~~TMM entered into~~
RECENT DEVELOPMENTS
Preferred Stock Dividends.  On January 12, 2007, the Company declared a cash dividend on the 4.25% Redeemable Cumulative Convertible Perpetual Preferred stock, series C (“Series C Preferred Stock”) and a stock dividend on the 5.125% Cumulative Convertible Perpetual Preferred Stock, Series D (“Series D Preferred Stock”) for dividends in arrears that were due May 15, 2006, August 15, 2006 and November 15, 2006, and the dividend payment due February 15, 2007. The dividend was paid February 15, 2007, to stockholders of record on February 5, 2007. The Company also declared a cash dividend on the 4%, noncumulative Preferred Stock, payable April 3, 2007, to stockholders of record on March 12, 2007.
Consent Solicitation.  On January 29, 2007, KCSR commenced a consent solicitation to amend the indentures under which KCSR’s 91/2% Senior Notes due 2008 (“91/2% Notes”) and 71/2% Senior Notes due 2009 (“71/2% Notes” and together with the 91/2% Notes, the “Notes”) were issued. The purpose of the consent solicitation was to (i) resolve an ~~amended~~inconsistency in the inclusion of certain expenses, but not the income, of restricted subsidiaries in the calculation of the consolidated coverage ratio under the indentures, (ii) amend the definition of refinancing indebtedness to allow the inclusion of certain related premiums, interest, fees and ~~restated acquisition agreement, referred~~expenses in permitted refinancing indebtedness and (iii) obtain waivers of any defaults arising from certain actions taken in the absence of such proposed amendments. On February 5, 2007, KCSR obtained the requisite consents from the holders of each series of Notes to amend their respective indentures as described above and executed supplemental indentures containing such amendments and waivers.
Credit Facility Waiver.  On January 31, 2007, KCS provided written notice to the ~~“Acquisition~~lenders under the 2006 Credit Agreement~~” amending~~ of certain representation and ~~restating~~other defaults under the ~~Original~~2006 Credit Agreement arising from the potential defaults which existed under the KCSR indentures as described above. These defaults limited KCSR’s access to the revolving credit facility. In its notice of default, the Company also requested that the lenders waive these defaults. On February 5, 2007 the Company received a waiver of such defaults from all of the lenders under the 2006 Credit Agreement. The Company is currently not in default of the 2006 Credit Agreement and has access to the revolving credit facility.
Claims Asserted under the TMM Acquisition Agreement. ~~Under~~  As part of the acquisition of Grupo KCSM in 2005, KCS issued escrow notes to TMM totaling $47.0 million which are subject to reduction for certain potential losses related to incorrect representations and warranties or breaches of covenants in the Acquisition Agreement by TMM. On January 29, 2007, KCS ~~will acquire control of TFM~~advised TMM that KCS intended to assert claims for indemnification under the Acquisition Agreement related to representations and ~~all of~~warranties made by TMM. On February 1, 2007, KCS received a notice from TMM indicating that TMM would seek damages from KCS under the ~~shares of stock with full voting rights of TFM. We anticipate closing this transaction in late March or early April of 2005.~~
~~2004 Analysis~~
      For 2004, KCS continued to experience consolidated revenue growth with an increase of 10% over 2003. For the year, we experienced revenue growth in all commodity groups except coal. For the fourth quarter, all commodity groups experienced revenue growth over the fourth quarter of 2003. This revenue growth was the result of continued growth in traffic volume, especially for Mexican traffic. Management believes much of this growth in traffic volume is a direct result of improvements in the North American economy and continued high levels of operating performance and service evidenced by low terminal dwell times and high average train velocity. Additionally, revenue increases also reflect targeted rate increases and variable fuel surcharges.
      Operational improvements and increases in efficiency have yielded reductions in equipment costs as foreign cars spend less time on KCSR’s lines. Equipment costs have also been reduced through credits resulting from KCSR equipment spending more time on foreign lines as a result of congestion on foreign lines. Depreciation expense declined in 2004, primarily as a result of the implementation of new depreciation rates derived from a study conducted on track structure and rolling stock usage by a professional engineering firm specializing in railway engineering applications. These improvements in operating expense were more than offset by increases in compensation and benefits expense (driven by increases in wage and salary ratesAcquisition Agreement, aggregating approximately $43 million as well as ~~increased crew starts related to increased traffic), and fuel costs (related to fuel price increases and increased consumption).~~
      Equity in net earnings from Grupo TFM for 2004 declined $14.7 million resulting in equity in net losses from Grupo TFM of $2.4 million. This decline resulted from reduced operating income of $1.2 million primarily related to increased fuel costs and a $56.2 million increase in the provision for income taxes. See Note 3 to the financial statements in Item 8 to this Form 10-K.other unspecified damages. The significant increase in the tax provision is due primarily to a reduction in the Mexican corporate tax rate and corresponding reductions in the value of certain tax assets previously recorded by Grupo TFM. These reductions in the corporate tax ratesparties are ~~expected to reduce future tax expense and thereby result in increases to future earnings.~~
~~2005 Outlook~~
      For 2005, we expect to build on the momentum and gains achieved in 2004 by taking advantage of continued improvements in the North American economy and our domestic operations. On December 15, 2004, KCS and TMM announced the signing ofobligated under the Acquisition Agreement ~~which, upon closing, will result in KCS’s control of TFM. We expect~~ to ~~close the transaction on April 1, 2005. Combining KCSR, TFM~~attempt to resolve their differences informally and, ~~Tex-Mex under the common control of KCS is expected~~if not successful, then to make us a stronger, more competitive railway network. Upon closing of the transaction, the financial results of TFM will be consolidated into KCS. As a result, factors that affect the Mexican economy and business climate, such as foreign exchange rates, tax laws and inflation will directly impact the consolidated results of KCS. Duesubmit them to ~~their variability, we are unable to predict the impact of such factors on KCS’s consolidated results.~~binding arbitration.
In 2005, revenues are expected to increase as an improving economy continues to drive higher demand. With certain exceptions, we expect increases in variable operating expenses to be proportionate to revenue activities. Gains in operating efficiencies are expected to continue to be realized as a result of continued utilization of the data available from our transportation operating system, Management Control System (“MCS”). Fuel prices are expected to fluctuate with market conditions and will continue to be a significant dynamic in our operating expenses. For 2005, we currently have 4% of our projected fuel usage hedged through fuel swaps. In 2005, we expect fuel surcharges to continue to provide the most effective hedge against fuel price volatility. In 2004, we began purchasing a significant amount of our fuel through a pipeline system, which has resulted in fuel cost savings as well as fuel source stability. Insurance costs are expected to increase commensurate with market conditions.
20
~~RISK FACTORS~~RESULTS OF OPERATIONS

~~The Company Faces Competition from Other Railroads and Other Transportation Providers.~~ The Company is subject to competition from other railroads, many of which are much larger and have significantly greater financial and other resources. In addition, the Company is subject to competition from truck carriers and from barge lines and other maritime shipping. 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. While the Company must build or acquire and maintain its infrastructure, truck carriers and maritime shippers and barges are able to use public rights-of-way. Continuing competitive pressures and declining margins, future improvements that increase the service quality of alternative modes of transportation in the locations in which the Company operates, or legislation that provides motor carriers with additional advantages, such as increased size of vehicles and less weight restrictions, could have a material adverse effect on the Company’s results of operations, financial condition and liquidity.

~~The Company may be required to make additional investments in TFM.~~ The Mexican government has put rights with respect to the shares of TFM it holds to compel the purchase of those shares by Grupo TFM. The Mexican government provided Grupo TFM with notice of its intention to sell its interest in TFM. Grupo TFM has responded to the Mexican government’s notice reaffirming its right and interest in purchasing the Mexican government’s remaining interest in TFM, but also advising the Mexican government that it would not take any action until its lawsuit seeking a declaratory judgment was resolved. Grupo TFM filed a lawsuit seeking a declaratory judgment concerning its interpretation of its obligation to purchase the Mexican government’s shares of TFM, and that lawsuit is ongoing. KCS and TMM have been made parties to the lawsuit. In the event that Grupo TFM does not purchase the Mexican government’s 20% interest in TFM and Grupo TFM’s lawsuit is resolved in favor of the Mexican government, then TMM and KCS, or either of TMM or KCS alone, would, following notification by the Mexican government in accordanceYear Ended December 31, 2006, Compared with the terms of the applicable agreements, be obligated to purchase the Mexican government’s remaining interest in TFM. If the Acquisition is completed prior to the purchase of the Mexican government’s interest in TFM, KCS will be solely responsible for purchasing the Mexican government’s 20% interest in TFM. If KCS had been required to purchase this interest as ofYear Ended December 31, ~~2004,~~2005

Net Income. Consolidated net income increased $139.9 million excluding the ~~total purchase price would have been approximately $468 million.~~

~~We may be unable to complete the Acquisition.~~ KCS and TMM have entered into the Acquisition Agreement dated December 15, 2004. This agreement is subject to completion of closing on April 1, 2005. If the Acquisition is not consummated, the value of our investment in Grupo TFM may become impaired.

If the Mexican government’s preliminary findings and conclusions arising from its tax audit of TFM’s 1997 tax returns are sustained, it could have a material adverse effect on the financial condition, results of operations and business of TFM. As a result, the value of our investment in Grupo TFM could be materially adversely affected. On January 20, 2004, TFM was served with an official letter notifying TFM of the Mexican government’s preliminary findings and conclusions arising from its tax audit of TFM’s 1997 tax returns (the “Tax Audit Summary”). In the Tax Audit Summary, the Mexican government notified TFM of its preliminary conclusion that the documentation provided by TFM in support of the VAT refund credit shown on the 1997 tax return and TFM’s basis in the Concession title, locomotives and rail equipment, and capital leases purchased by TFM’s predecessor in interest prior to Grupo TFM’s purchase of 80% of the shares of TFM, do not comply with the formalities required by the applicable tax legislation. On March 16, 2005 ~~TFM was notified by the Mexican Fiscal Administration Service (~~~~“Servicio de Administración Tributaria”~~ ~~or the~~~~“SAT”~~) that it had finished its audit of TFM’s 1997 tax returns. As of March 16, 2005. The SAT had not yet assessed any penalties or taxes against TFM as a result of the audit. In the notice, the SAT stated that TFM did not supply documentation complying with the requirements of the Mexican fiscal code and, therefore, it was not entitled in its 1997 tax returns to depreciate and deduct the concession title, the railway equipment and other assets that were assets of TFM at the time that it was privatized in 1997. If sustained, the SAT’s conclusions would prevent TFM from depreciating for Mexican tax purposes the Concession title, locomotives

and rail equipment, and capital leases, which represent the majority of the value of the assets owned by TFM. If TFM is unable to depreciate the Concession title and the other assets reported on its 1997 tax return for Mexican tax purposes, this could have a material adverse effect on the financial condition, results of operations and business of TFM. As a result, the value of our investment in Grupo TFM could be materially adversely impacted.

~~We may not receive the proceeds specified by the VAT Refund Claim.~~ On January 19, 2004, TFM received a Special Certificate from the Mexican Federal Treasury in the amount of 2.1 billion pesos (the same amount as the value added tax (“VAT”) refund claimed by TFM in 1997). The Mexican government also attached the Special Certificate pending resolution of the audit, as a potential asset to be used to satisfy any tax obligations owed by TFM as a result of the audit. TFM has advised that it has, within the time allowed by the Tax Audit Summary, contested the conclusions of the Mexican tax authorities, and it has filed a constitutional appeal against the Tax Audit Summary, alleging the process followed by the Mexican government violated TFM’s constitutional rights. TFM also filed a complaint against the Mexican government, seeking to have the amount of the Special Certificate adjusted to reflect interest and inflation from 1997 to the date of issuance in accordance with Mexican law. In a decision dated November 24, 2004, the Mexican Federal Appellate Court issued a decision upholding TFM’s claim that it is entitled to inflation and interest on the VAT refund. The Federal Appellate Court remanded the case to the Mexican Fiscal Court with instructions to enter a new order consistent with this decision. On January 26, 2005, the Mexican Fiscal Court issued from the bench an oral order implementing the Appellate Court decisions. This order was delivered to TFM in written form on February 18, 2005. There can be no assurance that we will receive the proceeds specified by the VAT refund claim.

~~Our business strategy, operations and growth rely significantly on joint ventures and other strategic alliances.~~ Operation of our integrated rail network and our plans for growth and expansion rely significantly on joint ventures and other strategic alliances. Unless the Acquisition is consummated, we will continue to hold an indirect minority interest in TFM. As a minority shareholder, we are not in a position to control operations, strategies or financial decisions without the concurrence of TMM, the largest shareholder in Grupo TFM. In addition, our operations are dependent on interchange, trackage rights, haulage rights and marketing agreements with other railroads and third parties that enable us to exchange traffic and utilize trackage we do not own. Our ability to provide comprehensive rail service to our customers depends in large part upon our ability to maintain these agreements with other railroads and third parties. The termination of, or the failure to renew, these agreements could adversely affect our business, financial condition and results of operations. We are also dependent in part upon the financial health and efficient performance of other railroads. There can be no assurance that we will not be materially affected adversely by operational or financial difficulties of other railroads.

~~Our Mexican and Panamanian investments subject us to political and economic risks.~~ Our investment in Grupo TFM involves a number of risks. The Mexican government exercises significant influence over the Mexican economy and its actions could have a significant impact on TFM. Our Mexican investment may also be adversely affected by currency fluctuations, price instability, inflation, interest rates, regulations, taxation, cultural differences, social instability, labor disputes and other political, social and economic developments in or affecting Mexico. Moreover, TFM’s commercial success is heavily dependent on expected increases in U.S.-Mexico trade and will be strongly influenced by the effect of NAFTA on such trade. Downturns in either of the U.S. or Mexican economies or in trade between the United States and Mexico would likely adversely impact TFM’s business, financial condition and results of operations. Additionally, the Mexican government may revoke the exclusivity of TFM’s Concession after 20 years if it determines that there is insufficient competition and may terminate the Concession as a result of certain conditions or events. TFM’s assets and its rights under the Concession may also be seized temporarily by the Mexican government. Revocation or termination of the Concession would materially adversely affect TFM’s operations and its ability to make payments on its debt. Our investment in PCRC has risks associated with operating in Panama, including, among others, cultural differences, varying labor and operating practices, political risk and differences between the U.S. and Panamanian economies. There can be no assurances that the various risks associated with

~~operating in Mexico can be effectively and economically mitigated by TFM or that the risks associated with operating in Panama can be effectively and economically mitigated by PCRC.~~

Our leverage could adversely affect our ability to fulfill obligations under various debt instruments and operate our business. KCS is leveraged and will have significant debt service obligations. In addition, TFM is also leveraged and the acquisition of a controlling interest in TFM would increase our consolidated indebtedness and leverage. Our level of debt could make it more difficult to borrow money in the future, reduce the amount of money available to finance our operations and other business activities, expose KCS to the risk of increased interest rates, make KCS more vulnerable to general economic downturns and adverse industry conditions, reduce the flexibility in planning for, or responding to, changing business and economic conditions, and prevent us from raising the funds necessary to repurchase all of certain senior notes that could be tendered upon the occurrence of a change of control, which would constitute an event of default, or all of the Convertible Preferred Stock that could be put to KCS under certain circumstances. Our failure to comply with the financial and other restrictive covenants in our debt instruments, which, among other things, require KCS to maintain specified financial ratios and limit our ability to incur additional debt and sell assets, could result in an event of default that, if not cured or waived, could have a material adverse effect on our business or prospects. If we do not have enough cash to service our debt, meet other obligations and fund other liquidity needs, we may be required to take actions such as reducing or delaying capital expenditures, selling assets, restructuring or refinancing all or part of our existing debt or seeking additional equity capital. We cannot assure that any of these remedies can be effected on commercially reasonable terms or at all. In addition, the terms of existing or future debt agreements may restrict us from adopting any of these alternatives.

~~We may be adversely affected by changes in general economic, weather or other conditions.~~ KCS’s operations may be adversely affected by changes in the economic conditions of the industries and geographic areas that produce and consume the freight that KCS transports. The relative strength or weakness of the U.S. economy as well as various international and regional economies also affects the businesses served. TFM and PCRC are more directly affected by their respective local economies. Historically, a stronger economy has resulted in improved results for rail transportation operations. Conversely, when the economy has slowed, results have been less favorable. Our revenues may be affected by prevailing economic conditions and, if an economic slowdown or recession occurs in our key markets, the volume of rail shipments is likely to be reduced. Additionally, our operations may be affected by adverse weather conditions, which may, for example, substantially reduce the volume of business handled for agricultural products customers. Additionally, many of the goods and commodities we transport experience cyclical demand. Our results of operations can be expected to reflect this cyclical demand because of the significant fixed costs inherent in railroad operations. Our operations may also be affected by natural disasters or terrorist acts. Significant reductions in our volume of rail shipments due to economic, weather or other conditions could have a material adverse effect on our business, financial condition, results of operations and cash flows.

~~We are Subject to Governmental Regulation.~~ We are subject to governmental regulation by federal, state and local regulatory agencies with respect to our railroad operations, as well as a variety of health, safety, labor, environmental, and other matters. Government regulation of the railroad industry is a significant determinant of the competitiveness and profitability of railroads. Our failure to comply with applicable laws and regulations could have a material adverse effect on our operations, including limitations on our operating activities until compliance with applicable requirements is completed. These government agencies may change the legislative or regulatory framework within which we operate without providing any recourse for any adverse effects on our business that occur as a result of this change. Additionally, some of the regulations require us to obtain and maintain various licenses, permits and other authorizations, and we cannot assure that we will continue to be able to do so.

~~We are Subject to Environmental Laws and Regulations.~~ Our operations are subject to extensive federal, state and local environmental laws and regulations concerning, among other things, emissions to the air, discharges to waters, the handling, storage, transportation and disposal of waste and other materials and cleanup of hazardous material or petroleum releases, decommissioning of underground storage tanks and soil and groundwater contamination. We incur, and expect to continue to incur, environmental compliance costs, including, in particular, costs necessary to maintain compliance with requirements governing chemical and

hazardous material shipping operations, refueling operations and repair facilities. New laws and regulations, stricter enforcement of existing requirements, new spills, releases or violations or the discovery of previously unknown contamination could require us to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on our business, results of operations, financial condition and cash flows.

~~We are Vulnerable to Rising Fuel Costs or Disruptions in Fuel Supplies.~~ We incur substantial fuel costs in our operations and these costs represent a significant portion of our transportation expenses. Fuel costs are affected by traffic levels, efficiency of operations and equipment, and petroleum market conditions. The supply and cost of fuel is subject to market conditions and is influenced by numerous factors beyond our control, including general economic conditions, world markets, government programs and regulations and competition. Significant price increases may have a material adverse effect on our operating results. Additionally, fuel prices and supplies could also be affected by any limitation in the fuel supply or by any imposition of mandatory allocation or rationing regulations. In the event of a severe disruption of fuel supplies resulting from supply shortages, political unrest, a disruption of oil imports, war or otherwise, the resulting impact on fuel prices could materially adversely affect our operating results, financial condition and cash flows.

~~A Majority of Our Employees Belong to Labor Unions, and Strikes or Work Stoppages Could Adversely Affect Our Operations.~~ We are a party to collective bargaining agreements with various labor unions in the United States. Approximately 83% of KCSR employees are covered under these agreements. We may be subject to, among other things, strikes, work stoppages or work slowdowns as a result of disputes with regard to the terms of these collective bargaining agreements or our potential inability to negotiate acceptable contracts with these unions. Moreover, because such agreements are generally negotiated on an industry-wide basis, determination of the terms and conditions of future labor agreements could be beyond our control and, as a result, we may be subject to terms and conditions in amended or future labor agreements that could have a material adverse affect on our results of operations, financial position and cash flows. If the unionized workers were to engage in a strike, work stoppage or other slowdown, or other employees were to become unionized or the terms and conditions in future labor agreements were renegotiated, we could experience a significant disruption of our operations and higher ongoing labor costs.

~~Loss of our largest coal customer could have a material effect on our operations.~~ ~~Our largest coal customer accounted for approximately 56.1% of our coal revenues and approximately 8.1% of our total revenues~~non-recurringVAT/Put settlement for the year ended December 31, ~~2004. The loss~~2006, compared to the same period in 2005. Including the $131.9 million VAT/Put settlement in 2005, consolidated net income increased $8 million. Operating income increased by $242.0 million primarily driven by targeted price increases and fuel surcharge, new and expanded existing business in both the U.S. and Mexico segments, and the integration of ~~all or a significant part of this business, or a service outage at one of the facilities that KCSR serves, could materially adversely affect our financial condition, results of~~KCSM operations and ~~cash flows.~~

~~We May Be Subject~~a full year of consolidated operating results. Operating expenses increased by only 5% due to ~~Various Claims and Lawsuits.~~ ~~The nature~~increased efficiencies from the integration of the railroad business exposes us to the potential for various claims and litigation related to labor and employment, personal injury and property damage, environmental and other matters. We maintain insurance (including self-insurance) consistent with the industry practice against accident-related risks involved in the operation of the railroad. However, there can be no assurance that such insurance would be sufficient to cover the cost of damages suffered or that such insurance will continue to be available at commercially reasonable rates. Any material changes to current litigation trends could have a material adverse effect on our results of operations, financial condition and cash flows.KCSM.

~~We May Be Affected by Future Acts of Terrorism or War.~~ Terrorist attacks, such as those that occurred on September 11, 2001, any government response thereto and war or risk of war may adversely affect our results of operations, financial condition, and cash flows. These acts may also impact our ability to raise capital or our future business opportunities. Our rail lines and facilities could be direct targets or indirect casualties of an act or acts of terror, which could cause significant business interruption and result in increased costs and liabilities and decreased revenues. These acts could have a material adverse effect on our results of operations, financial condition, and cash flows. In addition, insurance premiums charged for some or all of the coverage currently maintained by KCS could increase dramatically or certain coverage may not be available in the future.

~~RECENT DEVELOPMENTS~~

~~KCS and Janus Capital Group Finalize Settlement Agreement and Mutual General Release.~~ On October 15, 2004 KCS and Janus Capital Group Inc., formerly Stilwell Financial Inc. (“Janus or Stilwell”), finalized the Settlement Agreement and Mutual General Release (“Release”) (see Note 9 in the Notes to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K). The terms of the Release effect settlement of all disputes that arose on or before August 13, 2004 relating to the spin-off of Janus from KCS on July 12, 2000. As part of the settlement, all arbitration claims filed by the parties with the American Arbitration Association were dismissed. Consistent with the disclosures in the KCS 2003 Form 10-K, this settlement results in no adverse financial consequences to KCS.

~~KCS adds New Director.~~ On July 26, 2004, we announced that Robert J. Druten had been elected to our Board of Directors. Mr. Druten currently serves as Executive Vice President and Chief Financial Officer of Hallmark Cards, Inc., the world’s largest publisher of greeting cards and related products. He serves on that company’s corporate executive council. He is also a member of the Board of Directors of Crown Media Holdings, Inc. In addition, Mr. Druten is the Chairman of the Board of Trustees of Entertainment Properties Trust and a member of the Board of Directors of BHA Group, Inc. On September 28, 2004, Mr. Druten was appointed as a member and chairman of KCS’s audit committee.

~~Amended 2004 Senior Secured Credit Facility.~~ During March 2004, we used cash on-hand to repay approximately $98.5 million relating to our former credit facility. On March 30, 2004, we concluded a new credit facility (“2004 Credit Facility.”) The 2004 Credit Facility consisted of a $100 million revolving credit facility (“2004 Revolving Credit Facility”) maturing on March 30, 2007 and a $150 million Term B loan facility (“Term B Loan Facility”) maturing on March 30, 2008. The Term B Loan Facility was fully funded on the closing date and the proceeds are expected to be, or have been, used to pay transaction costs, and for other general corporate purposes, including additional investments in the Company’s Mexican affiliates. There are no funds drawn under the 2004 Revolving Credit Facility as of December 31, 2004, and the full $100 million borrowing capacity is currently available to KCS. Up to $25 million of the 2004 Revolving Credit Facility is available for letters of credit and up to $15 million is available for swing line loans. The proceeds from future borrowings under the 2004 Revolving Credit Facility may be used for working capital and for general corporate purposes, including additional investments in our Mexican affiliates. The letters of credit may be used for general corporate purposes. Borrowings under the 2004 Credit Facility are secured by substantially all of the Company’s assets and are guaranteed by the majority of its subsidiaries.

On December 22, 2004, we entered into an amendment and waiver of the 2004 Credit Facility (the “Amended 2004 Credit Facility”). The credit agreement was amended to, among other things, increase the term loan by $100 million to a total amount outstanding at December 31, 2004 of $249,250,000 and decrease the borrowing spread by 25 basis points to 175 basis points over LIBOR. In addition, a waiver was granted that would allow KCSR to make an additional $55 million of capital expenditures during 2004 and 2005. The maturity date of the credit agreement was unchanged. For additional information regarding the new credit facility, see Note 5 tofollowing summarizes the consolidated ~~financial statements under Item 8 of this Form 10-K.~~

~~KCS and TMM Enter Into Acquisition Agreement.~~ On December 15, 2004, we entered into the Acquisition Agreement with TMM and other parties under which KCS ultimately would acquire control of TFM through the purchase of shares of common stock of Grupo TFM. Grupo TFM holds an 80% economic interest in TFM and all of the shares of stock with full voting rights of TFM. The remaining 20% economic interest in TFM is owned by the Mexican government in the form of shares with limited voting rights. The Mexican government has put rights with respect to its TFM shares as discussed below. The obligations of KCS and TMM to complete the Acquisition are subject to a number of conditions. On March 29, 2005, at a special meeting of the KCS shareholders approval of the acquisition as described above was received. Closing on the acquisition is expected to occur on April 1, 2005. For additional discussion of the terms of the Acquisition Agreement, see Note 3 in the Notes to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K.

The purpose of the Acquisition is to place TFM under the control of KCS, which will also control KCSR, Tex-Mex and Gateway Eastern. Management believes that common control of these railroads, which are

already physically linked in an end-to-end configuration, will enhance competition and give shippers in the NAFTA trade corridor a strong transportation alternative as they make their decisions to move goods between the United States, Mexico and Canada.

Under the terms of the Acquisition Agreement, KCS would acquire all of the interest of TMM in Grupo TFM for $200.0 million in cash, 18 million shares of KCS common stock and promissory notes in the aggregate principal amount of $47.0 million to be deposited in an escrow account and held, reduced and released in accordance with the terms of an escrow agreement (see Note 3 in the Notes to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K). In addition, upon the successful resolution of both the VAT refund claim and the Mexican Government’s Put (defined below), KCS will be obligated to pay to TMM an additional amount of up to $110 million payable in a combination of cash and KCS common stock. We anticipate that we would pay the cash portion of the purchase price using a combination of existing cash assets and proceeds from the Amended 2004 Credit Facility as further described above in “Amended 2004 Senior Secured Credit Facility.”

In connection with the Acquisition, KCS has entered into a consulting agreement, to become effective upon the closing of the Acquisition (the “Consulting Agreement”), with José F. Serrano International Business, S.A. de C.V., a consulting company controlled by Jose Serrano, Chairman of the Board of TMM, Grupo TFM and TFM, pursuant to which it would provide consulting services to KCS in connection with the portion of the business of KCS in Mexico for a period of three years. As consideration for these services, the consulting company would receive an annual fee of $3 million and an additional $9 million upon satisfactory resolution of all issues related to the VAT Claim and the Mexican Government’s Put. The Consulting Agreement requires KCS to deposit the total amount of annual fee payable under the Consulting Agreement ($9 million) in an escrow account to be held and released in accordance with the terms and conditions of the Consulting Agreement and the applicable escrow agreement.

