will affect the utility subsidiaries adversely. For example, lenders may raise the cost of debt to the electric subsidiary or subsidiaries because lenders will be concerned that debt-heavy WRI might draw funds from the electric subsidiary or subsidiaries. See, e.g., Dunn Direct at 11-12. Similarly, the cost of equity to WRI will increase because the imbalance increases the financial risk for an equity investment in WRI, and thus equity holders’ investment value will be diminished. Because WRI will be the source of equity for the electric subsidiary or subsidiaries (the electric subsidiary or subsidiaries do not raise equity on their own), the effect is to raise the cost of equity to the electric subsidiary or subsidiaries. While the Commission, in a rate case, may declare that excessive costs for debt and equity, arising from nonutility causes, are not recoverable in utility rates, such nonrecovery may increase financial distress. The risk is that of a vicious circle, whereby the ratemaking actions taken by the Commission to protect the utility customers from WRI's financial troubles increase those troubles, and also increase the likelihood that the customers will bear the cost of those troubles. To avoid the ratemaking dilemma, therefore, the public interest requires that the

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Commission order WRI to reduce its consolidated debt while also transferring its utility business to a subsidiary.

99.The Commission is issuing these two directives — to reduce debt and to separate all of the utility businesses into a subsidiary—to WRI, because WRI is a public utility subject to the Commission's jurisdiction, and because WRI has the excess debt which endangers that public utility. The two directives are linked: the utility business must be separated so that it no longer is subject to the debt misallocations of the past, and WRI must reduce its debt so that the dangers caused by the past decisions do not harm the utility's future. WRI, the entity subject to the Commission’s jurisdiction, must take both actions. It is true that after WRI transfers its utility business to a subsidiary, WRI itself will not itself operate a public utility business. It is also true that the transfer of the public utility operations may occur before WRI has carried out the debt reduction actions required by the Commission. But because the Commission is imposing the two obligations today, on WRI in its capacity as a public utility, WRI cannot avoid its debt-reduction obligations by transferring its utility operations.

100.The record shows that WRI has a number of alternatives, which, in combination, should provide for the elimination of excess consolidated debt and the restoration of WRI to the investment grade credit rating to which its ratepayers are entitled. WRI urges, Reply Brief at Part III that its management should be permitted discretion to devise the appropriate mix of debt-reducing actions. The Commission will allow management to select the mix, subject to Commission review, so as to assure a combination of actions that is consistent with the principles and prohibitions in this Order and that will have the necessary debt-reducing effect within a reasonable amount of time. In doing so, however, WRI may not propose a form of the “rights offering” — which the Commission has rejected twice — because of the risk such a transaction

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imposes on regulated utility activities. Moreover, the Commission's willingness to allow management to make the initial proposal, as opposed to the Commission mandating some mix of debt-reduction actions, depends on the Commission being assured, through WRI's words and actions, that there is no further conflict between the needs of the utility operations and WRI's nonutility business goals. As stated above, management is not entitled to discretion where it has the opportunity and incentive to use that discretion in a manner not consistent with the public interest.

101.Because of the dangers posed by WRI’s consolidated debt, the Commission will require WRI to provide quarterly status reports beginning with the quarter ending December 31, 2002, describing the progress achieved to reduce WRI’s consolidated debt. Staff shall actively monitor and review WRI’s status reports.

2.WRI’s Debt Reduction Measures Shall Consider and Implement those Measures Shown By the Record to Be Appropriate.

102.The record shows that the following are measures that provide feasible alternatives for the needed WRI debt reduction package. These measures must be among those considered and, with respect to the cash flow alternative discussed below, must be implemented by WRI. This obligation to consider means that if WRI rejects a particular measure, it must explain why, in the form of expert testimony.

Cash Flow.  As stated herein, Staff witness Proctor demonstrated that debt can be reduced by $100 million per year from cash flow. Staff Exhibit No. JMP-17. The Commission therefore requires this debt reduction method to be employed. Specifically, WRI shall first reduce the debt assigned to the newly created electric subsidiary or subsidiaries.

