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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002
[ ] 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 Identification No.)
incorporation or organization)
427 West 12th Street, Kansas City, Missouri 64105
(Address of principal executive offices) (Zip Code)
Company's telephone number, including area code (816) 983-1303
Securities registered pursuant to Section 12 (b) of the Act:
Name of each exchange on
Title of each class which registered
- ----------------------------------------- ------------------------
Preferred Stock, Par Value $25 Per Share, New York Stock Exchange
4%, Noncumulative
Common Stock, $.01 Per Share Par Value New York Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act: None
----
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Company's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the Company is an accelerated filer (as defined
in Exchange Act Rule 12b-2)
YES [X] NO [ ]
Company Stock. The Company's common stock is listed on the New York Stock
Exchange under the symbol "KSU." As of June 30, 2002, the aggregate market value
of the voting and non-voting common and preferred stock held by non-affiliates
of the Company was approximately $1,027 million (amount computed based on
closing prices of preferred and common stock on New York Stock Exchange). As of
February 28, 2003, 61,495,992 shares of common stock and 242,170 shares of
voting preferred stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the following documents are incorporated herein by reference into
Part of the Form 10-K as indicated:
Document Part of Form 10-K into which incorporated
- ------------------------------------ -----------------------------------------
Company's Definitive Proxy Statement Parts I, III
for the 2003 Annual Meeting of
Stockholders, which will be filed no
later than 120 days after
December 31, 2002
KANSAS CITY SOUTHERN
2002 FORM 10-K ANNUAL REPORT
Table of Contents
Page
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PART I
Item 1. Business............................................................ 1
Item 2. Properties.......................................................... 14
Item 3. Legal Proceedings................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders................. 18
Executive Officers of the Company................................... 18
PART II
Item 5. Market for the Company's Common Stock and
Related Stockholder Matters....................................... 19
Item 6. Selected Financial Data............................................. 20
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations .............................. 21
Item 7A Quantitative and Qualitative Disclosures About Market Risk.......... 55
Item 8. Financial Statements and Supplementary Data......................... 58
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................... 102
PART III
Item 10. Directors and Executive Officers of the Company..................... 102
Item 11. Executive Compensation.............................................. 103
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters........................ 103
Item 13. Certain Relationships and Related Transactions...................... 103
Item 14. Controls and Procedures............................................. 103
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K........................................................ 104
Signatures.......................................................... 111
ii
Part I
Item 1. Business
(a) GENERAL DEVELOPMENT OF COMPANY BUSINESS
Kansas City Southern ("KCS" or the "Company"), a Delaware corporation, is a
holding company with principal operations in rail transportation that was
initially organized in 1962 as Kansas City Southern Industries, Inc. In 2002,
the Company formally changed its name to Kansas City Southern.
On June 14, 2000, KCS's Board of Directors approved the spin-off of Stilwell
Financial Inc. ("Stilwell"), the Company's then wholly-owned financial services
subsidiary. On July 12, 2000, KCS completed the spin-off of Stilwell through a
special dividend of Stilwell common stock distributed to KCS common stockholders
of record on June 28, 2000 ("Spin-off"). Each KCS stockholder received two
shares of the common stock of Stilwell for every one share of KCS common stock
owned on the record date. The total number of Stilwell shares distributed was
222,999,786. Under tax rulings received from the Internal Revenue Service
("IRS"), the Spin-off qualifies as a tax-free distribution under Section 355 of
the Internal Revenue Code of 1986, as amended. Also on July 12, 2000, KCS
completed a reverse stock split whereby every two shares of KCS common stock
were converted into one share of KCS common stock.
Other information set forth in response to Item 101 of Regulation S-K under Part
II Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations", of this Form 10-K is incorporated by reference in
response to this Item 1.
(b) INDUSTRY SEGMENT FINANCIAL INFORMATION
KCS, as the holding company, supplies its various subsidiaries with managerial,
legal, tax, financial and accounting services, in addition to managing other
minor "non-operating" investments. KCS's principal subsidiaries and affiliates,
which are reported under one business segment, include 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");
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").
Other subsidiaries of the Company include:
o Trans-Serve, Inc., (d/b/a Superior Tie and Timber - "ST&T"), an
owner/operator of a railroad wood tie treating facility;
o PABTEX GP, LLC ("Pabtex") located in Port Arthur, Texas with deep-water
access to the Gulf of Mexico. Pabtex is an owner of a bulk materials
handling facility that stores and transfers petroleum coke from trucks and
rail cars to ships primarily for export; and
o Transfin Insurance, Ltd., a single-parent captive insurance company,
providing property, general liability and certain other insurance coverage
to KCS and its subsidiaries and affiliates.
Effective December 31, 2002, the Company merged Mid-South Microwave, Inc.
("Mid-South Microwave") and Rice-Carden Corporation ("Rice-Carden), two
wholly-owned subsidiaries, into KCSR. Prior to the merger, Mid-South Microwave
owned and operated a 1,600-mile industrial frequency microwave transmission
system. This system is now
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owned and operated by KCSR and serves as its primary communications facility.
Prior to the merger, Rice-Carden owned and operated various industrial real
estate and spur rail tracks. This real estate, which is primarily contiguous to
the KCSR right-of-way, is now owned and operated by KCSR.
During 2002, due to the relocation of the Company's headquarters to a new
building in downtown Kansas City, Missouri, the Company sold its interests in
Wyandotte Garage Corporation, which owns and operates a parking facility located
adjacent to the Company's former headquarters building in downtown Kansas City,
Missouri.
Other information set forth in response to Item 101 of Regulation S-K under Part
II Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" of this Form 10-K and under Item 8, "Financial Statements
and Supplementary Data" of this Form 10-K, is incorporated by reference in
response to this Item 1.
(c) NARRATIVE DESCRIPTION OF THE BUSINESS
The information set forth in response to Item 101 of Regulation S-K under Part
II Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," of this Form 10-K is incorporated by reference in
response to this Item 1.
OVERVIEW
The Company, along with its subsidiaries and affiliates, owns and operates a
uniquely positioned North American rail network strategically focused on the
growing north/south freight corridor that connects key commercial and industrial
markets in the central United States with major industrial cities in Mexico. The
Company's principal subsidiary, KCSR, which was founded in 1887, is one of seven
Class I railroads in the United States. The Company's rail network (KCSR, TFM
and Tex Mex) is comprised of approximately 6,000 miles of main and branch lines.
Through a strategic alliance with Canadian National Railway Company ("CN") and
Illinois Central Corporation ("IC") (together "CN/IC"), the Company has access
to a contiguous rail network of approximately 25,000 miles of main and branch
lines connecting Canada, the United States and Mexico. Management believes that,
as a result of the strategic position of our rail network, the Company is poised
to continue to benefit from the growing north/south trade between the United
States, Mexico and Canada promoted by the North American Free Trade Agreement
("NAFTA").
The Company's rail network interconnects with all other Class I railroads and
provides shippers with an effective alternative to other railroad routes, giving
direct access to Mexico and the southeastern and southwestern United States
through less congested interchange hubs.
The Company's rail network links directly to major trading centers in Mexico
through Tex Mex and TFM. TFM operates a railroad that runs from the U.S./Mexico
border at Laredo, Texas to Mexico City and serves most of Mexico's principal
industrial cities and three of its major shipping ports. TFM also owns Mexrail,
which wholly owns Tex Mex. Tex Mex operates between Laredo and the port city of
Corpus Christi, Texas and with trackage rights connects to KCSR at Beaumont,
Texas. TFM, through its concession with the Mexican government, has the right to
control and operate the southern half of the rail-bridge at Laredo and,
indirectly through its ownership of Mexrail, owns the northern half of the
rail-bridge at Laredo, which spans the Rio Grande River between the United
States and Mexico. Our principal international gateway is at Laredo, where more
than 50% of all rail and truck traffic between the United States and Mexico
crosses the border.
KCS's rail network is further expanded through its strategic alliance with CN/IC
and marketing agreements with Norfolk Southern Railway Company ("Norfolk
Southern"), The Burlington Northern and Santa Fe Railway Company ("BNSF") and
the Iowa, Chicago & Eastern Railroad Corporation ("IC&E" - formerly I&M Rail
Link, LLC). The CN/IC alliance connects Canadian markets with major midwestern
and southern markets in the United States as well as with major markets in
Mexico through KCRS's connections with Tex Mex and TFM. Marketing agreements
with Norfolk Southern allow the Company to capitalize on its east/west route
from Meridian, Mississippi to Dallas, Texas ("Meridian
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Speedway") to gain incremental traffic volume between the southeast and the
southwest. The marketing alliance with BNSF was developed to promote
cooperation, revenue growth and extend market reach for both railroads in the
United States and Canada. It is also designed to improve operating efficiencies
for both KCSR and BNSF in key market areas, as well as provide customers with
expanded service options. KCSR's marketing agreement with IC&E provides access
to Minneapolis, Minnesota and Chicago and to originations of corn and other
grain in Iowa, Minnesota and Illinois.
The Company also owns 50% of the common stock (or a 42% equity interest) of
PCRC, which holds the concession to operate a 47-mile coast-to-coast railroad
located adjacent to the Panama Canal. The railroad handles containers in freight
service across the isthmus. Panarail, a wholly owned subsidiary of PCRC,
operates a commuter and tourist railway service over the lines of the Panama
Canal Railway. Passenger service commenced during the third quarter of 2001 and
freight service started during the fourth quarter of 2001.
RAIL NETWORK
Owned Network
KCSR owns and operates approximately 3,100 miles of main and branch lines and
1,250 miles of other tracks in a ten-state region that includes Missouri,
Kansas, Arkansas, Oklahoma, Mississippi, Alabama, Tennessee, Louisiana, Texas
and Illinois. KCSR has the shortest north/south rail route between Kansas City
and several key ports along the Gulf of Mexico in Louisiana, Mississippi and
Texas. KCSR's rail route also serves the Meridian Speedway and the east/west
route linking Kansas City with East St. Louis, Illinois and Springfield,
Illinois. In addition, KCSR has limited haulage rights between Springfield and
Chicago that allow for shipments that originate or terminate on the rail lines
of the former Gateway Western Railway Company ("Gateway Western"). These lines
also provide access to East St. Louis and allow rail traffic to avoid the St.
Louis terminal. This geographic reach enables service to a customer base that
includes electric generating utilities, which use coal, and a wide range of
companies in the chemical and petroleum, agricultural and mineral, paper and
forest, and automotive and intermodal markets.
Eastern railroads and their customers can bypass the gateways at Chicago,
Illinois; St. Louis, Missouri; Memphis, Tennessee and New Orleans, Louisiana by
interchanging with KCSR at Springfield, Illinois and East St. Louis and at
Meridian and Jackson, Mississippi. Other railroads can also interconnect with
the Company's rail network via other gateways at Kansas City, Missouri;
Birmingham, Alabama; Shreveport and New Orleans, Louisiana; and Dallas, Beaumont
and Laredo, Texas.
KCSR revenues and net income are dependent on providing reliable service to
customers at competitive rates, the general economic conditions in the
geographic region served and the ability to effectively compete against other
rail carriers and alternative modes of surface transportation, such as
over-the-road truck transportation. The ability of KCSR to construct and
maintain the roadway in order to provide safe and efficient transportation
service is important to its ongoing viability as a rail carrier. Additionally,
cost containment is important in maintaining a competitive market position,
particularly with respect to employee costs, as approximately 84% of KCSR
employees are covered under various collective bargaining agreements.
Significant Investments
Grupo TFM
In December 1995, the Company entered into a joint venture agreement with
Transportacion Maritima Mexicana, S.A. de C.V. ("TMM") to provide for
participation in the privatization of the Mexican national railway system
through Grupo TFM, and to promote the movement of rail traffic over Tex Mex, TFM
and KCSR. In 1997, the Company invested $298 million to obtain a 36.9% interest
in Grupo TFM. At the time of purchase, TMM, the largest shareholder of Grupo
TFM, owned 38.5% of Grupo TFM and the Mexican government owned the remaining
24.6%. In 2001, TMM and Grupo TMM, S.A. ("Grupo TMM" - formerly Grupo Servia
S.A. de C.V) merged with the surviving entity being Grupo TMM. In 2002, KCS and
Grupo TMM exercised their call option and, on July 29, 2002, TFM completed the
purchase of the
Page 3
Mexican government's 24.6% ownership of Grupo TFM. The $256.1 million purchase
price was funded utilizing a combination of proceeds from an offering of debt
securities by TFM, a credit from the Mexican government for the reversion of
certain rail facilities and other resources. This transaction resulted in an
increase in the Company's ownership percentage of Grupo TFM from 36.9% to
approximately 46.6%. Grupo TFM owns 80% of the common stock of TFM and all of
the shares entitled to full voting rights, while the remaining 20% of TFM is
owned by the Mexican government.
TFM holds the concession, which was awarded by the Mexican Government in 1996,
to operate Mexico's Northeast Rail Lines (the "Concession"; the "Northeast Rail
Lines are now known as "TFM") for the 50 years ending in June 2047 and, subject
to certain conditions, has an option to extend the Concession for an additional
50 years. The Concession is subject to certain mandatory trackage rights and is
exclusive until 2027. However, the Mexican government may revoke TFM's
exclusivity after 2017 if it determines that there is insufficient competition
and may terminate the Concession as a result of certain conditions or events,
including (1) TFM's failure to meet its operating and financial obligations with
regard to the Concession under applicable Mexican law, (2) a statutory
appropriation by the Mexican government for reasons of public interest and (3)
liquidation or bankruptcy of TFM. TFM's assets and its rights under the
Concession may, under certain circumstances such as natural disaster, war or
other similar situations, also be seized temporarily by the Mexican government.
Under the Concession, TFM operates a strategically significant corridor between
Mexico and the United States, and has as its core route a key portion of the
shortest, most direct rail passageways between Mexico City and Laredo, Texas.
TFM's rail lines are the only ones which serve Nuevo Laredo, the largest rail
freight exchange point between the United States and Mexico. TFM's rail lines
connect the most populated and industrialized regions of Mexico with Mexico's
principal U.S. border railway gateway at Laredo. In addition, TFM serves three
of Mexico's primary seaports at Veracruz and Tampico on the Gulf of Mexico and
Lazaro Cardenas on the Pacific Ocean. TFM serves 15 Mexican states and Mexico
City, which together represent a majority of the country's population and
account for a majority of its estimated gross domestic product. KCS management
believes the Laredo gateway is the most important interchange point for rail
freight between the United States and Mexico. As a result, TFM's routes are an
integral part of Mexico's foreign trade.
This route structure enables the Company to benefit from growing trade resulting
from the increasing integration of the North American economy through NAFTA.
Trade between Mexico and the United States has grown from 1993 through 2002.
Through Tex Mex and KCSR, as well as through interchanges with other major U.S.
railroads, TFM provides its customers with access to an extensive rail network
through which they may distribute their products throughout North America and
overseas.
TFM operates approximately 2,650 miles of main and branch lines and certain
additional sidings, spur tracks and main line tracks under trackage rights. TFM
has the right to operate the rail lines, but does not own the land, roadway or
associated structures. Approximately 81% of the main line operated by TFM
consists of continuously welded rail. As of December 31, 2002, TFM owned 468
locomotives, owned or leased from affiliates 4,558 freight cars and leased from
non-affiliates 150 locomotives and 6,800 freight cars.
On February 27, 2002, the Company, 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. Mexrail owns the northern half of the
international railway bridge at Laredo, Texas and all of the common stock of the
Tex Mex. 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 of Mexrail to reduce debt. Although the Company no
longer directly owns 49% of Mexrail, it retains an indirect ownership through
its 46.6% ownership of Grupo TFM. Under the 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 the Company's super majority rights contained in Grupo TFM's
bylaws.
Tex Mex operates a 160-mile rail line extending from Laredo to Corpus Christi.
Tex Mex connects to KCSR through trackage rights over The Union Pacific Railroad
Company ("UP") between Robbstown, Texas and Beaumont. These
Page 4
trackage rights were granted pursuant to a 1996 Surface Transportation Board
("STB") decision and have an initial term of 99 years. Tex Mex provides a vital
link between the Company's U.S. operations through KCSR and its Mexican
operations through TFM.
On March 12, 2001, Tex Mex purchased from UP a line of railroad right-of-way
extending 84.5 miles between Rosenberg, Texas and Victoria, Texas, and granted
Tex Mex trackage rights sufficient to integrate the line into the existing
trackage rights. The line is not in service and will require extensive
reconstruction, which has not yet been scheduled. The purchase price for the
line of $9.2 million was determined through arbitration and the acquisition also
required the prior approval or exemption of the transaction by the STB. By its
Order entered on December 8, 2000, the STB granted Tex Mex's Petition for
Exemption and exempted the transaction from this prior approval requirement.
Once reconstruction of the line is completed, Tex Mex will be able to shorten
its existing route between Corpus Christi and Houston, Texas by over 70 miles.
TFM, including its indirect ownership of Tex Mex, is both a strategic and
financial investment for KCS. Strategically KCSR's investment in TFM promotes
the NAFTA growth strategy whereby the Company and its strategic partners can
provide transportation services between the heart of Mexico's industrial base,
the United States and Canada. TFM seeks to establish its railroad as the primary
inland freight transporter linking Mexico with the U.S. and Canadian markets
along the NAFTA corridor. TFM's strategy is to provide reliable customer
service, capitalize on foreign trade growth and convert truck tonnage to rail.
KCS management believes TFM is an excellent long-term financial investment.
TFM's operating strategy has been to increase productivity and maximize
operating efficiencies. With Mexico's economic progress, growth of NAFTA trade
between Mexico, the United States and Canada, and customer focused rail service,
KCS management believes that the growth potential of TFM could be significant.
The term of the Grupo TFM joint venture agreement was renewed for a term of
three years on December 1, 2000 and will automatically renew for additional
terms of three years each unless either Grupo TMM or the Company gives notice of
termination at least 90 days prior to the end of the then-current term. The
joint venture agreement may also terminate under certain circumstances prior to
the end of a term, including upon a change of control or bankruptcy of either
Grupo TMM or the Company or a material default by Grupo TMM or the Company. Upon
termination of the agreement, any joint venture assets that are not held in the
name of KCS or Grupo TMM will be distributed proportionally to Grupo TMM and
KCS. The joint venture does not have any material assets and management believes
that a termination of the joint venture agreement would not have a material
adverse effect on the Company or its interest in Grupo TFM.
The shareholders agreement dated May 1997 between KCS and Grupo TMM and certain
affiliates, which governs the Company's investment in Grupo TFM (1) restricts
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) provides
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 Grupo TFM
bylaws prohibit any transfer of shares of Grupo TFM to any person other than an
affiliate of the existing shareholders without the prior consent of Grupo TFM's
board of directors. In addition, the Grupo TFM bylaws grant the shareholders of
Grupo TFM a right of first refusal to acquire shares to be transferred by any
other shareholder in proportion to the number of shares held by each
non-transferring shareholder, although holders of preferred shares or shares
with special or limited rights are only entitled to acquire those shares and not
ordinary shares. The shareholders agreement requires 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.
On or prior to October 31, 2003 the Mexican government may sell its 20% interest
in TFM through a public offering (with the consent of Grupo TFM if prior to
October 31, 2003). 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. In the
event that Grupo TFM does not purchase the Mexican government's remaining
interest in TFM, Grupo TMM and KCS, or
Page 5
either Grupo TMM or KCS, are obligated to purchase the Mexican government's
interest. KCS and Grupo TMM have cross indemnities in the event the Mexican
government requires only one of them to purchase its interest. The cross
indemnities allow the party required to purchase the Mexican government's
interest to require the other party to purchase its pro rata portion of such
interest. However, if KCS were required to purchase the Mexican government's
interest in TFM and Grupo TMM could not meet its obligations under the
cross-indemnity, then KCS would be obligated to pay the total purchase price for
the Mexican government's interest. 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 as of December 31, 2002, the total purchase price would have been
approximately $485.0 million.
Panama Canal Railway Company
In January 1998, the Republic of Panama awarded PCRC, a joint venture between
KCSR and Mi-Jack Products, Inc. ("Mi-Jack"), the concession to reconstruct and
operate the Panama Canal Railway, a 47-mile railroad located adjacent to the
Panama Canal, that provides international shippers with a railway transportation
option to complement the Panama Canal. The Panama Canal Railway, which traces
its origins back to the mid-1800's, is a north-south railroad traversing the
Panama isthmus between the Pacific and Atlantic Oceans. The railroad has been
reconstructed and it resumed freight operations on December 1, 2001. KCS
management believes the prime potential and opportunity for this railroad to be
in the movement of container traffic between the ports of Balboa and Colon for
shipping customers repositioning of such containers. The Panama Canal Railway
has significant interest from both shipping companies and port terminal
operators. In addition, there is demand for passenger traffic for both commuter
and pleasure/tourist travel. Panarail operates and promotes commuter and tourist
passenger service over the Panama Canal Railway. Passenger service started
during July 2001. While only 47 miles long, KCS management believes the Panama
Canal Railway provides the Company with a unique opportunity to participate in
transoceanic shipments as a complement to the existing Panama Canal traffic.
As of December 31, 2002, the Company has invested approximately $19.9 million
toward the reconstruction and operations of the Panama Canal Railway. This
investment is comprised of $12.9 million of equity and $7.0 million of
subordinated loans. These loans carry a 10% interest rate and are payable on
demand, subject to certain restrictions.
In November 1999, PCRC completed the financing arrangements for this project
with the International Finance Corporation ("IFC"), a member of the World Bank
Group. The financing is comprised of a $5 million investment by the IFC and
senior loans through the IFC in an aggregate amount of up to $45 million.
Additionally, PCRC has $4.2 million of equipment loans from Transamerica
Corporation and other capital leases totaling $3.8 million. The IFC's investment
of $5 million in PCRC is comprised of non-voting preferred shares which pay a
10% cumulative dividend. As of December 31, 2002, PCRC has recorded a $1.5
million liability for these cumulative preferred dividends. The preferred shares
may be redeemed at the IFC's option any year after 2008 at the lower of (1) a
net cumulative internal rate of return of 30% or (2) eight times earnings before
interest, income taxes, depreciation and amortization for the two years
preceding the redemption that is proportionate to the IFC's percentage ownership
in PCRC. Under the terms of the loan agreement with IFC, the Company is a
guarantor for up to $5.6 million of the associated debt. Also if PCRC terminates
the concession contract without the IFC's consent, the Company is a guarantor
for up to 50% of the outstanding senior loans. The Company is also a guarantor
for up to $2.1 million of the equipment loans from Transamerica Corporation and
approximately $50,000 relating to the other capital leases. The cost of the
reconstruction totaled approximately $80 million. The Company expects to loan an
additional $2 million to PCRC during 2003 under the same terms as the existing
$7.0 million subordinated loans.
Southern Capital
In 1996, KCSR and GATX Capital Corporation ("GATX") formed a 50-50 joint
venture--Southern Capital--to perform certain leasing and financing activities.
Southern Capital's operations are comprised of the acquisition of locomotives
and rolling stock and the leasing thereof to KCSR. Concurrent with the formation
of this joint venture, KCSR entered into operating leases with Southern Capital
for substantially all the locomotives and rolling stock that KCSR contributed or
sold to Southern Capital at the time of formation of the joint venture. GATX
contributed cash in the joint venture transaction formation. Southern Capital
formerly managed a portfolio of non-rail loan assets primarily in the amusement
entertainment, construction and trucking industries which it sold in April 1999
to Textron Financial Corporation, thereby leaving only the rail equipment
related assets that are leased to KCSR.
Page 6
The purpose for the formation of Southern Capital was to partner a Class I
railroad in KCSR with an industry leader in the rail equipment financing in
GATX. Southern Capital provides the Company with access to equipment financing
alternatives.
Expanded Network
Through our strategic alliance with CN/IC and marketing agreements with Norfolk
Southern, BNSF and the IC&E, the Company has expanded the domestic geographic
reach beyond that covered by its owned network.
Strategic Alliance with Canadian National and Illinois Central.
In 1998, KCSR, CN and IC announced a 15-year strategic alliance aimed at
coordinating the marketing, operations and investment elements of north-south
rail freight transportation. The strategic alliance did not require STB approval
and was effective immediately. This alliance connects Canadian markets, the
major midwest U.S. markets of Detroit, Michigan, Chicago, Kansas City and St.
Louis and the key southern markets of Memphis, Dallas and Houston. It also
provides U.S. and Canadian shippers with access to Mexico's rail system through
connections with Tex Mex and TFM.
In addition to providing access to key north-south international and domestic
U.S. traffic corridors, the alliance with CN/IC is intended to increase business
primarily in the automotive and intermodal markets, the grain market, the
chemical and petroleum market and the paper and forest products markets. This
alliance has provided opportunities for revenue growth and positioned the
Company as a key provider of rail service for NAFTA trade.
KCSR and CN formed a management group made up of senior management
representatives from both railroads to, among other things, guide the
realization of the alliance goals, and to develop plans for the construction of
new facilities to support business development, including investments in
automotive, intermodal and transload facilities at Memphis, Dallas, Kansas City
and Chicago.
Under a separate agreement, KCSR was granted certain trackage and haulage rights
and CN and IC were granted certain haulage rights. Under the terms of this
agreement, and through action taken by the STB, in October 2000 KCSR gained
access to six additional chemical customers in the Geismar, Louisiana industrial
area through haulage rights.
Marketing Agreements with Norfolk Southern.
In December 1997, KCSR entered into a three-year marketing agreement with
Norfolk Southern and Tex Mex that allows KCSR to increase its traffic volume
along the east-west corridor between Meridian and Dallas by using interchange
points with Norfolk Southern. This agreement provides Norfolk Southern
run-through service with access to Dallas and the Mexican border at Laredo while
avoiding the rail gateways of Memphis and New Orleans. This agreement was
renewed in December 2000 for a term of three years and will be automatically
renewed for additional three-year terms unless written notice of termination is
given at least 90 days prior to the expiration of the then-current term.
In May 2000, KCSR entered into an additional marketing agreement with Norfolk
Southern under which KCSR provides haulage services for intermodal traffic
between Meridian and Dallas in exchange for fees from Norfolk Southern. Under
this agreement Norfolk Southern may quote rates and enter into transportation
service contracts with shippers and receivers covering this haulage traffic.
This agreement terminates on December 31, 2006.
The May 2000 marketing agreement with Norfolk Southern provides KCSR with
additional sources of intermodal business. Under the current arrangement, trains
run between the Company's connection with Norfolk Southern at Meridian and the
BNSF connection at Dallas. The structure of the agreement provides for lower
gross revenue to KCSR, but improved operating income since, as a haulage
arrangement, locomotives, locomotive fuel and car hire expenses are the
responsibility of Norfolk Southern, not KCSR. Management believes this business
has additional growth potential as Norfolk Southern seeks to shift its traffic
to southern gateways to increase its length of haul.
Page 7
Marketing Alliance with BNSF
In April 2002, KCSR and BNSF formed a comprehensive joint marketing alliance
aimed at promoting cooperation, revenue growth and extending market reach for
both railroads in the United States and Canada. The marketing alliance is also
expected to improve operating efficiencies for both carriers in key market
areas, as well as provide customers with expanded service options. KCSR and BNSF
have agreed to coordinate marketing and operational initiatives in a number of
target markets. The marketing alliance is expected to allow the two railroads to
be more responsive to shippers' requests for rates and service throughout the
two rail networks. Coal and unit train operations are excluded from the
marketing alliance, as well as any points where KCSR and BNSF are the only
direct rail competitors. Movements to and from Mexico by either party are also
excluded. Management believes this marketing alliance will afford important
opportunities to grow KCSR's revenue base, particularly in the chemical, grain
and forest product markets, providing both participants with expanded access to
important markets and providing shippers with enhanced options and competitive
alternatives.
Marketing Agreement with IC&E.
In May 1997, KCSR entered into a marketing agreement with I&M Rail Link, now
known as IC&E. This marketing agreement provides KCSR with access to Minneapolis
and Chicago and to originations of corn and other grain in Iowa, Minnesota and
Illinois. Through this marketing agreement, KCSR receives and originates
shipments of grain products for delivery to poultry industry feed mills on its
network. Grain is currently KCSR's largest export into Mexico. This agreement is
terminable upon 90 days notice. Management believes this agreement provides IC&E
with an important channel of distribution over our rail network versus other
railroads.
Haulage Rights.
As a result of the 1988 acquisition of the Missouri-Kansas-Texas Railroad by UP,
KCSR was granted (1) haulage rights between Kansas City and each of Council
Bluffs, Iowa, Omaha and Lincoln, Nebraska and Atchison and Topeka, Kansas, and
(2) a joint rate agreement for our grain traffic between Beaumont and each of
Houston and Galveston, Texas. KCSR has the right to convert these haulage rights
to trackage rights. KCSR's haulage rights require UP to move KCSR traffic in UP
trains; trackage rights would allow KCSR to operate its trains over UP tracks.
These rights have a term of 199 years. In addition, KCSR has limited haulage
rights between Springfield and Chicago that allow for shipments that originate
or terminate on the former Gateway Western's rail lines.
Markets Served
The following table summarizes KCSR revenue and carload statistics by commodity
category. Certain prior year amounts have been reclassified to reflect changes
in the business groups and to conform to the current year presentation.
Carloads and
Revenues Intermodal Units
--------------------------------- ---------------------------------
(dollars in millions) (in thousands)
2002 2001 2000 2002 2001 2000
--------- --------- --------- --------- --------- ---------
General commodities:
Chemical and petroleum $ 130.7 $ 124.8 $ 127.1 145.4 147.8 155.9
Paper and forest 134.8 129.1 130.8 178.2 182.2 190.6
Agricultural and mineral 97.2 93.8 100.1 126.5 125.7 132.0
--------- --------- --------- --------- --------- ---------
Total general commodities 362.7 347.7 358.0 450.1 455.7 478.5
Intermodal and automotive 59.9 69.1 64.2 287.4 299.8 274.1
Coal 101.2 118.7 105.0 210.0 202.3 184.2
--------- --------- --------- --------- --------- ---------
Carload revenues and carload
and intermodal units 523.8 535.5 527.2 947.5 957.8 936.8
========= ========= =========
Other rail-related revenues 35.8 36.8 42.4
--------- --------- ---------
Total KCSR revenues $ 559.6 $ 572.3 $ 569.6
========= ========= =========
Page 8
Chemical and Petroleum
Chemical and petroleum products accounted for approximately 23.4% of KCSR
revenues in 2002. KCSR transports chemical and petroleum products via tank and
hopper cars primarily to markets in the southeast and northeast United States
through interchanges with other rail carriers. Primary traffic includes
plastics, petroleum and oils, petroleum coke, rubber, and miscellaneous
chemicals. Under the terms of the CN/IC strategic alliance, and through certain
actions taken by the STB, KCSR obtained access to six additional chemical
customers in the Geismar, Louisiana industrial corridor (one of the largest
concentrations of chemical suppliers in the world) effective October 1, 2000.
This access has resulted in additional revenue for KCSR and management believes
it could provide future competitive opportunities for revenue growth as existing
contracts with other rail carriers expire for these customers.
Paper and Forest
Paper and forest products accounted for approximately 24.1% of 2002 KCSR
revenues. The Company's rail lines run through the heart of the southeastern
U.S. timber-producing region. Management believes that forest products made from
trees in this region are generally less expensive than those from other regions
due to lower production costs. As a result, southern yellow pine products from
the southeast are increasingly being used at the expense of western producers
who have experienced capacity reductions because of public policy
considerations. KCSR serves eleven paper mills directly and six others
indirectly through short-line connections. Primary traffic includes pulp and
paper, lumber, panel products (plywood and oriented strand board), engineered
wood products, pulpwood, woodchips, raw fiber used in the production of paper,
pulp and paperboard, as well as metal, scrap and slab steel, waste and military
equipment. Slab steel products are used primarily in the manufacture of drill
pipe for the oil industry, and military equipment is shipped to and from several
military bases on the Company's rail lines.
Agricultural and Mineral
Agricultural and mineral products accounted for approximately 17.4% of KCSR
revenues in 2002. Agricultural products consist of domestic and export grain,
food and related products. Shipper demand for agricultural products is affected
by competition among sources of grain and grain products as well as price
fluctuations in international markets for key commodities. In the domestic grain
business, the Company's rail lines receive and originate shipments of grain and
grain products for delivery to feed mills serving the poultry industry. Through
the marketing agreement with IC&E, the Company's rail lines have access to
sources of corn and other grain in Iowa and other Midwestern states. KCSR
currently serves 35 feed mills along its rail lines throughout Arkansas,
Oklahoma, Texas, Louisiana, Mississippi and Alabama. Export grain shipments
include primarily wheat, soybean and corn transported to the Gulf of Mexico for
overseas destinations and to Mexico via Laredo. Over the long term, grain
shipments are expected to increase as a result of the Company's strategic
investments in Tex Mex and TFM, given Mexico's reliance on grain imports. Food
and related products consist mainly of soybean meal, grain meal, oils and canned
goods, sugar and beer. Mineral shipments consist of a variety of products
including ores, clay, stone and cement.
Intermodal and Automotive
Intermodal and automotive products accounted for approximately 10.7% of 2002
KCSR revenues. The intermodal freight business consists primarily of hauling
freight containers or truck trailers by a combination of water, rail and motor
carriers, with rail carriers serving as the link between the other modes of
transportation. The Company's intermodal business has grown significantly over
the last eight years with intermodal units increasing from 61,748 in 1993 to
274,473 in 2002 and intermodal revenues increasing from $17 million to $51
million during the same period. Through our dedicated intermodal train service
between Meridian and Dallas, the Company competes directly with truck carriers
along the Interstate 20 corridor.
The intermodal business is highly price and service driven as the trucking
industry maintains certain competitive advantages over the rail industry. Trucks
are not obligated to provide or maintain rights of way and do not have to pay
real estate taxes on their routes. In prior years, the trucking industry
diverted a substantial amount of freight from railroads as truck operators'
efficiency over long distances increased. In response to these competitive
pressures, railroad industry management sought avenues to improve the
competitiveness of rail traffic and forged numerous alliances with truck
companies in order to move more traffic by rail and provide faster, safer and
more efficient service to their customers. KCSR has entered into agreements with
several trucking companies for train service in several corridors, but those
services are concentrated between Dallas and Meridian.
Page 9
The strategic alliance with CN/IC and marketing agreements with Norfolk Southern
provide the Company the potential to further capitalize on the growth potential
of intermodal freight revenues, particularly for traffic moving between points
in the upper midwest and Canada to Kansas City, Dallas and Mexico. Furthermore,
the Company is developing the former Richards-Gebaur Airbase in Kansas City as a
U.S. customs pre-clearance processing facility, the Kansas City International
Freight Gateway ("IFG"), which, when at full capacity, is expected to handle and
process large volumes of domestic and international intermodal freight. Through
an agreement with Mazda through the Ford Motor Company Claycomo manufacturing
facility located in Kansas City, KCSR has developed an automotive loading and
distribution facility at IFG. This loading and distribution facility became
operational in April 2000 for the movement of Mazda vehicles. Management
believes that, as additional opportunities arise, the IFG facility will be
expanded to include additional automotive and intermodal operations.
The Company's automotive traffic consists primarily of vehicle parts moving into
Mexico from the northern sections of the United States and finished vehicles
moving from Mexico into the United States. CN/IC, Norfolk Southern and TFM have
a significant number of automotive production facilities on their rail lines.
The Company's rail network essentially serves as the connecting bridge carrier
for these movements of automotive parts and finished vehicles.
Coal
Coal historically has been one of the most stable sources of revenues and is the
largest single commodity handled by KCSR. In 2002, coal revenues represented
18.1% of total KCSR revenues. Substantially all coal customers are under long
term contracts, which typically have an average contract term of approximately
five years. KCSR's most significant customer is Southwestern Electric Power
Company ("SWEPCO"- a subsidiary of American Electric Power, Inc.), which is
under contract through 2006. The Company, directly or indirectly, delivers coal
to eight electric generating plants, including the Flint Creek, Arkansas and
Welsh, Texas facilities of SWEPCO, Kansas City Power and Light plants in Kansas
City and Amsterdam, Missouri, an Empire District Electric Company plant near
Joplin, Missouri and an Entergy Gulf States plant in Mossville, Louisiana. The
coal KCSR transports originates in the Powder River Basin in Wyoming and is
transferred to KCSR's rail lines at Kansas City. KCSR serves as a bridge carrier
for coal deliveries to a Texas Utilities electric generating plant in Martin
Lake, Texas. In addition, KCSR delivers lignite to an electric generating plant
at Monticello, Texas. SWEPCO comprised approximately 63.9% of KCSR total coal
revenues and 11.4% of KCS consolidated revenues in 2002. Coal revenue declined
approximately 15% in 2002 compared to 2001 as a result of a contractual rate
reduction, which took effect on January 1, 2002, as well as the expiration in
April 2002 of a contract that was not renewed for another coal customer.
Other
Other rail-related revenues include a variety of miscellaneous services provided
to customers and interconnecting carriers and accounted for approximately 6.4%
of total KCSR revenues in 2002. Major items in this category include railcar
switching services, demurrage (car retention penalties) and drayage (local truck
transportation services). This category also includes haulage services performed
for the benefit of BNSF under an agreement that continues through 2004 and
includes minimum volume commitments.
Railroad Industry
Overview
U.S. railroad companies are categorized by the STB into three types: Class I,
(railroads with annual revenues of at least $250 million, as indexed for
inflation) Class II (Regional) and Class III (Local). There currently are seven
Class I railroads in the United States, which can be further divided
geographically by eastern or western classification. The eastern railroads are
CSX Corporation ("CSX"), Grand Trunk Corporation (which is owned by CN and
includes IC and Wisconsin Central Transportation Corporation - "Wisconsin
Central")) and Norfolk Southern. The western railroads include BNSF, KCSR, Soo
Line Railroad Company (owned by Canadian Pacific Railway Company ("CP")) and UP.
The STB and Regulation
The STB, an independent body administratively housed within the Department of
Transportation, is responsible for the economic regulation of railroads within
the United States. The STB's mission is to ensure that competitive, efficient
and
Page 10
safe transportation services are provided to meet the needs of shippers,
receivers and consumers. The STB was created by an Act of Congress known as the
ICC Termination Act of 1995 ("ICCTA"). Passage of the ICCTA represented a
further step in the process of streamlining and reforming the Federal economic
regulatory oversight of the railroad, trucking and bus industries that was
initiated in the late 1970's and early 1980's. The STB is authorized to have
three members, each with a five-year term of office. The STB Chairman is
designated by the President of the United States from among the STB's members.
The STB adjudicates disputes and regulates interstate surface transportation.
Railway transportation matters under the STB's jurisdiction in general include
railroad rate and service issues, rail restructuring transactions (mergers, line
sales, line construction and line abandonment) and railroad labor matters.
The U.S. railroad industry was significantly deregulated with the passage of The
Staggers Rail Act of 1980 (the "Staggers Act"). In enacting the Staggers Act,
Congress recognized that railroads faced intense competition from trucks and
other modes of transportation for most freight traffic and that prevailing
regulation prevented them from earning adequate revenues and competing
effectively. Through the Staggers Act, a new regulatory scheme allowing
railroads to establish their own routes, tailor their rates to market conditions
and differentiate rates on the basis of demand was put in place. The basic
principle of the Staggers Act was that reasonable rail rates should be a
function of supply and demand. The Staggers Act, among others things:
o allows railroads to price competing routes and services differently to
reflect relative demand;
o allows railroads to enter into confidential rate and service contracts
with shippers; and
o abolishes collective rate making except among railroads participating
in a joint-line movement.
If it is determined that a railroad is not facing enough competition to hold
down prices, then the STB has the authority to investigate the actions of the
railroad.
The Staggers Act has had a positive effect on the U.S. rail industry,
competition, and savings to consumers. Lower rail rates brought about by the
Staggers Act have resulted in significant cost savings for shippers and their
customers. After decades of steady decline, the rail market share of inter-city
freight ton-miles bottomed out at 35.2% in 1978 and has trended slowly upward
since then, reaching 41.0% in 2000 and 41.7% in 2001.
Recent Events in Railroad Consolidation
On June 11, 2001, the STB issued new rules governing major railroad mergers and
consolidations involving two or more "Class I" railroads. These rules
substantially increase the burden on rail merger applicants to demonstrate that
a proposed transaction would be in the public interest. The rules require
applicants to demonstrate that, among other things, a proposed transaction would
enhance competition where necessary to offset negative effects of the
transaction, such as competitive harm, and to address fully the impact of the
transaction on transportation service.
The STB recognized, however, that a merger between KCSR and another Class I
carrier would not necessarily raise the same concerns and risks as potential
mergers between larger Class I railroads. Accordingly, the STB decided that for
a merger proposal involving KCSR and another Class I railroad, the STB will
waive the application of the new rules and apply the rules previously in effect
unless it is persuaded that the new rules should apply.
Competition
The Company's rail operations compete against other railroads, many of which are
much larger and have significantly greater financial and other resources. Since
1994, there has been significant consolidation among major North American rail
carriers, including the 1995 merger of Burlington Northern, Inc. and Santa Fe
Pacific Corporation ("BN/SF", collectively "BNSF"), the 1995 merger of the UP
and the Chicago and North Western Transportation Company ("UP/CNW") and the 1996
merger of UP with Southern Pacific Corporation ("SP"). Further, Norfolk Southern
and CSX purchased the assets of Conrail in 1998 and the CN acquired the IC in
June 1999. In October 2001, CN completed its acquisition of Wisconsin Central
Transportation Corporation. As a result of this consolidation, the railroad
industry is now dominated by a few "mega-carriers." KCS management believes that
revenues were negatively affected by the UP/CNW, UP/SP and BN/SF mergers, which
led to diversions of rail traffic away from KCSR's rail lines. Management
Page 11
regards the larger western railroads (BNSF and UP), in particular, as
significant competitors to the Company's operations and prospects because of
their substantial resources. The ongoing impact of these mergers is uncertain.
KCS management believes, however, that because of the Company's investments and
strategic alliances, it is positioned to attract additional rail traffic through
our NAFTA rail network.
The Company is subject to competition from motor carriers, barge lines, and
other maritime shipping, which compete across certain routes in our operating
area. Truck carriers have eroded the railroad industry's share of total
transportation revenues. Changing regulations, subsidized highway improvement
programs and favorable labor regulations have improved the competitive position
of trucks in the United States as an alternative mode of surface transportation
for many commodities. In the United States, the trucking industry generally is
more cost and transit-time competitive than railroads for short-haul distances.
In addition, Mississippi and Missouri River barge traffic, among others, compete
with KCSR and its rail connections in the transportation of bulk commodities
such as grains, steel and petroleum products. Intermodal traffic and certain
other traffic face highly price sensitive competition, particularly from motor
carriers. However, rail carriers, including KCSR, have placed an emphasis on
competing in the intermodal marketplace and working together with motor carriers
and each other to provide end-to-end transportation of products.
While deregulation of freight rates has enhanced the ability of railroads to
compete with each other and with alternative modes of transportation, this
increased competition has resulted in downward pressure on freight rates.
Competition with other railroads and other modes of transportation is generally
based on the rates charged, the quality and reliability of the service provided
and the quality of the carrier's equipment for certain commodities.
Employees and Labor Relations
Labor relations in the U.S. railroad industry are subject to extensive
governmental regulation under the Railway Labor Act ("RLA"). Under the RLA,
national labor agreements are renegotiated when they become open for
modification, but their terms remain in effect until new agreements are reached.
Typically, neither management nor labor employees are permitted to take economic
action until extended procedures are exhausted. Existing national union
contracts with the railroads became amendable at the end of 1999. Included in
the contracts was a provision for wages to increase automatically in the year
following the contract term. These federal labor regulations are often more
burdensome and expensive than regulations governing other industries and may
place KCS at a competitive disadvantage relative to other non-rail industries,
such as trucking competitors, which are not subject to these regulations.
Railroad industry personnel are covered by the Railroad Retirement Act ("RRA")
instead of the Social Security Act. Employer contributions under the RRA are
currently substantially higher than those under the Social Security Act and may
rise further because of the increasing proportion of retired employees receiving
benefits relative to the number of working employees. The RRA currently requires
up to a 21.85% contribution by railroad employers on eligible wages while the
Social Security and Medicare Acts only require a 7.65% employer contribution on
similar wage bases. Railroad industry personnel are also covered by the Federal
Employers' Liability Act ("FELA") rather than state workers' compensation
systems. FELA is a fault-based system with compensation for injuries settled by
negotiation and litigation, which can be expensive and time-consuming. By
contrast, most other industries are covered by state administered no-fault plans
with standard compensation schedules. The difference in the labor regulations
for the rail industry compared to the non-rail industries illustrates the
competitive disadvantage placed upon the rail industry by federal labor
regulations.
Approximately 84% of KCSR employees are covered under various collective
bargaining agreements. Periodically, the collective bargaining agreements with
the various unions become eligible for re-negotiation. In 1996, national labor
contracts governing KCSR were negotiated with all major railroad unions,
including the United Transportation Union ("UTU"), the Brotherhood of Locomotive
Engineers ("BLE"), the Transportation Communications International Union
("TCU"), the Brotherhood of Maintenance of Way Employees ("BMWE"), and the
International Association of Machinists and Aerospace Workers. In August 2002, a
new labor contract was reached with the UTU. The provisions of this agreement
include the use of remote control locomotives in and around terminals and
retroactive application of wage increases back to July 1, 2002. Also, a new
labor contract has been reached with the TCU. It is anticipated that this
agreement will be signed during the first quarter of 2003. A new labor contract
was reached with the BMWE effective
Page 12
May 31, 2001. Formal negotiations to enter into new agreements are in progress
with the other unions and the 1996 labor contracts will remain in effect until
new agreements are reached. The wage increase elements of these new agreements
may have retroactive application. Management has reached new agreements with all
but one of the unions relating to the former Gateway Western. Gateway Western
was merged into KCSR on October 1, 2001. Similarly, management has reached new
agreements with all but one of the unions relating to the former MidSouth
Railroad ("MidSouth") employees (MidSouth was merged into KCSR on January 1,
1994). Discussions with these unions are ongoing. The provisions of the various
labor agreements generally include periodic general wage increases, lump-sum
payments to workers and greater work rule flexibility, among other provisions.