On October 6, 2004, Mexico’s Foreign Investment Commission (“FIC”) notified KCS of its approval of our application for authority to acquire TMM’s interest in TFM. This approval is necessary for a foreign company to become a majority owner of a Mexican railway company and remains valid until October 5, 2005. KCS’s notification with respect to the acquisition of the Grupo TFM shares was filed with the Mexican Competition Commission on April 21, 2003. KCS received formal written notice that the Mexican Competition Commission (“MCC” or the “Competition Commission”) had approved the proposed consolidation, without conditions. Through a series of extensions received from the MCC, KCS’s authority to purchase TMM’s interest in TFM remains valid through April 5, 2005. On January 25, 2005, the 30-day waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“HSR”) expired without a formal request from the U.S. Department of Justice (“DOJ”) for additional information of documentary material. This will allow KCS and TMM to complete the transaction without an antitrust challenge from the DOJ. With the extension of the Competition Commission approval, approval from the Mexican Foreign Investment Commission and completion of the HSR process, our shareholder approval of the issuance of the shares required under the Acquisition Agreement was the final condition precedent to completion of the proposed Acquisition. On March 29, 2005, at a special meeting of the KCS shareholders approval of the acquisition as described above was received. Closing on the acquisition is expected to occur on April 1, 2005.

~~Mexican Government’s Put Rights With Respect to TFM Stock.~~ Under the terms of the January 31, 1997 share purchase agreement through which Grupo TFM agreed to purchase the shares of TFM, as amended by the parties on June 9, 1997 (the “TFM Share Purchase Agreement”), the Mexican government has the right to compel the purchase of its 20% interest in TFM (referred to as the “Put”) by Grupo TFM following its compliance with the terms and conditions of the TFM Share Purchase Agreement. Upon exercise of the Put in accordance with the terms of the TFM Share Purchase Agreement, Grupo TFM would be obligated to purchase the TFM capital stock at the initial share price paid by Grupo TFM adjusted for interest and inflation. Prior to October 30, 2003, Grupo TFM filed suit in the Federal District Court of Mexico City seeking, among other things, a declaratory judgment interpreting whether Grupo TFM was obligated to honor its obligation under the TFM Share Purchase Agreement, as the Mexican government had not made any effort to sell the TFM shares subject to the Put prior to October 31, 2003. In its suit, Grupo TFM named TMM and KCS as additional interested parties. The Mexican Court has admitted Grupo TFM’s complaint

and issued an injunction that blocked the Mexican government from exercising the Put. The Mexican government provided Grupo TFM with notice of its intention to sell its interest in TFM on October 30, 2003. Grupo TFM has responded to the Mexican government’s notice reaffirming its right and interest in purchasing the Mexican government’s remaining interest in TFM, but also advising the Mexican government that it would not take any action until its lawsuit seeking a declaratory judgment was resolved. In the event that Grupo TFM does not purchase the Mexican government’s 20% interest in TFM, TMM and KCS, or either of TMM or KCS alone, would, following notification by the Mexican government in accordance with the terms of the TFM Share Purchase Agreement, be obligated to purchase the Mexican government’s remaining interest in TFM. As this matter is currently the subject of litigation in Mexico to which the Mexican government, Grupo TFM, TMM and KCS are parties, KCS management does not believe it is likely that the Mexican government will seek to exercise the Put until the litigation is resolved. On completion of the Acquisition, KCS will assume TMM’s rights and obligations with respect to the TFM shares subject to the Put and will indemnify TMM and its affiliates, and their respective officers, directors, employees and shareholders, against obligations or liabilities relating thereto. If KCS had been required to purchase this interest as of December 31, 2004, the total purchase price would have been approximately $468 million.

~~Value Added Tax Lawsuit and VAT Contingency Payment under the Acquisition Agreement.~~ The VAT lawsuit (“VAT Claim”) arose out of the Mexican Treasury’s delivery of a VAT credit certificate to a Mexican governmental agency rather than to TFM in 1997. The face value of the VAT credit at issue is 2,111,111,790 pesos or approximately $189 million in U.S. dollars, based on current exchange rates. The amount of the VAT refund will, in accordance with Mexican law, reflect the face value of the VAT credit adjusted for inflation and interest from 1997.

After several Mexican Fiscal Court and Mexican appellate court rulings during 2002 and 2003, on January 19, 2004, TFM received a Special Certificate from the Mexican Federal Treasury in the amount of 2.1 billion pesos. The Special Certificate delivered to TFM on January 19, 2004 has the same face amount as the original VAT refund claimed by TFM in 1997. TFM also filed a complaint against the Mexican government, seeking to have the amount of the Special Certificate adjusted to reflect interest and inflation in accordance with Mexican law. The Mexican Fiscal Court initially denied TFM’s claim. In a decision dated November 24, 2004, the Mexican Federal Appellate Court upheld TFM’s claim that it is entitled to inflation and interest from 1997 on the VAT refund. The Federal Appellate Court remanded the case to the Mexican Fiscal Court with instructions to enter a new order consistent with this decision. On January 26, 2005, the Mexican Fiscal Court issued from the bench an oral order implementing the Appellate Court decision. On February 18, 2005, TFM was served with the written order from the Mexican Fiscal Court.

In conjunction with the Acquisition Agreement, in the event of the Final Resolution of the VAT Claim and Put (as such term is defined in the Acquisition Agreement), KCS will be obligated to pay to TMM an additional amount (referred to as the “VAT Contingency Payment”) of up to $110 million payable in a combination of cash and KCS common stock. If the Acquisition is completed, KCS will assume TMM’s obligations to make any payment upon the successful exercise by the Mexican government of the Put and will indemnify TMM and its affiliates, and their respective officers, directors, employees and shareholders, against obligations or liabilities relating thereto.

~~1997 Tax Audit Summary.~~ TFM was served on January 20, 2004 with an official letter notifying TFM of the Mexican government’s preliminary findings and conclusions arising from its tax audit of TFM’s 1997 tax returns (“Tax Audit Summary”). In the Tax Audit Summary, the Mexican government notified TFM of its preliminary conclusion that the documentation provided by TFM in support of the VAT refund claim and depreciation of the TFM Concession title and the assets reported on TFM’s 1997 tax return do not comply with the formalities required by the applicable tax legislation. In addition, the Mexican government attached the Special Certificate pending resolution of the audit. TFM has advised that it has, within the time allowed by the Tax Audit Summary, contested the conclusions of the Mexican tax authorities, and it has filed a constitutional appeal against the Tax Audit Summary, alleging the process followed by the Mexican government violated TFM’s constitutional rights. On March 16, 2005, TFM was notified by the Mexican Fiscal Administration Service (~~“Servicio de Administración Tributaria”~~ ~~or the~~~~“SAT”~~~~) that it had finished its audit of TFM’s 1997 tax returns. As of March 16, 2005. The SAT had not yet assessed any penalties or taxes~~

against TFM as a result of the audit. In the notice, the SAT stated that TFM did not supply documentation complying with the requirements of the Mexican fiscal code and, therefore, it was not entitled in its 1997 tax returns to depreciate and deduct the concession title, the railway equipment and other assets that were assets of TFM at the time that it was privatized in 1997. KCS and TMM continue discussions with the Mexican government to resolve the outstanding disputes between the parties.

~~Repurchase of Mexrail Shares by KCS.~~ KCS, TMM and TFM entered into a new Stock Purchase Agreement dated August 16, 2004 (“New Mexrail Stock Purchase Agreement”). Pursuant to the terms of that agreement, KCS purchased from TFM 51% of the outstanding shares of Mexrail, a wholly-owned subsidiary of TFM, for $32.7 million and placed those shares into trust pending STB approval to exercise common control over KCSR, Gateway Eastern and Tex-Mex. Pending the STB’s approval, equity in net earnings (losses) of unconsolidated affiliates of $2.7 million was recognized representing our 51% share of Mexrail’s losses for the period from August 16, 2004 through December 31, 2004. We expect to complete an evaluation of the fair value of the assets and liabilities of Mexrail in the first quarter of 2005. The terms of the New Mexrail Stock Purchase Agreement are substantially similar to the May 9, 2003 Stock Purchase Agreement, but TFM does not have any right to repurchase the Mexrail shares sold to KCS and KCS has an option which, if not exercised on or before October 31, 2005, becomes an obligation on October 31, 2005, to purchase the remaining shares of Mexrail owned by TFM at a price of $31.4 million. On November 29, 2004, the STB approved our application for authority to control KCSR, Gateway Eastern and Tex-Mex which approval became effective on December 29, 2004. The shares representing 51% ownership of Mexrail were transferred by the trustee to KCS on January 1, 2005.

~~RESULTS OF OPERATIONS~~

~~YEAR ENDED DECEMBER 31, 2004 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2003~~

~~Net Income.~~ Net income for the year ended December 31, 2004 increased $12.2 million compared to the year ended December 31, 2003. The increase of $54.4 million in operating income was partially offset by a net decrease in other nonoperating income and expense items of $6.9 million, a $26.4 million increase in the provision for income taxes, and the impact of an $8.9 million cumulative effect of accounting change, net of income taxes in the first quarter of 2003.

~~The following table summarizes the~~ income statement components of KCS(in millions):.

Change

2004 2003 In Dollars Percentage

Revenues $ 639.5 $ 581.3 $ 58.2 10.0 %
Operating expenses 556.0 552.2 3.8 0.7 %

Operating income 83.5 29.1 54.4 186.9 %
Equity in net earnings (losses) of unconsolidated affiliates (4.5 ) 11.0 (15.5 ) (140.9 )%
Interest expense (44.4 ) (46.4 ) (2.0 ) 4.3 %
Debt retirement costs (4.2 ) — (4.2 ) 100.0 %
Other income 17.6 6.8 10.8 158.8 %

Income before income taxes and cumulative effect of accounting change 48.0 0.5 47.5 nm
Income tax provision (benefit) 23.6 (2.8 ) 26.4 nm

Income (loss) before cumulative effect of accounting change 24.4 3.3 21.1 nm
Cumulative effect of accounting change, net of income taxes — 8.9 (8.9 ) (100.0 )%

Net income (loss) $ 24.4 $ 12.2 $ 12.2 100.0 %


							Change
	2006			2005			Dollars			Percent

Revenues	$	1,659.7		$	1,352.0		$	307.7			23	%
Operating expenses		1,355.4			1,289.7			65.7			5	%

Operating income		304.3			62.3			242.0			388	%
Equity in net earnings of unconsolidated affiliates		7.3			2.9			4.4			152	%
Interest expense		(167.2	)		(133.5	)		(33.7	)		25	%
VAT/Put settlement gain, net		—			131.9			(131.9	)		(100	)%
Other income		10.2			12.4			(2.2	)		(18	)%

Income before income taxes and minority interest		154.6			76.0			78.6			103	%
Income tax provision (benefit)		45.4			(7.1	)		52.5			(739	)%

Income before minority interest		109.2			83.1			26.1			31	%
Minority interest		0.3			(17.8	)		18.1			(102	)%

Net income	$	108.9		$	100.9		$	8.0			8	%

~~nm — not meaningful percentage change in excess of 500%~~

U.S. Segment.

Revenues. The following ~~table~~ summarizes ~~consolidated KCS~~U.S. revenues ~~including the revenues~~ (in millions)and ~~carload~~carloads statistics ~~of KCSR, for the years ended December 31, 2004 and 2003.~~(in thousands). Certain prior period ~~amounts~~carloads and intermodal units have been reclassified to reflect changes in the business groups and to conform to the current period presentation.

Revenues Carloads and Intermodal Units

Change Change

2004 2003 In Dollars Percentage 2004 2003 In Units Percentage

(In millions) (In thousands)
General commodities:
Chemical and petroleum $ 135.0 $ 123.8 $ 11.2 9.0 % 147.9 140.0 7.9 5.6 %
Forest products and metals 169.6 146.1 23.5 16.0 % 197.3 186.2 11.1 6.0 %
Agricultural and mineral 125.2 108.5 16.7 15.4 % 149.4 140.6 8.8 6.3 %

Total general commodities 429.8 378.4 51.4 13.6 % 494.6 466.8 27.8 6.0 %
Intermodal and automotive 66.8 59.1 7.7 13.0 % 342.8 310.5 32.3 10.4 %
Coal 92.1 92.7 (0.6 ) (0.6 )% 194.7 191.4 3.3 1.7 %

Carload revenues and carload and intermodal units 588.7 530.2 58.5 11.0 % 1,032.1 968.7 63.4 6.5 %

Other rail-related revenues 47.0 45.1 1.9 4.2 %
��
Total KCSR revenues 635.7 575.3 60.4 10.5 %
Other subsidiary revenues 3.8 6.0 (2.2 ) (36.7 )%

Consolidated revenues $ 639.5 $ 581.3 $ 58.2 10.0 %

~~Revenues.~~


	Revenues										Carloads and Intermodal Units
					Change										Change
	2006		2005		Dollars			Percent			2006		2005		Units			Percent

General commodities:
Chemical and petroleum	$	173.5	$	153.5	$	20.0			13	%		158.8		155.7		3.1			2	%
Forest products and metals		241.2		219.0		22.2			10	%		199.0		211.7		(12.7	)		(6	)%
Agricultural and mineral		198.2		179.2		19.0			11	%		170.1		183.1		(13.0	)		(7	)%

Total general commodities		612.9		551.7		61.2			11	%		527.9		550.5		(22.6	)		(4	)%
Intermodal and automotive		74.8		76.6		(1.8	)		(2	)%		339.4		335.9		3.5			1	%
Coal		141.0		122.3		18.7			15	%		255.9		233.4		22.5			10	%

Carload revenues, units and intermodal units		828.7		750.6		78.1			10	%		1,123.2		1,119.8		3.4			0	%

Other revenue		57.0		53.8		3.2			6	%

Total revenues	$	885.7	$	804.4	$	81.3			10	%

For the year ended December 31, ~~2004, consolidated~~2006, revenues increased ~~$58.2 million. Freight revenues included fuel surcharges of~~$~~16.7~~$81.3 million compared ~~with $4.4 million in~~to the prior year. ~~Fuel surcharges will increase or decrease dependent on the price of West Texas Intermediate Crude Oil as published in the Wall Street Journal. KCSR~~The U.S. segment experienced revenue increases in ~~the chemical and petroleum, forest products and metals, and agriculture and mineral products, and intermodal~~all commodity groups ~~while~~

~~coal revenues were relatively flat. For most commodity groups, these~~except for the intermodal and automotive business, which decreased slightly due to a decline in automotive business driven by lower output and short term plant shutdowns in 2006. Overall increases in ~~revenue resulted from higher carloadings and~~the majority of the commodities were driven by targeted price ~~improvements.~~improvements, including increased fuel surcharges. The following discussion provides an analysis of ~~KCSR~~ revenues by commodity group.

Chemical and Petroleum. Revenues increased for all of the chemical and petroleum ~~products.~~ ~~For~~products for the year ended December 31, ~~2004, KCSR recorded higher revenues for all commodities within~~2006, due to targeted rate increases in the ~~chemical and petroleum products group. Revenue increases for~~ petroleum, agricultural chemicals and industrial gases ~~were primarily the result of targeted rate increases as well as~~sectors, and increased traffic volumes. ~~While some new business was added in 2004, increased volumes from existing customers driven by improvements in the economy accounts~~Pricing improvement and stronger economic conditions during 2006 accounted for ~~the~~a majority of the ~~volume change. Excluding organic chemicals,~~growth in revenue ~~per carload (RPC)~~in the year, while growth in the third and fourth quarters also reflected the Gulf Coast refineries’ recovery from the past year’s hurricanes.

Forest Products and Metals. Revenues increased ~~6.6% over 2003. Organic chemical revenues increased primarily as a result of increased traffic, partially offset by lower RPC due to shorter hauls and changes~~ in ~~commodity mix.~~

~~Forest~~forest products and ~~metals.~~ ~~For~~metal commodities for the year ended December 31, 2004, KCSR recorded higher revenues for all forest products and metal commodities compared to 2003. Revenue increases for all commodities in the group resulted from certain targeted rate increases, fuel surcharges, and increased volume attributed to higher production and service improvements. Volumes for lumber and plywood products experienced growth as a result of a robust housing industry and hurricane reconstruction in Florida. Wet weather in other areas of the country contributed to a rise in traffic for pulpwood, logs and chip. Military and other carloads increased due to strong traffic during the second half of 2004 as a result of increased movements for military installations serviced by KCSR.

~~Agricultural and mineral products.~~ ~~Revenues in all commodities in the agricultural business unit increased~~2006, primarily due to targeted rate increases. Decreases in volume can be attributed to the lumber and chip products due to rising mortgage rates. This volume decline was only partially offset by increases in volume from higher production in the metals, rolled paper and ~~fuel surcharges resulting in an overall RPC increase of 8.5%. Carload volumes~~military products.

Agricultural and Mineral. Revenues increased in all ~~commodities except~~agricultural and mineral products for ~~food and kindred. For~~ the year ended December 31, ~~2004, increases~~2006, due to targeted rate adjustments and an increase in ~~revenues~~velocity over certain corridors and business sectors. Overall improvement in velocity of unit grain and mineral trains accounted for ~~domestic grain were~~ a ~~direct result~~majority of ~~increased production~~the revenue growth during 2006. Declining market conditions during the third and fourth quarters of ~~feed mills on KCSR’s line. Export grain revenues~~the year accounted for ~~2004 versus 2003 improved as a result of increased volumes related to~~ the ~~shipment of current year grain harvests to ports~~decline in volume with the primary decrease in export grain.

Intermodal and Automotive. Revenues decreased in the ~~Gulf~~intermodal and automotive business for the year ended December 31, 2006, due to declines in the automotive business from suspended production at an automotive plant for a majority of ~~Mexico, combined with strong increases~~the year. This decrease was offset partially by increased revenues in ~~export volumes to Mexico. Ores and minerals revenue and stone, clay and glass revenues increased during 2004 as a result of higher production~~the intermodal business which were driven by ~~certain customers, as well as certain targeted rate increases and fuel surcharges. Food and kindred product revenues increased primarily as a result of longer hauls to domestic destinations.~~

~~Intermodal and automotive.~~ ~~Intermodal revenues increased as a result of~~ higher volumes from existing customers as well as the generation of new intermodal business. Automotive traffic increased partially as a result of a temporary shift in traffic from Ford Motor Company and increased volumes from GM and Mazda. These increases were partially offset by a decrease in haulage revenue per car resulting from a change in the traffic mix.

Coal. Revenues ~~for coal~~increased for the year ended December 31, ~~2004 decreased due primarily to lower~~2006, as a result of higher traffic volumes at certain electric generating ~~stations. These year-to-year~~stations in order to rebuild inventory stockpiles. The ability to rebuild stockpiles has been made possible by improved efficiencies at the coal mines and increased velocity achieved by KCSR and origin carriers.

Operating Expenses. For the year ended December 31, 2006, U.S. operating expenses increased $0.8 million. The following summarizes the Company’s U.S. operating expenses(in millions).


					Change
	2006		2005		Dollars			Percent

Compensation and benefits	$	264.3	$	244.8	$	19.5			8	%
Purchased services		82.8		84.6		(1.8	)		(2	)%
Fuel		140.8		123.8		17.0			14	%
Equipment costs		82.7		68.9		13.8			20	%
Depreciation and amortization		65.7		60.0		5.7			10	%
Casualties and insurance		44.9		88.7		(43.8	)		(49	)%
Other		78.9		88.5		(9.6	)		(11	)%

Total operating expenses	$	760.1	$	759.3	$	0.8			0	%

Compensation and benefits. Compensation and benefits expense increased $19.5 million for the year ended December 31, 2006, compared to 2005 as the result of increased incentive compensation, annual salary increases, increase in management headcount, and an increase in stock based compensation. Incentive compensation is tied to the financial results of the Company and accounted for $9.3 million of the increase. Stock based compensation increased by $2.9 million partially as a result of the implementation of SFAS No. 123(R). Additionally, the remaining increase is the result of annual salary increases and certain increases in headcount.

Purchased services. Purchased services expense decreased $1.8 million for the year ended December 31, 2006, compared to the same period in 2005. The decrease was primarily driven by decreases in legal costs, locomotive repair costs and rental income received on locomotives leased to Mexico operations on a short-term basis. The decreases were offset by increases in joint facilities expenses due to higher traffic and an increase in auto and truck repair expense.

Fuel. Fuel expense increased $17.0 million for the year ended December 31, 2006, compared to 2005 primarily as a result of a 7.9% increase in the average price per gallon and a 7.2% increase in consumption.

Equipment costs. Equipment costs increased $13.8 million for the year ended December 31, 2006, compared to 2005 as a result of entering into two new locomotive lease agreements for $14.8 million and new

freight car leases for $4.5 million during the year. This increase was offset by a decrease in car hire expense due to a reduction in the use of non-KCSR freight cars.

Depreciation and amortization. Depreciation and amortization expense increased $5.7 million for the year ended December 31, 2006, compared to 2005, primarily as a result of an increase in assets placed into service during the year. This increase was partially offset by an updated depreciation study which was completed during the year and resulted in a $3.0 million reduction in expense in the 4^th quarter.

Casualties and insurance. Casualties and insurance expense decreased $43.8 million for the year ended December 31, 2006, compared to 2005. During the third quarter of 2005, the Company recorded a $37.8 million pre-tax charge for personal injury liabilities based upon an actuarial study in 2005. The remaining decrease in 2006 was primarily driven by a lower number of incidence as well as a decrease in the severity of derailments during the year compared to the prior year.

Other. Other expense decreased $9.6 million for the year ended December 31, 2006, compared to 2005 primarily due to a $13.9 million reimbursement from the Mexico segment for shared service expenses paid by the U.S. segment during 2006. This was offset by an increase of $6.7 million in materials and supplies primarily as a result of price increases in freight car wheels.

Mexico Segment.

KCS acquired a controlling interest in Grupo KCSM effective April 1, 2005. The 2005 results reflect charges and costs associated with the acquisition and integration, as well as the effect of valuation adjustments as required by purchase accounting. Since April 1, 2005, the financial results of Grupo KCSM have been consolidated into KCS. Prior to that date, the investment for Grupo KCSM was accounted for under the equity method. Although not consolidated prior to April 1, 2005, revenue and expense information below includes Grupo KCSM results for the 1^st quarter of 2005 for comparative purposes. Accounting policies for Grupo KCSM prior to the acquisition were materially consistent with U.S. operations, however, certain adjustments have been made to the results presented for comparability.

Revenues. Mexico’s revenues(in millions)and carloads statistics(in thousands)follow.


	Revenues										Carloads and Intermodal Units
			Comparative		Change								Comparative		Change
	2006		2005		Dollars			Percent			2006		2005		Units			Percent

General commodities:
Chemical and petroleum	$	145.9	$	126.5	$	19.4			15	%		102.0		97.0		5.0			5	%
Forest products and metals		213.0		186.2		26.8			14	%		187.5		197.3		(9.8	)		(5	)%
Agricultural and mineral		232.7		219.2		13.5			6	%		196.0		200.1		(4.1	)		(2	)%

Total general commodities		591.6		531.9		59.7			11	%		485.5		494.4		(8.9	)		(2	)%
Intermodal and automotive		162.4		173.0		(10.6	)		(6	)%		312.0		326.8		(14.8	)		(5	)%

Carload revenues, units and intermodal units		754.0		704.9		49.1			7	%		797.5		821.2		(23.7	)		(3	)%

Other revenue		20.0		12.7		7.3			57	%

Total revenues	$	774.0	$	717.6	$	56.4			8	%

Revenues for the year ended December 31, 2006 totaled $774.0 million compared to $717.6 million for the comparable year ended December 31, 2005, which represented an increase of $56.4 million. Revenues increased despite a decrease in carloads mainly due to a reduction in the movement in finished vehicles for exportation. The increase in 2006 was mainly attributable to targeted rate increases and fuel surcharge. Carloads are a standard measure used by KCS to determine the volume of traffic transported over its rail lines. Imports into Mexico from the U.S., Canada and overseas represented approximately 56.3% and 56.2% of total revenues in 2006 and 2005, respectively. Approximately 77.8% of total revenues in 2006 were attributable to international freight.

Chemical and Petroleum Products. Revenues rose $19.4 million in 2006 primarily due to price increases, fuel surcharge revenue and volume increases over the prior year. The volume recovery increase was largely attributable to Hurricanes Katrina and Rita which had adversely impacted the Gulf coast refineries. Volume recovery was seen in fuel oil, diesel, gasoline and pet coke during 2006.

Forest Products and Metals. Revenues increased $26.8 million in 2006 compared to 2005, primarily due to price strategies, longer hauls and increased fuel surcharge. Targeted rate increases were implemented in 2006 for movements of steel slabs and steel coil imports. Increased revenue was seen from longer hauls to Laredo as a result of a customer’s relocation of its distribution center from Zacatecas to Tuxtepec. Increases in the number of cross border paper imports were seen during the year as well.

Agriculture and Mineral. Revenues from agricultural products increased $13.5 million compared to 2005 primarily as a result of targeted rate increases and fuel surcharges. Volume increases in corn and sugar were partially offset by reductions in import shipments of soybeans, sorghum and wheat products. Revenues also grew due to an embargo on Ferromex lines. There was also increased activity during the last quarter of 2006 not expected to be imported through theU.S.-Mexico border. The fructose market increased and it is still growing without quotas on imports. The revenue increase has been favorable with movements of grain and products from U.S. origin to destinations on the KCSM lines. These increases were negatively affected by a reduction of volumes of sand and clay products, and lower traffic in route from Jaltipan to Queretaro, due to dwell times at Ferrovalle. Additionally revenues were also affected by the ~~fourth~~reduction in consumption of limestone in Lázaro Cárdenas during the second quarter 2006.

Intermodal and Automotive. Intermodal revenue increased $7.8 million during 2006 compared to 2005, as a result of ~~2004 related~~increased numbers of steamship carriers that call at the port of Lázaro Cárdenas and consistent transit times on Intermodal trains. Automotive revenue decreased $18.4 million in 2006 compared to ~~new business,~~2005, as a result of a reduction in the movement of finished vehicles for exportation to the U.S. and Canadian markets. Additionally, the movements of importation of finished vehicles, as well ~~increased production at other electric generating stations.~~as the domestic distribution of these vehicles, have declined due to the logistics of their transportation.

Operating Expenses. The following summarizes Mexico operating expenses(in millions):


			Comparative		Change
	2006		2005		Dollars			Percent

Compensation and benefits	$	123.4	$	124.4	$	(1.0	)		(1	)%
Purchased services		131.0		145.5		(14.5	)		(10	)%
Fuel		112.8		106.3		6.5			6	%
Equipment costs		97.0		102.5		(5.5	)		(5	)%
Depreciation and amortization		89.3		88.9		0.4			0	%
Casualties and insurance		8.5		17.0		(8.5	)		(50	)%
KCSM employees’ statutory profit sharing		5.9		41.6		(35.7	)		(86	)%
Other		27.4		47.3		(19.9	)		(42	)%

Total operating expenses	$	595.3	$	673.5	$	(78.2	)		(12	)%

Compensation and benefits. For the year ended December 31, 2006, salaries, wages and employee benefits decreased $1.0 million compared to 2005. The decrease reflects a reduction in headcount and the depreciation effect of the Mexican peso against the U.S. dollar during 2006. This decrease was partially offset by the annual salaries increase and the increase in wages and fringe benefits resulting from labor negotiations in July 2006.

Purchased services. Purchased services decreased $14.5 million in 2006 compared to 2005. Certain trackage rights that were not used during 2006 resulting in lower costs, amortization of deferred credits established in connection with the push down of purchase accounting, and additional capitalization of certain overhead costs, reduced purchased services during the year. These decreases were slightly offset by increases in management and professional fees during 2006.

Fuel. Fuel expenses increased $6.5 million in 2006 compared to 2005 primarily due to the volatility of fuel prices during 2006. KCSM’s average price per gallon for fuel increased 4.6% in 2006 as compared to the prior year.