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Issuance of WRI Stock.  The record shows that WRI can issue more shares of WRI stock to reduce consolidated debt. Proctor testified that WRI can raise funds for the purposes of reducing debt most expeditiously by issuing additional shares of WRI stock. WRI’s opposition to the proposed sale of WRI stock to reduce debt is the claim that a sale of too large a volume will have negative effects on WRI’s stock price. However, Staff did not propose, and the record here does not require, that the entirety of the debt reduction be made by sale of WRI shares.(6) The Commission agrees with Staff witness Proctor that an issuance of WRI common stock should be considered to generate proceeds to decrease WRI’s consolidated debt. Staff’s argument is persuasive that WRI’s stock price increases when proceeds from the issuance of WRI common stock are used to decrease consolidated debt, and thus, decrease the current negative effect of financial distress and excessive interest expense payments on WRI’s current stock price. Proctor Direct at 59-64, and Errata Filing. See also Staff’s Reply Brief at 4. Therefore, WRI must consider the issuance of WRI stock among the alternatives.

(6)WRI, Initial Brief at 54, states that the sale of 81.4 million shares of its stock would not be practical. However, Staff used an 81.4 million figure merely to illustrate the effect of a stock sale; Staff did not advocate a sale in that amount. Rather, Staff witness Proctor testified that any WRI stock sale should be based on the “optimal combination of the issuance of WRI’s common stock and the sale of part, or all, of WRI’s investments in Protection One, Inc. and ONEOK, Inc.” Proctor Direct at 5; see also Staff Reply Brief at 4.

Sale of ONEOK stock.  The record shows that the sale of some or all of WRI’s investment in ONEOK stock is an alternative for debt reduction. Westar Industries currently owns approximately 44.5 percent of ONEOK’s stock, consisting of 7.8 percent of the ONEOK common stock and the balance in the form of convertible preferred stock. WRI Initial Brief at 8. WRI states that under a shareholder agreement between WRI and ONEOK, ONEOK or its designee has the right to purchase the stock owned by WRI at a cash sales price that is 98.5

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percent of the average of the closing price of the ONEOK stock for the 20 trading days preceding the day on which the sale notice is delivered.

103.WRI’s Initial Brief acknowledges that the sale of ONEOK stock is among the alternatives that should be pursued. WRI states that it intends to pursue ONEOK stock sale. WRI Reply Brief at 29-31. Thus, WRI states:

Westar Industries currently plans to sell outright, or sell an option to purchase, all or a portion of the ONEOK stock it owns in privately negotiated transactions or sales into the public market. Under the Shareholder Agreement applicable. . . Westar Industries is now free to pursue a sale of the stock and is free of certain restrictions (including percentage limitations on sales contained in that agreement).

WRI Reply Brief at 31-32.

104.WRI explains that the Shareholder Agreement allows WRI until September 30, 2003, to complete the sale of the stock. WRI Reply Brief at 32. In sum, the record shows that the sale of ONEOK stock provides a reasonable alternative for substantial consolidated debt reduction and, therefore, WRI should pursue this among the alternatives it will consider and employ to reduce its consolidated debt.

Dividend Reductions.  Staff and Intervenors (Proctor Direct at 61; Hill Direct at 24; and Dittmer Direct at 10) point out that WRI may also decrease dividends to reduce debt. WRI Initial Brief at 33, citing K.S.A. 66-1214, states that the Commission may prohibit dividends only following a hearing and requisite determination. The Commission in this Order does not prohibit WRI from making any payment of dividends; however, the Commission does direct WRI to consider the reduction or elimination (for some period) of dividends among the alternatives for a debt reduction package. If WRI does not consider or implement this measure, then WRI should

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include in its status report the explanation as to why it has not done so and why the Commission should not initiate a proceeding to require the electric subsidiary or subsidiaries to do so.