Management does not expect that the negotiations or the resulting labor
agreements will have a material impact on our consolidated results of
operations, financial condition or cash flows.
Railroad Retirement Improvement Act
On December 21, 2001, the Railroad Retirement and Survivors' Improvement Act of
2001 ("RRIA") was signed into law. This legislation liberalizes early retirement
benefits for employees with 30 years of service by reducing the full benefit age
from 62 to 60, eliminates a cap on monthly retirement and disability benefits,
lowers the minimum service requirement from 10 years to 5 years of service, and
provides for increased benefits for surviving spouses. It also provides for the
investment of railroad retirement funds in non-governmental assets, adjustments
in the payroll tax rates paid by employees and employers, and the repeal of a
supplemental annuity work-hour tax. The law also reduced the employer
contribution for payroll taxes by 0.5% in 2002 and by an additional 1.4% in
2003. Beginning in 2004, the employer contribution will be based on a formula
and could range between 8.2% and 22.1%. These reductions in the employer
contributions under the RRA are expected to have a favorable impact on fringe
benefits expenses in 2003. Additionally, the reduction in the retirement age
from 62 to 60 is expected to result in increased employee attrition, leading to
additional potential cost savings since it is not anticipated that all employees
selecting early retirement will be replaced.
Insurance
KCS maintains multiple insurance programs for its various subsidiaries including
rail liability and property, general liability, directors and officers'
coverage, workers compensation coverage and various specialized coverage for
specific entities as needed. Coverage for KCSR is by far the most significant
part of the KCS program. It includes liability coverage up to $250 million,
subject to a $3 million deductible ($10 million for incidents occurring on or
after July 1, 2002) and certain aggregate limitations, and property coverage up
to $200 million subject to a $2 million deductible and certain aggregate
limitations. We believe that our insurance program is in line with industry
norms given the size of the Company and provides adequate coverage for potential
losses.
Employees
As of December 31, 2002, the approximate number of employees of KCS and its
consolidated subsidiaries was as follows:
KCSR 2,653
All other combined 54
----------
Total 2,707
==========
Available Information
The Company's Internet address is www.kcsi.com. Through this website, KCS makes
available, free of charge, its Annual Reports on Form 10-K, Quarterly Reports on
Form 10-Q and Current Reports on Form 8-K, and amendments to those reports, as
soon as reasonably practicable after electronic filing or furnishing of these
reports with the Securities and Exchange Commission.
Page 13
Item 2. Properties
The information set forth in response to Item 102 of Regulation S-K under Item
1, "Business", of this Form 10-K and Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations", is incorporated by
reference in response to this Item 2.
In the opinion of management, the various facilities, office space and other
properties owned and/or leased by the Company and its subsidiaries are adequate
for current operating needs.
KCSR
Certain KCSR property statistics follow:
2002 2001 2000
--------- --------- ---------
Route miles - main and branch line 3,109 3,103 3,103
Total track miles 4,359 4,444 4,444
Miles of welded rail in service 2,261 2,197 2,157
Main line welded rail (%) 61% 59% 59%
Cross ties replaced 232,993 233,489 355,444
Average Age (in years): 2002 2001 2000
----------------------- --------- --------- ---------
Wood ties in service 16.0 16.0 15.2
Rail in main and branch line 29.9 28.9 29.5
Road locomotives 24.6 23.6 22.9
All locomotives 25.6 24.5 23.8
KCSR's fleet of locomotives and rolling stock consisted of the following at
December 31:
2002 2001 2000
Leased Owned Leased Owned Leased Owned
-------- -------- -------- -------- -------- --------
Locomotives:
Road Units 302 122 304 122 324 122
Switch Units 52 4 52 4 55 9
Other -- 8 -- 8 -- 8
-------- -------- -------- -------- -------- --------
Total 354 134 356 134 379 139
======== ======== ======== ======== ======== ========
Rolling Stock:
Box Cars 5,358 1,366 6,164 1,420 5,951 2,020
Gondolas 760 74 780 88 842 95
Hopper Cars 2,614 966 2,002 1,179 2,217 1,285
Flat Cars (Intermodal
And Other) 1,599 541 1,585 601 1,584 616
Tank Cars 42 40 44 43 46 55
Auto Rack 201 -- 201 -- 201 --
-------- -------- -------- -------- -------- --------
Total 10,574 2,987 10,776 3,331 10,841 4,071
======== ======== ======== ======== ======== ========
As of December 31, 2002, KCSR's fleet consisted of 488 diesel locomotives, of
which 134 were owned, 333 leased from Southern Capital and 21 leased from
non-affiliates. KCSR's fleet of rolling stock consisted of 13,561 freight cars,
of which 2,963 were owned, 3,387 leased from Southern Capital and 7,211 leased
from non-affiliates. The locomotives and freight cars leased from Southern
Capital secure pass through certificates issued by Southern Capital during 2002.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Recent Developments - Debt Refinancing - Southern
Capital."
Page 14
The owned equipment is subject to liens created under our senior secured credit
facilities, as well as liens created under certain conditional sales agreements,
capital leases, and equipment trust certificates. KCSR indebtedness with respect
to equipment trust certificates and capital leases totaled approximately $26.0
million at December 31, 2002.
KCSR, in support of its transportation operations, owns and operates repair
shops, depots and office buildings along its right-of-way. A major facility, the
Deramus Yard, is located in Shreveport, Louisiana and includes a general office
building, locomotive repair shop, car repair shops, customer service center,
material warehouses and fueling facilities totaling approximately 227,000 square
feet. KCSR owns a 107,800 square foot facility in Pittsburg, Kansas that
previously was used as a diesel locomotive repair facility. This facility was
closed during 1999 and is now being leased to an engineering and manufacturing
company. KCSR also owns freight warehousing and office facilities in Dallas,
Texas totaling approximately 150,000 square feet. Other facilities owned by KCSR
include a 21,000 square foot freight car repair shop in Kansas City, Missouri
and approximately 15,000 square feet of office space in Baton Rouge, Louisiana.
KCSR also has the support of a locomotive repair facility in Kansas City,
Missouri. This facility is owned and operated by General Electric Company ("GE")
to repair and maintain 50 AC 4400 locomotives manufactured by GE. These
locomotives are leased by KCSR from Southern Capital.
In June 2001, the Company entered into a 17-year lease agreement for a new
corporate headquarters building in downtown Kansas City, Missouri. In April
2002, the Company moved its corporate offices into this building. The Company's
corporate offices had previously been located in another building in downtown
Kansas City, Missouri, which was leased from a subsidiary of the Company until
the building was sold in June 2001.
KCSR owns six intermodal facilities and has contracted with third parties to
operate these facilities. These facilities are located in Dallas; Kansas City;
Shreveport and New Orleans, Louisiana; Jackson, Mississippi and Salisaw,
Oklahoma. The Company has constructed an automobile facility and has plans to
construct an intermodal facility at the former Richards-Gebaur Airbase in Kansas
City, Missouri. A portion of the automotive facility became operational in April
2000 for the storage and movement of automobiles. Intermodal and automotive
operations at the facility may be further expanded in the future as business
opportunities arise. The Company is also expanding the intermodal facilities in
Kansas City, Dallas and Shreveport. The various intermodal facilities include
strip tracks, cranes and other equipment used in facilitating the transfer and
movement of trailers and containers. KCSR also has six bulk transload facilities
located at Kansas City, Missouri; Spiro, Oklahoma; Jackson, Mississippi; Dallas
Texas; Sauget, Illinois and Baton Rouge, Louisiana. Due to growth in transload
traffic, KCSR expanded its facility in Spiro during the fourth quarter of 2002,
and plans to expand the facility in Jackson during the first half of 2003. The
sixth transload facility was opened in Baton Rouge, Louisiana in early 2003. A
second Dallas transload facility was expected to open during 2002, however, due
to lower than expected traffic as a result of the continued slowdown in the
North American economy, opening of this facility has been postponed pending
development of additional traffic. Transload operations consist of rail/truck
shipments whereby the products shipped are unloaded from the trailer, container
or rail car and reloaded onto the other mode of transportation. Transload is
similar to intermodal, except that intermodal shipments transfer the entire
container or trailer and transload shipments transfer only the product being
shipped.
KCSR owns 16.6% of the Kansas City Terminal Railway Company, which owns and
operates approximately 80 miles of track, and operates an additional eight miles
of track under trackage rights in greater Kansas City, Missouri. KCSR also
leases for operating purposes certain short sections of trackage owned by
various other railroad companies and jointly owns certain other facilities with
these railroads.
Systems and Technology
Management Control System
On July 14, 2002, the Company initiated a conversion from its legacy system
operating platform to a Management Control System ("MCS") on KCSR. The Company
had previously implemented a pilot version of MCS on the former Gateway Western
(which was merged into KCSR effective October 1, 2001) in the first quarter of
2000. In anticipation of the conversion to MCS, significant resources were
committed to the planning and training of personnel. However, upon
implementation of MCS, personnel responsible for train operations experienced
initial difficulties implementing the
Page 15
new system as they learned to respond to the data discipline demanded by the new
system. As a result, KCSR experienced considerable congestion throughout its
U.S. rail network with escalated freight car volumes in its major terminals and
less efficient train movements. Although management believes that the issues
related to the implementation of MCS largely were resolved prior to the end of
2002, the initial difficulties experienced by operating personnel in converting
to the new platform led to the congestion issues and operating inefficiencies
during the second half of 2002, which contributed to a decline in consolidated
operating income. See Item 7, "Management's Discussion of Financial Condition
and Results of Operations - Results of Operations" for a discussion of the
impact on operations. MCS includes the following elements:
o a new waybill system;
o a new transportation system;
o a work queue management infrastructure;
o a service scheduling system; and
o EDI interfaces to the new systems.
MCS is designed to deliver work orders to yard and train crews to ensure that
the service being provided reflects what was sold to the customer. The system
also tracks individual shipments as they move across the rail system, compares
that movement to the service sold to the customer and automatically reports the
shipment's status to the customer and to operations management. If a shipment
falls behind schedule, MCS automatically generates alerts and action
recommendations so that corrective action promptly can be initiated.
MCS provides better analytical tools for management to use in its
decision-making process. MCS provides more accurate and timely information on,
among other things, terminal dwell time, car velocity through terminals and
priority of switching to meet schedules. A data warehouse provides an improved
decision support infrastructure. By making decisions based upon that
information, management is working to improve service quality and the
utilization of locomotives, rolling stock, crews, yards, and line of road and
thereby reduce cycle times and costs. With the implementation of MCS service
scheduling, personnel are striving to improve customer service through improved
advanced planning and real-time decision support. With the design of all new
business processes around workflow technology, management intends to more
effectively follow key operating statistics to measure productivity and improve
performance across the entire operation.
As KCSR continues to become more accustomed to using MCS, management expects
that clerical and information technology group efficiencies will also continue
to improve. Management believes that information technology and other support
groups will be able to reduce maintenance costs, increase their flexibility to
respond to new requests and improve productivity. By using a layered design
approach, MCS is expected to have the ability to extend to new technology as it
becomes available. MCS can be further modified to connect customers with
additional applications via the Internet and is intended to be constructed to
support multiple railroads, permit modifications to accommodate the local
language requirements of the area and operate across multiple time zones. A
later enhancement of MCS is expected to also include revenue and car accounting
systems. Additionally, MCS is expected to be implemented on Tex Mex later this
year and on TFM next year.
Train Dispatching System
KCSR is currently operating on two types of train dispatching systems, Direct
Train Control ("DTC") and Centralized Traffic Control ("CTC"). DTC uses direct
radio communication between dispatchers and engineers to coordinate train
movement. DTC is used on approximately 65% of KCSR's track, including the track
from Shreveport to Meridian and Shreveport to New Orleans. CTC controls switches
and signals in the field from the dispatcher's desk top via microwave link. CTC
is used on approximately 35% of KCSR's track, including the track from Kansas
City to Beaumont and Shreveport to Dallas. CTC is normally utilized on heavy
traffic areas. Each dispatcher has an assigned territory displayed on
high-resolution monitors driven by a mini-mainframe in Shreveport with a remote
station in Beaumont. KCSR implemented a new dispatching computer system in May
1999, which has enhanced the overall efficiency of train movements on the
railroad system.
Page 16
Grupo TFM
TFM operates approximately 2,650 miles of main and branch lines and certain
additional sidings, spur tracks and main line under trackage rights. TFM has the
right to operate the rail lines, but does not own the land, roadway or
associated structures. Approximately 81% of the main line operated by TFM
consists of continuously welded rail. As of December 31, 2002, TFM owned 468
locomotives, owned or leased from affiliates 4,558 freight cars and leased from
non-affiliates 150 locomotives and 6,800 freight cars. Grupo TFM (through TFM)
has office space at which various operational, administrative, managerial and
other activities are performed. The primary facilities are located in Mexico
City and Monterrey, Mexico. TFM leases 94,915 square feet of office space in
Mexico City and holds, under the Concession, a 115,157 square foot facility in
Monterrey. On February 27, 2002, the Company, Grupo TMM, and certain of Grupo
TMM's affiliates entered into an agreement with TFM to sell to TFM all of the
common stock of Mexrail. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Recent Developments - Sale of
Mexrail, Inc. to TFM" for further discussion.
Panama Canal Railway Company
PCRC, a joint venture in which the Company owns 50% of the common stock (or a
42% equity interest), holds the concession to operate a 47-mile railroad that
runs parallel to the Panama Canal. Reconstruction of the railroad was completed
during 2001 and both passenger and freight traffic commenced during 2001. PCRC
leases four locomotives and owns two locomotives. PCRC also owns 12 double stack
cars, 6 passenger cars and various other infrastructure improvements and
equipment. Under the concession, PCRC constructed and operates operating
intermodal terminal facilities at each end of its railroad and an approximate
15,000 square foot equipment maintenance facility. All of this property and
equipment is subject to liens securing PCRC debt as further described in Item 1,
"Narrative Description of the Business - Rail Network - Significant Investments
- - Panama Canal Railway Company."
Other
The Company owns 1,025 acres of property located on the waterfront in the Port
Arthur, Texas area, which includes 22,000 linear feet of deep-water frontage and
three docks. Port Arthur is an uncongested port with direct access to the Gulf
of Mexico. Approximately 75% of this property is available for development.
Trans-Serve, Inc. operates a railroad wood tie treating plant in Vivian,
Louisiana under an industrial revenue bond lease arrangement with an option to
purchase. This facility includes buildings totaling approximately 12,000 square
feet.
Pabtex GP LLP owns a 70-acre bulk commodity handling facility in Port Arthur,
Texas.
Mid-South Microwave was merged into KCSR effective December 31, 2002. Prior to
the merger, Mid-South Microwave, Inc. owned and operated a microwave system,
which extended essentially along the right-of-way of KCSR from Kansas City to
Dallas, Beaumont and Port Arthur, Texas and New Orleans, Louisiana. This system
is now owned by KCSR.
Other subsidiaries of the Company own approximately 5,500 acres of land at
various points adjacent to the KCSR right-of-way. Other properties owned include
a 354,000 square foot warehouse at Shreveport, Louisiana and several former
railway buildings now being rented to non-affiliated companies, primarily as
warehouse space.
Item 3. Legal Proceedings
The information set forth in response to Item 103 of Regulation S-K under Part
II Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Other - Litigation, - Other - Environmental Matters and
- -Significant Developments - Houston Cases" of this Form 10-K is incorporated by
reference in response to this Item 3. In addition, see discussion in Part II
Item 8, "Financial Statements and Supplementary Data - Note 11 - Commitments and
Contingencies" of this Form 10-K.
Page 17
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the three-month
period ended December 31, 2002.
Executive Officers of the Company
Pursuant to General Instruction G(3) of Form 10-K and instruction 3 to paragraph
(b) of Item 401 of Regulation S-K, the following list is included as an
unnumbered Item in Part I of this Form 10-K in lieu of being included in KCS's
Definitive Proxy Statement which will be filed no later than 120 days after
December 31, 2002. All executive officers are elected annually and serve at the
discretion of the Board of Directors. All of the executive officers have
employment agreements with the Company.
Name Age Position(s)
- ---- --- -----------
Michael R. Haverty 58 Chairman of the Board, President and Chief
Executive Officer
Gerald K. Davies 58 Executive Vice President and Chief Operating
Officer
Ronald G. Russ 48 Executive Vice President and Chief Financial
Officer
Jerry W. Heavin 51 Senior Vice President - Operations of KCSR
Larry O. Stevenson 39 Senior Vice President - Sales and Marketing of
KCSR
Warren K. Erdman 44 Vice President - Corporate Affairs
Paul J. Weyandt 50 Vice President and Treasurer
Louis G. Van Horn 44 Vice President and Comptroller
Jay M. Nadlman 42 Associate General Counsel and Corporate
Secretary
The information set forth in the Company's Definitive Proxy Statement in the
description of Nominees for Directors to Serve Until the Annual Meeting of
Stockholders in 2006 in Proposal 1 with respect to Mr. Haverty is incorporated
herein by reference.
Gerald K. Davies has served as Executive Vice President and Chief Operating
Officer of KCS since July 18, 2000. Mr. Davies joined KCSR in January 1999 as
the Executive Vice President and Chief Operating Officer. Mr. Davies has served
as a director of KCSR since November 1999. Prior to joining KCSR, Mr. Davies
served as the Executive Vice President of Marketing with Canadian National
Railway from 1993 through 1998. Mr. Davies held senior management positions with
Burlington Northern Railway from 1976 to 1984 and 1991 to 1993, respectively,
and with CSX Transportation from 1984 to 1991.
Ronald G. Russ has served as Executive Vice President and Chief Financial
Officer since January 16, 2003. Mr. Russ served as Senior Vice President and
Chief Financial Officer from July 1, 2002 to January 15, 2003. Mr. Russ served
as Executive Vice President and Chief Financial Officer of Wisconsin Central
from 1999 to 2002. He served as Treasurer of Wisconsin Central from 1987 to
1993. From 1993 to 1999 he was executive manager and chief financial officer for
Tranz Rail Holdings Limited, an affiliate of Wisconsin Central in Wellington,
New Zealand. He also served in various capacities with Soo Line Railroad and The
Chicago, Milwaukee, St. Paul and Pacific Railroad Company, spanning a 25-year
career in the railroad industry.
Jerry W. Heavin has served as Senior Vice President of Operations and a director
of KCSR since July 9, 2002. Mr. Heavin joined KCSR on September 1, 2001 and
served as Vice President of Engineering of KCSR until July 8, 2002. Prior to
joining KCSR, Mr. Heavin served as an independent engineering consultant from
1997 through August 2001. Mr. Heavin began his railroad career in 1970 with UP,
serving in various capacities, including general superintendent transportation
and chief engineer of facilities.
Larry O. Stevenson has served as Senior Vice President of Marketing and Sales of
KCSR since January 1, 2003. Mr. Stevenson served as Vice President - Paper and
Forest Products of KCSR from September 1, 2000 to December 31, 2002 and General
Director Customer Service of KCSR from February 14, 2000 to August 31, 2000.
Prior to joining
Page 18
KCSR, Mr. Stevenson served in various capacities at Canadian National Railway
from June 1983 to December 1999, most recently as Assistant Vice President of
Sales.
Warren K. Erdman has served as Vice President--Corporate Affairs of KCS since
April 15, 1997 and as Vice President--Corporate Affairs of KCSR since May 1997.
Prior to joining KCS, Mr. Erdman served as Chief of Staff to United States
Senator Kit Bond of Missouri from 1987 to 1997.
Paul J. Weyandt has served as Vice and President and Treasurer of KCS and of
KCSR since September 2001. Before joining KCS, Mr. Weyandt was a consultant to
the Structured Finance Group of GE Capital Corporation from May 2001 to
September 2001. Prior to consulting, Mr. Weyandt spent 23 years with BNSF, most
recently as Assistant Vice President - Finance and Assistant Treasurer.
Louis G. Van Horn has served as Vice President and Comptroller of KCS since May
1996. Mr. Van Horn has also served as Vice President and Comptroller of KCSR
since 1995. Mr. Van Horn was Comptroller of KCS from September 1992 to May 1996.
From January 1992 to September 1992, Mr. Van Horn served as Assistant
Comptroller of KCS. Mr. Van Horn is a Certified Public Accountant.
Jay M. Nadlman has served as Associate General Counsel and Corporate Secretary
of KCS since April 1, 2001. Mr. Nadlman joined KCS in December 1991 as a General
Attorney, and was promoted to Assistant General Counsel in 1997, serving in that
capacity until April 1, 2001. Mr. Nadlman has served as Associate General
Counsel and Secretary of KCSR since May 3, 2001 and as Assistant General Counsel
and Assistant Secretary from August 1997 to May 3, 2001. Prior to joining KCS,
Mr. Nadlman served as an attorney with Union Pacific Railroad Company from 1985
to 1991.
There are no arrangements or understandings between the executive officers and
any other person pursuant to which the executive officer was or is to be
selected as an officer of KCS, except with respect to the executive officers who
have entered into employment agreements, which agreements designate the
position(s) to be held by the executive officer.
None of the above officers are related to one another by family.
Part II
Item 5. Market for the Company's Common Stock and Related Stockholder
Matters
The information set forth in response to Item 201 of Regulation S-K on the cover
(page i) under the heading "Company Stock," and in Part II Item 8, "Financial
Statements and Supplementary Data, at Note 13 - Quarterly Financial Data
(Unaudited)" of this Form 10-K is incorporated by reference in response to this
Item 5.
On July 12, 2000, KCS completed its spin-off of Stilwell through a special
dividend of Stilwell common stock distributed to KCS common stockholders of
record on June 28, 2000 ("Spin-off"). The Spin-off occurred after the close of
business of the New York Stock Exchange on July 12, 2000, and each KCS
stockholder received two shares of the common stock of Stilwell for every one
share of KCS common stock owned on the record date. The total number of Stilwell
shares distributed was 222,999,786. Also on July 12, 2000, KCS completed a
reverse stock split whereby every two shares of KCS common stock were converted
into one share of KCS common stock. The Company's stockholders approved a
one-for-two reverse stock split in 1998 in contemplation of the Spin-off. The
total number of KCS shares outstanding immediately following this reverse split
was 55,749,947.
The Company has not declared any cash dividends on its common stock during the
last two fiscal years and does not anticipate making any cash dividend payments
to common stockholders in the foreseeable future. Pursuant to the Company's
amended and restated credit agreement as further described in Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Recent Developments - Debt Refinancing - New Credit Agreement," the
Company is restricted from the payment of cash dividends on the Company's common
stock.
Page 19
During 2002 and 2000, certain debt securities were issued by KCSR pursuant to
Rule 144A under the Securities Act of 1933 in the United States and Regulation S
outside of the United States. These notes are guaranteed by the Company and were
ultimately exchanged for registered notes. See Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Recent
Developments - Debt Refinancing - 7 1/2% Senior Notes and - Significant
Developments - 2000 Debt Refinancing and Re-capitalization of the Company's Debt
Structure - Registration of Senior Unsecured Notes" for further discussion.
As of February 28, 2003, there were 5,674 holders of the Company's common stock
based upon an accumulation of the registered stockholder listing.
Item 6. Selected Financial Data (dollars in millions, except per share
and ratio data)
The selected financial data below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included under Item 7 of this Form 10-K and the consolidated
financial statements and the related notes thereto, and the Reports of
Independent Accountants thereon, included under Item 8, "Financial Statements
and Supplementary Data" of this Form 10-K and such data is qualified by
reference thereto. All years reflect the 1-for-2 reverse common stock split to
shareholders of record on June 28, 2000 paid July 12, 2000.
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Revenues $ 566.2 $ 583.2 $ 578.7 $ 609.0 $ 620.0
Equity in net earnings (losses)
from unconsolidated affiliates -
continuing operations $ 43.4 $ 27.1 $ 22.1 $ 5.2 $ (2.9)
Income from continuing operations (i) $ 57.2 $ 31.1(ii) $ 16.7 $ 10.2 $ 38.0
Income from continuing
operations per common share:
Basic $ 0.94 $ 0.53 $ 0.29 $ 0.18 $ 0.69
Diluted 0.91 0.51 0.28 0.17 0.67
Total assets (iii) $ 2,008.8 $ 2,010.9 $ 1,944.5 $ 2,672.0 $ 2,337.0
Total debt $ 582.6 $ 658.4 $ 674.6 $ 760.9 $ 836.3
Cash dividends per
Common share $ -- $ -- $ -- $ 0.32 $ 0.32
Ratio of earnings to fixed charges (iv) 1.3x 1.1x 1.0x 1.2x 1.9x
(i) Income from continuing operations for the years ended December 31, 2002,
2001 and 2000 include certain unusual costs and expenses and other income
as further described in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - "Results of Operations."
These costs include MCS implementation related costs, benefits received
from the settlement of certain legal and insurance claims, severance
costs and expenses associated with legal verdicts against the Company,
gains recorded on the sale of operating property, among others. Other
non-operating income includes gains recorded on sale of non-operating
properties and investments. For the year ended December 31, 1999, income
from continuing operations includes unusual costs and expenses related to
facility and project closures, employee separations Separation related
costs, labor and personal injury related issues.
(ii) Income from continuing operations for the year ended December 31, 2001
excludes a charge for the cumulative effect of an accounting change of
$0.4 million (net of income taxes of $0.2 million). This charge reflects
the Company's adoption of Statement of Financial Accounting Standard No.
133, "Accounting for Derivative Instruments and Hedging Activities"
effective January 1, 2001.
(iii) The total assets presented herein as of December 31, 1999 and 1998
include the net assets of Stilwell of $814.6 million and $540.2 million
respectively. Due to the Spin-off on July 12, 2000, the total assets as
of December 31, 2002, 2001 and 2000 do not include the net assets of
Stilwell.
Page 20
(iv) The ratio of earnings to fixed charges is computed by dividing earnings
by fixed charges. For this purpose "earnings" represent the sum of (i)
pretax income from continuing operations adjusted for income (loss) from
unconsolidated affiliates, (ii) fixed charges, (iii) distributed income
from unconsolidated affiliated and (iv) amortization of capitalized
interest, less capitalized interest. "Fixed charges" represent the sum of
(i) interest expensed, (ii) capitalized interest, (iii) amortization of
deferred debt issuance costs and (iv) one-third of our annual rental
expense, which management believes is representative of the interest
component of rental expense.
The information set forth in response to Item 301 of Regulation S-K under Part
II Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations", of this Form 10-K is incorporated by reference in
partial response to this Item 6.
Item 7. 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-K,
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-K. 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 ("SEC") (File
No.1-4717) and is hereby incorporated by reference herein. Readers are strongly
encouraged to consider these factors when evaluating any forward-looking
comments. The Company will not update any forward-looking comments set forth in
this Form 10-K.
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 8 of this Form 10-K. This discussion
should be read in conjunction with these consolidated financial statements, the
related notes and the Reports of Independent Accountants thereon, and is
qualified by reference thereto.
General
Kansas City Southern ("KCS" or the "Company") is a Delaware corporation. KCS,
formerly Kansas City Southern Industries, Inc., is a holding company and its
principal subsidiaries and affiliates include 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");
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").
During 2002, due to the relocation of the Company's headquarters to a new
building in downtown Kansas City, Missouri, the Company sold its interest in
Wyandotte Garage Corporation ("WGC"), which owns and operates a parking facility
located adjacent to the Company's former headquarters building in downtown
Kansas City, Missouri.
KCS, as the holding company, supplies its various subsidiaries with managerial,
legal, tax, financial and accounting services, in addition to managing other
"non-operating" investments.
Page 21
Effective October 1, 2001, the Gateway Western Railway Company ("Gateway
Western") was merged into KCSR. Discussions of KCSR in this Form 10-K include
the operations and operating results of Gateway Western.
All per share information included in this Item 7 is presented on a diluted
basis unless specifically identified otherwise.
RECENT DEVELOPMENTS
The following items reflect significant developments, events or transactions
that have occurred during the year ended December 31, 2002 or in 2003 prior to
the Company's filing of this Form 10-K.
Value Added Tax ("VAT") Lawsuit. As previously announced in the Company's
Current Report on Form 8-K dated October 11, 2002, a three judge panel of the
Court of the First Circuit ("Appellate Court") in Mexico City unanimously ruled
in favor of TFM, finding that the decision issued by the Superior Court of the
Federal Tribunal of Fiscal and Administrative Justice ("Fiscal Court") denying
TFM's VAT claim had violated TFM's constitutional rights. The Appellate Court,
in its decision, remanded the case back to the Fiscal Court with specific
instructions to vacate its prior decision and enter a new decision consistent
with the guidance provided by the Appellate Court's ruling. The Appellate Court
ruling requires the fiscal authorities to issue the VAT credit certificate only
in the name of the interested party, to issue the VAT credit certificate only in
strict accordance with the terms of the fiscal code, and to deliver the VAT
credit certificate only to the beneficiary.
As previously announced in the Company's Current Report on Form 8-K dated
December 9, 2002, the Fiscal Court once again has issued a ruling denying TFM's
VAT claim. TFM has filed in 2003 a timely constitutional appeal from the Fiscal
Court's decision with the Appellate Court. Based on the advice of TFM's legal
counsel, the Company and Grupo TMM remain confident of TFM's right under Mexican
law to receive the VAT credit certificate. The face value of the VAT credit at
issue is approximately $206 million. TFM's VAT claim dates from 1997. The amount
of any recovery would, in accordance with Mexican law, reflect the face value of
the VAT credit adjusted for inflation and interest accruals from 1997, with
certain limitations.
Automobile Accident. On January 28, 2003, a passenger car carrying a driver and
four passengers near Batchelor, Louisiana struck a KCSR section truck carrying
two employees. All five occupants of the passenger car were pronounced dead at
the scene while the two KCSR employees suffered minor injuries. The driver of
the KCSR truck has been charged with five counts of negligent homicide.
Investigation of the incident is still in its early stages and KCSR has not been
served with any litigation regarding this incident. KCSR believes that it has
insurance coverage for all but its $100,000 deductible in potential damages
arising from this incident.
Purchase of Mexican government's ownership of Grupo TFM. KCS and Grupo TMM
exercised their call option and, on July 29, 2002, completed the purchase of the
Mexican government's 24.6% ownership of Grupo TFM. The Mexican government's
ownership interest of Grupo TFM was purchased by TFM for a purchase price of
$256.1 million, utilizing a combination of proceeds from an offering of debt
securities by TFM, a credit from the Mexican government for the reversion of
certain rail facilities and other resources. This transaction results in an
increase in the Company's ownership percentage of Grupo TFM from 36.9% to
approximately 46.6%.
Debt Refinancing. During 2002, the Company was party to several debt refinancing
transactions as described below.
7 1/2% Senior Notes
On June 12, 2002, KCSR issued $200 million of 7 1/2% senior notes due June 15,
2009 ("7 1/2% Notes") through a private offering pursuant to Rule 144A under the
Securities Act of 1933 in the United States and Regulation S outside the United
States ("Note Offering"). Net proceeds from the Note Offering of $195.8 million,
together with cash, were used to repay a portion of the term debt under the
Company's senior secured credit facility ("KCS Credit Facility") and certain
other secured indebtedness of the Company. Debt issuance costs related to the
Note Offering of approximately $4.6 million were deferred and are being
amortized over the seven-year term of the 7 1/2% Notes. The remaining balance of
deferred debt issuance costs associated with the Note Offering was approximately
$4.2 million at December 31, 2002. Debt retirement costs associated with the
prepayment of certain term loans under the KCS Credit Facility using proceeds
from
Page 22
the Note Offering were approximately $4.3 million. These debt retirement costs
were previously reported as an extraordinary item, but have been reclassified in
accordance with Statement of Financial Accounting Standards No. 145, "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" ("SFAS 145"), which the Company early adopted in the
fourth quarter of 2002.
KCS submitted a Form S-4 Registration Statement to the SEC on July 12, 2002, as
amended on July 24, 2002, relative to an Exchange Offer for the $200 million 7
1/2% Notes due 2009. On July 30, 2002, the SEC declared this Registration
Statement effective thereby providing the opportunity for holders of the initial
7 1/2% Notes to exchange them for registered notes with substantially identical
terms. All of the 7 1/2% Notes due 2009 were exchanged for $200 million of
registered notes due June 15, 2009. The registered notes bear a fixed annual
interest rate to be paid semi-annually on June 15 and December 15 and are due
June 15, 2009. The registered notes are general unsecured obligations of KCSR,
are guaranteed by the Company and certain of its subsidiaries, and contain
certain covenants and restrictions customary for this type of debt instrument
and for borrowers with similar credit ratings.
New Credit Agreement
On June 12, 2002, in conjunction with the repayment of certain of the term loans
under the KCS Credit Facility using the net proceeds received from the Note
Offering, the Company amended and restated the KCS Credit Facility (the amended
and restated credit agreement is referred to as the New Credit Agreement
herein). The New Credit Agreement provides KCSR with a $150 million term loan
("Tranche B term loan"), which matures on June 12, 2008, and a $100 million
revolving credit facility ("Revolver"), which matures on January 11, 2006.
Letters of credit are also available under the Revolver up to a limit of $15
million. The proceeds from future borrowings under the Revolver may be used for
working capital and for general corporate purposes. The letters of credit may be
used for general corporate purposes. Borrowings under the New Credit Agreement
are secured by substantially all of the Company's assets and are guaranteed by
the majority of its subsidiaries.
The Tranche B term loan and the Revolver bear interest at the London Interbank
Offered Rate ("LIBOR"), or an alternate base rate, as the Company shall select,
plus an applicable margin. The applicable margin for the Tranche B term loan is
2% for LIBOR borrowings and 1% for alternate base rate borrowings. The
applicable margin for the Revolver is based on the Company's leverage ratio
(defined as the ratio of the Company's total debt to consolidated EBITDA
(earnings before interest, taxes, depreciation and amortization, excluding the
undistributed earnings of unconsolidated affiliates) for the prior four fiscal
quarters). Based on the Company's leverage ratio as of December 31, 2002, the
applicable margin was 2.25% per annum for LIBOR borrowings and 1.25% per annum
for alternate base rate borrowings.
The New Credit Agreement also requires the payment to the lenders of a
commitment fee of 0.50% per annum on the average daily, unused amount of the
Revolver. Additionally, a fee equal to a per annum rate of 0.25% plus the
applicable margin for LIBOR priced borrowings under the Revolver will be paid on
any letter of credit issued under the Revolver.
The New Credit Agreement contains certain provisions, covenants and restrictions
customary for this type of debt and for borrowers with a similar credit rating.
These provisions include, among others, restrictions on the Company's ability
and its subsidiaries ability to 1) incur additional debt or liens; 2) enter into
sale and leaseback transactions; 3) merge or consolidate with another entity; 4)
sell assets; 5) enter into certain transactions with affiliates; 6) make
investments, loans, advances, guarantees or acquisitions; 7) make certain
restricted payments, including dividends, or make certain payments on other
indebtedness; and 8) make capital expenditures. In addition, the Company is
required to comply with certain financial ratios, including minimum interest
expense coverage and leverage ratios. The New Credit Agreement also contains
certain customary events of default. These covenants, along with other
provisions, could restrict maximum utilization of the Revolver.
Debt issuance costs related to the New Credit Agreement of approximately $1.1
million were deferred and are being amortized over the respective term of the
loans. The remaining balance of deferred debt issuance costs associated with the
New Credit Agreement was approximately $1.0 million at December 31, 2002.
Page 23
Southern Capital
On June 25, 2002, Southern Capital refinanced the outstanding balance of its
one-year bridge loan through the issuance of approximately $167.6 million of
pass through trust certificates and the sale of 50 locomotives. The pass through
trust certificates are secured by the sold locomotives, all of the remaining
locomotives and rolling stock owned by Southern Capital and rental payments
payable by KCSR under the sublease of the sold locomotives and its leases of the
equipment owned by Southern Capital. Payments of interest and principal of the
pass through trust certificates, which are due semi-annually on June 30 and
December 30 commencing on December 30, 2002 and ending on June 30, 2022, are
insured under a financial guarantee insurance policy by MBIA Insurance
Corporation. KCSR leases or subleases all of the equipment securing the pass
through trust certificates.
Implementation of New Management Control System. On July 14, 2002, the Company
initiated the transition from its legacy operating system to a new platform
called the Management Control System ("MCS") on KCSR. This state-of-the-art
system is designed to provide better analytical tools for management to use in
its decision-making processes. MCS, among other things, delivers work orders to
yard and train crews to ensure that the service being provided reflects what was
sold to the customer. The system also tracks individual shipments as they move
across the rail system, compares that movement to the service sold to the
customer and automatically reports the shipment's status to the customer and to
operations management. If a shipment falls behind schedule, MCS automatically
generates alerts and action recommendations so that corrective action promptly
can be initiated. The Company's depreciation expense is expected to increase by
approximately $4.8 million per annum ($2.4 million in 2002) as a result of the
implementation of MCS.
As previously announced, in the second half of 2002, the Company's operating
results were impacted by higher operating costs and some temporary traffic
diversions caused by congestion directly related to the implementation of MCS.
The MCS implementation slowed the railroad as employees learned to respond to
the data discipline demanded by this new system. The initial difficulties
experienced by office and field personnel in transitioning to this new platform
led to the congestion issues and operating inefficiencies, which contributed to
a decline in consolidated operating income. By mid-November 2002, however, the
Company's operations began to experience improved transit times and terminal
activities as MCS capabilities began to be fully integrated into KCS management
processes and operations were virtually recovered by year end. See Results of
Operations below for a discussion of the impact on 2002 results of operations.
Sale of Mexrail, Inc. to TFM. The Company, Grupo TMM, and certain of Grupo TMM's
affiliates entered into an agreement on February 27, 2002 with TFM to sell to
TFM all of the common stock of Mexrail. Mexrail owns the northern half of the
international railway bridge at Laredo, Texas and all of the common stock of the
Tex Mex. 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 of Mexrail to reduce debt. Although the Company no
longer directly owns 49% of Mexrail, it retains an indirect ownership through
its ownership of Grupo TFM. 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 of excess proceeds
was deferred and is being amortized over 20 years.
Company Changes Name to Kansas City Southern. On May 2, 2002, at the Annual
Meeting of Stockholders, the shareholders of the Company approved a proposal to
amend the Certificate of Incorporation to change the name of the Company from
"Kansas City Southern Industries, Inc." to "Kansas City Southern." The name
change became effective on May 2, 2002 following the filing of the amended
Certificate of Incorporation with the Secretary of State of the State of
Delaware. The name change reflects the change in the Company's business and
holdings following the spin-off of Stilwell Financial Inc. on July 12, 2000. By
dropping "Industries, Inc." from the name, KCS will maintain the identification
in the marketplace of the Company and KCSR, while emphasizing KCS's focus on
transportation rather than a variety of industries. The name change did not
require a change in the security ticker symbol of KSU on the New York Stock
Exchange.
Page 24
Changes to Mexican Tax Law. Effective January 1, 2002, Mexico implemented
changes in its income tax laws. One of these changes reduced the Mexican
corporate income tax rate from 35% to 32% in one-percent increments beginning in
2003, resulting in a 32% income tax rate in 2005. Accordingly, under accounting
principles generally accepted in the United States of America ("U.S. GAAP"),
Grupo TFM recorded the impact of this rate change during 2002. This rate change
had the effect of reducing Grupo TFM's deferred tax asset, thus reducing Grupo
TFM's deferred tax benefit for 2002. After consideration of minority interest,
the impact of this rate change resulted in an approximate $2.8 million decline
in the Company's equity in earnings of Grupo TFM for 2002.
KCSR and The Burlington Northern and Santa Fe Railway Company ("BNSF") Form
Marketing Alliance. In April 2002, KCSR and BNSF formed a comprehensive joint
marketing alliance aimed at promoting cooperation, revenue growth and extending
market reach for both railroads in the United States and Canada. The marketing
alliance is also expected to improve operating efficiencies for both carriers in
key market areas, as well as provide customers with expanded service options.
KCSR and BNSF have agreed to coordinate marketing and operational initiatives in
a number of target markets. The marketing alliance is expected to allow the two
railroads to be more responsive to shippers' requests for rates and service
throughout the two rail networks. Coal and unit train operations are excluded
from the marketing alliance, as well as any points where KCSR and BNSF are the
only direct rail competitors. Movements to and from Mexico by either party are
also excluded. Management believes this marketing alliance will provide
important opportunities to grow KCSR's revenue base, particularly in the
intermodal, chemical, grain and forest product markets, providing both
participants with expanded access to important markets and providing shippers
with enhanced options and competitive alternatives.
SIGNIFICANT DEVELOPMENTS
Bogalusa Cases.. In July 1996, KCSR was named as one of twenty-seven defendants
in various lawsuits in Louisiana and Mississippi arising from the explosion of a
rail car loaded with chemicals in Bogalusa, Louisiana on October 23, 1995. As a
result of the explosion, nitrogen dioxide and oxides of nitrogen were released
into the atmosphere over parts of that town and the surrounding area allegedly
causing evacuations and injuries. Approximately 25,000 residents of Louisiana
and Mississippi (plaintiffs) have asserted claims to recover damages allegedly
caused by exposure to the released chemicals. On October 29, 2001, KCSR and
representatives for its excess insurance carriers negotiated a settlement in
principle with the plaintiffs for $22.3 million. A Master Global Settlement
Agreement ("MGSA") was signed in early 2002. During 2002, KCSR made all payments
under the MGSA and collected $19.3 million from its excess insurance carriers.
Court approval of the MGSA is expected in 2003 from the 22nd Judicial District
Court of Washington Parish, Louisiana. KCSR also expects to receive releases
from about 4,000 Mississippi plaintiffs in numerous cases pending in the First
Judicial District Circuit Court of Hinds County, Mississippi.
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, and legal counsel for the remaining plaintiffs (approximately
120) has withdrawn, leaving the status of those claims in doubt.
Railroad Retirement Improvement Act. On December 21, 2001, the Railroad
Retirement and Survivors' Improvement Act of 2001 ("RRIA") was signed into law.
This legislation liberalizes early retirement benefits for employees with 30
years of service by reducing the full benefit age from 62 to 60, eliminates a
cap on monthly retirement and disability benefits, lowers the minimum service
requirement from 10 years to 5 years of service, and provides for increased
benefits for surviving spouses. It also provides for the investment of railroad
retirement funds in non-governmental assets,
Page 25
adjustments in the payroll tax rates paid by employees and employers, and the
repeal of a supplemental annuity work-hour tax. The law also reduced the
employer contribution for payroll taxes by 0.5% in 2002 and by an additional
1.4% in 2003. Beginning in 2004, the employer contribution will be based on a
formula and could range between 8.2% and 22.1%. The reductions in the employer
contribution under RRIA had a favorable impact on fringe benefits expense in
2002 and are expected to have a favorable impact in 2003. Additionally, the
reduction in the retirement age from 62 to 60 is expected to result in increased
employee attrition, leading to additional potential cost savings since it is not
anticipated that all employees selecting early retirement will be replaced.
Shelf Registration Statements and Public Securities Offerings. 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 has 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.
Revision of Rules Governing Major Railroad Mergers and Consolidations. On June
11, 2001, the Surface Transportation Board ("STB") issued new rules governing
major railroad mergers and consolidations involving two or more "Class I"
railroads. These rules substantially increase the burden on rail merger
applicants to demonstrate that a proposed transaction would be in the public
interest. The rules require applicants to demonstrate that, among other things,
a proposed transaction would enhance competition where necessary to offset
negative effects of the transaction, such as competitive harm, and to address
fully the impact of the transaction on transportation service.
The STB recognized, however, that a merger between KCSR and another Class I
carrier would not necessarily raise the same concerns and risks as potential
mergers between larger Class I railroads. Accordingly, the STB decided that for
a merger proposal involving KCSR and another Class I railroad, the STB will
waive the application of the new rules and apply the rules previously in effect
unless it is persuaded that the new rules should apply.
New Corporate Headquarters. On June 26, 2001, the Company entered into a 17-year
lease agreement for a new corporate headquarters building in downtown Kansas
City, Missouri. The Company began occupancy of the building in April 2002.
Additionally, in June 2001, the Company sold the building that formerly served
as its corporate headquarters in Kansas City, Missouri in anticipation of
occupying this new facility. The Company realized a net gain of approximately
$0.9 million from this sale. Further, in 2002, the Company completed the sale of
WGC to a third party for a gain of approximately $4.9 million. As part of the
sale of WGC, the Company was able to eliminate approximately $4.9 million of
debt.
Cost Reduction Plan. During the first quarter of 2001, KCS announced a cost
reduction strategy designed to keep the Company competitive during the current
economic slow-down. The cost reduction strategy resulted in a reduction of
approximately 5% of the Company's total workforce (excluding train and engine
personnel). Additionally, KCS implemented a voluntary, temporary salary
reduction for middle and senior management and temporarily suspended certain
management benefits. This voluntary, temporary salary reduction ended December
31, 2001. As part of the cost reduction plan, the Company also delayed the
implementation of MCS until July 2002, as outlined above in "Recent Developments
- - Implementation of New Management Control System." Further, 2001 planned
capital expenditures were reduced by approximately $16 million. These capital
reductions did not affect the planned maintenance for the physical structure of
the railroad, but limited the amount of discretionary expenditures for projects
such as capacity improvements. During the first quarter of 2001, the Company
recorded approximately $1.3 million of costs related to severance benefits
associated with the workforce reduction.