Equipment cost. Equipment cost decreased $5.5 million compared to 2005. This decrease was attributed mainly to a reduction in the use of non-KCSM freight cars as a result of velocity and operations improvement. This decrease was partially offset by the amortization of certain deferred charges and credits established in connection with the push down of purchase accounting related to the fair value of operating leases for freight cars.

Casualties and insurance. During 2006, casualties and insurance decreased $8.5 million compared to 2005. This decrease was primarily the result of lower costs associated with derailments compared to activity that occurred during the second and third quarter of 2005.

Employees’ statutory profit sharing. The ~~following table summarizes~~$35.7 million decrease in employee statutory profit sharing expense for the year ended December 31, 2006 compared to 2005 was a result of four Supreme Court decisions in May of last year which denied the deductibility of NOL’s in a company’s profit sharing liability calculation. As a result of these court rulings the deferred profit sharing asset associated with these NOL’s was written down during 2005, which resulted in a non-cash charge to income of $35.6 million.

Other. Other expenses decreased $19.9 million compared to December 31, 2005. This decrease primarily reflects lower bad debt expense as compared to 2005 of approximately $9.3 million, the recognition of transition cost of $2.0 million in 2005, a charge due to the revaluation of the inventory parts associated with the maintenance of the catenary line in the second quarter 2005 of $1.6 million and losses on sale of property prior to adoption of the group method of depreciation on April 1, 2005, partially offset by a $1.3 million increase in other leases.

Consolidated Non-Operating Expenses.

Consolidated Interest Expense. Consolidated interest expense increased $33.7 million for the year ended December 31, 2006, driven primarily by the additional three months of KCSM interest expense. KCSM’s interest expense for the three months ended March 31, 2005, was $27.4 million. The remaining difference was due to higher average balances of and increased interest rates on floating rate debt in the current year.

Consolidated Debt Retirement Costs. Consolidated debt retirement costs increased $0.4 million for the year ended December 31, 2006, compared to the year ended December 31, 2005. During the year ended December 31, 2006, KCSR entered into an amended and restated credit agreement and wrote off $2.2 million and KCSM refinanced its 10.25% senior notes and wrote off $2.6 million in unamortized debt issuance costs. For the year ended December 31, 2005, $4.4 million in unamortized debt issuance costs were written off in connection with the refinancing of KCSM’s 11.75% debentures and its first amended and restated credit agreement.

Foreign Exchange. For the year ended December 31, 2006, the foreign exchange loss of $3.7 million compared to a gain of $3.5 million for the same period in 2005. During the year 2006 the U.S. dollar appreciated approximately 1.7% relative to the Mexican peso.

Equity in Net Earnings (Losses) of Unconsolidated Affiliates. Equity in earnings from unconsolidated affiliates was $7.3 million for the year ended December 31, 2006, compared to $2.9 million for the year ended December 31, 2005. Significant components of this change follow:


	•	Equity in losses from the operations of PCRC was $1.0 million for the year ended December 31, 2006, compared to $1.7 million for the same period in 2005. The decrease in losses of $.7 million is the result of a 13.1% increase in volume.

	•	Equity in earnings of Southern Capital was $5.4 million for the year ended December 31, 2006, versus $2.8 million for the same period in 2005. The $2.6 million increase in earnings is the result of a reduction in depreciation expense as a majority of the locomotives owned by Southern Capital became fully depreciated during the year.


	•	KCSM’s equity in earnings of FTVM was $2.9 million for the year ended December 31, 2006, compared to $2.9 million for the same period in 2005.

	•	Equity in losses of KCSM was $1.0 million for the year ended December 31, 2005.

Other Income. Other income increased $5.4 million for the year ended December 31, 2006, due to the sale of land and other long term assets that were not associated with KCS’s ~~consolidated operating expenses~~railroad operations during 2006.

Consolidated Income Tax Provision (Benefit). For the year ended December 31, 2006, KCS’ income tax expense was $45.4 million, a change of $52.5 million as compared to a $7.1 million benefit for the year ended December 31, 2005. The effective tax rate increased from (9.3%) to 29.4% for the years ended December 31, 2005 and 2006, respectively. This increase was primarily attributable to the absence of one-time items such as the non-taxable VAT/Put settlement which occurred in 2005 and the 2005 write-off of deferred profit sharing in Mexico.

Following the acquisition of control of Grupo KCSM in 2005, the Company has not provided U.S. federal income taxes on the undistributed earnings of Grupo KCSM since the Company intends to reinvest such earnings indefinitely outside of the United States.

Year Ended December 31, 2005, Compared with the Year Ended December 31, 2004

Net Income. Consolidated net income for 2005 increased $76.5 million compared to 2004 primarily as a result of a $131.9 million gain resulting from the VAT/Put Settlement, partially offset by a reduction in operating income of $21.2 million. Additionally, consolidated net income increased due to a reduction in provision for income taxes of $30.7 million.

The reduction in consolidated operating income was driven primarily by an additional $37.8 million charge in 2005 to recognize additional costs related to occupational and ~~2003.~~personal injury claims determined as a result of the annual actuarial study, which was completed during the third quarter of 2005, and the write off of KCSM’s deferred tax asset related to statutory profit sharing. On a consolidated basis, both revenues and operating expenses were significantly impacted by the acquisitions completed during the year. In addition to the acquisitions, revenue growth for 2005 continued to be driven by increased volume, targeted rate increases and increased fuel surcharges to help offset rising fuel prices. Consolidated operating costs generally increased consistent with the volume increases, although price increases also impacted compensation and benefits and fuel expense.

The following table summarizes the consolidated income statement components of KCS(in millions). Certain prior period amounts have been reclassified to reflect changes to the current period presentation.


							Change
	2005			2004			Dollars			Percent

Revenues	$	1,352.0		$	639.5		$	712.5			111	%
Operating expenses		1,289.7			556.0			733.7			132	%

Operating income		62.3			83.5			(21.2	)		(25	)%
Equity in net earnings (losses) of unconsolidated affiliates		2.9			(4.5	)		7.4			(164	)%
Interest expense		(133.5	)		(44.4	)		(89.1	)		201	%
VAT/Put settlement gain, net		131.9			—			131.9			—
Other income		12.4			13.4			(1.0	)		(7	)%

Income before income taxes and minority interest		76.0			48.0			28.0			58	%
Income tax provision (benefit)		(7.1	)		23.6			(30.7	)		(130	)%

Income before minority interest		83.1			24.4			58.7			241	%
Minority interest		(17.8	)		—			(17.8	)		—

Net income	$	100.9		$	24.4		$	76.5			314	%

U.S. Segment.

Revenues. The following table summarizes U.S. revenues, including the revenues and separate carload statistics of KCSR, and Mexrail, for the year ended December 31, 2005(in millions). For the year ended December 31, 2004, the revenue and carload statistics are KCSR only. Certain prior period amounts have been reclassified to conform to the current period presentation.


	Revenues									Carloads and Intermodal Units
					Change									Change
	2005		2004		Dollars		Percent			2005		2004		Units			Percent

General commodities:
Chemical and petroleum	$	153.5	$	135.0	$	18.5		14	%		155.7		147.9		7.8			5	%
Forest products and metals		219.0		169.6		49.4		29	%		211.7		197.3		14.4			7	%
Agricultural and mineral		179.2		125.2		54.0		43	%		183.1		149.4		33.7			23	%

Total general commodities		551.7		429.8		121.9		28	%		550.5		494.6		55.9			11	%
Intermodal and automotive		76.6		66.8		9.8		15	%		335.9		342.8		(6.9	)		(2	)%
Coal		122.3		92.1		30.2		33	%		233.4		194.7		38.7			20	%

Carload revenues, units and intermodal units		750.6		588.7		161.9		28	%		1,119.8		1,032.1		87.7			8	%

Other revenue		53.8		50.8		3.0		6	%

Total revenues	$	804.4	$	639.5	$	164.9		26	%

For the year ~~presentation.~~ended December 31, 2005, U.S. revenues increased $164.9 million. The Mexrail acquisition accounted for $73.3 million of the increase in revenues for the year ended December 31, 2005. U.S. revenue also experienced increases in all commodity groups due to a combination of higher carloadings, targeted price improvements and increased fuel surcharge revenue. Fuel surcharges increased to $52.0 million, which accounted for $35.3 million of the increase in revenues for the year ended December 31, 2005, compared to the same period in 2004. The following discussion provides an analysis of the segment’s revenues by commodity group. Pending completion of the ongoing effort to change the Tex-Mex mark and finalize its merger into KCS operations, carload data are presented based on the combination of the carloads for KCSR and Mexrail, without elimination for cars interchanged between the two roads.

Change

2004 2003 In Dollars Percentage

Compensation and benefits $ 213.0 $ 197.8 $ 15.2 7.7 %
Purchased services 62.3 63.5 (1.2 ) (1.9 )%
Fuel 66.4 47.4 19.0 40.1 %
Equipment costs 50.4 57.4 (7.0 ) (12.2 )%
Depreciation and amortization 53.5 64.3 (10.8 ) (16.8 )%
Casualties and insurance 42.4 56.4 (14.0 ) (24.8 )%
Other leases 11.8 9.8 2.0 20.4 %
Other 56.2 55.6 0.6 1.1 %

Total consolidated operating expenses $ 556.0 $ 552.2 $ 3.8 0.7 %

Chemical and Petroleum. For the year ended December 31, 2005, U.S. chemical and petroleum products experienced increases in revenues in all commodity groups with the exception of inorganic chemicals. These increases were attributed to higher production, certain targeted rate increases and fuel surcharges. These revenue increases were partially offset by the effects of plant and production shutdowns resulting from the hurricanes during the second half of 2005. The impact of the Mexrail consolidation increased revenues $12.1 million in the chemical and petroleum product commodities for the year ended December 31, 2005.

Forest Products and Metals. For the year ended December 31, 2005, forest products and metals revenue for the U.S. segment experienced growth in all commodities compared to the same period in 2004. For the year to date period, these increases resulted primarily from certain targeted rate increases and fuel surcharges partially offset by the impact of hurricanes in the 3rd quarter of 2005. For the year ended December 31, 2005, the consolidation of Mexrail contributed $19.0 million to forest products and metals revenue.

Agricultural and Mineral. U.S. revenues in the agricultural and mineral products business unit increased for the year ended December 31, 2005. The increases were primarily the result of targeted rate increases and fuel surcharges. Additionally, for the year ended December 31, 2005, all commodities, except grain, experienced increased traffic due to increased production. U.S. segment domestic grain carloads decreased, primarily due to a slowdown in equipment cycle times resulting in lower equipment availability for the year while the impact of local harvests moving to local feed mills reduced traffic in the third quarter of 2005 compared to the same period in 2004. Export grain carloads decreased primarily as a result of a decrease in gulf coast export traffic including the effects of hurricane weather in the gulf coast region. For the year ended

December 31, 2005, the consolidation of Mexrail contributed $30.7 million to agricultural and mineral products revenue.

Intermodal and Automotive. Revenue for the U.S. segment intermodal and automotive commodity group for the year ended December 31, 2005, increased $9.8 million compared to the same period in 2004. Excluding the impact of the acquisition of Mexrail, intermodal traffic declined for the year ended December 31, 2005. The declines were the result of changes in shipper traffic patterns as well as the effects of hurricane weather during the third quarter of 2005. Automotive traffic decreased as a result of decreased volumes from manufacturers for the year ended December 31, 2005. For the year ended December 31, 2005, the consolidation of Mexrail contributed $5.5 million to intermodal and automotive products revenue.

Coal. Increases in U.S. segment coal revenues for the year ended December 31, 2005, compared to the same period in 2004 were due primarily to the addition of two new coal customers that were previously served by other railroads, certain targeted rate increases related to renegotiated contracts and overall increases in carloadings and traffic volumes at certain electric generating stations in response to demand. Mexrail has no significant coal revenues.

Operating Expenses. For the year ended December 31, 2005, U.S. operating expenses increased $203.3 million (36.6%), when compared to the same period in 2004. Of this increase, $83.3 million was attributable to the consolidation of Mexrail’s operations for the year ended December 31, 2005. The following table summarizes U.S. operating expenses of KCSR and Mexrail for the year ended December 31, 2005(in millions). For the year ended December 31, 2004, ~~consolidated~~the operating expenses ~~increased $3.8 million compared to the year ended December 31, 2003.~~are KCSR only.


					Change
	2005		2004		Dollars		Percent

Compensation and benefits	$	244.8	$	213.0	$	31.8		15	%
Purchased services		84.6		62.3		22.3		36	%
Fuel		123.8		66.4		57.4		86	%
Equipment costs		68.9		50.4		18.5		37	%
Depreciation and amortization		60.0		53.5		6.5		12	%
Casualties and insurance		88.7		42.4		46.3		109	%
Other		88.5		68.0		20.5		30	%

Total operating expenses	$	759.3	$	556.0	$	203.3		37	%

Compensation and ~~Benefits.~~benefits. ~~Compensation~~Increases in compensation and benefits expense ~~increased $15.2 million~~ for the year ended December 31, ~~2004~~2005, compared to the ~~year ended December 31, 2003. This increase was~~same period in 2004 were primarily the result of annual wage and salary rate increases which were effective July 1, 2004, as well as higher ~~crew starts related~~employee counts. For the year ended December 31, 2005, the consolidation of Mexrail added $19.4 million to ~~higher traffic volume~~compensation and ~~increased incentive compensation. Average~~benefits expense. The average headcount for the year ended December 31, ~~2004~~2005, was ~~2,740~~approximately 3,060 compared to ~~2,676~~approximately 2,740 for the ~~year ended December 31, 2003.~~same period in 2004, including an increase of employees as a result of the consolidation of Mexrail.

Purchased ~~Services.~~services.Purchased services expense for the year ended December 31, ~~2004 decreased $1.2 million~~2005, increased compared to the ~~year ended December 31, 2003 resulting from lower levels~~same period in 2004, primarily as a result of the consolidation of Mexrail’s operations. Mexrail has historically contracted for services in the maintenance of equipment ~~repairs partially offset by increases in infrastructure repairs performed by outside parties~~ and ~~higher legal costs related~~way and structures. Accordingly, Mexrail contributed $19.7 million to ~~claim settlements.~~

~~Fuel.~~ ~~Fuel~~purchased services expense ~~increased $19.0 million~~ for the year ended December 31, 2004 compared to the year ended December 31, 2003. Increases of 30.2% in average price per gallon and 6.8% in consumption were offset in part by fuel cost savings of $3.0 million as a result of our fuel hedging program and improved fuel purchasing and distribution procedures implemented through our new Heavener, Oklahoma fueling facility. The 6.8% increase in consumption was a direct result of2005.

Fuel. Fuel expense increased ~~traffic, as gallons per gross ton mile remained unchanged from 2003 to 2004 at 1.37. Fuel cost represented approximately 11.9% of operating expenses~~ for the year ended December 31, ~~2004~~2005, compared to ~~8.6%~~the same period in 2004. This increase was the result of ~~operating costs and expenses for~~a 50.5% increase in the average price per gallon, as well as a 26.0% increase in consumption. For the year ended December 31, ~~2003.~~2005, the consolidation of Mexrail added $11.9 million to fuel expense.

Equipment ~~Costs.~~costs. Equipment costs for the year ended December 31, ~~2004 decreased $7.0~~2005, increased compared to the same period in 2004. Of this increase, $15.2 million ~~compared~~was related to the Mexrail acquisition for the year ended

December 31, 2005. Excluding the impact of the Mexrail acquisition, equipment costs increased for the year ended December 31, ~~2003. This decrease was~~2005, primarily ~~due~~as a result of increased equipment lease costs related to ~~continued efficiency gains in KCSR’s rail operations combined with an increase in car hire receivable for KCSR rolling stock on foreign lines~~higher traffic levels and ~~the 2004 acquisition of locomotives from Southern Capital, which were previously under lease.~~demand.

Depreciation and ~~Amortization.~~amortization. Depreciation and amortization expense for the year ended December 31, ~~2004 decreased $10.8 million~~2005, increased compared to the same period in 2004, primarily as a result of a higher asset base, partially offset by property retirements. For the year ended December 31, ~~2003~~2005, the consolidation of Mexrail added $3.5 million to depreciation and amortization expense.

Casualties and insurance. During the third quarter of 2005, the Company recorded a $37.8 million pre-tax charge reflecting changes in its estimates for the cost of personal injury claims, which includes $7.5 million related to the Company’s first actuarial estimate of the cost of incurred but not reported occupational illness claims. The charge was recorded in “Casualties and Insurance” expense. The majority of the increases for FELA and third party claims are attributable to adverse experience versus the study, including an increase in the number of new claims and adverse developments in the dollar amount of claims and potential settlements for many significant prior claims. Increase related to occupational illness claims resulted primarily from a first time actuarial study. The Company is continuing its practice of accruing monthly for estimated claim costs at levels recommended by the actuarial study, and those accruals have been increased accordingly.

Mexico Segment.

KCS acquired a controlling interest in KCSM effective April 1, 2005. The nine month period ended December 31, 2005, results reflect charges and costs associated with the acquisition and integration, as well as the effect of valuation adjustments as required by purchase accounting. Management evaluates the results of its Mexico operations based on its operating performance during the current year and comparison to plan.

Revenues. The following table summarizes consolidated Mexico revenues, including the revenues(in millions)and carloads statistics(in thousands), for the nine month periods ended December 31, 2005 and 2004. Although not consolidated in previous years, revenue recognition policies for the Mexico operations were consistent with those of U.S. operations in all material respects; therefore, commodity statistics are presented for purposes of comparison. Unaudited results for the nine months ended December 31, 2004 are presented for comparative purposes.


	Revenues										Carloads and Intermodal Units
					Change										Change
	2005		2004		Dollars			Percent			2005		2004		Units			Percent

General commodities:
Chemical and petroleum	$	94.5	$	94.7	$	(0.2	)		(0	)%		71.4		76.5		(5.1	)		(7	)%
Forest products and metals		141.5		120.5		21.0			17	%		147.3		143.3		4.0			3	%
Agricultural and mineral		168.9		158.6		10.3			6	%		152.4		162.1		(9.7	)		(6	)%

Total general commodities		404.9		373.8		31.1			8	%		371.1		381.9		(10.8	)		(3	)%
Intermodal and automotive		131.9		130.3		1.6			1	%		250.2		253.0		(2.8	)		(1	)%

Carload revenues, units and intermodal units		536.8		504.1		32.7			6	%		621.3		634.9		(13.6	)		(2	)%

Other revenue		10.8		6.4		4.4			69	%

Total revenues	$	547.6	$	510.5	$	37.1			7	%

Revenues for the nine months ended December 31, 2005, totaled $547.6 million compared to $510.5 million for the same period in 2004, an increase of $37.1 million. This increase was primarily attributable to the impact of fuel surcharges of $23.9 million which increased $21.5 million over the nine months ended December 31, 2004, and increases in other factors of $15.6 million.

Chemical and Petroleum. Revenues from chemical and petrochemical products during the nine months ended December 31, 2005, decreased from the same period in 2004 primarily due to disruptions related to the

impact of hurricanes offset by increases in Mexican domestic revenues for the same period, primarily related to the higher consumption of fuel products.

Forest Products and Metals. Domestic revenues increased during the nine months ended December 31, 2005, as a result of ~~changes in depreciable lives and salvage values approved by the STB and which took effect on January 1, 2004. These decreases were partially offset by increases~~an increase in the ~~property base~~production volumes of construction materials such as billets, bar and wire. Steel slab and steel coils revenue decreased as a result of ~~capital expenditures.~~lower international traffic, related to reduced consumption by manufacturing industries offset in part by certain targeted rate increases and fuel surcharges.

~~Casualties~~Agriculture and ~~Insurance.~~Mineral. ~~Casualties and insurance expense for~~Revenues from agriculture products increased during the ~~year~~nine months ended December 31, ~~2004 decreased $14.0 million~~2005, compared to the ~~year~~same periods in 2004. The increases were primarily the result of targeted rate increases and fuel surcharges. Volume increases were seen in corn and sugar partially offset by reductions in import shipments of soybeans, sorghum and wheat products during the same 2005 period.

Intermodal and Automotive. Intermodal freight revenue increased $1.6 million for the nine month period ended December 31, ~~2003. Casualties~~2005, compared to the same period in 2004. This increase was primarily attributable to the consolidation of steamship service at the port of Lázaro Cárdenas with the support of the port administration and ~~insurance expense~~Hutchinson Terminal. Automotive revenues for the nine month period ended December 31, 2005, decreased primarily as a consequence of lower domestic traffic offset by targeted increases in rates.

Operating Expenses. Mexico operations reported operating expenses of $530.3 million in the nine months ended December 31, 2005. The following table summarizes operating expenses of KCSM for the nine months ended December 31(in millions):


						Change
	2005		2004			Dollars			Percent

Compensation and benefits	$	95.6	$	87.2		$	8.4			10	%
Purchased services		108.7		120.5			(11.8	)		(10	)%
Fuel		83.1		65.3			17.8			27	%
Equipment costs		80.9		66.9			14.0			21	%
Depreciation and amortization		67.7		66.6			1.1			2	%
Casualties and insurance		14.7		9.7			5.0			52	%
KCSM employees’ statutory profit sharing		41.1		(2.1	)		43.2			(2,057	)%
Other		38.5		23.8			14.7			62	%

Total operating expenses	$	530.3	$	437.9		$	92.4			21	%

Compensation and benefits. Salary expenses increased $8.4 million for the nine months ended December 31, 2005 compared to the same period in 2004. The increase was ~~significantly impacted~~largely attributable to the net effects of annual salary increases (4% in ~~2003~~June 2005) and the increase in wages and fringe benefits as a result of our labor agreement revision in July 2005 (4.5% in wages and 2% in fringe benefits).

Purchased services. Costs of purchased services decreased by $11.8 million for the nine months ended December 31, 2005 compared to the same period in 2004. Costs of purchased services consist primarily of expenses related to equipment maintenance, haulage, terminal services, security expenses and legal expenses. The decrease includes the effect of establishing a fair market value for locomotive maintenance agreements under purchase accounting of $4.9 million. As a result of the acquisition of Grupo KCSM, Management fee agreements were cancelled, resulting in a reduction of expenses. Additionally, lower legal costs related to the VAT refund claim and a lower cost of expatriates as a result of a ~~$21.1 million provision~~personnel restructuring program contributed to the decrease.

Fuel. Fuel expenses increased for the nine months ended December 31, 2005 compared to the same period in 2004 primarily due to the volatility of fuel prices during 2005 and higher fuel consumption compared to 2004.

Equipment cost. Equipment cost increased for the nine months ended December 31, 2005 compared to the same period in 2004. The variance is attributable principally to an increase in the ~~fourth quarter~~number of ~~2003. Excluding this provision,~~hours and

number of movement miles in 2005 compared to 2004 for current traffic. Additionally the ~~$7.1 million~~ increase includes the effect of purchase accounting under which KCSM established a fair market value for all the operating leases for locomotives and freight cars. This, along with a higher number of freight cars leased for the nine months ended December 31, 2005 compared to 2004, resulted in ~~casualties~~higher rental expense.

Depreciation and ~~insurance~~amortization. Depreciation and amortization expenses in 2005 increased for the nine months ended December 31, 2005 compared to the same period in 2004. This increase includes the effects of purchase accounting, whereby the book values of assets were adjusted upward based on a market value appraisal along with capital improvements to the lines resulting in additional depreciation and amortization. This increase was offset by the effect of changes in the estimated useful lives on properties, machinery and equipment resulting in a lower depreciation expense in 2005.

Casualties and insurance. These expenses increased for the nine months ended December 31, 2005 compared to the same period ended in 2004. These increases were primarily the result of costs associated with derailments that occurred over the nine months ending in 2005. This increase was partially offset by a ~~$5.0 million derailment~~reduction in ~~Bolton, Mississippi~~the insurance premiums compared to 2004.

Employees’ statutory profit sharing. The increase in ~~September 2004. Casualties and insurance expense~~the employees’ statutory profit sharing for the nine months ended December 31, 2005 compared to the same period in 2004 was a result of recent Mexican Supreme Court decisions in May 2005 denying the deductibility of NOL’s in calculating the Company’s employees’ profit sharing liability. As part of purchase accounting, KCS valued the profit sharing NOL asset at zero as a result of the court rulings and wrote off the deferred profit sharing asset associated with these NOL’s. This resulted in a charge to income of $35.6 million.

Other. For the nine months ended December 31, 2005, these expenses increased compared to the same period ended December 31, 2004. The increase was primarily due to the reduction in value of certain assets after purchase accounting as well as management’s decision to increase the allowance for doubtful customer accounts based upon current prospects for collection of certain customer accounts.

Consolidated Non-Operating Expenses.

Consolidated Interest Expense. Consolidated interest expense increased $89.1 million for year ended December 31, ~~2004 reflects~~2005, when compared to the ~~net effect of approximately $4.4 million in insurance settlements.~~

~~Other Leases.~~ ~~Other lease expense for the year~~twelve months ended December 31, ~~2004~~2004. This increase was the result of higher floating interest rates incurred under the credit agreement, increased ~~$2.0~~borrowings under the revolving credit facility, interest associated with the debt assumed as part of the locomotive acquisition from El-Mo and the addition of interest expense of $71.4 million ~~compared to~~for the ~~year~~nine months ended December 31, ~~2003, related~~2005, due to ~~pipeline rents~~the acquisition of KCSM and $1.1 million for ~~KCSR’s new fuel facility in Heavener, Oklahoma. Additionally, KCSR experienced normal rate increases in long-term leases.~~the twelve months ending December 31, 2005, due to the acquisition of Mexrail.

~~Operating Income.~~Consolidated Debt Retirement Costs. Consolidated ~~operating income for the year ended December 31, 2004~~debt retirement costs increased ~~$54.4 million to $83.5 million compared to $29.1~~$0.2 million for the year ended December 31, ~~2003. Accordingly, KCS experienced a reduction~~2005, when compared to the same period in its consolidated operating ratio (ratio of operating expenses to operating revenues) of 8.1 basis points to 86.9% in 2004 from 95.0% in 2003. This decrease was the result of a $58.2 million increase in revenue, partially offset by a corresponding $3.8 million increase in operating expenses.

~~Interest Expense.~~ ~~Consolidated interest expense for~~2004. For the year ended December 31, ~~2004 decreased $2.0~~2005, $4.4 million ~~compared to~~in unamortized debt issuance costs were written off primarily in connection with the ~~year ended December 31, 2003. This reduction was primarily the result~~refinancing of ~~decreased balances on higher fixed rate debt instruments~~KCSM’s 11.75% debentures and ~~lower average interest rates related to the 2004~~its First Amended and Restated Credit ~~Facility.~~

~~Debt Retirement Costs.~~Agreement dated as of June 24, 2004. During the year ended December 31, 2004, KCS recorded $4.2 million of debt retirement costs resulting from the write-off of the unamortized balance of debt issuance costs associated with ~~our~~the previous credit facility.

~~Other Income.~~ Increases in KCS’s other income for the year ended December 31, 2004 were primarily the result of interest on tax refunds received in 2004 related to certain prior year tax returns as well as fluctuations in gains on sales of non-operating property.

~~Income Tax Provision (Benefit).~~ For the year ended December 31, 2004, KCS’s income tax provision was $23.6 million, an increase of $26.4 million compared to a $2.8 million benefit for the year ended December 31, 2003. This increase was primarily due to a $47.5 million increase in income before income taxes, resulting in an effective income tax rate of 49.1% and (600.7)% for the years ended December 31, 2004 and 2003, respectively. The primary cause of the increase in the effective rate was the increase in KCS pre-tax earnings, excluding equity in earnings of unconsolidated subsidiaries, of $50.4 million in 2004 compared to a pre-tax loss of $11.8 million in 2003, resulting in a consolidated effective income tax rate of 46.8% for 2004 compared to 23.8% for 2003. KCS intends to indefinitely reinvest the equity earnings from Grupo TFM and accordingly, does not provide deferred income tax expense for the excess of its book basis over the tax basis of its investment in Grupo TFM.