Sale of Protection One stock.  The record shows that the sale of some or all of WRI’s Protection One stock can play a significant role in the reduction of WRI’s consolidated debt, especially in combination with the sale of ONEOK stock. Several witnesses explained that the sale of Protection One should be considered as part of a package with the sale of ONEOK stock. Proctor Direct at 5; Dunn Direct at 46. WRI states that the sale of Protection One is not presently desirable for a variety of reasons, including the positive outlook for Protection One. WRI Initial Brief at 30-31. WRI's arguments do not provide an adequate basis for permitting WRI to exclude consideration of a sale of Protection One stock as part of the debt reduction mix. In WRI’s current financial circumstances, the question is not whether Protection One might conceivably be an attractive investment for the future; but rather, given WRI’s need to reduce its debt promptly, whether the sale of part or all of Protection One is preferable to other debt reduction alternatives. To accept WRI's argument would be to accept WRI's premise: that in establishing priorities within the corporate family, favor is given to the nonutility businesses before the utility businesses. If this Order could be boiled down to one sentence, it would be a sentence rejecting that premise. WRI shall show that its proposed debt reduction steps include consideration of the relative costs and benefits of the sale of part or all of Protection One stock.

V.WRI Shall Refrain from Any Action that Results, Directly or Indirectly, in its Electric Utilities Subsidizing Nonutility Business Activities.

A.Initiation of Additional Proceedings to Determine Standards and Guidelines for Affiliate Relations within the WRI Corporate Family.

105.The corporate restructuring of WRI leaves WRI still holding a combination of utility businesses, and nonutilty businesses and investments. WRI's joint control of these two

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types of business still leaves in place the risk that the utility businesses can bear risks and costs associated with the nonutility businesses. The financial and corporate restructuring discussed above therefore must be accompanied with appropriate guidelines for affiliate transactions and nonutility investments, to prevent subsidies flowing from WRI’s utility business to nonutility businesses and investments that could increase electric utility rates or harm the utility’s capital structure. Even with the benefits of financial and corporate restructuring required earlier in this order, there is still a need to provide better guidelines for and reporting of affiliate transactions, so that transactions that implicate or affect the regulated utility business operations meet the public interest test. WRI has argued that the Commission adopt such requirements only after a generic rulemaking procedure that applies to all jurisdictional utilities.

106.Up to this point, this Order has focused on two goals: (1) removing immediate harms or threats of harm; and (2) creating protections from additional harm. This Order sought to achieve the first goal by (a) rejecting WRI's proposed plan, which would make permanent the misallocation of debt and assets between the utility and nonutility businesses; and (b) requiring WRI to reverse those interaffiliate transactions that unjustly enriched Westar Industries’ equity. This Order sought to achieve the second goal by requiring WRI to move its electric business to a subsidiary, so that, in the future, financing associated with nonutility businesses would not be incurred, backed or guaranteed by the utility business.

107.These general requirements along with the new CAM and financial reporting requirements, if implemented expeditiously and conscientiously, should shield the utility businesses from the financial harm arising from past WRI actions described in this Order and put the WRI corporate family on a path to financial stability. However, standing alone, these changes do not guarantee that cross-subsidy problems will not recur.

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108.As explained in Part IV(C) of this Order, the Commission’s concern that WRI’s electric utility business has been used to subsidize nonutility businesses is not adequately addressed by external audits applying GAAP or the SEC filing requirements. Where utilities are part of a holding company, external auditors are primarily concerned with ensuring that consolidated financial statements are presented fairly and in adherence to GAAP. Therefore, cross-subsidy issues between utility and nonutility subsidiaries, such as assignments of assets or liabilities that may be to the detriment of the utility subsidiary, are of little or no concern to a holding company’s external auditors. However, the Commission is greatly concerned with one segment of the holding company, the regulated utility operations. The cross-subsidy issues are very much a concern to the Commission, especially, where the record demonstrates that WRI has acted on incentives to enrich Westar Industries and its nonutility businesses and investments at the expense of WRI’s electric utility operations.

