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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15
(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from to
Commission File Number 1-4717
KANSAS CITY SOUTHERN
(Exact name of Company as specified in its charter)
DELAWARE 44-0663509
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
427 WEST 12TH STREET, KANSAS CITY, MISSOURI 64105
(Address of principal executive offices) (Zip Code)
(816) 983-1303
(Company's telephone number, including area code)
NO CHANGES
(Former name, former address and former fiscal year, if changed
since last report.)
Indicate by check mark whether the Company (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 the Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the Company is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT OCTOBER 31, 2003
COMMON STOCK, $.01 PER SHARE PAR VALUE 62,074,579 SHARES
- --------------------------------------------------------------------------------
KANSAS CITY SOUTHERN
FORM 10-Q
SEPTEMBER 30, 2003
INDEX
PAGE
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Introductory Comments 2
Consolidated Balance Sheets -
September 30, 2003 and December 31, 2002 3
Consolidated Statements of Income -
Three and Nine Months Ended September 30, 2003 and 2002 4
Per Share Data 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2003 and 2002 5
Consolidated Statement of Changes in Stockholders' Equity -
Nine Months Ended September 30, 2003 6
Notes to Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 32
ITEM 4. CONTROLS AND PROCEDURES 32
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 33
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 33
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 33
SIGNATURES 35
- ----------
KANSAS CITY SOUTHERN
FORM 10-Q
SEPTEMBER 30, 2003
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTRODUCTORY COMMENTS
The Consolidated Financial Statements included herein have been prepared by
Kansas City Southern (the "Company" or "KCS"), without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC"). Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America ("U.S. GAAP") have been condensed or omitted pursuant
to such rules and regulations, although the Company believes that the
disclosures are adequate to enable a reasonable understanding of the information
presented. These Consolidated Financial Statements should be read in conjunction
with the consolidated financial statements and the notes thereto, as well as
Management's Discussion and Analysis of Financial Condition and Results of
Operations, included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2002 and Management's Discussion and Analysis of Financial
Condition and Results of Operations included in this Form 10-Q. Results for the
nine months ended September 30, 2003 are not necessarily indicative of the
results expected for the full year 2003.
KANSAS CITY SOUTHERN
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
September 30, December 31,
2003 2002
---------------- ---------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 230.2 $ 19.0
Accounts receivable, net 109.7 114.9
Accounts receivable from related parties 3.3 3.6
Inventories 36.2 34.2
Other current assets 18.0 44.5
---------------- ---------------
Total current assets 397.4 216.2
---------------- ---------------
Investments 433.8 423.1
Properties (net of $720.9 and $682.9 accumulated
depreciation and amortization, respectively) 1,348.9 1,337.4
Goodwill 10.6 10.6
Other assets 27.3 21.5
---------------- ---------------
Total assets $ 2,218.0 $ 2,008.8
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt due within one year $ 10.0 $ 10.0
Accounts and wages payable 46.6 47.7
Accrued liabilities 139.7 128.6
---------------- ---------------
Total current liabilities 196.3 186.3
---------------- ---------------
Other Liabilities
Long-term debt 568.7 572.6
Deferred income taxes 393.9 392.8
Other liabilities and deferred credits 92.9 104.2
---------------- ---------------
Total other liabilities 1,055.5 1,069.6
---------------- ---------------
Stockholders' Equity
Preferred stock 6.5 6.1
Common stock 0.6 0.6
Retained earnings 851.4 748.5
Paid in capital 108.9 -
Accumulated other comprehensive loss (1.2) (2.3)
---------------- ---------------
Total stockholders' equity 966.2 752.9
---------------- ---------------
Total liabilities and stockholders' equity $ 2,218.0 $ 2,008.8
================ ===============
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------------- ----------------------------
2003 2002 2003 2002
-------------- ------------- ------------- --------------
Revenues $ 146.3 $ 138.9 $ 432.8 $ 422.0
Costs and expenses
Compensation and benefits 48.4 51.2 146.4 147.1
Depreciation and amortization 16.2 15.8 48.1 45.3
Purchased services 15.8 15.6 46.1 43.5
Operating leases 14.9 13.8 43.4 41.1
Fuel 11.2 8.9 35.3 27.7
Casualties and insurance 9.7 6.9 26.2 22.0
Car hire 2.8 5.6 8.5 14.9
Other 12.4 14.9 42.9 46.3
-------------- ------------- ------------- --------------
Total costs and expenses 131.4 132.7 396.9 387.9
Operating income 14.9 6.2 35.9 34.1
Equity in net earnings (losses) of
unconsolidated affiliates:
Grupo Transportacion Ferroviaria Mexicana,
S.A. de C.V. 1.6 9.8 6.2 27.6
Other (0.9) (0.7) (1.0) (1.9)
Gain on sale of Mexrail, Inc. - - - 4.4
Interest expense (11.6) (11.5) (34.8) (33.3)
Debt retirement costs - - - (4.3)
Other income 2.0 6.5 4.8 15.3
-------------- ------------- ------------- --------------
Income before income taxes and cumulative
effect of accounting change 6.0 10.3 11.1 41.9
Income tax provision (benefit) 1.7 (0.3) 2.6 5.1
-------------- ------------- ------------- --------------
Income before cumulative effect of accounting
change 4.3 10.6 8.5 36.8
Cumulative effect of accounting change, net of
income taxes - - 8.9 -
-------------- ------------- ------------- --------------
Net income $ 4.3 $ 10.6 $ 17.4 $ 36.8
Less: preferred stock dividends 3.3 0.1 4.7 0.2
-------------- ------------- ------------- --------------
Net income available to common shareholders $ 1.0 $ 10.5 $ 12.7 $ 36.6
============== ============= ============= ==============
PER SHARE DATA
Basic earnings per common share
Income before cumulative effect
of accounting change $ 0.02 $ 0.17 $ 0.06 $ 0.61
Cumulative effect of accounting change, net
of income taxes - - 0.15 -
-------------- ------------- ------------- --------------
Net income per basic share $ 0.02 $ 0.17 $ 0.21 $ 0.61
============== ============= ============= ==============
Diluted earnings per common share
Income before cumulative effect
of accounting change $ 0.02 $ 0.17 $ 0.06 $ 0.59
Cumulative effect of accounting change, net
of income taxes - - 0.14 -
-------------- ------------- ------------- --------------
Net income per diluted share $ 0.02 $ 0.17 $ 0.20 $ 0.59
============== ============= ============= ==============
Weighted average common shares outstanding (in
thousands)
Basic 61,765 60,481 61,607 60,123
Potential dilutive common shares 1,378 1,972 1,391 2,090
-------------- ------------- ------------- --------------
Diluted 63,143 62,453 62,998 62,213
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
Nine Months
Ended September 30,
---------------------------------
2003 2002
---------------- ---------------
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income $ 17.4 $ 36.8
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 48.1 45.3
Deferred income taxes 7.8 1.7
Equity in undistributed earnings of unconsolidated
affiliates (5.2) (25.7)
Gain on sale of investments - (9.3)
Gain on sale of assets (4.1) (10.0)
Cumulative effect of accounting change (8.9) -
Tax benefit realized upon exercise of stock options 1.4 3.6
Changes in working capital items
Accounts receivable 5.5 18.7
Inventories (2.0) (7.4)
Other current assets 14.5 35.8
Accounts and wages payable 0.6 (10.3)
Accrued liabilities 10.9 5.9
Other, net (1.3) 8.9
---------------- ---------------
Net cash provided by operating activities 84.7 94.0
---------------- ---------------
INVESTING ACTIVITIES:
Property acquisitions (53.4) (63.1)
Proceeds from disposal of property 8.6 17.5
Investment in and loans to affiliates (37.5) (4.0)
Proceeds from sale of investments, net 32.7 31.7
Other, net (6.8) (1.3)
---------------- ---------------
Net cash provided by (used for) investing activities (56.4) (19.2)
---------------- ---------------
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt - 200.0
Repayment of long-term debt (3.9) (264.8)
Issuance of preferred stock, net 193.2 -
Debt issuance costs - (5.5)
Proceeds from stock plans 3.6 7.7
Cash dividends paid (2.6) (0.2)
Other, net (7.4) (1.2)
---------------- ---------------
Net cash provided by (used for) financing activities 182.9 (64.0)
---------------- ---------------
CASH AND CASH EQUIVALENTS:
Net increase in cash and cash equivalents 211.2 10.8
At beginning of year 19.0 24.7
---------------- ---------------
At end of period $ 230.2 $ 35.5
================ ===============
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN MILLIONS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
Accumulated
$1 Par Other
$25 Par Cumulative $.01 Par Paid Comprehensive
Preferred Preferred Common In Retained Income
Stock Stock Stock Capital Earnings (Loss) Total
---------- ---------- --------- ---------- ---------- ----------- ----------
Balance at December 31, 2002 $ 6.1 $ - $ 0.6 $ - $ 748.5 $ (2.3)$ 752.9
Comprehensive income:
Net income 17.4
Change in fair value of cash
flow hedge 0.2
Amortization of accumulated
other comprehensive income (loss)
related to interest rate swap 0.9
Comprehensive income 18.5
Preferred stock issued 0.4 108.9 83.8 193.1
Dividends on $25 Par Preferred
Stock (0.2) (0.2)
($0.75/share)
Dividends on $1 Par Cumulative
Preferred Stock ($11.22/share) (4.5) (4.5)
Options exercised and stock
subscribed 3.1 3.1
Stock plan shares issued from
treasury 3.3 3.3
---------- ---------- --------- ---------- ---------- ----------- ----------
Balance at September 30, 2003 $ 6.1 $ 0.4 $ 0.6 $ 108.9 $ 851.4 $ (1.2)$ 966.2
========== ========== ========= ========== ========== =========== ==========
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ACCOUNTING POLICIES AND INTERIM FINANCIAL STATEMENTS. In the opinion of the
management of KCS, the accompanying unaudited consolidated financial statements
contain all adjustments (consisting of normal closing procedures) necessary to
present fairly the financial position of the Company and its subsidiary
companies as of September 30, 2003 and December 31, 2002, the results of its
operations for the three and nine months ended September 30, 2003 and 2002, its
cash flows for the nine months ended September 30, 2003 and 2002, and its
changes in stockholders' equity for the nine months ended September 30, 2003.
The accompanying consolidated financial statements have been prepared
consistently with accounting policies described in Note 2 to the consolidated
financial statements included in the Company's Annual Report on Form 10-K as of
and for the year ended December 31, 2002 except as discussed herein in note 10.
The results of operations for the three and nine-month periods ended September
30, 2003 are not necessarily indicative of the results to be expected for the
full year 2003. Certain comparative prior year amounts in the consolidated
financial statements have been reclassified to conform to the current period
presentation. These reclassifications did not impact net income.
2. EARNINGS PER SHARE DATA. Basic earnings per common share is computed by
dividing income available to common shareholders by the weighted-average number
of common shares outstanding for the period. Diluted earnings per share reflects
the potential dilution that could occur if convertible securities or stock
options were converted into common stock or exercised. The following is a
reconciliation from the weighted average shares used for the basic earnings per
share computation to the diluted earnings per share computation for the three
and nine months ended September 30, 2003 and 2002, respectively (in thousands):
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------ ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Basic shares 61,765 60,481 61,607 60,123
Effect of dilution: Stock options 1,378 1,972 1,391 2,090
Effect of dilution: Convertible
preferred stock - - - -
Diluted shares 63,143 62,453 62,998 62,213
=========== =========== =========== ===========
Shares excluded from diluted
computation 1,019 175 1,034 83
----------- ----------- ----------- -----------
For the three and nine months ended September 30, 2003, 13,389 and 7,438 shares,
respectively, related to the convertible preferred stock were excluded from the
computation of diluted earnings per share because the inclusion of these shares
would have been antidilutive to earnings per share. For the three and nine
months ended September 30, 2003, 1,019 and 1,034 shares, respectively, related
to stock options were excluded from the calculation of diluted earnings per
share because the exercise prices were greater than the average market price of
the common shares. For the three and nine months ended September 30, 2002, 175
and 83 shares respectively, related to stock options were excluded from the
calculation of diluted earnings per share because the exercise prices were
greater than the average market price of the common shares. For the three and
nine months ended September 30, 2003 and 2002, earnings per share were as
follows:
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------- ----------------------
2003 2002 2003 2002
----------- ----------- ------------------------
Net income $ 4.3 $ 10.6 $ 17.4 $ 36.8
Less: preferred stock dividends 3.3 0.1 4.7 0.2
----------- ----------- ----------- -----------
Net income available to common
shareholders $ 1.0 $ 10.5 $ 12.7 $ 36.6
=========== =========== =========== ===========
EARNINGS PER SHARE
Basic earnings per common share
Income before cumulative effect
of accounting change $ 0.02 $ 0.17 $ 0.06 $ 0.61
Cumulative effect of accounting
change, net of income taxes - - 0.15 -
----------- ----------- ----------- -----------
Net income per basic share $ 0.02 $ 0.17 $ 0.21 $ 0.61
=========== =========== =========== ===========
Diluted earnings per common share
Income before cumulative effect
of accounting change $ 0.02 $ 0.17 $ 0.06 $ 0.59
Cumulative effect of accounting
change, net of income taxes - - 0.14 -
----------- ----------- ----------- -----------
Net income per diluted share $ 0.02 $ 0.17 $ 0.20 $ 0.59
=========== =========== =========== ===========
3. INVESTMENTS. Investments in unconsolidated affiliates and certain other
investments accounted for under the equity method generally include all entities
in which the Company or its subsidiaries have significant influence, but not
more than 50% voting control. Investments in unconsolidated affiliates at
September 30, 2003 include, among others, equity interests in Grupo
Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), Southern
Capital Corporation, LLC ("Southern Capital"), Mexrail, Inc. ("Mexrail"), a
former 49% unconsolidated affiliate of the Company. Mexrail owns the northern
half of the international railway bridge at Laredo and all of the common stock
of The Texas-Mexican Railway Company ("Tex-Mex"), and the Panama Canal Railway
Company ("PCRC").
The Company, it's Mexican partner, Grupo TMM, S.A. ("Grupo TMM"), and certain of
Grupo TMM's affiliates entered into an agreement on February 27, 2002 with TFM,
S.A. de C.V. ("TFM") to sell to TFM all of the common stock of Mexrail. The sale
closed on March 27, 2002 and the Company received approximately $31.4 million
for its 49% interest in Mexrail. The Company used the proceeds from the sale to
reduce debt. The Company's share of the proceeds from the sale of Mexrail to TFM
exceeded the carrying value of the Company's investment in Mexrail by $11.2
million. The Company recognized a $4.4 million gain on the sale of Mexrail to
TFM in the first quarter of 2002, while the remaining $6.8 million of excess
proceeds was deferred and is being amortized into net income over 20 years. See
"Mexrail Transactions" below.
The Company is party to certain agreements with Grupo TMM covering the Grupo TFM
joint venture. These agreements contain "change in control" provisions,
provisions intended to preserve the Company's and Grupo TMM's proportionate
ownership of the joint venture, and super-majority provisions with respect to
voting on certain significant transactions. Such agreements also provide a right
of first refusal in the event that either party initiates a divestiture of its
equity interest in Grupo TFM and a prohibition on transfers to competitors.
Under certain circumstances, such agreements could affect the Company's
ownership percentage and rights in these equity affiliates. See "Notice of
Termination of Joint Venture Agreement" below.
PROPOSED ACQUISITION OF GRUPO TFM FROM GRUPO TMM. On April 20, 2003, the Company
entered into an agreement with Grupo TMM under which KCS ultimately would
acquire control of TFM through the purchase of shares of common stock of Grupo
TFM ("Acquisition Agreement"). Grupo TFM holds an 80% economic interest in TFM
and all of the shares of stock with full voting rights of TFM. The remaining 20%
economic interest in TFM is owned by the Mexican government in the form of
shares with limited voting rights. KCS currently owns a 46.6% economic interest
in Grupo TFM and 49.0% of the shares of common stock of Grupo TFM entitled to
full voting rights. The Acquisition Agreement and other related agreements were
designed to, following shareholder approval and regulatory approval, place The
Kansas City Southern Railway Company ("KCSR"), Tex-Mex, Gateway Eastern Railway
Company ("Gateway Eastern") and TFM, under the common control of a single
transportation holding company, NAFTA Rail, to be headquartered in Kansas City,
Missouri. As part of this NAFTA Rail transaction, subject to shareholder
approval, KCS is expected to change its name to NAFTA Rail. See "Dispute over
Acquisition Agreement" below.