Equity in Net Earnings (Losses) of Unconsolidated Affiliates. For the years ended December 31, 2004 and 2003, Grupo TFM’s operating results and KCS’s corresponding equity in earnings under United States Generally Accepted Accounting Principles (“U.S. GAAP”) were as follows~~(in millions):~~

2004 2003

Revenue $ 699.2 $ 698.5
Operating expenses 593.1 591.2

Net income (loss) $ (8.3 ) $ 27.3

KCS equity in earnings (losses) of Grupo TFM $ (2.4 ) $ 12.3

The increase in Grupo TFM operating expenses was driven primarily by increases in fuel costs of $19.2 million partially offset by decreases in other operating expenses. Net income of Grupo TFM was significantly impacted by a $4.7 million income tax provision (U.S. GAAP) compared to a $51.5 million income tax benefit for 2003. This net increase in the tax provision was largely driven by tax legislation passed in the fourth quarter of 2004 that lowered future corporate income tax rates in Mexico. As a result of this legislation, the value of certain net deferred tax assets was adjusted to reflect lower values resulting in a charge to the tax provision of $23.7 million. Grupo TFM’s principal deferred tax assets are the result of prior year net operating losses for income tax purposes. Grupo TFM’s tax provision for 2004 was also impacted by changes in the peso/dollar exchange rate as well as adjustments for inflation within the Mexican economy.

Grupo TFM reports its financial results under International Financial Reporting Standards (“IFRS”). Because we are required to report our equity in net earnings in Grupo TFM under U.S. GAAP and Grupo TFM reports under IFRS, 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 KCS. Additionally, in 2004, TFM recognized a loss, net of tax and minority interest, of $4.2 million on the sale of its interest in Mexrail to KCS. For purposes of recording our equity in the net losses of Grupo TFM, this loss was eliminated due to the sale being to KCS, a related party.

~~For the~~ year ended December 31, ~~2004,~~2005, equity in ~~losses~~earnings from other unconsolidated affiliates was ~~$2.1~~$3.9 million compared to equity in losses from other unconsolidated ~~affiliates~~affiliate of ~~$1.3~~$2.1 million ~~in 2003.~~for the same period of 2004. Significant components of this change were as follows:


	•	For ~~2004, KCS recorded~~the year ended December 31, 2005, equity in losses from the operations of PCRC was $1.7 million, compared to $2.1 million ~~from PCRC compared to $3.1 million~~ for ~~2003 as PCRC continues to operate below full capacity due to delays~~the same period in ~~the completion of port expansion in Balboa.~~2004.

	•	~~Equity~~For the year ended December 31, 2005, equity in ~~losses~~earnings of Southern Capital was $2.8 million, compared to $2.7 million, ~~from KCS’s investment~~for the same period in ~~Mexrail. For 2003 and the first half of 2004, Mexrail’s results were consolidated into the results of Grupo TFM.~~2004.


	•	~~Equity~~For the nine months ended December 31, 2005, KCSM’s equity in earnings ~~from Southern Capital~~ of ~~$2.7 million compared to $1.8 million in 2003.~~Ferrocarril y Terminal del Valle de México, S.A. de C.V. (“FTVM”) was $2.9 million.

For ~~2004,~~2005, earnings for Southern Capital were ~~$11.8~~$13.1 million compared to ~~$4.1~~$11.8 million in ~~2003.~~2004. This increase of ~~$7.7~~$1.3 million was primarily the result of ~~the recognition~~a gain recognized by Southern Capital ~~of an approximate $6.0 million gain related to~~for the sale of locomotives in 2005 of approximately $7.7 million as compared to $6.0 million in 2004. The sales of locomotives were to KCSR in the second ~~quarter~~quarters of ~~2004.~~2005 and 2004, respectively. For purposes of recording its share of Southern Capital earnings, the Company has recorded its share of the gain as a reduction to the cost basis of the equipment acquired. As a result, the Company will recognize its equity in the gain over the remaining depreciable life of the locomotives as a reduction of depreciation expense.

~~Cumulative Effect of Accounting Change.~~ The Company adopted the provisions of Statement of Financial Accounting Standards No. 143 “Accounting for Asset Retirement Obligations” (“SFAS 143”) effective January 1, 2003. As a result, the Company changed its method of accounting for removal costs of certain track structure assets and recorded a one-time benefit of $8.9 million (net of income taxes of $5.6 million) during the first quarter of 2003. This change is reported as a cumulative effect of an accounting change in the accompanying consolidated statement of income.

~~YEAR ENDED DECEMBER 31, 2003 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2002~~

~~Net Income.~~ Net income for the year ended December 31, 2003 decreased $45.0 million compared to the year ended December 31, 2002. This decrease resulted from a $33.5 million decrease in equity in earnings of Grupo TFM, a $34.0 million increase in operating expenses (mostly related to increases in casualty and fuel expenses as discussed further below), a $10.8 million decline in other income and a $1.4 million increase in interest expense. Also contributing to the comparably lower 2003 net income was the impact of a $4.4 million gain on the sale of Mexrail recorded in 2002. These factors were partially offset by a $15.1 million increase in revenue, a $9.7 million decrease in the provision for income taxes, a benefit of $8.9 million (net of income taxes of $5.6 million) reported during 2003 relating to the cumulative effect of an accounting change, the effect of $4.3 million in debt retirement costs reported in 2002 and a $1.1 million improvement in the equity in net losses of other unconsolidated affiliates (PCRC and Southern Capital)Consolidated Income Tax Provision (Benefit).

~~The following table summarizes the income statement components of KCS~~~~(in millions):~~

Change

2003 2002 In Dollars Percentage

Revenues $ 581.3 $ 566.2 $ 15.1 2.7 %
Operating expenses 552.2 518.2 34.0 6.6 %

Operating income 29.1 48.0 (18.9 ) (39.4 )%
Equity in net earnings of unconsolidated affiliates 11.0 43.4 (32.4 ) (74.7 )%
Gain on sale of Mexrail — 4.4 (4.4 ) (100.0 )%
Interest expense (46.4 ) (45.0 ) 1.4 3.1 %
Debt retirement costs — (4.3 ) 4.3 100.0 %
Other income 6.8 17.6 (10.8 ) (61.4 )%

Income before income taxes and cumulative effect of accounting change 0.5 64.1 (63.6 ) (99.2 )%
Income tax provision (benefit) (2.8 ) 6.9 (9.7 ) (140.6 )%

Income before cumulative effect of accounting change 3.3 57.2 (53.9 ) (94.2 )%
Cumulative effect of accounting change, net of income taxes 8.9 — 8.9 100.0 %

Net income $ 12.2 $ 57.2 $ (45.0 ) (78.7 )%

The following table summarizes consolidated KCS revenues, including the revenues and carload statistics of KCSR, for the years ended December 31, 2003 and 2002. Certain prior period amounts have been reclassified to reflect changes in the business groups and to conform to the current period presentation.

Revenues Carloads and Intermodal Units

Change Change

2003 2002 In Dollars Percentage 2003 2002 In Units Percentage

(In millions) (In thousands)
General commodities:
Chemical and petroleum $ 123.8 $ 130.7 $ (6.9 ) (5.3 )% 140.0 145.4 (5.4 ) (3.7 )%
Forest products and metals 146.1 134.8 11.3 8.4 % 186.2 178.2 8.0 4.5 %
Agricultural and mineral 108.5 97.2 11.3 11.6 % 140.6 126.5 14.1 11.1 %

Total general commodities 378.4 362.7 15.7 4.3 % 466.8 450.1 16.7 3.7 %
Intermodal and automotive 59.1 59.9 (0.8 ) (1.3 )% 310.5 287.4 23.1 8.0 %
Coal 92.7 101.2 (8.5 ) (8.4 )% 191.4 210.0 (18.6 ) (8.9 )%

Carload revenues and carload and intermodal units 530.2 523.8 6.4 1.2 % 968.7 947.5 21.2 2.2 %

Other rail-related revenues 45.1 37.9 7.2 19.0 %

Total KCSR revenues 575.3 561.7 13.6 2.4 %
Other subsidiary revenues 6.0 4.5 1.5 33.3 %

Total consolidated revenues $ 581.3 $ 566.2 $ 15.1 2.7 %

~~Revenues.~~ For the year ended December 31, 2003, consolidated revenues increased $15.1 million. KCSR experienced revenue increases in forest products and metals, agriculture and mineral and intermodal commodity groups as well as higher revenues for extra services (haulage, switching, and demurrage). These revenue increases were partially offset by revenue declines in coal, chemical and petroleum products and automotive traffic. During the second half of 2002, operations were slowed by the implementation of MCS, contributing to a decline in 2002 revenues. In 2003, most of the slowdown, which resulted from the implementation of MCS, had been reversed and KCSR began to realize the benefits of more and better

quality data in the form of additional extra service revenues. Revenue for the year ended December 31, 2003 included approximately $3.6 million related to reductions of certain allowances and reserves based upon revised estimates. Revenue from other subsidiaries increased approximately $1.5 million year over year primarily due to volume increases at the Company’s bulk petroleum coke facility and higher sales to third parties at the Company’s wood tie treating facility. These increases were partially offset by a reduction of other revenues due to the sale of the Wyandotte Garage Corporation (“WGC”) during August 2002. The following discussion provides an analysis of KCSR revenues by commodity group.

~~Chemical and Petroleum.~~ For the year ended December 31, ~~2003, KCSR recorded lower revenues for chemical and petroleum products. This decrease~~2005, KCS’s income tax benefit was ~~primarily~~$7.1 million, a ~~result~~change of lower volumes for plastic product shipments, in large part due to the loss of a customer and lower production. Petroleum revenues for 2003 dropped as a result of the adverse impact of high natural gas prices on petroleum production. Natural gas serves as both a feedstock and a source of energy for producers. Lower agri-chemical revenues resulted from changes in traffic mix. These declines in agri-chemical, petroleum and plastic product revenues were partially offset by higher revenues for gases, organic and inorganic products. Higher revenues for gases and organic products were primarily the result of production increases by certain customers, as well as targeted rate increases and longer hauls due to gateway changes. 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.

~~Forest Products and Metals.~~ For the year ended December 31, 2003, KCSR recorded higher revenues for forest products and metals. Revenues for pulp and paper products as well as scrap paper increased primarily from higher production at KCSR’s paper mill customers and increased exports to Mexico. The increase in lumber and plywood product revenues resulted from continued strength in the housing and homebuilding industry due to sustained levels of housing starts. Increases in revenues for pulpwood/logs/chips resulted from higher production by certain customers and targeted rate increases. Partially offsetting these increases in forest product and metal revenues were lower military/other revenues as a result of the reduction of certain military training exercises, for which KCSR handles equipment transportation, due to the associated deployment of troops to the Middle East.

~~Agricultural and Mineral.~~ For the year ended December 31, 2003, increases in revenues for agricultural and mineral product were primarily the result of higher revenues for export grain, food products, ore and mineral products, as well as stone, clay and glass products while domestic grain remained relatively flat. Increases in revenues for export grain reflected higher volumes of grain exports to Mexico. Food product revenues rose as a result of a new contract with an existing customer yielding increased carloads, as well as longer hauls. Food product revenues also increased due to more beer shipments from Mexico into the United States and Canada. Ore and mineral product revenues increased due to higher demand from producers.

~~Intermodal and Automotive.~~ ~~Intermodal and automotive revenues for the year ended December 31, 2003 declined as a result of lower automotive revenues. Automotive revenues declined $3.7~~$30.7 million as a result of the loss of certain automotive traffic in the third quarter of 2002, as well as the negative effects of the sluggish economy on the automotive industry as a whole. Intermodal revenues for the year ended December 31, 2003 increased $2.9 million as a result of higher intermodal traffic with other connecting railroads.

~~Coal.~~ ~~Coal revenues for the year ended December 31, 2003 declined primarily due~~compared to a decline in tons shipped related to lower overall customer demand. A portion of the coal revenue decline related to the loss of a coal customer in April 2002, as well as to the impact of scheduled maintenance shutdowns in 2003, which where longer in duration compared to 2002. These factors, which led to a reduction in coal revenues, were partially offset by the impact of higher per-carload revenues as a result of the use of aluminum cars, which are capable of greater hauling capacity.

~~Other.~~ For the year ended December 31, 2003, other rail-related revenues increased primarily as a result of higher revenues for demurrage and other rail-related extra services, which resulted from improved operating efficiencies associated with the implementation of MCS in third quarter 2002. Haulage revenue also increased slightly for the year ended December 31, 2003 compared to 2002.

The following table summarizes KCS’s consolidated operating expenses for the years ended December 31, 2003 and 2002. Certain prior period amounts have been reclassified to conform to the current year presentation.

Increase (decrease)

2003 2002 In Dollars Percentage

Compensation and benefits $ 197.8 $ 197.8 $ — 0.0 %
Purchased services 63.5 59.6 3.9 6.5 %
Fuel 47.4 38.4 9.0 23.4 %
Equipment costs 57.4 67.6 (10.2 ) (15.1 )%
Depreciation and amortization 64.3 61.4 2.9 4.7 %
Casualties and insurance 56.4 25.2 31.2 123.8 %
Other leases 9.8 7.1 2.7 38.0 %
Other 55.6 61.1 (5.5 ) (9.0 )%

Total consolidated operating expenses $ 552.2 $ 518.2 $ 34.0 6.6 %

~~Operating Expenses.~~ ~~For the year ended December 31, 2003, consolidated operating expenses increased $34.0~~$23.6 million compared to the year ended December 31, 2002. As described further below, this increase resulted primarily from higher costs for casualties and insurance and for fuel, which increased $31.2 million and $9.0 million, respectively, year over year. These costs were partially offset by lower expenses related to equipment costs and certain other expenses arising from operating efficiencies realized through improved employee knowledge and effectiveness in using MCS. In 2002, certain costs and expenses were higher than normal due to the impact of the implementation of MCS and the related congestion. 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, 2003, consolidated compensation and benefits expense remained unchanged at $197.8 million compared to the year ended December 31, 2002. During 2003, KCSR experienced a reduction in the number of crew starts and lower overtime pay in its transportation operations, even though carload volumes increased more than 2% in 2003 compared to 2002. We believe these improvements were partially a result of the increased efficiency of train operations as KCSR operating personnel gained a better understanding of the data demands of MCS and have become more proficient at using this technology tool to enhance train operations. Furthermore, 2002 compensation and benefits costs were higher due to operating inefficiencies that occurred as a result of the implementation of MCS. The efficiency gains realized during 2003 were offset by an increase in certain union wage rates and related back pay for prior service time as a result of the settlement of certain union contracts and higher overall health insurance related costs. In 2002, operating expenses were also affected by a $1.3 million increase in expenses for the estimate of post employment benefits arising from the Company’s third party actuarial study and the impact of a favorable adjustment related to the accrual for retroactive wage increases to union employees.

~~Purchased Services.~~ ~~Consolidated purchased services~~ expense for the year ended December 31, 2003 increased $3.9 million compared to the year ended December 31, 2002. The year over year increase primarily resulted from increased legal expenses, an increase in track, bridge, locomotive and car repairs performed by third parties and a reduction in intermodal lift fee credits received from other railroads. These cost increases were partially offset by higher car repairs billed to others by KCSR and lower training expenses in 2003. Training costs in 2002 were higher than normal due to the training associated with the implementation of MCS. Legal fees in 2003 were higher than 2002 due to the impact of a $1.0 million legal settlement received in 2002 and insurance recovery credits of $4.0 million realized in 2002.

~~Fuel.~~ ~~Locomotive fuel costs for the year ended December 31, 2003 increased $9.0 million compared to the year ended December 31, 2002.~~2004. This ~~increase~~change was primarily due to ~~an approximate 23% increase in~~ the ~~average cost per gallon of fuel. KCSR’s average fuel price was approximately $0.86 per gallon in 2003~~

~~compared~~complexities relating to approximately $0.69 per gallon in 2002. Fuel consumption remained relatively unchanged year over year as a result of fuel conservation measures offsetting higher consumption due to increased traffic volumes. Fuel costs represented approximately 8.6% of operating costs and expenses for the year ended December 31, 2003 compared to 7.4% for the year ended December 31, 2002.

~~Equipment Costs.~~ Consolidated equipment costs for the year ended December 31, 2003 decreased $10.2 million compared to the year ended December 31, 2002. This decline resulted from improved fleet utilization associated with the implementation of MCS, as KCSR was operating more efficiently during 2003 than in 2002. The improvement in fleet utilization has led to an increase in the number of KCSR freight cars being used by other railroads as well as a reduction in the number of freight cars owned by other railroads on KCSR’s rail line. In the last half of 2002, the congestion-related issues associated with the implementation of MCS substantially impacted 2002 equipment costs.

~~Depreciation and Amortization.~~ Consolidated depreciation expense for the year ended December 31, 2003 increased primarily as a result of the implementation of MCS in July 2002, which was only depreciated for six months in 2002 compared to a full year in 2003. The remainder of the increase resulted from a net increase in the property, plant and equipment asset base.

~~Casualties and Insurance.~~ For the year ended December 31, 2003, consolidated casualties and insurance expense increased $31.2 million compared to the year ended December 31, 2002. This year over year increase was primarily due to additional costs recorded during the fourth quarter of 2003 related to personal injury liability reserves. KCS’s process of establishing liability reserves for personal injury incidents is based upon an actuarial study by an independent outside actuary, a process followed by most large railroads. This adjustment to the personal injury liability reserves was based on this actuarial study and was required due to adverse development of prior year claims and the continuing tort litigious environment surrounding the railroad industry, particularly for occupational injury claims. Also contributing to the increase in 2003 was higher property and liability related insurance costs, as well as the impact of $8.5 million in legal and insurance settlements in 2002, which reduced the comparable 2002 expense.

~~Other Leases.~~ Consolidated other lease expense for the year ended December 31, 2003 increased $2.7 million over the year ended December 31, 2002. This increase was partially related to a new lease for maintenance vehicles and work equipment, which in prior periods were owned by KCSR, and partially as a result of a full year of lease payments in 2003 for the Company’s new corporate headquarters building. The Company began leasing this facility in the second quarter of 2002.

~~Other Expense.~~ Consolidated other expense decreased $5.5 million for the year ended December 31, 2003 compared to the year ended December 31, 2002, primarily as a result of higher gains recorded on the sale of operating properties which increased $2.7 million year over year.

~~Operating Income.~~ Consolidated operating income for the year ended December 31, 2003 decreased $18.9 million to $29.1 million compared to $48.0 million for the year ended December 31, 2002. Accordingly, KCS experienced an increase in consolidated operating ratio (ratio of operating expenses to operating revenues) of 3.5 basis points to 95.0% from 91.5% in 2002. This increase was the result of a $34.0 million increase in operating expenses, partially offset by a $15.1 million increase in operating revenues.

~~Equity in Net Earnings (Losses) of Unconsolidated Affiliates.~~ ~~For the years ended December 31, 2003 and 2002, Grupo TFM’s operating results and KCS’s corresponding equity in earnings under U.S. GAAP were as follows~~~~(in millions):~~

2003 2002

Revenue $ 698.5 $ 712.1
Operating Expenses 591.2 554.2

Net Income $ 27.3 $ 110.2

KCS Equity in Earnings (Losses) of Grupo TFM $ 12.3 $ 45.8

Revenues for Grupo TFM for the year ended December 31, 2003 were adversely affected by an 8% decline in automotive shipments year over year and the devaluation of the Mexican peso against the U.S. dollar, which resulted in a reduction of revenues of approximately $34 million during 2003 versus 2002. Similar to KCSR, the increase in operating expenses at Grupo TFM was driven by higher fuel costs, which rose $13.8 million in 2003 versus 2002. Grupo TFM’s interest expense in 2003 increased approximately $15.3 million primarily as a result of increased debt related to TFM’s acquisition of the Mexican government’s ownership of Grupo TFM. For 2003, the fluctuation in the tax benefit was the result of numerous factors, including fluctuations in the foreign exchange rate of the Mexican peso and the U.S. dollar during 2003, as well as lower future Mexican corporate tax rates. These rate changes had the effect of reducing Grupo TFM’s deferred tax asset, thus reducing Grupo TFM’s deferred tax benefit. Fluctuations in the Mexican peso exchange rate also contributed to a $13.7 million exchange loss compared to an exchange loss of $17.4 million for the year ended December 31, 2002. KCS’s equity in net earnings of Grupo TFM was also impacted by our increased ownership of Grupo TFM to 46.6% from 36.9%, which KCS obtained indirectly in July 2002 as a result of the purchase by TFM of the Mexican government’s 24.6% ownership of Grupo TFM.

For the year ended December 31, 2003, equity in losses from other unconsolidated affiliates was $1.3 million compared to equity in losses from other unconsolidated affiliates of $2.4 million in 2002. In 2003, losses associated with PCRC were $3.1 million compared to $3.8 million in 2002. PCRC is not operating at full capacity as initially planned due to the delay in completion of the port expansion at Balboa. These losses were offset by equity in net earnings from Southern Capital of $1.8 million and $1.4 million for the years ended December 31, 2003 and 2002, 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 of $4.4 million.~~

~~Interest Expense.~~ Consolidated interest expense increased $1.4 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. Interest expense rose due to higher interest rates arising from a shift to more fixed rate debt in June 2002, partially offset by the impact of a lower debt balance. Our debt balance declined $59.2 million during 2003 to $523.4 million at December 31, 2003 from $582.6 million at December 31, 2002.

~~Debt Retirement Costs.~~ ~~Net income for the year ended December 31, 2002 was reduced by debt retirement costs of $4.3 million related to the debt refinancing during the second quarter of 2002.~~

~~Other Income.~~ Other income for the year ended December 31, 2003 declined $10.8 million compared to 2002, primarily due to substantially lower gains on the sale of non-operating property compared to 2002 as well as the impact of the sale of WGC in 2002. Gains recorded on the sale of non-operating property were $0.3 million and $7.4 million for the years ended December 31, 2003 and 2002, respectively.

~~Income Tax Provision (Benefit).~~ For the year ended December 31, 2003, KCS’s income tax provision decreased $9.7 million to a $2.8 million benefit compared to a $6.9 million provision for the year ended December 31, 2002, primarily due to a $63.6 million decline in income before income taxes. This resultedMexico taxes resulting in an effective income tax rate of ~~(600.7)%~~(9.3%) and ~~11.3%~~49.1% for the years ended December 31, ~~2003~~2005 and ~~2002,~~2004, respectively. ~~Exclusive~~The primary causes of ~~equity earnings~~the decrease in ~~Grupo TFM, KCS realized a pre-tax loss of $11.8 million in 2003 compared to pre-tax income of $18.3 million in 2002, resulting in a~~the consolidated effective ~~income~~rate were the VAT/Put Settlement, the utilization of U.S. tax credits enacted for the tax year 2005, a lower Mexican statutory tax rate of ~~23.8% for 2003~~30% as compared to ~~37.7%~~U.S. statutory rate of 35%, and foreign exchange rate fluctuations and inflation. The VAT/Put Settlement gain was not taxable in Mexico and is not expected to be taxable for ~~2002. This variance~~U.S. income tax purposes. The Company believes, based upon opinions of outside legal counsel and other factors, that the VAT/Put Settlement should not be taxable to KCS for U.S. income tax purposes. Such position has not been examined by taxing authorities and it is possible that this position could be challenged. The amount of such tax would be material; however the Company believes that it would have the right to indemnification under the terms of the Acquisition Agreement.

Following the acquisition of control of Grupo KCSM in 2005, the ~~effective tax rate was primarily the result of changes in associated book/tax temporary differences, the level of pre-tax~~Company has not provided U.S. federal income ~~and the impact of permanent book/tax differences~~taxes on the ~~effective rate computation.~~undistributed earnings of Grupo KCSM since the Company intends to reinvest such earnings indefinitely outside of the United States.

~~Cumulative Effect~~LIQUIDITY AND CAPITAL RESOURCES

Overview

KCS’s primary uses of ~~Accounting Change.~~cash are to support operations; maintain and improve its railroad and information systems infrastructure; pay debt service and preferred stock dividends; acquire new and maintain existing locomotives, rolling stock and other equipment; and meet other obligations. See “Cash Flow Information and Contractual Obligations” below.

KCS ~~adopted~~has a Debt/Equity ratio of 52.6 percent. Its primary sources of liquidity are cash flows generated from operations, borrowings under its revolving credit facilities and access to debt and equity capital markets. Although KCS has had excellent access to capital markets, as a highly leveraged company, the ~~provisions~~financial terms under which funding is obtained often contain restrictive covenants. The covenants constrain financial flexibility by restricting or prohibiting certain actions, including the ability to incur debt, create or suffer to exist liens, make prepayments of ~~SFAS 143 effective January 1, 2003.~~ particular debt, pay dividends, make capital investments, engage in transactions with stockholders and affiliates, issue capital stock, sell certain assets, and engage in mergers and consolidations or in sale-leaseback transactions. On December 31, 2006, total available liquidity (the unrestricted cash balance plus revolving credit facility availability) was $144 million.

As a result ~~we changed our method~~ of ~~accounting~~KCS acquiring a controlling interest in Grupo KCSM and KCSM, both companies became subject to the terms and conditions of the indentures governing KCSR’s two senior notes issues. The restrictive covenants of these indentures limit the ability of Grupo KCSM and KCSM to incur additional debt for ~~removal costs~~any purpose other than the refinancing of existing debt and certain ~~track structure assets~~new asset financing.

During 2006 KCS’ ability to access capital markets was affected by the late filing of the Company’s annual report onForm 10-K for the year ended December 31, 2005. This late filing also caused defaults under the Company’s credit agreements due to the Company’s failure to meet certain reporting requirements. Additionally, the Company’s ability to incur additional indebtedness and ~~recorded a benefit of $8.9 million (net of income taxes of $5.6 million) during the first quarter of 2003.~~pay cash dividends was restricted by

the Company’s failure to comply with certain financial ratios under its indentures and credit agreements. A consequence of the late filing of the Company’s annual report onForm 10-K for the year ended December 31, 2005 and its failure to pay dividends on preferred stock was that its ability to quickly access the public equity markets has been reduced significantly, since KCS did not qualify as a “well-known seasoned issuer” and also cannot utilize the short-form registration statement onForm S-3. KCS paid accrued and unpaid and current dividends on its outstanding 4% Preferred Stock, Series C Preferred Stock and Series D Preferred Stock on February 15, 2007, and believes it will become a well-known seasoned issuer and again be eligible to use short-form registration onForm S-3 on May 1, 2007, as described below in “Shelf Registration Statements and Public Securities Offerings.” KCS sought and obtained amendments and waivers for each of these defaults in 2006.

The Company believes, based on current expectations, that cash and other liquid assets, operating cash flows, access to capital markets, and other available financing resources will be sufficient to fund anticipated operating, capital and debt service requirements and other commitments through 2007. However, KCS’ operating cash flow and financing alternatives can be unexpectedly impacted by various factors, some of which are outside of its control. For example, if KCS was 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 its ability to obtain financing under reasonable terms is subject to market conditions. Further, KCS’ 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.

As of December 31, 2006, Standard & Poor’s Rating Service (“S&P”) rated the senior secured debt as BB−, our senior unsecured debt as B− and the preferred stock as D. S&P also maintained a corporate rating on KCS of B and had a negative outlook. Moody’s Investor Service (“Moody’s”) rated the senior secured debt as Ba2, the senior unsecured debt as B3 and the preferred stock as Caa1. Moody’s also maintained a probability of default rating on KCS of B2 and had a stable outlook. On February 8, 2007, S&P changed the Company’s outlook from negative to stable and on February 16, 2007, they upgraded the rating on the preferred stock from D to CCC.