109.To protect the electric utility operations, the Commission must determine, for example, the types and amount of nonutility investment with which the public utility can be associated; the corporate structure relationship between the utility and the nonutility business; and the types of regulatory rules and monitoring which should apply to the relationship between WRI’s utility operations and its nonutility investments. The Commission will not make or impose final standards or guidelines governing affiliate relations within the WRI corporate family on the present record. Although some witnesses offered suggestions for the proper relationship between the utility and nonutility businesses, the main focus of this proceeding has been on WRI's present problems and the various plans for resolving those financial problems. The record has not been developed sufficiently for the Commission, assisted by the parties, to fashion a full policy for WRI to govern the affiliate relations between the electric subsidiary or

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subsidiaries required by this Order and other WRI affiliates. Accordingly, the Commission will institute a new phase to this proceeding, which will fully address this problem. In this proceeding, the parties shall address at least the questions set forth in Appendix A. Within 30 days of this order, parties shall submit to the Commission additional questions they believe should be considered. Shortly thereafter, the Commission will issue an order setting forth the final question list and a schedule for submissions.

110.While a generic rulemaking is one way to govern affiliate relations, it is not statutorily required, particularly, when there is a record replete with company-specific justification. The record in this case confirms that WRI presents such unique circumstances. The public interest requires the Commission to call upon this agency’s specialized expertise in utility matters to craft appropriate guidelines and standards for affiliate relations within the WRI corporate family. While the actions the Commission directs here are subject to further review and revision in connection with any generic proceeding the Commission might initiate later, the record mandates the Commission act immediately to address the acute problems related to WRI's affiliated relations.

B.Interim Standstill Protections

111.The Commission must also address a remaining problem that has the potential to completely frustrate the policy objectives of this Order. During the pendency of this investigation, WRI may take further actions which increase risk to utility customers, misallocate debt and assets within the WRI corporate family or engage in interaffiliate on terms that disfavor the utility. Such actions by WRI would raise questions as to their consistency with the utility's statutory obligations to provide sufficient and efficient service and make the Commission’s investigation unnecessarily difficult. The Commission cannot successfully regulate a moving

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target. The Commission cannot establish proper parameters on the relationships between the utility and the nonutility businesses if WRI is simultaneously creating or modifying those relationships. The Commission therefore will establish for this interim period standstill protections to require WRI to refrain from any action that results, directly or indirectly, in its electric utilities subsidizing nonutility business activities. These activities would include, but not limited to those described below.

112.These standstill protections shall be effective immediately upon issuance of this Order, and will remain in effect for an interim period ending when the Commission adopts final guidelines and standards pursuant to the new phase of the proceeding described in Appendix A. At some point during this interim period, WRI's corporate structure will change, due to the requirement, discussed in Part IV of this Order, that WRI move its KPL utility division to a subsidiary. As explained further below, the entity or entities to which these protections apply vary, depending on whether the utility business has moved from WRI to a subsidiary.

113.For purposes of these protections, “nonutility affiliates” of WRI include Westar Industries or any subsidiary thereof, and “KPLCo” refers to the subsidiary of WRI that is the transferee of WRI’s KPL utility business pursuant to the requirement of Part IV of this Order, and to any subsidiary of WRI that holds the stock of KPLCo.

Interaffiliate loans, investments and other cash transfers.  WRI and KG&E shall seek Commission approval before making any loan to, investment in or transfer of cash to a nonutility affiliate of WRI from either WRI or KG&E, where the value of such transaction equals or exceeds $100,000. After the transfer of the KPL utility business from WRI to KPLCo, this requirement shall apply to both WRI and KPLCo. This requirement applies to WRI and KG&E before KPLCo comes into being, and to KPLCo and KG&E after KPLCo comes into being, so

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that utility resources are not inappropriately diverted to nonutility businesses. This requirement applies to WRI after KPLCo comes into being because, even though WRI at that time would not itself be a utility, its financial status could be weakened by such loans, investments and cash transfers; such weakening could raise the cost of capital for the utility subsidiary, as explained elsewhere in this order.

Interaffiliate agreements.  WRI and KG&E shall seek Commission approval before either WRI or KG&E enter into any interaffiliate agreement with any WRI nonutility affiliate, where the value of goods or services exchanged exceeds $100,000. After the transfer of the KPL utility business from WRI to KPLCo, this requirement shall apply to WRI, KG&E and KPLCo. The rationale for this requirement is the same as that expressed in the final two sentences of the preceding paragraph concerning interaffiliate loans, investments and other cash transfers.