Upon the terms and subject to the conditions of the agreement to acquire Grupo
TFM, TMM Multimodal, S.A. de C.V., a subsidiary of Grupo TMM, would receive 18
million shares of Class A Convertible Common Stock of the Company, representing,
at the time of the agreement, approximately 22% (20% voting, 2% subject to
voting restrictions) of the Company, $200 million in cash (with the option to
pay up to $80 million of the $200 million cash component due at closing to Grupo
TMM with up to 6.4 million additional shares of Company stock) and a potential
incentive payment of between $100 million and $180 million based on the
resolution of certain future contingencies.
The common control of KCSR and Tex-Mex (See "Mexrail Transactions" below) under
NAFTA Rail requires approval of the United States Department of Justice
("Department of Justice") and the Surface Transportation Board ("STB") in the
United States. Additionally, the acquisition of Grupo TFM shares by NAFTA Rail
requires the approval of Mexico's Competition Commission and the Mexican
National Foreign Investment Commission in Mexico. See "STB Review Status" below.
KCS's solicitation for permission as a foreign investor to control TFM, through
Grupo TFM, was filed with the Mexican National Foreign Investments Commission on
April 25, 2003. On August 27, 2003, KCS announced that it received notice from
the Mexican National Foreign Investments Commission of that Commission's
decision to close the proceeding with respect to KCS's application to acquire
control of Grupo TFM and, through Grupo TFM, of TFM, without prejudice to refile
in the event the dispute is resolved between KCS and Grupo TMM over whether the
Acquisition Agreement remains in effect. See "Dispute over Acquisition
Agreement" below.
KCS's Notification with respect to the acquisition of the Grupo TFM shares was
filed with the Mexican Competition Commission on April 21, 2003. KCS has
received formal written notice that the Mexican Competition Commission has
approved the proposed consolidation, without conditions. On September 26, 2003,
KCS announced this approval was extended for an additional 180 days.
On August 1, 2003, the Company announced that the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR") for the proposed
NAFTA Rail transaction had expired without a formal request from the Department
of Justice for additional information of documentary material, allowing KCS and
Grupo TMM to consummate the transaction without any further delays that could
have resulted from requests for additional information by the Department of
Justice under U.S. antitrust laws. Under the HSR process, the Department of
Justice had thirty days after notice was filed to issue a "second request"
asking for various documents and information from the HSR parties. The waiting
period officially expired on July 31, 2003, without action by the Department of
Justice.
DISPUTE OVER ACQUISITION AGREEMENT. On August 18, 2003, Grupo TMM shareholders
voted not to approve the sale of Grupo TMM's interests in Grupo TFM to KCS. See
"Proposed Acquisition of Grupo TFM from Grupo TMM" above. On August 23, 2003,
Grupo TMM sent a notice to KCS claiming to terminate the Acquisition Agreement,
because the Grupo TMM shareholders had failed to approve the Acquisition
Agreement.
On August 29, 2003, KCS delivered to Grupo TMM a formal Notice of Dispute,
pursuant to the Acquisition Agreement. This initiated a 60-day negotiation
period between the parties. The parties were unable to resolve the dispute
within that period of time. On August 29, 2003, KCS filed a complaint in the
Delaware Chancery Court alleging that Grupo TMM had breached the Acquisition
Agreement and seeking a preliminary injunction requiring Grupo TMM not to take
any action in violation of the terms of the Acquisition Agreement. KCS' position
has been and remains that the Acquisition Agreement does not provide that a
negative shareholder vote by Grupo TMM shareholders is a basis for termination.
KCS maintains that the Acquisition Agreement is still valid and remains in
effect until December 31, 2004 (unless otherwise validly terminated in
accordance with its terms).
On September 2, 2003, the Company filed in the Delaware Court of Chancery a
motion for a preliminary injunction to preserve the parties' positions while KCS
seeks to resolve its dispute over Grupo TMM's attempt to terminate the
Acquisition Agreement. KCS asked for an expedited hearing on its motion for a
preliminary injunction.
On September 15, 2003, KCS confirmed that negotiations with Grupo TMM have begun
under the dispute resolution process contained in the Acquisition Agreement for
Grupo TMM's interest in Grupo TFM. One meeting was held to discuss negotiations,
but no further meetings have been held.
On October 28, 2003, Chancellor William B. Chandler III of the Delaware Court of
Chancery entered a written order granting KCS' motion seeking a preliminary
injunction to preserve the parties' positions pending resolution of KCS' dispute
with Grupo TMM.
On October 31, 2003, KCS initiated a binding arbitration in accordance with the
terms of the Acquisition Agreement by serving an Arbitration Demand on Grupo TMM
and the American Arbitration Association. In its Arbitration Demand KCS seeks a
determination that the Acquisition Agreement is in full force and effect,
specific performance of the Acquisition Agreement, and damages for Grupo TMM's
breach of the terms of the Acquisition Agreement and failure to negotiate in
good faith during the 60-day negotiation period.
MEXRAIL TRANSACTIONS. On May 9, 2003, pursuant to the terms of a stock purchase
agreement for KCS to acquire control of Mexrail (the "Stock Purchase
Agreement"), KCS acquired from Grupo TMM (through its subsidiary TFM) 51% of the
shares of Mexrail for approximately $32.7 million. KCS deposited the Mexrail
shares into a voting trust pending resolution of KCS's application to the STB
seeking authority to exercise common control over Tex-Mex and KCS's other rail
companies, KCSR and Gateway Eastern. Under the Stock Purchase Agreement, the
Company had an exclusive option until December 31, 2005 to purchase the
remaining outstanding shares of Mexrail as of the date of the exercise of the
option. The Stock Purchase Agreement also provided TFM the right to repurchase
all of the Mexrail stock acquired by the Company at any time for the purchase
price paid by the Company, subject to any STB orders or directions. Upon any
such repurchase, the Stock Purchase Agreement would automatically terminate. If
not exercised within two years of the date of the agreement, TFM's repurchase
right would expire.
On August 29, 2003, KCS received a demand for TFM to repurchase from KCS shares
of Mexrail sold to KCS in May 2003. On September 23, 2003, the STB issued a
decision finding no need to rule on the transfer back to TFM of the 51% interest
in Mexrail that KCS acquired on May 9, 2003. The effect of the decision was to
allow TFM to reacquire the shares in accordance with the Stock Purchase
Agreement and KCS has abided by that agreement. The repurchase of Mexrail by TFM
closed on September 30, 2003 returning 100% ownership of Mexrail to TFM and the
Stock Purchase Agreement automatically terminated. The repurchase price was
$32.7 million; the same price KCS paid TFM in May 2003. However, the Stock
Purchase Agreement provided that in the event TFM reacquired the Mexrail shares
from KCS, the parties to the Stock Purchase Agreement intended the terms and
conditions of a February 27, 2002 stock purchase agreement under which TFM
acquired the Mexrail shares, the Grupo TFM bylaws and the shareholders agreement
dated May 1997 to become again valid and fully enforceable against the parties
to such agreements.
On February 27, 2002, KCS, Grupo TMM, and certain of Grupo TMM's affiliates
entered into a stock purchase agreement with TFM to sell to TFM all of the
common stock of Mexrail. Under this stock purchase agreement, KCS retained
rights to prevent further sale or transfer of the stock or significant assets of
Mexrail and Tex-Mex and the right to continue to participate in the corporate
governance of Mexrail and Tex-Mex, which will remain U.S. corporations and
subject to KCS's super majority rights contained in Grupo TFM's bylaws.
The shareholders agreement dated May 1997 between KCS and Grupo TMM and certain
affiliates, which governed KCS's investment in Grupo TFM (1) restricted each of
the parties to the shareholders agreement from directly or indirectly
transferring any interest in Grupo TFM or TFM to a competitor of Grupo TFM or
TFM without the prior written consent of each of the parties, and (2) provided
that KCS and Grupo TMM may not transfer control of any subsidiary holding all or
any portion of shares of Grupo TFM to a third party, other than an affiliate of
the transferring party or another party to the shareholders agreement, without
the consent of the other parties to the shareholders agreement. The shareholders
agreement required that the boards of directors of Grupo TFM and TFM be
constituted to reflect the parties' relative ownership of the ordinary voting
common stock of Grupo TFM.
STB REVIEW STATUS. KCS filed with the STB on May 13, 2003 a Railroad Control
Application, (Finance Docket No. 34342), seeking permission to exercise common
control over KCSR, Gateway Eastern and Tex-Mex. On June 9, 2003, the STB issued
its decision, effective June 13, 2003, finding that the transaction proposed in
KCS's application is a "minor transaction" under 49 CFR 1180.2(c), although KCS
was required to supplement its application as discussed in the decision, to
address some of the implications of KCS's acquisition of control of TFM. KCS
filed the supplement on June 23, 2003, as required by the decision. The STB also
outlined a procedural schedule for consideration of KCS's application to
exercise common control over KCSR, Gateway Eastern and Tex-Mex. The STB decision
set October 17, 2003 as the date by which it would issue its final decision on
the merits of the application. On September 23, 2003, the STB entered an order
asking all interested parties to file comments by September 30, 2003 addressing
whether "in light of recent developments" the STB should continue with the
procedural schedule, which called for a decision on the merits to be issued by
October 17, 2003. On October 8, 2003, the STB issued an order suspending the
procedural schedule pending a resolution of the uncertainties that now surround
KCS's efforts to acquire control of Tex-Mex, and requiring KCS to file status
reports regarding developments in its efforts to acquire control of TFM and
Tex-Mex. In accordance with the STB's order, KCS filed its first status report
on November 3, 2003.
NOTICE OF TERMINATION OF JOINT VENTURE AGREEMENT. KCS acknowledged receipt from
Grupo TMM of a notice to terminate the joint venture agreement between the
parties entered into in 1995. Pursuant to such notice, the joint venture
agreement will terminate on December 1, 2003. The joint venture agreement
between the parties provides that upon its termination, the joint venture shall
be liquidated and any assets held in the name of the joint venture shall be
distributed proportionally to KCS and Grupo TMM. There are no significant assets
held by the joint venture and KCS does not expect the termination of the joint
venture agreement to have a material adverse effect on KCS.
Condensed financial information of certain unconsolidated affiliates is shown
below. All amounts, including those for Grupo TFM, are presented under U.S.
GAAP. Financial information of immaterial unconsolidated affiliates has been
omitted:
FINANCIAL CONDITION (DOLLARS IN MILLIONS):
September 30, 2003 December 31, 2002
-------------------------------- --------------------------------
Grupo Southern Grupo Southern
PCRC TFM* Capital PCRC TFM* Capital
---------- ---------- ---------- ---------- ---------- ----------
Current assets $ 5.1 $ 223.3 $ 13.0 $ 2.7 $ 265.2 $ 5.5
Non-current assets 83.4 2,076.6 131.3 88.2 2,061.3 139.4
---------- ---------- ---------- ---------- ---------- ----------
Assets $ 88.5 $ 2,299.9 $ 144.3 $ 90.9 $ 2,326.5 $ 144.9
========== ========== ========== ========== ========== ==========
Current liabilities $ 6.1 $ 266.7 $ 3.6 $ 5.1 $ 147.3 $ -
Non-current liabilities 72.0 882.3 85.9 70.8 1,045.3 95.1
Minority interest - 351.5 - - 348.0 -
Equity of stockholders and 10.4 799.4 54.8 15.0 785.9 49.8
partners
---------- ---------- ---------- ---------- ---------- ----------
Liabilities and equity $ 88.5 $ 2,299.9 $ 144.3 $ 90.9 $ 2,326.5 $ 144.9
========== ========== ========== ========== ========== ==========
KCS's investment $ 5.2 $ 386.1 $ 27.4 $ 7.5 $ 380.1 $ 24.9
---------- ---------- ---------- ---------- ---------- ----------
* Includes Mexrail as a fully consolidated subsidiary
OPERATING RESULTS (DOLLARS IN MILLIONS):
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------- -----------------------
2003 2002 2003 2002
-------- -------- --------- --------
Revenues:
Grupo TFM* $ 178.2 $ 175.3 $ 523.3 $ 519.1
Southern Capital 7.7 8.0 23.6 23.0
PCRC 1.3 0.9 5.5 2.5
Mexrail - - - 13.3
Operating costs and expenses:
Grupo TFM* $ 139.6 $ 132.1 $ 420.1 $ 384.3
Southern Capital 6.9 7.1 20.8 19.2
PCRC 3.6 2.5 10.1 8.5
Mexrail - - - 13.3
Net income (loss):
Grupo TFM* $ 3.6 $ 23.1 $ 13.9 $ 71.1
Southern Capital 0.8 0.9 2.8 2.1
PCRC (2.3) (2.2) (4.6) (6.0)
Mexrail - - - 0.0
* Includes Mexrail as a fully consolidated subsidiary as of April 2002.
4. NONCASH INVESTING AND FINANCING ACTIVITIES. The Company initiated the
Fourteenth Offering of KCS common stock under the Employee Stock Purchase Plan
("ESPP") during 2002. Stock subscribed under the Fourteenth Offering will be
issued to employees in 2004 and is being paid for through employee payroll
deductions in 2003. During the first nine months of 2003, the Company has
received approximately $1.9 million from payroll deductions associated with the
Fourteenth Offering of the ESPP. In the first quarter of 2003, the Company
issued approximately 337,917 shares of KCS common stock under the Thirteenth
Offering of the ESPP. These shares, totaling a purchase price of approximately
$3.5 million, were subscribed and paid for through employee payroll deductions
in 2002.
5. DERIVATIVE FINANCIAL INSTRUMENTS. The Company does not engage in the trading
of derivative instruments for speculative purposes but uses them for risk
management purposes only. The Company's objective is to manage its fuel and
interest rate risk through the use of derivative instruments as deemed
appropriate. At September 30, 2003, the Company was a party to six fuel swap
agreements for a notional amount of approximately 6.6 million gallons of fuel.
Under the terms of these swaps, the Company receives a variable price based upon
the average of the spot prices calculated on a monthly basis as reported through
a petroleum price reporting service.
A summary of the swap agreements to which KCSR was a party as of September 30,
2003 is as follows:
Trade Date Notional Amount Fixed pay per gallon Expiration Date
- ----------------- --------------------- -------------------- -------------------
November 14, 2002 0.8 million gallons 62.5(cent) December 31, 2003
March 18, 2003 1.9 million gallons 65.0(cent) December 31, 2004
March 21, 2003 0.6 million gallons 64.0(cent) June 30, 2004
April 11, 2003 0.2 million gallons 67.8(cent) September 30, 2003
April 11, 2003 0.6 million gallons 68.7(cent) December 31, 2003
April 11, 2003 2.5 million gallons 66.0(cent) December 31, 2004
Additionally, in October 2003, the Company entered into two additional fuel
swaps. A summary of these additional swap agreements is as follows:
Trade Date Notional Amount Fixed pay per gallon Expiration Date
- ----------------- ---------------------- -------------------- ------------------
October 30, 2003 1.9 million gallons 69.0(cent) December 31, 2004
October 30, 2003 2.5 million gallons 68.0(cent) December 31, 2005
Cash settlements of these swaps occur on a monthly basis on the fifth business
day of the month following the month in which the settlement is calculated.
These swaps, combined with the Company's forward purchase policies, are designed
to hedge the Company's exposure to movements in the price of No. 2 Gulf Coast
Heating Oil on which the Company's diesel fuel prices are determined. Using
these risk management strategies, the Company is able to limit its risk to
rising diesel fuel prices. As of September 30, 2003, the fair market value of
the swaps was $0.4 million. For the years ended December 31, 2002 and 2001, KCSR
consumed 55.3 million gallons and 57.6 million gallons of fuel, respectively.
6. STOCK PLANS. Proceeds received from the exercise of stock options or
subscriptions are credited to the appropriate capital accounts in the year they
are exercised.
The Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS
123") in October 1995. This statement allows companies to continue under the
approach set forth in Accounting Principles Board Opinion No. 25 "Accounting for
Stock Issued to Employees" ("APB 25"), for recognizing stock-based compensation
expense in the financial statements, but encourages companies to adopt the fair
value method of accounting for employee stock options. Under SFAS 123, companies
must either record compensation expense based on the estimated grant date fair
value of stock options granted or disclose the impact on net income as if they
had adopted the fair value method (for grants subsequent to December 31, 1994.)