~~LIQUIDITY AND CAPITAL RESOURCES~~Long Term Debt and Credit Facility Activity.

On March 1, 2006, KCS, KCSR, and other KCS subsidiaries entered into a fourth waiver (the “Fourth Waiver”) of the credit agreement dated March 30, 2004 (the “2004 Credit Agreement”). Under the terms of the Fourth Waiver, which was to expire on April 30, 2006, the Lenders agreed to waive the requirement that KCS maintain a leverage ratio (as defined in the 2004 Credit Agreement) of not more than 5.00:1 for the quarter ended December 31, 2005, provided that such ratio did not exceed 5.50:1. The ratio did not exceed 5.50:1.

On March 31, 2006, KCSM failed to meet certain reporting requirements under the 2005 KCSM Credit Agreement and had not met the leverage ratio covenant at the end of 2005. These failures resulted in defaults under the 2005 KCSM Credit Agreement and limited KCSM’s access to the revolving credit facility. On April 7, 2006, KCSM entered into an amendment and waiver (“Amendment and Waiver”) to the 2005 KCSM Credit Agreement. The 2005 KCSM Credit Agreement was amended to (i) exclude certain payment obligations accrued under two locomotive maintenance agreements and under a track maintenance rehabilitation agreement from the definition of Indebtedness, (ii) eliminate certain minimum and multiple borrowing thresholds for peso borrowings under the revolving credit facility and (iii) eliminate the reporting requirement to provide unaudited consolidated financial statements for the fourth fiscal quarter. The Amendment and Waiver also waived certain reporting requirements, including the requirement of KCSM to provide audited consolidated financial statements 90 days after the end of the 2005 fiscal year, provided such reports were delivered by April 30, 2006, and compliance with the Consolidated Leverage Ratio obligations of Section 7.1(c) of the 2005 KCSM Credit Agreement for the four quarters ending December 31, 2005, if compliance therewith was calculated without giving effect to the amendment to the definition of “Indebtedness” in the Amendment and Waiver,providedthat KCSM was in compliance therewith after giving effect to the Amendment and Waiver.

KCSM is not currently in default under the 2005 KCSM Credit Agreement and currently has access to the revolving credit facility.

On April 7, 2006, KCS, KCSR and other KCS subsidiaries entered into a fifth waiver of the 2004 Credit Agreement (the “Fifth Waiver”). Under the terms of the Fifth Waiver, which was to expire on April 30, 2006, the Lenders agreed to waive the requirement of Section 5.03(b) that KCS furnish a copy of its 2005 annual audited financial statements by March 31, 2006, so long as KCS furnished such audited financial statements by April 30, 2006. The Company furnished such audited financial statements by that date.

On April 28, 2006, KCS, KCSR and the other subsidiary guarantors named therein entered into an amended and restated credit agreement (the “2006 Credit Agreement”), in an aggregate amount of $371.1 million with The Bank of Nova Scotia and other lenders named in the 2006 Credit Agreement. Proceeds from the 2006 Credit Agreement were used to refinance the 2004 Credit Agreement. The 2006 Credit Agreement consists of (a) a $125.0 million revolving credit facility with a letter of credit sublimit of $25.0 million and swing line advances of up to $15.0 million, and (b) a $246.1 million term loan facility. The maturity date for the revolving credit facility is April 28, 2011 and the maturity date of the term loan facility is April 28, 2013. The 2006 Credit Agreement contains covenants that restrict or prohibit certain actions, including, but not limited to, KCS’ ability to incur debt, create or suffer to exist liens, make prepayment of particular debt, pay dividends, make investments, engage in transactions with stockholders and affiliates, issue capital stock, sell certain assets, and engage in mergers and consolidations or in sale-leaseback transactions. In addition, KCS must meet certain consolidated interest coverage and leverage ratios. Failure to maintain compliance with the covenants could constitute a default which could accelerate the payment of any outstanding amounts under the 2006 Credit Agreement.

On October 23, 2006, pursuant to an offer to purchase dated such date, KCSM commenced a cash tender offer and consent solicitation for any and all outstanding $150.0 million aggregate principal amount of its 101/4% Senior Notes due 2007 (the “KCSM 2007 Senior Notes”). The consent solicitation expired on November 3, 2006. KCSM received consents in connection with the tender offer and consent solicitation from holders of over 97% of the KCSM 2007 Senior Notes to amend the indenture under which the KCSM 2007 Senior Notes were issued (the “2007 Indenture”), to eliminate substantially all of the restrictive covenants included in the 2007 Indenture. The supplemental indenture relating to the KCSM 2007 Senior Notes containing the proposed changes (the “2007 Supplemental Indenture”) became effective on November 21, 2006. The tender offer expired at midnight, New York City time, on November 20, 2006 and KCSM purchased tendered notes on November 21, 2006, in accordance with the terms of the tender offer.

On November 21, 2006 KCSM issued $175.0 million of new, unsecured, 75/8% senior notes due 2013 (the “KCSM 2013 Senior Notes”). Proceeds from the issuance were used to purchase the $146.0 million of tendered KCSM 2007 Senior Notes and repay $29.0 million of term loans under the 2005 KCSM Credit Agreement.

On January 29, 2007, the Company commenced a consent solicitation to amend the indentures under which KCSR’s 91/2% Senior Notes due 2008 (the “91/2% Notes”) and 71/2% Senior Notes due 2009 (the “71/2% Notes” and together with the 91/2% Notes, the “Notes”) were issued. The Company identified certain inconsistencies in the language of the indentures which prevented KCS from obtaining a coverage ratio of at least 2.00:1. The purpose of the consent solicitation was to (i) resolve an inconsistency in the inclusion of certain expenses, but not the income, of restricted subsidiaries in the calculation of the consolidated coverage ratio under the indentures, (ii) amend the definition of refinancing indebtedness to allow the inclusion of certain related premiums, interest, fees and expenses in permitted refinancing indebtedness and (iii) obtain waivers of any defaults arising from certain actions taken in the absence of such proposed amendments. On February 5, 2007, the Company obtained the requisite consents from the holders of each series of Notes to amend their respective indentures as described above and executed supplemental indentures containing such amendments and waivers.

KCSR’s access to the revolving credit facility. In its notice of default, the Company also requested that the lenders waive these defaults. On February 5, 2007, the Company received a waiver of such defaults from all of the lenders under the 2006 Credit Agreement. The Company is currently not in default of the 2006 Credit Agreement and has access to the revolving credit facility.

Cash Flow Information and Contractual ~~Obligations~~Obligations.

Summary cash flow data follows(in millions):

2006 2005 2004

Cash flows provided by (used for):
Operating activities $ 267.5 $ 178.8 $ 142.7
Investing activities (166.0 ) (289.5 ) (376.8 )
Financing activities (53.6 ) 103.2 137.3

Net increase (decrease) in cash and cash equivalents 47.9 (7.5 ) (96.8 )
Cash and cash equivalents at beginning of year 31.1 38.6 135.4

Cash and cash equivalents at end of year $ 79.0 $ 31.1 $ 38.6

During 2006, the consolidated cash position increased $47.9 million due to increased operating income which was partially offset by additional payments for the ~~years ended December 31, 2004, 2003~~acquisition of Grupo KCSM and ~~2002, respectively:~~~~(dollars in millions)~~

2004 2003 2002

Cash flows provided by (used for):
Operating activities $ 142.7 $ 68.0 $ 93.8
Investing activities (376.8 ) (86.0 ) (33.0 )
Financing activities 137.3 134.4 (66.5 )

Net increase (decrease) in cash and cash equivalents (96.8 ) 116.4 (5.7 )
Cash and cash equivalents at beginning of year 135.4 19.0 24.7

Cash and cash equivalents at end of year $ 38.6 $ 135.4 $ 19.0

the refinancing and repayment of debt. During 2005, the ~~year ended December 31, 2004, our~~ consolidated cash position decreased ~~by $96.8~~$7.5 million ~~from December 31, 2003.~~due to an increased level of capital expenditures. The primary sources of cash were ~~as follows: increased borrowing under the Amended 2004 Credit Facility;~~ cash inflows from operating ~~activities; proceeds from~~activities, the ~~disposal~~issuance and assumption of ~~property;~~long-term debt, the issuance of preferred stock and ~~proceeds from employee stock plans.~~borrowings under the revolving credit facilities. The primary uses of cash were ~~as follows: funding of the escrow account~~ for ~~purposes of the Acquisition;~~capital expenditures, investments in ~~and loans to affiliates;~~affiliates, repayment of ~~debt; costs related to~~long-term debt and the ~~Acquisition; cash dividends paid; and property acquisitions.~~repurchase of KCS’ common stock.
~~Operating Cash Flows.~~ ~~KCS’s~~
KCS’ cash flow from operations has historically been positive and sufficient to fund operations, ~~KCSR~~ roadway capital expenditures, other capital improvements and debt service. External sources of cash (principally bank debt, public debt, preferred stock and ~~public debt)~~leases) have been used to refinance existing indebtedness and to fund acquisitions, new investments and equipment additions.
Operating Cash Flows. The following ~~table~~ summarizes consolidated operating cash flow information ~~for the years ended December 31, 2004, 2003, and 2002, respectively:~~~~(dollars in~~ (in millions):

2004 2003 2002

Net income $ 24.4 $ 12.2 $ 57.2
Depreciation and amortization 53.5 64.3 61.4
Equity in undistributed (earnings) losses of unconsolidated affiliates 4.5 (11.0 ) (43.4 )
Distributions from unconsolidated affiliates 8.8 — —
Deferred income taxes 35.9 1.6 21.8
Gains on sales of properties and investments (3.8 ) (6.2 ) (20.1 )
Tax benefit realized upon exercise of stock options 9.5 2.5 4.5
Cumulative effect of accounting change — (8.9 ) —
Change in working capital items 1.3 6.3 8.5
Other 8.6 (7.2 ) 3.9

Net cash flow from operating activities $ 142.7 $ 68.0 $ 93.8

2006 2005 2004

Net income $ 108.9 $ 100.9 $ 24.4
Depreciation and amortization 155.0 127.7 53.5
Equity in undistributed losses (earnings) of unconsolidated affiliates (7.3 ) (2.9 ) 4.5
VAT/put settlement gain — (131.9 ) —
Minority interest 0.3 (17.8 ) —
Distributions from unconsolidated affiliates 4.5 8.3 8.8
Deferred income taxes 41.0 (17.3 ) 35.9
KCSM employees’ statutory profit sharing 5.9 41.1 —
Loss (gain) on sale of assets (7.8 ) 1.0 (3.8 )
Changes in working capital items (24.5 ) 45.9 1.3
Other, net (8.5 ) 23.8 18.1

Net cash flow provided by operating activities $ 267.5 $ 178.8 $ 142.7

Net operating cash flows for ~~2004~~2006 increased ~~$74.7~~$88.7 million to ~~$142.7~~$267.5 million compared to ~~$68.0~~$178.8 million in ~~2003.~~2005. This increase in operating cash flows was primarily attributable to ~~an increase in net income, distributions from unconsolidated affiliates, the increase in deferred tax expense recognized in 2004~~better operating performance and the ~~impact~~consolidation of ~~certain tax benefits related~~KCSM for twelve months in 2006 as compared to ~~stock options. These factors, which increased operating cash flow, were~~nine months in 2005. The increase was partially offset by changes in working capital balances relating to the timing of payments and ~~receipts, as well as the discharge of certain non-current liabilities.~~receipts.

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Net operating cash flows for ~~2003 declined $25.8~~2005 increased $36.1 million to ~~$68.0~~$178.8 million ~~compared~~largely due to ~~$93.8 million in 2002. This decrease in operating cash flows~~the consolidation of KCSM which was ~~primarily attributable to a reduction of net income and~~

partially offset by changes in working capital ~~balances, resulting mainly from~~relating to the timing of payments and ~~receipts, partially offset by the receipt of income tax refunds.~~receipts.

Investing Cash Flows. Net investing cash outflows were ~~$376.8~~$166.0 million and ~~$86.0~~$289.5 million during ~~the years ended December 31, 2004~~2006 and ~~2003,~~2005, respectively. This ~~$290.8~~$123.5 million ~~increase~~decrease was related to decreased capital expenditures, increased property sales and the ~~$200.0 million funding of a restricted escrow account in anticipation~~receipt of the ~~Acquisition of Grupo TFM, the purchase of and loans to Mexrail by KCS, increases in capital expenditures and costs related~~MSLLC investment from NS.

Net investing cash outflows for 2005 decreased $87.3 million from 2004 due primarily to the ~~Acquisition of Grupo TFM. As discussed in “Recent Developments — Repurchase of Mexrail Shares by KCS,” KCS repurchased a 51% stake~~investments in Mexrail ~~from TFM for $32.7 million~~ and ~~increased its loans to Tex-Mex and Mexrail by approximately $13.4 million. Proceeds of the loans were used by Tex-Mex and Mexrail to fund capital improvements.~~Grupo KCSM in 2004. During ~~2004,~~2005, KCS capital expenditures increased ~~by approximately $33.2 million. Consistent with 2003, KCS also incurred approximately $9.5~~$158.5 million, of ~~deferred costs associated with the Acquisition of Grupo TFM.~~which KCSM and Mexrail contributed $100.6 million.

Net investing cash outflows were $86.0 million and $33.0 million during the years ended December 31, 2003 and 2002, respectively. This $53.0 million increase in investing cash outflows was primarily related to the sale of Mexrail to TFM for $31.4 million in 2002. During 2003, in contemplation of the Acquisition, KCS repurchased a 51% interest in Mexrail for $32.7 million. In accordance with a demand from TFM, KCS sold its interest in Mexrail back to TFM on September 30, 2003 for $32.7 million. As a result of these two Mexrail transactions in 2003, there was no net impact to net investing cash outflows during 2003. Therefore, the impact of the cash received in 2002 from the sale of Mexrail resulted in higher comparable investing cash outflows during 2003. Also impacting net investing cash outflows for 2003 was approximately $9.3 million of costs associated with the Acquisition that have been deferred and included in other investing activities. Additionally, proceeds from the sale of property for 2003 were $3.1 million less than 2002.

~~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~~were derived from the issuance of long-term debt, including borrowings under the revolving credit facilities, the issuance of preferred stock and proceeds from the issuance of common stock under employee stock plans. ~~During 2004, financing~~Financing cash ~~flows~~outflows were ~~also generated through~~used for the ~~expansion~~repayment of debt, the ~~2004 Credit Facility with net proceeds~~repurchase of ~~$142.4 million.~~KCS’ common stock, the payment of dividends on KCS’ preferred stock and the payment of debt and preferred stock issuance costs. Financing cash flows for ~~2004, 2003,~~2006, 2005, and ~~2002~~2004 were as follows:


	•	~~Repayment of indebtedness in the amounts of $107.6~~Financing cash outflows for 2006 were $53.6 million, ~~$59.2 million and $270.9 million in 2004, 2003 and 2002, respectively. Repayment of indebtedness is generally funded through operating cash flows and proceeds~~resulting primarily from ~~the disposals of property. In 2004,~~ the repayment of short and long term debt, ~~was funded through financing cash flows. In 2003,~~including amounts related to the ~~repayment of debt was funded through operating cash flows, proceeds from the disposal of property~~Grupo KCSM acquisition, and the ~~proceeds received from the Convertible Preferred Stock. In 2002, the repayment of indebtedness was funded from~~costs associated with refinancing debt. During 2006, KCS entered into a new $371.1 million amended and restated credit agreement and used the proceeds ~~from~~to repay all amounts outstanding under the ~~issuance~~previous credit agreement. KCS also borrowed a net amount of ~~debt, as well as operating~~$27.5 million under the Tex-Mex RRIF loan, repaid a net amount of $2.0 million under the KCSR revolving credit facility and repaid other amounts. KCSM issued $175.0 million of 75/8% senior unsecured notes and used the proceeds to purchase $146.0 million of its 101/4% senior unsecured notes and repay $29.0 million under its term loan facility. KCSM also used cash ~~flows and proceeds from the disposals of certain assets.~~on hand to repay all amounts outstanding under its revolving credit facility.

	•	~~The bank facility was refinanced in March 2004 and subsequently amended in December 2004. The borrowing~~Financing cash flows for 2005 were $103.2 million, resulting primarily from borrowings under the ~~bank facility was increased to $250~~revolving credit facilities. During 2005 KCS issued $210.0 million ~~from $150 million. Proceeds from~~of preferred stock and the ~~issuance of debt in June 2002~~net proceeds were used to ~~refinance term debt. There~~repurchase 9.0 million shares of KCS common stock. KCS also assumed debt under a purchase agreement for 75 locomotives, of which $24.3 million was outstanding at year end, borrowed $21.7 million under the Tex-Mex RRIF loan, and had borrowings of $92.0 million outstanding at year end under the KCSR revolving credit facility. KCSM issued $460.0 million of 93/8% senior unsecured notes, and entered into a $106.0 million credit facility. The proceeds from these last two financings were ~~no borrowings during 2003.~~used by KCSM to repay $443.5 million of senior discount debentures, $31.0 million under a bridge loan, the remaining balance of $67.5 million under the previous credit facility and the costs associated with the transactions.

	•	InFinancing cash flows for 2004 ~~we paid debt issuance costs~~were $137.3 million, resulting primarily from borrowings under a new $350.0 million credit agreement consisting of ~~$3.8~~a $250.0 million ~~related to the Amended 2004 Credit Facility. In 2002, we paid $5.7~~term loan facility and a $100.0 million revolving credit facility. KCS used $100.0 million of ~~debt issuance costs related~~the term loan to fund a portion of the ~~$200 million offering in June 2002~~escrow account under the acquisition of 7¹/2~~% senior notes due June 15, 2009.~~Grupo KCSM.

	•	Proceeds from the sale of KCS common stock pursuant to employee stock plans were $8.6 million, $1.7 million and $7.4 million ~~$5.3 million~~in 2006, 2005 and ~~$10.3 million in~~ 2004, ~~2003 and 2002,~~ respectively.

	•	Payment of cash dividends were $4.3 million, $8.7 million ~~$4.7~~and $8.7 million in 2006, 2005 and 2004, respectively. Dividends of approximately $0.2 million ~~in 2004, 2003 and 2002, respectively. Approximately~~were paid each year on the 4.0% noncumulative preferred stock; approximately $2.1 million, $8.5 million and ~~$4.5~~$8.5 million of dividends were paid in 2006, 2005 and 2004, respectively, on the Series C Preferred Stock; and ~~2003, respectively, relating to the Cumulative Preferred Stock and $0.2~~approximately $2.0 million of dividends were paid in ~~each of 2004 and 2003 relating~~2006 on the Series D Preferred Stock. Cumulative dividends in arrears were paid February 15, 2007. Refer to Note 16 to the ~~Preferred Stock.~~Consolidated Financial Statements in Item 8 of thisForm 10-K.

Contractual Obligations. The following table outlines ~~our~~the material obligations under long-term debt, operating lease and other contractual commitments aton December 31, ~~2004.~~2006(in millions). Typically, payments for ~~these~~operating leases, other contractual obligations and interest on long-term debt are funded through operating cash flows. Principal payment obligations on long-term debt are typically refinanced by issuing new long-term debt. If operating cash flows are not sufficient, funds received from other sources, including borrowings under credit facilities and proceeds from property and other asset dispositions might also be available. These obligations are customary transactions similar to those entered into by others in the transportation industry. ~~We anticipate~~KCS anticipates refinancing certain parts of ~~our~~the long-term debt prior to maturity.

Payments Due by Period

Less than More Than
Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years

(Dollars in millions)
Long-term debt (including capital lease obligations) $ 665.7 $ 9.9 $ 193.2 $ 461.9 $ 0.7
Operating leases 426.0 56.5 87.0 69.1 213.4
Locomotive Purchase Commitments 55.0 55.0 — — —
Purchase Commitment to Grupo TFM for remaining 49% interest in Mexrail 31.4 31.4 — — —
Other contractual obligations(a) 67.8 11.9 8.0 8.0 39.9

Total contractual obligations $ 1,245.9 $ 164.7 $ 288.2 $ 539.0 $ 254.0

Payments Due by Period
Less Than
1-3
3-5

Total 1 Year Years Years Thereafter

Long-term debt (including interest and capital lease obligations)(i) $ 2,496.7 $ 243.4 $ 697.6 $ 351.0 $ 1,204.7
Operating leases 958.6 123.6 205.5 167.9 461.6
Other contractual obligations(ii) 508.7 89.3 130.6 94.8 194.0

Total contractual obligations $ 3,964.0 $ 456.3 $ 1,033.7 613.7 $ 1,860.3

~~(a)~~ (i) Includes current and long-term liability related to Grupo KCSM acquisition.
(ii) Other contractual obligations include purchase commitments and certain maintenance agreements.
In the normal course of business, the Company enters into long-term contractual requirements for future goods and services needed for the operations of the business. Such commitments are not in excess of expected requirements and are not reasonably likely to result in performance penalties or payments that would have a material adverse effect on the Company’s liquidity.
The Company is party to three utilization leases covering 888 railcars where car hire revenue as defined in the lease agreements is shared between the lessor and the Company. The leases expire at various times through 2011. Amounts that may be due to lessors under these utilization leases vary from month to month based on car hire rental with the minimum monthly cost to the Company being zero. Accordingly, the utilization leases have been excluded from contractual obligations above.
Off-Balance Sheet ~~Arrangements~~Arrangements.

As further described in Note 3 to ~~KCS’s~~the Consolidated Financial Statements in Item 8 of thisForm 10-K, ~~we hold~~ KCSR holds a ~~50%~~fifty percent interest in Southern ~~Capital, a joint venture that provides us with access to equipment financing alternatives.~~Capital. Southern Capital’s principal operations are the acquisition and leasing of equipment including locomotives, rolling stock and other railroad ~~equipment and the leasing thereof to KCSR.~~equipment. On June 25, 2002, Southern Capital partially refinanced the outstanding balance of certain debt through the issuance of 5.7% pass through trust certificates ~~and proceeds from the sale of 50 locomotives. These pass through trust certificates are~~ secured by all of the locomotives and rolling stock owned by Southern Capital and rental payments payable by KCSR under the operating leases of the equipment owned by Southern Capital. As Southern Capital is a ~~50%~~fifty percent owned ~~unconsolidated~~ joint venture accounted for under the equity method, this debt is not reflected in KCS’ Consolidated Balance Sheets which are included in Item 8 of thisForm 10-K.
As discussed in “Recent Developments — Mexican Government’s Put Rights with Respect to TFM Stock,” TMM and KCS, or either TMM or KCS, could be required to purchase the Mexican government’s interest in TFM. If KCS and TMM, or either KCS or TMM individually had been required to purchase the Mexican government’s 20% interest in TFM, the total purchase price would have been approximately $468 million as of December 31, 2004. If the Acquisition is consummated, KCS will assume TMM’s rights, duties and obligations with respect to the purchase of the TFM shares subject to the Put. We are exploring various alternatives for financing this transaction. It is anticipated that this financing, if necessary, can be accomplished by using capital markets. No commitments for such financing have been obtained at this time.
~~Also,~~PCRC, as described in Note 3, has the concession to ~~KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K, under~~reconstruct and operate the Panama Canal Railway. Under the terms of ~~the~~a loan agreement with International Finance Corporation (“IFC”)~~, we are~~ the Company is a guarantor for up to ~~$5.6~~$4.4 million of associated debt. Also, if PCRC terminates the concession contract without the IFC’s consent, ~~we are~~KCS is a guarantor for up to ~~50%~~half of the outstanding senior loans. ~~Furthermore, we are~~The Company is also a guarantor for up to ~~$3.0~~$0.5 million of ~~the~~PCRC equipment loans and capital leases, and has issued two irrevocable letters of credit totaling approximately ~~$100,000 relating to the other capital leases.~~
On March 28, 2005, PCRC and the IFC finalized an agreement whereby PCRC would redeem the shares subscribed and owned by the IFC pursuant to the IFC Subscription. Under the agreement, PCRC will pay to the IFC $10.5 million. These shares have a recorded value of $5.0 million and approximately $2.6 million in accrued unpaid dividends. When the transaction is completed, PCRC will record an additional cost of approximately $2.9$2.0 million to ~~reflect~~fulfill the ~~premium paid to IFC and, as~~Company’s fifty percent guarantee of a ~~result, KCS expects to record its share~~approximately $4.0 million equipment loan.

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41

~~of this cost of approximately $1.5 million in recording its equity in earnings of PCRC in the first quarter of 2005.~~
Capital ~~Expenditures~~Expenditures.

Capital improvements for ~~KCSR~~ roadway track structures have historically been funded with cash flows from ~~operations and external debt. We have~~operations. During 2005, however, KCS used borrowings under its revolving credit facility to fund an expanded capital expenditure program. KCS has historically used ~~equipment trust certificates for major purchases of locomotives and rolling stock, while using~~ internally generated cash flows or leasing for ~~other equipment. Through our~~equipment capital expenditures. The Southern Capital joint venture ~~we have~~provides the ability to ~~finance~~lease-finance railroad equipment, and therefore, ~~have~~KCS has increasingly used lease-financing alternatives for ~~our~~its locomotives and rolling stock.

The following ~~table~~ summarizes ~~the~~ cash capital expenditures by type for ~~2004, 2003~~the consolidated operations for the year ended December 31, 2006, KCSR and ~~2002, respectively.~~Mexrail for the year ended 2005 and KCSM for the last nine months of 2005, and KCSR only for 2004(in millions).

Capital Expenditure Category 2004 2003 2002

(Dollars in millions)
Track infrastructure $ 57.2 $ 52.9 $ 40.4
Locomotives, freight cars and other equipment 22.6 14.9 15.3
Facilities and capacity projects 27.4 6.8 16.2
Information technology 5.4 3.8 6.0
Other 4.6 5.6 —

Total capital expenditures $ 117.2 $ 84.0 $ 77.9

2006 2005 2004

Track infrastructure $ 100.4 $ 190.1 $ 57.2
Locomotives, freight cars and other equipment 40.4 41.8 22.6
Facilities and capacity projects 70.7 1.7 27.4
Information technology 15.4 12.2 5.4
Other 14.9 29.9 4.6

Total capital expenditures $ 241.8 $ 275.7 $ 117.2

Internally generated cash flows ~~and borrowings under our line of credit were used to finance capital expenditures. Internally generated cash flows and borrowings~~ are expected to be used to fund cash capital ~~programs~~expenditures planned for ~~2005,~~2007, currently estimated at ~~approximately $144.0 million, of which, approximately $55.0 million has been earmarked for new locomotive power.~~$270 million.
~~KCSR~~ Maintenance and Repairs.

KCSR and KCSM, like other railroads, isare required to maintain ~~its~~their 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 GAAP as well as with the ~~Federal Railroad Administration’s track~~ standards recognized within the rail industry and ~~are accounted for in accordance with applicable~~related regulatory ~~accounting rules. We expect~~agencies. KCS expects to continue funding 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, 2004, 2003 and 2002, respectively, as a percentage of KCSR revenues were as follows~~(dollars in millions)~~:

KCSR Maintenance

Way and Structure Equipment

Percent of Percent of
Amount Revenue Amount Revenue

2004 $ 46.4 7.3 % $ 39.6 6.2 %
2003 41.1 7.1 42.5 7.3
2002 43.6 7.7 48.2 8.5
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Capital ~~Structure~~Structure.