Implementation of Derivative Standard. In June 1998, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). SFAS 133 was amended by Statement of Accounting Standards No. 137,
"Accounting for Derivative
Page 26
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133" and Statement of Financial Accounting Standards No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities,
an amendment of SFAS 133." SFAS 133, as amended, requires that derivatives be
recorded on the balance sheet as either assets or liabilities measured at fair
value. Changes in the fair value of derivatives are recorded either through
current earnings or as other comprehensive income, depending on the type of
hedge transaction. Gains and losses on the derivative instrument reported in
other comprehensive income are reclassified into earnings in the periods in
which earnings are impacted by the variability of the cash flow of the hedged
item. The ineffective portion of all hedge transactions is recognized in current
period earnings.
The Company adopted the provisions of SFAS 133, as amended, effective January 1,
2001. As a result of this change in the method of accounting for derivative
instruments and hedging activities, the Company recorded an after-tax charge to
earnings of $0.4 million in the first quarter of 2001. This charge is presented
as a cumulative effect of an accounting change in the accompanying financial
statements and represents the ineffective portion of certain interest rate cap
agreements the Company had as of December 31, 2000. The Company recorded an
additional $0.4 million charge during the year ended December 31, 2001 for
subsequent changes in the fair value of its interest rate hedging instruments.
These interest rate cap agreements had a fair value of approximately zero at
December 31, 2001 and were completely charged off during 2001. These agreements
expired during the first quarter of 2002. During the year ended December 31,
2002, the Company did not record any adjustments to income for derivative
transactions. The Company does not currently have any interest rate derivative
transactions outstanding and currently has two diesel fuel swap transactions
outstanding related to 2003. See Item 7A, "Quantitative and Qualitative
Disclosures About Market Risk" for further information with respect to these
fuel swap transactions.
In addition, the Company records adjustments to its stockholders' equity
(accumulated other comprehensive income (loss)) for its portion of the
adjustment to the fair value of derivative transactions to which Southern
Capital, a 50% owned unconsolidated affiliate, is a participant. The Company
also adjusts its investment in Southern Capital by the change in the fair value
of these derivative instruments. For the years ended December 31, 2002 and 2001,
the Company recorded a reduction to its stockholders equity (accumulated other
comprehensive loss) of approximately $0.3 million and $2.9 million,
respectively, for its portion of the amount recorded by Southern Capital for the
adjustment to the fair value of interest rate swap transactions. The Company
also reduced its investment in Southern Capital by this same amount.
In conjunction with the refinancing transaction discussed above in "Recent
Developments - Debt Refinancing," Southern Capital terminated these interest
rate swap transactions. As a result, Southern Capital is amortizing the balance
of accumulated other comprehensive income (loss) into interest expense over the
former remaining life of the interest rate swap transactions. This charge
resulted in additional interest expense of approximately $1.3 million in 2002
and is expected to increase Southern Capital's interest expense by approximately
$2.4 million in 2003 and $0.9 million in each of 2004, 2005 and 2006. The
Company is realizing the impact of this charge through a related reduction in
equity in earnings from Southern Capital and is amortizing its balance in
accumulated other comprehensive income (loss) to its investment in Southern
Capital.
Spin-off of Stilwell Financial Inc. On June 14, 2000, KCS's Board of Directors
approved the spin-off of Stilwell. On July 12, 2000, KCS completed the spin-off
of Stilwell through a special dividend of Stilwell common stock distributed to
KCS common stockholders of record on June 28, 2000 ("Spin-off"). Each KCS
stockholder received two shares of the common stock of Stilwell for every one
share of KCS common stock owned on the record date. The total number of Stilwell
shares distributed was 222,999,786. Under tax rulings received from the Internal
Revenue Service ("IRS"), the Spin-off qualifies as a tax-free distribution under
Section 355 of the Internal Revenue Code of 1986, as amended. Also on July 12,
2000, KCS completed a reverse stock split whereby every two shares of KCS common
stock were converted into one share of KCS common stock. The Company's
stockholders approved a one-for-two reverse stock split in 1998 in contemplation
of the Spin-off. The total number of KCS shares outstanding immediately
following this reverse split was 55,749,947. In preparation for the Spin-off,
the Company re-capitalized its debt structure on January 11, 2000 as further
described in "2000 Debt Refinancing and Re-capitalization of the Company's Debt
Structure" below. Additionally, the Company does not have any remaining
contingencies with respect to Change in Ownership provisions contained within
certain restriction agreements between Stilwell and certain Janus Capital
Corporation minority
Page 27
stockholders. Previously, the Company would have been obligated to make payments
under certain of these agreements if Stilwell had been unable to meet its
obligations under the agreements. These minority shareholder agreements have
been superceded by new agreements and the Company is no longer a party to any of
these agreements.
Duncan Case Settlement. In 1998, a jury in Beauregard Parish, Louisiana returned
a verdict against KCSR in the amount of $16.3 million. This case arose from a
railroad crossing accident that occurred at Oretta, Louisiana on September 11,
1994, in which three individuals were injured. Of the three, one was injured
fatally, one was rendered quadriplegic and the third suffered less serious
injuries. Subsequent to the verdict, the trial court held that the plaintiffs
were entitled to interest on the judgment from the date the suit was filed,
dismissed the verdict against one defendant and reallocated the amount of that
verdict to the remaining defendants. On November 3, 1999, the Third Circuit
Court of Appeals in Louisiana affirmed the judgment. Subsequently KCSR obtained
review of the case in the Supreme Court of Louisiana. On October 30, 2000, the
Supreme Court of Louisiana entered its order affirming in part and reversing in
part the judgment. The net effect of the Louisiana Supreme Court action was to
reduce the allocation of negligence to KCSR and reduce the judgment, with
interest, against KCSR from approximately $28 million to approximately $14.2
million (approximately $9.7 million of damages and $4.5 million of interest).
This judgment was in excess of KCSR's insurance coverage of $10 million for this
case. KCSR filed an application for rehearing in the Supreme Court of Louisiana,
which was denied on January 5, 2001. KCSR then sought a stay of judgment in the
Louisiana court. The Louisiana court denied the stay application on January 12,
2001. KCSR reached an agreement as to the payment structure of the judgment in
this case and payment of the settlement was made on March 7, 2001.
KCSR had previously recorded a liability of approximately $3.0 million for this
case. Based on the Supreme Court of Louisiana's decision, as of December 31,
2000, management recorded an additional liability of $11.2 million and also
recorded a receivable in the amount of $7.0 million representing the amount of
the insurance coverage. This resulted in recording $4.2 million of net operating
expense in the accompanying consolidated financial statements for the year ended
December 31, 2000. The final installment on the $7.0 million receivable from the
insurance company was received by KCSR in June 2001.
2000 Debt Refinancing and Re-capitalization of the Company's Debt Structure.
Registration of Senior Unsecured Notes. During the third quarter of 2000, the
Company completed a $200 million private offering of debt securities through its
wholly-owned subsidiary, KCSR. The offering, completed pursuant to Rule 144A
under the Securities Act of 1933 in the United States and Regulation S outside
the United States, consisted of 8-year senior unsecured notes ("9 1/2% Notes").
Net proceeds from this offering of $196.5 million were used to refinance term
debt and reduce commitments under the KCS Credit Facility. The refinanced debt
was scheduled to mature on January 11, 2001 (see below). Costs related to the
issuance of the 9 1/2% Notes were deferred and are being amortized over their
eight-year term. The remaining balance of deferred debt issuance costs
associated with the 9 1/2% Notes was approximately $3.3 million at December 31,
2002.
On January 25, 2001, the Company filed a Form S-4 Registration Statement with
the SEC registering exchange notes under the Securities Act of 1933. The Company
filed Amendment No. 1 to this Registration Statement and the SEC declared this
Registration Statement, as amended, effective on March 15, 2001, thereby
providing the opportunity for holders of the initial 9 1/2% Notes to exchange
them for registered notes with substantially identical terms. All of the 9 1/2%
Notes were exchanged for $200 million of registered notes. These registered
notes bear a fixed annual interest rate and are due on October 1, 2008. These
registered notes are general unsecured obligations of KCSR, are guaranteed by
the Company and certain of its subsidiaries, and contain certain covenants and
restrictions customary for this type of debt instrument and for borrowers with
similar credit ratings.
Re-capitalization of Debt Structure in anticipation of Spin-off. In preparation
for the Spin-off, the Company re-capitalized its debt structure in January 2000
through a series of transactions as follows:
Bond Tender and Other Debt Repayment. On December 6, 1999, KCS commenced offers
to purchase and consent solicitations with respect to any and all of the
Company's outstanding 7.875% Notes due July 1, 2002, 6.625% Notes due
Page 28
March 1, 2005, 8.8% Debentures due July 1, 2022, and 7% Debentures due December
15, 2025 (collectively "Debt Securities" or "notes and debentures").
Approximately $398.4 million of the $400 million outstanding Debt Securities
were validly tendered and accepted by the Company. Total consideration paid for
the repurchase of these outstanding notes and debentures was $401.2 million. In
conjunction with the early retirement of these Debt Securities, the Company
reported $10.9 million of debt retirement costs. These debt retirement costs
were previously reported as an extraordinary item, but have been reclassified in
accordance with SFAS 145. Funding for the repurchase of these Debt Securities
and for the repayment of $264 million of borrowings under then-existing
revolving credit facilities was obtained from two credit facilities (the "KCS
Credit Facility" and the "Stilwell Credit Facility", or collectively the "Credit
Facilities"), each of which was entered into on January 11, 2000. The Credit
Facilities provided for total commitments of $950 million. Stilwell assumed the
Stilwell Credit Facility, including the borrowings thereunder, and, upon
completion of the Spin-off, the Company was released from all obligations
thereunder.
KCS Credit Facility. The KCS Credit Facility initially provided for total
commitments of $750 million comprised of three separate term loans totaling $600
million and a revolving credit facility available until January 11, 2006. On
January 11, 2000, KCSR borrowed the full amount ($600 million) of the term loans
and used the proceeds to repurchase the Debt Securities, retire other debt
obligations and pay related fees and expenses. No funds were initially borrowed
under the revolving credit facility. The term loans were initially comprised of
the following: $200 million due January 11, 2001, $150 million due December 30,
2005 and $250 million due December 29, 2006. The $200 million term loan due
January 11, 2001 was refinanced during the third quarter of 2000 as described
above. The remainder of the KCS Credit Facility has also been refinanced as
described above.
Issue costs relating to the KCS Credit Facility of approximately $17.6 million
were deferred and amortized over the respective term of the loans. In
conjunction with the refinancing of a $200 million term loan previously due
January 11, 2001, which was a part of the KCS Credit Facilities, approximately
$1.8 million of these deferred costs were immediately recognized. Additionally,
for the year ended December 31, 2001, $1.4 million in fees were incurred related
to a waiver for certain credit facility covenants. These fees have also been
deferred and are being amortized over the respective term of the loans. After
consideration of current year amortization, the remaining balance of these
deferred costs was approximately $4.4 million at December 31, 2002.
Restricted Share and Option Program. In connection with the Spin-off, KCS
adopted a restricted share and option program (the "Option Program") under which
(1) certain senior management employees were granted performance based KCS stock
options and (2) all management employees and those directors of KCS who were not
employees (the "Outside Directors") became eligible to purchase a specified
number of KCS restricted shares and were granted a specified number of KCS stock
options for each restricted share purchased.
The performance stock options have an exercise price of $5.75 per share, which
was the mean trading price of KCS common stock on the New York Stock Exchange
(the "NYSE") on July 13, 2000. The performance stock options vested and became
exercisable in equal installments as KCS's stock price achieved certain
thresholds and after one year following the grant date. All performance
thresholds were met for these performance stock options and all became
exercisable on July 13, 2001. These stock options expire at the end of 10 years,
subject to certain early termination events.
The purchase price of the restricted shares, and the exercise price of the stock
options granted in connection with the purchase of restricted shares, was based
on the mean trading price of KCS common stock on the NYSE on the date the
employee or Outside Director purchased restricted shares under the Option
Program. Each eligible employee and Outside Director was allowed to purchase the
restricted shares offered under the Option Program on one date out of a
selection of dates offered. With respect to management employees, the number of
shares available for purchase and the number of options granted in connection
with shares purchased were based on the compensation level of the employees.
Each Outside Director was granted the right to purchase up to 3,000 restricted
shares of KCS, with two KCS stock options granted in connection with each
restricted share purchased. Shares purchased are restricted from sale and the
options are not exercisable for a period of three years from the date of grant
for senior management and the Outside
Page 29
Directors and two years from the date of grant for other management employees.
KCS provided senior management and the Outside Directors with the option of
using a sixty-day interest-bearing full recourse note to purchase these
restricted shares. These loans accrued interest at 6.49% per annum and were all
fully repaid by September 11, 2000.
Management employees purchased 475,597 shares of KCS restricted stock under the
Option Program and 910,697 stock options were granted in connection with the
purchase of those restricted shares. Outside Directors purchased a total of
9,000 shares of KCS restricted stock under the Option Program and 18,000 KCS
stock options were granted in connection with the purchase of those shares.
Norfolk Southern Haulage and Marketing Agreement. In May 2000, KCSR and Norfolk
Southern entered into an agreement under which KCSR provides haulage services
for intermodal traffic between Meridian and Dallas and receives fees for such
services from Norfolk Southern. Under this agreement, Norfolk Southern may quote
rates and enter into transportation service contracts with shippers and
receivers covering this haulage traffic.
Safety and Quality Programs. KCSR's safety vision is to become the safest
railway in North America. In 2002, KCSR continued working toward this vision.
Federal Railroad Administration ("FRA") Reportable Derailments declined nearly
9% during 2002 compared to 2001 and grade crossing accidents decreased by almost
14% compared to 2001. KCSR had the best safety record among mid-tier railroads
in both 2001 and 2000 and received the Gold Harriman award, the highest
recognition for safety in the industry, in both years.
KCS management believes the driving force for these improvements is strong
leadership at the senior field and corporate levels and joint responsibility for
the safety processes by craft employees and managers. KCS management believes
the leadership and joint responsibility in safety is helping shape an improved
safety culture at KCSR.
The Company is in the process of completing its implementation of Beltpack, a
remote-control locomotive operating system. This system allows a train engine
employee to run switching by remote control. The use of Beltpack is expected to
improve safety and allow a decrease in the number of employees per switching
train crew.
RESULTS OF OPERATIONS
The following table details certain income statement components for the Company
for the years ended December 31, 2002, 2001, and 2000, respectively, for use in
the analysis below. See the consolidated financial statements accompanying this
Form 10-K for other captions not presented within this table.
(dollars in millions)
2002 2001 2000
--------- --------- ---------
Revenues $ 566.2 $ 583.2 $ 578.7
Costs and expenses 518.2 527.8 520.9
--------- --------- ---------
Operating income 48.0 55.4 57.8
Equity in net earnings of unconsolidated affiliates 43.4 27.1 22.1
Gain on sale of Mexrail, Inc. 4.4 -- --
Interest expense (45.0) (52.8) (65.8)
Debt retirement costs (i) (4.3) -- (10.9)
Other, net 17.6 4.2 6.0
--------- --------- ---------
Income from continuing operations
before income taxes 64.1 33.9 9.2
Income tax expense (benefit) 6.9 2.8 (7.5)
--------- --------- ---------
Income from continuing operations $ 57.2 $ 31.1 $ 16.7
========= ========= =========
(i) In prior periods, debt retirement costs were previously reported as an
extraordinary item, but have been reclassified in accordance with SFAS
145.
Page 30
The following table summarizes consolidated KCS revenues, including the revenues
and carload statistics of KCSR for the years ended December 31, 2002, 2001,
2000, respectively. Certain prior year amounts have been reclassified to reflect
changes in the business groups and to conform to the current year presentation.
Carloads and
Revenues Intermodal Units
--------------------------------- ---------------------------------
(dollars in millions) (in thousands)
2002 2001 2000 2002 2001 2000
--------- --------- --------- --------- --------- ---------
General commodities:
Chemical and petroleum $ 130.7 $ 124.8 $ 127.1 145.4 147.8 155.9
Paper and forest 134.8 129.1 130.8 178.2 182.2 190.6
Agricultural and mineral 97.2 93.8 100.1 126.5 125.7 132.0
--------- --------- --------- --------- --------- ---------
Total general commodities 362.7 347.7 358.0 450.1 455.7 478.5
Intermodal and automotive 59.9 69.1 64.2 287.4 299.8 274.1
Coal 101.2 118.7 105.0 210.0 202.3 184.2
--------- --------- --------- --------- --------- ---------
Carload revenues and carload
And intermodal units 523.8 535.5 527.2 947.5 957.8 936.8
========= ========= =========
Other rail-related revenues 35.8 36.8 42.4
--------- --------- ---------
Total KCSR revenues 559.6 572.3 569.6
Other subsidiary revenues 6.6 10.9 9.1
--------- --------- ---------
Total consolidated revenues $ 566.2 $ 583.2 $ 578.7
========= ========= =========
The following table summarizes consolidated KCS costs and expenses for the years
ended December 31, 2002, 2001, and 2000, respectively. Certain prior year
amounts have been reclassified to conform to the current year presentation:
(dollars in millions)
2002 2001 2000
--------- --------- ---------
Compensation and benefits $ 197.8 $ 192.9 $ 197.8
Depreciation and amortization 61.4 58.0 56.1
Purchased services 59.6 57.0 54.8
Operating leases 55.0 56.8 58.2
Fuel 38.4 43.9 48.1
Casualties and insurance 25.2 42.1 34.9
Car hire 19.7 19.8 14.8
Other 61.1 57.3 56.2
--------- --------- ---------
Total consolidated costs and expenses $ 518.2 $ 527.8 $ 520.9
========= ========= =========
YEAR ENDED DECEMBER 31, 2002 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2001
Net Income. For the year ended December 31, 2002, net income increased $26.5
million to $57.2 million (91(cent) per diluted share) from $30.7 million
(50(cent) per diluted share) for the year ended December 31, 2001. This increase
was primarily the result of a $17.3 million increase in equity in earnings of
Grupo TFM, a $13.4 million increase in other income, a $7.8 million decrease in
interest expense, and a $4.4 million gain realized on the sale of Mexrail to
TFM. This increase in net income was partially offset by a $7.4 million decline
in operating income, a $4.1 million increase in the provision for income taxes,
and a $1.0 million decline in equity in net earnings (losses) of other
unconsolidated affiliates. Additionally, net income for the year ended December
31, 2002 includes debt retirement costs of $4.3 million related to the early
retirement of term debt in June 2002. These costs were previously reported as an
extraordinary item, but have been reclassified in accordance with SFAS 145. See
"Recent Developments - Debt Refinancing - 7 1/2% Senior Notes." Net income for
the year ended December 31, 2001 includes a $0.4 million charge relating to the
implementation of Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities"("SFAS 133").
Page 31
Revenues. Consolidated revenues for the year ended December 31, 2002 declined
$17.0 million to $566.2 compared to $583.2 million for the year ended December
31, 2001. In 2002, KCSR revenues declined $12.7 million compared to 2001,
primarily as a result of lower coal and automotive revenues partially offset by
higher revenues for all other major commodity groups. The increase in revenues
for certain commodity groups, including chemical and petroleum products,
agricultural and mineral, paper and forest products and intermodal traffic, was
driven by a combination of volume gains in certain commodities, increased length
of haul and price improvements in key traffic lanes. These revenue gains were
partially offset by volume losses in certain commodities within these groups.
KCS management believes that revenues for these commodity groups would have
improved even further during 2002, but were adversely affected by lower
carloadings arising from MCS related congestion. See "Recent Developments -
Implementation of New Management Control System" for further information.
Revenue from other subsidiaries decreased approximately $4.3 million year over
year primarily due to demand driven volume declines related to the Company's
petroleum coke bulk handling facility. The following discussion provides an
analysis of KCSR revenues by commodity group.
Chemical and Petroleum. For the year ended December 31, 2002, chemical and
petroleum product revenues increased $5.9 million (4.7%) to $130.7 million
compared to $124.8 million for the year ended December 31, 2001. These revenue
increases were the result of a combination of higher traffic volumes for certain
commodities within this business group as well as targeted rate increases and
longer hauls due to gateway changes. Higher revenues for gases and organic
products were primarily the result of production increases by certain customers,
as well as changes in traffic patterns and targeted rate increases. Higher
revenues for inorganic products were primarily the result of increased access to
production facilities in Geismar, Louisiana as well as new business previously
shipped by other rail carriers, which resulted in higher traffic volume.
Increases in the production of PVC and plastic pellet products led to an
increase in carloadings and higher revenues for plastic products. These
increases were partially offset by volume related declines in agrichemical and
petroleum product revenues due to lower industrial production related to the
continued slowdown in the U.S. economy. Chemical and petroleum products revenue
accounted for 25.0% and 23.3% of carload revenues for the years ended December
31, 2002 and 2001, respectively.
Paper and Forest. For the year ended December 31, 2002, paper and forest
product revenue increased $5.7 million (4.4%) to $134.8 million versus $129.1
million for the year ended December 31, 2001. Increases in revenues for pulp and
paper, scrap paper and lumber/plywood were partially offset by lower revenues
for pulpwood/logs/chips, scrap metal and military /other traffic. Increase in
pulp and paper revenues resulted from higher traffic volumes as a result of
production growth in the paper industry, while continued strength in the home
building market and housing starts led to increases in lumber and plywood
product revenues. These revenues were also higher due to certain rate increases
and changes in traffic mix and length of haul. Declines in industrial production
as a result of the continued slowdown in the U.S. economy led to lower
carloadings and revenues for pulpwood, logs, and chip products as well as metal
products. The decline in military and other carload revenues is a reflection of
the effect of a significant one-time military movement in 2001. Targeted rate
increases and changes in traffic patterns for metal products and pulpwood, logs
and chips partially offset the related revenue decline resulting from lower
traffic volumes for these commodities. Paper and forest products revenue
accounted for 25.7% and 24.1% of carload revenues for the years ended December
31, 2002 and 2001, respectively.
Agricultural and Mineral. For the year ended December 31, 2002, revenues
for agricultural and mineral product increased $3.4 million (3.6%) to $97.2
million compared to $93.8 million for the year ended December 31, 2001, as a
result of higher revenues across all major products in the agricultural and
mineral commodity group. Domestic grain revenues increased as a result of
certain rate increases and longer hauls partially mitigated by lower domestic
demand. Export grain revenue increased slightly during 2002 versus 2001 on the
strength of higher demand from Mexico and other export markets during the first
half of 2002. This demand eased somewhat during the last half of 2002. Increases
in revenue for stone, clay and glass product were primarily the result of higher
production by two customers in addition to targeted rate increases and longer
hauls. Agricultural and mineral products revenue accounted for 18.6% and 17.5%
of carload revenues for the years ended December 31, 2002 and 2001,
respectively.
Intermodal and Automotive. For the year ended December 31, 2002, combined
intermodal and automotive revenues decreased $9.2 million (13.3%) to $59.9
million compared to $69.1 million for the year ended December 31, 2001,
primarily as a result of lower automotive revenues, which declined $12.3 million
(57.0%) year over year. This decline in
Page 32
automotive revenues resulted from the loss of certain business in the third
quarter of 2001 due to competitive pricing from another railroad and the loss of
a significant movement effective May 2002. Also contributing was the general
decline in the domestic automobile industry as a result of continued weakness in
the U.S. economy. These factors contributed to a 62.8% year over year decline in
carload volumes for automotive traffic. For the year ended December 31, 2002,
intermodal revenues increased $3.1 million (6.6%) compared to 2001, as a result
of increases in domestic carload traffic as well as international traffic moving
to Mexico. Intermodal and automotive revenues accounted for 11.4% and 12.9% of
carload revenues for the years ended December 31, 2002 and 2001, respectively.
Coal. For the year ended December 31, 2002, coal revenues declined $17.5
million to $101.2 million compared to $118.7 million for the year ended December
31, 2001. Coal revenues were significantly impacted by a rate reduction at the
Company's largest utility customer as well as the loss of a coal customer in
April 2002 due to the expiration of a contract. These revenue declines were
partially mitigated by a near 7% increase in net tons delivered in 2002 compared
to 2001 due to higher demand at certain utility customers and the reopening of a
utility plant in Kansas City, Missouri in the second quarter of 2001 that had
been out of service since July of 1999. Coal revenue accounted for 19.3% and
22.2% of carload revenues for the years ended December 31, 2002 and 2001,
respectfully.
Other. For the year ended December 31, 2002, other rail-related revenues
declined $1.0 million to $35.8 million compared to $36.8 million for the year
ended December 31, 2001. This decline was primarily the result of declines in
switching and demurrage revenues partially offset by increases in other
revenues. Haulage revenues remained relatively unchanged in 2002 compared to
2001.
Costs and Expenses. For the year ended December 31, 2002, consolidated operating
expenses decreased $9.6 million to $518.2 million compared to $527.8 million for
the year ended December 31, 2001, resulting from a $6.0 million decline in KCSR
expenses coupled with a $3.6 million decline in expenses from other
subsidiaries. This decrease was partially mitigated by the impact of higher
costs associated with the implementation of MCS (See "Recent Developments -
Implementation of New Management Control System"). The expenses most affected by
the MCS implementation were compensation and benefits, depreciation, purchased
services and car hire. See further discussion below.
Compensation and Benefits. For the year ended December 31, 2002,
consolidated compensation and benefits expense increased $4.9 million to $197.8
million compared to $192.9 million for the year ended December 31, 2001. This
increase was primarily the result of higher overtime and crew costs during the
second half of 2002 related to the traffic congestion resulting from the third
quarter 2002 implementation of MCS. Compensation and benefits expense in 2002
was also impacted by the implementation of an increase in certain union wages
effective July 1, 2002, higher health insurance costs and a $1.3 million
increase in expenses for the estimate of post employment benefits arising from
the Company's third party actuarial study. Additionally, the increase in
compensation and benefits was affected by the impact of a $2.0 million reduction
in retirement-based costs for certain union employees recorded in 2001, which
reduced comparable 2001 expense. These factors were partially mitigated by lower
employee counts, the automation of certain switch locomotive crew functions, a
favorable adjustment related to the accrual for retroactive wage increases to
union employees, which was not provided for in the national labor union contract
and lower railroad retirement taxes as a result of the reduction in employer
contributions under the Railroad Retirement Act. (See "Significant Developments
- - Railroad Retirement Improvement Act"). The increase in compensation and
benefits expense was also impacted by the effect of workforce reduction costs of
$1.3 million recorded in the first quarter of 2001.
Depreciation and Amortization. For the year ended December 31, 2002,
consolidated depreciation expense increased $3.4 million to $61.4 million
compared to $58.0 million for the year ended December 31, 2001. This increase
was primarily the result of the implementation of MCS in July of 2002, which
increased depreciation expense $2.4 million in 2002. The remainder of the
increase resulted from a net increase in the property, plant and equipment asset
base.
Purchased Services. For the year ended December 31, 2002, purchased
services expense increased $2.6 million to $59.6 million compared to $57.0
million for the year ended December 31, 2001. This increase was the result of
higher environmental compliance costs and legal costs, higher locomotive and car
repair costs contracted to third parties as well as increased other general
purchased services. Also contributing to the increase in purchased services
expense were
Page 33
higher employee training costs associated with the implementation of MCS and an
increase to the reserve for environmental remediation related to a specific
site. This increase in costs was partially mitigated by insurance and legal
settlements totaling approximately $5.0 million.
Operating Leases. Consolidated operating lease expense for the year ended
December 31, 2002 decreased $1.8 million to $55.0 million compared to $56.8
million for the year ended December 31, 2001. This decrease was primarily the
result of the expiration of leases that have not been renewed due to continued
changes in fleet utilization. This decrease in lease expense was partially
mitigated by increases in lease costs of approximately $1.9 million in 2002
associated with the lease for the Company's new corporate headquarters building.
Fuel. Locomotive fuel costs for the year ended December 31, 2002 decreased
$5.5 million to $38.4 million compared to $43.9 million for the year ended
December 31, 2001. This decrease was the combined result of an 8.8% decrease in
the average cost per gallon of fuel and a 4.0% decline in fuel consumption due
primarily to aggressive fuel conservation measures.
Casualties and Insurance. For the year ended December 31, 2002,
consolidated casualties and insurance expense decreased $16.9 million to $25.2
million compared to $42.1 million for the year ended December 31, 2001 due
primarily to lower derailment costs, and the receipt of insurance settlements in
2002, partially offset by higher insurance costs. In the first quarter of 2001,
the Company incurred $8.5 million in costs related to several significant
derailments as well as the settlement of a personal injury claim. Derailment
costs for the year ended December 31, 2002 were more normalized compared to
2001. Also impacting the decrease in casualties and insurance expense was the
receipt of $8.2 million in legal and insurance settlements during 2002. Expenses
in 2002 for personal injury claims were slightly higher compared to 2001. The
Company's process of establishing liability reserves for these types of
incidents is based upon an actuarial study by an independent outside actuary, a
process followed by most large railroads.
Car Hire. Car hire expense for the year ended December 31, 2002 was
relatively unchanged, decreasing only $0.1 million to $19.7 million compared to
$19.8 million for the year ended December 31, 2001. For the first half of 2002,
car hire expense decreased approximately $2.9 million compared to the same
period in 2001 as KCSR was operating a more efficient and well-controlled
railroad. In early 2001, an unusual number of significant derailments (as
discussed in casualties and insurance), as well as the effects of line washouts
and flooding had a significant adverse impact on the efficiency of KCSR's
operations in the first half of 2001. The resulting inefficiency led to
congestion on KCSR during the first half of 2001, which contributed to an
increase in the number of freight cars from other railroads on the Company's
rail line. For the second half of 2002, car hire expense increased $2.8 million
compared to the second half of 2001. This increase was due to a higher number of
freight cars from other railroads on the Company's rail line as well as fewer
KCSR freight cars on other railroads as a result of increased congestion
resulting from the implementation of MCS in the third quarter of 2002. (See
"Recent Developments - Implementation of New Management Control System".)
Other Expense. Consolidated other expense increased $3.8 million to $61.1
million for the year ended December 31, 2002 compared to $57.3 million for the
year ended December 31, 2001. Factors contributing to this increase included an
increase in material and supply costs related to maintenance of way and
equipment of $2.5 million as well as a $2.6 million decline in gains recorded on
the sale of operating assets by KCSR. The effect of these increases was
partially offset by a decline in the cost of sales and other expenses incurred
by certain subsidiaries.
Operating Income and KCSR Operating Ratio. For the year ended December 31,
2002, consolidated operating income decreased $7.4 million to $48.0 million
compared to $55.4 million for the year ended December 31, 2001. This decrease
was primarily the result of a $17.0 million decline in revenues partially
mitigated by a $9.6 million decline in operating expenses. The operating ratio
for KCSR was 89.2% and 88.2% for the years ended December 31, 2002 and 2001,
respectively.
Equity in Net Earnings (Losses) of Unconsolidated Affiliates. For the year ended
December 31, 2002, the Company recorded equity in earnings of unconsolidated
affiliates of $43.4 million reflecting an increase of $16.3 million compared to
$27.1 million for the year ended December 31, 2001. This increase was driven by
an increase in equity in earnings
Page 34
from Grupo TFM of $17.3 million partially offset by a $1.0 million decline in
equity in earnings from other unconsolidated affiliates.
Equity in earnings related to Grupo TFM increased to $45.8 million for the year
ended December 31, 2002 compared to $28.5 million for 2001. For the year ended
December 31, 2001, the Company's equity in the earnings of Grupo TFM included
the Company's proportionate share ($9.1 million) of the income recorded by Grupo
TFM related to the reversion of certain concession assets to the Mexican
government. Exclusive of this 2001 reversion income, equity in earnings of Grupo
TFM for the year ended December 31, 2002 increased $26.4 million compared to the
year ended December 31, 2001. Revenues for Grupo TFM for the year ended December
31, 2002 decreased $7.5 million compared to the year ended December 31, 2001
(exclusive of Mexrail's results) while operating expenses (under U.S.GAAP) were
$29.5 million lower (exclusive of the 2001 reversion income and Mexrail's
results). For the year ended December 31, 2002, Grupo TFM's results include a
deferred tax benefit of $91.5 million (calculated under U.S. GAAP) compared to a
deferred tax expense of $10.9 million for the year ended December 31, 2001. This
increase was the result of numerous factors, including a deferred tax expense
recorded in 2001 related to the line reversion income, the weakening of the
Mexican peso exchange rate and tax benefits derived from the impact of Mexican
inflation in 2002. For the year ended December 31, 2002, fluctuations in the
Mexican peso exchange rate also contributed to a $17.4 million exchange loss
compared to an exchange gain of $2.8 million for the year ended December 31,
2001.
Results of the Company's investment in Grupo TFM are reported under U.S. GAAP
while Grupo TFM reports its financial results under International Accounting
Standards ("IAS"). Because the Company is required to report its equity earnings
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. The deferred income tax calculations are significantly
impacted by fluctuations in the relative value of the Mexican peso versus the
U.S. dollar and the rate of Mexican inflation, and can result in significant
variability in the amount of equity earnings reported by the Company.
Equity in losses of the Company's other unconsolidated affiliates for the year
ended December 31, 2002 were $2.4 million compared to equity in losses of $1.4
million for the year ended December 31, 2001. In 2002, losses associated with
PCRC were $3.8 million compared to $1.6 million in 2001. PCRC is not operating
at full capacity as initially planned due to the delay in completion of the port
expansion at Balboa. During 2001, losses were primarily related to the start-up
of operations at PCRC. Additionally, the Company reported equity losses from
Mexrail of $2.1 million in 2001 compared to essentially a break-even amount for
2002 prior to its sale to TFM. These losses were mitigated by equity earnings
from Southern Capital of $1.4 million and $2.4 million for the years ended
December 31, 2002 and 2001, respectively.
Gain on Sale of Mexrail, Inc. Net income for the year ended December 31, 2002
includes a gain on the sale of the Company's investment in Mexrail, Inc. of $4.4
million (See "Recent Developments - Sale of Mexrail, Inc. to TFM").
Interest Expense. Consolidated interest expense declined $7.8 million to $45.0
million for the year ended December 31, 2002 compared to $52.8 million for the
year ended December 31, 2001. This decrease was the result of lower effective
interest rates for the first six months of 2002 as well as lower debt balances.
The Company's debt balance declined $75.8 million during 2002 from $658.4
million at December 31, 2001 to $582.6 million at December 31, 2002.
Debt Retirement Costs. Net income for the year ended December 31, 2002 includes
debt retirement costs of $4.3 million related to the debt refinancing during the
second quarter of 2002. (See "Recent Developments - Debt Refinancing - 7 1/2%
Senior Notes").
Other Income. Other items affecting net income for the year ended December 31,
2002 were gains totaling approximately $7.4 million related to the sale of
certain non-operating properties at a subsidiary of the Company and a $4.9
million gain on the sale of WGC. These items account for the majority of the
increase reported in other income for 2002 compared to 2001.
Income Tax Expense. For the year ended December 31, 2002, the Company's income
tax provision increased $4.1 million to $6.9 million compared to $2.8 million
for the year ended December 31, 2001. This increase was primarily the
Page 35
result of gains on the sale of the Company's investments in WGC and Mexrail as
well as gains realized on the sale of other non-operating assets. Lower interest
costs for the year ended December 31, 2002 also contributed to the increase in
the income tax provision. These factors, which led to an increase in the income
tax provision, were partially mitigated by lower domestic operating income.
Exclusive of equity earnings in Grupo TFM, the consolidated effective income tax
rate for the year ended December 31, 2002 was 37.7% compared to 51.8% for the
year ended December 31, 2001. This variance in the effective tax rate was
primarily the result of changes in associated book/tax temporary differences and
certain non-taxable items. The Company intends to indefinitely reinvest the
equity earnings from Grupo TFM and accordingly, the Company does not provide
deferred income tax expense for the excess of its book basis over the tax basis
of its investment in Grupo TFM.
Cumulative Effect of Accounting Change. The Company adopted the provisions of
SFAS 133 effective January 1, 2001. As a result of this change in the method of
accounting for derivative financial instruments, the Company recorded an
after-tax charge to earnings of $0.4 million in the first quarter of 2001. This
charge is presented as a cumulative effect of an accounting change in the
accompanying consolidated financial statements.
YEAR ENDED DECEMBER 31, 2001 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2000
Income from Continuing Operations. For the year ended December 31, 2001, income
from continuing operations increased $14.4 million to $31.1 million (51(cent)
per diluted share) from $16.7 million (28(cent) per diluted share) for the year
ended December 31, 2000. This increase was primarily the result of a $13.0
million decline in interest expense, a $10.9 million decline in debt retirement
costs and an $8.6 million increase in equity earnings from Grupo TFM, partially
offset by an increase in the income tax provision of $10.3 million, a $3.6
million decrease in equity earnings from other unconsolidated affiliates, and a
$2.4 million decrease in domestic operating income. Equity earnings for the year
ended December 31, 2001 reflect the Company's proportionate share ($9.1 million)
of the income recorded by Grupo TFM relating to the reversion of certain
concession assets to the Mexican government.
Revenues. Consolidated revenues for the year ended December 31, 2001 totaled
$583.2 million compared to $578.7 million for the year ended December 31, 2000.
This $4.5 million, or 0.8%, increase resulted from higher KCSR revenues of
approximately $2.7 million coupled with higher revenues from certain other
smaller subsidiaries. The following discussion provides an analysis of KCSR
revenues by commodity group.
Chemical and Petroleum. For the year ended December 31, 2001, chemical and
petroleum product revenues decreased $2.3 million (1.8%) compared to the year
ended December 31, 2000. Higher revenues for plastic and inorganic chemical
products were offset by declines in most other chemical products. The increase
in revenues for plastic products resulted from a plant expansion by a customer
in late 2000. The decline in other chemical and petroleum products resulted
primarily from lower industrial production reflecting the impact of the slowdown
of the U.S. economy. These volume related revenue declines were somewhat
mitigated through certain price increases taken in 2001.
Paper and Forest. Revenues for paper and forest products decreased $1.7
million (1.3%) for the year ended December 31, 2001 compared to the year ended
December 31, 2000. As a result of the transfer of certain National Guard
personnel and related equipment to a military base near KCSR's rail lines,
military and other carloads increased $4.3 million for the year ended December
31, 2001. Additionally, for the year ended December 31, 2001, revenues for
pulpwood and logchips increased $1.6 million due to a fungus problem with
logchips during 2000 (which reduced 2000 revenues) that has since been resolved.
These increases for the year ended December 31, 2001 were offset by declines in
steel shipments and most other paper and forest product commodities.
Contributing to the decline in certain lumber product revenues was an ongoing
trade dispute between the United States and Canada relating to softwood lumber
producers, which has reduced certain lumber traffic between Canada and Mexico.
Negotiations between the United States and Canada are continuing in an effort to
resolve this trade dispute. Steel shipments declined due to the loss of certain
business and the timing of the receipt of steel shipments in 2001 compared to
2000. Additionally, a significant portion of our steel shipments relate to
drilling pipe for oil exploration. Drilling activity has declined due to the
reductions in the price of oil, thus resulting in less demand for drilling pipe.
The continued decline in the U.S. economy continues to affect the paper and
forest product industry significantly as the need for raw materials in related
Page 36
manufacturing and production industries decreased during 2001. Certain price
increases during 2001 have partially offset related volume declines.
Agricultural and Mineral. Agricultural and mineral product revenues
decreased $6.3 million (6.3%) for the year ended December 31, 2001 compared to
the year ended December 31, 2000. In 2001, domestic grain revenues decreased
$4.1 million compared to 2000 primarily due to a general decline in the
production of poultry in the United States, which decreased demand for grain
deliveries to the Company's poultry producing customers. Additionally, during
the first half of 2001, flooding in Iowa and Minnesota forced a temporary shift
in the origination of some domestic grain shipments to Illinois and Indiana,
resulting in significantly shorter hauls for KCSR. Export grain increased $1.3
million (14.0%) compared to the year ended December 31, 2000, primarily as a
result of increased shipments of soybeans for export through the ports of
Beaumont, Texas and Reserve, Louisiana during the fourth quarter of 2001. Annual
declines in food products, ores and minerals and stone, clay and glass product
revenues resulted primarily from the ongoing decline in the U.S. and global
economies.
Intermodal and Automotive. For the year ended December 31, 2001, intermodal
and automotive revenues increased $4.9 million (7.6%) compared to the year ended
December 31, 2000 as a result of an increase in automotive revenues of $9.1
million partially offset by a decrease in intermodal revenues of $4.2 million.
Automotive revenues increased as a result of the following: (i) Mazda traffic
originating at the International Freight Gateway ("IFG") at the former
Richards-Gebaur airbase, located adjacent and connecting to KCSR's main line
near Kansas City, Missouri; and (ii) Ford business originating on the CSX in
Louisville and interchanged with the KCSR in East St. Louis. This Ford
automotive traffic was shipped to Kansas City via KCSR and interchanged with
Union Pacific Railroad for delivery to the western United States. During the
third quarter of 2001, KCSR lost this Ford business due to competitive pricing
from another rail carrier. Intermodal revenues for the year ended December 31,
2001 declined due to several factors, including (i) the impact of the slow-down
in the U.S. economy, which has caused related declines in demand; (ii) customer
erosion due to service delays arising from congestion experienced in the first
quarter of 2001; and (iii) a marketing agreement with Norfolk Southern, which
provides that KCSR will perform haulage services for Norfolk Southern from
Meridian, Mississippi to Dallas, Texas for an agreed upon haulage fee. This
marketing agreement was entered into in May 2000 and became fully operational in
June 2000. A portion of the decline in intermodal revenues resulted from the
Norfolk Southern haulage traffic that replaced existing intermodal revenues as
KCSR is now receiving a smaller per unit haulage fee than the share of revenue
it received as part of the intermodal movement. The margins on this traffic are
improved, however, because it has a lower cost base to KCSR as certain costs
such as fuel and car hire are incurred and paid by Norfolk Southern.
Coal. For the year ended December 31, 2001, coal revenue increased $13.7
million (13.0%) compared to the year ended December 31, 2000. These increases
were primarily the result of higher demand from coal customers replenishing
depleted stockpiles and to satisfy weather-related demands as a result of hot
weather conditions in the summer months. Net tons of unit coal shipped increased
approximately 9.3% for 2001. Also contributing to the increase was the return of
the Kansas City Power and Light Hawthorn plant to production in the second
quarter of 2001. The Hawthorn plant had been out of service since January 1999
due to an explosion at the Kansas City facility.
Other. For the year ended December 31, 2001, other rail-related revenues
declined $5.6 million, comprised of declines in switching and demurrage revenues
of $2.9 million and $2.2 million, respectively, as well as declines in haulage
revenues of $0.4 million. These declines related primarily to volume declines
reflecting the weak economy. Demurrage revenues also declined due to more
efficient fleet utilization resulting from a well operating railroad.
Costs and Expenses. Consolidated operating expenses increased $6.9 million
(1.3%) to $527.8 million for the year ended December 31, 2001 compared to $520.9
for the year ended December 31, 2000 as a result of higher KCSR expenses of $1.7
million and higher expenses at certain other subsidiaries of $5.2 million.
Compensation and Benefits. For the year ended December 31, 2001,
consolidated compensation and fringe benefits expense declined $4.9 million
compared to the year ended December 31, 2000, resulting from a $5.6 million
reduction in costs for salaries and wages partially offset by an increase in
fringe benefits expense of $0.7 million. This variance results primarily from a
$4.2 million reduction of compensation and fringe benefits at KCSR resulting
from a reduction in
Page 37
employee headcount arising from the workforce reduction discussed in
"Significant Developments - Cost Reduction Plan" and lower costs associated with
overtime due to improved operating efficiency. Fringe benefit costs were higher
because of an approximate 17% increase in health insurance costs and an increase
in unemployment insurance partially offset by a decline in expenses associated
with stock option exercises and a $2.0 million reduction in retirement-based
costs for certain union employees. The decline in compensation and fringe
benefits expense was partially offset by the one-time severance costs of
approximately $1.3 million associated with the workforce reduction.
Depreciation and Amortization. Consolidated depreciation and amortization
expense for the year ended December 31, 2001 increased $1.9 million compared to
the year ended December 31, 2000. This increase was primarily the result of an
increase in KCSR's asset base partially offset by property retirements and lower
STB approved depreciation rates.
Purchased Services. For the year ended December 31, 2001, purchased
services expense increased $2.2 million compared to the year ended December 31,
2000. This variance is comprised of a $0.2 million decline in purchased services
for KCSR offset by a $2.4 million increase in purchased services for other
subsidiaries. The decline in purchased services for KCSR resulted from lower
costs related to intermodal lift services and lower environmental compliance
costs. The decline in intermodal lift services was the result of a decline in
the number of trailers handled at terminals combined with an increase in lift
charges billed to others. These declines in costs were partially offset by
higher costs for locomotive and car repairs contracted to third parties as well
as higher professional fees related to casualty claims. The increase in
purchased services related to other subsidiaries consists mostly of higher
holding company costs and higher legal costs at a subsidiary related to the
settlement of a lawsuit.