If KCS had measured compensation cost for the KCS stock options granted to its
employees and shares subscribed by its employees under the KCS employee stock
purchase plan, under the fair value based method prescribed by SFAS 123, net
income and earnings per share would have been as follows:
Three Months ended September 30, Nine Months ended September 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
---------------- --------------- --------------- ---------------
NET INCOME (IN MILLIONS):
As reported $ 4.3 $ 10.6 $ 17.4 $ 36.8
Total stock-based compensation
expense determined under fair value
method, net of income taxes (0.5) (0.2) (1.5) (1.1)
---------------- --------------- --------------- ---------------
Pro forma $ 3.8 $ 10.4 $ 15.9 $ 35.7
EARNINGS PER BASIC SHARE:
As reported $ 0.02 $ 0.17 $ 0.21 $ 0.61
Pro forma $ 0.01 $ 0.17 $ 0.18 $ 0.59
EARNINGS PER DILUTED SHARE:
As reported $ 0.02* $ 0.17 $ 0.20 $ 0.59
Pro forma $ 0.01* $ 0.17 $ 0.17 $ 0.57
* The sum of the current quarter and previous quarters may not equal
year-to-date due to rounding.
7. AMENDMENT OF CREDIT AGREEMENT. On April 3, 2003, the Company received
approval from more than 96% of its lenders of its request for an amendment to
certain provisions under its Amended and Restated Credit Agreement dated June
12, 2002. The Company requested this amendment in order to provide flexibility
in structuring the funding for the transaction to acquire the Mexican
Government's interest in TFM. As discussed in the Company's Annual Report on
Form 10-K for the year ended December 31, 2002 as filed with the Securities and
Exchange Commission, the Mexican Government has the right to require Grupo TFM
to purchase the Mexican Government's interest in TFM on or after October 31,
2003. Should Grupo TFM fail to purchase the Mexican Government's interest within
60 days of notification by the Mexican Government of its obligation to buy, then
Grupo TMM and KCS, or either Grupo TMM or KCS, could be required to purchase
their respective portion, or all, as applicable, of the Mexican Government's
interest in TFM within 60 days following written notification to Grupo TMM and
KCS, or either Grupo TMM or KCS, of their, or its obligation to purchase. Should
KCS be required to purchase all of the Mexican Government's TFM shares, it has
the option under Mexican law and the Shareholder Agreement between Grupo TMM and
KCS to require Grupo TMM to purchase 51% of the shares acquired by KCS. In
addition, if the Mexican Government's interest in TFM has not been purchased
prior to the closure of the proposed NAFTA Rail transaction contemplated by the
Acquisition Agreement, KCS shall, as a condition precedent to, and
contemporaneous with, the closure of such transaction, enter into an agreement
under which KCS shall assume and discharge Grupo TMM's obligation to purchase
the Mexican Government's interest in TFM.
On April 28, 2003, the Company entered into a second amendment to its Amended
and Restated Credit Agreement under which 93% of the lenders specifically
approved the Company's investment in further equity interests of Grupo TFM, in
equity interests representing 51% of Mexrail's issued and outstanding capital
stock and the use of the Company's cash to acquire Mexrail, in connection with
the proposed NAFTA Rail transaction (see note 3).
8. REDEEMABLE CUMULATIVE CONVERTIBLE PERPETUAL PREFERRED STOCK. On May 5, 2003,
the Company completed the sale of $200 million of Redeemable Cumulative
Convertible Perpetual Preferred Stock with a liquidation preference of $500 per
share in a private offering. The convertible preferred stock offering was made
only by means of an offering memorandum pursuant to Rule 144A. Dividends on the
convertible preferred stock will be cumulative and will be payable quarterly at
an annual rate of 4.25% of the liquidation preference, when, as and if declared
by the Company's board of directors. Each share of the convertible preferred
stock will be convertible, under certain conditions, and subject to adjustment
under certain conditions, into 33.4728 shares of the Company's common stock. On
or after May 20, 2008, the Company will have the option to redeem any or all of
the preferred stock, subject to certain conditions. Under certain circumstances,
at the option of the holders of the preferred stock, the Company may be required
to purchase shares of the convertible preferred stock from the holders. The
convertible preferred stock is redeemable at the option of a holder only in the
event of a "fundamental change," which is defined as "any transaction or event
(whether by means of an exchange offer, liquidation, tender offer,
consolidation, merger, combination, reclassification, recapitalization or
otherwise) in connection with which all or substantially all of the Company's
common stock is exchanged for, converted into, acquired for or constitutes
solely the right to receive common stock that is not listed on a United States
national securities exchange or approved for quotation on the Nasdaq National
Market or similar system. The practical effect of this provision is to limit the
Company's ability to eliminate a holder's ability to convert the convertible
preferred stock into common shares of a publicly traded security through a
merger or consolidation transaction. In no other circumstances is the Company
potentially obligated to redeem the convertible preferred stock for cash.
Accordingly, since the Company is in a position to control whether the Company
experiences a "fundamental change," the convertible preferred stock is
classified as permanent equity capital.
The net proceeds from the offering of the convertible preferred stock are
expected to be used to pay a portion of the purchase price for the proposed
acquisition of a controlling interest of Grupo TFM. On August, 1, 2003, KCS
filed a Form S-3 Registration Statement with the SEC to register for resale by
the holders the convertible preferred stock and the common stock into which such
preferred stock may be converted. On October 24, 2003, this Registration
Statement, as amended, was declared effective by the SEC. On November 4, KCS
filed Post-Effective Amendment No. 1 to this registration statement which was
declared effective by the SEC on November 5, 2003. On November 12, KCS filed
Post-Effective Amendment No.2 to this registration statement which was declared
effective by the SEC on November 12, 2003. KCS will not receive any
proceeds from the sale of the securities under this Registration Statement.
9. COMMITMENTS AND CONTINGENCIES. There have been no significant changes in
outstanding litigation or other commitments and contingencies from that
previously reported in Note 11 of the Company's Annual Report on Form 10-K for
the year ended December 31, 2002. The following provides a review of the Houston
cases.
HOUSTON CASES. In August 2000, KCSR and certain of its affiliates were added as
defendants in lawsuits pending in Jefferson and Harris Counties, Texas. These
lawsuits allege damage to approximately 3,000 plaintiffs as a result of an
alleged toxic chemical release from a tank car in Houston, Texas on August 21,
1998. Litigation involving the shipper
and the delivering carrier had been pending for some time, but KCSR, which
handled the car during the course of its transport, had not previously been
named a defendant. On June 28, 2001, KCSR reached a final settlement with the
1,664 plaintiffs in the lawsuit filed in Jefferson County, Texas. In 2002, KCSR
settled with virtually all of the plaintiffs in the lawsuit filed in the 164th
Judicial District Court of Harris County, Texas, for approximately $0.3 million.
The remaining plaintiffs have indicated that they intend to retain new counsel,
yet to date, KCS has not received any notice of new counsel entering the case.
10. NEW ACCOUNTING PRONOUNCEMENTS. In June 2001, the FASB issued Statement No.
143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 is
effective for fiscal years beginning after June 15, 2002. Under SFAS 143, the
fair value of a liability for an asset retirement obligation must be recognized
in the period in which it is incurred if a reasonable estimate of the fair value
can be made. The associated asset retirement costs are capitalized as part of
the carrying amount of the long-lived asset. KCSR, along with other Class I
railroads, depreciates track structure (rail, ties, and other track material) in
accordance with regulations promulgated by the STB. These regulations require
KCSR to depreciate track structure to a net salvage value (gross estimated
salvage value less estimated costs to remove the track structure at the end of
its useful life). For certain track structure such as ties, with little or no
gross salvage value, this practice ultimately results in depreciating an asset
below zero, and thus, in effect, results in a liability. Under the requirements
of SFAS 143, in the absence of a legal obligation to remove the track structure,
such accounting practice is prohibited. The Company adopted the provisions of
SFAS 143 in the first quarter of 2003, and, as a result, reviewed its
depreciation of track structures to determine instances where the depreciation
of removal costs has resulted or would be expected (based on the current
depreciation rate) to result in the depreciation of an asset below zero when
considering net salvage value. As a result of this review, the Company estimated
the excess depreciation recorded on such assets and recorded this amount as a
reduction in accumulated depreciation of $14.5 million and as a cumulative
effect of an accounting change of $8.9 million (net of taxes of $5.6 million) as
required by SFAS 143 in the first quarter of 2003. Additionally, depreciation
rates applied to certain track structure elements that were previously yielding
a negative salvage value have been modified to comply with the provisions of
SFAS 143. For the nine months ended September 30, 2003, this resulted in a
reduction in depreciation expense of approximately $1.0 million. Management
currently estimates the net effect of the adoption of SFAS 143 on full year
depreciation expense to be approximately $1.4 million.
A summary of the pro forma net income and earnings per share had SFAS 143 been
applied retroactively is as follows:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
--------------- ---------------- ---------------- ---------------
NET INCOME (IN MILLIONS)
As reported $ 4.3 $ 10.6 $ 17.4 $ 36.8
Pro forma $ 4.3 $ 11.0 $ 8.5 $ 37.8
EARNINGS PER BASIC SHARE:
As reported $ 0.02 $ 0.17 $ 0.21 $ 0.61
Pro forma $ 0.02 $ 0.17 $ 0.06 $ 0.62
EARNINGS PER DILUTED SHARE:
As reported $ 0.02 $ 0.17 $ 0.20 $ 0.59
Pro forma $ 0.02 $ 0.17 $ 0.06 $ 0.60
In December 2002, the FASB issued Statement No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123" ("SFAS 148"). SFAS 148 provides two additional transition methods for
entities that adopt the method of accounting for stock-based compensation as
defined in SFAS 123. Additionally, SFAS 148 amends the disclosure requirements
of SFAS 123 to require disclosures in interim financial statements regarding the
method of accounting for stock-based employee compensation and the effect of the
method on . The Company is currently evaluating the
provisions of this new accounting pronouncement and does not expect this
pronouncement, if adopted, to have a material impact on its consolidated results
of operations, financial position, or cash flows. See note 6 for interim
disclosures required under SFAS 148.
In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of
Variable Interest Entities," ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to
certain variable interest entities created after January 31, 2003 as well as
certain entities created prior to this date. In October 2003, FIN 46 was amended
to allow certain organizations additional time to implement FIN 46. As a result,
the Company is not required to adopt this interpretation until the fourth
quarter of 2003. The Company has performed an initial assessment of its equity
method investment in Southern Capital as well as PCRC for any potential impact
this interpretation
may have on its accounting for these entities as equity investments. The Company
anticipates that FIN 46 will have no material impact on the Company's accounting
for its investment in Southern Capital or PCRC since, at inception, these
entities had sufficient funding and capital.
11. CONDENSED CONSOLIDATING FINANCIAL INFORMATION. In September 2000, KCSR
issued $200 million of 9 1/2% senior notes due 2008. In addition, in June 2002,
KCSR issued $200 million of 7 1/2% senior notes due 2009. Both of these note
issues are unsecured obligations of KCSR, however, they are also jointly and
severally and fully and unconditionally guaranteed on an unsecured senior basis
by KCS and certain of the subsidiaries (all of which are wholly-owned) within
the KCS consolidated group. For each of these note issues, KCS registered
exchange notes with the SEC that have substantially identical terms and
associated guarantees and all of the initial senior notes for each issue have
been exchanged for $200 million of registered exchange notes for each respective
note issue.
The accompanying condensed consolidating financial information has been prepared
and presented pursuant to SEC Regulation S-X Rule 3-10 "Financial statements of
guarantors and issuers of guaranteed securities registered or being registered."
This information is not intended to present the financial position, results of
operations and cash flows of the individual companies or groups of companies in
accordance with U.S. GAAP.