New investment in nonutility businesses.  WRI and KG&E shall seek Commission approval before WRI or any affiliate thereof invests more than $100,000 in an existing or new nonutility business. After the transfer of KPL utility business from WRI to KPLCo, this requirement shall apply to WRI, KG&E and KPLCo. The rationale for this requirement is the same as that expressed in the paragraph above concerning interaffiliate loans, investments and other cash transfers.

Interest on interaffiliate loans.  The outstanding balance of any existing or future interaffiliate loans, receivables or other cash advances due WRI or KG&E from any WRI nonutility affiliate shall accrue interest payable to WRI or KG&E from that debtor at an interest rate equal to the incremental cost of debt of the nonutility affiliate that is the borrower. For purposes of the preceding sentence, the incremental cost of debt is the cost of debt such nonutility affiliate would incur if it borrowed money, contemporaneously, from a nonaffiliate

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lender at terms and conditions comparable to those in the loan agreement between WRI and the borrowing nonutility affiliate. After the transfer of the KPL utility business from WRI to KPLCo, this requirement shall apply to WRI, KG&E and KPLCo. The rationale for this requirement is the same as that expressed in the final two sentences of the paragraph above concerning interaffiliate loans, investments and other cash transfers.

Interaffiliate asset transfers.  WRI and KG&E shall not transfer or cause to be transferred, any non-cash assets, including intangible assets or intellectual property, of WRI or KG&E to Westar Industries or any WRI nonutility affiliate without Commission approval. After the transfer of the KPL utility business from WRI to KPLCo, this requirement shall apply to KG&E and KPLCo only. This requirement applies to WRI before KPLCo comes into being, and to KPLCo after KPLCo comes into being, so that utility resources are not inappropriately diverted to nonutility businesses.

Issuance of debt.  WRI and KG&E shall obtain Commission approval before the issuance of any debt. After the transfer of the KPL utility business from WRI to KPLCo, this requirement shall apply to WRI, KG&E and KPLCo. The rationale for this requirement is the same as that expressed in the final two sentences of the paragraph above concerning interaffiliate loans, investments and other cash transfers.

Sale of ONEOK.  If Westar Industries sells any portion of its investment in ONEOK, the requirements of Order No. 45, issued in this docket on July 9, 2002, shall apply.

114.The Commission's statutory authority, as described in Part III above, allows the Commission to govern affiliate relations within the WRI corporate family in the manner set forth in these interim standstill protections. The public utility enjoys a monopoly status which protects it from competition. That status is a privilege, not a right. While there are rights associated with

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the status, such as statutory and constitutional rights to reasonable rates and to procedural due process, there is not a right to the monopoly role permanently. Nor is there a right to engage in, or to affiliate with a company that engages in, nonutility businesses which, by virtue of their type, size or actions, pose a substantial risk of harm to the utility or its customers. There is no right in the utility to act as a financier or guarantor or risk-bearer of nonutility businesses, as a trainer of future employees of or a procurer of headquarters space for a nonutility business. There is instead an obligation in the utility to refrain from activities and associations that render the utility unable to carry out its statutory obligations. These interim standstill protections assure that the utility complies with this obligation.

VI.CONCLUSION

115.A utility's statutory responsibility to the public requires focus on the utility's core obligation of servicing the public. A public utility must provide sufficient and efficient service. This means that the utility has an on-going responsibility to achieve efficiencies and remove inefficiencies. The utility must be alert to the best practices of similarly situated electric utilities and make best efforts to adopt those practices. In a competitive market, a company that does not achieve best practices loses customers to companies that do. A utility may not rely on its monopoly position to escape this type of accountability. To do so is not consistent with efficient and sufficient service.

116.The facts of this case demonstrate that nonutility investments have distracted WRI management from the core obligation of servicing monopoly customers. Further, senior management lacked knowledge or understanding of the company’s important internal policies and have demonstrated an inability to work with Kansas customers, Kansas communities, creditors and regulators.