Components of ~~our~~the capital structure ~~are as follows~~follow(~~dollars~~ in millions).:

2004 2003

Debt due within one year $ 9.9 $ 9.9
Long-term debt 655.8 513.5

Total debt 665.7 523.4
Stockholders’ equity 1,024.5 963.7

Total debt plus equity $ 1,690.2 $ 1,487.1

Total debt as a percent of
Total debt plus equity (“debt ratio”) 39.4 % 35.2 %

~~Our~~

2006 2005

Debt due within one year(i) $ 92.8 $ 116.3
Long-term debt(ii) 1,664.2 1,744.3

Total debt 1,757.0 1,860.6
Stockholders’ equity 1,582.4 1,426.2

Total debt plus equity $ 3,339.4 $ 3,286.8

Debt ratio(total debt as a percent of total debt plus equity)
52.6 % 56.6 %
(i) Includes current liability related to Grupo KCSM acquisition.
(ii) Includes long-term liability related to Grupo KCSM acquisition.
The consolidated debt ratio ~~as of~~on December 31, ~~2004 increased 4.2~~2006, improved 4.0 percentage points compared to December 31, ~~2003 as a result of an increase in debt partially offset by an increase in stockholders’ equity.~~2005. Total consolidated debt increased $142.3 million as a result of additional borrowings under the Amended 2004 Credit Facility, partially offset by repayments of principal. Additionally, KCS repaid approximately $50 million of long term debt during December of 2003. The $50 million was then subsequently refinanced under the 2004 Credit Facility in the first quarter of 2004. Stockholders’ equity increased $60.8decreased $103.6 million, primarily as a result of ~~the reclassification from other liabilities~~payments of ~~the tax benefits associated with the settlement of the dispute with Stilwell of $27.1 million, $24.4 million in net income and $9.5~~$75.4 million of ~~tax benefits associated with current year exercise~~debt related to the Grupo KCSM acquisition and KCSM’s payments of ~~stock options~~$55.4 million on the revolver and term loans. These debt payments were offset by ~~$8.7~~the issuance of $27.5 million ~~in preferred stock dividends.~~on the Tex-Mex RRIF loan.

47

Shelf Registration Statements and Public Securities ~~Offerings~~Offerings.

~~Kansas City Southern~~

KCS currently has ~~two~~three shelf registration statements on file with the SEC (“Initial Shelf” —Registration No. 33-69648; “Second Shelf” — RegistrationNo. ~~333-61006)~~333-61006; “Third Shelf” —Registration No. 333-130112). 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. The Third Shelf was filed in accordance with the securities offering reform rules of the SEC that allow well known seasoned issuers to register an unspecified amount of different types of securities on an immediately effectiveForm S-3 registration statement. On December 9, 2005, the Company completed the sale and issuance of 210,000 shares of its Series D Preferred Stock pursuant to the Third Shelf. There remains an unspecified amount of securities available under the Third Shelf. To date, no securities have been issued under either the Initial Shelf or Second Shelf.

~~Overall Liquidity~~

~~During March 2004, we refinanced the former credit facility, including the revolving credit facility. Under the terms~~ As a consequence of the ~~new 2004 Credit Facility, we borrowed $150 million~~late filing of the 2005Form 10-K, KCS is ineligible to use any of these shelf registration statements until it has timely filed all periodic reports required under Section 13(a) or Section 15(d) of the Exchange Act during the twelve calendar months and any portion of the month after the lateForm 10-K filing was made. KCS was also ineligible to use the shelf registration statements during the period in which it failed to pay dividends on its 4% Preferred Stock, Series C Preferred Stock and Series D Preferred Stock. KCS paid the accrued and unpaid dividends and current dividends on the Series C Preferred Stock and Series D Preferred Stock on February 15, 2007. KCS believes it will be eligible to use the shelf registration statements commencing May 1, 2007, provided KCS continues to pay dividends on its preferred stock, timely files all periodic reports required under the ~~new Term B Loan Facility due March 2008. Additionally,~~Exchange Act and otherwise meets the ~~2004 Credit Facility provides~~requirements for ~~the new 2004 Revolving Credit Facility, which expires in March 2007, with a maximum borrowing amount of $100 million. As of December 31, 2004, no amounts had been borrowed~~short-form registration under the 2004 Revolving Credit Facility. The 2004 Credit Facility contains, among other provisions, various financial covenants. We are in compliance with these provisions, including the financial covenants as of December 31, 2004. At December 31, 2004, KCS had available borrowing under the 2004 Revolving Credit Facility in the full amount of $100 million. As a result of these financial covenants, our borrowings under the 2004 Revolving Credit Facility may be restricted. We do anticipate borrowings from time to time under the 2004 Revolving Credit Facility during 2005. On December 22, 2004, we amended the 2004 Credit Facility to among other things, increase the Term B Loan Facility by $100.0 million to a total outstanding amount of approximately $249 million.Form S-3.

As described in “Recent Developments — KCS and TMM Enter into Amended Acquisition Agreement,” we entered into the Acquisition Agreement with TMM and other parties under which KCS ultimately would acquire control of TFM through the purchase of shares of common stock of Grupo TFM. Under the terms of the Acquisition Agreement, KCS would acquire all of the interest of TMM in Grupo TFM for $200.0 million in cash, 18 million shares of KCS common stock, and promissory notes in the aggregate principal amount of $47.0 million to be (held in an escrow account and reduced and released in accordance with the terms of an escrow agreement). In addition, pursuant to the Acquisition Agreement, upon successful

resolution related to the VAT Claim and the Mexican government’s Put, KCS would pay TMM up to $110.0 million payable in a combination of cash and KCS common stock. At December 31, 2004, KCS funded the restricted escrow account with $200.0. The $200.0 million was financed with cash on hand plus the additional $100.0 million borrowed under the Amended 2004 Credit Facility.

As discussed in “Recent Developments — Mexican Government’s Put Rights with Respect to TFM Stock,” TMM and KCS, or either TMM or KCS, could be required to purchase the Mexican government’s interest in TFM. If KCS and TMM, or either KCS or TMM individually had been required to purchase the Mexican government’s 20% interest in TFM, the total purchase price would have been approximately $468 million as of December 31, 2004. If the Acquisition is consummated, KCS will assume TMM’s rights, duties and obligations with respect to the purchase of the TFM shares subject to the Put. We are exploring various alternatives for financing this transaction. It is anticipated that this financing, if necessary, can be accomplished by using capital markets. No commitments for such financing have been obtained at this time.

We believe, based on current expectations, that our 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 2005. Also, if necessary, we believe that we will be able to obtain the necessary financing to fund the Acquisition and the purchase of the Mexican government’s 20% interest in TFM. Our operating cash flow and financing alternatives, however, can be impacted by various factors, some of which are outside of our control. For example, if we were to experience a substantial reduction in revenues or a substantial increase in operating costs or other liabilities, our operating cash flows could be significantly reduced. Additionally, we are subject to economic factors surrounding capital markets and our ability to obtain financing under reasonable terms is subject to market conditions. Further, our 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. During 2004, Moody’s downgraded our debt rating. This reduction in our debt rating did not have any impact on our interest rates or financial covenant ratios, but could adversely impact borrowing costs in the future. Standard and Poor’s currently has the Company on credit watch.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

~~KCS’s~~

KCS’ accounting and financial reporting policies are in conformity with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires ~~our~~ 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 believes that the following accounting policies and estimates are critical to an understanding of ~~KCS’s~~KCS’ historical and future performance. Management has discussed the development and selection of the following critical accounting estimates with the Audit Committee of ~~KCS’s~~KCS’ Board of Directors and the Audit Committee has reviewed the ~~related disclosures.~~selection, application and disclosure of the Company’s critical accounting policies and estimates.

Depreciation of Property ~~Plant~~ and ~~Equipment~~Equipment.

The railroad industry is extremely capital intensive. ~~Plant maintenance~~Maintenance and the depreciation of operating assets constitute a substantial operating expense for KCS, as well as the railroad industry as a whole. ~~We capitalize~~The Company capitalizes costs relating to additions and replacements of property ~~plant~~ and equipment, including certain overhead costs representing the indirect costs associated with construction and ~~depreciate it~~improvement projects. Overhead factors are periodically reviewed and adjusted to reflect current costs using the full absorption method. All of these costs are depreciated using the group method 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~~group straight-line rates for financial statement purposes. The STB approves the depreciation rates used by KCSR (excluding the amortization of computer software). but not for KCSM. Both KCSR and KCSM periodically ~~conducts~~conduct 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 judgment. Accordingly, management believes that accounting estimates related to depreciation expense are critical.

For the year ended December 31, 2004, changes were made to certain depreciation rates. As described above, depreciation is computed using group straight-line rates for financial statement purposes, which require approval of the STB. During the year ended December 31, 2003, the registrant engaged a civil engineering firm with expertise in railway property usage to conduct a study to evaluate depreciation rates for properties

Currently, KCSR and equipment. The study centered on evaluating actual historical replacement patterns to assess future lives and indicated that KCS was depreciating its property over shorter periods than we actually utilize the assets, as estimated by the study. Specifically, the average rate applied to the Road and Structures Asset class (primarily rail, railroad ties and bridges — with a depreciable cost of approximately $1.5 billion) decreased approximately 0.7%, while the average rate applied to the Rolling Stock and Equipment Asset class (locomotives and railcars with a depreciable cost of approximately $263.5 million) decreased approximately 0.5%. The effect of this change in estimate on net income was approximately $8.0 million, net of tax of $5.0 million ($0.12 per share, on a diluted basis), for the year ended December 31, 2004.

~~Currently, KCS depreciates its~~KCSM depreciate operating assets, including road and structures, rolling stock and equipment, and capitalized leases generally over a range of 3 to ~~120~~50 years depending upon the estimated life of the particular asset. ~~KCS amortizes computer software over a range of 3 to 12 years depending upon the estimated useful life of the software.~~ In addition to the adjustment to rates as a result of the depreciation studies, certain other events could occur that would materially ~~effect~~affect the Company’s estimates and assumptions related to depreciation. Unforeseen changes in operations or technology could substantially alter ~~our~~management’s assumptions regarding ~~our~~KCS’ ability to realize the return of ~~our~~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 ~~our~~the 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 future studies indicate that assets have longer lives, the estimate of depreciation expense could decrease.

KCSR Depreciation Review. During the year ended December 31, 2006, KCSR engaged a civil engineering firm with expertise in railway property usage to conduct a study to evaluate depreciation rates for properties and equipment. The study centered on evaluating actual historical replacement patterns to assess future lives and indicated that KCSR was depreciating its property over shorter periods than the assets were actually used, as estimated by the study. The effect of this change in estimate was a $3.0 million decrease in depreciation expense for the year ended December 31, 2006.

KCSM Depreciation Review.For the year ended December 31, ~~2004, consolidated~~2005, KCSM adopted the group depreciation ~~expense (after implementation~~method for consistency with KCSR during 2005. Accordingly, changes were made to certain historical depreciation rates. Unlike KCSR, KCSM depreciation rates are not subject to the approval of the ~~new~~STB, accordingly, the changes to the depreciation rates ~~resulting from the 2003 study) was $53.5 million, representing 9.6% of consolidated operating expenses. For~~were applied in 2005. During the year ended December 31, ~~2003, consolidated~~2005, KCSM engaged a civil engineering firm with expertise in railway property usage to conduct an analysis of depreciation rates for properties and equipment. The analysis centered on evaluating actual historical replacement patterns to assess future lives and indicated that KCSM was depreciating its property over shorter periods than the assets were actually utilized. As a result, depreciation expense ~~(prior~~recorded in the fourth quarter of 2005 reflected an adjustment totaling $5.5 million, to ~~implementation~~reduce depreciation expense as recorded in the second and third quarters of 2005. Concession rights and related assets are amortized over the shorter of their remaining useful lives as determined by the KCSM depreciation review or the life of the new rates resulting from the 2002 study) was $64.3 million, representing 11.6% of consolidated operating expenses. Had the new depreciation rates been implemented in 2003, depreciation expense would have declined approximately $12.0 million or 18.7%.Concession.

Provision for Environmental ~~Remediation~~Remediation.

~~Our~~

As further described in Note 11 to the Consolidated Financial Statements in Item 8 of thisForm 10-K, the Company’s operations are subject to extensive federal, state and local environmental laws and regulations. The major environmental laws to which we are 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 risk of incurring environmental liability is inherentregulations in the ~~railroad industry. We own property that is, or has been, used for industrial purposes. Use of these properties may subject KCS to potentially material liabilities relating to the investigation~~U.S. and ~~cleanup of contaminants, claims alleging personal injury, or property damage as the result of exposures to, or release of, hazardous substances.~~

Mexico. KCS conducts studies, as well as site surveys, to determine the extent of environmental damage and 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. Our recorded liabilities for these issues represent our best estimates (on an undiscounted basis) of remediation and restoration costs that may be required to comply with present laws and regulations.derived. These cost estimates are based on forecasts of the total future direct costs related to environmental ~~remediation. These estimates~~remediation and change periodically as additional or better information becomes available as to the extent of site remediation required, if any. ~~In addition,~~KCS accrues for the cost of remediation where the obligation is probable and such costs can be reasonably estimated.

Cost estimates can be influenced by advanced technologies related to the detection, appropriate remedial course of action and anticipated ~~cost can influence these estimates.~~cost. Certain changes could occur that would materially affect ~~our~~management’s estimates and assumptions related to costs for environmental remediation. If KCS becomes subject to more stringent environmental remediation costs at known sites, ~~if we discover~~discovers additional contamination, ~~discover~~discovers previously unknown sites, or ~~become~~becomes subject to related personal or property damage, KCS could incur ~~material~~additional costs that could be significant in connection with its environmental remediation. Accordingly,

management believes that estimates related to the accrual of environmental remediation liabilities are critical to ~~our~~KCS’ results of operations.

~~For~~

Environmental remediation expense was $3.1 million for the year ended December 31, ~~2004, the expense related to environmental remediation~~2006, and was ~~$2.3 million and is~~ included asin purchased services expense on the consolidated statements of income. Additionally, as of December 31, ~~2004,~~2006, KCS ~~has~~had a ~~total~~ liability ~~recorded~~ for environmental remediation of ~~$3.4~~$7.8 million. This amount was derived from a range of reasonable estimates based upon the studies and site surveys described above and in accordance with SFAS 5. For environmental remediation sites known as of December 31, 2004, if the highest estimate from the range (based upon information presently available) were recorded, the total estimated liability would have increased approximately $3.9 million.

Provision for Casualty ~~Claims~~Claims.

Due to the nature of railroad operations, claims related to personal injuries and third party liabilities resulting from crossing collisions and derailments, as well as claims related to personal property damage and other casualties, is a substantial expense to KCS. 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, ~~our~~the estimated liability for these casualty expenses is actuarially determined on an undiscounted basis. In estimating the liability for casualty claims, ~~we obtain~~KCS obtains an estimate from an independent third party actuarial firm, which calculates an estimate using historical experience and estimates of claim costs as well as numerous assumptions regarding factors relevant to the derivation of an estimate of future claim costs. ~~Employees are compensated for work related personal injury claims according to provisions contained within the Federal Employers’ Liability Act (“FELA”).~~

Our accounting policy has been to accrue for occupational injury claims that have been asserted against KCS, based upon management’s estimate of the cost of each case. In the case of occupational injury claims, specifically asbestos related claims, incurred but not yet reported, management believes that a provision for such claims cannot be reasonably estimated as required by Statement of Financial Accounting Standard Number 5~~“Accounting for Contingencies.”~~(“SFAS 5”). This is due to our low number of claims, the lack of detailed records of the population of potentially exposed employees, and the wide range of possible outcomes of such claims. Management believes that any type of estimate of the potential liability for asbestos related claims not yet reported would not be significant to the Company’s financial condition or results of operations.

Personal injury and casualty claims are subject to a significant degree of uncertainty, especially estimates related to ~~IBNR~~incurred but not reported personal injuries for which 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. In estimating costs related to casualty claims, management must make assumptions regarding future costs. The cost of casualty claims is related to numerous factors, including the severity of the injury, the age of the claimant, and the legal jurisdiction.claim. In deriving an estimate of the provision for casualty claims, management must make assumptions related to substantially uncertain ~~matters.~~matters (injury severity, claimant age and legal jurisdiction). Changes in the assumptions used for actuarial studies could have a material effect on the estimate of the provision for casualty claims. Management believes that the accounting estimate related to the liability for personal injuries and other casualty claims is critical to ~~our~~KCS’ results of operations. See also Note 11 to the Consolidated Financial Statements in Item 8 of thisForm 10-K.

For the year ended December 31, ~~2004,~~2006, casualty expense ~~was approximately $17.7~~equaled $33.8 million and was included in casualties and insurance expense in the consolidated statements of income. Based on the methods described above and information available as of December 31, ~~2004, a range of liability of $52.8 to $57.4 million was established. Based on~~2006, the ~~information available, our recorded~~ liability for casualty claims was ~~$52.8~~$114.4 million. ~~For the year ended December 31, 2004, the provision for casualty expense represented 3.2% of consolidated operating expenses.~~ For purposes of earnings sensitivity analysis, if the December 31, ~~2004~~2006 reserve were adjusted (increased or decreased) by 10%, casualty expense would ~~have changed $5.3~~change $11.4 million.

Provision for Income ~~Taxes~~Taxes.

Deferred income taxes represent a substantial liability of KCS. For financial reporting purposes, management determines ~~our~~the current tax liability, as well as deferred tax assets and ~~liabilities. In~~liabilities, 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,~~Taxes.”~~the~~ The provision for income taxes is the sum of income taxes both currently payable and deferred into the future. Currently payable income taxes represent the liability related to ~~KCS’s~~KCS’ U.S., state and Mexican income tax ~~return~~returns for the current year and anticipated tax payments resulting from income tax audits 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 using the enacted tax rates that management estimates will be in effect when these differences reverse. In addition, the tax provision for Mexico is further complicated by the impacts of inflation as well as the exchange rate, both of which can have a significant impact on the calculation. 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 KCS. Accordingly, management believes that the ~~estimate~~estimates related to the provision for income taxes is critical to ~~our~~the Company’s results of operations.

For the years ended December 31, 2004, 2003, and 2002, 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 our 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 our income tax provision. Additionally, significant declines in taxable operating income could materially impact the realizable value of deferred tax assets.

As of December 31, 2004, our financial reporting basis exceeded the tax basis of our investment in Grupo TFM by approximately $90 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 because management considers Grupo TFM to be a foreign corporate investment and anticipates that Grupo TFM’s earnings will be permanently invested in Grupo TFM. Likewise, management 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, 2004, the Company could incur additional gross federal income taxes of approximately $31.3 million, which may be partially or fully offset by Mexican income taxes that could be available to reduce U.S. federal income taxes.

For the year ended December 31, 2004, KCS’s income tax provision was $23.6 million. Changes in management’s estimates 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 10% change in the effective tax rate from 49.1% (exclusive of the equity in earnings of Grupo TFM — see “Results of Operations — Income Tax Provision (Benefit)”) to 59.1% would increase the current year income tax provision approximately $5 million.

~~Equity in Net Earnings of Grupo TFM~~Other.

Equity in the earnings of unconsolidated affiliates is a significant component of KCS’s net income. For financial reporting purposes, we record equity in the net earnings of our 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 our 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 KCS 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 our results of operations.

Effective January 1, 2002, Mexico implemented changes in its income tax laws that had an impact on KCS’s equity in Grupo TFM’s earnings reported under the equity method of accounting. Beginning in 2003, the Mexican legislature revised the corporate income tax rate reducing it from 35% to 32% in one-percent increments. Implementation of these lower corporate income tax rates was accelerated in 2004 through further legislation reducing the corporate tax rate from 33% in 2004 to 30% in 2005, with further reductions in 2006 and 2007 through one-percent increments. Reflecting this change in tax rates, combined with inflation and currency impacts, management’s assumptions and estimates related to the value of Grupo TFM’s deferred tax asset and deferred profit sharing as of December 31, 2004 was approximately $253 million. The provision for income taxes and the value of Grupo TFM’s net deferred tax assets could be further 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 of Grupo TFM.

~~OTHER~~

~~Management Control System.~~ On July 14, 2002, KCSR initiated the transition from its legacy operating system to a platform called MCS (Management Control System). 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 can be promptly initiated.

During the second half of 2002, KCS’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 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 2002 consolidated operating income. By mid-November 2002, however, our 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 the end of 2002. Operating statistics, such as terminal dwell time, train velocity and cars on-line, significantly improved during 2003 continuing through 2004, confirming this recovery. See “Results of Operations” for further information.

Derivative Instruments. KCS does not engage in the trading of derivatives. ~~Our~~Management’s objective for using derivative instruments is to manage ~~our~~ fuel and ~~interest rate~~currency risk to mitigate the impact of ~~fluctuations in fuel prices, and interest rates. We account~~their fluctuations. KCS accounts for derivative transactions under Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities” as amended, as set forth in Note 2 to the Consolidated Financial Statements in Item 8 of thisForm 10-K.

In general, ~~we enter~~the Company enters into derivative transactions in limited situations based on management’s assessment of current market conditions and perceived risks. Management intends to respond to evolving business and market conditions in order to manage risks and exposures associated with ~~our~~ various operations, and in so doing, may enter into such transactions more frequently as deemed appropriate.

Fuel Derivative Transactions. Fuel expense is a significant component of ~~our~~ operating expenses. Fuel costs are affected by (i) traffic levels, (ii) efficiency of operations and equipment, and (iii) fuel market conditions. ~~To stabilize the price for future fuel purchases and protect our operating results against adverse fuel price fluctuations, from time to time, KCSR~~KCS enters into transactions, such as forward purchase commitments and commodity swap ~~transactions.~~transactions from time to time, to stabilize the price for future fuel purchases and protect operating results against adverse fuel price fluctuations. These derivative instruments hedge against fluctuations in the price of No. 2 Gulf Coast Heating Oil, the commodity on which ~~KCSR’s~~the Company’s diesel fuel prices are ~~determined. Using these~~based. The use of certain risk management strategies ~~we are able~~enables risk to ~~reduce our risk~~be reduced related to rising diesel fuel prices. ~~These derivative transactions are correlated~~On December 31, 2006, KCS was party to ~~market benchmarks~~fuel swap agreements for 1.3 million gallons of fuel.

Foreign Exchange Matters. KCSM uses the dollar as its functional currency. Earnings from KCSM included in results of operations reflect any transaction gains and ~~positions are monitored to ensure~~losses that ~~they will not exceed actual fuel requirements in any period. See Item 7A and Note 10~~KCSM records in the ~~Notes~~process of translating certain transactions from pesos to ~~KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K.~~

~~Foreign Exchange Matters.~~ In connection with our 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. KCS follows the requirements outlined in Statement of Financial Accounting Standards No. 52 “Foreign Currency Translation” ~~(“SFAS 52”)~~, and related authoritative guidance. Grupo TFM uses the U.S. dollar as its functional currency. Equity earnings (losses) from Grupo TFM included in our results of operations reflect our 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 our investment in Grupo TFM are reported under U.S. GAAP, while Grupo TFM reports its financial results under IFRS. Because we are required to report our equity earnings (losses) in Grupo TFM under U.S. GAAP and Grupo TFM reports under IFRS, differences in deferred income tax calculations and the classification of certain operating expense categories occur.

~~We continue~~The Company continues to evaluate existing alternatives with respect to utilizing foreign currency instruments to hedge ~~our U.S.~~the dollar investment in ~~Grupo TFM~~KCSM as market conditions change or exchange rates fluctuate. ~~At each~~As of December 31, ~~2004 and 2003, we had no~~2006, KCSM did not have any outstanding ~~foreign currency hedging instruments.~~forward contracts.

Litigation. The Company is a party to various legal proceedings and administrative actions, all of which are of an ordinary, routine nature and incidental to its operations. Included in these proceedings are various tort claims brought by current and former employees for job related injuries and by third parties for injuries related to railroad operations. WeKCS aggressively ~~defend~~defends these matters and ~~have~~has established liability reserves ~~which~~that management believes are adequate to cover expected costs. Although it is not possible to predict the outcome of any legal proceeding, in the opinion of the Company’s management, other than those proceedings described in detail below, such proceedings and actions should not, individually, or in the aggregate, have a material adverse effect on the Company’s financial condition.

~~Stilwell Tax Dispute.~~Reinsurance Litigation. ~~On October 15, 2004, KCS and Janus Capital Group Inc.~~As the Company has previously reported, insurance companies who provided insurance to the Company filed an action in federal court in Vermont (“~~Janus”~~the Reinsurance Litigation”) seeking a declaration that they have no obligation to indemnify the Company concerning a particular casualty claim. That claim,Kemp, et al v. The Kansas City Southern Railway Company, et al, ~~formerly Stilwell Financial Inc.~~in the Circuit Court of Jackson County, Missouri (“~~Stilwell”~~the Kemp Litigation”)~~, finalized~~ went to trial in September 2006. The Company reached a settlement ~~agreement (“Release”), effecting~~with the plaintiffs in the Kemp Litigation. The Company has also reached settlements with various parties, including several of the insurance companies involved in the Reinsurance Litigation, to indemnify the Company for a significant portion of the settlement. The Kemp settlement ~~of all disputes which arose on or before August 13, 2004 relating~~is fully reflected in the Company’s 2006 financial statements and the Company has no further risk associated with this litigation. The Company is however continuing the Reinsurance Litigation against certain other insurance companies, seeking to establish their obligation to indemnify the ~~spin-off of Stilwell from KCS on July 12, 2000 (the “Spin-off”). As part~~Company for their share of the settlement ~~all arbitration claims filed by the parties~~ with ~~the American Arbitration Association were dismissed. This claim involved the entitlement~~Kemp.

Recent Accounting Pronouncements. Refer to compensation expense deductions for federal income tax purposes, associated with the exercise of certain stock options issued by Stilwell (the “Substituted Options”) in connection with the Spin-off. PriorNote 2 to the settlement, amounts related to the tax benefits of exercises of the Substituted Options were recorded as a noncurrent liability in the consolidated financial statements pending resolution of this dispute. As a result of this settlement, the Company reclassified approximately $27.1 million in tax benefits from previous exercises of the Substituted Options to additional paid in capital on the balance sheet. As previously disclosed, the settlement had no adverse consequences to the Company.

~~Environmental Matters.~~ ~~As discussed above in “Critical Accounting Policies and Estimates,” our operations, as well as those of our 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. We do not foresee that compliance with the requirements imposed by the current environmental legislation will impair our 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. Our operations involve the use and, as part of serving the petroleum and chemicals industry, transportation of hazardous materials. KCSR has a professional team available to respond and handle environmental issues that might occur in the transport of such materials. KCSR also is a partner in the Responsible Care® program and, as a result, has initiated certain additional environmental, health and safety practices. KCSR performs ongoing review and evaluation of the various environmental programs and issues within it’s operations, and, as necessary, takes actions to limit it’s exposure to environmental liabilities.

Although we are responsible for investigating and remediating contamination at several locations, based on currently available information, we do not expect any related liabilities, individually or collectively, to have a material impact on our results of operations, financial position or cash flows. In the event that we do become subject to more stringent cleanup requirements at these sites, discover additional contamination, or become subject to related personal or property damage claims, we 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 to 1974 and leased to a small 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 completed a Record of Decision of the site. Management is in the process of negotiating a settlement with respect to this site and continues to evaluate its potential financial statement impact. Management has recorded its best estimate of potential liability of$1.7 million as of December 31, 2004 related to 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.

KCS records liabilities for remediation and restoration costs related to past activities when our obligation is probable and the costs can be reasonably estimated. Costs of ongoing compliance activities to current operations are expensed as incurred. Our recorded liabilities with respect to these various environmental issues represent our 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 our consolidated results of operations, financial condition or cash flows.

~~Recent Accounting Pronouncements~~~~See Note 2 in the Notes to KCS’s~~ Consolidated Financial Statements in Item 8 of thisForm 10-K for information relative to recent accounting pronouncements.

~~Regulatory Influence.~~ In addition to the environmental agencies mentioned above, KCSR’s 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. We do not foresee that regulatory compliance under present statutes will impair our competitive capability or result in any material effect on our results of operations, financial condition or cash flows.