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
Nine months ended September 30, 2003 (dollars in millions)
-----------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
---------- ----------- ------------ ------------- ------------- ------------
Revenues $ - $ 428.1 $ 15.7 $ 21.1 $ (32.1) $ 432.8
Costs and expenses 9.5 382.6 15.3 21.6 (32.1) 396.9
---------- ----------- ------------ ------------- ------------- ------------
Operating income (loss) (9.5) 45.5 0.4 (0.5) - 35.9
Equity in net earnings
(losses) of unconsolidated
affiliates and subsidiaries 23.9 5.8 - 5.4 (29.9) 5.2
Interest expense (0.5) (34.4) (0.3) - 0.4 (34.8)
Other income 0.1 4.1 0.1 0.9 (0.4) 4.8
---------- ----------- ------------ ------------- ------------- ------------
Income (loss) before
income taxes and
cumulative effect of
accounting change 14.0 21.0 0.2 5.8 (29.9) 11.1
Income tax provision
(benefit) (3.3) 6.0 0.1 (0.2) - 2.6
---------- ----------- ------------ ------------- ------------- ------------
Income (loss) before
cumulative effect of
accounting change 17.3 15.0 0.1 6.0 (29.9) 8.5
Cumulative effect of
accounting change, net
of income taxes - 8.9 - - - 8.9
---------- ----------- ------------ ------------- ------------- ------------
Net income (loss) $ 17.3 $ 23.9 $ 0.1 $ 6.0 $ (29.9) $ 17.4
========== =========== ============ ============= ============= ============
Nine months ended September 30, 2002 (dollars in millions)
-----------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
---------- ----------- ------------ ------------- ------------- ------------
Revenues $ - $ 422.7 $ 14.4 $ 12.5 $ (27.6) $ 422.0
Costs and expenses 8.3 378.5 15.8 12.9 (27.6) 387.9
---------- ----------- ------------ ------------- ------------- ------------
Operating income (loss) (8.3) 44.2 (1.4) (0.4) - 34.1
Equity in net earnings
(losses) of unconsolidated
affiliates and subsidiaries 34.2 26.2 - 25.8 (60.5) 25.7
Gain on Sale of Mexrail 4.4 4.4 - - (4.4) 4.4
Interest expense (0.3) (32.6) (0.4) (0.2) 0.2 (33.3)
Debt retirement costs - (4.3) - - - (4.3)
Other, net 5.0 10.0 0.1 0.4 (0.2) 15.3
---------- ----------- ------------ ------------- ------------- ------------
Income (loss) before
income taxes 35.0 47.9 (1.7) 25.6 (64.9) 41.9
Income tax provision
(benefit) (1.8) 8.2 (0.6) (0.7) - 5.1
---------- ----------- ------------ ------------- ------------- ------------
Income (loss) before
extraordinary item 36.8 39.7 (1.1) 26.3 (64.9) 36.8
Extraordinary item - - - - - -
---------- ----------- ------------ ------------- ------------- ------------
Net income (loss) $ 36.8 $ 39.7 $ (1.1) $ 26.3 $ (64.9) $ 36.8
========== =========== ============ ============= ============= ============
CONDENSED CONSOLIDATING BALANCE SHEETS
As of September 30, 2003 (dollars in millions)
-----------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
---------- ----------- ------------ ------------- ------------- ------------
ASSETS
Current assets $ 232.8 $ 413.7 $ 11.5 $ 15.8 $ (276.4) $ 397.4
Investments 794.4 422.8 - 449.6 (1,233.0) 433.8
Properties, net 0.2 1,344.8 3.9 - - 1,348.9
Goodwill and other 7.7 30.1 1.7 6.3 (7.9) 37.9
assets
---------- ----------- ------------ ------------- ------------- ------------
Total assets $ 1,035.1 $ 2,211.4 $ 17.1 $ 471.7 $ (1,517.3) $ 2,218.0
========== =========== ============ ============= ============= ============
LIABILITIES AND EQUITY
Current liabilities $ 7.3 $ 426.6 $ 3.7 $ 32.8 $ (274.1) $ 196.3
Long-term debt 1.2 566.8 0.7 - - 568.7
Payable to affiliates 23.6 - 0.7 - (24.3) -
Deferred income taxes 4.9 394.2 0.2 2.5 (7.9) 393.9
Other liabilities 31.9 39.1 4.3 19.9 (2.3) 92.9
Stockholders' equity 966.2 784.7 7.5 416.5 (1,208.7) 966.2
---------- ----------- ------------ ------------- ------------- ------------
Total liabilities and
equity $ 1,035.1 $ 2,211.4 $ 17.1 $ 471.7 $ (1,517.3) $ 2,218.0
========== =========== ============ ============= ============= ============
As of December 31, 2002 (dollars in millions)
-----------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
---------- ----------- ------------ ------------- ------------- ------------
ASSETS
Current assets $ 43.3 $ 234.7 $ 17.6 $ 13.0 $ (92.4) $ 216.2
Investments 769.1 412.1 - 432.5 (1,190.6) 423.1
Properties, net 0.2 1,333.2 3.9 0.1 - 1,337.4
Goodwill and other assets 1.6 30.5 1.7 8.1 (9.8) 32.1
---------- ----------- ------------ ------------- ------------- ------------
Total assets $ 814.2 $ 2,010.5 $ 23.2 $ 453.7 $ (1,292.8) $ 2,008.8
========== =========== ============ ============= ============= ============
LIABILITIES AND EQUITY
Current liabilities $ 7.2 $ 245.3 $ 9.1 $ 16.2 $ (91.5) $ 186.3
Long-term debt 1.2 569.6 1.8 - - 572.6
Payable to affiliates 12.8 - 0.6 - (13.4) -
Deferred income taxes 8.6 391.1 0.3 2.6 (9.8) 392.8
Other liabilities 31.5 44.7 4.0 25.1 (1.1) 104.2
Stockholders' equity 752.9 759.8 7.4 409.8 (1,177.0) 752.9
---------- ----------- ------------ ------------- ------------- ------------
Total liabilities and
equity $ 814.2 $ 2,010.5 $ 23.2 $ 453.7 $ (1,292.8) $ 2,008.8
========== =========== ============ ============= ============= ============
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2003 (dollars in millions)
-----------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
---------- ----------- ------------ ------------- ------------- ------------
Net cash flows provided
by (used for) operating
activities: $ (187.6) $ 264.3 $ (11.2) $ 14.4 $ 4.8 $ 84.7
---------- ----------- ------------ ------------- ------------- ------------
Investing activities:
Property acquisitions - (53.4) - - - (53.4)
Proceeds from disposal of property - 8.6 - - - 8.6
Investments in and loans to
affiliates (33.1) (4.0) - (11.1) 10.7 (37.5)
Proceeds from sale of investments 32.7 - - - - 32.7
Other, net (6.2) (0.4) (0.3) 1.9 (1.8) (6.8)
---------- ----------- ------------ ------------- ------------- ------------
Net (6.6) (49.2) (0.3) (9.2) 8.9 (56.4)
---------- ----------- ------------ ------------- ------------- ------------
Financing activities:
Proceeds from issuance of
long-term debt - - - - - -
Repayment of long-term debt - (2.8) (1.1) - - (3.9)
Proceeds from loans from affiliates 20.1 - - - (20.1) -
Repayment of loans from affiliates (9.4) - - - 9.4 -
Issuance of preferred stock 193.2 - - - - 193.2
Debt issuance costs - - - - - -
Proceeds from stock plans 3.6 - - - - 3.6
Cash dividends paid (2.6) - - - - (2.6)
Other, net 0.2 0.1 0.4 (5.1) (3.0) (7.4)
---------- ----------- ------------ ------------- ------------- ------------
Net 205.1 (2.7) (0.7) (5.1) (13.7) 182.9
---------- ----------- ------------ ------------- ------------- ------------
Cash and cash equivalents:
Net increase (decrease) 10.9 212.4 (12.2) 0.1 - 211.2
At beginning of period (10.8) 17.5 11.8 0.5 - 19.0
---------- ----------- ------------ ------------- ------------- ------------
At end of period $ 0.1 $ 229.9 $ (0.4) $ 0.6 $ - $ 230.2
========== =========== ============ ============= ============= ============
Nine months ended September 30, 2002 (dollars in millions)
-----------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
---------- ----------- ------------ ------------- ------------- ------------
Net cash flows provided by (used
for) operating activities: $ (14.1)$ 98.3 $ 1.2 $ 8.2 $ 0.4 $ 94.0
---------- ----------- ------------ ------------- ------------- ------------
Investing activities:
Property acquisitions - (62.5) (0.6) - - (63.1)
Proceeds from disposal of property - 17.5 - - - 17.5
Investments in and loans to
affiliates - - - (9.3) 5.3 (4.0)
Proceeds from sale of investments 1.4 31.4 - - (1.1) 31.7
Other, net - 0.3 - (2.2) 0.6 (1.3)
---------- ----------- ------------ ------------- ------------- ------------
Net 1.4 (13.3) (0.6) (11.5) 4.8 (19.2)
---------- ----------- ------------ ------------- ------------- ------------
Financing activities:
Proceeds from issuance of
long-term debt - 200.0 - - - 200.0
Repayment of long-term debt (0.4) (263.2) (1.0) (0.2) - (264.8)
Proceeds from loans from affiliates 7.3 - 0.1 - (7.4) -
Repayment of loans from affiliates (2.0) - - - 2.0 -
Debt issuance costs - (5.5) - - - (5.5)
Proceeds from stock plans 7.7 - - - - 7.7
Cash dividends paid (0.2) - - - - (0.2)
Other, net - (6.3) 0.3 4.6 0.2 (1.2)
---------- ----------- ------------ ------------- ------------- ------------
Net 12.4 (75.0) (0.6) 4.4 (5.2) (64.0)
---------- ----------- ------------ ------------- ------------- ------------
Cash and cash equivalents:
Net increase (decrease) (0.3) 10.0 - 1.1 - 10.8
At beginning of period 1.3 23.2 - 0.2 - 24.7
---------- ----------- ------------ ------------- ------------- ------------
At end of period $ 1.0 $ 33.2 $ - $ 1.3 $ - $ 35.5
========== =========== ============ ============= ============= ============
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
THE DISCUSSION SET FORTH BELOW, AS WELL AS OTHER PORTIONS OF THIS FORM 10-Q,
CONTAINS FORWARD-LOOKING COMMENTS THAT ARE NOT BASED UPON HISTORICAL
INFORMATION. SUCH FORWARD-LOOKING COMMENTS ARE BASED UPON INFORMATION CURRENTLY
AVAILABLE TO MANAGEMENT AND MANAGEMENT'S PERCEPTION THEREOF AS OF THE DATE OF
THIS FORM 10-Q. READERS CAN IDENTIFY THESE FORWARD-LOOKING COMMENTS BY THE USE
OF SUCH VERBS AS EXPECTS, ANTICIPATES, BELIEVES OR SIMILAR VERBS OR CONJUGATIONS
OF SUCH VERBS. THE ACTUAL RESULTS OF OPERATIONS OF KANSAS CITY SOUTHERN ("KCS"
OR THE "COMPANY") COULD MATERIALLY DIFFER FROM THOSE INDICATED IN
FORWARD-LOOKING COMMENTS. THE DIFFERENCES COULD BE CAUSED BY A NUMBER OF FACTORS
OR COMBINATION OF FACTORS INCLUDING, BUT NOT LIMITED TO, THOSE FACTORS
IDENTIFIED IN THE COMPANY'S CURRENT REPORT ON FORM 8-K DATED DECEMBER 11, 2001,
WHICH IS ON FILE WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION (FILE NO.
1-4717) AND IS HEREBY INCORPORATED BY REFERENCE HEREIN. READERS ARE STRONGLY
ENCOURAGED TO CONSIDER THESE FACTORS WHEN EVALUATING FORWARD-LOOKING COMMENTS.
THE COMPANY WILL NOT UPDATE ANY FORWARD-LOOKING COMMENTS SET FORTH IN THIS FORM
10-Q.
THE DISCUSSION HEREIN IS INTENDED TO CLARIFY AND FOCUS ON THE COMPANY'S RESULTS
OF OPERATIONS, CERTAIN CHANGES IN ITS FINANCIAL POSITION, LIQUIDITY, CAPITAL
STRUCTURE AND BUSINESS DEVELOPMENTS FOR THE PERIODS COVERED BY THE CONSOLIDATED
FINANCIAL STATEMENTS INCLUDED UNDER ITEM 1 OF THIS FORM 10-Q. THIS DISCUSSION
SHOULD BE READ IN CONJUNCTION WITH THESE CONSOLIDATED FINANCIAL STATEMENTS AND
THE RELATED NOTES THERETO, AND IS QUALIFIED BY REFERENCE THERETO.
GENERAL
KCS, a Delaware corporation, is a holding company with principal subsidiaries
and affiliates including the following:
o The Kansas City Southern Railway Company ("KCSR"), a wholly-owned
subsidiary;
o Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), a
46.6% owned unconsolidated affiliate, which owns 80% of the common stock of
TFM, S.A. de C.V. ("TFM"). TFM wholly-owns Mexrail, Inc. ("Mexrail").
Mexrail owns 100% of The Texas-Mexican Railway Company ("Tex-Mex") (See
Recent Developments for a discussion of the sale by the Company of its
former 51% ownership interest in Mexrail back to TFM during the third
quarter of 2003);
o Southern Capital Corporation, LLC ("Southern Capital"), a 50% owned
unconsolidated affiliate that leases locomotive and rail equipment to KCSR;
o Panama Canal Railway Company ("PCRC"), an unconsolidated affiliate of which
KCSR owns 50% of the common stock. PCRC owns all of the common stock of
Panarail Tourism Company ("Panarail").
KCS supplies its various subsidiaries with managerial, legal, tax, financial and
accounting services, in addition to managing other "non-operating" investments.
RECENT DEVELOPMENTS
PROPOSED ACQUISITION OF GRUPO TFM FROM GRUPO TMM. On April 20, 2003, the Company
entered into an agreement with Grupo TMM, S.A. ("Grupo TMM") under which KCS
ultimately would acquire control of TFM through the purchase of shares of common
stock of Grupo TFM ("Acquisition Agreement"). Grupo TFM holds an 80% economic
interest in TFM and all of the shares of stock with full voting rights of TFM.
The remaining 20% economic interest in TFM is owned by the Mexican government in
the form of shares with limited voting rights. KCS currently owns a 46.6%
economic interest in Grupo TFM and 49.0% of the shares of common stock of Grupo
TFM entitled to full voting rights. The Acquisition Agreement and other related
agreements were designed to, following KCS shareholder approval and regulatory
approval, place KCSR, Tex-Mex, Gateway Eastern Railway Company ("Gateway
Eastern") and TFM, under the common control of a single transportation holding
company, NAFTA Rail, to be headquartered in Kansas City, Missouri. As part of
this NAFTA Rail transaction, subject to KCS shareholder approval, KCS is
expected to change its name to NAFTA Rail. See "Dispute over Acquisition
Agreement" below.
Upon the terms and subject to the conditions of the agreement to acquire Grupo
TFM, TMM Multimodal, S.A. de C.V., a subsidiary of Grupo TMM, would receive 18
million shares of Class A Convertible Common Stock of the Company, representing,
at the time of the agreement, approximately 22% (20% voting, 2% subject to
voting restrictions) of the Company, $200 million in cash (with the option to
pay up to $80 million of the $200 million cash component due at closing
to Grupo TMM with up to 6.4 million additional shares of Company stock) and a
potential incentive payment of between $100 million and $180 million based on
the resolution of certain future contingencies.
The common control of KCSR and Tex-Mex (See "Mexrail Transactions" below) under
NAFTA Rail requires approval of the United States Department of Justice
("Department of Justice") and the Surface Transportation Board ("STB") in the
United States. Additionally, the acquisition of Grupo TFM shares by NAFTA Rail
requires the approval of Mexico's Competition Commission and the Mexican
National Foreign Investments Commission in Mexico. See "STB Review Status"
below.
KCS's solicitation for permission as a foreign investor to control TFM, through
Grupo TFM, was filed with the Mexican National Foreign Investments Commission on
April 25, 2003. On August 27, 2003, KCS announced that it received notice from
the Mexican National Foreign Investments Commission of that Commission's
decision to close the proceeding with respect to KCS's application to acquire
control of Grupo TFM and, through Grupo TFM, of TFM, without prejudice to refile
in the event the dispute is resolved between KCS and Grupo TMM over whether the
Acquisition Agreement remains in effect.
KCS's Notification with respect to the acquisition of the Grupo TFM shares was
filed with the Mexican Competition Commission on April 21, 2003. KCS has
received formal written notice that the Mexican Competition Commission has
approved the proposed consolidation, without conditions. On September 26, 2003,
KCS announced this approval was extended for an additional 180 days.
On August 1, 2003, the Company announced that the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR") for the proposed
NAFTA Rail transaction had expired without a formal request from the Department
of Justice for additional information of documentary material, allowing KCS and
Grupo TMM to consummate the transaction without any further delays that could
have resulted from requests for additional information by the Department of
Justice under U.S. antitrust laws. Under the HSR process, the Department of
Justice had thirty days after notice was filed to issue a "second request"
asking for various documents and information from the HSR parties. The waiting
period officially expired on July 31, 2003, without action by the Department of
Justice.
DISPUTE OVER ACQUISITION AGREEMENT. On August 18, 2003, Grupo TMM, S.A. ("Grupo
TMM") shareholders voted not to approve the sale of Grupo TMM's interests in
Grupo TFM to KCS. See "Proposed Acquisition of Grupo TFM from Grupo TMM" above.
On August 23, 2003, Grupo TMM sent a notice to KCS claiming to terminate the
Acquisition Agreement, because the Grupo TMM shareholders had failed to approve
the Acquisition Agreement.
On August 29, 2003, KCS delivered to Grupo TMM a formal Notice of Dispute,
pursuant to the Acquisition Agreement. This initiated a 60-day negotiation
period between the parties. The parties were unable to resolve the dispute
within that period of time. On August 29, 2003, KCS filed a complaint in the
Delaware Chancery Court alleging that Grupo TMM had breached the Acquisition
Agreement and seeking a preliminary injunction requiring Grupo TMM not to take
any action in violation of the terms of the Acquisition Agreement. KCS' position
has been and remains that the Acquisition Agreement does not provide that a
negative shareholder vote by Grupo TMM shareholders is a basis for termination.
KCS maintains that the Acquisition Agreement is still valid and remains in
effect until December 31, 2004 (unless otherwise validly terminated in
accordance with its terms).
On September 2, 2003, the Company filed in the Delaware Court of Chancery a
motion for a preliminary injunction to preserve the parties' positions while KCS
seeks to resolve its dispute over Grupo TMM's attempt to terminate the
Acquisition Agreement. KCS asked for an expedited hearing on its motion for a
preliminary injunction.
On September 15, 2003, KCS confirmed that negotiations with Grupo TMM have begun
under the dispute resolution process contained in the Acquisition Agreement for
Grupo TMM's interest in Grupo TFM. One meeting was held to discuss negotiations,
but no further meetings have been held.
On October 28, 2003, Chancellor William B. Chandler III of the Delaware Court of
Chancery entered a written order granting KCS' motion seeking a preliminary
injunction to preserve the parties' positions pending resolution of KCS' dispute
with Grupo TMM.
On October 31, 2003, KCS initiated a binding arbitration in accordance with the
terms of the Acquisition Agreement by serving an Arbitration Demand on Grupo TMM
and the American Arbitration Association. In its Arbitration Demand KCS seeks a
determination that the Acquisition Agreement is in full force and effect,
specific performance of the Acquisition
Agreement, and damages for Grupo TMM's breach of the terms of the Acquisition
Agreement and failure to negotiate in good faith during the 60-day negotiation
period.
MEXRAIL TRANSACTIONS. On May 9, 2003, pursuant to the terms of a stock purchase
agreement for KCS to acquire control of Mexrail (the "Stock Purchase
Agreement"), KCS acquired from Grupo TMM (through its subsidiary TFM) 51% of the
shares of Mexrail for approximately $32.7 million. KCS deposited the Mexrail
shares into a voting trust pending resolution of KCS's application to the STB
seeking authority to exercise common control over Tex-Mex and KCS's other rail
companies, KCSR and Gateway Eastern. Under the Stock Purchase Agreement, the
Company had an exclusive option until December 31, 2005 to purchase the
remaining outstanding shares of Mexrail as of the date of the exercise of the
option. The Stock Purchase Agreement also provided TFM the right to repurchase
all of the Mexrail stock acquired by the Company at any time for the purchase
price paid by the Company, subject to any STB orders or directions. Upon any
such repurchase, the Stock Purchase Agreement would automatically terminate. If
not exercised within two years of the date of the agreement, TFM's repurchase
right would expire.