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117.WRI has argued that electricity service has not failed yet, but this argument misses the point. By virtue of a grant from the state, a utility has the special privilege of providing an essential service to Kansas customers; in return for such a privilege, a utility must offer more than a promise that its service will not fail. A standard of mere non-failure would leave management free to channel surplus time and talent to matters other than providing efficiency and excellence in utility service. The premise of a natural monopoly, and the regulatory system that supports it, is that a single company will operate more efficiently as a monopoly than as a competitor. But this premise carries a risk: that the freedom from competition will cause management to take its monopoly responsibilities for granted. In this case, management has treated the monopoly business less as an obligation to maximize efficiencies, and more as a device to create value for nonutility investments. That is what has happened here.

118.WRI's argument that electricity service has not failed also ignores the distinct detriment of the company's nonutility investment in terms of the use of resources. So many individuals—Commissioners, Staff and its consultants, the parties, their lawyers and their consultants; and WRI personnel—have been forced to spend significant portions of their resources, and derivatively the resources of Kansas citizens, engaged not in the productive endeavor of improving service for utility customers but in addressing problems related to WRI's nonutility activities. This waste has occurred not because of the Commission's policies but because of WRI's behavior.

119.This Order has removed the immediate opportunities, created by WRI, to use the utility businesses to benefit the nonutility business. The Commission has also initiated a process by which the Commission will determine an appropriate relationship between WRI's utility

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business and its nonutility businesses. However, Staff and intervening parties have requested a management investigation to focus on management’s ability to address the problems the utility businesses find themselves in. While the record supports fully and completely a management investigation, the Commission declines to do so at this time. The Commission hopes that as result of this Order, the management will focus less on nonutility businesses and more on bringing innovation and excellence to the utility business. The Commission notes that the utility’s infrastructure continues to provide electric service to over 600,000 customers and remains a stable source of revenue for the company. However, the Commission reserves the option to initiate a management investigation if and as warranted by subsequent events or information.

IT IS THEREFORE, BY THE COMMISSION ORDERED THAT:

(A)The foregoing statements, discussion and analysis are hereby adopted as findings and conclusions of the Commission.

(B)The Commission rejects WRI’s Financial Plan, as amended.

(C)WRI is directed to initiate corporate restructuring in accordance with the parameters provided above and to submit a corporate restructuring plan for Commission approval along with new CAM procedures for the electric subsidiary or subsidiaries required by this Order within 90 days from the date of this Order.

(D)WRI is further directed to reverse the accounting transactions described herein and to comply with the reporting requirements and

(E)The prohibitions as set forth in the July 20, 2001 Order at Ordering Clauses (B), (C) and (D) shall remain in full force and effect until further order of the Commission.

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(F)WRI shall take immediate action to reduce the excessive consolidated debt consistent with the principles discussed herein and shall provide the Commission reports addressing consolidated debt reduction on a quarterly basis beginning with the quarter ending December 31, 2002.

(G)WRI shall not take any action that results, directly or indirectly, in its regulated electric public utilities subsidizing unregulated business activities and shall abide by the interim standstill protections established herein,

(H)The Commission directs the investigation to consider standards and guidelines to govern affiliate relations within the WRI corporate family. The parties shall file comments on the list of questions set forth in Appendix A, within 30 days from the date of this Order.

(I)This Order will be served United States mail to all of the parties in this docket. A party may file a Petition for Reconsideration of this Order within fifteen (15) days, plus three (3) days for service by mail, of the date of this Order.

(J)The Commission has jurisdiction over the subject matter and the parties pursuant to K.S.A. 66-101 el seq. that jurisdiction is continuing over the subject matter and parties for the purpose of entering such further orders as it may deem necessary.

BY THE COMMISSION IT IS SO ORDERED.		ORDER MAILED
Wine, Chro; Claus, Com.; Moline, Com.		Nov 08 2002
Dated:	Nov 08 2002		/s/ Jeffrey S. Wagaman
		Jeffrey S. Wagaman
		Executive Director

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Appendix A

Investigation of Utility Affiliation With Non-Utility Businesses

Rationale for the Investigation

The corporate restructuring of WRI leaves WRI still holding a combination of regulated utility businesses, and unregulated businesses and investments. The joint control of these two types of business still leaves in place the risk that the utility businesses will bear risks and costs associated with the nonutility businesses.  (1) The financial and corporate restructuring discussed in Order 51 therefore must be accompanied by appropriate guidelines for the amount and type of nonutility businesses with which the utility businesses may be affiliated, as well as the type of affiliate transactions they may engage in.