Operating Leases. For the year ended December 31, 2001, consolidated
operating lease expense decreased $1.4 million compared to the year ended
December 31, 2000. This decline was primarily the result of lower KCSR operating
lease costs due to the expiration of certain leases for rolling stock that were
not renewed due to better fleet utilization.
Fuel. Fuel costs for the year ended December 31, 2001 decreased $4.2
million compared to the year ended December 31, 2000. This decrease was
primarily the result of a 9.0% decline in the average price per gallon coupled
with only a slight increase in fuel usage in 2001 compared to 2000. Fuel costs
represented approximately 8.7% of total KCSR costs and expenses for the year
ended December 31, 2001.
Casualties and Insurance. For the year ended December 31, 2001, casualties
and insurance expense increased $7.2 million compared to the year ended December
31, 2000 primarily as a result of higher casualties and insurance costs at KCSR
of $6.6 million. Excluding the impact of the Duncan case settlement (See
"Significant Developments - Duncan Case Settlement") in 2000, KCSR casualties
and insurance costs would have increased $10.8 million. This resulted from an
$8.5 million increase in higher derailment costs related to several significant
first quarter 2001 derailments and higher personal injury costs associated with
third party claims. Also contributing to the fluctuation in casualties and
insurance expense was an increase in the personal injury reserve of
approximately $5.7 million arising from the Company's annual actuarial study.
During 2001, the Company changed its approach towards employee and third party
personal injury liabilities by aggressively pursuing settlement of open claims.
The Company's approach for many years prior to 2001 had been to challenge
claimants and prolong litigation, thereby, in some cases management believes,
increasing the long-term costs of the incident. This change in approach towards
claim settlement led to substantial payments to claimants in 2001 approximating
$44 million for current and prior year casualty incidents, including the Duncan
case discussed earlier. The Company's process of establishment of liability
reserves for these types of incidents is based upon an actuarial study by an
independent outside actuary, a process followed by most large railroads. The
significant change in settlement philosophy in 2001 led to the need to establish
additional reserves for personal injury liabilities as indicated by the annual
actuarial study.
Car Hire. For the year ended December 31, 2001, car hire expense increased
$5.0 million compared to the year ended December 31, 2000. An unusual number of
significant first quarter 2001 derailments (as discussed in casualties and
insurance), as well as the effects of the economic slowdown, line washouts and
flooding had an adverse impact on the efficiency of the Company's U.S.
operations during the first quarter and early second quarter of 2001. The
resulting inefficiency led to congestion on KCSR. This congestion contributed to
an increase in the number of freight cars from other railroads on the Company's
rail line, as well as a lower number of KCSR freight cars being used by other
railroads,
Page 38
resulting in an increase in car hire expense in 2001 compared to 2000. Also
contributing to the increase in car hire expense was the larger number of auto
rack cars being used in 2001 compared to 2000 to serve the related increase in
automotive traffic. Partially offsetting these effects were more efficient
operations in the third and fourth quarters of 2001, which led to a decline in
the number of freight cars and trailers from other railroads and third parties
on the Company's rail line. As operations continued to improve throughout the
second half of 2001, car hire costs also continued to improve, declining 37.7%
compared to the first half of 2001.
Other. Other operating expenses increased $1.1 million year to year as a
result of several factors. The Company recorded higher expenses associated with
its petroleum coke bulk handling facility of approximately $3.2 million
resulting from a $1.1 million expense related to a legal settlement and higher
terminal operating costs. Additionally, in 2000, the Company recorded a $3.0
million reduction to the allowance for doubtful accounts due to the collection
of an outstanding receivable, which reduced other operating expenses in 2000.
These variances resulting in increases to other 2001 operating expenses were
partially offset by a decline in materials and supplies expense of approximately
$3.0 million. Additionally, in 2001 the Company recorded $5.8 million of gains
on the sale of operating property compared to $3.4 million in 2000.
Operating Income and KCSR Operating Ratio. Consolidated operating income
for the year ended December 31, 2001 decreased $2.4 million, or 4.2%, to $55.4
million compared to $57.8 million for the year ended December 31, 2000. This
decrease resulted from a $6.9 million increase in operating expenses partially
offset by a $4.5 million increase in revenues. The operating income and
operating ratio for KCSR improved to $67.0 million and 88.2%, respectively, for
the year ended December 31, 2001 compared to $66.0 million and 88.3%,
respectively, for the year ended December 31, 2000.
Equity in Net Earnings (Losses) of Unconsolidated Affiliates. For the year ended
December 31, 2001, the Company recorded equity earnings of $27.1 million
compared to equity earnings of $22.1 million for the year ended December 31,
2000. This increase is primarily the result of higher equity earnings from Grupo
TFM of $8.6 million and an increase in equity earnings from Southern Capital of
$1.0 million. These increases were partially offset by a $2.3 million decline in
equity earnings from Mexrail and equity losses of $1.6 million recorded from
PCRC relating mostly to costs associated with the start-up of the business.
Equity earnings related to Grupo TFM increased to $28.5 million for the year
ended December 31, 2001 from $19.9 million for the year ended December 31, 2000.
During the year ended December 31, 2001, TFM recorded approximately $54 million
in pre-tax income related to the reversion of certain concession assets to the
Mexican government. The Company's equity earnings for the year ended December
31, 2001 reflect it's proportionate share of this income of approximately $9.1
million. Grupo TFM's revenues increased 4.2% to $667.8 million for the year
ended December 31, 2001 from $640.6 for the year ended December 31, 2000. These
higher revenues were partially offset by an approximate 9.5% increase in
operating expenses (exclusive of the income related to the reversion of certain
concession assets to the Mexican government discussed above as well as other
gains/losses recorded on the sales of other operating assets) resulting in a
year to year decline in ongoing operating income of approximately 10.3%. Under
U.S. GAAP, the deferred tax expense for Grupo TFM was $10.9 million for the year
ended December 31, 2001 compared to a deferred tax benefit of $13.2 million for
the year ended December 31, 2000.
Interest Expense. Consolidated interest expense for the year ended December 31,
2001 declined $13.0 million compared to the year ended December 31, 2000
primarily as a result of lower interest rates (LIBOR) on variable rate debt, a
lower average debt balance and lower amortization related to debt issue costs.
Also contributing to the decline in interest expense was $4.2 million of
capitalized interest recorded in 2001 relating to MCS. On a comparative basis,
interest expense in 2001 increased as a result of a $2.4 million benefit related
to an adjustment to interest expense due to the settlement of certain income tax
issues for 2001 compared to a $5.5 million benefit for similar items in 2000.
Debt Retirement Costs. Income from continuing operations for the year ended
December 31, 2000, includes debt retirement costs of $10.9 million related to
certain debt refinancing and re-capitalization transactions during 2000. These
costs were previously reported as an extraordinary item, but have been
reclassified in accordance with SFAS 145. (See
Page 39
"Significant Developments - Debt Refinancing and Re-capitalization of the
Company's Debt Structure - Bond Tender and Other Debt Repayment").
Income Tax Expense. For the year ended December 31, 2001, the Company's income
tax provision was $2.8 million compared to an income tax benefit of $7.5 million
for the year ended December 31, 2000. Exclusive of equity earnings from Grupo
TFM, the consolidated effective income tax rate for 2001 was 51.8%. In 2000, the
comparable effective tax rate was negative. This variance in the income tax
provision and effective tax rate was primarily the result of an increase in the
Company's domestic operating results and changes in associated book/tax
temporary differences and certain non-taxable items. Also contributing to this
variance was a lower settlement amount during 2001 compared to 2000 relating to
various income tax audit issues. Exclusive of equity earnings from Grupo TFM for
the years ended December 31, 2001 and 2000, the Company recognized pre-tax
income of $5.4 million for the year ended December 31, 2001 compared to a
pre-tax loss of $10.7 million for the year ended December 31, 2000. The Company
intends to indefinitely reinvest the equity earnings from Grupo TFM and
accordingly, the Company does not provide deferred income tax expense for the
excess of its book basis over the tax basis of its investment in Grupo TFM.
Income from Discontinued Operations. Net income for the year ended December 31,
2000 includes income from discontinued operations (Stilwell) of $363.8 million.
As a result of the spin-off of Stilwell effective July 12, 2000, the Company did
not report income from discontinued operations during the year ended December
31, 2001.
Cumulative Effect of Accounting Change. As a result of the implementation of
SFAS 133 discussed in "Recent Developments- Implementation of Derivative
Standard," the Company recorded an after-tax charge to earnings of $0.4 million
in the first quarter of 2001. This charge is presented as a cumulative effect of
an accounting change in the accompanying consolidated statements of income for
the year ended December 31, 2001.
TRENDS AND OUTLOOK
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Overview" for cautionary statements concerning forward-looking
comments.
The Company improved its profitability and reduced its debt during the first
half of 2002 in spite of the continued downturn in the North American economy.
Consolidated revenue for the first half of 2002 declined 2.4% primarily as a
result of slowdowns in the U.S. economy as well as reduced coal revenues. While
the decline in revenues during the first half of 2002 adversely impacted
operating results, the Company's efforts to maintain it's cost structure were
effective as operating income increased compared to the first half of 2001.
However, from mid-July to mid-November 2002, the Company's operations were
significantly impacted by congestion throughout it's U.S. rail network and
reduced operating efficiency related to the implementation of MCS (See "Recent
Developments - Implementation of New Management Control System"). This MCS
related congestion resulted in certain operating delays and higher expenses for
certain categories including car hire, regular and overtime wages, fuel, certain
equipment charges as well as MCS implementation related expenses. In addition to
its impact on certain operating expenses, congestion related to the
implementation of MCS also impacted revenues during the second half of 2002.
Also contributing to these revenue declines were lower coal and automotive
revenues, as well as the continued economic slowdown. Coal revenues declined due
to a contractual rate reduction at one of the Company's major coal customers and
the loss of business in the second quarter of 2002 due to the expiration of the
contract. Automotive revenues declined due to the loss of certain business.
Despite the overall decline in revenues year over year, however, management was
encouraged by the positive trends noted for revenues in certain commodity
groups, including chemical and petroleum products, paper and forest products,
agricultural and mineral products, and intermodal traffic. Revenues for those
commodities increased in 2002 compared to 2001 despite the continued slump in
the U.S. economy. Additionally, during the latter part of the fourth quarter of
2002, the operational performance of the Company started to show signs of
improvement. Key performance measurements such as terminal dwell time, train
speed and average daily crew starts improved compared to the third quarter of
2002. Operations were essentially at normal levels by late fourth quarter of
2002. Management believes this trend will continue in 2003 and that MCS will
provide the management tools necessary to enhance productivity and efficiency
while decreasing costs.
Page 40
While domestic operating results for the year ended December 31, 2002 were
adversely impacted by the factors mentioned above, other areas showed
improvement. The Company's investment in Grupo TFM continues to provide
significant value as part of the Company's NAFTA rail network. Equity in
earnings of Grupo TFM increased 136% for the year ended December 31, 2002
compared to the year ended December 31, 2001 (after adjusting for the Company's
$9.1 million share of the income recorded by Grupo TFM related to the reversion
of certain concession asset to the Mexican government during 2001). During 2002,
the Company's equity in earnings in Grupo TFM was favorably impacted by a
significant change in the deferred tax benefit for Grupo TFM. The year to year
increase also resulted from the Company's increased ownership interest in Grupo
TFM arising from the purchase of the Mexican government's ownership interest in
Grupo TFM. Interest expense continued to decline as a result of lower effective
interest rates during the first half of 2002, as well as lower debt balances as
the Company continued to reduce its debt. The Company reduced consolidated debt
by approximately $75.8 million from $658.4 million at December 31, 2001 to
$582.6 million at December 31, 2002. Additionally, the Company realized
significant gains in 2002 on the sale of certain investments and non-operating
assets. During 2002, the Company realized a gain of $4.4 million on the sale of
its investment in Mexrail to TFM and a gain of $4.9 million on the sale of its
investment in WGC. The Company also realized gains of approximately $7.4 million
on the sale of certain other non-operating assets. For the year ended December
31, 2002, the Company's diluted earnings per share increased 82.0% compared to
the year ended December 31, 2001.
A current outlook for the Company's businesses for 2003 is as follows (refer to
the first paragraph of "Overview" section of this Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations,
regarding forward-looking comments):
For 2003, the Company will focus on improving domestic operations and generating
stronger growth in operating income. Management expects traffic growth to exceed
growth in the economy and expects revenues for 2003 to increase approximately
3%. The Company plans to strive to increase efficiencies through a continued
focus on improvements in productivity and operations, using MCS as the
management tool to help enable this process.
Except as outlined herein, assuming normalized rail operations, variable costs
and expenses are expected to be proportionate with revenues as management
believes that operating difficulties related to the implementation of MCS have
been resolved and the railroad has returned to relatively normal operations.
Fuel expenses are expected to reflect market conditions, which management
believes will be higher in 2003 given the current situations in foreign markets,
such as Iraq and Venezuela. Insurance costs are expected to increase based on
market conditions. Depreciation expense is expected to be higher in the first
half of 2003 compared to the same period in 2002 primarily as a result of the
implementation of MCS while remaining relatively flat for the remainder of the
year. Operating leases are expected to remain relatively flat as increases in
operating leases as a result of the occupancy of the Company's new corporate
headquarters are expected to be mitigated by declines associated with better
equipment utilization.
The Company expects to continue to participate in the earnings and 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 regarding the impact that a change in the value of the peso or change
in Mexican inflation will have on the results of Grupo TFM. See "Other - Foreign
Exchange Matters" and Item 7A, "Quantitative and Qualitative Disclosures About
Market Risk" for further information. Upon completion of expansion of the port
of Balboa in Panama, management believes that PCRC should provide the Company
with opportunities for future earnings growth beginning in the early part of
2004.
Page 41
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW INFORMATION AND CONTRACTUAL OBLIGATIONS
Summary cash flow data follows for the years ended December 31, 2002, 2001 and
2000, respectively (dollars in millions):
2002 2001 2000
--------- --------- ---------
Cash flows provided by (used for):
Operating activities $ 100.4 $ 68.2 $ 74.7
Investing activities (34.9) (55.7) (101.8)
Financing activities (71.2) (9.3) 36.7
--------- --------- ---------
Net increase (decrease) in
Cash and cash equivalents (5.7) 3.2 9.6
Cash and cash equivalents at beginning of year 24.7 21.5 11.9
--------- --------- ---------
Cash and cash equivalents at end of year $ 19.0 $ 24.7 $ 21.5
========= ========= =========
During the year ended December 31, 2002, the Company's consolidated cash
position decreased by $5.7 million from December 31, 2001. This decrease was
primarily the result of capital expenditures as well as the net repayment of
long-term debt and debt issuance costs partially offset by cash flows from
operating activities, proceeds from the sale of certain investments (Mexrail and
WGC) and certain non-operating property and proceeds received from issuance of
stock under employee stock plans.
Operating Cash Flows. The Company's cash flow from operations has historically
been positive and sufficient to fund operations, as well as KCSR roadway capital
improvements, other capital improvements and debt service. External sources of
cash (principally bank debt and public debt) have been used to refinance
existing indebtedness and to fund acquisitions, new investments, equipment
additions and repurchases of Company common stock. The following table
summarizes consolidated operating cash flow information for the years ended
December 31, respectively (dollars in millions):
2002 2001 2000
--------- --------- ---------
Net income $ 57.2 $ 30.7 $ 380.5
Income from discontinued operations -- -- (363.8)
Depreciation and amortization 61.4 58.0 56.1
Equity in undistributed earnings (43.4) (27.1) (23.8)
Distributions from unconsolidated affiliates -- 3.0 5.0
Deferred income taxes 21.8 30.4 23.1
Gains on sales of properties and investments (20.1) (5.8) (3.4)
Tax benefit realized upon exercise of stock options 4.5 5.6 9.3
Change in working capital items 10.4 (41.2) (9.3)
Other 8.6 14.6 1.0
--------- --------- ---------
Net operating cash flow $ 100.4 $ 68.2 $ 74.7
========= ========= =========
Net operating cash flows for 2002 were $100.4 million compared to $68.2 million
in 2001 for an increase of $32.2 million. This increase was primarily
attributable to higher net income as well as changes in working capital items
related to collections on receivables partially offset by reductions in accounts
payable, accrued liabilities and deferred income taxes as well as fluctuations
in certain non-cash adjustments to net income.
Page 42
Net operating cash inflows for 2001 decreased $6.5 million over 2000. This
decrease was primarily attributable to changes in working capital balances
relating primarily to casualty payments and variances in the current tax
liability, lower cash flows related to the tax benefit associated with the
exercise of stock options, and increase in income from continuing operations and
fluctuations in certain non-cash adjustments to net income.
Investing Cash Flows. Net investing cash outflows were $34.9 million and $55.7
million during the years ended December 31, 2002 and 2001, respectively. This
variance of $20.8 million was primarily caused by an increase of $31.1
million of proceeds received from the sale of investments and a $3.8 million
decrease in investment in and loans to affiliates. In the first quarter of 2002,
the Company sold its 49% interest in Mexrail to TFM for approximately $31.4
million. The proceeds from the sale exceeded the Company's carrying value of
Mexrail by $11.2 million. The Company recognized a gain of $4.4 million on the
sale while the remaining $6.8 million in excess proceeds has been deferred. The
Company used the proceeds from the sale of Mexrail to reduce debt. These cash
inflows were partially offset by a $13.8 million increase in capital
expenditures compared to 2001.
Net investing cash outflows were $55.7 million and $101.8 million during the
years ended December 31, 2001 and 2000, respectively. This variance of $46.1
million was primarily the result of a $38.5 million decline in 2001 capital
expenditures and a $12.6 million increase in funds received from property
dispositions, partially offset by an increase in investments in and loans to
affiliates of $4.0 million. During the third quarter of 2001, the Company
entered into a sale/leaseback transaction whereby it sold 446 boxcars to a third
party for approximately $7.8 million. The Company realized a $4.7 million gain
on this transaction, which has been deferred and will be recognized ratably over
the lease term. The proceeds received from the sale of these boxcars were
included as funds received from property dispositions in the accompanying cash
flow statement and were used to reduce the Company's outstanding debt.
Cash used for property acquisitions was $79.8, $66.0 and $104.5 million in 2002,
2001 and 2000, respectively. Cash used for investments in and loans to
affiliates was $4.4, $8.2 and $4.2 million in 2002, 2001 and 2000, respectively.
Proceeds from the disposals of property were $18.1, $18.1, and $5.5 million in
2002, 2001 and 2000, respectively.
Generally, operating cash flows and borrowings under lines of credit have been
used to finance property acquisitions and investments in and loans to
affiliates.
Financing Cash Flows. Financing cash outflows are used primarily for the
repayment of debt while financing cash inflows are generated from proceeds from
the issuance of long-term debt and proceeds from the issuance of common stock
under employee stock plans. Also included in financing cash flows are
fluctuations in long-term liability accounts including long-term personal injury
reserves. Financing cash flows for 2002, 2001, and 2000 were as follows:
o Borrowings of $200, $35, and $1,052 million in 2002, 2001 and 2000,
respectively. Proceeds from the issuance of debt in June 2002 were used to
refinance term debt. In 2001, borrowings under the Company's revolving
credit facility were used to make payments on the term debt. Proceeds from
the issuance of debt in 2000 were used for refinancing debt in January and
September 2000.
o Repayment of indebtedness in the amounts of $270.9, $51.3 and $1,015.4
million in 2002, 2001 and 2000, respectively. Repayment of indebtedness is
generally funded through operating cash flows and proceeds from the
disposals of property. In 2002, the repayment of indebtedness was funded
from the proceeds from the issuance of debt as well as operating cash flows
and proceeds from the disposals of certain assets. In 2001, the repayment
of indebtedness was funded through borrowings under the Company's revolving
credit facility, as well as operating cash flows and proceeds from the
disposals of property. In 2000, repayments of debt included the refinancing
of debt in January and September 2000.
o Payment of debt issuance costs of $5.7, $0.4, and $17.6 million in 2002,
2001 and 2000, respectively. In 2002, the Company paid $5.7 million of debt
issuance costs related to the $200 million offering of 7 1/2% Notes in June
of 2002. During the year ended December 31, 2000, the Company paid $17.6
million of debt issuance costs including $13.4 million associated with the
January 2000 restructuring of the Company's debt and approximately $4.2
million associated with the $200 million offering of 9 1/2% Notes in the
third quarter of 2000.
Page 43
o Proceeds from the sale of KCS common stock pursuant to employee stock plans
of $10.3, $8.9 and $17.9 million in 2002, 2001 and 2000, respectively.
o Payment of cash dividends of $0.2, $0.2 and $4.8 million in 2002, 2001 and
2000, respectively.
o Net accruals (payments) of long-term casualty claims of $3.4, ($2.1), and
($1.5) million in 2002, 2001, and 2000, respectively.
Contractual Obligations. The following table outlines the Company's obligations
for payments under its capital leases, debt obligations and operating leases for
the periods indicated. Typically, payments for these obligations are funded
through operating cash flows. If operating cash flows are not sufficient, funds
received from other sources, including property and other asset dispositions,
might also be available. Additionally, the Company anticipates refinancing
certain of its long-term debt maturing in 2006 and 2008 prior to maturity
(dollars in millions).
Capital Leases Operating Leases
------------------------------------- -------------------------------------
Minimum Net Long-
Lease Less Present Term Total Southern Third
Payments Interest Value Debt Debt Capital Party Total
---------- ---------- ---------- ----------- ---------- ---------- ---------- ----------
2003 $ 0.7 $ 0.1 $ 0.6 $ 9.4 $ 10.0 $ 34.1 $ 26.1 $ 60.2
2004 0.6 0.2 0.4 9.4 9.8 30.7 22.1 52.8
2005 0.5 0.1 0.4 8.7 9.1 27.0 16.4 43.4
2006 0.4 0.1 0.3 7.6 7.9 26.4 15.3 41.7
2007 0.3 0.1 0.2 72.7 72.9 21.9 15.2 37.1
Later years 0.6 0.0 0.6 472.3 472.9 151.3 58.8 210.1
---------- ---------- ---------- ----------- ---------- ---------- ---------- ----------
Total $ 3.1 $ 0.6 $ 2.5 $ 580.1 $ 582.6 $ 291.4 $ 153.9 $ 445.3
========== ========== ========== =========== ========== ========== ========== ==========
CAPITAL EXPENDITURE REQUIREMENTS
Capital improvements for KCSR roadway track structures have historically been
funded with cash flows from operations and external debt. The Company has
traditionally used equipment trust certificates for major purchases of
locomotives and rolling stock, while using internally generated cash flows or
leasing for other equipment. Through its Southern Capital joint venture, the
Company has the ability to finance railroad equipment, and therefore, has
increasingly used lease-financing alternatives for its locomotives and rolling
stock. As discussed in "Recent Events - Debt Refinancing," Southern Capital
refinanced the outstanding balance of its bridge loan through the issuance of
approximately $167.6 million of pass through trust certificates and the sale of
50 locomotives.
Internally generated cash flows and borrowings under the Company's lines of
credit were used to finance capital expenditures (property acquisitions) of
$79.8 million, $66.0 million and $104.5 million in 2002, 2001 and 2000,
respectively. Internally generated cash flows and borrowings are expected to be
used to fund capital programs for 2003, currently estimated at approximately $79
million.
KCSR MAINTENANCE
KCSR, like all railroads, is required to maintain its own property
infrastructure. Portions of roadway and equipment maintenance costs are
capitalized and other portions are expensed (as components of material and
supplies, purchased services and others), as appropriate. Maintenance and
capital improvement programs are in conformity with the Federal Railroad
Administration's track standards and are accounted for in accordance with
applicable regulatory accounting rules. Management expects to continue to fund
roadway and equipment maintenance expenditures with internally generated cash
flows. Maintenance expenses (exclusive of amounts capitalized) for way and
structure (roadbed, rail, ties, bridges, etc.) and equipment (locomotives and
rail cars) for the three years ended December 31, 2002, 2001 and 2000,
respectively, as a percentage of KCSR revenues were as follows (dollars in
millions):
Page 44
KCSR Maintenance
----------------------------------------------------------
Way and Structure Equipment
----------------------- -----------------------
Percent of Percent of
Amount Revenue Amount Revenue
-------- ---------- -------- ----------
2002 $ 43.6 7.7% $ 48.2 8.5%
2001 43.9 7.5 44.8 7.7
2000 39.8 6.9 44.3 7.7
CAPITAL STRUCTURE
Components of the Company's capital structure are as follows (dollars in
millions).
2002 2001 2000
-------- -------- --------
Debt due within one year $ 10.0 $ 46.7 $ 36.2
Long-term debt 572.6 611.7 638.4
-------- -------- --------
Total debt 582.6 658.4 674.6
Stockholders' equity 752.9 680.3 643.4
-------- -------- --------
Total debt plus equity $1,335.5 $1,338.7 $1,318.0
======== ======== ========
Total debt as a percent of
Total debt plus equity ("debt ratio") 43.6% 49.2% 51.2%
-------- -------- --------
The Company's consolidated debt ratio as of December 31, 2002 decreased 5.6
percentage points compared to December 31, 2001. Total consolidated debt
decreased $75.8 million as a result of net repayments of long-term debt and the
elimination of $4.9 million of debt as a result of the sale of WGC.
Stockholders' equity increased $72.6 million as a result of 2002 net income of
$57.2 million and the issuance of common stock under employee stock plans
partially offset by dividends on preferred stock. This increase in stockholders'
equity coupled with the decrease in debt resulted in the continued decline in
the debt ratio from December 31, 2001.
The Company's consolidated debt ratio as of December 31, 2001 decreased 2.0
percentage points compared to December 31, 2000. Total debt decreased $16.2
million as a result of net repayments of long-term debt. Stockholders' equity
increased $36.9 million as a result of 2001 net income of $30.7 million, and the
issuance of common stock under employee stock plans partially offset by
dividends on preferred stock and a reduction of equity related to accumulated
comprehensive income arising from a SFAS 133 adjustment related to our
unconsolidated affiliate, Southern Capital. The increase in stockholders' equity
coupled with the decrease in debt resulted in the decline in the debt ratio from
December 31, 2000.
Under the existing capital structure of KCS at December 31, 2002, management
anticipates that the ratio of debt to total capitalization will decline slightly
during 2003 as a result of net debt repayments and an increase to stockholders'
equity.
Registration of 7 1/2% Senior Unsecured Notes. On June 12, 2002, KCSR issued
$200 million of 7 1/2% senior notes due June 15, 2009 through a private offering
pursuant to rule 144A under the Securities Act of 1933 in the United States and
Regulation S outside the United States. On July 12, 2002, KCSR submitted a Form
S-4 Registration Statement to the SEC as amended on July 24, 2002, relative to
an Exchange Offer for the $200 million 7 1/2% senior notes due 2009 as described
above in "Recent Developments - Debt Refinancing - 7 1/2% Senior Notes."
KCS Credit Agreement. In June 2002, the Company entered into a new credit
agreement as described above in "Recent Developments - Debt Refinancing - New
Credit Agreement."
Page 45
Refinance of Southern Capital Bridge Loan. On June 25, 2002, Southern Capital
refinanced the outstanding balance of its bridge loan through the issuance of
approximately $167.6 million of pass through trust certificates and the sale of
50 locomotives as described above in "Recent Developments - Debt Refinancing -
Southern Capital."
Registration of 9 1/2% Senior Unsecured Notes. During the third quarter of 2000,
KCSR completed a $200 million private offering of debt securities. On January
25, 2001, KCSR filed a Form S-4 Registration Statement with the SEC relative to
an Exchange Offer for the $200 million 9 1/2% Senior unsecured notes due 2008 as
described above in "Significant Developments - Debt Refinancing and
Re-capitalization of the Company's Debt Structure - Registration of Senior
Unsecured Notes."
OVERALL LIQUIDITY
The Company has financing available under the Revolver with a maximum borrowing
amount of $100 million. As of December 31, 2002, all $100 million was available
under the Revolver. The New Credit Agreement contains, among other provisions,
various financial covenants. The Company was in compliance with these
provisions, including the financial covenants as of December 31, 2002 and
expects to be in compliance throughout 2003. As a result of these financial
covenants, the Company's borrowings under the Revolver may be restricted. See
below for discussion of the possibility of the Company requesting a waiver from
these financial covenants during 2003. Also see "Recent Developments - Debt
Refinancing."
As discussed in Item 1, "Business - Rail Network - Significant Investments -
Grupo TFM," Grupo TMM and KCS, or either Grupo TMM or KCS, could be required to
purchase the Mexican government's interest in TFM. However, this provision is
not exercisable prior to October 31, 2003 without the consent of Grupo TFM. 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 $485.0 million as of December 31, 2002. The
Company is exploring various alternatives for financing this transaction. 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. In conjunction with exploring various
alternatives for financing this transaction, the Company anticipates requesting
a waiver from existing financial covenants in the New Credit Agreement to
provide flexibility in structuring the funding for this transaction. Although,
the Company's current cash position would allow it to meet its financial
covenants as of March 31, 2003, management has decided to seek this waiver in
order to permit the Company to retain this cash pending its analysis of
financing alternatives for this transaction.
As discussed in "Significant Developments - Shelf Registration Statements and
Public Securities Offerings," the Company filed the Initial Shelf on Form S-3
(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 has carried forward $200 million
aggregate amount of unsold securities from the Initial Shelf to the Second Shelf
filed on Form S-3 (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 remains available under the Second Shelf. To
date, no securities have been issued under either the Initial Shelf or Second
Shelf.
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 (see comment above with respect to purchase of Mexican
government's 20% interest in TFM). 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 can be
impacted by independent rating agencies, which assign debt ratings based on
certain credit measurements such as interest coverage and leverage ratios.
Page 46
CRITICAL ACCOUNTING ESTIMATES
The accounting and financial reporting policies of the Company are in conformity
with U.S. GAAP. The preparation of financial statements in conformity with U.S.
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting period. Management has
discussed the development and selection of the critical accounting estimates
discussed herein related to the recoverability and useful lives of assets as
well as liabilities for litigation, environmental remediation, casualty claims,
and income taxes with the audit committee of the Company's Board of Directors
and the audit committee has reviewed the Company's related disclosures herein.
Depreciation of Property, Plant and Equipment
The railroad industry is extremely capital intensive. Plant maintenance and the
depreciation of operating assets constitutes a substantial operating cost for
the Company, as well as the railroad industry as a whole. The Company
capitalizes property, plant and equipment and depreciates it consistent with
industry standards and rules established by the STB. The cost of property, plant
and equipment normally retired, less salvage value, is charged to depreciation
expense over the estimated life of the operating assets using composite
straight-line rates for financial statement purposes. The STB approves the
depreciation rates used by KCSR (excluding the amortization of computer
software). KCSR periodically conducts studies of depreciation rates for
properties and equipment and implements approved changes, as necessary, to
depreciation rates. These studies take into consideration the historical
retirement experience of similar assets, the current condition of the assets,
current operations and potential changes in technology, estimated salvage value
of the assets, and industry regulations. For all other consolidated
subsidiaries, depreciation is derived based upon the asset value in excess of
estimated salvage value using the straight-line method over the estimated useful
lives of the assets for financial reporting purposes. Depreciation is based upon
estimates of the useful lives of assets as well as their net salvage value at
the end of their useful lives. Estimation of the useful lives of assets that are
long-lived as well as their salvage value requires significant management
judgement. Accordingly, management believes that accounting estimates related to
depreciation expense are critical.
For the years ended December 31, 2002, 2001 and 2000, no significant changes
have been made to the depreciation rates applied to operating assets, the
underlying assumptions related to estimates of depreciation, or the methodology
applied. Currently, the Company depreciates its operating assets, including road
and structures, rolling stock and equipment, and capitalized leases over a range
of 3 to 100 years, depending upon the estimated life of the particular asset.
The Company amortizes computer software over a range of 3 to 12 years, depending
upon the estimated useful life of the software. However, certain events could
occur that would materially effect the Company's estimates and assumptions
related to depreciation. Unforeseen changes in operations or technology could
substantially alter management's assumptions regarding the Company's ability to
realize the return of its investment in operating assets and therefore affect
the amount of depreciation expense to charge against both current and future
revenues. Because depreciation expense is a function of analytical studies made
of property, plant and equipment, subsequent studies could result in different
estimates of useful lives and net salvage values. If future depreciation studies
yield results indicating that the Company's assets have shorter lives as a
result of obsolescence, physical condition, changes in technology or changes in
net salvage values, the estimate of depreciation expense could increase.
Likewise, if studies indicate that assets have longer lives, the estimate of
depreciation expense could decrease. For the year ended December 31, 2002,
consolidated depreciation expense was $61.4 million, representing 11.8% of
consolidated operating expenses. If the estimated lives of all assets being
depreciated were increased by one year, the consolidated depreciation expense
would have decreased by approximately $2.4 million or 3.9%. If the estimated
lives of all assets being depreciated were decreased by one year, the
consolidated depreciation expense would have increased by approximately $2.6
million or 4.2%.
Provision for Environmental Remediation
The Company's operations are subject to extensive federal, state and local
environmental laws and regulations. The major environmental laws to which the
Company is subject, include, among others, the Federal Comprehensive
Environmental Response, Compensation and Liability Act ("CERCLA," also known as
the Superfund law), the Toxic Substances Control Act, the Federal Water
Pollution Control Act, and the Hazardous Materials Transportation Act. CERCLA
can impose joint and several liability for cleanup and investigation costs,
without regard to fault or legality of
Page 47
the original conduct, on current and predecessor owners and operators of a site,
as well as those who generate, or arrange for the disposal of, hazardous
substances. The risk of incurring environmental liability is inherent in the
railroad industry. The Company owns property that is, or has been, used for
industrial purposes. Use of these properties may subject the Company to
potentially material liabilities relating to the investigation and cleanup of
contaminants, claims alleging personal injury, or property damage as the result
of exposures to, or release of, hazardous substances.
The Company conducts studies, as well as site surveys, to determine the extent
of environmental damage and determine the necessary requirements to remediate
this damage. These studies incorporate the analysis of our internal
environmental engineering staff and consultation with legal counsel. From these
studies and surveys, a range of estimates of the costs involved is derived and a
liability and related expense for environmental remediation is recorded within
this range. The Company's recorded liabilities for these issues represent its
best estimates (on an undiscounted basis) of remediation and restoration costs
that may be required to comply with present laws and regulations. These
estimates are based on forecasts of the total future direct costs related to
environmental remediation. These estimates change periodically as additional or
better information becomes available as to the extent of site remediation
required, if any. In addition, advanced technologies related to the detection,
appropriate remedial course of action and anticipated cost can influence these
estimates. Certain changes could occur that would materially effect the
Company's estimates and assumptions related to costs for environmental
remediation. If the Company becomes subject to more stringent environmental
remediation costs at known sites, if the Company discovers additional
contamination, discovers previously unknown sites, or becomes subject to related
personal or property damage, the Company could incur material costs in
connection with its environmental remediation. Accordingly, management believes
that estimates related to the accrual of environmental remediation liabilities
are critical to the Company's results of operations.
For the year ended December 31, 2002, the expense related to environmental
remediation was $2.4 million and is included as purchased services expense on
the consolidated statements of income. Additionally, as of December 31, 2002,
the Company has a total liability recorded for environmental remediation of $5.4
million. This amount was derived from a range of reasonable estimates based upon
the Company's studies and site surveys described above and in accordance with
Statement of Financial Accounting Standards No. 5 "Accounting for Contingencies"
("SFAS 5"). For environmental remediation sites known as of December 31, 2002,
if the highest estimate from the range (based upon information presently
available) were recorded, the total estimated liability would have increased
$3.7 million in 2002.
Provision for Casualty Claims
Due to the nature of railroad operations, claims related to personal injuries,
or third party liability resulting from crossing collisions as well as claims
related to damage to personal property and other casualties, is a substantial
expense to the Company. For personal injury claims, employees are compensated
for work related injuries according to provisions contained within the Federal
Employers Liability Act. ("FELA"). Claims are estimated and recorded for known
reported occurrences as well as for incurred but not reported ("IBNR")
occurrences. Consistent with the general practice within the railroad industry,
the Company's estimated liability for these casualty expenses is actuarially
determined on an undiscounted basis. In estimating the liability for casualty
claims, the Company obtains an estimate from an independent third party
actuarial firm, which calculates an estimate using historical experiences and
estimates of claim costs as well as numerous assumptions regarding factors
relevant to the derivation of an estimate of future claim costs. For other
occupational injury claims, an assessment is made on a case-by-case basis in
accordance with SFAS 5.
Personal injury and casualty claims are subject to a significant degree of
uncertainty, especially estimates related to IBNR personal injuries as a party
has yet to assert a claim and therefore the degree to which injuries have been
incurred and the related costs have not yet been determined. Additionally, in
estimating costs related to casualty claims, management must make assumptions
regarding future costs. The cost of casualty claims is significantly related to
numerous factors, including the severity of the injury, the age of the claimant,
and the legal jurisdiction. Therefore, in deriving an estimation of the
provision for casualty claims, management must make assumptions related to
substantially uncertain matters. Additionally, changes in the assumptions made
in actuarial studies could potentially have a material effect on the estimate of
the provision for casualty claims. Accordingly, management believes that the
accounting estimate related to the liability for personal injuries and other
casualty claims is critical to the Company's results of operations.
Page 48
During the year ended December 31, 2001, the Company modified its approach
towards employee and third party personal injury liabilities. Prior to 2001, the
Company's strategy had been to challenge claimants and prolong litigation,
thereby potentially increasing the long-term costs of the incident. In 2001, the
Company decided to aggressively pursue settlement options of open claims when
warranted, thereby reducing legal costs and ultimately overall casualty expense.
This change in approach towards claim settlement led to substantial payments to
claimants in 2001 for 2001 and prior year casualty incidents. While this
significantly impacted the Company's 2001 casualty expense and related liability
accounts, we believe this methodology has the Company better positioned to
control its ongoing casualty expense.
Additionally, this change in approach towards claim settlement also led to
changes in assumptions relating to the actuarial study conducted in order to
estimate future claims cost and estimate an adequate reserve for casualty losses
incurred.
For the year ended December 31, 2002, the provision for casualty events was
approximately $15.3 million and was included in casualties and insurance expense
in the consolidated statements of income. Additionally, as of December 31, 2002,
the Company had a total liability recorded for casualty claims of approximately
$36.9 million. For the year ended December 31, 2002, the provision for casualty
expense represented 2.7% of consolidated operating expenses. For purposes of
earnings sensitivity analysis, if the December 31, 2002 reserve were adjusted
(increased or decreased) 10%, casualty expense would have changed $3.7 million.
Provision for Income Taxes
Deferred income taxes represent a substantial liability of the Company. For
financial reporting purposes, the Company's management determines the Company's
current tax liability as well as those taxes incurred as a result of current
operations yet deferred until future periods. In accordance with the liability
method of accounting for income taxes as specified in Statement of Financial
Accounting Standards No. 109 "Accounting for Income Taxes," the provision for
income taxes is the sum of income taxes both currently payable and deferred.
Currently payable income taxes represent the liability related to the Company's
income tax return for the current year while the net deferred tax expense or
benefit represents the change in the balance of deferred tax assets or
liabilities as reported on the balance sheet. The changes in deferred tax assets
and liabilities are determined based upon the changes in differences between the
basis of assets and liabilities for financial reporting purposes and the basis
of assets and liabilities for tax purposes as measured by the enacted tax rates
that management estimates will be in effect when these differences reverse. In
addition to estimating the future tax rates applicable to the reversal of tax
differences, management must also make certain assumptions regarding whether tax
differences are permanent or temporary. If the differences are temporary,
management must estimate the timing of their reversal, and whether taxable
operating income in future periods will be sufficient to fully recognize any
gross deferred tax assets of the Company. Accordingly, management believes that
the estimate related to the provision for income taxes is critical to the
Company's results of operations.
For the years ended December 31, 2002, 2001, and 2000, management made no
material changes in its assumptions regarding the determination of the provision
for income taxes. However, certain events could occur that would materially
affect the Company's estimates and assumptions regarding deferred taxes. Changes
in current tax laws and applicable enacted tax rates could affect the valuation
of deferred tax assets and liabilities, thereby impacting the Company's income
tax provision. Additionally, significant declines in taxable operating income
could materially impact the realizable value of deferred tax assets.
As of December 31, 2002, the Company's financial reporting basis exceeded the
tax basis of its investment in Grupo TFM by $79.4 million. Management has not
provided a deferred income tax liability for the income taxes, if any, that
would become payable upon the realization of this basis difference as the
Company intends to reinvest in Grupo TFM the financial statement earnings that
yielded the basis difference. Likewise the Company has no plans to realize this
basis differential by a sale of its investment in Grupo TFM. If management were
to change this assumption in determining its provision for deferred taxes, the
impact on earnings could be significant. If the Company were to realize this
basis difference in the future by a receipt of dividends or the sale of its
investment in Grupo TFM, as of December 31, 2002, the Company could incur
additional gross federal income taxes of approximately $27.8 million, which may
be partially or fully offset by Mexican income taxes and could be available to
reduce federal income taxes at such time.
For the year ended December 31, 2002, the Company's provision for income taxes
was $6.9 million consisting of ($14.9) million for the current tax benefit and
$21.8 million for the deferred tax expense. Changes in management's estimates
Page 49
and assumptions regarding the enacted tax rate applied to deferred tax assets
and liabilities, the ability to realize the value of deferred tax assets, or the
timing of the reversal of tax basis differences could potentially impact the
provision for income taxes. Changes in these assumptions could potentially
change the effective tax rate. A 1% change in the effective tax rate from 37.7%
(exclusive of the equity in earnings of Grupo TFM - see "Results of Operations -
Income Tax Expense") to 38.7% would increase the current year income tax
provision $0.2 million.
Equity in Net Earnings of Grupo TFM
Equity in the earnings of unconsolidated affiliates is a significant component
of the Company's net income. For financial reporting purposes, the Company
records equity in the net earnings of its unconsolidated affiliates in
accordance with the provisions of Accounting Principles Board Opinion No. 18
"The Equity Method of Accounting for Investments in Common Stock." For the
Company's investment in Grupo TFM, the equity in net earnings recorded by the
Company is materially impacted by estimates included in Grupo TFM's tax
computation. These estimates are dependent to a certain extent on changes in
Mexican tax rates, fluctuations in the Mexican rate of inflation and changes in
the exchange rate between the U.S. dollar and the Mexican peso. To determine the
income tax provision (benefit) and the value of deferred tax assets and
liabilities, Grupo TFM and KCS management must make assumptions and estimates
related to material amounts into the future. Accordingly, management of the
Company believes that the accounting estimate made by Grupo TFM and KCS
management related to Grupo TFM's provision for income taxes is a "critical
accounting estimate" due to its significant impact on the Company's results of
operations.
For the years ended December 31, 2001 and 2000, there were no material changes
in the assumptions regarding the determination of the provision for income taxes
for Grupo TFM. Effective January 1, 2002, Mexico implemented changes in its
income tax laws that had an impact on the Company's equity in Grupo TFM's
earnings reported under the equity method of accounting. Beginning in 2003, the
Mexican corporate income tax rate will be reduced from 35% to 32% in one-percent
increments over the next four years. As a result of this change in tax rates,
management's assumptions and estimates related to the value of Grupo TFM's net
tax asset changed, and the value of Grupo TFM's tax asset was reduced by
approximately $7.6 million in the year ended December 31, 2002 resulting in an
impact of approximately $2.8 million to the Company. The provision for income
taxes and the value of Grupo TFM's net deferred tax assets could further be
impacted by changes in the rate of inflation in Mexico, provisions within
Mexican tax law that provide for inflation indexation for tax purposes, as well
as changes in the exchange rate between the U.S. dollar and the Mexican peso.
Changes in these estimates could have a material impact on the Company's equity
in earnings in Grupo TFM.
OTHER
Significant Customer. Southwestern Electric Power Company ("SWEPCO") is the
Company's only customer that accounted for more than 10% of revenues during the
years ended December 31, 2002, 2001, and 2000, respectively. SWEPCO is a
subsidiary of American Electric Power, Inc. Revenues related to SWEPCO during
these periods were $64.7, $75.9, and $67.2 million, respectively. KCSR coal
revenues declined in 2002 as a result of a contractual rate reduction for
SWEPCO, which became effective on January 1, 2002.
Derivative Instruments and Purchase Commitments. Fuel expense is a significant
component of the Company's operating expenses. Fuel costs are affected by (i)
traffic levels, (ii) efficiency of operations and equipment, and (iii) fuel
market conditions. Controlling fuel expenses is a top priority of management. As
a result, from time to time, the Company will enter into transactions to hedge
against fluctuations in the price of its diesel fuel purchases to protect the
Company's operating results against adverse fluctuations in fuel prices. KCSR
enters into forward diesel fuel purchase commitments and commodity swap
transactions (fuel swaps or caps) as a means of fixing future fuel prices.
Commodity swap or cap transactions are accounted for as hedges under SFAS 133
and are correlated to market benchmarks. Positions are monitored to ensure that
they will not exceed actual fuel requirements in any period. See Item 7A,
"Quantitative and Qualitative Disclosures About Market Risk" for further
information with respect to these fuel transactions.
Page 50
At December 31, 2001 the Company had five separate interest rate cap agreements
for an aggregate notional amount of $200 million. These interest rate cap
agreements expired during 2002. See "Significant Developments - Implementation
of Derivative Standard" and Item 7A, "Quantitative and Qualitative Disclosures
About Market Risk" for discussion of these interest rate cap transactions. As of
December 31, 2002, the Company did not have any interest rate cap agreements or
interest rate hedging instruments.