On August 29, 2003, KCS received a demand for TFM to repurchase from KCS shares
of Mexrail sold to KCS in May 2003. On September 23, 2003, the STB issued a
decision finding no need to rule on the transfer back to TFM of the 51% interest
in Mexrail that KCS acquired on May 9, 2003. The effect of the decision was to
allow TFM to reacquire the shares in accordance with the Stock Purchase
Agreement and KCS has abided by that agreement. The repurchase of Mexrail by TFM
closed on September 30, 2003 returning 100% ownership of Mexrail to TFM and the
Stock Purchase Agreement automatically terminated. The repurchase price was
$32.7 million; the same price KCS paid TFM in May 2003. However, the Stock
Purchase Agreement provided that in the event TFM reacquired the Mexrail shares
from KCS, the parties to the Stock Purchase Agreement intended the terms and
conditions of a February 27, 2002 stock purchase agreement under which TFM
acquired the Mexrail shares, the Grupo TFM bylaws and the shareholders agreement
dated May 1997 to become again valid and fully enforceable against the parties
to such agreements.
On February 27, 2002, KCS, Grupo TMM, and certain of Grupo TMM's affiliates
entered into a stock purchase agreement with TFM to sell to TFM all of the
common stock of Mexrail. Under this stock purchase agreement, KCS retained
rights to prevent further sale or transfer of the stock or significant assets of
Mexrail and Tex-Mex and the right to continue to participate in the corporate
governance of Mexrail and Tex-Mex, which will remain U.S. corporations and
subject to KCS's super majority rights contained in Grupo TFM's bylaws.
The shareholders agreement dated May 1997 between KCS and Grupo TMM and certain
affiliates, which governed KCS's investment in Grupo TFM (1) restricted each of
the parties to the shareholders agreement from directly or indirectly
transferring any interest in Grupo TFM or TFM to a competitor of Grupo TFM or
TFM without the prior written consent of each of the parties, and (2) provided
that KCS and Grupo TMM may not transfer control of any subsidiary holding all or
any portion of shares of Grupo TFM to a third party, other than an affiliate of
the transferring party or another party to the shareholders agreement, without
the consent of the other parties to the shareholders agreement. The shareholders
agreement required that the boards of directors of Grupo TFM and TFM be
constituted to reflect the parties' relative ownership of the ordinary voting
common stock of Grupo TFM.
STB REVIEW STATUS. KCS filed with the STB on May 13, 2003 a Railroad Control
Application, seeking permission to exercise common control over KCSR, Gateway
Eastern and Tex-Mex. On June 9, 2003, the STB issued its decision, effective
June 13, 2003, finding that the transaction proposed in KCS's application is a
"minor transaction" under 49 CFR 1180.2(c), although KCS was required to
supplement its application as discussed in the decision, to address some of the
implications of KCS's acquisition of control of TFM. KCS filed the supplement on
June 23, 2003, as required by the decision. The STB also outlined a procedural
schedule for consideration of KCS's application to exercise common control over
KCSR, Gateway Eastern and Tex-Mex. The STB decision set October 17, 2003 as the
date by which it would issue its final decision on the merits of the
application. On September 23, 2003, the STB entered an order asking all
interested parties to file comments by September 30, 2003 addressing whether "in
light of recent developments" the STB should continue with the procedural
schedule, which called for a decision on the merits to be issued by October 17,
2003. On October 8, 2003, the STB issued an order suspending the procedural
schedule pending a resolution of the uncertainties that now surround KCS's
efforts to acquire control of Tex-Mex, and requiring KCS to file status reports
regarding developments in its efforts to acquire control of TFM and Tex-Mex.
NOTICE OF TERMINATION OF JOINT VENTURE AGREEMENT. KCS acknowledged receipt from
Grupo TMM of a notice to terminate the joint venture agreement between the
parties entered into in 1995. Pursuant to such notice, the joint venture
agreement will terminate on December 1, 2003. The joint venture agreement
between the parties provides that upon its termination, the joint venture shall
be liquidated and any assets held in the name of the joint venture shall be
distributed
proportionally to KCS and Grupo TMM. There are no significant assets held by the
joint venture and KCS does not expect the termination of the joint venture
agreement to have a material adverse effect on KCS.
TFM VAT CLAIM. On July 9, 2003, Grupo TMM and KCS, announced that TFM was
formally notified by a three-judge panel of the Court of the First Circuit
("Circuit Court") of its June 11, 2003 judgment, which granted TFM
constitutional protection ("Amparo") against the ruling of the Federal Tribunal
of Fiscal and Administrative Justice ("Fiscal Court") issued on December 6,
2002, which had denied TFM the right to receive the Value Added Tax ("VAT")
refund. TFM initiated its claim for the VAT refund in 1997.
The Circuit Court's judgment ordered the Fiscal Court to vacate its December 6,
2002 resolution, and to issue a new resolution following the guidelines of the
Circuit Court's judgment. The Circuit Court found that the VAT refund
certificate had not been delivered to TFM, and confirmed the Fiscal Court's
determination that TFM has the right to receive the VAT refund certificate. The
Circuit Court's ruling states that the Treasury's decision denying delivery of
the VAT refund certificate to TFM violated the law, and it instructs that the
VAT reimbursement certificate be issued to TFM on the terms established by
Article 22 of the Federal Fiscal Code in effect at that time.
As a result of this ruling by the Circuit Court, the case was remanded to the
Fiscal Court. On August 14, 2003, Grupo TMM announced that in a public session
held August 13, 2003, the Fiscal Court issued a resolution regarding TFM's VAT
claim vacating its previous resolution of December 6, 2002, and, in strict
compliance with the ruling issued on June 11, 2003 by the Circuit Court,
resolved that TFM has proved its case, and that a "ficta denial" occurred,
declaring such denial null and void as ordered by the Circuit Court. On October
3, 2003, Grupo TMM announced that the Tax Attorney of the Mexican Government has
filed for review of the ruling. The Company is presently unable to predict the
amount or timing of any VAT refund recovery.
THOMAS A. MCDONNELL NAMED TO BOARD OF DIRECTORS. On March 19, 2003, the Company
announced that Thomas A. McDonnell, President and Chief Executive Officer of DST
Systems, Inc. had been named to its board of directors. Mr. McDonnell began his
career with Kansas City Southern Railway in 1968. In 1969, he moved to DST
Systems, Inc. From 1983 to October 1995, he served as a director of Kansas City
Southern Industries, Inc. (now KCS). From December 1989 through October 1995, he
served as a director of The Kansas City Southern Railway Company.
AMENDMENT OF CREDIT AGREEMENT. On April 3, 2003, the Company received approval
from more than 96% of its lenders of its request for an amendment to certain
provisions under its Amended and Restated Credit Agreement dated June 12, 2002.
The Company requested this amendment in order to provide flexibility in
structuring the funding for the transaction to acquire the Mexican Government's
interest in TFM. As discussed in the Company's Annual Report on Form 10-K for
the year ended December 31, 2002 as filed with the Securities and Exchange
Commission, the Mexican Government has the right to require Grupo TFM to
purchase the Mexican Government's interest in TFM on or after October 31, 2003.
Should Grupo TFM fail to purchase the Mexican Government's interest within 60
days of notification by the Mexican Government of its obligation to buy, then
Grupo TMM and KCS, or either Grupo TMM or KCS, could be required to purchase
their respective portion, or all, as applicable, of the Mexican Government's
interest in TFM within 60 days following written notification to Grupo TMM and
KCS, or either Grupo TMM or KCS, of their or its obligation to purchase. In
addition, if the Mexican Government's interest in TFM has not been purchased
prior to the closure of the proposed NAFTA Rail transaction contemplated by the
Acquisition Agreement discussed above, KCS shall, as a condition precedent to,
and contemporaneous with, the closure of such transaction, enter into an
agreement under which KCS shall assume and discharge Grupo TMM's obligation to
purchase the Mexican Government's interest in TFM. See "Dispute over Acquisition
Agreement" above.
On April 28, 2003, the Company entered into a second amendment to its Amended
and Restated Credit Agreement under which 93% of the lenders specifically
approved the Company's investment in further equity interests of Grupo TFM, in
equity interests representing 51% of Mexrail's issued and outstanding capital
stock and the use of the Company's cash to acquire Mexrail, in connection with
the proposed NAFTA Rail transaction (See "Dispute over Acquisition Agreement"
and Mexrail Transactions" above).
REDEEMABLE CUMULATIVE CONVERTIBLE PERPETUAL PREFERRED STOCK. On May 5, 2003, the
Company completed the sale of $200 million of Redeemable Cumulative Convertible
Perpetual Preferred Stock with a liquidation preference of $500 per share in a
private offering. The convertible preferred stock offering was made only by
means of an offering memorandum pursuant to Rule 144A. Dividends on the
convertible preferred stock will be cumulative and will be payable quarterly at
an annual rate of 4.25% of the liquidation preference, when, as and if declared
by the Company's board of directors. Accumulated unpaid dividends will cumulate
dividends at the same rate as dividends cumulate on the convertible preferred
stock. Each share of the convertible preferred stock will be convertible, under
certain conditions, and subject to adjustment under certain conditions, into
33.4728 shares of the Company's common stock. On or after May 20, 2008, the
Company will have the option to redeem any or all of the preferred stock,
subject to certain conditions. Under certain circumstances, at the option of the
holders of the preferred stock, the Company may be required to purchase shares
of the convertible preferred stock from the holders. The convertible preferred
stock is redeemable at the option of a holder only in the event of a
"fundamental change," which is defined as "any transaction or event (whether by
means of an exchange offer, liquidation, tender offer, consolidation, merger,
combination, reclassification, recapitalization or otherwise) in connection with
which all or substantially all of the Company's common stock is exchanged for,
converted into, acquired for or constitutes solely the right to receive common
stock that is not listed on a United States national securities exchange or
approved for quotation on the Nasdaq National Market or similar system. The
practical effect of this provision is to limit the Company's ability to
eliminate a holder's ability to convert the convertible preferred stock into
common shares of a publicly traded security through a merger or consolidation
transaction. In no other circumstances is the Company potentially obligated to
redeem the convertible preferred stock for cash. Accordingly, since the Company
is in a position to control whether the Company experiences a "fundamental
change," the convertible preferred stock is classified as permanent equity
capital.
The net proceeds from the offering of the convertible preferred stock are
expected to be used to pay a portion of the purchase price for the proposed
acquisition of a controlling interest of Grupo TFM. On August, 1, 2003, KCS
filed a Form S-3 Registration Statement with the SEC to register for resale by
the holders the convertible preferred stock and the common stock into which such
preferred stock may be converted. On October 24, 2003, this registration
statement, as amended, was declared effective by the SEC. On November 4, KCS
filed Post-Effective Amendment No. 1 to this registration statement which was
declared effective by the SEC on November 5, 2003. On November 12, KCS filed
Post-Effective Amendment No.2 to this registration statement which was declared
effective by the SEC on November 12, 2003. KCS will not receive any proceeds
from the sale of the securities under this registration statement. If the
acquisition of the controlling interest of Grupo TFM were not to be completed,
the Company would explore alternative uses of the net proceeds realized from the
issuance of the convertible preferred stock.
RESULTS OF OPERATIONS
The following table summarizes the income statement components of the Company
for the three and nine months ended September 30, 2003 and 2002, respectively,
for use in the analysis below. Certain prior period amounts have been
reclassified to conform to the current period presentation (IN MILLIONS):
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------------- --------------------------
2003 2002 2003 2002
------------- ------------ ------------- ------------
Revenues $ 146.3 $ 138.9 $ 432.8 $ 422.0
Costs and expenses 131.4 132.7 396.9 387.9
------------- ------------ ------------- ------------
Operating income 14.9 6.2 35.9 34.1
Equity in net earnings of unconsolidated
affiliates 0.7 9.1 5.2 25.7
Gain on sale of Mexrail, Inc. - - - 4.4
Interest expense (11.6) (11.5) (34.8) (33.3)
Debt retirement costs - - - (4.3)
Other income 2.0 6.5 4.8 15.3
------------- ------------ ------------- ------------
Income before income taxes and
cumulative effect of accounting change 6.0 10.3 11.1 41.9
Income tax provision (benefit) 1.7 (0.3) 2.6 5.1
------------- ------------ ------------- ------------
Income before cumulative effect
of accounting change 4.3 10.6 8.5 36.8
Cumulative effect of accounting change, net
of income taxes - - 8.9 -
------------- ------------ ------------- ------------
Net income $ 4.3 $ 10.6 $ 17.4 $ 36.8
============= ============ ============= ============
The following table summarizes consolidated KCS revenues, including the revenues
and carload statistics of KCSR, for the three and nine months ended September
30, 2003 and 2002, respectively. Certain prior period amounts have been
reclassified to reflect changes in the business groups and to conform to the
current period presentation.
Carloads and
Revenues Intermodal Units
-------------------------------------- --------------------------------------
(IN MILLIONS) (IN THOUSANDS)
Three Months Nine Months Three Months Nine Months
ended September 30, ended September 30, ended September 30, ended September 30,
-------------------------------------- --------------------------------------
2003 2002 2003 2002 2003 2002 2003 2002
-------- -------- -------- -------- -------- -------- -------- --------
General commodities:
Chemical and petroleum $ 30.8 $ 32.4 $ 92.6 $ 98.1 34.1 35.6 104.4 109.3
Paper and forest 37.7 34.7 109.9 100.8 47.7 46.0 140.0 134.8
Agricultural and
mineral 25.6 22.2 78.0 71.2 33.8 29.1 102.5 93.5
-------- -------- -------- -------- -------- -------- -------- --------
Total general commodities 94.1 89.3 280.5 270.1 115.6 110.7 346.9 337.6
Intermodal and automotive 15.3 15.5 43.7 46.3 79.9 78.9 229.5 222.6
Coal 23.6 24.4 69.9 74.7 48.6 50.2 141.5 155.4
-------- -------- -------- -------- -------- -------- -------- --------
Carload revenues and
carload and intermodal
units 133.0 129.2 394.1 391.1 244.1 239.8 717.9 715.6
======== ======== ======== ========
Other rail-related
revenues 11.9 8.4 34.2 25.8
-------- -------- -------- --------
Total KCSR revenues 144.9 137.6 428.3 416.9
Other subsidiary
revenues 1.4 1.3 4.5 5.1
-------- -------- -------- --------
Total consolidated
revenues $ 146.3 $ 138.9 $ 432.8 $ 422.0
======== ======== ======== ========
The following table summarizes KCS's consolidated costs and expenses for the
three and nine months ended September 30, 2003 and 2002, respectively. Certain
prior period amounts have been reclassified to conform to the current year
presentation. (IN MILLIONS)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------- ------------
Compensation and benefits $ 48.4 $ 51.2 $ 146.4 $ 147.1
Depreciation and amortization 16.2 15.8 48.1 45.3
Purchased services 15.8 15.6 46.1 43.5
Operating leases 14.9 13.8 43.4 41.1
Fuel 11.2 8.9 35.3 27.7
Casualties and insurance 9.7 6.9 26.2 22.0
Car hire 2.8 5.6 8.5 14.9
Other 12.4 14.9 42.9 46.3
------------ ------------ ------------- ------------
Total consolidated costs and expenses $ 131.4 $ 132.7 $ 396.9 $ 387.9
============ ============ ============= ============
NET INCOME. KCS recorded net income of $4.3 million (2(cent) per diluted share)
for the three months ended September 30, 2003 compared to net income of $10.6
million (17(cent) per diluted share) for the three months ended September 30,
2002. For the third quarter of 2003, KCS experienced an $8.7 million increase in
operating income driven by a $7.4 million increase in consolidated revenues
coupled with a $1.3 million decline in operating expenses. These positive
contributors to net income were offset by an $8.2 million decline in equity
earnings from Grupo TFM, a $4.5 million decrease in other income, a $2.0 million
increase in the provision for income taxes, a $0.2 million fluctuation in the
equity losses of other unconsolidated affiliates (PCRC and Southern Capital) and
a $0.1 million increase in interest expense.