(1)The equity component of the utility’s capital structure can be harmed or impaired even though inappropriately but incurred costs are excluded from rates. That is, if costs incurred by the regulated electric business are not included in rates, the revenue shortfall will decrease the common equity in the capital structure.

Questions for the Investigation

The Commission expects its investigation to cover the questions set forth below, among others. Within 30 days of this order, parties shall submit to the Commission additional questions they believe should be considered. Shortly thereafter, the Commission will issue an order setting forth the final question list and a schedule for submissions.

The questions cover five topics: (a) new nonutility investment, (b) interaffiliate agreements, (c) issuances of debt, (d) ownership of WRI stock and (e) reports.

I.New Nonutility Investment

A.Type and Amount of Investment

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1.Should the Commission limit the dollar amount of investment in nonutility businesses, and types of such businesses, with which the utility business may be affiliated?

2.What quantity limits should exist? (e.g., percentage of the value of utility assets, percentage of value of all affiliated assets, percentage of retained earnings in the utility or in the entire corporate family).

3.What type-of-business limits should exist? (e.g., energy-related vs. non-energy related, domestic vs. foreign, industries in which management has proven success)

B.Notification and Approval of Investment Plans

1.Should the Commission require WRI to seek Commission approval for —

a.any new or expanded lines of nonutility business or investment ventures entered into by WRI or any of WRI's affiliates or

b.any change or transfer of rights, obligations, or assets between or among the regulated electric subsidiaries, WRI and any of WRI's affiliates?

2.Should there be a de minimis or safe harbor exception from Commission review and approval for certain amounts or types of investment?

3.What criteria should the Commission apply in reviewing such investments?

4.As an alternative to advance approval, is it sufficient for the Commission to place no limits on investment but to require after-the-fact notice of such investments?

II.Interaffiliate Agreements

A.In General

1.Should the Commission require that any agreements between WRI and any of WRI's subsidiaries or affiliates be filed with the Commission for review and approval prior to their implementation?

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2.Should there be a de minimis or safe harbor exception from Commission review and approval?

B.Loans from the Utility Business to Other Affiliates

1.With respect to loans from the utility business to other affiliates, should the Commission —

a.prohibit them

b.allow them up to a certain amount

c.allow them only for certain purposes

d.allow them subject to certain advance approvals

e.allow them subject to certain reporting requirements, such as reporting —

(1)the date of the transfer, the amount of the transfer, the maturity date, if any, of the transfer, and the interest earning rate on the transfer

(2)the security provided

(3)daily balances of borrowings for each individual borrowing

(4)the duties and responsibilities of each cash transfer participant

(5)the methods of calculating interest

(6)the purpose of the loan and any restrictions on the borrower's use of the proceeds

2.How should the foregoing concepts be applied where the lender is not the utility but instead is the holding company (i.e., when KPL becomes a subsidiary of the holding company)?

C.Interaffiliate Transfers of Cash and other Assets

1.The cost allocation manual and reporting requirements described in Part IV of the Order should provide the Commission with some information concerning interaffiliate accounting practices. In light of WRI's history of improper use of utility resources to support

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nonutility ventures, there is a further need for standards regarding interaffiliate transactions. Examples of standards, on which the parties can comment, appear below.

2.Dividends

a.As explained in Part IV of the Order, WRI has attributed excess debt to its utility business. Even after the KPL utility business is moved from WRI to a subsidiary, the level of debt secured by utility assets will be of such magnitude that the electric utility subsidiary or subsidiaries, at least initially, may hold debt which should be the responsibility of WRI's nonutility businesses. The Commission therefore has ordered that WRI expeditiously pay down utility-secured debt to the level correctly attributable to the regulated electric subsidiaries.

b.This need to pay down debt gives rise to several questions:

(1)Should the Commission prohibit the regulated electric subsidiary or subsidiaries from paying a dividend to WRI, except as determined under particular guidelines? Consider, for example, the following possible guidelines:

(a)When the quarterly dividend is limited:  Limit the quarterly dividend for any quarter in which the combined regulated electric subsidiaries' common equity percentage for the previous quarter-ending balance sheet is less than 45 percent of total capital. (For purposes of determining this limitation, total capital would be the sum of common equity, preferred equity, long-term debt, quarterly income preferred securities, and current maturities of long-term debt and short-term debt.)