Derivative transactions entered into by the Company are intended to mitigate the
impact of rising fuel prices and interest rates and, if applicable, are recorded
using the accounting policies as set forth in Item 8, "Financial Statements and
Supplementary Data - Note 2- Significant Accounting Policies" of this Form 10-K.
In general, the Company enters into transactions such as those discussed above
in limited situations based on management's assessment of current market
conditions and perceived risks. Historically, the Company has engaged in a
limited number of such transactions and their impact has been insignificant.
However, the Company intends to respond to evolving business and market
conditions in order to manage risks and exposures associated with the Company's
various operations, and in doing so, may enter into transactions similar to
those discussed above.
Foreign Exchange Matters. In connection with the Company's investment in Grupo
TFM, matters arise with respect to financial accounting and reporting for
foreign currency transactions and for translating foreign currency transactions
into U.S. dollars. The Company follows the requirements outlined in Statement of
Financial Accounting Standards No. 52 "Foreign Currency Translation" ("SFAS
52"), and related authoritative guidance. The Company uses the U.S. dollar as
the functional currency for Grupo TFM. Equity earnings (losses) from Grupo TFM
included in the Company's results of operations reflect the Company's share of
any such translation gains and losses that Grupo TFM records in the process of
translating certain transactions from Mexican pesos to U.S. dollars. Results of
the Company's investment in Grupo TFM are reported under U.S. GAAP while Grupo
TFM reports its financial results under IAS. Because the Company is required to
report its equity 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.
The Company continues to evaluate existing alternatives with respect to
utilizing foreign currency instruments to hedge its U.S. dollar investment in
Grupo TFM as market conditions change or exchange rates fluctuate. At December
31, 2002, 2001and 2000, the Company had no outstanding foreign currency hedging
instruments.
New Accounting Pronouncements. Effective January 1, 2002, the Company
implemented Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"). SFAS 142 provides, among other things,
that goodwill with an indefinite life shall no longer be amortized, but shall be
evaluated for impairment on an annual basis. SFAS 142 also requires separate
presentation of goodwill on the balance sheet and impairment losses are to be
shown as a separate item on the income statement. Additionally, changes in the
carrying amount of goodwill should be disclosed in the footnotes to the
financial statements. SFAS 142 also requires various transitional disclosures
until all periods presented reflect the provisions of SFAS 142. These
transitional disclosures include the presentation of net income and earnings per
share information adjusted to exclude amortization expense (including the
related income tax effects) for all periods presented. These transitional
disclosures are presented in the table below.
The Company has presented its goodwill as a separate line item in the
accompanying balance sheets. Additionally, the Company has performed its
goodwill impairment test and determined that existing goodwill is not impaired.
During the year ended December 31, 2002, the Company's goodwill decreased $8.5
million due to the sale of Mexrail to TFM and $0.2 million due to the sale of
WGC.
Page 51
Year Ended December 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
Reported income from continuing operations $ 57.2 $ 31.1 $ 16.7
Add back: Goodwill amortization -- 0.6 0.6
--------- --------- ---------
Adjusted income from continuing operations $ 57.2 $ 31.7 $ 17.3
========= ========= =========
Reported income from discontinued operations $ -- $ -- $ 363.8
Add back: Goodwill amortization -- -- 5.7
--------- --------- ---------
Adjusted income from discontinued operations $ -- $ -- $ 369.5
========= ========= =========
Reported net income $ 57.2 $ 30.7 $ 380.5
Add back: Goodwill amortization -- 0.6 6.3
--------- --------- ---------
Adjusted net income $ 57.2 $ 31.3 $ 386.8
========= ========= =========
Reported diluted earnings per share from
Continuing operations $ 0.91 $ 0.51 $ 0.28
Add back: Goodwill amortization -- 0.01 0.01
--------- --------- ---------
Adjusted diluted earnings per share from
Continuing operations $ 0.91 $ 0.52 $ 0.29
========= ========= =========
Reported diluted earnings per share from
Discontinued operations $ -- $ -- $ 6.14
Add back: Goodwill amortization -- -- 0.10
--------- --------- ---------
Adjusted diluted earnings per share from
Discontinued operations $ -- $ -- $ 6.24
========= ========= =========
Reported diluted earnings per share - net income $ 0.91 $ 0.50 $ 6.42
Add back: Goodwill amortization -- 0.01 0.11
--------- --------- ---------
Adjusted diluted earnings per share - net income $ 0.91 $ 0.51 $ 6.53
========= ========= =========
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 regulation
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 new requirements of SFAS 143, in the
absence of a legal obligation to remove the track structure, such accounting
practice is not allowed. In the opinion of management, a legal obligation to
remove track structure does not exist. Accordingly, the Company is currently
reviewing 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. To the extent that accumulated depreciation
includes amounts related to instances of excess depreciation, a cumulative
effect adjustment will be recorded to reflect the change in accounting principle
required by SFAS 143 in the first quarter of 2003. Additionally, future
depreciation rates applied to certain track structure elements that were
previously yielding a negative salvage value will be modified to comply with the
provisions of SFAS 143. The Company intends to adopt the provisions of SFAS 143
in the first quarter of 2003. The Company is currently assessing the potential
impact of SFAS 143 on its consolidated results of operations, financial
position, and cash flows.
In June 2002, the FASB issued Statement No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 is effective for exit
or disposal activities that are initiated after December 31, 2002. Under SFAS
146, a liability for a cost associated with an exit or disposal activity must be
recognized when the liability is incurred. Previously, a liability for an exit
cost was recognized as of the date of an entity's commitment to an exit or
Page 52
disposal plan. The Company is currently evaluating the provisions of SFAS 146
and does not expect the adoption of this pronouncement to have a material impact
on its consolidated results of operations, financial position, or cash flows.
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. The Company is currently evaluating the provisions of SFAS
148 and, if adopted, does not expect it to have a material impact on its
consolidated results of operations, financial position, or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 provides guidance on
the accounting and disclosure requirements relating to the issuance of certain
types of guarantees and requires the guarantor to recognize at the inception of
a guarantee a liability for the fair value of the potential obligation. The
provisions for the initial recognition and measurement of guarantees are
effective prospectively for all guarantees issued or modified after December 31,
2002. The disclosure requirements under FIN 45 were effective for financial
statements for periods ending after December 15, 2002. KCS management does not
believe that the adoption of FIN 45 will have a material impact on its
consolidated results of operations, financial position, or cash flows. See Item
8, "Financial Statements and Supplementary Data - Note 5 and - Note 11 to the
Company's consolidated financial statements for disclosures of guarantees.
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. The Company
is currently assessing the potential impact of this accounting interpretation on
its method of accounting for unconsolidated subsidiaries and does not believe it
will have a material impact on its consolidated results of operations, financial
position, or cash flows.
Litigation. The Company and its subsidiaries are involved as plaintiff or
defendant in various legal actions arising in the normal course of business.
While the ultimate outcome of the various legal proceedings involving the
Company and its subsidiaries cannot be predicted with certainty, it is
management's opinion (after consultation with legal counsel) that the Company's
litigation reserves are adequate. See "Significant Developments - Bogalusa
Cases" and "Significant Developments - Duncan Case Settlement" for a discussion
of the dismissal and settlement of those cases, respectively. Additionally, see
"Significant Developments- Houston Cases" for a discussion of the ongoing
proceedings in that case. Also see "Recent Developments - Automobile Accident"
for discussion of a potential legal claim.
The Company also is a defendant in various matters brought primarily by current
and former employees and third parties for job related injury incidents or
crossing accidents. The Company is aggressively defending these matters and has
established liability reserves which management believes are adequate to cover
expected costs. Nevertheless, due to the inherent unpredictability of these
matters, the Company could incur substantial costs above reserved amounts.
Stilwell Tax Dispute. On November 19, 2002, Stilwell, now Janus Capital Group
Inc., filed a Statement of Claim against KCS with the American Arbitration
Association. This claim involves the entitlement to compensation expense
deductions for federal income tax purposes which are associated with the
exercise of certain stock options issued by Stilwell (the "Substituted Options")
in connection with the Spin-off of Stilwell from KCS on July 12, 2000. Stilwell
alleges that upon exercise of a Substituted Option, Stilwell is entitled to the
associated compensation expense deductions. Stilwell bases its claim on a
letter, dated August 17, 1999, addressed to Landon H. Rowland, Chairman,
President and Chief Executive Officer of Kansas City Southern Industries, Inc.
(the "Letter"), purporting to allow Stilwell to claim such deductions. The
Letter was signed by the Vice President and Tax Counsel of Stilwell, who was
also at the time the Senior Assistant Vice President and Tax Counsel of KCS, and
by Landon H. Rowland, currently a director of KCS and the non-executive Chairman
of Janus Capital Group Inc., who was at that time a director and officer of both
Stilwell and KCS.
Stilwell seeks a declaratory award and/or injunction ordering KCS to file and
amend its tax returns for the tax year 2000 and subsequent years to reflect that
KCS does not claim the associated compensation expense deductions and to
indemnify Stilwell against any related taxes imposed upon Stilwell, which
allegedly has taken, and plans to take, such
Page 53
deductions. On December 20, 2002, KCS filed an Objection to Stilwell's Demand
for Arbitration and Motion to Dismiss. KCS disputes the validity and
enforceability of the Letter. KCS asserts, among other things, that a Private
Letter Ruling issued by the Internal Revenue Service on July 9, 1999 provides
that KCS subsidiaries are entitled to compensation expense deductions upon
exercise of Substituted Options by their employees.
KCS has answered that the claims of Stilwell are without merit and intends to
vigorously defend against them. Given the early stage of the proceeding, KCS is
unable to predict the outcome, but does not expect this matter to result in any
material adverse financial consequences to KCS's net income in the event, which
it regards as unlikely, that it would not prevail.
Environmental Matters. As discussed above in "Critical Accounting Estimates,"
the Company's operations, as well as those of its competitors, are subject to
extensive federal, state and local environmental laws and regulations. Certain
laws and regulations can impose joint and several liability for cleanup and
investigation costs, without regard to fault or legality of the original
conduct, on current and predecessor owners and operators of a site, as well as
those who generate, or arrange for the disposal of, hazardous substances. The
Company does not foresee that compliance with the requirements imposed by the
environmental legislation will impair its competitive capability or result in
any material additional capital expenditures, operating or maintenance costs.
However, stricter environmental requirements relating to our business, which may
be imposed in the future, could result in significant additional costs.
The risk of incurring environmental liability is inherent in the railroad
industry. The Company's operations involve the use and, as part of serving the
petroleum and chemicals industry, transportation of significant quantities of
hazardous materials. The Company has a professional team available to respond
and handle environmental issues that might occur in the transport of such
materials. The Company also is a partner in the Responsible Care(R)
environmental program and, as a result, has initiated certain additional
environmental and safety practices. KCSR performs ongoing review and evaluation
of the various environmental programs and issues within the Company's
operations, and, as necessary, takes actions to limit the Company's exposure to
environmental liabilities.
Although the Company is responsible for investigating and remediating
contamination at several locations, based on currently available information,
the Company does not expect any related liabilities, individually or
collectively, to have a material impact on its results of operations, financial
position or cash flows. In the event that the Company becomes subject to more
stringent cleanup requirements at these sites, discovers additional
contamination, or becomes subject to related personal or property damage claims,
the Company could incur material costs in connection with these sites.
KCSR has been named a Potential Responsible Party (PRP) in connection with a
former foundry site in Alexandria, Louisiana. A small portion of this property
was owned through a former subsidiary during the years 1924 - 1974 and leased to
a foundry operator. The foundry operator, Ruston Foundry, ceased operations in
early 1990. The site is on the CERCLA National Priorities List of contaminated
sites. The United States Environmental Protection Agency has recently completed
a Record of Decision of the site. Management is in the process of evaluating the
potential impact with respect to this site and has recorded a $1.6 million
liability to provide for potential remediation costs at this site. Further
evaluation is ongoing and any remaining exposure is not expected to have a
material effect on the Company's results of operations, financial condition, or
cash flows.
In 1996, the Louisiana Department of Transportation ("LDOT") sued KCSR and a
number of other defendants in Louisiana state court to recover cleanup costs
incurred by LDOT while constructing Interstate Highway 49 at Shreveport,
Louisiana (Louisiana Department of Transportation v. The Kansas City Southern
Railway Company, et al., Case No. 417190-B in the First Judicial District Court,
Caddo Parish, Louisiana). The cleanup was associated with contamination in the
area of a former oil refinery site, operated by Crystal Refinery. KCSR's main
line was adjacent to that site. LDOT claims that a 1966 derailment contributed
to contamination at the site. However, KCSR management believes that KCSR's
liability exposure with respect to this site is remote.
Page 54
The Company is presently investigating and remediating environmental impacts
associated with historical roundhouse and fueling operations at KCSR rail yards
located in East St. Louis, Illinois; Venice, Illinois; Kansas City, Missouri;
Roodhouse, Illinois; and Mexico, Missouri. Management does not expect costs
relating to these activities to have a material effect on the Company's results
of operations, financial condition or cash flows.
The Company records liabilities for remediation and restoration costs related to
past activities when the Company's obligation is probable and the costs can be
reasonably estimated. Costs of ongoing compliance activities to current
operations are expensed as incurred. The Company's recorded liabilities with
respect to these various environmental issues represent its best estimates of
remediation and restoration costs that may be required to comply with present
laws and regulations. Although these costs cannot be predicted with certainty,
management believes that the ultimate outcome of identified matters will not
have a material adverse effect on the Company's consolidated results of
operations, financial condition, or cash flows.
Regulatory Influence. In addition to the environmental agencies mentioned above,
KCSR operations are regulated by the STB, various state regulatory agencies, and
the Occupational Safety and Health Administration ("OSHA"). State agencies
regulate some aspects of rail operations with respect to health and safety and
in some instances, intrastate freight rates. OSHA has jurisdiction over certain
health and safety features of railroad operations. The Company does not foresee
that regulatory compliance under present statutes will impair its competitive
capability or result in any material effect on its results of operations.
Inflation. Inflation has not had a significant impact on the Company's
operations in the past three years. Changes in fuel prices, however, impacted
our operating results in 2002, 2001 and 2000. During the two-year period ended
December 31, 1999, locomotive fuel expenses represented an average of 6.9% of
KCSR's total costs and expenses compared to 9.7% in 2000, 8.8% in 2001, and 7.7%
in 2002. U.S. GAAP requires the use of historical costs. Replacement cost and
related depreciation expense of the Company's property would be substantially
higher than the historical costs reported. Any increase in expenses from these
fixed costs, coupled with variable cost increases due to significant inflation,
would be difficult to recover through price increases given the competitive
environments of the Company's principal subsidiaries. See "Foreign Exchange
Matters" above with respect to inflation in Mexico.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company utilizes various financial instruments that have certain inherent
market risks. Generally, these instruments have not been entered into for
trading purposes. The following information, together with information included
in Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Item 8, "Financial Statements and Supplementary Data
- - Note 11" in this Form 10-K, describe the key aspects of certain financial
instruments that have market risk to the Company.
Interest Rate Sensitivity
The Company's floating-rate indebtedness totaled $149.3 million and $397.5
million at December 31, 2002 and 2001, respectively. The Company's variable rate
debt, comprised of a revolving credit facility and a term loan, accrues interest
based on target interest indexes (e.g., LIBOR, federal funds rate, etc.) plus an
applicable spread, as set forth in the credit agreement. See "Recent
Developments - Debt Refinancing - New Credit Agreement" for further information.
As a result of the refinancing of $200 million of variable rate debt with the 7
1/2% Notes, the Company has been able to reduce its sensitivity to fluctuations
in interest rates compared to previous years. However, given the balance of
$149.3 million variable rate debt at December 31, 2002, the Company is still
sensitive to fluctuations in interest rates. For example, a hypothetical 100
basis points increase in each of the respective target interest indexes would
result in additional interest expense of approximately $1.5 million on an
annualized basis for the floating-rate instruments held by the Company as of
December 31, 2002.
Based upon the borrowing rates available to KCS and its subsidiaries for
indebtedness with similar terms and average maturities, the fair value of the
Company's long-term debt was approximately $616.9 million at December 31, 2002
and $681 million at December 31, 2001.
Page 55
One of the Company's objectives is to manage its interest rate risk through the
use of derivative instruments. In 2000, the Company entered into five separate
interest rate cap agreements for an aggregate notional amount of $200 million,
which were designated as cash flow hedges. These interest rate cap agreements
were designed to hedge the Company's exposure to movements in the LIBOR on which
the Company's variable rate interest is calculated. $100 million of the
aggregate notional amount provided a cap on the Company's LIBOR based interest
rate of 7.25% plus the applicable spread, while $100 million limited the LIBOR
based interest rate to 7% plus the applicable spread. By holding these interest
rate cap agreements, the Company was able to limit the risk of rising interest
rates on its variable rate debt. These interest rate cap agreements expired
during 2002 and as of December 31, 2002, the Company did not have any other
interest rate cap agreements or interest rate hedging instruments.
Commodity Price Sensitivity
Fuel expense is a significant component of the Company's operating expenses.
Fuel costs are affected by (i) traffic levels, (ii) efficiency of operations and
equipment, and (iii) fuel market conditions. Controlling fuel expenses is a top
priority of management. As a result, from time to time, the Company will enter
into transactions to hedge against fluctuations in the price of its diesel fuel
purchases to protect the Company's operating results against adverse
fluctuations in fuel prices. KCSR enters into forward diesel fuel purchase
commitments and commodity swap transactions (fuel swaps or caps) as a means of
fixing future fuel prices. Forward purchase commitments are used to secure fuel
volumes at competitive prices. These contracts normally require the Company to
purchase defined quantities of diesel fuel at prices established at the
origination of the contract. Commodity swap or cap transactions are accounted
for as hedges under SFAS 133 and are typically based on the price of heating oil
#2, which the Company believes to produce a high correlation to the price of
diesel fuel. These transactions are generally settled monthly in cash with the
counterparty. Positions are monitored to ensure that they will not exceed actual
fuel requirements in any period.
At December 31, 1999, the Company was party to two diesel fuel cap transactions
for a total of six million gallons (approximately 10% of expected 2000 usage) at
a cap price of $0.60 per gallon. The contract prices for these diesel fuel cap
transactions did not include taxes, transportation costs or other incremental
fuel handling costs. These hedging instruments expired during 2000. The Company
received approximately $0.8 million during 2000 related to these diesel fuel cap
transactions and recorded the proceeds as a reduction of diesel fuel expenses.
At December 31, 1999, the Company did not have any outstanding purchase
commitments for 2000. At December 31, 2000, KCSR had purchase commitments for
approximately 12.6% of budgeted gallons of fuel for 2001, which resulted in
higher fuel expense of approximately $0.4 million in 2001. There were no fuel
swap or cap transactions outstanding at December 31, 2000. At December 31, 2001,
KCSR had purchase commitments for approximately 39% of its budgeted gallons of
fuel for 2002, which resulted in a decrease in fuel expenses of approximately
$0.4 million in 2002. There were no diesel fuel cap or swap transactions
outstanding as of December 31, 2001. At December 31, 2002, KCSR had purchase
commitments and was a party to a fuel swap transaction, which, on a combined
basis, resulted in approximately 21% of expected 2003 diesel fuel usage. On
January 14, 2003, KCSR entered into an additional fuel swap transaction, which
raised the total hedged gallons to approximately 25% of budgeted 2003 diesel
fuel usage. KCSR is also a party to swap transactions for approximately 2.5
million gallons of fuel for 2004. The commodity swap transaction entered into
prior to December 31, 2002 is recorded on the accompanying balance sheet at its
fair market value, which approximates $0.2 million at December 31, 2002. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Other - Derivative Instruments and Purchase Commitments."
The excess of payments to be received or savings to be realized over the current
market price at December 31, 2002 related to the diesel fuel purchase
commitments and fuel swap transactions approximated $1.8 million and $0.6
million, respectively, at December 31, 2002. The excess of current market prices
for diesel fuel purchase commitments over the payments to be made under such
commitments approximated $2.6 million at December 31, 2001. A hypothetical 10%
increase in the price of diesel fuel would have resulted in additional fuel
expense of approximately $3.8 million for the year ended December 31, 2002.
Page 56
At December 31, 2002, the Company held fuel inventories for use in normal
operations. These inventories were not material to the Company's overall
financial position. With the exception of the 16.6% of fuel currently under
forward purchase commitments and 8.8% of fuel currently hedged under fuel swap
transactions for 2003, fuel costs are expected to mirror market conditions in
2003.
Foreign Exchange Sensitivity
The Company owns a 46.6% interest in Grupo TFM, incorporated in Mexico. In
connection with the Company's investment in Grupo TFM, matters arise with
respect to financial accounting and reporting for foreign currency transactions
and for translating foreign currency transactions into U.S. dollars. The Company
uses the U.S. dollar as the functional currency for Grupo TFM. Equity earnings
(losses) from Grupo TFM included in the Company's results of operations reflect
the Company's share of any such translation gains and losses that Grupo TFM
records in the process of translating certain transactions from Mexican pesos to
U.S. dollars. Therefore, the Company has exposure to fluctuations in the value
of the Mexican peso. While not currently utilizing foreign currency instruments
to hedge the Company's U.S. dollar investment in Grupo TFM, the Company
continues to evaluate existing alternatives as market conditions and exchange
rates fluctuate.
Page 57
Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
- -----------------------------
Page
----
Management Report on Responsibility for Financial Reporting............... 59
Financial Statements:
Reports of Independent Accountants................................... 60
Consolidated Statements of Income
for the three years ended December 31, 2002........................ 61
Consolidated Balance Sheets at December 31, 2002
2001 and 2000...................................................... 62
Consolidated Statements of Cash Flows for the three
years ended December 31, 2002...................................... 63
Consolidated Statements of Changes in Stockholders'
Equity for the three years ended December 31, 2002................. 64
Notes to Consolidated Financial Statements........................... 65
Financial Statement Schedules:
All schedules are omitted because they are not applicable, are
insignificant or the required information is shown in the consolidated
financial statements or notes thereto.
The combined and consolidated financial statements of Grupo TFM as of
December 31, 2002 and for each of the three years in the period ended
December 31, 2002 are attached to this Form 10-K as Exhibit 99.3.
Page 58
Management Report on Responsibility for Financial Reporting
The accompanying consolidated financial statements and related notes of Kansas
City Southern and its subsidiaries were prepared by management in conformity
with generally accepted accounting principles appropriate in the circumstances.
In preparing the financial statements, management has made judgments and
estimates based on currently available information. Management is responsible
for not only the financial information, but also all other information in this
Annual Report on Form 10-K. Representations contained elsewhere in this Annual
Report on Form 10-K are consistent with the consolidated financial statements
and related notes thereto.
The Company's financial statements as of and for the years ended December 31,
2002 and 2001 have been audited by our independent accountants, KPMG LLP. The
Company's financial statements as of and for the year ended December 31, 2000
were audited by our previous independent accountants, PricewaterhouseCoopers
LLP. Management has made available to the independent accountants all of the
Company's financial records and related data, as well as the minutes of
shareholders' and directors' meetings. Furthermore, management believes that all
representations made to its independent accountants during their audits were
valid and appropriate.
The Company has a formalized system of internal accounting controls designed to
provide reasonable assurance that assets are safeguarded and that its financial
records are reliable. Management monitors the system for compliance, and the
Company's internal auditors review and evaluate both internal accounting and
operating controls and recommend possible improvements thereto. In addition, as
part of their audit of the consolidated financial statements, the independent
accountants, review and test the internal accounting controls on a selective
basis to establish the extent of their reliance thereon in determining the
nature, extent and timing of audit tests to be applied. The internal audit staff
coordinates with the independent accountants on the annual audit of the
Company's financial statements.
The Board of Directors pursues its oversight role in the area of financial
reporting and internal accounting control through its Audit Committee. This
committee, composed solely of qualified non-management directors, meets
regularly with the respective independent accountants, management and internal
auditors to monitor the proper discharge of responsibilities relative to
internal accounting controls and to evaluate the quality of external financial
reporting. Both the independent accountants and internal auditors have full and
free access to this committee.
/s/ MICHAEL R. HAVERTY
- --------------------------------------------------
Michael R. Haverty
Chairman, President & Chief Executive Officer
/s/ RONALD G. RUSS
- --------------------------------------------------
Ronald G. Russ
Executive Vice President & Chief Financial Officer
Page 59
Report of Independent Accountants
To the Board of Directors and Stockholders of
Kansas City Southern
We have audited the accompanying consolidated balance sheets of Kansas City
Southern and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the years in the two-year period ended December 31, 2002.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits. We did not audit the financial
statements of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (Grupo
TFM), a 36.9% owned investee company, as of and for the year ended December 31,
2001. The Company's investment in Grupo TFM at December 31, 2001 was $334.4
million and its equity in earnings of Grupo TFM was $28.5 million for the year
2001. The financial statements of Grupo TFM, as of and for the year ended
December 31, 2001, were audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the amounts included
for Grupo TFM as of and for the year ended December 31, 2001, is based solely on
the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits and the report of other auditors for 2001 provide a reasonable basis for
our opinion.
In our opinion, based on our audits, and the report of other auditors for 2001,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Kansas City Southern and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
KPMG LLP
Kansas City, Missouri
March 24, 2003
Report of Independent Accountants
To the Board of Directors and Stockholders of
Kansas City Southern
In our opinion, the accompanying consolidated balance sheet as of December 31,
2000 and the related consolidated statement of income, of changes in
stockholders' equity and of cash flows for the year then ended present fairly,
in all material respects, the financial position of Kansas City Southern and its
subsidiaries at December 31, 2000 and the results of their operations and their
cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audit. We
conducted our audit of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Kansas City, Missouri
March 22, 2001, except as to the adoption of Statement of Financial Accounting
Standards No. 142 described in Note 2 which is as of January 1, 2002
Page 60
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31
Dollars in Millions, Except per Share Amounts
2002 2001 2000
---------- ---------- ----------
Revenues $ 566.2 $ 583.2 $ 578.7
Costs and expenses
Compensation and benefits 197.8 192.9 197.8
Depreciation and amortization 61.4 58.0 56.1
Purchased services 59.6 57.0 54.8
Operating leases 55.0 56.8 58.2
Fuel 38.4 43.9 48.1
Casualties and insurance 25.2 42.1 34.9
Car hire 19.7 19.8 14.8
Other 61.1 57.3 56.2
---------- ---------- ----------
Total costs and expenses 518.2 527.8 520.9
---------- ---------- ----------
Operating income 48.0 55.4 57.8
Equity in net earnings (losses) of unconsolidated affiliates:
Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V 45.8 28.5 19.9
Other (2.4) (1.4) 2.2
Gain on sale of Mexrail, Inc. 4.4 -- --
Interest expense (45.0) (52.8) (65.8)
Debt retirement costs (4.3) -- (10.9)
Other income 17.6 4.2 6.0
---------- ---------- ----------
Income from continuing operations before income taxes
And cumulative effect of accounting change 64.1 33.9 9.2
Income tax provision (benefit) (Note 8) 6.9 2.8 (7.5)
---------- ---------- ----------
Income from continuing operations before
Cumulative effect of accounting change 57.2 31.1 16.7
Income from discontinued operations, (net of income
Taxes of $0.0, $0.0 and $233.3, respectively) -- -- 363.8
---------- ---------- ----------
Income before cumulative effect of accounting change 57.2 31.1 380.5
Cumulative effect of accounting change, net of income taxes -- (0.4) --
---------- ---------- ----------
Net income $ 57.2 $ 30.7 $ 380.5
========== ========== ==========
Per Share Data
Basic earnings per Common share
Continuing operations $ 0.94 $ 0.53 $ 0.29
Discontinued operations -- -- 6.42
---------- ---------- ----------
Basic earnings per share before cumulative
Effect of accounting change 0.94 0.53 6.71
Cumulative effect of accounting change, net of income taxes -- (0.01) --
---------- ---------- ----------
Total basic earnings per Common share $ 0.94 $ 0.52 $ 6.71
========== ========== ==========
Diluted earnings per Common share
Continuing operations $ 0.91 $ 0.51 $ 0.28
Discontinued operations -- -- 6.14
---------- ---------- ----------
Diluted earnings per share before cumulative
Effect of accounting change 0.91 0.51 6.42
Cumulative effect of accounting change, net of income taxes -- (0.01) --
---------- ---------- ----------
Total diluted earnings per Common share $ 0.91 $ 0.50 $ 6.42
========== ========== ==========
Weighted average Common shares outstanding (in thousands)
Basic 60,336 58,598 56,650
Potential dilutive common shares 1,982 2,386 1,740
---------- ---------- ----------
Diluted 62,318 60,984 58,390
========== ========== ==========
Dividends per Preferred share $ 1.00 $ 1.00 $ 1.00
See accompanying notes to consolidated financial statements
Page 61
KANSAS CITY SOUTHERN
CONSOLIDATED BALANCE SHEETS
at December 31
Dollars in Millions, Except per Share Amounts
2002 2001 2000
-------- -------- --------
ASSETS
Current Assets:
Cash and cash equivalents $ 19.0 $ 24.7 $ 21.5
Accounts receivable, net (Note 6) 118.5 130.0 135.0
Inventories 34.2 27.9 34.0
Other current assets (Note 6) 44.5 71.8 25.9
-------- -------- --------
Total current assets 216.2 254.4 216.4
-------- -------- --------
Investments (Notes 3, 5) 423.1 386.8 358.2
Properties, net (Note 6) 1,337.4 1,327.4 1,327.8
Goodwill 10.6 19.3 19.9
Other assets 21.5 23.0 22.2
-------- -------- --------
Total assets $2,008.8 $2,010.9 $1,944.5
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt due within one year (Note 7) $ 10.0 $ 46.7 $ 36.2
Accounts and wages payable 47.7 50.4 52.9
Accrued liabilities (Note 6) 128.6 150.0 157.4
-------- -------- --------
Total current liabilities 186.3 247.1 246.5
-------- -------- --------
Other Liabilities
Long-term debt (Note 7) 572.6 611.7 638.4
Deferred income taxes (Note 8) 392.8 370.2 332.2
Other deferred credits 104.2 101.6 84.0
Commitments and contingencies
(Notes 3,7,8,11,12)
-------- -------- --------
Total other liabilities 1,069.6 1,083.5 1,054.6
-------- -------- --------
Stockholders' Equity (Notes 2,3,4,7,9):
$25 par, 4% noncumulative, Preferred stock 6.1 6.1 6.1
$.01 par, Common stock 0.6 0.6 0.6
Retained earnings 748.5 676.5 636.7
Accumulated other comprehensive loss (2.3) (2.9) --
-------- -------- --------
Total stockholders' equity 752.9 680.3 643.4
-------- -------- --------
Total liabilities and stockholders' equity $2,008.8 $2,010.9 $1,944.5
======== ======== ========
See accompanying notes to consolidated financial statements
Page 62
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
Dollars in Millions
2002 2001 2000
-------- -------- --------
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income $ 57.2 $ 30.7 $ 380.5
Adjustments to reconcile net income to net cash
Provided by operating activities
Income from discontinued operations -- -- (363.8)
Depreciation and amortization 61.4 58.0 56.1
Deferred income taxes 21.8 30.4 23.1
Equity in undistributed earnings of unconsolidated affiliates (43.4) (27.1) (23.8)
Distributions from unconsolidated affiliates -- 3.0 5.0
Gains on sales of properties and investments (20.1) (5.8) (3.4)
Tax benefit realized upon exercise of stock options 4.5 5.6 9.3
Changes in working capital items
Accounts receivable 12.4 4.0 (2.8)
Inventories (8.8) 6.1 6.5
Other current assets 29.8 (19.3) 11.7
Accounts and wages payable (2.4) (5.1) (15.7)
Accrued liabilities (20.6) (26.9) (9.0)
Other, net 8.6 14.6 1.0
-------- -------- --------
Net 100.4 68.2 74.7
-------- -------- --------
INVESTING ACTIVITIES:
Property acquisitions (79.8) (66.0) (104.5)
Proceeds from disposal of property 18.1 18.1 5.5
Investment in and loans to affiliates (4.4) (8.2) (4.2)
Proceeds from sale of investments, net 31.7 0.6 --
Other, net (0.5) (0.2) 1.4
-------- -------- --------
Net (34.9) (55.7) (101.8)
-------- -------- --------
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 200.0 35.0 1,052.0
Repayment of long-term debt (270.9) (51.3) (1,015.4)
Debt issuance costs (5.7) (0.4) (17.6)
Proceeds from stock plans 10.3 8.9 17.9
Cash dividends paid (0.2) (0.2) (4.8)
Other, net (4.7) (1.3) 4.6
-------- -------- --------
Net (71.2) (9.3) 36.7
-------- -------- --------
CASH AND CASH EQUIVALENTS:
Net decrease in cash and cash equivalents (5.7) 3.2 9.6
At beginning of year 24.7 21.5 11.9
-------- -------- --------
At end of period $ 19.0 $ 24.7 $ 21.5
======== ======== ========
See accompanying notes to consolidated financial statements.
Page 63
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Dollars in Millions, Except per Share Amounts
Accumulated
$25 Par $.01 Par other
Preferred Common Retained comprehensive
Stock Stock Earnings income (loss) Total
-------- -------- -------- -------- --------
Balance at December 31, 1999 $ 6.1 $ 1.1 $1,167.0 $ 108.9 $1,283.1
Comprehensive income:
Net income 380.5
Net unrealized gain on investments 5.9
Less: Reclassification adjustment for
gains included in net income (1.1)
Foreign currency translation adjustment (2.6)
Comprehensive income 382.7
Spin-off of Stilwell Financial Inc. (954.1) (111.1) (1,065.2)
1-for-2 reverse stock split (0.5) 0.5
Dividends (0.2) (0.2)
Stock plan shares issued from treasury 6.3 6.3
Options exercised and stock subscribed 36.7 36.7
-------- -------- -------- -------- --------
Balance at December 31, 2000
6.1 0.6 636.7 -- 643.4
-------- -------- -------- -------- --------
Comprehensive income:
Net income 30.7
Cumulative effect of accounting change (0.9)
Change in fair market value of cash flow
Hedge of unconsolidated affiliate (2.0)
Comprehensive income 27.8
Dividends (0.2) (0.2)
Options exercised and stock subscribed 9.3 9.3
-------- -------- -------- -------- --------
Balance at December 31, 2001 6.1 0.6 676.5 (2.9) 680.3
-------- -------- -------- -------- --------
Comprehensive income:
Net income 57.2
Change in fair value of cash flow hedges (0.1)
Amortization of accumulated other
Comprehensive income (loss) related to
Interest rate swaps 0.7
Comprehensive income 57.8
Dividends (0.2) (0.2)
Options exercised and stock subscribed 15.0 15.0
-------- -------- -------- -------- --------
Balance at December 31, 2002 $ 6.1 $ 0.6 $ 748.5 $ (2.3) $ 752.9
======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
Page 64
KANSAS CITY SOUTHERN
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Description of the Business
- -----------------------------------
Kansas City Southern ("KCS" or the "Company") is a Delaware corporation that was
initially organized in 1962 as Kansas City Southern Industries, Inc. In 2002,
the Company formally changed its name to Kansas City Southern. KCS is a holding
company with principal operations in rail transportation. On July 12, 2000 KCS
completed its spin-off of Stilwell Financial Inc. ("Stilwell" - a former
wholly-owned financial services subsidiary) through a special dividend of
Stilwell common stock distributed to KCS common stockholders of record on June
28, 2000 ("Spin-off"). See Note 3. KCS's principal subsidiaries and affiliates,
which are reported under one business segment, include the following:
o The Kansas City Southern Railway Company ("KCSR"), a wholly-owned
subsidiary of KCS;
o Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), a
46.6% owned unconsolidated affiliate of KCSR. Grupo TFM owns 80% of the
common stock of TFM, S.A. de C.V. ("TFM"). TFM wholly-owns Mexrail, Inc.
("Mexrail"). Mexrail wholly-owns The Texas-Mexican Railway Company ("Tex
Mex");
o Southern Capital Corporation, LLC ("Southern Capital"), a 50% owned
unconsolidated affiliate of KCSR that leases locomotive and rail equipment
to KCSR;
o Panama Canal Railway Company ("PCRC"), an unconsolidated affiliate of which
KCSR indirectly owns 50% of the common stock. PCRC owns all of the common
stock of Panarail Tourism Company ("Panarail").
KCS, along with its principal subsidiaries and joint ventures, owns and operates
a rail network that links key commercial and industrial markets in the United
States and Mexico. The Company also has a strategic alliance with the Canadian
National Railway Company ("CN") and Illinois Central Corporation ("IC")
(collectively "CN/IC") and other marketing agreements, which provide the ability
for the Company to expand its geographic reach.
KCS's rail network, including its joint ventures, strategic alliances and
marketing agreements, connects shippers in the midwestern and eastern regions of
the United States, including shippers utilizing Chicago, Illinois and Kansas
City, Missouri--the two largest rail centers in the United States--with the
largest industrial centers of Canada and Mexico, including Toronto, Edmonton,
Mexico City and Monterrey. KCS's rail system, through its core network,
strategic alliances and marketing agreements, interconnects with all Class I
railroads in North America.
KCSR, which owns and operates one of seven Class I railroad systems in the
United States, is comprised of approximately 3,100 miles of main and branch
lines and approximately 1,250 miles of other tracks in a ten-state region that
includes Missouri, Kansas, Arkansas, Oklahoma, Mississippi, Alabama, Tennessee,
Louisiana, Texas and Illinois. KCSR, which traces its origins to 1887, offers
the shortest north/south rail route between Kansas City and several key ports
along the Gulf of Mexico in Louisiana, Mississippi and Texas. Additionally,
KCSR, in conjunction with the Norfolk Southern Railway Company ("Norfolk
Southern"), operates the most direct rail route (referred to as the "Meridian
Speedway"), between the Atlanta, Georgia and Dallas, Texas rail gateways, for
rail traffic moving between the southeast and southwest regions of the United
States. The "Meridian Speedway" also provides eastern shippers and other U.S.
and Canadian railroads with an efficient connection to Mexican markets. KCSR's
rail route also serves the east/west route linking Kansas City with East St.
Louis and Springfield, Illinois. Further, KCSR has limited haulage rights
between Springfield and Chicago that allow for shipments that originate or
terminate on the former Gateway Western's rail lines. These lines also provide
access to East St. Louis and allow rail traffic to avoid the St. Louis, Missouri
terminal. KCSR's geographic reach enables service to a customer base that
includes, among others, electric generating utilities, which use coal, and a
wide range of companies in the chemical and petroleum, agricultural and mineral,
paper and forest, and automotive and intermodal markets.
Southwestern Electric Power Company ("SWEPCO"), which is a subsidiary of
American Electric Power, Inc., is the Company's only customer which accounted
for more than 10% of revenues during the years ended December 31, 2002, 2001,
and 2000, respectively. Revenues related to SWEPCO during these periods were
$64.7, $75.9 and $67.2, million, respectively.
Page 65
The Company's rail network links directly to major trading centers in Mexico
through TFM and Tex Mex. TFM operates a railroad of approximately 2,650 miles of
main and branch lines running from the U.S./Mexican border at Laredo, Texas to
Mexico City and serves most of Mexico's principal industrial cities and three of
its major shipping ports. TFM also owns all of Mexrail, which in turn
wholly-owns Tex Mex. Tex Mex operates approximately 160 miles of main and branch
lines between Laredo and the port city of Corpus Christi, Texas. TFM, through
its concession with the Mexican government, has the right to control and operate
the southern half of the rail-bridge at Laredo and, indirectly through its
ownership of Mexrail, owns the northern half of the rail-bridge at Laredo, which
spans the Rio Grande River between the United States and Mexico. Our principal
international gateway is at Laredo where more than 50% of all rail and truck
traffic between the United States and Mexico crosses the border.
Note 2. Significant Accounting Policies
- ---------------------------------------
Basis of Presentation. Use of the term "Company" as described in these Notes to
Consolidated Financial Statements means Kansas City Southern and all of its
consolidated subsidiaries and unconsolidated affiliates. Significant accounting
and reporting policies are described below. Certain prior year amounts have been
reclassified to conform to the current year presentation.
As a result of the Spin-off, the accompanying consolidated financial statements
for each of the applicable periods presented reflect the financial position,
results of operations and cash flows of Stilwell as discontinued operations.
Use of Estimates. The accounting and financial reporting policies of the Company
conform with accounting principles generally accepted in the United States of
America ("U.S. GAAP"). The preparation of financial statements in conformity
with U.S. GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting period. Management reviews
its estimates, including those related to the recoverability and useful lives of
assets as well as liabilities for litigation, environmental remediation,
casualty claims, and income taxes. Changes in facts and circumstances may result
in revised estimates. Actual results could differ from those estimates.
Principles of Consolidation. The accompanying consolidated financial statements
are presented using the accrual basis of accounting and include the Company and
its majority owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
The equity method of accounting is used for all entities in which the Company or
its subsidiaries have significant influence, but not more than 50% voting
interest; the cost method of accounting is generally used for investments of
less than 20% voting interest.
Revenue Recognition. The Company recognizes freight revenue based upon the
percentage of completion of a commodity movement. Other revenues, in general,
are recognized when the product is shipped, as services are performed or
contractual obligations fulfilled.
Cash Equivalents. Short-term liquid investments with an initial maturity of
generally three months or less are considered cash equivalents.
Inventories. Materials and supplies inventories are valued at the lower of
average cost or market.
Properties and Depreciation. Properties are stated at cost. Additions and
renewals, including those on leased assets that increase the life of the asset
or utility and constitute a unit of property are capitalized and all properties
are depreciated over the estimated remaining life or leased life of such assets,
whichever is shorter. Ordinary maintenance and repairs are charged to expense as
incurred.
Page 66
The cost of transportation equipment and road property normally retired, less
salvage value, is charged to accumulated depreciation. The cost of industrial
and other property retired, and the cost of transportation property abnormally
retired, together with accumulated depreciation thereon, are eliminated from the
property accounts and the related gains or losses are reflected in net income.
Gains recognized on the sale or disposal of operating properties that were
reflected in operating income were $3.1, $5.8 and $3.4 million in 2002, 2001 and
2000, respectively. Gains or losses recognized on the sale of non-operating
properties reflected in other income were $7.4 million in 2002. Gains or losses
recognized on the sale of non-operating properties reflected in other income
were not significant in 2001 and 2000.
Depreciation is computed using composite straight-line rates for financial
statement purposes. The Surface Transportation Board ("STB") approves the
depreciation rates used by KCSR. KCSR evaluates depreciation rates for
properties and equipment and implements approved rates. Periodic revisions of
rates have not had a material effect on operating results. Depreciation for
other consolidated subsidiaries is computed based on the asset value in excess
of estimated salvage value using the straight-line method over the estimated
useful lives of the assets. Accelerated depreciation is used for income tax
purposes. The ranges of annual depreciation rates for financial statement
purposes are:
Road and structures 1% - 20%
Rolling stock and equipment 1% - 24%
Other equipment 1% - 33%
Computer software 8%
Capitalized leases 3% - 20%
Long-lived assets. The Company periodically evaluates the recoverability of its
operating properties. The measurement of possible impairment is based primarily
on the ability to recover the carrying value of the asset from expected future
operating cash flows of the assets on an undiscounted basis.
Casualty Claims. Casualty claims in excess of self-insurance levels are insured
up to certain coverage amounts, depending on the type of claim. The Company's
process for establishing its casualty liability reserves is based on an
actuarial study by an independent third party actuarial firm on an undiscounted
basis. It is based on claims filed and an estimate of claims incurred but not
yet reported. While the ultimate amount of claims incurred is dependent on
various factors, it is management's opinion that the recorded liability is
adequate to provide for the payment of future claims. Adjustments to the
liability will be reflected as operating expenses in the period in which the
adjustments are known. For other occupational injury claims, an assessment is
made on a case-by-case basis in accordance with SFAS 5.
Computer Software Costs. Costs incurred in conjunction with the purchase or
development of computer software for internal use are accounted for in
accordance with American Institute of Certified Public Accountant's Statement of
Position 98-1 "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP 98-1"). Costs incurred in the preliminary
project stage, as well as training and maintenance costs, are expensed as
incurred. Direct and indirect costs associated with the application development
stage of internal use software are capitalized until such time that the software
is substantially complete and ready for its intended use. Capitalized costs are
amortized on a straight-line basis over the useful life of the software. As of
December 31, 2002 and 2001, a total of approximately $58 and $55 million,
respectively, was capitalized (including a total of approximately $5.9 and $4.2
million of capitalized interest costs related to 2002 and 2001, respectively)
for a new transportation operating system, management control system ("MCS"),
which was implemented on July 14, 2002.
Goodwill and other intangible assets. Effective January 1, 2002, the Company
implemented Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"). SFAS 142 provides, among other things,
that goodwill with an indefinite life shall no longer be amortized, but shall be
evaluated for impairment on an annual basis. SFAS 142 also requires separate
presentation of goodwill on the balance sheet and impairment losses are to be
shown as a separate item on the income statement. Additionally, changes in the
carrying amount of goodwill should be disclosed in the footnotes to the
financial statements. SFAS 142 also requires various transitional disclosures
until all periods presented reflect the provisions of SFAS 142. These
transitional disclosures include the presentation of
Page 67
net income and earnings per share information adjusted to exclude amortization
expense (including the related income tax effects) for all periods presented.
The transitional disclosures are presented in the table below.
The Company has presented its goodwill as a separate line item in the
accompanying balance sheets. Additionally, the Company has performed its
goodwill impairment test and determined that existing goodwill is not impaired.