Net income for the nine months ended September 30, 2003 was $17.4 million
(20(cent) per diluted share) compared to $36.8 million (59(cent) per diluted
share) for the nine months ended September 30, 2002. This $19.4 million period
to period decline in net income resulted from a $21.4 million decrease in equity
in earnings of Grupo TFM, a $10.5 million decline in other income, a $9.0
million increase in consolidated operating expenses and a $1.5 million increase
in interest expense. Also contributing to the comparably lower 2003 net income
was the impact of a $4.4 million gain on the sale of Mexrail recorded in the
nine months ended September 30, 2002. These factors, which led to a period to
period decline in net income, were partially offset by a $10.8 million increase
in revenue, a one-time benefit of $8.9 million (net of taxes of $5.6 million)
reported during year to date 2003 relating to the cumulative effect of an
accounting change, the effect of $4.3 million in debt retirement costs reported
in 2002, a $2.5 million decrease in the provision for income taxes and a $0.9
million improvement in the equity in net losses of other unconsolidated
affiliates (PCRC and Southern Capital).
REVENUES. Consolidated revenues for the three and nine months ended September
30, 2003 increased $7.4 million and $10.8 million to $146.3 million and $432.8
million, respectively, compared to $138.9 million and $422.0 million for the
three and nine months ended September 30, 2002, respectively. This third quarter
and year to date 2003 revenue growth resulted mostly from higher KCSR revenues,
most notably from improvements in the agricultural and mineral, and paper and
forest product commodity groups. Additionally, higher revenues from other rail
related ancillary services contributed to the comparably higher revenues during
these periods. Revenues for the nine months ended September 30, 2003 included
approximately $1.4 million related to reductions of certain allowances and
reserves based upon revised estimates. The following discussion provides an
analysis of KCSR revenues by commodity group for the quarter and year to date
ended September 30, 2003.
CHEMICAL AND PETROLEUM PRODUCTS. Revenues for chemical and petroleum
products for the three and nine months ended September 30, 2003 decreased $1.6
million and $5.5 million, respectively, compared to the same periods in 2002,
primarily as a result of lower revenues for plastic product shipments. For the
three and nine months ended September 30, 2003, revenue for plastic products
declined $2.1 million and $5.8 million, respectively, compared to the same prior
year periods due mostly to the loss of a customer. For the quarter ended
September 30, 2003, demand related revenue increases in agri-chemical, organic
and inorganic traffic partially offset the quarterly decline in plastic product
revenues. For the nine months ended September 30, 2003, declines in petroleum
and agri-chemical product revenues also contributed to lower comparable chemical
and petroleum product revenues. Year to date 2003 petroleum revenues dropped as
a result of the adverse impact of high natural gas prices (both a feedstock and
a source of energy for producers) on petroleum production, while lower
agri-chemical revenues resulted from reduced customer production and changes in
traffic mix. These year to date 2003 declines in agri-chemical, petroleum and
plastic product revenues were partially offset by higher revenues for gases and
inorganic products, primarily due to increased customer demand. Chemical and
petroleum product revenues accounted for 23.5% and 25.1% of carload revenues for
the nine months ended September 30, 2003 and 2002, respectively.
PAPER AND FOREST PRODUCTS. Paper and forest product revenues for the three
and nine months ended September 30, 2003 increased $3.0 million and $9.1
million, respectively, compared to the same periods in 2002, driven by higher
revenues for pulp and paper, scrap paper, pulpwood/logs/chips and lumber/plywood
products. Revenues for pulp and paper products as well as scrap paper increased
primarily from higher production at KCSR's paper mill customers and increased
exports to Mexico. The increase in lumber and plywood product revenues resulted
from continued strength in the housing and homebuilding industry due to
sustained levels of housing starts. Increases in revenues for
pulpwood/logs/chips resulted from higher production by certain customers and
targeted rate increases. Revenues for metal/ scrap products were relatively
unchanged for both the three and nine months ended September 30, 2003. These
quarter and year to date increases were partially offset by lower military/other
revenues as a result of the cancellation of certain military training exercises,
for which KCSR handles equipment transportation, due to the associated
deployment of troops to the Middle East. Paper and forest products revenue
accounted for 27.9% and 25.8% of carload revenues for the nine months ended
September 30, 2003 and 2002, respectively.
AGRICULTURAL AND MINERAL PRODUCTS. Revenues for agricultural and mineral
products for the three and nine months ended September 30, 2003 increased $3.4
million and $6.8 million, respectively, compared to the same periods in 2002.
For the three and nine months ended September 30, 2003, KCSR experienced revenue
growth for export grain, food products, ore and mineral products as well as
stone, clay and glass products. These revenue increases were partially offset by
slight declines in domestic grain revenues for both the third quarter and year
to date 2003 periods versus comparable 2002 primarily due to the effects of
continued declines in poultry production, reducing the demand for grain
shipments to the Company's poultry producing customers. The impact on domestic
grain revenues of reduced poultry production was mostly offset by higher
revenues associated with longer hauls gained as a result of a new contract with
an existing customer. Increases in revenues for export grain reflect higher
volumes of grain exports to Mexico. Food product revenues rose as a result of a
new contract with an existing customer yielding increased carloads as well as
longer hauls. Food product revenues were also higher due to higher beer
shipments from Mexico into the United States and Canada. Revenue increases for
ore and mineral products were the result of increased demand from producers.
Agricultural and minerals revenue accounted for 19.8% and 18.2% of carload
revenues for the nine months ended September 30, 2003 and 2002, respectively.
INTERMODAL AND AUTOMOTIVE. Intermodal and automotive revenues for the
three and nine months ended September 30, 2003 declined $0.2 million and $2.6
million, respectively, compared to the same periods in 2002. For the third
quarter of 2003, automotive revenues increased slightly (3.5%) compared to the
third quarter of 2002 due to higher shipments from KCSR's customers and the
effect of new automotive parts traffic obtained in the first quarter of 2003.
Automotive revenues declined $3.7 million for the nine months ended September
30, 2003 compared to the same period in 2002 as a result of the loss of certain
automotive traffic in the third quarter of 2002. The effects of the sluggish
economy on the automotive industry as a whole also negatively impacted
automotive revenues. These year to date 2003
automotive revenue declines were partially offset by the favorable impact on
revenues of new automotive parts traffic obtained in the first quarter of 2003.
Intermodal revenues for the three months ended September 30, 2003 declined $0.3
million due to lower traffic volumes. Intermodal revenues for the nine months
ended September 30, 2003 increased $1.0 million as a result of higher intermodal
traffic with other connecting railroads. Intermodal and automotive revenue
accounted for 11.1% and 11.8% of carload revenues for the nine months ended
September 30, 2003 and 2002, respectively.
COAL. For the three and nine months ended September 30, 2003 coal revenues
decreased $0.8 million and $4.8 million, respectively, compared to the same
periods in 2002, primarily resulting from a decline in tons shipped due to
overall customer demand. A portion of the year to date coal revenue decline
related to the loss of a coal customer in April of 2002, as well as to the
impact of scheduled maintenance shutdowns in 2003, which where longer in
duration compared to year to date 2002. These factors, which led to a reduction
in coal revenues for the nine months ended September 30, 2003, were partially
offset by the impact of higher per-carload revenues as a result of the use of
aluminum cars, which are capable of greater hauling capacity. Coal revenue
accounted for 17.8% and 19.1% of carload revenues for the nine months ended
September 30, 2003 and 2002, respectively.
OTHER. Other rail related revenues for the three and nine months ended
September 30, 2003 increased $3.5 million and $8.4 million, respectively,
compared to the same periods in 2002. These increases were primarily the result
of higher revenues for demurrage and other rail related ancillary services,
which resulted from improved operating efficiencies associated with the
implementation of the Company's transportation operating platform, Management
Control System ("MCS") in third quarter 2002. Haulage revenue has also increased
slightly for the three and nine months ended September 30, 2003 compared to the
same periods in 2002.
COSTS AND EXPENSES. For the three months ended September 30, 2003, consolidated
costs and expenses decreased $1.3 million compared to the three months ended
September 30, 2002. This decline resulted primarily from lower operating
expenses at KCSR of approximately $3.1 million partially offset by higher
operating expenses at other KCS subsidiaries of $1.8 million. On a year to date
basis, 2003 consolidated costs and expenses increased $9.0 million compared to
2002 due to higher costs and expenses at KCSR of $9.1 million and a slight
decline ($0.1 million) in operating expenses from KCS's other subsidiaries.
Operating expenses for the three and nine months ended September 30, 2003 were
significantly impacted by increases in fuel costs. See further discussion below
for a more comprehensive discussion of operating expenses.
COMPENSATION AND BENEFITS. For the three and nine months ended September
30, 2003, consolidated compensation and benefits decreased $2.8 million and $0.7
million, respectively, compared to the same periods in 2002. These declines
resulted from a reduction in the number of crew starts and lower overtime pay,
despite the increase in carload volumes during 2003 compared to 2002. Management
believes these improvements are partially a result of the increased efficiency
of train operations due to the improving effectiveness of the MCS transportation
system. Furthermore, third quarter 2002 compensation and benefits costs were
significantly influenced by the operating inefficiencies that occurred as a
result of the implementation of MCS in July 2002. The efficiency gains realized
during 2003 have been partially offset by an increase in certain union wage
rates as a result of the settlement of certain contracts in the third quarter of
2002 and higher overall health insurance related costs.
DEPRECIATION AND AMORTIZATION. Consolidated depreciation and amortization
expense was $16.2 million and $48.1 million for the three and nine months ended
September 30, 2003, respectively, compared to $15.8 million and $45.3 million
for the three and nine months ended September 30, 2002, respectively. For the
three months ended September 30, 2003, depreciation expense rose as a result of
an increase in KCSR's depreciable asset base. The increase in depreciation
expense for the nine months ended 2003 relates primarily to the implementation
of MCS, which increased depreciation expense by approximately $2.5 million
compared to the same period in 2002.
PURCHASED SERVICES. Consolidated purchased services expense for the three
and nine months ended September 30, 2003 increased $0.2 million and $2.6
million, respectively, to $15.8 million and $46.1 million, respectively,
compared to $15.6 million and $43.5 million, respectively, for the same periods
in 2002. The quarter to quarter increase resulted from an increase in track,
bridge and locomotive repairs performed by third parties, mostly offset by an
increase in car repairs billed to others by KCSR. For year to date 2003, the
increase primarily resulted from increased legal expenses related to the
settlement of certain casualty claims, higher car and locomotive repairs being
performed by third parties and a reduction in lift fee credits received from
other railroads. Consistent with the quarterly analysis, these year to date 2003
cost increases were partially offset by an increase in car repairs billed to
others by KCSR. The quarter to quarter comparison
was also impacted by a $1.0 million legal settlement received in the third
quarter of 2002, which reduced purchased services expense in the prior year
quarter. In addition to the $1.0 million legal settlement, the year to date
comparison was also impacted by an insurance recovery credit of approximately
$1.8 million realized in the second quarter of 2002. On a combined basis, these
one-time credits reduced year to date 2002 purchased services by approximately
$2.8 million.
OPERATING LEASES. Consolidated operating lease expense for the three and
nine months ended September 30, 2003 increased $1.1 million and $2.3 million,
respectively, to $14.9 million and $43.4 million, respectively, from $13.8
million and $41.1 million, respectively, for the same periods in 2002. The
increases for both periods were partially related to the lease of maintenance
vehicles and work equipment, which in prior periods were owned by KCSR.
Partially offsetting these increases was reduced costs related to other car
equipment leases due to better fleet utilization. Additionally, for the nine
months ended September 30, 2003, operating leases increased partially as a
result of the timing of the lease for the Company's new corporate headquarters
building. The Company began leasing this facility in the second quarter of 2002.
FUEL. Consolidated fuel expense for the three and nine months ended
September 30, 2003 increased $2.3 million and $7.6 million, respectively, to
$11.2 million and $35.3 million, respectively, compared to $8.9 million and
$27.7 million, respectively, for the same periods in 2002. The $2.3 million
quarter to quarter increase was the result of a 19% increase in the average
price per gallon of fuel (adjusted for the effects of the Company's fuel hedging
program) coupled with an 5.3% increase in consumption. The $7.6 million year to
date increase was the result of a 28% increase in the average price per gallon
of fuel (adjusted for the effects of the Company's fuel hedging program)
partially mitigated by the effects of a 1% decrease in fuel consumption. Fuel
cost represented approximately 8.5% and 8.9%, respectively, of consolidated
costs and expenses for the three and nine months ended September 30, 2003
compared to 6.7% and 7.1%, respectively, for the same periods in 2002.
CASUALTIES AND INSURANCE. Consolidated casualties and insurance expense
for the three and nine months ended September 30, 2003 increased $2.8 million
and $4.2 million, respectively, to $9.7 million and $26.2 million, respectively,
compared to $6.9 million and $22.0 million, respectively, for the same periods
in 2002. The quarter to quarter increase was primarily the result of higher
insurance costs and higher equipment damage and derailment expenses, partially
offset by reduced personal injury expenses. For the nine months ended September
30, 2003, the increase was mostly related to higher insurance costs, partially
offset by lower derailment related expenses. On a comparative basis, the
increase in casualties and insurance expense for the third quarter of 2003 was
also impacted by the effect of a legal settlement of $1.5 million received in
the third quarter of 2002, which reduced casualties and insurance expense in the
prior year quarter. In addition to the $1.5 million legal settlement, the year
to date comparison was also impacted by an insurance recovery credit of
approximately $1.4 million realized in the second quarter of 2002. On a combined
basis, these one-time credits reduced year to date 2002 casualties and insurance
expense by approximately $2.9 million.
CAR HIRE. Consolidated net car hire expense was $2.8 million and $8.5
million, respectively, for the three and nine months ended September 30, 2003
compared to $5.6 million and $14.9 million, respectively, for the same periods
in 2002. This decrease in net car hire expense for both the three and nine-month
periods ended September 30, 2003 resulted from improved fleet utilization
associated with the implementation of MCS. The improvement in fleet utilization
has led to an increase in the number of KCSR freight cars being used by other
railroads as well as a reduction in the number of freight cars owned by other
railroads on the Company's rail line.
OTHER EXPENSES. Consolidated other expenses for the three and nine months
ended September 30, 2003 declined $2.5 million and $3.4 million, respectively,
compared to the same periods in 2002, primarily as a result of higher gains
recorded on the sale of operating properties. For the third quarter of 2003,
gains from property sales were $2.5 million compared to $0.7 million for the
third quarter of 2002, an increase of $1.8 million. For the nine months ended
September 30, 2003, gains recorded from property sales increased $1.4 million to
$4.1 million compared to $2.7 million for the nine months ended September 30,
2002. Also impacting the year to date comparison was a decline in costs for
materials and supplies and a reduction in miscellaneous taxes.
OPERATING INCOME AND KCS OPERATING RATIO. Consolidated operating income
for the three months ended September 30, 2003 increased $8.7 million to $14.9
million from $6.2 million for the same period in 2002, resulting from a $7.4
million increase in revenues and a $1.3 million decrease in operating expenses.
For the nine months ended September 30, 2003, consolidated operating income
increased $1.8 million to $35.9 million from $34.1 million for the same period
in 2002, resulting from a $10.8 million increase in revenues partially offset by
a $9.0 million increase in operating expenses. For the three months ended
September 30, 2003 and 2002, the consolidated operating ratio was 89.8% and
95.5%, respectively. For the nine months ended September 30, 2003 and 2002, the
consolidated operating ratio was 91.7% and 91.9%, respectively.
INTEREST EXPENSE. Consolidated interest expense for the three and nine months
ended September 30, 2003 increased $0.1 million and $1.5 million, respectively,
to $11.6 million and $34.8 million, respectively, from $11.5 million and $33.3
million, respectively, for the same periods in 2002. Interest expense rose in
each of these periods due to higher interest rates arising from a shift to more
fixed rate debt in June 2002, partially offset by the impact of a lower debt
balance. Consolidated debt declined $10.0 million from $588.7 million at
September 30, 2002 to $578.7 million at September 30, 2003.
DEBT RETIREMENT COSTS. Net income for the nine months ended September 30, 2002
includes debt retirement costs of $4.3 million related to the debt refinancing
during the second quarter of 2002.
OTHER INCOME. For the three and nine months ended September 30, 2003
consolidated other income decreased $4.5 million and $10.5 million,
respectively, compared to the same periods in 2002. The quarter to quarter
decline related primarily to a $4.9 million pre-tax gain recorded in the third
quarter of 2002 related to the sale of the Company's interest in Wyandotte
Garage Corporation. The year to date decline was due to substantially lower
gains on the sale of non-operating property compared to the same 2002 periods,
as well as the impact of the sale of Wyandotte Garage Corporation in 2002. Gains
recorded on the sale of non-operating property were $0.2 million and $7.4
million for the nine months ended September 30, 2003 and 2002, respectively.