Should an exception to this type of limitation be available when the total consolidated debt level of the regulated electric subsidiaries for the immediately previous quarter-ending balance sheet falls below $1.5 billion or some other amount?

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(b)Maximum dividend when limited:  During quarters in which cash transfers from the regulated electric subsidiaries to WRI in the form of a dividend is limited pursuant to criteria set forth above, should the maximum cash transfers to WRI in the form of a dividend be limited to a percentage, such as 85 percent of the cash dividend payable to WRI's common equity shareholders?

(2)What facts exist to support the findings required by K.S.A. 66-1214 (relating to Commission-imposed restrictions on dividends)?

3.Cash Transfers Other Than Dividends

a.Given WRI's history of using the cash flow of the electric utility to support nonutility businesses, is it necessary to consider limits on the transfer of cash to WRI, or to any affiliate of WRI?

b.Should the Commission limit the frequency or quantity of such transfers?

c.For example, should the Commission require that a prerequisite to any loan by the electric business be that WRI shall maintain a minimum common equity percentage of, say, 30 percent of total capital in WRI's consolidated capital structure and WRI must maintain investment grade credit ratings?

d.Should the Commission require advance notice and approval of such transfers?

e.Should the Commission require that any such transfer be recorded as a loan or receivable payable to the regulated electric subsidiary or subsidiaries, and be supported by contract documents obligating the nonutility?

4.Interest

a.Should the Commission require that the outstanding balance of loans from the regulated electric subsidiaries to either WRI, or to any WRI affiliate, accrue interest payable to the regulated electric subsidiary from the debtor at an interest rate equal to the nonutility's incremental cost of

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debt, comparable to what the borrower would pay to an unaffiliated lender?

5.Asset Transfers

a.What conditions should the Commission place on asset transfers from the utility business to other affiliates?

b.For example, should the Commission require

(1)advance approvals of asset transfers exceeding a particular dollar value?

(2)demonstrations that the price of the transfer meets some standard, such as the higher of market or book cost?

c.What types of assets should be subject to these or other requirements?

III.Issuances of Debt

A.Should the Commission require advance approval before debt issuances (a) by the utility subsidiaries, (b) by the chief holding company, or (c) by nonutility affiliates or their holding companies?

B.Should the Commission prohibit, limit or require advance approval of, the pledging of utility resources as security for loans obtained for nonutility purposes?

IV.Ownership of WRI stock

Assuming nonutility businesses continue to exist in the WRI corporate family,

1.Should the Commission prohibit ownership by them or by Westar Industries, of stock in WRI?

2.Should the Commission direct how they are held, whether they be owned by WRI directly or through an intermediate holding company like Westar Industries?

V.Reports

A.Affiliate Descriptions

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Should the Commission require WRI to provide the Commission, annually, an explanation and description of all affiliates, their relationship to each other and to the regulated electric subsidiaries, the types of business in which they are involved, and a listing of their exact names and home office addresses?

B.Organization Charts

2.Should the Commission require WRI to maintain and file organizational charts with the Commission periodically?

3.Should these charts include:

a.WRI, the regulated electric subsidiaries and WRI's other nonutility businesses;

b.reporting requirements among management of WRI, utility subsidiaries and WRI's other nonutility businesses and;

c.additional information?

C.Affiliate Transactions

1.Should the Commission require WRI to provide the Commission a periodic summary and explanation of any transactions or agreements between regulated electric subsidiaries and WRI or the regulated electric subsidiaries and any of WRI's affiliates?

2.If so, what information should be contained in these reports?

D.Affiliate Financial Statements

1.Should the Commission require WRI to provide the Commission the total market value for each nonutility investment on a periodic basis for which such investment exceeds a market value of some dollar threshold?

2.Should the Commission require WRI to provide the Commission, periodically, the balance sheet and income statement for each of WRI's nonutility affiliates having a book value of assets exceeding some minimum figure?

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