~~Inflation.~~ U.S. GAAP requires the use of historical costs. Replacement cost and related depreciation expense of KCS’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 our principal subsidiaries.

Higher fuel prices have impacted KCSR’s operating results in 2004, 2003 and 2002. During the year ended December 31, locomotive fuel expenses as a percentage of KCSR’s total costs and expenses were 12.6%, in 2004, compared to 9.2% in 2003 and 7.7% in 2002. See also “Foreign Exchange Matters” above with respect to inflation in Mexico.

~~Significant Customer.~~ Our largest coal customer accounted for approximately 56.1% of our coal revenues and approximately 8.1% of our total revenues for the year ended December 31, 2004. The loss of all or a significant part of this business, or a service outage at one the facilities that KCSR serves, could materially adversely affect our financial condition, results of operations and cash flows.

~~CAUTIONARY INFORMATION~~Cautionary Information.

The discussions set forth in this Annual Report onForm 10-K may contain ~~statements concerning potential future events. Such~~ forward-looking statements ~~are based upon assumptions by KCS’s management, as~~within the meaning of Section 27A of the ~~date~~Securities Act of ~~this Annual Report, including assumptions about risks~~1933, as amended and ~~uncertainties faced by KCS.~~Section 21E of the Securities Exchange Act of 1934, as amended. In addition, management may make forward-looking statements orally or in other writings, including, but not limited to, in press releases, in the annual report to ~~shareholders~~stockholders and in ~~KCS’s~~ other filings with the Securities and Exchange Commission. Readers can identify these forward-looking statements by the use of such verbs as ~~expects, anticipates, believes~~“expects,” “anticipates,” “believes” or similar verbs or conjugations of such verbs. These statements involve a number of risks and uncertainties. Actual results could materially differ from those anticipated by such forward-looking statements. Such differences could be caused by a number of factors or combination of factors including, but not limited to, the factors identified below and ~~the factors~~those discussed ~~above~~ under ~~the heading~~Item 1A of thisForm 10-K, “Risk Factors.” Readers are strongly encouraged to consider these factors and the following factors when evaluating any forward-looking statements concerning ~~KCS.~~the Company:


	•	~~whether we are fully successful~~fluctuations in executing our business strategy, including capitalizing on NAFTA trade to generate traffic and increase revenues, exploiting our domestic opportunities, establishing new and expanding existing strategic alliances and marketing agreements and providing superior customer service;the market price for the Company’s common stock;

	•	~~whether KCS is successful in retaining~~KCS’ dividend policy and ~~attracting qualified management personnel;~~restrictions on its ability to pay dividends on its common stock;

	•	~~whether KCS is able to generate cash that will be sufficient to allow us to pay principal and interest on our debt and meet our obligations and to fund our other liquidity needs;~~KCS’ high degree of leverage;

	•	~~whether we are able~~The Company’s potential need for and ability to ~~complete the Acquisition;~~obtain additional financing;

	•	~~our~~KCS’ ability to ~~satisfy our contingent obligation~~successfully implement its business strategy, including the strategy to ~~purchase shares~~convert customers from using trucking services to rail transportation services;

	•	the impact of ~~TFM, owned by~~competition, including competition from other rail carriers and trucking companies in the ~~government of~~United States and Mexico;

	•	~~material adverse changes in~~United States, Mexican and global economic, political and ~~industry conditions, both within~~social conditions;

	•	The effects of the North American Free Trade Agreement, or NAFTA, on the level of trade among the United States, Mexico and ~~globally;~~Canada;

	•	uncertainties regarding the litigation KCS faces and any future claims and litigation;

	•	the effects of employee training, technological improvements and capital expenditures on labor productivity, operating efficiencies and service reliability;

	•	changes in legal or regulatory requirements in the United States, Mexico or Canada;

	•	KCS’ ability to generate sufficient cash to pay principal and interest on its debt, meet its obligations and fund its other liquidity needs;

	•	the effects of adverse general economic conditions affecting customer demand and the industries and geographic areas that produce and consume the commodities ~~carried;~~KCS carries;

	•	~~industry competition, conditions, performance and consolidation;~~

	•	~~general legislative and regulatory developments, including possible enactment of initiatives to re-regulate the rail industry;~~

	•	legislative, regulatory, or legal developments involving taxation, including enactment of new federal or state income tax rates, revisions of controlling authority, and the outcome of tax claims and litigation;

	•	material adverse changes in ~~securities~~economic and ~~capital markets;~~industry conditions, both within the United States and Mexico and globally;

	•	natural events such as severe weather, fire, floods, hurricanes, earthquakes or other disruptions of ~~our~~the Company’s operating systems, structures and ~~equipment;~~equipment or the ability of customers to produce or deliver their products;

	•	~~any adverse economic~~changes in fuel prices;

	•	KCS’ ability to attract and retain qualified management personnel;

	•	changes in labor costs and labor difficulties, including work stoppages affecting either operations or ~~operational repercussions~~customers” abilities to deliver goods for shipment;


	•	the outcome of claims and litigation, including those related to environmental contamination, personal injuries, and occupational illnesses arising from hearing loss, repetitive motion and exposure to asbestos and diesel fumes;

	•	acts of terrorism or risk of terrorist ~~activities and any governmental response thereto;~~activities;

	•	war or risk of war;

	•	~~changes~~political and economic conditions in ~~fuel prices;~~


	•	~~changes in labor costs~~Mexico; and ~~labor difficulties, including stoppages affecting either our operations or our customers’ abilities to deliver goods to it for shipment;~~the level of trade between the United States and Mexico;

	•	legislative, regulatory, or legal developments involving taxation, including enactment of new foreign, federal or state income or other tax rates, revisions of controlling authority, and the outcome of tax claims and ~~litigation, including those related to environmental contamination, personal injuries and occupational illness from hearing loss, repetitive motion and exposure to asbestos and diesel fumes.~~litigation.

~~We caution against placing undue reliance on forward-looking~~

Forward-looking statements ~~which reflect our current beliefs and are based on information currently available to us~~speak only as of the date ~~a forward-looking statement is~~on which they are made. ~~We undertake no obligation to revise~~The Company will not update any forward-looking statements to reflect future events, ~~changes in circumstances,~~developments, or ~~changes in beliefs. In the event we do~~other information. If KCS does update ~~any~~one or more forward-looking ~~statement,~~statements, no inference should be ~~made~~drawn that ~~we will make~~ additional updates ~~with respect to~~will be made regarding that statement ~~related matters,~~ or any other forward-looking statements. ~~Any corrections or revisions may appear in our public filings with the Securities and Exchange Commission, which are accessible atwww.sec.gov, and on our website atwww.kcsi.com~~ ~~and which investors are advised to consult.~~


Item 7A.	*Quantitative and Qualitative Disclosures ~~About~~Concerning Market Risk*

KCS utilizes various financial instruments that have certain inherent market ~~risks. Generally,~~risks, but 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” ~~in this Form 10-K~~ and Note ~~10 of~~12 to the ~~Notes to~~ Consolidated Financial Statements in Item 8 of thisForm 10-K, ~~which are hereby incorporated by reference,~~ describe the key aspects of certain financial instruments that have market risk to KCS.

Interest Rate ~~Sensitivity~~

~~Our floating-rate~~Sensitivity. Floating-rate indebtedness totaled ~~$249.2~~$381.6 million and ~~$98.5~~$440.9 million at December 31, ~~2004~~2006 and ~~2003,~~2005, respectively. ~~Our variable rate debt,~~Two credit agreements, each comprised of a revolving credit facility and a term loan facility, contain variable rate debt which accrues interest based on target interest indexes ~~(e.g., London~~(London Interbank Offered Rate — ~~“LIBOR,” federal funds rate, etc.)~~“LIBOR” or an alternative base rate) plus an applicable spread, as set forth in ~~the~~each credit agreement. ~~As a result of the 2002 refinancing of $200 million of variable rate debt with the 7~~¹/2~~% Notes, we have been able to reduce our sensitivity to fluctuations in interest rates compared to previous years. However, given~~Given the balance of ~~$249.2~~$381.6 million of variable rate debt at December 31, ~~2004, we are still~~2006, KCS is 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 $2.5~~$3.8 million on an annualized basis for the floating-rate instruments ~~held~~issued by ~~KCS~~the Company as of December 31, ~~2004.~~2006.

Based upon the borrowing rates available to KCS and its subsidiaries for indebtedness with similar terms and average maturities, the fair value of ~~our~~the long-term debt was approximately ~~$704~~$1,814.1 million at December 31, ~~2004~~2006, and ~~$558~~$1,938.6 million at December 31, ~~2003.~~2005.

Commodity Price ~~Sensitivity~~

Sensitivity. As described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other — Derivative Instruments” of thisForm 10-K, KCS periodically participates in diesel fuel purchase commitment and swap transactions. At December 31, ~~2004,~~2006, KCS was a party to ~~one~~ fuel swap ~~agreement. Based on market prices at~~agreements for 1.3 million gallons. Subsequent to December 31, ~~2004, we would receive payments from the third party counterparty of approximately $1.1~~2006, KCS entered into fuel swap agreements for another 1.3 million on the settlement date of the agreement, representing the excess of the current market price over the agreed upon swap price. If market prices of fuel dropped below the swap price, then KCS would be obligated to pay an amount equal to the difference between the market price and the swap price for each gallon of fuel hedged. At December 31, 2003, based on market prices in effect at that time, we would have received payments from the third party counterparty of approximately $0.9 million on the settlement date of the agreement, representing the excess of the current market prices over the agreed upon swap price. A hypothetical 10% increase in the price of diesel fuel would have resulted in additional fuel expense of approximately $6.6 million for the year ended December 31, 2004.

~~At December 31, 2004, we held~~gallons. The Company also holds fuel inventories for use in operations. These inventories ~~were~~are not material to ~~our~~KCS’ overall financial position. With the exception of the ~~4% of~~ fuel currently hedged under fuel swap transactions for ~~2005,~~2007, fuel costs are expected to mirror market conditions in ~~2005.~~2007. KCS also cushions the impact of increased fuel costs through fuel surcharge revenues from customers. Assuming annual consumption of 145 million gallons, a $0.10 change in the price per gallon of fuel would cause a $14.5 million change in operating expenses.

Foreign Exchange ~~Sensitivity~~

We own a 46.6% interest in Grupo TFM, incorporated in Mexico. In connection with our 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. Grupo TFMSensitivity. KCSM uses the ~~U.S.~~ dollar as its functional currency. ~~Equity earnings (losses)~~Earnings from ~~Grupo TFM~~KCSM included in ~~our~~the Company’s results of operations reflect ~~our share of any such translation~~revaluation gains and losses that ~~Grupo TFM~~KCSM records in the process of translating certain transactions from ~~Mexican~~ pesos to ~~U.S.~~ dollars. Therefore, ~~we have~~the Company has exposure to fluctuations in the value of the ~~Mexican~~ peso. While not currently utilizing foreign currency instruments to hedge ~~our U.S.~~ KCS’

dollar investment in ~~Grupo TFM, we continue to evaluate~~KCSM, existing alternatives are evaluated as market conditions and exchange rates fluctuate. For example, a hypothetical 10% increase in the US dollar to the Mexican peso exchange rate on net monetary assets of Ps.1,652.6 million would result in a translation loss of approximately $13.9 million and a 10% decrease in the exchange rate would result in a translation gain of approximately $17.0 million.

Inflation. U.S. generally accepted accounting principles require the use of historical cost, which does not reflect the effects of inflation on the replacement cost of property. Due to the capital intensive nature of KCS’ business, the replacement cost of these assets would be substantially greater than the amounts reported under the historical cost basis.

~~[This page intentionally left blank]~~


Item 8.	*Financial Statements and Supplementary Data*

Index to Financial Statements


		Page

Management’s Report on Internal Control Over Financial Reporting			56
Report of Independent Registered Public Accounting Firm			57
~~Financial Statements:~~
	Report of Independent Registered Public Accounting Firm			5958
	Consolidated Statements of Income for the ~~three years~~Three Years ended December 31, ~~2004~~2006			6059
	Consolidated Balance Sheets at December 31, ~~2004~~2006 and ~~2003~~2005			6160
	Consolidated Statements of Cash Flows for the ~~three years~~Three Years ended December 31, ~~2004~~2006			6261
	Consolidated Statements of Changes in Stockholders’ Equity for the ~~three years~~Three Years ended December 31, ~~2004~~2006			6362
	Notes to Consolidated Financial Statements			6463
Financial Statement Schedules:

~~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~~KCSM as of December 31, 2005 (successor) and 2004 (predecessor) for the nine months ended December 31, 2005 (successor), the three months ended March 31, 2005 (predecessor) and ~~2003 and for each of~~ the ~~years in the three-year period~~year ended December 31, 2004 (predecessor) are ~~attached~~incorporated by reference into this annual report.

Introductory Comments

The following Consolidated Financial Statements have been prepared by Kansas City Southern, pursuant to ~~this Form 10-K~~the rules and regulations of the Securities and Exchange Commission (“SEC”). Beginning with the year ended December 31, 2005, these financial statements include the results of operations and cash flows of Mexrail and Grupo KCSM, which were consolidated on January 1, 2005, and April 1, 2005, respectively, as ~~Exhibit 99.1.~~a result of the acquisition of a controlling interest in each entity as of these respective dates. Results for the years ended December 31, 2006 and 2005 are not indicative of the expected results for future periods.

Management’s Report on Internal Control ~~Over~~over Financial Reporting

The management of Kansas City Southern ~~(“KCS” or “the Company”)~~ is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange ActRules 13a-15(f) and15d-15(f). ~~KCS’s~~ KCS’ internal control ~~system~~over financial reporting was designed to provide reasonable assurance to the Company’s management and ~~board~~Board of ~~directors~~Directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Under the supervision and participation of the Company’s Chief Executive Officer and Chief Financial Officer, ~~KCS~~ management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, ~~2004~~2006, based on the framework established by the Committee of Sponsoring Organizations of the Treadway Commission inInternal Control — Integrated Framework~~(“COSO”)~~(commonly referred to as the COSO framework). Based on its evaluation, ~~KCS~~ management concluded that the Company’s internal control over financial reporting was effective as of December 31, ~~2004~~2006, based on the criteria outlined in the COSO framework.

~~KCS management’s~~

Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, ~~2004~~2006, has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their attestation report, which ~~is included herein on page 57.~~immediately follows this report.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of

Kansas City Southern:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control ~~Over~~over Financial Reporting, that Kansas City Southern and subsidiaries (the ~~“Company”)~~Company) maintained effective internal control over financial reporting as of December 31, ~~2004,~~2006, based on criteria established in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). ~~Kansas City Southern’s~~The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, ~~2004,~~2006, is fairly stated, in all material respects, based on criteria established in ~~Internal~~“Internal Control — Integrated ~~Framework~~Framework” issued by COSO. Also, in our opinion, ~~the Company~~Kansas City Southern maintained, in all material respects, effective internal control over financial reporting as of December 31, ~~2004,~~2006, based on criteria established in ~~Internal~~“Internal Control — Integrated ~~Framework~~Framework” issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of ~~Kansas City Southern and subsidiaries~~the Company as of December 31, ~~2004~~2006 and ~~2003,~~2005, and the related consolidated statements of income, ~~changes in~~ stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, ~~2004,~~2006, and our report dated ~~March 29, 2005,~~February 26, 2007 expressed an unqualified opinion on those consolidated financial statements. The financial statements of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (Grupo TFM), a 46.6% owned investee company, as of and for the years ended December 31, 2004 and 2003 were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Grupo TFM as of and for the years ended December 31, 2004 and 2003, is based solely on the reports of other auditors.


	~~/s/KPMG LLP~~

KPMG LLP

Kansas City, Missouri

~~March 29, 2005~~February 26, 2007

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of

Kansas City Southern:

We have audited the accompanying consolidated balance sheets of Kansas City Southern and subsidiaries ~~(the “Company”)~~ as of December 31, ~~2004~~2006 and ~~2003,~~2005, and the related consolidated statements of income, ~~changes in~~ stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, ~~2004.~~2006. 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~~Transportación Ferroviaria Mexicana, S.A. de C.V. (Grupo ~~TFM)~~TFM and currently known as Grupo KCSM), a 46.6% owned investee company ~~as of December 31, 2004 and 2003 or~~ for the ~~years~~year ended December 31, ~~2004 and 2003.~~2004. The Company’s ~~investment in Grupo TFM at December 31, 2004 and 2003 was $389.6 million and $392.1 million, respectively, and its~~ equity in ~~earnings (loss)~~loss of Grupo TFM was ~~$(2.4) million and $12.3~~$2.4 million for ~~years~~the year ended December 31, ~~2004 and 2003, respectively.~~2004. The financial statements of Grupo TFM ~~as of and~~ for the ~~years~~year ended December 31, 2004 ~~and 2003~~ were audited by other auditors whose ~~reports have~~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 ~~years~~year ended December 31, 2004, ~~and 2003,~~ is based solely on the ~~reports~~report of other auditors.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards 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. 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 provide a reasonable basis for our opinion.

In our opinion, based on our audits, and the ~~reports~~report of other auditors for 2004, ~~and 2003,~~ 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, ~~2004~~2006 and ~~2003,~~2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, ~~2004,~~2006, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, effective January 1, ~~2003,~~2006, the Company adopted the fair value method of accounting for stock-based compensation as required by Statement of Financial Accounting Standards No. ~~143, “Accounting for Asset Retirement Obligations.~~123R, “Share Based Payment.”

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Kansas City ~~Southern’s~~Southern and subsidiaries internal control over financial reporting as of December 31, ~~2004,~~2006, based on criteria established in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated ~~March 29, 2005~~February 26, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.


	~~KPMG LLP~~

KPMG LLP

Kansas City, Missouri

~~March 29, 2005~~February 26, 2007

~~KANSAS CITY SOUTHERN~~Kansas City Southern

Consolidated Statements of Income

~~CONSOLIDATED STATEMENTS OF INCOME~~Years ended December 31

~~Years Ended December 31~~

2004 2003 2002

Dollars in millions, except share and
per share amounts
Revenues $ 639.5 $ 581.3 $ 566.2
Operating expenses
Compensation and benefits 213.0 197.8 197.8
Depreciation and amortization 53.5 64.3 61.4
Purchased services 62.3 63.5 59.6
Other leases 11.8 9.8 7.1
Casualties and insurance 42.4 56.4 25.2
Fuel 66.4 47.4 38.4
Equipment costs 50.4 57.4 67.6
Other 56.2 55.6 61.1

Total operating expenses 556.0 552.2 518.2

Operating income 83.5 29.1 48.0
Equity in net earnings (losses) of unconsolidated affiliates:
Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (2.4 ) 12.3 45.8
Other (2.1 ) (1.3 ) (2.4 )
Gain on sale of Mexrail, Inc. — — 4.4
Interest expense (44.4 ) (46.4 ) (45.0 )
Debt retirement costs (4.2 ) — (4.3 )
Other income 17.6 6.8 17.6

Income before income taxes and cumulative effect of accounting change 48.0 0.5 64.1
Income tax provision (benefit) (Note 6) 23.6 (2.8 ) 6.9

Income before cumulative effect of accounting change 24.4 3.3 57.2
Cumulative effect of accounting change, net of income taxes — 8.9 —

Net income $ 24.4 $ 12.2 $ 57.2
Preferred stock dividends 8.7 5.9 0.2

Net income available to common shareholders $ 15.7 $ 6.3 $ 57.0

Per Share Data

Basic earnings (loss) per common share
Basic earnings (loss) per share before cumulative effect of accounting change $ 0.25 $ (0.04 ) $ 0.94
Cumulative effect of accounting change, net of income taxes — 0.14 —

Total basic earnings per common share $ 0.25 $ 0.10 $ 0.94

Diluted earnings (loss) per common share
Diluted earnings (loss) per share before cumulative effect of accounting change $ 0.25 $ (0.04 ) $ 0.91
Cumulative effect of accounting change, net of income taxes — 0.14 —

Total diluted earnings per common share $ 0.25 $ 0.10 $ 0.91

Weighted average common shares outstanding (in thousands)
Basic 62,715 61,725 60,336
Potential dilutive common shares 1,268 — 1,982

Diluted 63,983 61,725 62,318


	2006			2005			2004
	In millions, except share
	and per share amounts

Revenues	$	1,659.7		$	1,352.0		$	639.5

Operating expenses:
Compensation and benefits		387.7			340.4			213.0
Depreciation and amortization		155.0			127.7			53.5
Purchased services		215.2			195.1			62.3
Casualties and insurance		53.4			103.4			42.4
Fuel		253.6			206.9			66.4
Equipment costs		179.7			149.8			50.4
KCSM employees’ statutory profit sharing		5.9			41.1			—
Other		104.9			125.3			68.0

Total operating expenses		1,355.4			1,289.7			556.0

Operating income		304.3			62.3			83.5
Equity in net earnings (losses) of unconsolidated affiliates		7.3			2.9			(4.5	)
Interest expense		(167.2	)		(133.5	)		(44.4	)
Debt retirement costs		(4.8	)		(4.4	)		(4.2	)
Foreign exchange gain (loss)		(3.7	)		3.5			—
VAT/Put settlement gain, net		—			131.9			—
Other income, net		18.7			13.3			17.6

Income before income taxes and minority interest		154.6			76.0			48.0
Income tax expense (benefit)		45.4			(7.1	)		23.6

Income before minority interest		109.2			83.1			24.4
Minority interest		0.3			(17.8	)		—

Net income		108.9			100.9			24.4
Preferred stock dividends		19.5			9.5			8.7

Net income available to common shareholders	$	89.4		$	91.4		$	15.7

Earnings per share:
Basic earnings per share	$	1.20		$	1.21		$	0.25

Diluted earnings per share	$	1.08		$	1.10		$	0.25

Average shares outstanding(in thousands):
Basic		74,593			75,527			62,715
Potential dilutive common shares		17,793			17,220			1,268

Diluted		92,386			92,747			63,983

See accompanying notes to consolidated financial statements.

~~KANSAS CITY SOUTHERN~~Kansas City Southern

Consolidated Balance Sheets

~~CONSOLIDATED BALANCE SHEETS~~December 31

~~at December 31~~

2004 2003

Dollars in millions,
except share and per
share amounts
ASSETS
Current Assets:
Cash and cash equivalents $ 38.6 $ 135.4
Accounts receivable, net (Note 4) 131.4 108.2
Accounts receivable from related parties 8.2 6.4
Inventories 48.2 36.8
Other current assets (Note 4) 27.2 21.3

Total current assets 253.6 308.1

Investments (Note 3) 484.9 442.7
Properties, net (Note 4) 1,424.0 1,362.5
Goodwill 10.6 10.6
Restricted funds — escrow account for Grupo TFM acquisition 200.0 —
Other assets 67.5 29.0

Total assets $ 2,440.6 $ 2,152.9

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Debt due within one year (Note 5) $ 9.9 $ 9.9
Accounts and wages payable 52.8 45.5
Payable to related parties 34.7 —
Accrued liabilities (Note 4) 148.4 119.4

Total current liabilities 245.8 174.8

Other Liabilities
Long-term debt (Note 5) 655.8 513.5
Deferred income taxes (Note 6) 430.9 391.5
Other noncurrent liabilities and deferred credits (Note 4) 83.6 109.4
Commitments and contingencies (Notes 3,5,6,7,8,9,10) — —

Total other liabilities 1,170.3 1,014.4

Stockholders’ Equity (Notes 2,7):
$25 par, 4% noncumulative, Preferred stock, 840,000 shares authorized, 649,736 shares issued, 242,170 shares outstanding at December 31, 2004 and 2003 6.1 6.1
$1 par, Cumulative Preferred stock, 400,000 shares authorized, issued and outstanding at December 31, 2004 and 2003 0.4 0.4
$.01 par, Common stock, 400,000,000 shares authorized; 73,369,116 shares issued; 63,270,204 and 62,175,621 shares outstanding at December 31, 2004 and 2003, respectively 0.6 0.6
Paid in capital 155.3 110.9
Retained earnings 861.9 846.2
Accumulated other comprehensive income (loss) 0.2 (0.5 )

Total stockholders’ equity 1,024.5 963.7

Total liabilities and stockholders’ equity $ 2,440.6 $ 2,152.9


	2006		2005
	In millions, except share amounts

ASSETS
Current assets:
Cash and cash equivalents	$	79.0	$	31.1
Accounts receivable, net (Note 2)		334.3		315.7
Restricted funds (Note 2)		26.5		—
Inventories		72.5		73.9
Other current assets (Note 5)		93.7		46.1

Total current assets		606.0		466.8
Investments (Note 3)		64.9		60.3
Property and equipment, net (Note 5)		2,452.2		2,298.3
Concession assets, net (Note 5)		1,303.3		1,360.4
Deferred tax asset (Note 7)		128.7		152.2
Other assets		82.2		85.6

Total assets	$	4,637.3	$	4,423.6


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Debt due within one year (Note 6)	$	41.9	$	38.0
Accounts and wages payable		189.9		124.3
Current liability related to Grupo KCSM acquisition (Note 6)		50.9		78.3
Accrued liabilities (Note 5)		354.7		333.1

Total current liabilities		637.4		573.7

Other liabilities
Long-term debt (Note 6)		1,631.8		1,663.9
Long-term liability related to Grupo KCSM acquisition (Note 6)		32.4		80.4
Deferred income taxes (Note 7)		417.3		409.2
Other noncurrent liabilities and deferred credits		235.7		270.2

Total other liabilities		2,317.2		2,423.7

Minority interest		100.3		—
Commitments and contingencies (Note 11)		—		—

Stockholders’ equity (Notes 2,8):
$25 par, 4% noncumulative, preferred stock, 840,000 shares authorized, 649,736 shares issued, 242,170 shares outstanding		6.1		6.1
Series C — redeemable cumulative convertible perpetual preferred stock, $1 par, 4.25%, 400,000 shares authorized, issued and outstanding		0.4		0.4
Series D — cumulative convertible perpetual preferred stock, $1 par, 5.125%, 210,000 shares authorized, issued and outstanding		0.2		0.2
$.01 par, common stock, 400,000,000 shares authorized; 92,863,585 and 91,369,116 shares issued at December 31, 2006 and 2005, respectively; 75,920,333 and 73,412,081 shares outstanding at December 31, 2006 and 2005, respectively		0.7		0.7
Paid in capital		523.0		473.1
Retained earnings		1,050.7		946.1
Accumulated other comprehensive income (loss)		1.3		(0.4	)

Total stockholders’ equity		1,582.4		1,426.2

Total liabilities and stockholders’ equity	$	4,637.3	$	4,423.6

See accompanying notes to consolidated financial statements.