INCOME TAX EXPENSE. The consolidated income tax provision for the three months
ended September 30, 2003 was $1.7 million compared to an income tax benefit of
$0.3 million for the same period in 2002. This increase resulted primarily from
higher domestic operating profit partially offset by a decline in other income.
For the nine months ended September 30, 2003, the consolidated income tax
provision was $2.6 million compared to $5.1 million for the same period in 2002.
This decrease in the income tax provision was primarily the result of a $10.5
million decline in other income for the nine months ended September 30, 2003.
Exclusive of equity earnings in Grupo TFM, the consolidated effective income tax
rate for the three and nine months ended September 30, 2003 was approximately
38% and 53% respectively, compared to (60%) and 36%, respectively, for the same
periods in 2002. This variance in the effective tax rate was primarily the
result of changes in associated book/tax temporary differences, the level of
pre-tax income, and the impact of permanent book/tax differences on the
effective rate computation.
EQUITY IN NET EARNINGS (LOSSES) OF UNCONSOLIDATED AFFILIATES. For the three
months ended September 30, 2003, KCS recorded equity in net earnings of
unconsolidated affiliates of $0.7 million compared to equity in net earnings of
unconsolidated affiliates of $9.1 million for the same period in 2002. This $8.4
million quarter to quarter decrease resulted primarily from an $8.2 million
decrease in equity in net earnings from Grupo TFM. For the three months ended
September 30, 2003, revenues for Grupo TFM increased approximately $2.9 million
(1.6%) compared to the same period in 2002, despite a negative impact due to the
weakening of the Mexican peso versus the United States dollar on a year over
year basis. Operating expenses for Grupo TFM for the three months ended
September 30, 2003 increased $7.6 million (6%) primarily as a result of higher
fuel, car hire and purchased services. Also contributing to the lower earnings
of Grupo TFM was an increase in exchange losses of $4.1 million and a $13.8
million increase in non-operating expenses quarter to quarter.
For the nine months ended September 30, 2003, KCS recorded equity in earnings of
unconsolidated affiliates of $5.2 million compared to $25.7 million for the same
period in 2002. This $20.5 million year to year decrease resulted primarily from
a $21.4 million decrease in equity in earnings from Grupo TFM. For the nine
months ended September 30, 2003, Grupo TFM's earnings were adversely impacted by
an $18.4 million decrease in deferred income tax benefits as calculated under
U.S. GAAP, which primarily resulted from the strengthening of the Mexican peso
compared to the United States dollar during 2003 as well as lower future Mexican
corporate tax rates. These rate changes had the effect of reducing Grupo TFM's
deferred tax asset, thus increasing Grupo TFM's deferred tax provision. Grupo
TFM's deferred tax assets are the result of prior year net operating losses for
income tax purposes. Also impacting Grupo TFM's earnings for the nine months
ended September 30, 2003 was a $9.0 million decrease in revenues as well as a
$21.4 million increase in operating expenses. Revenues for Grupo TFM were
adversely affected by the devaluation of the Mexican peso against the United
States dollar on a year over year basis which resulted in a reduction of
revenues of approximately $28.1 million period to period. For the nine months
ended September 30, 2003, interest expense for Grupo TFM increased approximately
$16.0 million compared to the same period in 2002 primarily as a result of
increased debt costs related to the acquisition of the Mexican Government's
ownership of Grupo TFM. Also contributing to the lower earnings of Grupo TFM was
a $16.5 million increase in non-operating expenses. The Company's equity in
earnings (losses) of Grupo TFM was also impacted by the Company's increased
ownership of Grupo TFM to 46.6% from 36.9%, which the Company obtained
indirectly in July 2002 as a result of the purchase by TFM of the Mexican
Government's 24.6% ownership of Grupo TFM.
The Company reports its equity in Grupo TFM under U.S. GAAP while Grupo TFM
reports under International Accounting Standards ("IAS"). Because the Company is
required to report its equity in earnings (losses) in Grupo TFM under U.S. GAAP
and Grupo TFM reports under IAS, differences in deferred income tax calculations
and the classification of certain operating expense categories occur.
For the three and nine months ended September 30, 2003, equity in losses from
other unconsolidated affiliates was $0.9 million and $1.0 million, respectively,
compared to $0.7 million and $1.9 million for the three and nine months ended
September 30, 2002, respectively. For the three and nine months ended September
30, 2003, equity in losses related to PCRC were $1.2 million and $2.3 million,
respectively, compared to $1.1 million and $2.9 million, respectively, for the
same periods in 2002. These losses were partially offset by earnings from
Southern Capital. For the three and nine months ended September 30, 2003, equity
in earnings from Southern Capital was $0.4 million and $1.4 million,
respectively, compared to $0.4 million and $1.0 million, respectively, for the
same periods in 2002.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE. The Company adopted the provisions of
Statement of Financial Accounting Standard ("SFAS 143") effective January 1,
2003. As a result, the Company changed its method of accounting for removal
costs of certain track structure assets and recorded a one-time benefit of $8.9
million (net of income taxes of $5.6 million) for the first quarter of 2003.
This change is reported as a cumulative effect of an accounting change in the
accompanying consolidated financial statements.
TRENDS AND OUTLOOK
For both the quarter and year to date periods ended September 30, 2003, the
Company's consolidated revenue increased compared to the same periods in 2002.
These revenue increases resulted from targeted rate increases and volume growth
in certain commodity segments throughout the year despite an economy that has
experienced only limited improvements within certain sectors. While the Company
experienced revenue growth for the quarter ended September 30, 2003,
consolidated operating expenses decreased slightly quarter to quarter, resulting
from improvements in operating performance and demonstrating the impact of
efficiencies gained from a more fully functional MCS, which was implemented at
the beginning of the third quarter of 2002. For the nine months ended September
30, 2003, higher operating expenses were primarily driven by increases in fuel
costs, legal fees, insurance costs and depreciation expense which was related to
the implementation of MCS.
For the quarter and year to date periods ended September 30, 2003, the Company's
equity in earnings of unconsolidated affiliates decreased compared to the same
periods in 2002. This decrease was primarily the result of a reduction in
earnings from Grupo TFM during both of these periods. On a year to date basis,
the Company's earnings from Grupo TFM were adversely affected by deferred tax
calculations under U.S. GAAP related to the exchange rate between the U.S.
Dollar and the Mexican peso as well as future Mexican income tax rates. Year to
date 2003 earnings from Grupo TFM have also been adversely impacted by a
reduction in revenues and an increase in operating expenses. For both the
quarter and year to date periods ended September 30, 2003, the Company's equity
in earnings from Grupo TFM has been favorably impacted by the increase in
ownership percentage arising from the purchase, by TFM, of the Mexican
government's 24.6% ownership of Grupo TFM during the second quarter of 2002.
For the year to date ended September 30, 2003, net income was favorably affected
by a one-time benefit of $8.9 million (net of income taxes of $5.6 million),
related to the cumulative effect resulting from a required change in the method
of accounting for removal costs of certain railroad track structures. These
factors contributed to the Company's third quarter and year to date ended
September 30, 2003 diluted earnings per share, which decreased 88.2% and 66.1%
to 02(cent) and 20(cent) per diluted share, respectively, from 17(cent) and
59(cent) per diluted share, respectively, for the same periods in 2002.
A current outlook for the Company's businesses for the remainder of 2003 is as
follows: (refer to the first paragraph of "Overview" section of this Item 2,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, regarding forward-looking comments).
For the remainder of 2003, management will continue to focus on the improvement
of the Company's domestic operations. Management expects overall KCSR revenues
to increase compared to the same period in 2002 as certain commodity segments
continue to experience growth based on higher demand. Except as discussed
herein, assuming normalized rail operations, management expects KCSR's variable
costs and expenses to be proportionate with revenue activity with cost
efficiencies expected as a result of the continued improvements realized from
the utilization of MCS. Fuel prices will fluctuate subject to market conditions.
To mitigate these market risks, KCSR currently has approximately 17% of its
budgeted fuel usage for the fourth quarter 2003 hedged through purchase
commitments as well as fuel swaps, both of which
reduce the risk of the adverse impact of volatile fuel prices. Insurance costs
are expected to rise commensurate with market conditions.
As previously discussed in "Recent Developments - Proposed Acquisition of Grupo
TFM from Grupo TMM," after announcing a series of agreements that would,
following shareholder and regulatory approval, place KCSR, Tex-Mex, Gateway
Eastern, and TFM under the common control of a single transportation holding
company, NAFTA Rail, the shareholders of Grupo TMM purportedly voted not to
approve the sale of Grupo TMM's interests in Grupo TFM to KCS. Negotiations have
begun under the dispute resolution process contained in the Acquisition
Agreement. One meeting has been held to discuss the negotiations, but no further
meetings have been held. As previously discussed in "Recent Developments -
Dispute over Acquisition Agreement," on October 31, 2003, KCS initiated a
binding arbitration in accordance with the terms of the Acquisition Agreement by
serving an Arbitration Demand on Grupo TMM and the American Arbitration
Association. In its Arbitration Demand KCS seeks a determination that the
Acquisition Agreement is in full force and effect, specific performance of the
Acquisition Agreement, and damages for Grupo TMM's breach of the terms of the
Acquisition Agreement and failure to negotiate in good faith during the 60-day
negotiation period. The Company's management maintains that the Acquisition
Agreement is still valid and remains in effect until December 31, 2004 (unless
otherwise validly terminated in accordance with its terms.)
The Company expects to continue to participate in the earnings/losses from its
equity investments in Grupo TFM, Southern Capital and PCRC. Due to the
variability of factors affecting the Mexican economy, management can make no
assurances as to the impact that a change in the value of the Mexican peso or a
change in Mexican inflation will have on the results of Grupo TFM. In addition,
if a resolution is reached regarding the dispute over the agreement to acquire
Grupo TMM's interest in Grupo TFM and the transaction to place KCSR, TFM and
Tex-Mex under common control is consummated, then the Company expects to
consolidate the results of operations of TFM and Tex-Mex into its consolidated
financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Summary cash flow data for the Company is as follows (IN MILLIONS):
Nine Months
Ended September 30,
-------------------------
2003 2002
----------- -----------
Cash flows provided by (used for):
Operating activities $ 84.7 $ 94.0
Investing activities (56.4) (19.2)
Financing activities 182.9 (64.0)
----------- -----------
Cash and cash equivalents:
Net increase 211.2 10.8
At beginning of year 19.0 24.7
----------- -----------
At end of period $ 230.2 $ 35.5
=========== ===========
During the nine months ended September 30, 2003, the Company's consolidated cash
position increased $211.2 million from December 31, 2002. This increase in cash
position was primarily a result of the issuance of convertible preferred stock,
cash inflows from operating activities, proceeds from the disposal of property
and the proceeds from employee stock plans. These increases were partially
offset by investments in and loans to affiliates, repayment of debt, acquisition
costs related to the NAFTA rail transaction, cash dividends paid and property
acquisitions.
Net operating cash inflows were $84.7 million and $94.0 million for the nine
months ended September 30, 2003 and 2002, respectively. The $9.3 million
decrease in operating cash flows was primarily attributable to lower net income
and changes in working capital balances, resulting mainly from the timing of
payments and receipts, partially offset by fluctuations in certain non-cash
adjustments to net income.
Net investing cash outflows were $56.4 million and $19.2 million for the nine
months ended September 30, 2003 and 2002, respectively. This $37.2 million
increase in investing cash outflows was primarily a result of the Company's
transactions with respect to Mexrail during 2003 and 2002. During the nine
months ended September 30, 2002, the Company sold its interest in Mexrail to TFM
for approximately $31.4 million, thus increasing cash flows from investing
activities. During 2003, in contemplation of the NAFTA Rail transaction, KCS
repurchased a 51% interest in Mexrail for $32.7 million. As discussed in "Recent
Developments - Mexrail Transactions", in accordance with a demand from TFM, KCS
sold its interest in Mexrail back to TFM on September 30, 2003 for $32.7
million. As a result of these two Mexrail transactions in
2003 offsetting each other, there was no impact to net investing cash outflows
for the nine months ended September 30, 2003. Therefore, the impact of the cash
received in 2002 from the sale of Mexrail resulted in higher comparable
investing cash outflows during 2003. Also impacting net investing cash outflows
for the nine months ended September 30, 2003 was approximately $6.1 million of
cost associated with the NAFTA Rail transaction that have been capitalized and
included in other investing activities. dditionally, proceeds from the sale of
property for the nine months ended September 30, 2003 were $8.9 million less
than for the same period in 2002. These factors, which led to higher net
investing cash outflows, were partially offset by a $9.7 million decline in cash
outflows for capital expenditures for the nine months ended September 30, 2003.
Net financing cash inflows for the first nine months of 2003 were $182.9 million
compared to net financing cash outflows of $64.0 million for the first nine
months of 2002. This difference was primarily due to the issuance of convertible
preferred stock of $193.2 during the second quarter of 2003 as well as net
repayments of long-term debt of $3.9 million during the first nine months of
2003 compared to net repayments of long-term debt of $64.8 million during the
first nine months of 2002. Additionally, dividends paid increased $2.4 million
period to period as a result of dividends related to the new convertible
preferred stock.
Management expects cash flows from operations to be positive throughout the
remainder of 2003 as a result of operating income, which has historically
resulted in positive operating cash flows. Investing activities could
potentially use significant amounts of cash during the remainder of 2003 for
capital expenditures and investments in affiliates pending resolution of the
dispute over the acquisition of Grupo TMM's interest in Grupo TFM, if such
resolution occurs. Future roadway improvement projects will continue to be
primarily funded by operating cash flows or, secondarily, through borrowings
under the Company's line of credit.
The Company's consolidated ratio of debt to total capitalization was 37.5% and
43.6% at September 30, 2003 and December 31, 2002, respectively. The Company's
debt decreased $3.9 million from $582.6 million at December 31, 2002 to $578.7
million at September 30, 2003 as a result of net repayments of long-term debt.
Stockholders' equity increased $213.3 million to $966.2 million at September 30,
2003, primarily due to the issuance of convertible preferred stock of $193.2
million, net income of $17.4 million and the issuance of common stock under
employee stock plans. The increase in stockholders' equity coupled with the
decrease in debt resulted in a continued decline in the debt ratio from December
31, 2002.
In addition to operating cash flows, the Company has financing available under a
senior secured revolving credit facility ("Credit Facility") with a maximum
borrowing amount of $100 million. As of September 30, 2003, all $100 million was
available under the Credit Facility. The Amended and Restated Credit Agreement
contains, among other provisions, various financial covenants. As a result of
certain financial covenants contained in the Amended and Restated Credit
Agreement, maximum utilization of the Company's Credit Facility may be
restricted.
On May 5, 2003, the Company issued $200 million of 4.25% Redeemable Cumulative
Convertible Perpetual Preferred Stock, Series C with a liquidation preference of
$500 per share in a private offering. The net proceeds from the offering of the
convertible preferred stock are expected to be used to pay a portion of the
purchase price for the proposed acquisition of a controlling interest of Grupo
TFM pending resolution of the dispute over the acquisition if such resolution
occurs. See "Recent Developments - Proposed Acquisition of Grupo TFM from Grupo
TMM" and "Recent Developments - Dispute over Acquisition Agreement." On August,
1, 2003, KCS filed a Form S-3 Registration Statement with the SEC to register
for resale by the holders the convertible preferred stock and the common stock
into which such preferred stock may be converted. On October 24, 2003, this
registration statement, as amended, was declared effective by the SEC. On
November 4, KCS filed Post-Effective Amendment No. 1 to this registration
statement which was declared effective by the SEC on November 5, 2003. On
November 12, KCS filed Post-Effective Amendment No.2 to this registration
statement which was declared effective by the SEC on November 12, 2003. KCS will
not receive any proceeds from the sale of the securities under this registration
statement. If the acquisition of the controlling interest of Grupo TFM were not
to be completed, the Company would explore alternative uses of the cash receipts
realized from the issuance of the Redeemable Cumulative Convertible Perpetual
Preferred Stock.