During the year ended December 31, 2002, the Company's goodwill decreased $8.5
million due to the sale of Mexrail to TFM and $0.2 million due to the sale of
Wyandotte Garage Corporation.
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Reported income from continuing operations $ 57.2 $ 31.1 $ 16.7
Add back: Goodwill amortization -- 0.6 0.6
-------- -------- --------
Adjusted income from continuing operations $ 57.2 $ 31.7 $ 17.3
======== ======== ========
Reported income from discontinued operations $ -- $ -- $ 363.8
Add back: Goodwill amortization -- -- 5.7
-------- -------- --------
Adjusted income from discontinued operations $ -- $ -- $ 369.5
======== ======== ========
Reported net income $ 57.2 $ 30.7 $ 380.5
Add back: Goodwill amortization -- 0.6 6.3
-------- -------- --------
Adjusted net income $ 57.2 $ 31.3 $ 386.8
======== ======== ========
Reported diluted earnings per share from
continuing operations $ 0.91 $ 0.51 $ 0.28
Add back: Goodwill amortization -- 0.01 0.01
-------- -------- --------
Adjusted diluted earnings per share from
continuing operations $ 0.91 $ 0.52 $ 0.29
======== ======== ========
Reported diluted earnings per share from
discontinued operations $ -- $ -- $ 6.14
Add back: Goodwill amortization -- -- 0.10
-------- -------- --------
Adjusted diluted earnings per share from
discontinued operations $ -- $ -- $ 6.24
======== ======== ========
Reported diluted earnings per share - net income $ 0.91 $ 0.50 $ 6.42
Add back: Goodwill amortization -- 0.01 0.11
-------- -------- --------
Adjusted diluted earnings per share - net income $ 0.91 $ 0.51 $ 6.53
======== ======== ========
Derivative Instruments. In June 1998, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 was
amended by Statement of Accounting Standards No. 137, "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133" and Statement of Financial Accounting Standards No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities,
an amendment of SFAS 133." SFAS 133, as amended, requires that derivatives be
recorded on the balance sheet as either assets or liabilities measured at fair
value. Changes in the fair value of derivatives are recorded either through
current earnings or as other comprehensive income, depending on the type of
hedge transaction. Gains and losses on the derivative instrument reported in
other comprehensive income are reclassified into earnings in the periods in
which earnings are impacted by the variability of the cash flow of the hedged
item. The ineffective portion of all hedge transactions will be recognized in
current period earnings.
The Company does not engage in the trading of derivatives. The Company's
objective is to manage its fuel and interest rate risk through the use of
derivative instruments as deemed appropriate. At December 31, 2002, the Company
had one fuel swap agreement for a notional amount of approximately 2.5 million
gallons of fuel. Under the terms of this swap, the Company will receive a
variable price based upon an average of the spot prices calculated on a monthly
basis as reported through a petroleum price reporting service. The Company will
pay a fixed price of 62.5(cent) per gallon. This
Page 68
swap will expire on December 31, 2003. Additionally, on January 14, 2003, the
Company entered into an additional swap with a notional amount of approximately
2.5 million gallons of fuel. Under the terms of this swap, the Company will
receive a variable price under the same terms as discussed above and pay a fixed
price of 73.8(cent) per gallon. This swap will expire on June 30, 2003.
Additionally, KCSR is also a party to swap transactions for approximately 2.5
million gallons of fuel for 2004. 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 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. By holding these swaps,
the Company is able to limit its risk to rising fuel prices.
At December 31, 2001 the Company had five separate interest rate cap agreements
for an aggregate notional amount of $200 million. These interest rate cap
agreements expired during 2002 and as of December 31, 2002, the Company did not
have any interest rate cap agreements or interest rate hedging instruments.
KCS adopted the provisions of SFAS 133, as amended, effective January 1, 2001.
As a result of this change in the method of accounting for derivative
instruments, the Company recorded an after-tax charge to earnings of $0.4
million in the first quarter of 2001. This charge is presented as a cumulative
effect of an accounting change in the accompanying financial statements and
represents the ineffective portion of the interest rate cap agreements discussed
above. The Company recorded an additional $0.4 million charge during the year
ended December 31, 2001 for subsequent changes in the fair value of its interest
rate hedging instruments. In 2002, these interest rate cap agreements expired
with no significant effect on earnings.
In addition, the Company records adjustments to its stockholders' equity
(accumulated other comprehensive income (loss)) for its portion of the
adjustment to the fair value of derivative transactions to which Southern
Capital, a 50% owned unconsolidated affiliate, was a participant. The Company
also adjusts its investment in Southern Capital by the change in the fair value
of these derivative instruments. For the years ended December 31, 2002 and 2001,
the Company recorded a reduction to its stockholders equity (accumulated other
comprehensive loss) of approximately $0.3 million and $2.9 million,
respectively, for its portion of the amount recorded by Southern Capital for the
adjustment to the fair value of interest rate swap transactions. The Company
also reduced its investment in Southern Capital by the same amount.
In conjunction with the refinancing of its debt, Southern Capital terminated
these interest rate swap transactions (See Note 7). As a result, Southern
Capital will amortize the balance of accumulated other comprehensive income
(loss) into interest expense over the former remaining life of the interest rate
swap transactions. This charge resulted in additional interest expense of
approximately $1.3 million in 2002. The Company is realizing the impact of this
charge through a related reduction in equity earnings from Southern Capital and
is amortizing its balance in accumulated other comprehensive income (loss) to
its investment in Southern Capital. During the year ended December 31, 2002, the
Company recorded amortization of its balance in accumulated other comprehensive
income (loss) of $0.7 million.
Fair Value of Financial Instruments. Statement of Financial Accounting Standards
No. 107 "Disclosures About Fair Value of Financial Instruments" ("SFAS 107")
requires an entity to disclose the fair value of its financial instruments. The
Company's financial instruments include cash and cash equivalents, accounts
receivable, lease and contract receivables, accounts payable and long-term debt.
In accordance with SFAS 107, lease financing and contracts that are accounted
for under Statement of Financial Accounting Standards No. 13 "Accounting for
Leases," are excluded from fair value presentation.
The carrying value of the Company's cash equivalents approximate their fair
values due to their short-term nature. Carrying value approximates fair value
for all financial instruments with six months or less to re-pricing or maturity
and for financial instruments with variable interest rates. The Company
estimates the fair value of long-term debt based upon borrowing rates available
at the reporting date for indebtedness with similar terms and average
maturities. Based upon the borrowing rates currently available to the Company
and its subsidiaries for indebtedness with similar terms and average maturities,
the fair value of long-term debt was approximately $617, $681 and $685 million
at December 31, 2002, 2001 and 2000, respectively.
Page 69
Income Taxes. Deferred income tax effects of transactions reported in different
periods for financial reporting and income tax return purposes are recorded
under the liability method of accounting for income taxes. This method gives
consideration to the future tax consequences of the deferred income tax items
and immediately recognizes changes in income tax laws upon enactment. The income
statement effect is generally derived from changes in deferred income taxes on
the balance sheet.
Grupo TFM provides deferred income taxes for the difference between the
financial reporting and income tax bases of its assets and liabilities. The
Company records its proportionate share of these income taxes through our equity
in Grupo TFM's earnings. As of December 31, 2002 the Company had not provided
deferred income taxes for the temporary difference between the financial
reporting basis and income tax basis of its investment in Grupo TFM because
Grupo TFM is a foreign corporate joint venture that is considered permanent in
duration, and the Company does not expect the reversal of the temporary
difference to occur in the foreseeable future.
Changes of Interest in Subsidiaries and Equity Investees. A change of the
Company's interest in a subsidiary or equity investee resulting from the sale of
the subsidiary's or equity investee's stock is generally recorded as a gain or
loss in the Company's net income in the period that the change of interest
occurs. If an issuance of stock by the subsidiary or affiliate is from treasury
shares on which gains have been previously recognized, however, KCS will record
the gain directly to its equity and not include the gain in net income. A change
of interest in a subsidiary or equity investee resulting from a subsidiary's or
equity investee's purchase of its stock increases the Company's ownership
percentage of the subsidiary or equity investee. The Company records this type
of transaction under the purchase method of accounting, whereby any excess of
fair market value over the net tangible and identifiable intangible assets is
recorded as goodwill.
Treasury Stock. The excess of par over cost of the Preferred shares held in
Treasury is credited to capital surplus. Common shares held in Treasury are
accounted for as if they were retired and the excess of cost over par value of
such shares is charged to capital surplus, if available, then to retained
earnings.
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 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:
2002 2001 2000
-------- -------- --------
Net income (in millions):
As reported $ 57.2 $ 30.7 $ 380.5
Total stock-based compensation expense
determined under fair value method, net of
income taxes (1.7) (4.0) (4.7)
-------- -------- --------
Pro forma 55.5 26.7 375.8
Earnings per Basic share:
As reported $ 0.94 $ 0.52 $ 6.71
Pro forma 0.92 0.45 6.63
Earnings per Diluted share:
As reported $ 0.91 $ 0.50 $ 6.42
Pro forma 0.88 0.43 6.37
Page 70
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. 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.
All shares held in the Employee Stock Ownership Plan ("ESOP") are treated as
outstanding for purposes of computing the Company's earnings per share. See
additional information on the ESOP in Note 10.
Earnings Per Share. Basic earnings per share is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed giving
effect to all dilutive potential common shares that were outstanding during the
period (i.e., the denominator used in the basic calculation is increased to
include the number of additional common shares that would have been outstanding
if the dilutive potential shares had been issued).
The effect of stock options issued to employees represent the only difference
between the weighted average shares used for the basic earnings per share
computation compared to the diluted earnings per share computation. The
following is a reconciliation from the weighted average shares used for the
basic earnings per share computation and the diluted earnings per share
computation for the years ended December 31, 2002, 2001 and 2000, respectively
(in thousands):
2002 2001 2000
-------- -------- --------
Basic shares 60,336 58,598 56,650
Effect of dilution: Stock options 1,982 2,386 1,740
-------- -------- --------
Diluted shares 62,318 60,984 58,390
======== ======== ========
Shares excluded from diluted computation 321 97 18
-------- -------- --------
Shares were excluded from the applicable periods diluted earnings per share
computation because the exercise prices were greater than the average market
price of the common shares.
The only adjustments that currently affect the numerator of the Company's
diluted earnings per share computation include preferred dividends and
potentially dilutive securities at certain subsidiaries and affiliates.
Adjustments related to potentially dilutive securities totaled $5.4 million for
the year ended December 31, 2000. This adjustment related to securities at
certain Stilwell subsidiaries and affiliates and affected the diluted earnings
per share from discontinued operations computation in 2000. Preferred dividends
are the only adjustments that affect the numerator of the diluted earnings per
share from continuing operations computation. Adjustments related to preferred
dividends were not material for the periods presented.
Stockholders' Equity. Information regarding the Company's capital stock at
December 31, 2002, 2001 and 2000 follows:
Shares Shares
Authorized Issued
----------- ----------
$25 Par, 4% noncumulative, Preferred stock 840,000 649,736
$1 Par, Preferred stock 2,000,000 None
$1 Par, Series A, Preferred stock 150,000 None
$1 Par, Series B convertible, Preferred stock 1,000,000 None
$.01 Par, Common stock 400,000,000 73,369,116
Page 71
The Company's stockholders approved a one-for-two reverse stock split at a
special meeting held on July 15, 1998. On July 12, 2000, KCS completed the
reverse stock split whereby every two shares of KCS common stock were converted
into one share of KCS common stock. All share and per share data reflect this
split.
Shares outstanding are as follows at December 31, (in thousands):
2002 2001 2000
-------- -------- --------
$25 Par, 4% noncumulative, Preferred stock 242 242 242
$.01 Par, Common stock 61,103 59,243 58,140
Comprehensive Income. In 2002, the Company's other comprehensive income (loss)
consists of the adjustment to the fair value of its fuel swap transactions as
well as its proportionate share of the amount recorded by Southern Capital for
the adjustment to the fair value of its interest rate swap transactions. In
2001, the Company's other comprehensive income consists of its proportionate
share of the amount recorded by Southern Capital for the adjustment to the fair
value of its interest rate swap transactions. In 2000, the Company's other
comprehensive income consists primarily of its proportionate share of unrealized
gains and losses relating to investments held by certain subsidiaries and
affiliates of Stilwell (discontinued operations) as "available for sale"
securities as defined by Statement of Financial Accounting Standards No. 115
"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115").
The Company recorded its proportionate share of any unrealized gains or losses
related to these investments, net of deferred income taxes, in stockholders'
equity as accumulated other comprehensive income. The unrealized gain related to
these investments increased $5.9 million, net of deferred taxes, for the year
ended December 31, 2000. Subsequent to the Spin-off the Company has not and does
not expect to hold investments that are accounted for as "available for sale"
securities.
Postretirement benefits. The Company provides certain medical, life and other
postretirement benefits to certain retirees. The costs of such benefits are
expensed over the estimated period of employment.
Environmental liabilities. The Company records liabilities for remediation and
restoration costs related to past activities when the Company's obligation is
probable and the costs can be reasonably estimated. Costs of ongoing compliance
activities related to current operations are expensed as incurred. As of
December 31, 2002, 2001 and 2000, liabilities for environmental remediation were
not material.
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 regulation 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 new
requirements of SFAS 143, in the absence of a legal obligation to remove the
track structure, such accounting practice is not allowed. In the opinion of
management, a legal obligation to remove track structure does not exist.
Accordingly, the Company is currently reviewing 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.
To the extent that accumulated depreciation includes amounts related to
instances of excess depreciation, a cumulative effect adjustment will be
recorded to reflect the change in accounting principle required by SFAS 143 in
the first quarter of 2003. Additionally, future depreciation rates applied to
certain track structure elements that were previously yielding a negative
salvage value will be modified to comply with the provisions of SFAS 143. The
Company intends to adopt the provisions of SFAS 143 in the first quarter of
2003. The Company is currently assessing the potential impact of this accounting
pronouncement on its consolidated results of operations, financial position, and
cash flows.
Page 72
In June 2002, the FASB issued Statement No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 is effective for exit
or disposal activities that are initiated after December 31, 2002. Under SFAS
146, a liability for a cost associated with an exit or disposal activity must be
recognized when the liability is incurred. Previously, a liability for an exit
cost was recognized as of the date of an entity's commitment to an exit or
disposal plan. The Company is currently evaluating the provisions of SFAS 146
and does not expect adoption of this pronouncement to have a material impact on
its consolidated results of operations, financial position, or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 provides guidance on
the accounting and disclosure requirements relating to the issuance of certain
types of guarantees and requires the guarantor to recognize at the inception of
a guarantee a liability for the fair value of the potential obligation. The
provisions for the initial recognition and measurement of guarantees are
effective prospectively for all guarantees issued or modified after December 31,
2002. The disclosure requirements under FIN 45 were effective for financial
statements for periods ending after December 15, 2002. KCS management does not
believe that the adoption of FIN 45 will have a material impact on its
consolidated results of operations, financial position, or cash flows. See Note
5 and Note 11 for disclosures of guarantees.
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. The Company
is currently assessing the potential impact of this accounting interpretation on
its method of accounting for unconsolidated subsidiaries and does not believe it
will have a material impact on the its consolidated results of operations,
financial position, or cash flows.
Note 3. Acquisitions and Dispositions
- -------------------------------------
Purchase of the Mexican government's ownership of Grupo TFM. The Company and
Grupo TMM exercised their call option and, on July 29, 2002, completed the
purchase of the Mexican government's 24.6% ownership of Grupo TFM. The Mexican
government's ownership interest of Grupo TFM was purchased by TFM for a purchase
price of $256.1 million, utilizing a combination of proceeds from an offering by
TFM of debt securities, a credit from the Mexican government for the reversion
of certain rail facilities and other resources. This transaction resulted in an
increase in the Company's ownership percentage of Grupo TFM from 36.9% to
approximately 46.6%. The purchase price was calculated by accreting the Mexican
government's initial investment of approximately $199 million from the date of
the Mexican government's investment through the date of the purchase, using the
interest rate on one-year U.S. Treasury securities.
Sale of Mexrail, Inc. to TFM. On February 27, 2002, the Company, Grupo TFM, 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. Mexrail owns the northern
half of the international railway bridge at Laredo, Texas and all of the common
stock of the Tex Mex. 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 of Mexrail to reduce debt. Although the Company no
longer directly owns 49% of Mexrail, it retains an indirect ownership through
its ownership of Grupo TFM. The Company's proportionate 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 of excess proceeds was deferred and is being amortized over 20
years.
Sale of Wyandotte Garage Corporation. In 2002, the Company sold its 80% interest
in Wyandotte Garage Corporation for a gain of $4.9 million. Additionally, as a
result of this sale, the Company was able to eliminate approximately $4.9
million of debt.
Spin-off of Stilwell. On July 12, 2000, KCS completed the Spin-off, which was
approved by KCS's Board of Directors on June 14, 2000. Each KCS stockholder
received two shares of the common stock of Stilwell for every one share of KCS
common stock owned on the record date. The total number of Stilwell shares
distributed was 222,999,786. Under
Page 73
tax rulings received from the Internal Revenue Service ("IRS"), the Spin-off
qualifies as a tax-free distribution under Section 355 of the Internal Revenue
Code of 1986, as amended. Also on July 12, 2000, KCS completed a reverse stock
split whereby every two shares of KCS common stock were converted into one share
of KCS common stock. The Company's stockholders approved this one-for-two
reverse stock split in 1998 in contemplation of the Spin-off. The total number
of KCS shares outstanding immediately following this reverse split was
55,749,947.
As a result of the Spin-off, the accompanying consolidated financial statements
for the year ended December 31, 2000 reflect the results of operations and cash
flows of Stilwell as discontinued operations through the date of the Spin-off
(July 12, 2000). Effective with the Spin-off, the net assets of Stilwell were
removed from the consolidated balance sheet. The accompanying consolidated
financial statements for the year ended December 31, 2000 reflect the results of
operations and cash flows of Stilwell as discontinued operations.
Prior to the Spin-off, KCS and Stilwell entered into various agreements for the
purpose of governing certain of the limited ongoing relationships between KCS
and Stilwell during a transitional period following the Spin-off, including an
intercompany agreement, a contribution agreement and a tax disaffiliation
agreement. See Note 12.
For the period between January 1, 2000 and July 12, 2000, the Company reported
revenues related to Stilwell of $1,187.9 million, operating expenses of $646.2
million and operating income of $541.7 million. After further adjustments for
the recognition of certain gains, interest expense, income taxes and a minority
interest in earnings, the Company reported net income from discontinued
operations, net of income taxes, of $363.8 million for the period between
January 1, 2000 and July 12, 2000.
Note 4. Supplemental Cash Flow Disclosures
- ------------------------------------------
Supplemental Disclosures of Cash Flow Information.
2002 2001 2000
--------- --------- ---------
Cash payments (refunds) (in millions):
Interest (includes $0.0, $0.0 and $0.7 million,
Respectively, related to Stilwell) $ 45.5 $ 49.1 $ 72.4
Income tax payments (refunds) (includes $0.0, $0.0 and
$195.9 million, respectively, related to Stilwell) $ (29.6) $ (25.0) $ 143.1
Non-cash Investing and Financing Activities.
The Company initiated the Thirteenth Offering of KCS common stock under the
Employee Stock Purchase Plan ("ESPP") during 2001. Stock subscribed under the
Thirteenth Offering was issued to employees in January 2003 and was paid for
through employee payroll deductions in 2002. The Company received approximately
$3.5 million from payroll deductions associated with this offering of the ESPP.
In connection with the Twelfth Offering of the ESPP (initiated in 2000), in 2001
the Company received approximately $4.5 million from employee payroll deductions
for the purchase of KCS common stock. This stock was issued to employees in
January 2002. The Company did not initiate an offering of KCS common stock under
the ESPP during 1999. Accordingly, no payroll deductions related to an ESPP were
recorded in 2000.
In conjunction with the January 2000 refinancing of the Company's debt
structure, KCS borrowed $125 million under a $200 million 364-day senior
unsecured competitive advance/revolving credit facility to retire debt
obligations. Stilwell assumed this credit facility and repaid the $125 million
in March 2000. Upon such assumption, KCS was released from all obligations, and
Stilwell became the sole obligor, under this credit facility. The Company's
indebtedness decreased as a result of the assumption of this indebtedness by
Stilwell.
During 1999, the Company's Board of Directors declared a quarterly dividend
totaling approximately $4.6 million payable in January of 2000. The dividend
declaration reduced retained earnings and established a liability at the end of
Page 74
1999. No cash outlay occurred until 2000. During the first quarter of 2000, the
Company's Board of Directors suspended common stock dividends of KCS in
conjunction with the terms of the KCS Credit Facility discussed above. It is not
anticipated that KCS will make any cash dividend payments to its common
stockholders for the foreseeable future.
In 2002, 2001 and 2000, the Company capitalized approximately $2, $4, and $9
million, respectively, of costs related to capital projects for which no cash
outlay had yet occurred. These costs were included in accounts payable and
accrued liabilities at December 31, 2002, 2001 and 2000 respectively.
Note 5. Investments
- -------------------
Investments, including investments in unconsolidated affiliates, are as follows
(in millions):
Percentage
Ownership
Company Name December 31, 2002 Carrying Value
- ----------------------------- ---------------------- --------------------------------------
2002 2001 2000
---------- ---------- ----------
Grupo TFM 46.6% $ 380.1 $ 334.4 $ 306.0
Southern Capital 50% 24.9 23.2 24.6
Mexrail 0%(1) -- 11.7 13.3
PCRC 50%(2) 14.5 11.0 9.9
Other 3.6 6.5 4.4
---------- ---------- ----------
$ 423.1 $ 386.8 $ 358.2
========== ========== ==========
(1) The Company's investment in Mexrail was sold to TFM during 2002. See Note 3
for further information.
(2) The Company owns 50% of the outstanding voting common stock of PCRC.
Grupo TFM. In June 1996, the Company and Transportacion Maritima Mexicana, S.A.
de C.V. ("TMM" - now Grupo TMM - see below) formed Grupo TFM to participate in
the privatization of the Mexican railroad system. In December 1996, the Mexican
government awarded Grupo TFM the right to acquire an 80% interest (representing
100% of the shares with unrestricted voting rights) in TFM for approximately
11.072 billion Mexican pesos (approximately $1.4 billion based on the U.S.
dollar/Mexican peso exchange rate on the award date). TFM holds a 50-year
concession (with the option of a 50-year extension subject to certain
conditions) to operate approximately 2,650 miles of track which directly link
Mexico City and Monterrey (as well as Guadalajara through trackage rights) with
the ports of Lazaro Cardenas, Veracruz and Tampico and the Mexican/United States
border crossings of Nuevo Laredo-Laredo, Texas and Matamoros-Brownsville, Texas.
TFM's route network provides a connection to the major industrial and population
areas of Mexico from the United States. TFM interchanges traffic with Tex Mex
and the Union Pacific Railroad ("UP") at Laredo, Texas.
During December 2001, the Company's partner in Grupo TFM, TMM announced that its
largest shareholder, Grupo TMM S.A. ("Grupo TMM" - formerly known as Grupo
Servia, S.A. de C.V.), filed a registration statement on Form F-4 with the
Securities and Exchange Commission ("SEC"). This registration statement, which
was declared effective December 13, 2001, was filed to register securities that
would be issued in the proposed merger of TMM with Grupo TMM. The proposed
merger was approved with the surviving entity being Grupo TMM.
The Company and Grupo TMM exercised their call option and on July 29, 2002,
completed the purchase of the Mexican government's 24.6% ownership of Grupo TFM.
See Note 3 for further information.
On or prior to October 31, 2003, the Mexican government may sell its 20%
interest in TFM through a public offering (with the consent of Grupo TFM if
prior to October 31, 2003). If, on October 31, 2003, the Mexican government has
not
Page 75
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. In the
event that Grupo TFM does not purchase the Mexican government's remaining
interest in TFM, Grupo TMM and KCS, or either Grupo TMM or KCS, are obligated to
purchase the Mexican government's interest. KCS and Grupo TMM have cross
indemnities in the event the Mexican government requires only one of them to
purchase its interest. The cross indemnities allow the party required to
purchase the Mexican government's interest to require the other party to
purchase its pro rata portion of such interest. However, if KCS were required to
purchase the Mexican government's interest in TFM and Grupo TMM could not meet
its obligations under the cross-indemnity, then KCS would be obligated to pay
the total purchase price for the Mexican government's interest. 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 as of December 31, 2002, the total purchase
price would have been approximately $485.0 million.
At December 31, 2002, the Company's investment in Grupo TFM was approximately
$380.1 million. The Company's interest in Grupo TFM is approximately 46.6%, with
Grupo TMM owning approximately 48.5% and the remaining 4.9% is owned indirectly
by the Mexican government through its 20% ownership of TFM. The Company has a
management services agreement with Grupo TFM to provide certain consulting and
management services. At December 31, 2002, $2.4 million is reflected as an
account receivable in the Company's consolidated balance sheet related to this
management service agreement. The Company accounts for its investment in Grupo
TFM under the equity method.
Southern Capital. In 1996, the Company and GATX Capital Corporation ("GATX")
completed a transaction for the formation and financing of a joint venture,
Southern Capital, to perform certain leasing and financing activities. Southern
Capital's principal operations are the acquisition of locomotives and rolling
stock and the leasing thereof to the Company. The Company holds a 50% interest
in Southern Capital, which it accounts for using the equity method of
accounting. Concurrent with the formation of this joint venture, the Company
entered into operating leases with Southern Capital for substantially all the
locomotives and rolling stock contributed or sold to Southern Capital at rental
rates which management believes reflected market conditions at that time. KCSR
paid Southern Capital $28.7, $28.8, and $27.3 million under these operating
leases in 2002, 2001 and 2000, respectively. In connection with the formation of
Southern Capital, the Company received cash that exceeded the net book value of
assets contributed to the joint venture by approximately $44.1 million.
Accordingly, this excess fair value over book value is being recognized as a
reduction in lease rental expense over the terms of the leases (approximately
$4.5, $4.4 and $5.8 million in 2002, 2001 and 2000, respectively). During 2001
and 2000, the Company received dividends of $3.0 million and $5.0 million,
respectively, from Southern Capital. No dividends were received from Southern
Capital during 2002.
Additionally, the Company performs certain general administrative and accounting
functions for Southern Capital. Payments to the Company under these agreements
were not material in 2002, 2001, and 2000, respectively. GATX also entered into
an agreement to manage the rail portfolio assets, as well as to perform certain
general and administrative services.
During 2001, Southern Capital refinanced its five-year credit facility, which
was scheduled to mature on October 19, 2001, with a one-year bridge loan for
$201 million. On June 25, 2002, Southern Capital refinanced the outstanding
balance of this bridge loan through the issuance of approximately $167.6 million
of pass through trust certificates and the sale of 50 locomotives. The pass
through trust certificates are secured by the sold locomotives, all of the
remaining locomotives and rolling stock owned by Southern Capital and rental
payments payable by KCSR under the sublease of the sold locomotives and its
leases of the equipment owned by Southern Capital. Payments of interest and
principal of the pass through trust certificates, which are due semi-annually on
June 30 and December 30 commencing on December 30, 2002 and ending on June 30,
2022, are insured under a financial guarantee insurance policy by MBIA Insurance
Corporation. KCSR leases or subleases all of the equipment securing the pass
through certificates.
Panama Canal Railway Company. In January 1998, the Republic of Panama awarded
PCRC, a joint venture between KCSR and Mi-Jack Products, Inc. ("Mi-Jack"), the
concession to reconstruct and operate the Panama Canal Railway, a 47-mile
railroad located adjacent to the Panama Canal, that provides international
shippers with a railway transportation option to complement the Panama Canal.
The Panama Canal Railway, which traces its origins back to the late 1800's, is a
north-south railroad traversing the Panama isthmus between the Pacific and
Atlantic Oceans. The railroad has been
Page 76
reconstructed and it resumed freight operations on December 1, 2001. Panarail
operates and promotes commuter and tourist passenger service over the Panama
Canal Railway. Passenger service started during July 2001.
As of December 31, 2002, the Company has invested approximately $19.9 million
toward the reconstruction and operations of the Panama Canal Railway. This
investment is comprised of $12.9 million of equity and $7.0 million of
subordinated loans. These loans carry a 10% interest rate and are payable on
demand, subject to certain restrictions.
In November 1999, PCRC completed the financing arrangements for this project
with the International Finance Corporation ("IFC"), a member of the World Bank
Group. The financing is comprised of a $5 million investment by the IFC and
senior loans through the IFC in an aggregate amount of up to $45 million.
Additionally, PCRC has $4.2 million of equipment loans from Transamerica
Corporation and other capital leases totaling $3.8 million. The IFC's investment
of $5 million in PCRC is comprised of non-voting preferred shares which pay a
10% cumulative dividend. As of December 31, 2002, PCRC has recorded a $1.5
million liability for these cumulative preferred dividends. The preferred shares
may be redeemed at the IFC's option any year after 2008 at the lower of (1) a
net cumulative internal rate of return of 30% or (2) eight times earnings before
interest, income taxes, depreciation and amortization for the two years
preceding the redemption that is proportionate to the IFC's percentage ownership
in PCRC. Under the terms of the loan agreement with IFC, the Company is a
guarantor for up to $5.6 million of the associated debt. Also if PCRC terminates
the concession contract without the IFC's consent, the Company is a guarantor
for up to 50% of the outstanding senior loans. The Company is also a guarantor
for up to $2.1 million of the equipment loans from Transamerica Corporation and
approximately $50 thousand relating to the other capital leases. The cost of the
reconstruction totaled approximately $80 million. The Company expects to loan an
additional $2 million to PCRC during 2003 under the same terms as the existing
$7.0 million subordinated loans.
Financial Information. Combined financial information of all unconsolidated
affiliates that the Company and its subsidiaries account for under the equity
method follows. All amounts, including those for Grupo TFM, are presented under
U.S. GAAP. Certain prior year amounts have been reclassified to reflect amounts
from applicable audited financial statements (dollars in millions).
December 31, 2002
------------------------------
Grupo Southern
TFM Capital PCRC
-------- -------- --------
Investment in unconsolidated affiliates $ 380.1 $ 24.9 $ 7.5
Equity in net assets of unconsolidated affiliates 366.0 24.9 7.5
Dividends and distributions received from
Unconsolidated affiliates -- -- --
Financial Condition:
Current assets $ 265.2 $ 5.5 $ 8.8
Non-current assets 2,061.3 139.4 83.3
-------- -------- --------
Assets $2,326.5 $ 144.9 $ 92.1
======== ======== ========
Current liabilities $ 147.3 $ -- $ 4.0
Non-current liabilities 1,045.3 95.1 73.1
Minority interest 348.0 -- --
Equity of stockholders and partners 785.9 49.8 15.0
-------- -------- --------
Liabilities and equity $2,326.5 $ 144.9 $ 92.1
======== ======== ========
Operating results:
Revenues $ 712.1 $ 31.0 $ 5.0
-------- -------- --------
Costs and expenses 540.6 26.4 12.9
-------- -------- --------
Net income $ 110.2 $ 2.7 $ (7.9)
-------- -------- --------
Page 77
December 31, 2001
----------------------------------------------
Grupo Southern
TFM Capital Mexrail PCRC
--------- --------- --------- ---------
Investment in unconsolidated affiliates $ 334.4 $ 23.2 $ 11.7 $ 11.5
Equity in net assets of unconsolidated affiliates 331.3 23.2 12.0 11.5
Dividends and distributions received from
Unconsolidated affiliates -- 3.0 -- --
Financial Condition:
Current assets $ 294.3 $ 2.5 $ 34.9 $ 3.6
Non-current assets 1,924.3 240.6 59.3 85.5
--------- --------- --------- ---------
Assets $ 2,218.6 $ 243.1 $ 94.2 $ 89.1
========= ========= ========= =========
Current liabilities $ 350.8 $ 196.6 $ 42.8 $ 10.8
Non-current liabilities 593.8 -- 27.5 55.3
Minority interest 376.3 -- -- --
Equity of stockholders and partners 897.7 46.5 23.9 23.0
--------- --------- --------- ---------
Liabilities and equity $ 2,218.6 $ 243.1 $ 94.2 $ 89.1
========= ========= ========= =========
Operating results:
Revenues $ 667.8 $ 30.2 $ 55.0 $ 1.8
--------- --------- --------- ---------
Costs and expenses $ 457.7 $ 25.5 $ 58.2 $ 3.2
--------- --------- --------- ---------
Net income $ 76.7 $ 4.8 $ (2.0) $ (2.0)
--------- --------- --------- ---------
December 31, 2000
----------------------------------------------
Grupo Southern
TFM Capital Mexrail PCRC
--------- --------- --------- ---------
Investment in unconsolidated affiliates $ 306.0 $ 24.6 $ 13.3 $ 9.5
Equity in net assets of unconsolidated affiliates 303.0 24.6 13.9 9.5
Dividends and distributions received from
Unconsolidated affiliates -- 5.0 -- --
Financial Condition:
Current assets $ 190.9 $ 0.2 $ 24.7 $ 7.1
Non-current assets 1,885.6 262.0 42.7 49.4
--------- --------- --------- ---------
Assets $ 2,076.5 $ 262.2 $ 67.4 $ 56.5
========= ========= ========= =========
Current liabilities $ 80.5 $ 0.4 $ 32.2 $ 0.6
Non-current liabilities 817.8 212.5 6.8 37.0
Minority interest 357.2 -- -- --
Equity of stockholders and partners 821.0 49.3 28.4 18.9
--------- --------- --------- ---------
Liabilities and equity $ 2,076.5 $ 262.2 $ 67.4 $ 56.5
========= ========= ========= =========
Operating results:
Revenues $ 640.6 $ 30.8 $ 56.5 $ 0.3
--------- --------- --------- ---------
Costs and expenses $ 493.7 $ 27.7 $ 57.7 $ 1.2
--------- --------- --------- ---------
Net income $ 44.8 $ 3.2 $ (0.1) $ (0.9)
--------- --------- --------- ---------
The Company, Grupo TFM, and certain of their affiliates entered into an
agreement on February 27, 2002 with TFM to sell to TFM all of the common stock
of Mexrail. The sale closed on March 27, 2002. Accordingly for 2002, the results
of Mexrail have been consolidated into the results of Grupo TFM.
Generally, the difference between the carrying amount of the Company's
investment in unconsolidated affiliates and the underlying equity in net assets
is attributable to certain equity investments whose carrying amounts have been
reduced to zero, and report a net deficit. With respect to the Company's
investment in Grupo TFM, the effects of foreign currency transactions and
capitalized interest prior to June 23, 1997, which are not recorded on the
investee's books, also result in these differences. Additionally, the purchase
by TFM of the Mexican government's former 24.6% interest in Grupo
Page 78
TFM resulted in a reduction of Grupo TFM's stockholder's equity as the purchased
shares from the Mexican government were recorded as Treasury shares at Grupo
TFM. The Company invested no funds in this transaction, however, and, therefore,
it did not have an impact on the Company's investment in Grupo TFM. As a result,
the difference between the Company's equity in net assets of Grupo TFM and its
underlying investment arising as a result of this transaction will be amortized
against the Company's equity in earnings from Grupo TFM over a 33 year period,
which is the estimate of the average remaining useful life of Grupo TFM's
concession assets.
The deferred income tax calculations for Grupo TFM are significantly impacted by
fluctuations in the relative value of the Mexican peso versus the U.S. dollar
and the rate of Mexican inflation, and can result in significant variability in
the amount of equity earnings (losses) reported by the Company.
Note 6. Other Balance Sheet Captions
- ------------------------------------
Accounts Receivable. Accounts receivable include the following items (in
millions):
2002 2001 2000
--------- --------- ---------
Accounts receivable $ 127.5 $ 140.4 $ 140.2
Allowance for doubtful accounts (9.0) (10.4) (5.2)
--------- --------- ---------
Accounts receivable, net $ 118.5 $ 130.0 $ 135.0
========= ========= =========
Bad debt expense $ 0.5 $ 1.7 $ (0.6)
--------- --------- ---------
Other Current Assets. Other current assets include the following items (in
millions):
2002 2001 2000
--------- --------- ---------
Deferred income taxes $ 18.7 $ 16.0 $ 9.3
Federal income taxes receivable 16.6 27.6 --
Receivable - Duncan case (Note 11) -- -- 7.0
Receivable - Bogalusa case (Note 11) -- 19.3 --
Prepaid expenses 3.8 2.9 1.0
Other 5.4 6.0 8.6
--------- --------- ---------
Total $ 44.5 $ 71.8 $ 25.9
========= ========= =========
Properties. Properties and related accumulated depreciation and amortization are
summarized below (in millions):
2002 2001 2000
--------- --------- ---------
Properties, at cost
Road properties $ 1,606.4 $ 1,520.4 $ 1,394.8
Equipment 342.9 289.2 295.5
Equipment under capital leases 6.6 6.6 6.7
Other 8.4 28.8 32.4
--------- --------- ---------
Total 1,964.3 1,845.0 1,729.4
Accumulated depreciation and amortization 702.3 660.2 622.9
--------- --------- ---------
Total 1,262.0 1,184.8 1,106.5
Construction in progress 75.4 142.6 221.3
--------- --------- ---------
Net Properties $ 1,337.4 $ 1,327.4 $ 1,327.8
========= ========= =========
Page 79
Accrued Liabilities. Accrued liabilities include the following items (in
millions):
2002 2001 2000
--------- --------- ---------
Claims reserves $ 35.3 $ 30.1 $ 45.7
Prepaid freight charges due other railroads 24.5 21.2 24.5
Duncan case liability (Note 11) -- -- 14.2
Bogalusa case liability (Note 11) -- 22.3 --
Car hire per diem 11.5 12.0 12.1
Vacation accrual 7.8 8.0 8.5
Other non-income related taxes 4.4 4.1 5.3
Federal income taxes payable -- -- 3.5
Interest payable 6.4 10.1 7.4
Other 38.7 42.2 36.2
--------- --------- ---------
Total $ 128.6 $ 150.0 $ 157.4
========= ========= =========
Note 7. Long-Term Debt
- ----------------------
Indebtedness Outstanding. Long-term debt and pertinent provisions follow (in
millions):
2002 2001 2000
--------- --------- ---------
KCS
Notes and Debentures, due March
2005 to December 2025
Rates: 6.625% to 7.00% $ 1.3 $ 1.6 $ 1.6
KCSR
Revolving Credit Facility, variable interest rate
4.03%, due January 2006 -- 20.0 --
Term Loans, variable interest rates
3.78%, due June 2008 149.2 377.5 400.0
Senior Notes, 7.5% interest rate, due
June 15, 2009 200.0 -- --
Senior Notes, 9.5% interest rate, due
October 1, 2008 200.0 200.0 200.0
Equipment Trust Certificates, 8.56% to 9.23%,
due serially to December 15, 2006 23.5 43.5 54.9
Capital Lease Obligations, 7.15% to 9.00%,
due serially to September 30, 2009 2.5 3.0 3.5
Term Loans with State of Illinois, 3% to 5%
due serially to 2009 3.3 3.9 4.4
Other
Industrial Revenue Bond 2.0 3.0 4.0
Mortgage Note -- 5.1 5.3
Term Loan with State of Illinois, 3% due
February 2018 0.8 0.8 0.9
--------- --------- ---------
Total 582.6 658.4 674.6
Less: debt due within one year 10.0 46.7 36.2
--------- --------- ---------
Long-term debt $ 572.6 $ 611.7 $ 638.4
========= ========= =========
Page 80
Debt Refinancing
7 1/2% Senior Notes. On June 12, 2002, KCSR issued $200 million of 7 1/2% senior
notes due June 15, 2009 ("7 1/2% Notes") through a private offering pursuant to
Rule 144A under the Securities Act of 1933 in the United States and Regulation S
outside the United States ("Note Offering"). Net proceeds from the Note Offering
of $195.8 million, together with cash, were used to repay term debt under the
Company's former senior secured credit facility ("KCS Credit Facility") and
certain other secured indebtedness of the Company. Debt issuance costs related
to the Note Offering of approximately $4.6 million were deferred and are being
amortized over the seven-year term of the 7 1/2% Notes. The remaining balance of
deferred debt issuance costs associated with the Note Offering was approximately
$4.2 million at December 31, 2002. Debt retirement costs associated with the
prepayment of certain term loans under the KCS Credit Facility using proceeds
from the Note Offering were approximately $4.3 million. These debt retirement
costs were previously reported as an extraordinary item, but have been
reclassified in accordance with Statement of Financial Accounting Standards No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" ("SFAS 145"), which the Company
early adopted in the fourth quarter of 2002.
KCS submitted a Form S-4 Registration Statement to the SEC on July 12, 2002, as
amended on July 24, 2002, relative to an Exchange Offer for the $200 million 7
1/2% senior notes due 2009. On July 30, 2002, the SEC declared this Registration
Statement effective thereby providing the opportunity for holders of the initial
7 1/2% Senior Notes due 2009 to exchange them for registered notes with
substantially identical terms. All of the 7 1/2% Senior Notes due 2009 were
exchanged for $200 million of registered notes due June 15, 2009. The registered
notes bear a fixed annual interest rate to be paid semi-annually on June 15 and
December 15 and are due June 15, 2009. These registered notes are general
unsecured obligations of KCSR, are guaranteed by the Company and certain of its
subsidiaries, and contain certain covenants and restrictions customary for this
type of debt instrument and for borrowers with similar credit ratings.
9 1/2% Senior Notes. During the third quarter of 2000, the Company completed a
$200 million private offering of debt securities through KCSR. The offering,
completed pursuant to Rule 144A under the Securities Act of 1933 in the United
States and Regulation S outside the United States, consisted of 8-year senior
unsecured notes ("9 1/2% Notes"). Net proceeds from this offering of $196.5
million were used to refinance term debt and reduce commitments under the KCS
Credit Facility. The refinanced debt was scheduled to mature on January 11, 2001
(see below). Costs related to the issuance of these 9 1/2% Notes were deferred
and are being amortized over their eight-year term. The remaining balance of
these deferred costs was approximately $3.3 million at December 31, 2002.
On January 25, 2001, the Company filed a Form S-4 Registration Statement with
the SEC registering exchange notes under the Securities Act of 1933. The Company
filed Amendment No. 1 to this Registration Statement and the SEC declared this
Registration Statement, as amended, effective on March 15, 2001, thereby
providing the opportunity for holders of the initial 9 1/2% Notes to exchange
them for registered notes with substantially identical terms. All of the 9 1/2%
Notes were exchanged for $200 million of registered notes. These registered
notes bear a fixed annual interest rate and are due on October 1, 2008. These
registered notes are general unsecured obligations of KCSR, are guaranteed by
the Company and certain of its subsidiaries, and contain certain covenants and
restrictions customary for this type of debt instrument and for borrowers with
similar credit ratings.
New Credit Agreement. On June 12, 2002, in conjunction with the repayment of
certain of the term loans under the KCS Credit Facility using the net proceeds
received from the Note Offering, the Company amended and restated the KCS Credit
Facility (the amended and restated credit agreement is referred to as the New
Credit Agreement herein). The New Credit Agreement provides KCSR with a $150
million term loan ("Tranche B term loan"), which matures on June 12, 2008, and a
$100 million revolving credit facility ("Revolver"), which matures on January
11, 2006. Letters of credit are also available under the Revolver up to a limit
of $15 million. The proceeds from future borrowings under the Revolver may be
used for working capital and for general corporate purposes. The letters of
credit may be used for general corporate purposes. Borrowings under the New
Credit Agreement are secured by substantially all of the Company's assets and
are guaranteed by the majority of its subsidiaries.
Page 81
The Tranche B term loan and the Revolver bear interest at the London Interbank
Offered Rate ("LIBOR") or an alternate base rate, as the Company shall select,
plus an applicable margin. The applicable margin for the Tranche B term loan is
2% for LIBOR borrowings and 1% for alternate base rate borrowings. The
applicable margin for the Revolver is based on the Company's leverage ratio
(defined as the ratio of the Company's total debt to consolidated EBITDA
(earnings before interest, taxes, depreciation and amortization, excluding the
undistributed earnings of unconsolidated affiliates) for the prior four fiscal
quarters). Based on the Company's leverage ratio as of December 31, 2002, the
applicable margin was 2.25% per annum for LIBOR borrowings and 1.25% per annum
for alternate base rate borrowings.
The New Credit Agreement also requires the payment to the lenders of a
commitment fee of 0.50% per annum on the average daily, unused amount of the
Revolver. Additionally, a fee equal to a per annum rate of 0.25% plus the
applicable margin for LIBOR priced borrowings under the Revolver will be paid on
any letter of credit issued under the Revolver.
The New Credit Agreement contains certain provisions, covenants and restrictions
customary for this type of debt and for borrowers with a similar credit rating.
These provisions include, among others, restrictions on the Company's ability
and its subsidiaries ability to 1) incur additional debt or liens; 2) enter into
sale and leaseback transactions; 3) merge or consolidate with another entity; 4)
sell assets; 5) enter into certain transactions with affiliates; 6) make
investments, loans, advances, guarantees or acquisitions; 7) make certain
restricted payments, including dividends, or make certain payments on other
indebtedness; and 8) make capital expenditures. In addition, the Company is
required to comply with certain financial ratios, including minimum interest
expense coverage and leverage ratios. The New Credit Agreement also contains
certain customary events of default. These covenants, along with other
provisions, could restrict maximum utilization of the Revolver.
Debt issuance costs related to the New Credit Agreement of approximately $1.1
million were deferred and are being amortized over the respective term of the
loans. The remaining balance of deferred debt costs associated with the New
Credit Agreement was approximately $1.0 million at December 31, 2002.
Re-capitalization of Debt Structure in anticipation of Spin-off. In preparation
for the Spin-off, the Company re-capitalized its debt structure in January 2000
through a series of transactions as follows:
Bond Tender and Other Debt Repayment. On December 6, 1999, KCS commenced offers
to purchase and consent solicitations with respect to any and all of the
Company's outstanding 7.875% Notes due July 1, 2002, 6.625% Notes due March 1,
2005, 8.8% Debentures due July 1, 2022, and 7% Debentures due December 15, 2025
(collectively "Debt Securities" or "notes and debentures").
Approximately $398.4 million of the $400 million outstanding Debt Securities
were validly tendered and accepted by the Company. Total consideration paid for
the repurchase of these outstanding notes and debentures was $401.2 million. In
conjunction with the early retirement of these Debt Securities, the Company
reported $10.9 million of debt retirement costs. These debt retirement costs
were previously reported as an extraordinary item, but have been reclassified in
accordance with SFAS 145. Funding for the repurchase of these Debt Securities
and for the repayment of $264 million of borrowings under then-existing
revolving credit facilities was obtained from two credit facilities (the "KCS
Credit Facility" and the "Stilwell Credit Facility", or collectively the "Credit
Facilities"), each of which was entered into on January 11, 2000. The Credit
Facilities, initially provided for total commitments of $950 million. Stilwell
assumed the Stilwell Credit Facility, including the borrowings thereunder, and,
upon completion of the Spin-off, the Company was released from all obligations
thereunder.
KCS Credit Facility. The KCS Credit Facility initially provided for total
commitments of $750 million comprised of three separate term loans totaling $600
million and a revolving credit facility available until January 11, 2006. On
January 11, 2000, KCSR borrowed the full amount ($600 million) of the term loans
and used the proceeds to repurchase the Debt Securities, retire other debt
obligations and pay related fees and expenses. No funds were initially borrowed
under the revolving credit facility. The term loans were initially comprised of
the following: $200 million due January 11, 2001, $150 million due December 30,
2005 and $250 million due December 29, 2006. The $200 million term loan due
January 11, 2001 was refinanced during the third quarter of 2000 as described
above. The remainder of the KCS Credit Facility has also been refinanced as
described above.
Page 82
Issue costs relating to the KCS Credit Facility of approximately $17.6 million
were deferred and amortized over the respective term of the loans. In
conjunction with the refinancing of a $200 million term loan previously due
January 11, 2001, which was a part of the KCS Credit Facilities, approximately
$1.8 million of these deferred costs were immediately recognized. In conjunction
with the issuance of the 7 1/2% Notes and related prepayment of certain term
loans under the KCS Credit Facility, debt retirement costs of approximately $4.3
million were recognized for the year ended December 31, 2002. Additionally, for
the year ended December 31, 2001, $1.4 million in fees were incurred related to
a waiver for certain credit facility covenants. These fees have also been
deferred and are being amortized over the respective term of the loans. After
consideration of current year amortization, the remaining balance of these
deferred costs was approximately $4.4 million at December 31, 2002.
Leases and Debt Maturities. The Company and its subsidiaries lease
transportation equipment, as well as office and other operating facilities under
various capital and operating leases. Rental expenses under operating leases
were $55.0 million, $56.8 and $58.2 million for the years 2002, 2001 and 2000,
respectively. Minimum annual payments and present value thereof under existing
capital leases, other debt maturities, and minimum annual rental commitments
under noncancellable operating leases are as follows (dollars in millions):
Capital Leases Operating Leases
------------------------------ ------------------------------
Minimum Net Long-
Lease Less Present Term Total Southern Third
Payments Interest Value Debt Debt Capital Party Total
-------- -------- -------- -------- -------- -------- -------- --------
2003 $ 0.7 $ 0.1 $ 0.6 $ 9.4 $ 10.0 $ 34.1 $ 26.1 $ 60.2
2004 0.6 0.2 0.4 9.4 9.8 30.7 22.1 52.8
2005 0.5 0.1 0.4 8.7 9.1 27.0 16.4 43.4
2006 0.4 0.1 0.3 7.6 7.9 26.4 15.3 41.7
2007 0.3 0.1 0.2 72.7 72.9 21.9 15.2 37.1
Later years 0.6 0.0 0.6 472.3 472.9 151.3 58.8 210.1
-------- -------- -------- -------- -------- -------- -------- --------
Total $ 3.1 $ 0.6 $ 2.5 $ 580.1 $ 582.6 $ 291.4 $ 153.9 $ 445.3
======== ======== ======== ======== ======== ======== ======== ========
KCSR Indebtedness. KCSR has purchased locomotives and rolling stock under
conditional sales agreements, equipment trust certificates and capitalized lease
obligations. The equipment, which has been pledged as collateral for the related
indebtedness, has an original cost of $134.7 million and a net book value of
$72.4 million.
Other Agreements, Guarantees, Provisions and Restrictions. The Company has debt
agreements containing restrictions on subsidiary indebtedness, advances and
transfers of assets, and sale and leaseback transactions, as well as requiring
compliance with various financial covenants. At December 31, 2002, the Company
was in compliance with the provisions and restrictions of these agreements.
Because of certain financial covenants contained in the debt agreements,
however, maximum utilization of the Company's available line of credit may be
restricted. As discussed in Note 5, the Company is a guarantor for up to $5.6
million of debt associated with PCRC. Also if PCRC terminates its' concession
contract without the IFC's consent, the Company is a guarantor for up to 50% of
PCRC's outstanding senior loans. The Company is also a guarantor for up to $2.1
million of the equipment loans from Transamerica Corporation and approximately
$50 thousand relating to other capital leases.
Note 8. Income Taxes
- --------------------
Under the liability method of accounting for income taxes specified by Statement
of Financial Accounting Standards No. 109 "Accounting for Income Taxes," the
provision for income tax expense is the sum of income taxes currently payable
and deferred income taxes. Currently payable income taxes represents the amounts
expected to be reported on the Company's income tax return, and deferred tax
expense or benefit represents the change in deferred taxes. Deferred tax assets
and liabilities are determined based on the difference between the financial
statement and tax basis of assets and liabilities as measured by the enacted tax
rates that will be in effect when these differences reverse.
Page 83
Tax Expense. Income tax provision (benefit) attributable to continuing
operations consists of the following components (in millions):
2002 2001 2000
--------- --------- ---------
Current
Federal $ (15.3) $ (26.6) $ (30.6)
State and local 0.4 (1.1) (0.2)
Foreign withholding taxes -- 0.1 0.2
--------- --------- ---------
Total current (14.9) (27.6) (30.6)
Deferred
Federal 20.8 29.5 23.4
State and local 1.0 0.9 (0.3)
--------- --------- ---------
Total deferred 21.8 30.4 23.1
--------- --------- ---------
Total income tax provision (benefit) $ 6.9 $ 2.8 $ (7.5)
========= ========= =========
The federal and state deferred tax liabilities (assets) attributable to
continuing operations at December 31 are as follows (in millions):
2002 2001 2000
--------- --------- ---------
Liabilities:
Depreciation $ 409.5 $ 380.7 $ 351.0
Other, net -- 10.0 6.3
--------- --------- ---------
Gross deferred tax liabilities 409.5 390.7 357.3
--------- --------- ---------
Assets:
NOL and AMT credit carryovers (3.4) (3.4) (8.8)
Book reserves not currently deductible
for tax (26.8) (30.0) (22.3)
Vacation accrual (2.8) (3.1) (2.5)
Other, net (2.4) -- (0.8)
--------- --------- ---------
Gross deferred tax assets (35.4) (36.5) (34.4)
--------- --------- ---------
Net deferred tax liability $ 374.1 $ 354.2 $ 322.9
========= ========= =========
Based upon the Company's history of operating income and its expectations for
the future, management has determined that operating income of the Company will,
more likely than not, be sufficient to recognize fully the gross deferred tax
assets set forth above.
Tax Rates. Differences between the Company's effective income tax rates
applicable to continuing operations and the U.S. federal income tax statutory
rates of 35% are as follows (in millions):
2002 2001 2000
--------- --------- ---------
Income tax provision using the
Statutory rate in effect $ 21.4 $ 11.9 $ 3.2
Tax effect of
Earnings of equity investees (15.0) (9.4) (6.6)
Other, net (0.9) 0.4 (3.8)
--------- --------- ---------
Federal income tax provision (benefit) 5.5 2.9 (7.2)
State and local income tax provision (benefit) 1.4 (0.2) (0.5)
Foreign withholding taxes -- 0.1 0.2
--------- --------- ---------
Total $ 6.9 $ 2.8 $ (7.5)
========= ========= =========
Effective tax rate 11.3% 8.3% (82.5)%
========= ========= =========
Page 84
Temporary Difference Attributable to Grupo TFM Investment. At December 31, 2002,
the Company's book basis exceeded the tax basis of its investment in Grupo TFM
by $79.4 million. The Company has not provided a deferred income tax liability
for the income taxes, if any, which might become payable on the realization of
this basis difference because the Company intends to indefinitely reinvest in
Grupo TFM the financial statement earnings which gave rise to the basis
differential. Moreover, the Company has no other plans to realize this basis
differential by a sale of its investment in Grupo TFM. If the Company were to
realize this basis difference in the future by a receipt of dividends or the
sale of its interest in Grupo TFM, as of December 31, 2002 the Company would
incur gross federal income taxes of $27.8 million, which might be partially or
fully offset by Mexican income taxes and could be available to reduce federal
income taxes at such time.
Tax Carryovers. At December 31, 2000, the Company had $3.4 million of
alternative minimum tax credit carryover generated by the MidSouth Railroad
("MidSouth") prior to its acquisition by the Company. This was fully utilized on
the 2000 tax return filed in 2001. The amount of federal net operating loss
(NOL) carryover generated by MidSouth and Gateway Western prior to acquisition
by the Company was $67.8 million, of which $57.6 million was utilized in
pre-2000 years. The Company utilized approximately $1.5 million of these NOL's
in 2000, leaving approximately $8.7 million available for carryforward at
December 31, 2002 with expiration dates beginning in 2008. The use of
preacquisition net operating losses and tax credit carryovers is subject to
limitations imposed by the Internal Revenue Code. The Company does not
anticipate that these limitations will affect utilization of the carryovers
prior to their expiration. Additionally, in 2002 and 2001, the Company generated
net operating losses. These NOL's were carried back to 2000 and 1999 and the
applicable tax returns have been amended.
Tax Examinations. The IRS is currently in the process of examining the
consolidated federal income tax returns for the years 1993 through 1996. For
years prior to 1993, the statute of limitations has closed. In addition, other
taxing authorities are currently examining the years 1994 through 1999 and have
proposed additional tax assessments for which the Company believes it has
recorded adequate reserves. Since most of these asserted tax deficiencies
represent temporary differences, subsequent payments of taxes will not require
additional charges to income tax expense. In addition, accruals have been made
for interest (net of tax benefit) for estimated settlement of the proposed tax
assessments. Thus, management believes that final settlement of these matters
will not have a material adverse effect on the Company's consolidated results of
operations, financial condition, or cash flows.
Note 9. Stockholders' Equity
- ----------------------------
Reverse Stock Split. All periods presented in the accompanying consolidated
financial statements reflect the one-for-two reverse stock split completed on
July 12, 2000 in conjunction with the Spin-off. See Note 3.
Stock Option Plans. During 1998, various existing Employee Stock Option Plans
were combined and amended as the Kansas City Southern 1991 Amended and Restated
Stock Option and Performance Award Plan (as amended and restated effective
November 7, 2002). The Plan provides for the granting of options to purchase up
to 16.0 million shares of the Company's common stock by officers and other
designated employees. Options granted under this Plan have been granted at 100%
of the average market price of the Company's stock on the date of grant and
generally may not be exercised sooner than one year or longer than ten years
following the date of the grant, except that options outstanding with limited
rights ("LRs") or limited stock appreciation rights ("LSARs"), become
immediately exercisable upon certain defined circumstances constituting a change
in control of the Company. The Plan includes provisions for stock appreciation
rights, LRs and LSARs. All outstanding options include LSARs, except for options
granted to non-employee Directors prior to 1999.
Page 85
For purposes of computing the pro forma effects of option grants under the fair
value accounting method prescribed by SFAS 123, the fair value of each option
grant is estimated on the date of grant using a version of the Black-Scholes
option pricing model. The following assumptions were used for the various grants
depending on the date of grant, nature of vesting and term of option:
2002 2001 2000
---------------- ---------------- ----------------
Dividend Yield 0% 0% 0%
Expected Volatility 35% to 38% 35% to 40% 34 to 50%
Risk-free Interest Rate 2.16% to 3.88% 2.98% to 4.84% 5.92% to 6.24%
Expected Life 3 years 3 years 3 years
Effect of Spin-off on Existing Stock Options. FASB Interpretation No. 44,
"Accounting for Certain Transactions involving Stock Compensation" ("FIN 44")
addresses the issues surrounding fixed stock option plans resulting from an
equity restructuring, including spin-offs. This guidance indicates that changes
to fixed stock option grants made to restore the option holder's economic
position as a result of a spin-off do not result in additional compensation
expense if certain criteria are met as follows: i) aggregate intrinsic value
(difference between the market value per share and exercise price) of the
options immediately after the change is not greater than the aggregate intrinsic
value of the options immediately before the change; ii) the ratio of the
exercise price per option to the market value per share is not reduced; and iii)
the vesting provisions and option period of the original option grant remain the
same.
As part of the Spin-off, generally holders of an option to purchase one share of
KCS common stock received options to purchase two shares of Stilwell common
stock. The option exercise price for the KCS and Stilwell stock options was
prorated based on the market value for KCS common stock and Stilwell common
stock on the date of the Spin-off. The exercise prices for periods subsequent to
the Spin-off were accordingly reduced to reflect this amount. The changes made
to the Company's fixed stock option grants as a result of the Spin-off in 2000
resulted in the option holder having the same economic position both immediately
before and immediately after the Spin-off. In accordance with the provisions of
FIN 44, the Company, therefore, did not record additional compensation expense
as a result of the Spin-off.
Summary of Company's Stock Option Plans. A summary of the status of the
Company's stock option plans as of December 31, 2002, 2001 and 2000 and changes
during the years then ended is presented below. The number of shares, the
weighted average exercise price and the weighted average fair value of options
granted reflect the reverse stock split on July 12, 2000 for all periods
presented. However, the weighted average exercise price and the weighted average
fair value of options were not restated to reflect the impact of the Spin-off
for the periods prior to the Spin-off (1/1/2000 - 7/12/2000).
2002 2001
------------------------ ------------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
---------- ---------- ---------- ----------
Outstanding at January 1 5,821,315 $ 5.44 6,862,036 $ 4.92
Exercised (1,265,418) 4.87 (1,128,838) 3.71
Canceled/Expired (144,388) 6.15 (105,537) 4.79
Granted 433,717 14.25 193,654 13.37
---------- ----------
Outstanding at December 31 4,845,226 $ 6.35 5,821,315 $ 5.44
========== ==========
Exercisable at December 31 3,784,417 $ 5.63 4,803,942 $ 5.13
Weighted-Average fair value of
Options granted during the period $ 3.97 $ 4.18
Page 86
7/13/2000-12/31/2000 1/1/2000-7/12/2000
------------------------ ------------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
---------- ---------- ---------- ----------
Outstanding at beginning of period 4,165,692 $ 1.26 4,280,581 $ 33.94
Exercised (2,469,667) 0.76 (394,803) 47.14
Canceled/Expired (388,686) 4.82 (1,800) 89.13
Granted 5,554,697 5.81 281,714 142.08
---------- ----------
Outstanding at end of period 6,862,036 $ 4.92 4,165,692 $ 39.98
========== ==========
Exercisable at December 31 1,355,464 $ 1.41
Weighted-Average fair value of
Options granted during the period $ 1.54 $ 49.88
The following table summarizes information about stock options outstanding at
December 31, 2002:
OUTSTANDING EXERCISABLE
------------------------------------------------- ----------------------------
Weighted- Weighted- Weighted-
Range of Average Average Average
Exercise Shares Remaining Exercise Shares Exercise
Prices Outstanding Contractual Life Price Exercisable Price
----------- ------------- ---------------- ---------- ------------- ----------
$.20 - 1 244,556 2.4 years $ 0.88 244,556 $ 0.88
1 - 2 161,296 4.2 1.33 161,296 1.33
2 - 4 163,399 5.8 2.84 126,399 2.80
4 - 7 3,570,216 7.5 5.76 2,955,451 5.77
7 - 10 105,072 7.7 8.37 105,072 8.37
10 - 13 85,000 8.5 12.62 85,000 12.62
13 - 17 515,687 9.4 14.28 106,643 14.20
------------- -------------
.20 - 17 4,845,226 7.3 6.35 3,784,417 5.63
============= =============
At December 31, 2002, shares available for future grants under the stock option
plan were 1,771,372.
Stock Purchase Plan. The ESPP, established in 1977, provides to substantially
all full-time employees of the Company, certain subsidiaries and certain other
affiliated entities, the right to subscribe to an aggregate of 11.4 million
shares of common stock. The purchase price for shares under any stock offering
is to be 85% of the average market price on either the exercise date or the
offering date, whichever is lower, but in no event less than the par value of
the shares. At December 31, 2002 there were approximately 4.8 million shares
available for future offerings.
The following table summarizes activity related to the various ESPP offerings:
Date Shares Shares Date
Initiated Subscribed Price Issued Issued
--------- ---------- ------------- ----------- -----------
Fourteenth Offering 2002 248,379 $12.29 -- --
Thirteenth Offering 2001 402,902 $10.24-$10.57 337,917 2002/2003
Twelfth Offering 2000 705,797 $ 7.31 623,060 2001/2002
For purposes of computing the pro forma effects of employees' purchase rights
under the fair value accounting method prescribed by SFAS 123, the fair value of
the offerings under the ESPP is estimated on the date of grant using a version
of the Black-Scholes option pricing model. The following weighted-average
assumptions were used for the Fourteenth, Thirteenth and Twelfth Offerings,
respectively: i) dividend yield of 0.00%, 0.00% and 0.00%; ii) expected
volatility of 36%, 38%, and 38%; iii) risk-free interest rate of 2.22%, 2.98%
and 5.77%; and iv) expected life of one year. The
Page 87
weighted-average fair value of purchase rights granted under the Fourteenth,
Thirteenth and Twelfth Offerings of the ESPP were $3.00, $3.00 and $2.19,
respectively.
Restricted Share and Option Program. In connection with the Spin-off, KCS
adopted a restricted share and option program (the "Option Program") under which
(1) certain senior management employees were granted performance based KCS stock
options and (2) all management employees and those directors of KCS who were not
employees (the "Outside Directors") became eligible to purchase a specified
number of KCS restricted shares and were granted a specified number of KCS stock
options for each restricted share purchased.
The performance stock options have an exercise price of $5.75 per share, which
was the mean trading price of KCS common stock on the New York Stock Exchange
(the "NYSE") on July 13, 2000. The performance stock options vested and became
exercisable in equal installments as KCS's stock price achieved certain
thresholds and after one year following the grant date. All performance
thresholds were met for these performance stock options and all became
exercisable on July 13, 2001. These stock options expire at the end of 10 years,
subject to certain early termination events.
The purchase price of the restricted shares, and the exercise price of the stock
options granted in connection with the purchase of restricted shares, is based
on the mean trading price of KCS common stock on the NYSE on the date the
employee or Outside Director purchased restricted shares under the Option
Program. Each eligible employee and Outside Director was allowed to purchase the
restricted shares offered under the Option Program on one date out of a
selection of dates offered. With respect to management employees, the number of
shares available for purchase and the number of options granted in connection
with shares purchased were based on the compensation level of the employees.
Each Outside Director was granted the right to purchase up to 3,000 restricted
shares of KCS, with two KCS stock options granted in connection with each
restricted share purchased. Shares purchased are restricted from sale and the
options are not exercisable for a period of three years for senior management
and the Outside Directors and two years for other management employees. KCS
provided senior management and the Outside Directors with the option of using a
sixty-day interest-bearing full recourse note to purchase these restricted
shares. These loans accrued interest at 6.49% per annum and were all fully
repaid by September 11, 2000.
Management employees purchased 475,597 shares of KCS restricted stock under the
Option Program and 910,697 stock options were granted in connection with the
purchase of those restricted shares. Outside Directors purchased a total of
9,000 shares of KCS restricted stock under the Option Program and 18,000 KCS
stock options were granted in connection with the purchase of those shares.
Treasury Stock. Shares of common stock in Treasury at December 31, 2002 totaled
12,266,101 compared with 14,125,949 at December 31, 2001 and 15,221,844 at
December 31, 2000. The Company issued shares of common stock from Treasury -
1,859,848 in 2002, 1,095,895 in 2001 and 2,375,760 in 2000 - to fund the
exercise of options and subscriptions under various employee stock option and
purchase plans. In 2000, the Company issued 484,597 of restricted stock in
connection with the Restricted Share and Option Program (see above). Treasury
stock previously acquired had been accounted for as if retired. Shares
repurchased during 2002, 2001 and 2000 were not material.
Note 10. Profit Sharing and Other Postretirement Benefits
- ---------------------------------------------------------
The Company maintains various plans for the benefit of its employees as
described below. For the years ended December 31, 2002, 2001 and 2000, the
Company expensed $0.4, $0.9 and $2.3 million, respectively, related to the
401(k) and Profit Sharing Plan and ESOP. During 2002 and 2001, the Company did
not record any expenses relative to profit sharing or the ESOP.
401(k) and Profit Sharing Plan. During 2000, the Company combined the Profit
Sharing Plan and the 401(k) Plan into the KCS 401(k) and Profit Sharing Plan
(the "Plan"). The Plan permits participants to make contributions by salary
reduction pursuant to section 401(k) of the Internal Revenue Code and also
allows employees to direct their profit sharing accounts into selected
investments. The Company matched employee 401(k) contributions up to a maximum
of 3% of
Page 88
compensation during 2002, 2001 and 2000. Effective January 1, 2003, the
Company will match employee 401(k) contributions up to a maximum of 5% of
compensation. Qualified profit sharing plans are maintained for most employees
not included in collective bargaining agreements. Contributions for the Company
and its subsidiaries are made at the discretion of the Board of Directors of KCS
in amounts not to exceed the maximum allowable for federal income tax purposes.
Employee Stock Ownership Plan. KCS established the ESOP for employees not
covered by collective bargaining agreements. KCS contributions to the ESOP are
based on a percentage of wages earned by eligible employees. Contributions and
percentages are determined by the Compensation and Organization Committee of the
Board of Directors.
Other Postretirement Benefits. The Company provides certain medical, life and
other postretirement benefits other than pensions to its retirees. The medical
and life plans are available to employees not covered under collective
bargaining arrangements, who have attained age 60 and rendered ten years of
service. Individuals employed as of December 31, 1992 were excluded from a
specific service requirement. The medical plan is contributory and provides
benefits for retirees, their covered dependents and beneficiaries. Benefit
expense begins to accrue at age 40. The medical plan was amended effective
January 1, 1993 to provide for annual adjustment of retiree contributions, and
also contains, depending on the plan coverage selected, certain deductibles,
co-payments, coinsurance and coordination with Medicare. The life insurance plan
is non-contributory and covers retirees only. The Company's policy, in most
cases, is to fund benefits payable under these plans as the obligations become
due. However, certain plan assets (e.g., money market funds) do exist with
respect to life insurance benefits.
The following assumptions were used to determine postretirement
obligations/costs for the years ended December 31:
2002 2001 2000
--------- --------- ---------
Annual increase in CPI 2.50% 2.00% 3.00%
Expected rate of return on life
Insurance plan assets 6.50 6.50 6.50
Discount rate 6.50 7.00 7.50
Salary increase 3.00 3.00 3.00
A reconciliation of the accumulated postretirement benefit obligation, change in
plan assets and funded status, respectively, at December 31 follows (in
millions):
2002 2001 2000
--------- --------- ---------
Accumulated postretirement
Benefit obligation at beginning of year $ 9.1 $ 13.1 $ 14.6
Service cost 0.2 0.2 0.3
Interest cost 0.6 0.8 1.1
Plan terminations/amendments -- (3.4) --
Actuarial and other (gain) loss 1.0 (0.6) (1.8)
Benefits paid (i) (0.9) (1.0) (1.1)
--------- --------- ---------
Accumulated postretirement
Benefit obligation at end of year 10.0 9.1 13.1
--------- --------- ---------
Fair value of plan assets
at beginning of year 1.0 1.2 1.3
Actual return on plan assets 0.1 -- 0.1
Benefits paid (i) (0.1) (0.2) (0.2)
--------- --------- ---------
Fair value of plan assets at end of year 1.0 1.0 1.2
--------- --------- ---------
Funded status and accrued benefit cost $ (9.0) $ (8.1) $ (11.9)
========= ========= =========
Page 89
(i) Benefits paid for the reconciliation of accumulated postretirement benefit
obligation include both medical and life insurance benefits, whereas
benefits paid for the fair value of plan assets reconciliation include only
life insurance benefits. Plan assets relate only to the life insurance
benefits. Medical benefits are funded as obligations become due.
Net periodic postretirement benefit cost included the following components (in
millions):
2002 2001 2000
-------- -------- --------
Service cost $ 0.2 $ 0.2 $ 0.3
Interest cost 0.6 0.8 1.1
Expected return on plan assets (0.1) (0.1) (0.1)
-------- -------- --------
Net periodic postretirement benefit cost $ 0.7 $ 0.9 $ 1.3
======== ======== ========
The Company's health care costs, excluding former Gateway Western employees and
certain former employees of the MidSouth, are limited to the increase in the
Consumer Price Index ("CPI") with a maximum annual increase of 5%. Accordingly,
health care costs in excess of the CPI limit will be borne by the plan
participants, and therefore assumptions regarding health care cost trend rates
are not applicable.
During 2001, the Company reduced its liability and recorded a reduction of
operating expenses by approximately $2.0 million in connection with the transfer
of union employees formerly covered by the Gateway Western plan to a
multi-employer sponsored union plan, which effectively eliminated the Company's
postretirement liability for this group of employees. This reduced the number of
former Gateway Western employees or retirees covered under Gateway Western's
benefit plan. The Gateway Western benefit plans are slightly different from
those of the Company and other subsidiaries. Gateway Western provides
contributory health, dental and life insurance benefits to these remaining
employees and retirees. In 2001, the assumed annual rate of increase in health
care costs for Gateway Western employees and retirees under this plan was 10%,
decreasing over six years to 5.5% in 2008 and thereafter. An increase or
decrease in the assumed health care cost trend rates by one percent in 2002,
2001 and 2000 would not have a significant impact on the accumulated
postretirement benefit obligation. The effect of this change on the aggregate of
the service and interest cost components of the net periodic postretirement
benefit is not significant.
During 2001 a post-retirement benefit for directors was eliminated, resulting in
a reduction of the related liability of approximately $1.4 million. This plan
termination, as well as the transfer of Gateway Western union employees to a
multi-employer sponsored union plan are reflected in the reconciliation above as
plan terminations/amendments.
Under collective bargaining agreements, KCSR participates in a multi-employer
benefit plan, which provides certain post-retirement health care and life
insurance benefits to eligible union employees and certain retirees. Premiums
under this plan are expensed as incurred and were $1.0, $0.8 and $0.5 million
for 2002, 2001 and 2000, respectively.
Note 11. Commitments and Contingencies
- --------------------------------------
Litigation. The Company and its subsidiaries are involved as plaintiff or
defendant in various legal actions arising in the normal course of business.
While the ultimate outcome of the various legal proceedings involving the
Company and its subsidiaries cannot be predicted with certainty, it is
management's opinion that the Company's litigation reserves are adequate.
Bogalusa Cases
In July 1996, KCSR was named as one of twenty-seven defendants in
various lawsuits in Louisiana and Mississippi arising from the explosion of a
rail car loaded with chemicals in Bogalusa, Louisiana on October 23, 1995. As a
result of the explosion, nitrogen dioxide and oxides of nitrogen were released
into the atmosphere over parts of that town and the surrounding area allegedly
causing evacuations and injuries. Approximately 25,000 residents of Louisiana
and Mississippi (plaintiffs) have asserted claims to recover damages allegedly
caused by exposure to the released chemicals. On October 29, 2001, KCSR and
representatives for its excess insurance carriers negotiated a settlement in
principle with the plaintiffs for $22.3 million. A Master Global Settlement
Agreement was signed in early 2002. During 2002, KCSR
Page 90
made all payments under this agreement and collected $19.3 million from its
excess insurance carriers. Court approval of the MGSA is expected in 2003 from
the 22nd Judicial District Court of Washington Parish, Louisiana. KCSR also
expects to receive releases from about 4,000 Mississippi plaintiffs in numerous
cases pending in the First Judicial District Circuit Court of Hinds County,
Mississippi.
Duncan Case Settlement
In 1998, a jury in Beauregard Parish, Louisiana returned a verdict against KCSR
in the amount of $16.3 million. This case arose from a railroad crossing
accident that occurred at Oretta, Louisiana on September 11, 1994, in which
three individuals were injured. Of the three, one was injured fatally, one was
rendered quadriplegic and the third suffered less serious injuries. Subsequent
to the verdict, the trial court held that the plaintiffs were entitled to
interest on the judgment from the date the suit was filed, dismissed the verdict
against one defendant and reallocated the amount of that verdict to the
remaining defendants. On November 3, 1999, the Third Circuit Court of Appeals in
Louisiana affirmed the judgment. Subsequently, KCSR obtained review of the case
in the Supreme Court of Louisiana. On October 30, 2000, the Supreme Court of
Louisiana entered its order affirming in part and reversing in part the
judgment. The net effect of the Louisiana Supreme Court action was to reduce the
allocation of negligence to KCSR and reduce the judgment, with interest, against
KCSR from approximately $28 million to approximately $14.2 million
(approximately $9.7 million of damages and $4.5 million of interest). This
judgment was in excess of KCSR's insurance coverage of $10 million for this
case. KCSR filed an application for rehearing in the Supreme Court of Louisiana,
which was denied on January 5, 2001. KCSR then sought a stay of judgment in the
Louisiana court. The Louisiana court denied the stay application on January 12,
2001. KCSR reached an agreement as to the payment structure of the judgment in
this case and payment of the settlement was made on March 7, 2001.
KCSR had previously recorded a liability of approximately $3.0 million for this
case. Based on the Supreme Court of Louisiana's decision, as of December 31,
2000, management recorded an additional liability of $11.2 million and also
recorded a receivable in the amount of $7.0 million representing the amount of
the insurance coverage. This resulted in recording $4.2 million of net operating
expense in the accompanying consolidated financial statements for the year ended
December 31, 2000. The final installment on the $7.0 million receivable from the
insurance company was received by KCSR in June 2001.
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, and
legal counsel for the remaining plaintiffs (approximately 120) has withdrawn,
leaving the status of those claims in doubt.
Stilwell Tax Dispute
On November 19, 2002, Stilwell, now Janus Capital Group Inc., filed a Statement
of Claim against KCS with the American Arbitration Association. This claim
involves the entitlement to compensation expense deductions for federal income
tax purposes which are associated with the exercise of certain stock options
issued by Stilwell (the "Substituted Options") in connection with the Spin-off
of Stilwell from KCS on July 12, 2000. Stilwell alleges that upon exercise of a
Substituted Option, Stilwell is entitled to the associated compensation expense
deductions. Stilwell bases its claim on a letter, dated August 17, 1999,
addressed to Landon H. Rowland, Chairman, President and Chief Executive Officer
of Kansas City Southern Industries, Inc. (the "Letter"), purporting to allow
Stilwell to claim such deductions. The Letter was signed by the Vice President
and Tax Counsel of Stilwell, who was also at the time the Senior Assistant Vice
President and Tax Counsel of KCS, and by Landon H. Rowland, currently a director
of KCS and the non-executive Chairman of Janus Capital Group Inc., who was at
that time a director and officer of both Stilwell and KCS.
Page 91
Stilwell seeks a declaratory award and/or injunction ordering KCS to file and
amend its tax returns for the tax year 2000 and subsequent years to reflect that
KCS does not claim the associated compensation expense deductions and to
indemnify Stilwell against any related taxes imposed upon Stilwell, which
allegedly has taken, and plans to take, such deductions. On December 20, 2002,
KCS filed an Objection to Stilwell's Demand for Arbitration and Motion to
Dismiss. KCS disputes the validity and enforceability of the Letter. KCS
asserts, among other things, that a Private Letter Ruling issued by the Internal
Revenue Service on July 9, 1999 provides that KCS subsidiaries are entitled to
compensation expense deductions upon exercise of Substituted Options by their
employees.
KCS has answered that the claims of Stilwell are without merit and intends to
vigorously defend against them. Given the early stage of the proceeding, KCS is
unable to predict the outcome, but does not expect this matter to result in any
material adverse financial consequences to KCS's net income in the event, which
it regards as unlikely, that it would not prevail.
Environmental Liabilities. The Company's operations are subject to extensive
federal, state and local environmental laws and regulations. The major
environmental laws to which the Company is subject, include, among others, the
Federal Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA," also known as the Superfund law), the Toxic Substances Control Act,
the Federal Water Pollution Control Act, and the Hazardous Materials
Transportation Act. CERCLA can impose joint and several liability for cleanup
and investigation costs, without regard to fault or legality of the original
conduct, on current and predecessor owners and operators of a site, as well as
those who generate, or arrange for the disposal of, hazardous substances. The
Company does not foresee that compliance with the requirements imposed by the
environmental legislation will impair its competitive capability or result in
any material additional capital expenditures, operating or maintenance costs.
The risk of incurring environmental liability is inherent in the railroad
industry. As part of serving the petroleum and chemicals industry, KCSR
transports hazardous materials and has a professional team available to respond
and handle environmental issues that might occur in the transport of such
materials. Additionally, the Company is a Responsible Care(R) partner and has
initiated practices under this environmental program. KCSR performs ongoing
reviews and evaluations of the various environmental programs and issues within
the Company's operations, and, as necessary, takes actions to limit the
Company's exposure to potential liability.
The Company owns property that is, or has been, used for industrial purposes.
Use of these properties may subject the Company to potentially material
liabilities relating to the investigation and cleanup of contaminants, claims
alleging personal injury, or property damage as the result of exposures to, or
release of, hazardous substances. Although the Company is responsible for
investigating and remediating contamination at several locations, based on
currently available information, the Company does not expect any related
liabilities, individually or collectively, to have a material impact on its
results of operations, financial position or cash flows. In the event that the
Company becomes subject to more stringent cleanup requirements at these sites,
discovers additional contamination, or becomes subject to related personal or
property damage claims, the Company could incur material costs in connection
with these sites.
The Company records liabilities for remediation and restoration costs related to
past activities when the Company's obligation is probable and the costs can be
reasonably estimated. Costs of ongoing compliance activities to current
operations are expensed as incurred. The Company's recorded liabilities for
these issues represent its best estimates (on an undiscounted basis) of
remediation and restoration costs that may be required to comply with present
laws and regulations. Although these costs cannot be predicted with certainty,
management believes that the ultimate outcome of identified matters will not
have a material adverse effect on the Company's consolidated results of
operations, financial condition or cash flows.
Derivative Instruments and Purchase Commitments. Fuel expense is a significant
component of the Company's operating expenses. Fuel costs are affected by (i)
traffic levels, (ii) efficiency of operations and equipment, and (iii) fuel
market conditions. Controlling fuel expenses is a top priority of management. As
a result, from time to time, the Company will enter into transactions to hedge
against fluctuations in the price of its diesel fuel purchases to protect the
Company's operating results against adverse fluctuations in fuel prices. KCSR
enters into forward diesel fuel purchase commitments and commodity swap
transactions (fuel swaps or caps) as a means of fixing future fuel prices.
Page 92
At December 31, 1999, the Company was party to two diesel fuel cap transactions
for a total of six million gallons (approximately 10% of expected 2000 usage) at
a cap price of $0.60 per gallon. These hedging instruments expired on March 31,
2000 and June 30, 2000. The Company received approximately $0.8 million during
2000 related to these diesel fuel cap transactions and recorded the proceeds as
a reduction of fuel expense. At December 31, 1999, the Company did not have any
outstanding purchase commitments for 2000. At December 31, 2000, KCSR had
purchase commitments for approximately 12.6% of budgeted gallons of fuel for
2001, which resulted in higher fuel expense of approximately $0.4 million in
2001. There were no fuel swap or cap transactions outstanding at December 31,
2000. At December 31, 2001, KCSR had purchase commitments for approximately 39%
of its budgeted gallons of fuel for 2002, which resulted in a decrease in fuel
expense of approximately $0.4 million in 2002. There were no diesel fuel cap or
swap transactions outstanding at December 31, 2001. At December 31, 2002, KCSR
had purchase commitments and was a party to a fuel swap transaction, which, on a
combined basis, resulted in approximately 21% of expected 2003 diesel fuel
usage. On January 14, 2003, KCSR entered into an additional fuel swap
transaction, which raised the total hedged gallons to approximately 25% of
budgeted 2003 diesel fuel usage. KCSR is also a party to swap transactions for
approximately 2.5 million gallons of fuel for 2004. Commodity swap transactions
are accounted for as hedges under SFAS 133 and are typically based on the price
of No. 2 Gulf Coast Heating Oil, which the Company believes to produce a high
correlation to the price of diesel fuel. These transactions are generally
settled monthly in cash with the counter-party. Positions are monitored to
ensure that they will not exceed actual fuel requirements in any period. The
commodity swap transaction entered into prior to December 31, 2002 is recorded
on the accompanying balance sheet at its fair market value, which approximates
$0.2 million at December 31, 2002.
At December 31, 2001, the Company had five separate interest rate cap agreements
for an aggregate notional amount of $200 million. Three of these interest rate
cap agreements expired on February 10, 2002 while the remaining two expired on
March 10, 2002. As of December 31, 2002, the Company did not have any interest
rate cap agreements or interest rate hedging instruments.
These derivative transactions are intended to mitigate the impact of rising fuel
prices and interest rates and, if applicable, are recorded using the accounting
policies as set forth in Note 2 - "Significant Accounting Policies." In general,
the Company enters into transactions such as those discussed above in limited
situations based on management's assessment of current market conditions and
perceived risks. Historically, the Company has engaged in a limited number of
such transactions and their impact has been insignificant. However, the Company
intends to respond to evolving business and market conditions in order to manage
risks and exposures associated with the Company's various operations, and in
doing so, may enter into transactions similar to those discussed above.
Foreign Exchange Matters. In connection with the Company's investment in Grupo
TFM, matters arise with respect to financial accounting and reporting for
foreign currency transactions and for translating foreign currency financial
statements into U.S. dollars. The Company follows the requirements outlined in
Statement of Financial Accounting Standards No. 52 "Foreign Currency
Translation" ("SFAS 52"), and related authoritative guidance. The Company uses
the U.S. dollar as the functional currency for Grupo TFM. Equity earnings
(losses) from Grupo TFM included in the Company's results of operations reflect
the Company's share of any such translation gains and losses that Grupo TFM
records in the process of translating certain transactions from Mexican pesos to
U.S. dollars.
The Company continues to evaluate existing alternatives with respect to
utilizing foreign currency instruments to hedge its U.S. dollar investment in
Grupo TFM as market conditions change or exchange rates fluctuate. At December
31, 2002, 2001and 2000, the Company had no outstanding foreign currency hedging
instruments.
Results of the Company's investment in Grupo TFM are reported under U.S. GAAP
while Grupo TFM reports its financial results under IAS. Because the Company is
required to report its equity 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. The deferred
income tax calculations are significantly impacted by fluctuations in the
relative value of the Mexican peso versus the U.S. dollar and the rate of
Mexican inflation, and can result in significant variability in the amount of
equity earnings (losses) reported by the Company.
Page 93
Panama Canal Railway Company. Under certain limited conditions, the Company is a
guarantor for up to $5.6 million of cash deficiencies associated with the
operations of PCRC. In addition, the Company is a guarantor for up to $2.1
million of equipment loans. Further, if the Company or its partner terminate the
concession contract without the consent of the IFC, the Company is a guarantor
for up to 50% of the outstanding senior loans. See Note 5.
Note 12. Control
- ----------------
Subsidiaries and Affiliates. The Company is party to certain agreements with
Grupo TMM covering the Grupo TFM venture, which contains "change of control"
provisions, provisions intended to preserve the Company's and Grupo TMM's
proportionate ownership of the ventures, 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. Under certain circumstances,
such agreements could affect the Company's ownership percentage and rights in
these equity affiliates.
Employees. The Company and certain of its subsidiaries have entered into
agreements with employees whereby, upon defined circumstances constituting a
change in control of the Company or subsidiary, certain stock options become
exercisable, certain benefit entitlements are automatically funded and such
employees are entitled to specified cash payments upon termination of
employment.
Assets. The Company and certain of its subsidiaries have established trusts to
provide for the funding of corporate commitments and entitlements of officers,
directors, employees and others in the event of a specified change in control of
the Company or subsidiary. Assets held in such trusts at December 31, 2002 were
not material. Depending upon the circumstances at the time of any such change in
control, the most significant factor of which would be the highest price paid
for KCS common stock by a party seeking to control the Company, funding of the
Company's trusts could be substantial.
Debt. Certain loan agreements and debt instruments entered into or guaranteed by
the Company and its subsidiaries provide for default in the event of a specified
change in control of the Company or particular subsidiaries of the Company.
Stockholder Rights Plan. On September 19, 1995, the Board of Directors of the
Company declared a dividend distribution of one Right for each outstanding share
of the Company's common stock, $.01 par value per share (the "Common stock"), to
the stockholders of record on October 12, 1995. Each Right entitles the
registered holder to purchase from the Company 1/1,000th of a share of Series A
Preferred Stock (the "Preferred Stock") or in some circumstances, Common stock,
other securities, cash or other assets as the case may be, at a price of $210
per share, subject to adjustment.
The Rights, which are automatically attached to the Common stock, are not
exercisable or transferable apart from the Common stock until the tenth calendar
day following the earlier to occur of (unless extended by the Board of Directors
and subject to the earlier redemption or expiration of the Rights): (i) the date
of a public announcement that an acquiring person acquired, or obtained the
right to acquire, beneficial ownership of 20 percent or more of the outstanding
shares of the Common stock of the Company (or 15 percent in the case that such
person is considered an "adverse person"), or (ii) the commencement or
announcement of an intention to make a tender offer or exchange offer that would
result in an acquiring person beneficially owning 20 percent or more of such
outstanding shares of Common stock of the Company (or 15 percent in the case
that such person is considered an "adverse person"). Until exercised, the Rights
will have no rights as a stockholder of the Company, including, without
limitation, the right to vote or to receive dividends. In connection with
certain business combinations resulting in the acquisition of the Company or
dispositions of more than 50% of Company assets or earnings power, each Right
shall thereafter have the right to receive, upon the exercise thereof at the
then current exercise price of the Right, that number of shares of the highest
priority voting securities of the acquiring company (or certain of its
affiliates) that at the time of such transaction would have a market value of
two times the exercise price of the Right. The Rights expire on October 12,
2005, unless earlier redeemed by the Company as described below.
Page 94
At any time prior to the tenth calendar day after the first date after the
public announcement that an acquiring person has acquired beneficial ownership
of 20 percent (or 15 percent in some instances) or more of the outstanding
shares of the Common stock of the Company, the Company may redeem the Rights in
whole, but not in part, at a price of $0.005 per Right. In addition, the
Company's right of redemption may be reinstated following an inadvertent trigger
of the Rights (as determined by the Board) if an acquiring person reduces its
beneficial ownership to 10 percent or less of the outstanding shares of Common
stock of the Company in a transaction or series of transactions not involving
the Company.
The Series A Preferred shares purchasable upon exercise of the Rights will have
a cumulative quarterly dividend rate set by the Board of Directors or equal to
1,000 times the dividend declared on the Common stock for such quarter. Each
share will have the voting rights of one vote on all matters voted at a meeting
of the stockholders for each 1/1,000th share of preferred stock held by such
stockholder. In the event of any merger, consolidation or other transaction in
which the common shares are exchanged, each Series A Preferred share will be
entitled to receive an amount equal to 1,000 times the amount to be received per
common share. In the event of a liquidation, the holders of Series A Preferred
shares will be entitled to receive $1,000 per share or an amount per share equal
to 1,000 times the aggregate amount to be distributed per share to holders of
Common stock. The shares will not be redeemable. The vote of holders of a
majority of the Series A Preferred shares, voting together as a class, will be
required for any amendment to the Company's Certificate of Incorporation that
would materially and adversely alter or change the powers, preferences or
special rights of such shares.