The Company filed a Universal Shelf Registration Statement on Form S-3 ("Initial
Shelf" - Registration No. 33-69648) in September 1993, as amended in April 1996,
for the offering of up to $500 million in aggregate amount of securities. The
SEC declared the Initial Shelf effective on April 22, 1996; however, no
securities have been issued thereunder. The Company carried forward $200 million
aggregate amount of unsold securities from the Initial Shelf to a Shelf
Registration Statement filed on Form S-3 ("Second Shelf" - Registration No.
333-61006) on May 16, 2001 for the offering of up to $450 million in aggregate
amount of securities. The SEC declared the Second Shelf effective on June 5,
2001. Securities in the aggregate amount of $300 million remain available under
the Initial Shelf and securities in the aggregate amount of $450 million
remain available under the Second Shelf. To date, no securities have been issued
under either the Initial Shelf or Second Shelf.
As discussed in the 2002 Form 10-K, if, on October 31, 2003, the Mexican
Government has not sold all of its capital stock in TFM, Grupo TFM is obligated
to purchase the capital stock at the initial share price paid by Grupo TFM,
adjusted for Mexican inflation and changes in the U.S. Dollar/Mexican Peso
exchange rate. Should Grupo TFM fail to purchase the Mexican Government's
interest following notification by the Mexican Government of its obligation to
buy, then Grupo TMM and KCS, or either Grupo TMM or KCS, could be required to
purchase their respective portion, or all, as applicable, of the Mexican
Government's interest in TFM following written notification to Grupo TMM and
KCS, or either Grupo TMM or KCS, of its or their obligation to purchase. In
addition, if the Mexican Government's interest in TFM has not been purchased
prior to the closure of the proposed NAFTA Rail transaction contemplated by the
Acquisition Agreement, KCS shall, as a condition precedent to, and
contemporaneous with, the closure of such transaction, enter into an agreement
under which KCS shall assume and discharge Grupo TMM's obligation to purchase
the Mexican Government's interest in TFM. See "Recent Developments -Dispute over
Acquisition Agreement" for a discussion of the dispute between Grupo TMM and the
Company. If KCS and Grupo TMM, or either KCS or Grupo TMM alone had been
required to purchase the Mexican Government's 20% interest in TFM, the total
purchase price would have been approximately $470 million as of September 30,
2003. Based upon public disclosures made by Grupo TMM, they are not in a
position to make this purchase. The Company is exploring various alternatives
for financing the acquisition of the Mexican Government's interest in TFM. It is
anticipated that this financing, if necessary, can be accomplished using the
Company's ability to access the capital markets. No commitments for such
financing have been obtained at this time.
Grupo TMM has announced that Grupo TFM initiated on October 16, 2003 a lawsuit
in the Mexican Federal Courts located in Mexico City seeking a declaratory
judgment as to whether or not the Mexican Government had satisfied the
conditions precedent to Grupo TFM's obligation to purchase the Mexican
Government's remaining shares of TFM. KCS is not a party to this lawsuit and it
cannot speculate as to the effect this lawsuit may have, if any, on the timing
of or ability of the Mexican Government to exercise the put of its TFM shares to
Grupo TFM, Grupo TMM or KCS. KCS has not yet been notified by the Mexican
Government of its obligation to purchase all or any portion of the TFM shares
currently held by the Mexican Government. Should KCS be required to purchase all
of the Mexican Government's TFM shares, it has the option under Mexican law and
the Shareholder Agreement between Grupo TMM and KCS to require Grupo TMM to
purchase 51% of the shares acquired by KCS.
The Company believes, based on current expectations, that its cash and other
liquid assets, operating cash flows, access to capital markets, borrowing
capacity, and other available financing resources are sufficient to fund
anticipated operating, capital and debt service requirements and other
commitments through 2003. However, the Company's operating cash flows and
financing alternatives can be impacted by various factors, some of which are
outside of the Company's control. For example, if the Company were to experience
a substantial reduction in revenues or a substantial increase in operating costs
or other liabilities, its operating cash flows could be significantly reduced.
Additionally, the Company is subject to economic factors surrounding capital
markets and the Company's ability to obtain financing under reasonable terms is
subject to market conditions. Further, the Company's cost of debt relative to
potential future debt financing transactions could be impacted by independent
rating agencies, which assign debt ratings based on certain credit measurements
such as interest coverage and leverage ratios.
OTHER
NEW ACCOUNTING PRONOUNCEMENTS. In June 2001, the FASB issued Statement No. 143,
"Accounting for Asset Retirement Obligations". SFAS 143 is effective for fiscal
years beginning after June 15, 2002. Under SFAS 143, the fair value of a
liability for an asset retirement obligation must be recognized in the period in
which it is incurred if a reasonable estimate of the fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. KCSR, along with other Class I railroads, depreciates
track structure (rail, ties, and other track material) in accordance with
regulations promulgated by the STB. These regulations require KCSR to depreciate
track structure to a net salvage value (gross estimated salvage value less
estimated costs to remove the track structure at the end of its useful life).
For certain track structure such as ties, with little or no gross salvage value,
this practice ultimately results in depreciating an asset below zero, and thus,
in effect, results in a liability. Under the requirements of SFAS 143, in the
absence of a legal obligation to remove the track structure, such accounting
practice is prohibited. The Company adopted the provisions of SFAS 143 in the
first quarter of 2003, and, as a result, reviewed its depreciation of track
structures to determine instances where the depreciation of removal costs has
resulted or would be expected (based on the
current depreciation rate)to result in the depreciation of an asset below zero
when considering net salvage value. As a result of this review, the Company
estimated the excess depreciation recorded on such assets and recorded this
amount as a reduction in accumulated depreciation of $14.5 million and as a
cumulative effect of an accounting change of $8.9 million (net of taxes of $5.6
million) as required by SFAS 143 in the first quarter of 2003. Additionally,
depreciation rates applied to certain track structure elements that were
previously yielding a negative salvage value have been modified to comply with
the provisions of SFAS 143. For the nine months ended September 30, 2003, this
resulted in a decrease in depreciation expense of approximately $1.0 million.
Management currently estimates the net effect of the adoption of SFAS 143 on
full year depreciation expense to be approximately $1.4 million.
In December 2002, the FASB issued Statement No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123" ("SFAS 148"). SFAS 148 provides two additional transition methods for
entities that adopt the method of accounting for stock-based compensation as
defined in FASB Statement No. 123. Additionally, the statement amends the
disclosure requirements of SFAS 123 to require disclosures in interim financial
statements regarding the method of accounting for stock-based employee
compensation and the effect of the method on results of operations. The Company
is currently evaluating the transitional provisions of SFAS 148 and does not
expect this pronouncement, if adopted, to have a material impact on its
consolidated results of operations, financial position, or cash flows.
In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of
Variable Interest Entities," ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to
certain variable interest entities created after January 31, 2003 as well as
certain entities created prior to this date. In October 2003, FIN 46 was amended
to allow certain organizations additional time to implement FIN 46. As a result,
the Company is not required to adopt this interpretation until the fourth
quarter of 2003. The Company has performed an initial assessment of its equity
method investment in Southern Capital as well as PCRC for any potential impact
this interpretation may have on its accounting for these entities as equity
investments. The Company does not anticipate that FIN 46 will have a material
impact on the Company's accounting for its investment in Southern Capital or
PCRC since, at inception, these entities had sufficient funding and capital to
absorb all expected losses.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
There have been no significant changes in the Company's Quantitative and
Qualitative Disclosures About Market Risk from that previously reported in the
Annual Report on Form 10-K for the year ended December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer have reviewed
and evaluated the effectiveness of the Company's disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")), as of the end of the
period covered by this Quarterly Report on Form 10-Q. Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer have concluded that the
Company's current disclosure controls and procedures are effective to ensure
that information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission rules and forms, and include controls and procedures designed to
ensure that information required to be disclosed by the Company in such reports
is accumulated and communicated to the Company's management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.
There has been no change in the Company's internal control over financial
reporting that occurred during the fiscal quarter for which this quarterly
report on Form 10-Q is filed that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Part I, Item 1. Financial Statements, note 9 and the information regarding legal
proceedings under "Dispute Over Acquisition Agreement" in note 3 to the
Consolidated Financial Statements of this Form 10-Q are hereby incorporated
herein by reference.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On May 5, 2003, the Company completed the sale of $200 million (400,000 shares)
of 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C,
with a liquidation preference of $500 per share in a private offering under Rule
144A to qualified institutional buyers. Net proceeds to the Company were $193
million after discounts to the initial purchasers of $7 million and other
expenses of the offering. Dividends on the convertible preferred stock will be
cumulative and will be payable quarterly at an annual rate of 4.25% of the
liquidation preference, when, as and if declared by the Company's board of
directors. Accumulated unpaid dividends will cumulate dividends at the same rate
as dividends cumulate on the convertible preferred stock. Each share of the
convertible preferred stock will be convertible, under certain conditions, and
subject to adjustment under certain conditions, into 33.4728 shares of the
Company's common stock. Conversion rights arise only upon the occurrence of the
following: (i) the closing sale price of the Company common stock exceeds a
specified level for a specified period; (ii) upon certain credit rating
downgrades; (iii) upon the convertible preferred stock trading below a certain
level for a specified period; (iv) upon notice of redemption; and (v) upon the
occurrence of certain corporate transactions. On or after May 20, 2008, the
Company will have the option to redeem any or all of the preferred stock,
subject to certain conditions. Under certain circumstances, at the option of the
holders of the preferred stock, the Company may be required to purchase shares
of the convertible preferred stock from the holders. The net proceeds from the
offering of the convertible preferred stock are expected to be used to pay a
portion of the purchase price for the proposed acquisition of a controlling
interest of Grupo TFM.
On August, 1, 2003, KCS filed a Form S-3 Registration Statement with the SEC to
register for resale by the holders the convertible preferred stock and the
common stock into which such preferred stock may be converted. On October 24,
2003, this Registration Statement, as amended, was declared effective by the
SEC. On November 4, KCS filed Post-Effective Amendment No. 1 to this
registration statement which was declared effective by the SEC on November 5,
2003. On November 12, KCS filed Post-Effective Amendment No.2 to this
registration statement which was declared effective by the SEC on November 12,
2003. KCS will not receive any proceeds from the sale of the securities under
this Registration Statement.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
Exhibit 32 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K
The Company furnished a Current Report on Form 8-K on July 2, 2003
announcing its second quarter 2003 meeting and conference call. The
information included in this Current Report on Form 8-K was furnished
pursuant to Item 9 and shall not be deemed to be filed.
The Company filed a Current Report on Form 8-K on July 14, 2003, under
item 5 of such form, reporting that Grupo TMM and the Company, owners
through Grupo TFM of the controlling interest in TFM, announced that on
July 9, 2003, TFM was formally notified by a three-judge panel of the
Court of the First Circuit ("Circuit Court") of its June 11, 2003
judgment, which granted TFM constitutional protection ("Amparo") against
the ruling of the Federal Tribunal of Fiscal and Administrative Justice
("Fiscal Court") issued on December 6, 2002, which had denied TFM the
right to receive the Value Added Tax refund.
The Company furnished a Current Report on Form 8-K on July 15, 2003,
announcing the rescheduled date, time and other relevant information
regarding the Company's second quarter meeting and conference call of its
financial results for the three and six months ended June 30, 2003. The
information included in this Current Report on Form 8-K was furnished
pursuant to Item 9 and shall not be deemed to be filed.
The Company furnished a Current Report on Form 8-K on July 22, 2003
announcing that the Company anticipated that its second quarter 2003
consolidated earnings would be significantly below the consensus
estimates. The information included in this Current Report on Form 8-K
was furnished pursuant to Item 9 and shall not be deemed to be filed.
In a Current Report on Form 8-K dated August 1, 2003, the Company filed
under item 5 of such form, information on its second quarter 2003
earnings and operating results and furnished under item 9 and item 12 of
such form schedules regarding certain financial information discussed at
the Company's second quarter 2003 analyst presentation and conference
call. The information furnished in this Current Report on Form 8-K
pursuant to Item 9 and Item 12 shall not be deemed to be filed.
The Company filed a Current Report on Form 8-K on August 5, 2003, under
item 5 of such form, announcing that the waiting period under the
Hart-scott-rodino Antitrust Improvements Act of 1976 for the proposed
NAFTA Rail transactions had expired without a formal request from the
Department of Justice for additional information or documentary material,
allowing KCS and TMM to consummate their transaction without any further
delays that could have resulted from requests for additional information
by the Department of Justice under U.S. antitrust laws.
The Company furnished a Current Report on Form 8-K on August 14, 2003,
announcing that Mexico's Foreign Investment Commission would release its
NAFTA Rail Decision on or before August 28, 2003. The information
included in this Current Report on Form 8-K was furnished pursuant to
Item 9 and shall not be deemed to be filed.
The Company filed a Current Report on Form 8-K on August 19, 2003, under
item 5 of such form, announcing a statement issued by the Company in
reaction to an announcement on August 18, 2003 by Grupo TMM regarding its
shareholders' decision not to approve the sale of Grupo TMM's interests
in Grupo TFM to KCS. KCS issued a statement that it intends to pursue all
appropriate legal or administrative action against any persons or
entities involved in interfering with KCS and its agreements with TMM.
The Company furnished a Current Report on Form 8-K on August 22, 2003,
setting forth information provided in exhibit 99.1. Exhibit 99.1 was sent
by Sonnenschein Nath and Rosenthal LLP, counsel for the Company, to
Milbank, Tweed, Hadley and McCoy LLP, counsel for Grupo TMM in response
to Grupo TMM's announcement on August 18, 2003 that Grupo TMM's
shareholders voted down the Acquisition Agreement. The information
included in this Current Report on Form 8-K was furnished pursuant to
Item 9 and shall not be deemed to be filed.
The Company furnished a Current Report on Form 8-K on August 29, 2003
announcing the Mexican Foreign Investment Commission decision to defer
KCS' application to acquire control of Grupo TFM and, thus, TFM, until
after the dispute is resolved between KCS and Grupo TMM over whether the
Acquisition Agreement remains in effect. The information included in this
Current Report on Form 8-K was furnished pursuant to Item 9 and shall not
be deemed to be filed.
The Company furnished a Current Report on Form 8-K on August 29, 2003
acknowledging receipt of a letter from Jose Serrano Segovia, Chairman of
Grupo TMM and of TFM, the joint-venture subsidiary between KCS and Grupo
TMM, of a demand for TFM to repurchase KCS shares of Mexrail sold to KCS
in May 2003. The information included in this Current Report on Form 8-K
was furnished pursuant to Item 9 and shall not be deemed to be filed.
The Company furnished a Current Report on Form 8-K on September 3, 2003
announcing that the Company filed in the Delaware Court of Chancery a
motion for a preliminary injunction to preserve the parties' positions
while KCS seeks to resolve its dispute over Grupo TMM's attempt to
terminate the Acquisition Agreement. The information included in this
Current Report on Form 8-K was furnished pursuant to Item 9 and shall not
be deemed to be filed.
The Company furnished a Current Report on Form 8-K on September 16, 2003
whereby the Company, reacting to a report in the Friday, September 12,
2003 EL ECONOMISTA, a Mexican business newspaper, confirmed that
negotiations with Grupo TMM had begun under the dispute resolution
process contained in the Acquisition Agreement. The information included
in this Current Report on Form 8-K was furnished pursuant to Item 9 and
shall not be deemed to be filed.
The Company furnished a Current Report on Form 8-K on September 25, 2003
announcing the Board of Directors affirmation of the Company's efforts to
pursue all legal means to enforce provisions of the Acquisition Agreement
and announcing the STB's issuance of a decision finding no need to rule
on the transfer back to TFM of the Company's 51% interest in Mexrail. The
information included in this Current Report on Form 8-K was furnished
pursuant to Item 9 and shall not be deemed to be filed.
The Company furnished a Current Report on Form 8-K on September 26, 2003
announcing the Mexican Competition Commission had extended, without
conditions, for a period of six months its prior authorization of KCS'
purchase of all of the shares of Grupo TFM controlled by Grupo TMM. The
information included in this Current Report on Form 8-K was furnished
pursuant to Item 9 and shall not be deemed to be filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized and in the capacities indicated on November 13, 2003.
Kansas City Southern
/s/Ronald G. Russ
----------------------------------------------
Ronald G. Russ
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
/s/Louis G. Van Horn
----------------------------------------------
Louis G. Van Horn
Vice President and Comptroller
(Principal Accounting Officer)