Page 95
Note 13. Quarterly Financial Data (Unaudited)
- ----------------------------------------------
(in millions, except per share amounts):
2002
------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
Revenues (i) $ 144.2 $ 138.9 $ 139.2 $ 143.9
Costs and expenses (i) 114.2 116.9 110.1 115.6
Depreciation and amortization 16.1 15.8 14.6 14.9
--------- --------- --------- ---------
Operating income 13.9 6.2 14.5 13.4
Equity in net earnings (losses)
of unconsolidated affiliates
Grupo TFM 18.2 9.8 13.0 4.8
Other (0.5) (0.7) (1.3) 0.1
Gain on sale of Mexrail, Inc. -- -- -- 4.4
Interest expense (11.7) (11.5) (10.5) (11.3)
Debt retirement costs (i) -- -- (4.3) --
Other, net 2.3 6.5 4.4 4.4
--------- --------- --------- ---------
Income from operations before income taxes 22.2 10.3 15.8 15.8
Income taxes provision (benefit) 1.8 (0.3) 1.3 4.1
--------- --------- --------- ---------
Net income $ 20.4 $ 10.6 $ 14.5 $ 11.7
========= ========= ========= =========
Per Share Data
Total Basic Earnings per Common share $ 0.33 $ 0.17 $ 0.24 $ 0.20
========= ========= ========= =========
Total Diluted Earnings per Common share $ 0.32 $ 0.17 $ 0.23 $ 0.19
========= ========= ========= =========
Dividends per Preferred share $ 0.25 $ 0.25 $ 0.25 $ 0.25
Stock Price Ranges:
Preferred - High $ 20.00 $ 19.85 $ 20.75 $ 19.50
- Low $ 18.00 $ 16.25 $ 19.45 $ 17.95
Common - High $ 15.00 $ 17.35 $ 17.00 $ 15.99
- Low $ 12.00 $ 12.75 $ 14.96 $ 12.75
(i) The revenue and expense amounts reported hereon have been reclassified from
the amounts previously reported under the applicable period's Quarterly
Report on Form 10-Q. Additionally, debt retirement costs previously
reported as an extraordinary item have been reclassified in accordance with
SFAS 145.
Page 96
2001
------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
Revenues (i) $ 146.9 $ 146.1 $ 144.7 $ 145.5
Costs and expenses (i) 112.1 115.4 117.3 125.0
Depreciation and amortization 14.4 14.7 14.5 14.4
--------- --------- --------- ---------
Operating income 20.4 16.0 12.9 6.1
Equity in net earnings (losses)
of unconsolidated affiliates
Grupo TFM 5.0 7.5 4.9 11.1
Other (1.2) (0.6) 0.3 0.1
Interest expense (9.9) (13.2) (14.5) (15.2)
Other, net 1.2 0.9 1.1 1.0
--------- --------- --------- ---------
Income from operations before income taxes 15.5 10.6 4.7 3.1
Income taxes provision (benefit) 4.4 1.6 -- (3.2)
--------- --------- --------- ---------
Income from operations 11.1 9.0 4.7 6.3
Cumulative effect of accounting change,
net of income taxes -- -- -- (0.4)
--------- --------- --------- ---------
Net income $ 11.1 $ 9.0 $ 4.7 $ 5.9
========= ========= ========= =========
Per Share Data (ii)
Basic earnings per Common share
Continuing operations $ 0.19 $ 0.15 $ 0.08 $ 0.11
Cumulative effect of accounting change,
net of income taxes -- -- -- (0.01)
--------- --------- --------- ---------
Total Basic Earnings per Common share $ 0.19 $ 0.15 $ 0.08 $ 0.10
========= ========= ========= =========
Diluted earnings per Common share
Continuing operations $ 0.18 $ 0.15 $ 0.08 $ 0.10
Cumulative effect of accounting change,
net of income taxes -- -- -- (0.00)
--------- --------- --------- ---------
Total Diluted Earnings per Common share $ 0.18 $ 0.15 $ 0.08 $ 0.10
========= ========= ========= =========
Dividends per Preferred share
$ 0.25 $ 0.25 $ 0.25 $ 0.25
Stock Price Ranges:
Preferred - High $ 19.00 $ 21.00 $ 21.00 $ 20.95
- Low $ 16.50 $ 17.95 $ 20.63 $ 20.00
Common - High $ 15.40 $ 16.10 $ 16.75 $ 15.50
- Low $ 10.92 $ 10.25 $ 12.10 $ 9.00
(i) The revenue and expense amounts reported hereon have been reclassified
from the amounts previously reported under the applicable period's
Quarterly Report on Form 10-Q.
(ii) The accumulation of 2001's four quarters for Basic and Diluted earnings
(loss) per share data does not total the respective earnings per share
for the year ended December 31, 2001 due to rounding.
Page 97
Note 14. Condensed Consolidating Financial Information
- ------------------------------------------------------
As discussed in Note 7, in September 2000 KCSR issued $200 million of 9 1/2%
Notes due 2008. In addition, as discussed in Note 7, in June 2002, KCSR issued
$200 million of 7 1/2% Notes due 2009. Both of these note issues are an
unsecured obligation of KCSR, however, they are also jointly and severally and
fully and unconditionally guaranteed on an unsecured senior basis by KCS and
certain of its 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 affiliates whose securities collateralize an issue 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. Certain prior year information
has been reclassified to reflect the merger of Gateway Western and certain other
wholly-owned subsidiaries with KCSR.
Condensed Consolidating Statements of Income
December 31, 2002 (dollars in millions)
--------------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------ ------------ ------------ ------------ ------------ ------------
Revenues $ -- $ 567.4 $ 18.1 $ 38.3 $ (57.6) $ 566.2
Costs and expenses 10.8 506.4 19.5 39.1 (57.6) 518.2
------------ ------------ ------------ ------------ ------------ ------------
Operating income (loss) (10.8) 61.0 (1.4) (0.8) -- 48.0
Equity in net earnings (losses) of
unconsolidated affiliates and
subsidiaries 61.5 45.6 -- 43.6 (107.3) 43.4
Gain on sale of Mexrail -- 4.4 -- -- -- 4.4
Interest expense (0.4) (44.1) (0.4) (0.1) -- (45.0)
Debt retirement costs -- (4.3) -- -- -- (4.3)
Other income 3.9 11.0 2.0 0.7 -- 17.6
------------ ------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes 54.2 73.6 0.2 43.4 (107.3) 64.1
Income tax provision (benefit) (3.0) 10.6 0.1 (0.8) -- 6.9
------------ ------------ ------------ ------------ ------------ ------------
Net income $ 57.2 $ 63.0 $ 0.1 $ 44.2 $ (107.3) $ 57.2
============ ============ ============ ============ ============ ============
December 31, 2001 (dollars in millions)
--------------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------ ------------ ------------ ------------ ------------ ------------
Revenues $ -- $ 580.3 $ 12.3 $ 20.1 $ (29.5) $ 583.2
Costs and expenses 13.6 511.4 13.1 19.2 (29.5) 527.8
------------ ------------ ------------ ------------ ------------ ------------
Operating income (loss) (13.6) 68.9 (0.8) 0.9 -- 55.4
Equity in net earnings (losses) of
unconsolidated affiliates and
subsidiaries 39.2 26.8 -- 29.4 (68.3) 27.1
Interest expense 1.3 (55.2) (0.5) (0.4) 2.0 (52.8)
Other income 0.2 6.0 -- -- (2.0) 4.2
------------ ------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes 27.1 46.5 (1.3) 29.9 (68.3) 33.9
Income tax provision (benefit) (4.0) 6.7 (0.5) 0.6 -- 2.8
Income (loss) before cumulative
effect of accounting change 31.1 39.8 (0.8) 29.3 (68.3) 31.1
------------ ------------ ------------ ------------ ------------ ------------
Cumulative effect of accounting
Change, net of income taxes (0.4) (0.4) -- -- 0.4 (0.4)
------------ ------------ ------------ ------------ ------------ ------------
Net income $ 30.7 $ 39.4 $ (0.8) $ 29.3 $ (67.9) $ 30.7
============ ============ ============ ============ ============ ============
Page 98
December 31, 2000 (dollars in millions)
--------------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------ ------------ ------------ ------------ ------------ ------------
Revenues $ -- $ 577.8 $ 12.2 $ 11.0 $ (22.3) $ 578.7
Costs and expenses 10.0 511.1 11.5 10.6 (22.3) 520.9
------------ ------------ ------------ ------------ ------------ ------------
Operating income (loss) (10.0) 66.7 0.7 0.4 -- 57.8
Equity in net earnings (losses) of
unconsolidated affiliates and
subsidiaries 29.6 19.1 0.2 21.2 (48.0) 22.1
Interest expense (2.6) (68.6) (0.7) (1.1) 7.2 (65.8)
Debt retirement costs (10.9) -- -- -- -- (10.9)
Other income 4.0 9.1 0.1 -- (7.2) 6.0
------------ ------------ ------------ ------------ ------------ ------------
Income (loss) from continuing
operations before income taxes 10.1 26.3 0.3 20.5 (48.0) 9.2
Income tax provision (benefit) (6.6) (2.0) (0.2) 1.3 -- (7.5)
------------ ------------ ------------ ------------ ------------ ------------
Income (loss) from continuing
operations 16.7 28.3 0.5 19.2 (48.0) 16.7
Income (loss) from discontinued
operations 363.8 -- -- 363.8 (363.8) 363.8
------------ ------------ ------------ ------------ ------------ ------------
Net income (loss) $ 380.5 $ 28.3 $ 0.5 $ 383.0 $ (411.8) $ 380.5
============ ============ ============ ============ ============ ============
Condensed Consolidating Balance Sheets
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 held for
operating purposes and
investments in subsidiaries 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
============ ============ ============ ============ ============ ============
Page 99
As of December 31, 2001 (dollars in millions)
----------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------ ------------ ------------ ------------ ------------ ------------
ASSETS
Current assets $ 25.5 $ 231.7 $ 13.7 $ 6.6 $ (23.1) $ 254.4
Investments held for
operating purposes and
investments in subsidiaries 701.4 377.9 -- 376.4 (1,068.9) 386.8
Properties, net 0.3 1,321.5 3.8 1.8 -- 1,327.4
Goodwill and other assets 1.7 40.5 1.6 0.1 (1.6) 42.3
------------ ------------ ------------ ------------ ------------ ------------
Total assets $ 728.9 $ 1,971.6 $ 19.1 $ 384.9 $ (1,093.6) $ 2,010.9
============ ============ ============ ============ ============ ============
LIABILITIES AND EQUITY
Current liabilities $ 7.2 $ 254.4 $ 4.8 $ 3.8 $ (23.1) $ 247.1
Long-term debt 1.3 602.9 2.8 4.7 -- 611.7
Payable to affiliates 4.8 -- 0.6 -- (5.4) --
Deferred income taxes 9.5 355.9 0.2 6.2 (1.6) 370.2
Other liabilities 25.8 62.0 3.4 10.4 -- 101.6
Stockholders' equity 680.3 696.4 7.3 359.8 (1,063.5) 680.3
------------ ------------ ------------ ------------ ------------ ------------
Total liabilities and equity $ 728.9 $ 1,971.6 $ 19.1 $ 384.9 $ (1,093.6) $ 2,010.9
============ ============ ============ ============ ============ ============
As of December 31, 2000 (dollars in millions)
----------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------ ------------ ------------ ------------ ------------ ------------
ASSETS
Current assets $ 16.9 $ 203.8 $ 10.5 $ 10.1 $ (24.9) $ 216.4
Investments held for
operating purposes and
investments in subsidiaries 666.3 359.0 0.7 343.8 (1,011.6) 358.2
Properties, net 0.3 1,318.7 6.6 2.2 -- 1,327.8
Goodwill and other assets 0.2 41.3 2.2 0.3 (1.9) 42.1
------------ ------------ ------------ ------------ ------------ ------------
Total assets $ 683.7 $ 1,922.8 $ 20.0 $ 356.4 $ (1,038.4) $ 1,944.5
============ ============ ============ ============ ============ ============
LIABILITIES AND EQUITY
Current liabilities $ 21.8 $ 239.5 $ 5.2 $ 5.3 $ (25.3) $ 246.5
Long-term debt 1.6 627.9 3.8 5.1 -- 638.4
Payable to affiliates 3.4 -- -- -- (3.4) --
Deferred income taxes 7.2 323.2 (0.2) 3.9 (1.9) 332.2
Other liabilities 6.3 72.7 2.5 2.5 -- 84.0
Stockholders' equity 643.4 659.5 8.7 339.6 (1,007.8) 643.4
------------ ------------ ------------ ------------ ------------ ------------
Total liabilities and equity $ 683.7 $ 1,922.8 $ 20.0 $ 356.4 $ (1,038.4) $ 1,944.5
============ ============ ============ ============ ============ ============
Page 100
Condensed Consolidating Statements of Cash Flows
As of December 31, 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: $ (27.5) $ 118.5 $ 12.7 $ (6.7) $ 3.4 $ 100.4
------------ ------------ ------------ ------------ ------------ ------------
Investing activities:
Property acquisitions -- (79.1) (0.7) -- -- (79.8)
Proceeds from disposal of property -- 18.1 -- -- -- 18.1
Investments in and loans to affiliates (3.0) -- -- (13.0) 11.6 (4.4)
Proceeds from sale of investments 1.4 31.3 -- -- (1.0) 31.7
Other, net -- (1.0) -- (8.1) 8.6 (0.5)
------------ ------------ ------------ ------------ ------------ ------------
Net (1.6) (30.7) (0.7) (21.1) 19.2 (34.9)
------------ ------------ ------------ ------------ ------------ ------------
Financing activities:
Proceeds from issuance of
long-term debt -- 200.0 -- -- -- 200.0
Repayment of long-term debt (0.4) (269.3) (1.0) (0.2) -- (270.9)
Proceeds from loans from affiliates 8.0 -- 0.2 -- (8.2) --
Debt issuance costs (5.7) -- -- -- (5.7)
Proceeds from stock plans 10.0 0.3 -- -- 10.3
Cash dividends paid (0.2) -- -- -- (0.2)
Other, net (0.4) (18.9) 0.6 28.4 (14.4) (4.7)
------------ ------------ ------------ ------------ ------------ ------------
Net 17.0 (93.6) (0.2) 28.2 (22.6) (71.2)
------------ ------------ ------------ ------------ ------------ ------------
Cash and cash equivalents:
Net increase (decrease) (12.1) (5.8) 11.8 0.4 -- (5.7)
At beginning of period 1.3 23.2 -- 0.2 -- 24.7
------------ ------------ ------------ ------------ ------------ ------------
At end of period $ (10.8) $ 17.4 $ 11.8 $ 0.6 $ -- $ 19.0
============ ============ ============ ============ ============ ============
As of December 31, 2001 (dollars in millions)
---------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------ ------------ ------------ ------------ ------------ ------------
Net cash flows provided by (used
for) operating activities: $ (10.0) $ 82.2 $ (4.3) $ (0.8) $ 1.1 $ 68.2
------------ ------------ ------------ ------------ ------------ ------------
Investing activities:
Property acquisitions -- (65.7) (0.2) (0.1) -- (66.0)
Proceeds from disposal of property -- 14.8 3.3 -- -- 18.1
Investments in and loans to affiliates -- (2.6) -- (9.0) 3.4 (8.2)
Proceeds from sale of investments -- -- 0.6 -- -- 0.6
Other, net -- -- 0.5 -- (0.7) (0.2)
------------ ------------ ------------ ------------ ------------ ------------
Net -- (53.5) 4.2 (9.1) 2.7 (55.7)
------------ ------------ ------------ ------------ ------------ ------------
Financing activities:
Proceeds from issuance of
long-term debt -- 35.0 -- -- -- 35.0
Repayment of long-term debt -- (50.0) (1.0) (0.3) -- (51.3)
Proceeds from loans from affiliates 1.4 -- 0.6 -- (2.0) --
Repayment of loans from affiliates -- -- -- -- -- --
Debt issuance costs -- (0.4) -- -- -- (0.4)
Proceeds from stock plans 8.9 -- -- -- -- 8.9
Cash dividends paid (0.2) -- -- -- -- (0.2)
Other, net (0.3) (9.5) 0.4 9.9 (1.8) (1.3)
------------ ------------ ------------ ------------ ------------ ------------
Net 9.8 (24.9) -- 9.6 (3.8) (9.3)
------------ ------------ ------------ ------------ ------------ ------------
Cash and cash equivalents:
Net increase (decrease) (0.2) 3.8 (0.1) (0.3) -- 3.2
At beginning of period 1.5 19.4 0.1 0.5 -- 21.5
------------ ------------ ------------ ------------ ------------ ------------
At end of period $ 1.3 $ 23.2 $ -- $ 0.2 $ -- $ 24.7
============ ============ ============ ============ ============ ============
Page 101
As of December 31, 2000 (dollars in millions)
---------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------ ------------ ------------ ------------ ------------ ------------
Net cash flows provided by (used
for) operating activities: $ 3.5 $ 86.9 $ (2.0) $ 11.2 $ (24.9) $ 74.7
------------ ------------ ------------ ------------ ------------ ------------
Investing activities:
Property acquisitions -- (103.3) (1.2) -- -- (104.5)
Proceeds from disposal of property -- 5.5 -- -- -- 5.5
Investments in and loans to affiliates (43.0) -- -- (4.6) 43.4 (4.2)
Repayment of loans to affiliates 544.8 -- -- -- (544.8) --
Other, net 1.1 (2.6) -- -- 2.9 1.4
------------ ------------ ------------ ------------ ------------ ------------
Net 502.9 (100.4) (1.2) (4.6) (498.5) (101.8)
------------ ------------ ------------ ------------ ------------ ------------
Financing activities:
Proceeds from issuance of
long-term debt 125.0 927.0 -- -- -- 1,052.0
Repayment of long-term debt (648.3) (365.7) (1.2) (0.2) -- (1,015.4)
Proceeds from loans from affiliates -- 74.2 3.8 -- (78.0) --
Repayment of loans from affiliates -- (577.6) -- -- 577.6 --
Debt issuance costs -- (17.6) -- -- -- (17.6)
Proceeds from stock plans 17.9 -- -- -- -- 17.9
Cash dividends paid (4.8) (15.3) (0.3) (8.7) 24.3 (4.8)
Other, net 0.1 2.3 0.2 2.5 (0.5) 4.6
------------ ------------ ------------ ------------ ------------ ------------
Net (510.1) 27.3 2.5 (6.4) 523.4 36.7
------------ ------------ ------------ ------------ ------------ ------------
Cash and cash equivalents:
Net increase (decrease) (3.7) 13.8 (0.7) 0.2 -- 9.6
At beginning of period 5.2 5.6 0.8 0.3 -- 11.9
------------ ------------ ------------ ------------ ------------ ------------
At end of period $ 1.5 $ 19.4 $ 0.1 $ 0.5 $ -- $ 21.5
============ ============ ============ ============ ============ ============
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
The information regarding the Company's Change in and Disagreements with
Accountants on Accounting and Financial Disclosure is set forth under Item 4 of
the Company's Form 8-K dated June 20, 2001, which is incorporated herein by
reference.
There were no disagreements with accountants on accounting and financial
disclosure matters during 2002.
Part III
The Company has incorporated by reference certain responses to the Items of this
Part III pursuant to Rule 12b-23 under the Exchange Act and General Instruction
G(3) to Form 10-K. The Company's definitive proxy statement for the annual
meeting of stockholders scheduled for May 1, 2003 ("Proxy Statement") will be
filed no later than 120 days after December 31, 2002.
Item 10. Directors and Executive Officers of the Company
(a) Directors of the Company
The information set forth in response to Item 401 of Regulation S-K under the
heading "Proposal 1 - Election of Three Directors" and "The Board of Directors"
in the Company's Proxy Statement is incorporated herein by reference in partial
response to this Item 10.
Page 102
(b) Executive Officers of the Company
The information set forth in response to Item 401 of Regulation S-K under
"Executive Officers of the Company," an unnumbered Item in Part I (immediately
following Item 4, Submission of Matters to a Vote of Security Holders), of this
Form 10-K is incorporated herein by reference in partial response to this Item
10.
(c) Compliance with Section 16(a) of the Exchange Act
The information set forth in response to Item 405 of Regulation S-K under the
heading "Section 16(a) Beneficial Ownership Reporting Compliance" in the
Company's Proxy Statement is incorporated herein by reference in partial
response to this Item 10.
Item 11. Executive Compensation
The information set forth in response to Item 402 of Regulation S-K under
"Management Compensation" and "The Board of Directors -- Compensation of
Directors" in the Company's Proxy Statement, (other than the Compensation and
Organization Committee Report on Executive Compensation and the Stock
Performance Graph), is incorporated herein by reference in response to this Item
11.
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
The information set forth in response to Item 403 of Regulation S-K under the
heading "Principal Stockholders and Stock Owned Beneficially by Directors and
Certain Executive Officers" in the Company's Proxy Statement is incorporated
herein by reference in response to this Item 12.
The information set forth in response to Item 201(d) of Regulation S-K under the
heading, "Equity Compensation Plan Information" in the Company's Proxy Statement
is incorporated herein by reference in response to this Item 12.
The Company has no knowledge of any arrangement the operation of which may at a
subsequent date result in a change of control of the Company.
Item 13. Certain Relationships and Related Transactions
The information set forth in response to Item 404 of Regulation S-K under the
heading "Compensation Committee Interlocks and Insider Participation; Certain
Relationships and Related Transactions" in the Company's Proxy Statement is
incorporated herein by reference in response to this Item 13.
Item 14. 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-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")), as of a date within
ninety days before the filing of this annual report. 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
Page 103
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 have not been any significant changes in the Company's internal controls
or in other factors that could significantly affect these controls subsequent to
the date of their evaluation. There were no significant deficiencies or material
weakness in the internal controls, and therefore no corrective actions were
taken.
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) List of Documents filed as part of this Report
(1) Financial Statements
The financial statements and related notes, together with the report of KPMG LLP
dated March 24, 2003 and the report of PricewaterhouseCoopers LLP dated March
22, 2001, except as to the adoption of Statement of Financial Accounting
Standards No. 142 described in Note 2 which is as of January 1, 2002, appear in
Part II Item 8, Financial Statements and Supplementary Data, of this Form 10-K.
(2) Financial Statement Schedules
The schedules and exhibits for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission appear in Part
II Item 8, Financial Statements and Supplementary Data, under the Index to
Financial Statements of this Form 10-K.
(3) List of Exhibits
(a) Exhibits
The Company has incorporated by reference herein certain exhibits as specified
below pursuant to Rule 12b-32 under the Exchange Act.
(2) Plan of acquisition, reorganization, arrangement, liquidation or
succession (Inapplicable)
(3) Articles of Incorporation and Bylaws
Articles of Incorporation
-------------------------
3.1 Exhibit 3.1 to the Company's Registration Statement on Form
S-4 originally filed July 12, 2002 (Registration No.
333-92360), as amended and declared effective on July 30, 2002
(the " 2002 S-4 Registration Statement"), Restated Certificate
of Incorporation, is hereby incorporated by reference as
Exhibit 3.1
Bylaws
------
3.2 Exhibit 3.2 to the Company's Form 10-Q for the quarter ended
September 30, 2002 (Commission File No. 1-4717), The By-Laws
of Kansas City Southern, as amended and restated to September
24, 2002, is hereby incorporated by reference as Exhibit 3.2
Page 104
(4) Instruments Defining the Right of Security Holders, Including Indentures
4.1 The Fourth, Seventh, Eighth, Eleventh, Twelfth, Thirteenth,
Fourteenth, Fifteenth and Sixteenth paragraphs of Exhibit 3.1
hereto are incorporated by reference as Exhibit 4.1
4.2 Article I, Sections 1, 3 and 11 of Article II, Article V and
Article VIII of Exhibit 3.2 hereto are incorporated by
reference as Exhibit 4.2
4.3 The Indenture, dated July 1, 1992 between the Company and The
Chase Manhattan Bank (the "1992 Indenture") which is attached
as Exhibit 4 to the Company's Shelf Registration of $300
million of Debt Securities on Form S-3 filed June 19, 1992
(Registration No. 33-47198) and as Exhibit 4(a) to the
Company's Form S-3 filed March 29, 1993 (Registration No.
33-60192) registering $200 million of Debt Securities, is
hereby incorporated by reference as Exhibit 4.3
4.3.1 Exhibit 4.5.2 to the Company's Form 10-K for the fiscal year
ended December 31, 1999 (Commission File No. 1-4717),
Supplemental Indenture dated December 17, 1999 to the 1992
Indenture with respect to the 6.625% Notes Due March 1, 2005
issued pursuant to the 1992 Indenture, is hereby incorporated
by reference as Exhibit 4.3.1
4.3.2 Exhibit 4.5.4 to the Company's Form 10-K for the fiscal year
ended December 31, 1999 (Commission File No. 1-4717),
Supplemental Indenture dated December 17, 1999 to the 1992
Indenture with respect to the 7% Debentures Due December 15,
2025 issued pursuant to the 1992 Indenture, is hereby
incorporated by reference as Exhibit 4.3.2
4.4 Exhibit 99 to the Company's Form 8-A dated October 24, 1995
(Commission File No. 1-4717), which is the Stockholder Rights
Agreement by and between the Company and Harris Trust and
Savings Bank dated as of September 19, 1995, is hereby
incorporated by reference as Exhibit 4.4
4.5 Exhibit 4.1 to the Company's S-4 Registration Statement on
Form S-4 originally filed on January 25, 2001 (Registration
No. 333-54262), as amended and declared effective on March 15,
2001 (the "2001 S-4 Registration Statement") the Indenture,
dated as of September 27, 2000, among the Company, The Kansas
City Southern Railway Company ("KCSR"), certain other
subsidiaries of the Company and The Bank of New York, as
trustee (the "2000 Indenture"), is hereby incorporated by
reference as Exhibit 4.5
4.5.1 Exhibit 4.1.1 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Supplemental Indenture, dated as
of January 29, 2001, to the 2000 Indenture, among the Company,
KCSR, certain other subsidiaries of the Company and The Bank
of New York, as trustee, is hereby incorporated by reference
as Exhibit 4.5.1
4.6 Form of Exchange Note (included as Exhibit B to Exhibit 4.5.1
hereto)
4.7 Exhibit 4.3 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), the Exchange and Registration
Rights Agreement, dated as of September 27, 2000, among the
Company, KCSR, certain other subsidiaries of the Company, is
hereby incorporated by reference as Exhibit 4.7
4.8 The Indenture, dated June 12, 2002, among KCSR, the Company
and certain subsidiaries of the Company, and U.S. Bank
National Association, as Trustee (the "2002 Indenture"), which
is attached as Exhibit 4.1 to the 2002 S-4 Registration
Statement (Registration No. 333-92360) is hereby incorporated
by reference as Exhibit 4.8
Page 105
4.8.1 Form of Face of Exchange Note, included as Exhibit B to
Exhibit 4.8 and filed as Exhibit 4.2 to the 2002 S-4
Registration Statement (Registration No. 333-92360) is hereby
incorporated by reference as Exhibit 4.8.1
(9) Voting Trust Agreement
(Inapplicable)
(10) Material Contracts
10.1 Form of Officer Indemnification Agreement which is attached as
Exhibit 10.1 to the Company's Form 10-K for the year ended
December 31, 2001 (Commission File No. 1-4717), is hereby
incorporated by reference as Exhibit 10.1
10.2 Form of Director Indemnification Agreement which is attached
as Exhibit 10.2 to the Company's Form 10-K for the year ended
December 31, 2001 (Commission File No. 1-4717), is hereby
incorporated by reference as Exhibit 10.2
10.3 The 1992 Indenture (See Exhibit 4.3)
10.4.1 Supplemental Indenture dated December 17, 1999 to the 1992
Indenture with respect to the 6.625% Notes Due March 1, 2005
issued pursuant to the 1992 Indenture (See Exhibit 4.3.1)
10.4.2 Supplemental Indenture dated December 17, 1999 to the 1992
Indenture with respect to the 7% Debentures Due December 15,
2025 issued pursuant to the 1992 Indenture (See Exhibit 4.3.2)
10.5 Exhibit 10.1 to the Company's Form 10-Q for the period ended
March 31, 1997 (Commission File No. 1-4717), The Kansas City
Southern Railway Company Directors' Deferred Fee Plan as
adopted August 20, 1982 and the amendment thereto effective
March 19, 1997 to such plan, is hereby incorporated by
reference as Exhibit 10.5
10.6 Exhibit 10.4 to the Company's Form 10-K for the fiscal year
ended December 31, 1990 (Commission File No. 1-4717),
Description of the Company's 1991 incentive compensation plan,
is hereby incorporated by reference as Exhibit 10.6
10.7 Exhibit 10.10 to the Company's 2002 S-4 Registration Statement
(Registration No. 333-92360), Directors Deferred Fee Plan,
adopted August 20, 1982, amended and restated June 1, 2002, is
hereby incorporated by reference as Exhibit 10.7
10.8 Kansas City Southern 1991 Amended and Restated Stock Option
and Performance Award Plan, as amended and restated effective
as of November 7, 2002 is attached to this Form 10-K as
Exhibit 10.8
10.9 Exhibit 10.8 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Tax Disaffiliation Agreement,
dated October 23, 1995, by and between the Company and DST
Systems, Inc., is hereby incorporated by reference as Exhibit
10.9
10.10.1 Kansas City Southern 401(k) and Profit Sharing Plan (Amended
and Restated Effective April 1, 2002), is attached to this
Form 10-K as Exhibit 10.10.1
10.10.2 First Amendment to the Kansas City Southern 401(k) and Profit
Sharing Plan (As Amended and Restated Effective April 1,
2002), effective January 1, 2003, is attached hereto as
Exhibit 10.10.2
Page 106
10.11 Exhibit 10.10 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), the Assignment, Consent and
Acceptance Agreement, dated August 10, 1999, by and among the
Company, DST Systems, Inc. and Stilwell Financial, Inc., is
hereby incorporated by reference as Exhibit 10.11
10.12 Employment Agreement, as amended and restated January 1, 2001,
by and among the Company, KCSR and Michael R. Haverty, which
is attached as Exhibit 10.12 to the Company's Form 10-K for
the year ended December 31, 2001 (Commission File No. 1-4717),
is hereby incorporated by reference as Exhibit 10.12
10.13 Exhibit 10.14 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Employment Agreement, dated
January 1, 1999, by and among the Company, KCSR and Gerald K.
Davies, is hereby incorporated by reference as Exhibit 10.13
10.13.1 Amendment to Employment Agreement, dated as of January 1,
2001, by and among the Company, KCSR and Gerald K. Davies
which is attached as Exhibit 10.13.1 to the Company's Form
10-K for the year ended December 31, 2001 (Commission File No.
1-4717) is hereby incorporated by reference as
Exhibit 10.13.1
10.14 Employment Agreement, dated June 1, 2002 by and among the
Company, KCSR and Ronald G. Russ, which is attached as Exhibit
10.17 to the Company's 2002 S-4 Registration Statement
(Registration No. 333-92360) is hereby incorporated by
reference as Exhibit 10.14
10.14.1 First Amendment to Employment Agreement, dated March 14, 2003,
by and among the Company, KCSR, and Ronald G. Russ is attached
to this Form 10-K as Exhibit 10.14.1
10.15 Employment Agreement, dated September 1, 2001, by and between
the Company, KCSR and Jerry W. Heavin is attached to this Form
10-K as Exhibit 10.15
10.15.1 First Amendment to Employment Agreement, dated March 14, 2003,
by and among the Company, KCSR and Jerry W. Heavin is attached
to this Form 10-K as Exhibit 10.l5.1
10.16 Employment Agreement, dated August 14, 2000, by and between
the Company, KCSR and Larry O. Stevenson is attached to this
Form 10-K as Exhibit 10.16
10.16.1 Amendment to Employment Agreement dated January 1, 2002, by
and among the Company, KCSR and Larry O. Stevenson is attached
to this Form 10-K as Exhibit 10.16.1
10.16.2 Amendment to Employment Agreement, dated March 14, 2003, by
and among the Company, KCSR and Larry O. Stevenson is attached
to this Form 10-K as Exhibit 10.16.2
10.17 Employment Agreement (Amended and Restated January 1, 2001) by
and between the Company and Louis G. Van Horn is attached to
this Form 10-K as Exhibit 10.17
10.18 Employment Agreement dated as of August 1, 2001, as amended by
the Amendment to Employment Agreement dated as of August 1,
2001, by and among the Company, KCSR and William J. Pinamont,
which is attached as Exhibit 10.16 to the Company's Form 10-K
for the year ended December 31, 2001 (Commission File No.
1-4717) is hereby incorporated by reference as Exhibit 10.18
10.19 Exhibit 10.18 to the Company's Form 10-K for the year ended
December 31, 1998 (Commission File No. 1-4717), Kansas City
Southern Industries, Inc. Executive Plan, as amended and
restated effective November 17, 1998, is hereby incorporated
by reference as Exhibit 10.19
10.20 The Kansas City Southern Annual Incentive Plan is attached
hereto as Exhibit 10.20
Page 107
10.21 Amendment and Restatement Agreement dated June 12, 2002, among
the Company, KCSR and the lenders named therein, together with
the Amended and Restated Credit Agreement dated June 12, 2002
among the Company, KCSR and the lenders named therein attached
thereto as Exhibit A, which is attached as Exhibit 10.6 to the
Company's 2002 S-4 Registration Statement (Registration No.
333-92360), is hereby incorporated by reference as Exhibit
10.21
10.21.1 Reaffirmation Agreement, dated June 12, 2002, among the
Company, KCSR and JP Morgan Chase Bank, which is attached as
Exhibit 10.6.1 to the Company's 2002 S-4 Registration
Statement (Registration No. 333-92360), is hereby incorporated
by reference as Exhibit 10.21.1
10.21.2 Master Assignment and Acceptance, dated June 12, 2002, among
the Company, KCSR and the lenders named therein, which is
attached as Exhibit 10.6.2 to the Company's 2002 S-4
Registration Statement
(Registration No. 333-92360), is hereby incorporated by
reference as Exhibit 10.21.2
10.22 The 2000 Indenture (See Exhibit 4.5)
10.23 Supplemental Indenture, dated as of January 29, 2001, to the
2000 Indenture (See Exhibit 4.5.1)
10.24 Exhibit 10.23 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Intercompany Agreement, dated as
of August 16, 1999, between the Company and Stilwell Financial
Inc.,
is hereby incorporated by reference as Exhibit 10.24
10.25 Exhibit 10.24 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Tax Disaffiliation Agreement,
dated as of August 16, 1999, between the Company and Stilwell
Financial Inc., is hereby incorporated by reference as Exhibit
10.25
10.26 Exhibit 10.25 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Pledge Agreement, dated as of
January 11, 2000, among the Company, KCSR, the subsidiary
pledgors party thereto and The Chase Manhattan Bank, as
Collateral Agent (the "Pledge Agreement"), is hereby
incorporated by reference as Exhibit 10.26
10.27 Exhibit 10.26 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Guarantee Agreement, dated as of
January 11, 2000, among the Company, the subsidiary guarantors
party thereto and The Chase Manhattan Bank, as Collateral
Agent (the "Guarantee Agreement"), is hereby incorporated by
reference as Exhibit 10.27
10.28 Exhibit 10.27 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Security Agreement, dated as of
January 11, 2000, among the Company, KCSR, the subsidiary
guarantors party thereto and The Chase Manhattan Bank, as
Collateral Agent (the "Security Agreement"), is hereby
incorporated by reference as Exhibit 10.28
10.29 Exhibit 10.28 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Indemnity, Subrogation and
Contribution Agreement, dated as of January 11, 2000, among
the Company, KCSR, the subsidiary guarantors party thereto and
The Chase Manhattan Bank, as Collateral Agent (the "Indemnity,
Subrogation and Contribution Agreement"), is hereby
incorporated by reference as Exhibit 10.29
10.30 Exhibit 10.29 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Supplement No. 1, dated as of
January 29, 2001, to the Pledge Agreement, among PABTEX GP,
LLC, SIS Bulk Holding, Inc. and The Chase Manhattan Bank, as
Collateral Agent, is hereby incorporated by reference as
Exhibit 10.30
Page 108
10.31 Exhibit 10.30 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Supplement No. 1, dated as of
January 29, 2001, to the Guarantee Agreement, among PABTEX GP,
LLC, SIS Bulk Holding, Inc. and The Chase Manhattan Bank, as
Collateral Agent, is hereby incorporated by reference as
Exhibit 10.31
10.32 Exhibit 10.31 to the Company's 2001 S-4 Registration Statement
(Registration No. 333-54262), Supplement No. 1, dated as of
January 29, 2001, to the Security Agreement, among PABTEX GP,
LLC, SIS Bulk Holding, Inc. and The Chase Manhattan Bank, as
Collateral Agent, is hereby incorporated by reference as
Exhibit 10.32
10.33 Exhibit 10.32 to the Company's 2001 S-4 Registration
Statement (Registration No. 333-54262), Supplement No. 1,
dated as of January 29, 2001, to the Indemnity, Subrogation
and Contribution Agreement, among PABTEX GP, LLC, SIS Bulk
Holding, Inc. and The Chase Manhattan Bank, as Collateral
Agent, is hereby incorporated by reference as Exhibit 10.33
10.34 Lease Agreement, as amended, between The Kansas City Southern
Railway Company and Broadway Square Partners LLP dated June
26, 2001, which is attached as Exhibit 10.34 to the Company's
Form 10-K for the year ended December 31, 2001 (Commission
File No. 1-4717), is hereby incorporated by reference as
Exhibit 10.34
10.35 The 2002 Indenture (See Exhibit 4.8)
10.36 Agreement to Forego Compensation between A. Edward Allinson
and the Company, fully executed on March 30, 2001; Loan
Agreement between A. Edward Allinson and the Company fully
executed on September 18, 2001; and the Promissory Note
executed by the Trustees of The A. Edward Allinson Irrevocable
Trust Agreement dated, June 4, 2001, Courtney Ann Arnot, A.
Edward Allinson III and Bradford J. Allinson, Trustees, as
Maker, and the Company, as Holder, are attached hereto as
Exhibit 10.36
10.37 Agreement to Forego Compensation between Michael G. Fitt and
the Company, fully executed on March 30, 2001; Loan Agreement
between Michael G. Fitt and the Company, fully executed on
September 7, 2001; and the Promissory Note executed by the
Trustees of The Michael G. and Doreen E. Fitt Irrevocable
Insurance Trust, Anne E. Skyes, Colin M-D. Fitt and Ian D.G.
Fitt, Trustees, as Maker, and the Company, as Holder, are
attached hereto as Exhibit 10.37
10.38 Kansas City Southern Employee Stock Ownership Plan (As Amended
and Restated Effective April 1, 2002) is attached hereto as
Exhibit 10.38
(11) Statement Re Computation of Per Share Earnings
(Inapplicable)
(12) Statements Re Computation of Ratios
12.1 The Computation of Ratio of Earnings to Fixed Charges prepared
pursuant to Item 601(b)(12) of Regulation S-K is attached to
this Form 10-K as Exhibit 12.1
(13) Annual Report to Security Holders, Form 10-Q or Quarterly Report to
Security Holders (Inapplicable)
(16) Letter Re Change in Certifying Accountant
16.1 The information set forth under Item 4 and Exhibit 16.1 of the
Company's Form 8-K dated June 20, 2001 (Commission File No.
1-4717) prepared pursuant to Item 304 (a) of Regulation S-K is
hereby incorporated by reference as Exhibit 16.1
Page 109
(18) Letter Re: Change in Accounting Principles
(Inapplicable)
(21) Subsidiaries of the Company
21.1 The list of the Subsidiaries of the Company prepared pursuant
to Item 601(b)(21) of Regulation S-K is attached to this Form
10-K as Exhibit 21.1
(22) Published Report Regarding Matters Submitted to Vote of Security Holders
(Inapplicable)
(23) Consents of Experts and Counsel
23.1 The Consents of Independent Accountants prepared pursuant to
Item 601(b)(23) of Regulation S-K are attached to this Form
10-K as Exhibit 23.1
(24) Power of Attorney
(Inapplicable)
(99) Additional Exhibits
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.3 The combined and consolidated financial statements of Grupo
Transportacion Ferroviaria Mexicana, S.A. de C.V. (including
the notes thereto and the Report of Independent Accountants
thereon) as of December 31, 2002 and 2001 and for each of the
three years in the period ended December 31, 2002 as listed
under Item 15(a)(2) herein, are hereby included in this Form
10-K as Exhibit 99.3
(b) Reports on Form 8-K
The Company furnished a Current Report on Form 8-K dated October 10,
2002 announcing the date of its third quarter 2002 earnings release 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 furnished a Current Report on Form 8-K dated October 11,
2002 under Item 5 of such form, announcing a favorable ruling in the
Value Added Tax ("VAT") Lawsuit.
The Company furnished a Current Report on Form 8-K dated October 24,
2002 under Item 5 of such form, providing additional information about
the favorable ruling on the TFM VAT suit.
The Company furnished a Current Report on Form 8-K dated October 31,
2002 under Item 5 of such form, announcing the Company's VAT accounting
position.
The Company furnished a Current Report on Form 8-K dated November 5,
2002 reporting its third quarter 2002 operating results. 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 dated December 9, 2002,
under Item 5 of such form, announcing a new decision of the Mexican
Fiscal Court denying TFM's VAT claim.
Page 110
SIGNATURES
- ----------
Pursuant to the requirements of Section 13 or 15 (d) 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.
Kansas City Southern
March 26, 2003 By: /s/ M.R. HAVERTY
-------------------------------
M.R. Haverty
Chairman, President,
Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company and in
the capacities indicated on March 26, 2003.
Signature Capacity
--------- --------
/s/ M.R. HAVERTY Chairman, President, Chief Executive Officer
- ---------------------------- and Director
M.R. Haverty
/s/ G.K. DAVIES Executive Vice President and Chief Operating
- ---------------------------- Officer
G.K Davies
/s/ R.G. RUSS Executive Vice President and Chief Financial
- ---------------------------- Officer
R.G. Russ (Principal Financial Officer)
/s/ L.G. VAN HORN Vice President and Comptroller
- ---------------------------- (Principal Accounting Officer)
L.G. Van Horn
/s/ A.E ALLINSON Director
- ----------------------------
A.E. Allinson
/s/ M.G. FITT Director
- ----------------------------
M.G. Fitt
/s/ J.R. JONES Director
- ----------------------------
J.R. Jones
/s/ L.H. ROWLAND Director
- ----------------------------
L.H. Rowland
/s/ B.G. THOMPSON Director
- ----------------------------
B.G. Thompson
/s/ R.E. SLATER Director
- ----------------------------
R.E. Slater
Page 111
CERTIFICATION
- -------------
I, Michael R. Haverty, certify that:
1. I have reviewed this annual report on Form 10-K of Kansas City Southern;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including corrective actions with regard
to significant deficiencies and material weaknesses.
Date: March 26, 2003
/s/ MICHAEL R. HAVERTY
-----------------------------------------------
Michael R. Haverty
Chairman, President and Chief Executive Officer
Page 112
CERTIFICATION
- -------------
I, Ronald G. Russ, certify that:
1. I have reviewed this annual report on Form 10-K of Kansas City Southern;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including corrective actions with regard
to significant deficiencies and material weaknesses.
Date: March 26, 2003
/s/ RONALD G. RUSS
----------------------------------------------------
Ronald G. Russ
Executive Vice President and Chief Financial Officer
Page 113
KANSAS CITY SOUTHERN
2002 FORM 10-K ANNUAL REPORT
INDEX TO EXHIBITS
Regulation S-K
Exhibit Item 601(b)
No. Document Exhibit No.
- ------- ---------------------------------------------------------- -----------
10.8 Kansas City Southern 1991 Amended and Restated Stock Option
and Performance Award Plan (as amended and restated effective
as of November 7, 2002) 10
10.10.1 Kansas City Southern 401(k) and Profit Sharing Plan (Amended
and Restated Effective April 1, 2002) 10
10.10.2 First Amendment to the Kansas City Southern 401(k) and Profit
Sharing Plan (As Amended and Restated Effective April 1, 2002 10
10.14.1 First Amendment to Employment Agreement dated March 14, 2003
by and among the Company, KCSR and Ronald G. Russ 10
10.15 Employment Agreement dated September 1, 2001 by and between
KCSR, the Company and Jerry W. Heavin 10
10.15.1 First Amendment to Employment Agreement dated March 14, 2003
by and among KCSR, the Company and Jerry W. Heavin 10
10.16 Employment Agreement dated August 14, 2000 by and between
the Company, KCSR and Larry O. Stevenson 10
10.16.1 Amendment to Employment Agreement dated January 1, 2001 by
and among the Company, KCSR and Larry O. Stevenson 10
10.16.2 Amendment to Employment Agreement dated March 14, 2003 by and
among the Company, KCSR and Larry O. Stevenson 10
10.17 Employment Agreement (Amended and Restated January 1, 2001)
by and between the Company and Louis G. Van Horn 10
10.20 The Kansas City Southern Annual Incentive Plan 10
10.36 Agreement to Forego Compensation between A. Edward Allinson and the
Company, fully executed on March 30, 2001; Loan Agreement between
A. Edward Allinson and the Company fully executed on September 18, 2001;
and the Promissory Note executed by the Trustees of The A. Edward Allinson
Irrevocable Trust Agreement dated, June 4, 2001, Courtney Ann Arnot,
A. Edward Allinson III and Bradford J. Allinson, Trustees, as Maker, and
the Company, as Holder 10
10.37 Agreement to Forego Compensation between Michael G. Fitt and the
Company, fully executed on March 30, 2001; Loan Agreement between
Michael G. Fitt and the Company, fully executed on September 7, 2001;
and the Promissory Note executed by the Trustees of The Michael G. and
Doreen E. Fitt Irrevocable Insurance Trust, Anne E. Skyes, Colin M-D. Fitt
and Ian D.G. Fitt, Trustees, as Maker, and the Company, as Holder 10
Page 114
10.38 Kansas City Southern Employee Stock Ownership Plan (As Amended and
Restated Effective April 1, 2002) 10
12.1 Computation of Ratio of Earnings to Fixed Charges 12
21.1 Subsidiaries of the Company 21
23.1 Consents of Independent Accountants 23
99.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 99
99.2 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002 99
99.3 Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. combined and
consolidated financial statements as of December 31, 2002 and 2001 and for
each of the three years in the period ended December 31, 2002 99
Page 115