~~KANSAS CITY SOUTHERN~~Kansas City Southern

Consolidated Statements of Cash Flows

~~CONSOLIDATED STATEMENTS OF CASH FLOWS~~Years ended December 31

~~Years Ended December 31~~

2004 2003 2002

Dollars in millions
CASH FLOWS PROVIDED BY (USED FOR):

OPERATING ACTIVITIES:

Net income $ 24.4 $ 12.2 $ 57.2
Adjustments to reconcile net income to net cash
Provided by operating activities
Depreciation and amortization 53.5 64.3 61.4
Deferred income taxes 35.9 1.6 21.8
Equity in undistributed earnings (losses) of unconsolidated affiliates 4.5 (11.0 ) (43.4 )
Distributions from unconsolidated affiliates 8.8 — —
Gain on sale of assets (3.8 ) (6.2 ) (20.1 )
Cumulative effect of accounting change — (8.9 ) —
Tax benefit realized upon exercise of stock options 9.5 2.5 4.5
Changes in working capital items
Accounts receivable (25.0 ) 4.0 12.4
Inventories (11.4 ) (2.5 ) (8.8 )
Other current assets (2.2 ) 15.3 29.8
Accounts and wages payable 10.2 (2.4 ) (3.1 )
Accrued liabilities 29.7 (8.1 ) (21.8 )
Other, net 8.6 7.2 3.9

Net 142.7 68.0 93.8

INVESTING ACTIVITIES:

Property acquisitions (117.2 ) (84.0 ) (77.9 )
Proceeds from disposal of property 4.9 15.0 18.1
Funding of restricted escrow account (200.0 ) — —
Investment in and loans to affiliates (55.0 ) (40.4 ) (4.4 )
Proceeds from sale of investments, net 0.5 32.7 31.7
Deferred costs related to acquisition of Grupo TFM (9.5 ) (9.3 ) —
Other, net (0.5 ) — (0.5 )

Net (376.8 ) (86.0 ) (33.0 )

FINANCING ACTIVITIES:

Proceeds from issuance of long-term debt 250.0 — 200.0
Repayment of long-term debt (107.6 ) (59.2 ) (270.9 )
Net proceeds from issuance of preferred stock — 193.0 —
Debt issuance costs (3.8 ) — (5.7 )
Proceeds from stock plans 7.4 5.3 10.3
Cash dividends paid (8.7 ) (4.7 ) (0.2 )

Net 137.3 134.4 (66.5 )

CASH AND CASH EQUIVALENTS:

Net increase (decrease) in cash and cash equivalents (96.8 ) 116.4 (5.7 )
At beginning of year 135.4 19.0 24.7

At end of period $ 38.6 $ 135.4 $ 19.0

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Cash payments (refunds)

Interest $ 42.1 $ 42.4 $ 45.5
Income tax payments (refunds) $ (21.2 ) $ (23.6 ) $ (29.6 )


	2006			2005			2004
	In millions

Operating activities:
Net income	$	108.9		$	100.9		$	24.4
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		155.0			127.7			53.5
Deferred income taxes		41.0			(17.3	)		35.9
KCSM employees’ statutory profit sharing		5.9			41.1			—
Equity in undistributed losses (earnings) of unconsolidated affiliates		(7.3	)		(2.9	)		4.5
VAT/Put settlement gain		—			(131.9	)		—
Minority interest		0.3			(17.8	)		—
Distributions from unconsolidated affiliates		4.5			8.3			8.8
Loss (gain) on sale of assets		(7.8	)		1.0			(3.8	)
Changes in working capital items:
Accounts receivable		(18.6	)		5.8			(25.0	)
Inventories		0.4			(0.8	)		(11.4	)
Other current assets		(50.9	)		15.7			(2.2	)
Accounts payable and accrued liabilities		44.6			25.2			39.9
Other, net		(8.5	)		23.8			18.1

Net cash provided by operating activities		267.5			178.8			142.7

Investing activities:
Capital expenditures		(241.8	)		(275.7	)		(117.2	)
Proceeds from disposal of property		30.0			6.3			4.9
Contribution from NS for MSLLC (net of change in restricted contribution)		76.5			—			—
Property investments in MSLLC		(37.8	)		—			—
Investments in and loans to affiliates		(1.1	)		(10.5	)		(55.0	)
Proceeds from sales of investments, net		8.2			(8.0	)		0.5
Acquisition costs		—			(10.1	)		(9.5	)
Cash of Mexrail at date of acquisition		—			3.0			—
Cash of KCSM at date of acquisition		—			5.5			—
Change in other restricted cash		—			—			(200.0	)
Other, net		—			—			(0.5	)

Net cash used for investing activities		(166.0	)		(289.5	)		(376.8	)

Financing activities:
Proceeds from issuance of long-term debt		616.3			644.7			250.0
Repayment of long-term debt		(658.5	)		(521.5	)		(107.6	)
Net proceeds from issuance of preferred stock		—			203.9			—
Debt issuance costs		(15.9	)		(16.5	)		(3.8	)
Proceeds from stock plans		8.6			1.7			7.4
Repurchase of common stock		—			(200.4	)		—
Excess tax benefit realized from options exercised		0.2			—			—
Dividends paid		(4.3	)		(8.7	)		(8.7	)

Net cash provided by (used for) financing activities		(53.6	)		103.2			137.3

Cash and cash equivalents:
Net increase (decrease) during each year		47.9			(7.5	)		(96.8	)
At beginning of year		31.1			38.6			135.4

At end of year	$	79.0		$	31.1		$	38.6

Supplemental cash flow information:
Cash payments (refunds):
Interest	$	163.5		$	132.8		$	42.1
Income tax refunds (net of payments)		(0.4	)		(1.6	)		(21.2	)

See accompanying notes to consolidated financial statements.

~~KANSAS CITY SOUTHERN~~Kansas City Southern

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income

~~CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY~~

Accumulated
$1 Par Other
$25 Par Cumulative $.01 Par Comprehensive
Preferred Preferred Common Paid in Retained Income
Stock Stock Stock Capital Earnings (Loss) Total

Dollars in millions, except per share amounts
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 on $25 Par Preferred Stock ($1.00/share) (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

Comprehensive income:
Net income 12.2
Change in fair value of cash flow hedges 0.6
Amortization of accumulated other comprehensive income (loss) related to interest rate swaps 1.2
Comprehensive income 14.0
Issuance of preferred stock 0.4 110.9 81.7 193.0
Dividends on $25 Par Preferred Stock ($1.00/share) (0.2 ) (0.2 )
Dividends on $1 Par Cumulative Preferred Stock ($11.22/share) (4.5 ) (4.5 )
Options exercised and stock subscribed 5.2 5.2
Stock plan shares issued from treasury 3.3 3.3

Balance at December 31, 2003 6.1 0.4 0.6 110.9 846.2 (0.5 ) 963.7

Comprehensive income:
Net income 24.4
Change in fair value of cash flow hedges 0.2
Amortization of accumulated other comprehensive income (loss) related to interest rate swaps 0.5
Comprehensive income 25.1
Dividends on $25 Par Preferred Stock ($1.00/share) (0.2 ) (0.2 )
Dividends on $1 Par Cumulative Preferred Stock ($21.25/share) (8.5 ) (8.5 )
Options exercised and stock subscribed 42.0 42.0
Stock plan shares issued from treasury 2.4 2.4

Balance at December 31, 2004 $ 6.1 $ 0.4 $ 0.6 $ 155.3 $ 861.9 $ 0.2 $ 1,024.5


			$1 Par Cumulative													Accumulated
	$25 Par		Preferred Stock				$.01 par									Other
	Preferred		Series C		Series D		Common			Paid in			Retained			Comprehensive
	Stock		4.25%		5.125%		Stock			Capital			Earnings			Income (Loss)			Total
	(In millions)

Balance at December 31, 2003	$	6.1	$	0.4	$	—	$	0.6		$	110.9		$	838.2		$	(0.5	)	$	955.7

Comprehensive income:
Net income														24.4						24.4
Fair value change of cash flow hedges																	0.2			0.2
Amortization of interest rate swap loss																	0.5			0.5

Comprehensive income		—		—		—		—			—			24.4			0.7			25.1
Dividends on $25 par preferred stock ($1.00/share)														(0.2	)					(0.2	)
Dividends on series C cumulative preferred stock ($21.25/share)														(8.5	)					(8.5	)
Options exercised and stock subscribed											42.0									42.0
Stock plan shares issued from treasury											2.4									2.4

Balance at December 31, 2004		6.1		0.4		—		0.6			155.3			853.9			0.2			1,016.5

Comprehensive income:
Net income														100.9						100.9
Fair value change of cash flow hedges																	(1.1	)		(1.1	)
Amortization of interest rate swap loss																	0.5			0.5

Comprehensive income		—		—		—		—			—			100.9			(0.6	)		100.3
Dividends on $25 par preferred stock ($1.00/share)														(0.2	)					(0.2	)
Dividends on series C cumulative preferred stock ($21.25/share)														(8.5	)					(8.5	)
Options exercised and stock subscribed											8.3									8.3
Stock plan shares issued from treasury											2.3									2.3
Share-based compensation											1.5									1.5
Stock issued in acquisition of Grupo KCSM								0.2			304.2									304.4
Issuance of series D cumulative preferred stock						0.2					201.8									202.0
Repurchase of $.01 par common stock								(0.1	)		(200.3	)								(200.4	)

Balance at December 31, 2005		6.1		0.4		0.2		0.7			473.1			946.1			(0.4	)		1,426.2

Comprehensive income:
Net income														108.9						108.9
Amortization of interest rate swaps																	0.4			0.4

Comprehensive income		—		—		—		—			—			108.9			0.4			109.3
Dividends on $25 par preferred stock ($1.00/share)														(0.2	)					(0.2	)
Dividends on series C cumulative preferred stock ($5.31/share)														(2.1	)					(2.1	)
Dividends on series D cumulative preferred stock ($9.40/share)														(2.0	)					(2.0	)
Stock issued for repayment of debt											35.0									35.0
Options exercised and stock subscribed											8.6									8.6
Tax benefit of share-based compensation											2.0									2.0
Share-based compensation											4.3									4.3
Adjustment to adopt FASB Statement No. 158, net of tax of $.8 million																	1.3			1.3

Balance at December 31, 2006	$	6.1	$	0.4	$	0.2	$	0.7		$	523.0		$	1,050.7		$	1.3		$	1,582.4

See accompanying notes to consolidated financial statements.

~~KANSAS CITY SOUTHERN~~Kansas City Southern

Notes to Consolidated Financial Statements

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~


Note 1.	Description of the Business

~~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. ~~KCS’s principal subsidiaries and affiliates,~~

Until the second quarter of 2005, KCS operated under one reportable business segment in the rail transportation industry. Beginning in the second quarter of 2005, with the acquisition of a controlling interest in Grupo KCSM, KCS began operating under two reportable business segments, which are ~~reported under one~~defined geographically as United States (U.S.) and Mexico. In both the U.S. and the Mexico segments, the Company generates revenues and cash flows by providing its customers with freight delivery services both within its regions, and throughout North America through connections with other Class I rail carriers. KCS’ customers conduct business ~~segment,~~in a number of different industries, including electric-generating utilities, chemical and petroleum products, paper and forest products, agriculture and mineral products, automotive products and intermodal transportation.

KCS’ principal geographic business segments include the following:

U.S. Segment.


	•	The Kansas City Southern Railway Company (“KCSR”), a wholly-owned ~~subsidiary of KCS;~~

	•	Grupo Transportación Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”), a 46.6% owned unconsolidated affiliate, which owns an 80% economic interest in, and all of the shares of stock with full voting rights of , TFM, S.A. de C.V. (“TFM”). TFM owns 49% of Mexrail.consolidated subsidiary;

	•	Mexrail, Inc. (“Mexrail”), a ~~51% owned unconsolidated affiliate of KCS. Mexrail was reported on an unconsolidated basis pending approval of KCS’s application for authority to control Tex-Mex to the Surface Transportation Board~~wholly-owned consolidated subsidiary; which wholly owns The Texas Mexican Railway Company (“~~STB”~~Tex-Mex”). On November 29, 2004, the STB approved KCS’s application and that authority became final as of December 29, 2004. Effective January 1, 2005, Mexrail has been consolidated within the operations of KCS.;

	•	Meridian Speedway, LLC (“MSLLC”), a ninety percent owned consolidated affiliate.

	•	Combined with equity investments in:


	•	Southern Capital Corporation, LLC (“Southern Capital”), a ~~50%~~fifty percent owned unconsolidated affiliate ~~of KCSR~~ that owns and leases ~~locomotive~~locomotives and other rail ~~equipment to KCSR;~~equipment;

	•	Panama Canal Railway Company (“PCRC”), ana fifty percent owned unconsolidated affiliate of which ~~KCSR indirectly owns 50% of the common stock. PCRC~~ owns all of the common stock of Panarail Tourism Company (“Panarail”).

Mexico Segment.


	•	Grupo KCSM, S.A. de C.V. (“Grupo KCSM”), a wholly-owned subsidiary, formerly known as Grupo Transportación Ferroviaria Mexicana, S.A. de C.V., is KCS’ Mexican holding company which owns all but one share of Kansas City Southern de México, S. de R.L. de C.V. (“KCSM”).


	•	KCSM which is the principal operating subsidiary of Grupo KCSM operates under the rights granted by the Concession acquired from the Mexican government in 1997 (“the Concession”) as described below.

	•	Arrendadora KCSM, S.A. de C.V. (“Arrendadora”), is wholly-owned by Grupo KCSM and KCSM and has as its only operation, the leasing to KCSM of the locomotives and freight cars acquired through the privatization and subsequently sold to Arrendadora by KCSM.

	•	Ferrocarril y Terminal del Valle de México, S.A. de C.V. (“FTVM”), a twenty five percent owned unconsolidated affiliate that provides railroad services as well as ancillary services in the greater Mexico City area.

KCS completed its acquisition of control of Grupo KCSM on April 1, 2005, and Grupo KCSM became a consolidated subsidiary of KCS. On September 12, 2005, the Company and its subsidiaries, Grupo KCSM and KCSM, along with ~~its principal subsidiaries and joint ventures, owns and operates~~the Mexican holding company Grupo TMM, S.A. (“TMM”), entered into 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.settlement

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 railroads in the United States, within 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, forest product and metal, and automotive and intermodal markets.

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

agreement with the Mexican government resolving the controversies and disputes between the companies and the Mexican government concerning the payment of a VAT refund to KCSM and the purchase of the remaining shares of KCSM owned by the Mexican government. As a result of this settlement, KCS wholly owns Grupo KCSM and KCSM. Grupo KCSM and KCSM constituted 53% of consolidated assets at December 31, 2006 and 47% of 2006 consolidated revenues.

The ~~Company’s rail network links directly to major trading centers in Mexico through TFM and Tex-Mex. TFM operates~~KCSM Concession. KCSM holds a ~~railroad~~Concession from the ~~U.S./~~ Mexican ~~border at Laredo, Texas~~government until June 2047 (exclusive through 2027, subject to certain trackage rights) which is renewable under certain conditions for additional periods of up to 50 years. The Concession is to provide freight transportation services over rail lines which are a primary commercial corridor of the Mexican railroad system. These lines include the shortest, most direct rail passageway between Mexico City and ~~serves~~Laredo, Texas and serve most of Mexico’s principal industrial cities and three of its major shipping ports. KCSM has the right to use, but does not own, all track and buildings that are necessary for the rail lines’ operation. The Company ~~owns 51%~~is obligated to maintain the right of ~~Mexrail, which~~way, track structure, buildings and related maintenance facilities to the operational standards specified in ~~turn wholly-owns Tex-Mex. Tex-Mex operates between Laredo~~the concession agreement and to return the assets in that condition at the end of the Concession period. KCSM is required to pay the Mexican government a concession duty equal to 0.5% of gross revenues during the first 15 years of the concession period and 1.25% of such revenues during the remainder of the period.

Under the Concession and Mexican law, the Company may freely set rates unless the Mexican government determines that there is no effective competition in Mexico’s rail industry. KCSM is required to provide railroad services to all users on a fair and non-discriminatory basis and in accordance with efficiency and safety standards approved periodically by the Mexican government. In the event that rates charged are higher than the registered rates, KCSM must reimburse customers with interest, and risk the revocation of the Concession.

Mexican railroad services law and regulations and the ~~port city~~Concession establish several circumstances under which the Concession will terminate: revocation by the Mexican government, statutory appropriation, or KCSM’s voluntary surrender of ~~Corpus Christi, Texas. TFM, through~~ its ~~concession~~rights or liquidation or bankruptcy. The Concession requires the undertaking of capital projects, including those described in a business plan filed every five years with the Mexican government. KCSM filed its second business plan with the Mexican government ~~has~~in 2003 in which KCSM committed to certain minimal investment and capital improvement goals, which may be waived by the Mexican government upon application for relief for good cause. Mexico may also revoke KCSM’s exclusivity after 2017 if it determines that there is insufficient competition.

In the event that the Concession is revoked by the Mexican government, KCSM will receive no compensation. Rail lines and all other fixtures covered by the Concession, as well as all improvements, will revert to the Mexican government. All other property not covered by the Concession, including all locomotives and railcars otherwise acquired, will remain KCSM’s property. The Mexican government will have the right to ~~control and operate~~cause the ~~southern half~~Company to lease all service-related assets to it for a term of at least one year, automatically renewable for additional one-year terms up to five years. The Mexican government must exercise this right within four months after revocation of the ~~rail-bridge at Laredo. Through its ownership~~Concession. The Mexican government may also temporarily seize the rail lines and assets used in operating the rail lines in the event of ~~Mexrail,~~a natural disaster, war, significant public disturbances, or imminent danger to the domestic peace or economy for the duration of any of the foregoing events. Further, Mexican law requires that the Mexican government pay KCSM compensation equal to damages caused and losses suffered if it effects a statutory appropriation for reasons of the public interest. These payments may not be sufficient to compensate the Company ~~indirectly controls~~for its losses and may not be timely made.

Employees and Labor Relations. Labor relations in the ~~northern half~~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

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

action until extended procedures are exhausted. Various collective bargaining agreements cover approximately 81% of KCSR employees.

Under the negotiating process for new collective bargaining agreements which began on November 1, 1999, all U.S. unions reached new labor agreements with KCSR in 2005. Wages, health and welfare benefits, work rules and other issues have been negotiated on an industry-wide scale. Previously, these negotiations, which can take place over significant periods of time, have not resulted in any extended work interruptions. The existing agreements will remain in effect until new agreements are reached or the RLA’s procedures are exhausted. Until new agreements are reached, the current agreements provide for periodic wage adjustments.

A labor agreement covering approximately 75% of KCSM’s total employees was renewed in 2005 and is effective through July 2007. The compensation terms of the ~~rail-bridge~~labor agreement are subject to renegotiation on an annual basis and all other terms are renegotiated every two years. These negotiations have not resulted in any strikes, boycotts or other material disruptions at ~~Laredo, which spans the Rio Grande River between the United States and Mexico.~~KCSM.


Note 2.	Significant Accounting Policies

~~Note 2. Significant Accounting Policies~~

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. Certain prior year amounts have been reclassified to conform to the current year presentation.

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%~~fifty percent voting interest; and the cost method of accounting is generally used for investments of less than ~~20%~~twenty percent voting interest. The company evaluates less than majority owned investments for consolidation pursuant to FASB Interpretation No. 46 (Revised 2003). The Company currently does not have any less than majority owned investments requiring consolidation.

Goodwill and Other Intangible Assets. Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. As ~~it relates~~of December 31, 2006 and 2005, the goodwill balance was $10.6 million which is included in other assets in the Consolidated Balance Sheet. In accordance with Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets”, goodwill and intangible assets with indefinite useful lives are not amortized, but are reviewed at least annually for impairment. An impairment loss would be recognized to the ~~Company’s 51% investment in Mexrail,~~extent that the ~~equity method~~carrying amount exceeds the assets’ fair value. Intangible assets with estimable useful lives are amortized on a straight-line basis over their respective useful lives. The Company performed its annual impairment test for goodwill as of ~~accounting~~September 30, 2006 and there was ~~used pending the STB’s approval of KCS’s application for control of Tex-Mex which~~no indication that goodwill was ~~effective December 29, 2004. Shares representing 51% voting control of TexMex were transferred from the trustee to KCS on January 1, 2005.~~impaired.

Use of Estimates. The accounting and financial reporting policies of the Company conform ~~with~~to 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.

Currency Translation. For tax purposes, Grupo KCSM and its subsidiaries are required to maintain their books and records in Mexican pesos. For financial reporting purposes, Grupo KCSM and its subsidiaries maintain records in U.S. dollars, which is the functional currency. The dollar is the currency that reflects the economic substance of the underlying events and circumstances relevant to the entity (i.e., historical cost convention). Monetary assets and liabilities denominated in pesos are translated into dollars using current exchange rates. The difference between the exchange rate on the date of the transaction and the exchange rate

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

on the settlement date, or balance sheet date if not settled, is included in the income statement as other income.

Revenue Recognition. The Company recognizes freight revenue based upon the percentage of completion of a commodity ~~movement.~~movement as a shipment moves from origin to destination, with the related expense recognized as incurred. 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~~classified as cash equivalents. Cash equivalents at December 31, 2004 and 2003 also includes a $10 million deposit in connection with the litigation under the Original Acquisition Agreement which will be refunded on completion of the Acquisition.

~~Restricted Funds — Escrow Account for Grupo TFM Acquisition.~~ In connection with the acquisition of TFM, $200 million has been deposited into an escrow account. Such amounts are restricted for the purpose of that transaction and can only be released to the Company if the transaction is terminated.

Accounts Receivable, net. Accounts receivable are net ~~includes accounts receivable reduced by~~of an allowance for uncollectible ~~account~~accounts as determined ~~based on~~by historical experience and ~~may be~~ adjusted for economic

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

uncertainties or known trends. Accounts are charged to the allowance ~~for bad debts~~ when a customer enters bankruptcy, when an account has been transferred to a collection agent or submitted for legal action, ~~and in certain other cases,~~or when a customer is significantly past due and all available means of collection have been exhausted. At December 31, 2006 and 2005, the allowance for doubtful accounts was $31.4 million and $24.1 million, respectively. Bad debt expense was $10.8 million and $15.2 million for the year ended December 31, 2006 and 2005, respectively.

~~Inventories.~~ ~~Materials~~

Restricted Funds —JSIB Consulting. In connection with KCS’ acquisition of the controlling interest in Grupo KCSM, KCS entered into a consulting agreement with José F. Serrano International Business, S.A. de C.V. (“JSIB”), a consulting company controlled by Jose Serrano, Chairman of the Board of TMM, which became effective April 1, 2005. Under this agreement, JSIB will provide consulting services to KCS in connection with its Mexico business for a period of three years. As consideration for these services, JSIB receives an annual fee of $3.0 million. The consulting agreement required KCS to deposit the total amount of annual fees payable under the agreement ($9.0 million) in cash to be held and ~~supplies inventories~~released in accordance with the consulting agreement. On January 12, 2006, the first $3.0 million annual fee was released from the escrow account. Accordingly the balance in restricted funds was $6.0 million on December 31, 2006, of which $3.0 million was included in current assets and $3.0 million was included in other assets. JSIB directs the investment of the escrow fund and all gains and losses in the fund accrue to JSIB’s benefit.

Restricted Funds — MSLLC. On December 1, 2005, KCS and KCSR entered into a transaction agreement with Norfolk Southern Corporation (“NS”) and its wholly-owned subsidiary, The Alabama Great Southern Railroad Company (“AGS”), providing for the formation of a limited liability company between the parties relating to the ownership and improvement of the KCSR rail line between Meridian, Mississippi and Shreveport, Louisiana, which is the portion of the KCSR rail line between Dallas, Texas and Meridian known as the “Meridian Speedway”.

In connection with the formation of MSLLC, NS, through AGS, contributed $100.0 million to MSLLC, representing the initial NS investment in the joint venture. MSLLC commenced operations on May 1, 2006. NS’ initial investment, $76.5 million was distributed to KCS as reimbursement for capital expenditures incurred and paid by KCS for MSLLC during 2006. KCS has classified the remaining balance of $23.5 million, as funds restricted for payment of MSLLC capital assets at December 31, 2006. Substantially all of these funds will be used for capital improvements on the Meridian Speedway. NS has a binding commitment to fund additional cash contributions of $200 million, subject to the terms of the agreement, reflecting an ultimate ownership of 30% in MSLLC, once funded.

Inventories. Inventories consisting of diesel fuel, items to be used in the maintenance of rolling stock and items to be used in the maintenance or construction of road property, are valued at the lower of average cost or market.

Derivative Instruments. Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended, requires that derivatives be recorded on the balance

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

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 hedge designation. Gains and losses on derivative instruments classified as cash flow hedges are reported in other comprehensive income and 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.

Properties and Depreciation. Properties are stated at ~~cost.~~cost less accumulated depreciation. Additions and renewals, including those on leased assets that increase the life or utility of the asset, are capitalized and all properties are depreciated over the estimated remaining life or lease term of such assets, whichever is shorter. The Company capitalizes certain overhead costs representing the indirect costs associated with construction and improvement projects using the full absorption method. Overhead factors are periodically reviewed and adjusted to reflect current costs. Depreciation for railway operating assets is derived using the group-life method. This method classifies similar assets by equipment or road type and depreciates these assets as a whole. ~~Ordinary~~Repairs and maintenance ~~and repairs and major maintenance activities~~costs are charged to expense as incurred.

The ranges of annual depreciation rates for financial statement purposes are: road and structures — 1% to 4%, rolling stock and equipment — 2% to 14%, computer software — 8% to 14%, and capitalized leases — 3% to 7%.

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~~is 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 $3.2 million,$5.9 million and $3.1 million in 2004, 2003 and 2002, respectively. Gains~~ or losses recognized on the sale of non-operating property reflected in other income ~~were $0.6 million, $0.3 million, and $7.4 million in 2004, 2003, and 2002, respectively.~~are not material for the periods presented.

KCSR Depreciation ~~is computed using group straight-line rates for financial statement purposes, which require approval of the STB.~~Review. During the year ended December 31, ~~2003,~~2006, KCSR engaged a civil engineering firm with expertise in railway property usage to conduct a study to evaluate ~~deprecation~~depreciation rates for properties and equipment. The study centered on evaluating actual historical replacement patterns to assess future lives and indicated that ~~KCS~~KCSR was depreciating its property over shorter periods than itthe assets were actually ~~utilized the assets,~~used, as estimated by the study. Specifically, the average rate applied to the Road and Structures Asset class (primarily rail, railroad ties and bridges) decreased approximately 0.7%, while the average rate applied to the Rolling Stock and Equipment Asset class (locomotives and railcars) decreased approximately 0.6%. The effect of this change in estimate was a $3.0 million decrease in depreciation ~~rates on net income was approximately $8.0 million, net of tax of $5.0 million ($0.12 per share, on a diluted basis),~~expense for the year ended December 31, ~~2004.~~2006.

KCSM Depreciation Review. For the year ended December 31, 2005, KCSM adopted the group depreciation method for ~~other consolidated subsidiaries is computed based~~consistency with KCSR. Accordingly, changes were made to certain historical depreciation rates. During the year ended December 31, 2005, KCSM engaged a civil engineering firm with expertise in railway property usage to conduct an analysis of depreciation rates for properties and equipment. The analysis centered on evaluating actual historical replacement patterns to assess future lives and indicated that KCSM was depreciating its property over shorter periods than actually utilized. As a result, depreciation expense recorded in the ~~asset value~~fourth quarter of 2005 reflected an adjustment totaling $5.5 million to reduce depreciation expense recorded in ~~excess~~the second and third quarters of ~~estimated salvage value using~~2005. Concession rights and related assets are amortized over the ~~straight-line method~~shorter of their remaining useful lives as determined by the KCSM depreciation review or the life of the Concession.

Concession Rights and Related Assets. Costs incurred by the Company to acquire the Concession rights and related assets were capitalized and are amortized over the estimated useful lives of the ~~assets.~~related assets and rights acquired. Concession replacements and improvements are stated at cost. Major repairs and track rehabilitation are capitalized. Amortization is calculated using the straight-line method based on the estimated useful lives of the respective improvements, or the term of the Concession if shorter.

~~Accelerated depreciation~~

Computer Software Costs. Costs incurred in conjunction with the purchase or development of computer software for internal use are capitalized. 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

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

development stage of internal use software are capitalized until such time that the software is ~~used~~substantially complete and ready for ~~income tax purposes. The ranges~~its intended use. Capitalized costs are amortized on a straight-line basis over the useful life of ~~annual depreciation rates for financial statement purposes are:~~the software.


~~Road and structures~~			~~2% - 14%~~
~~Rolling stock and equipment~~			~~2% - 22%~~
~~Computer software~~			~~8% - 14%~~
~~Capitalized leases~~			~~3% - 7%~~

~~Long-lived assets.~~

Long-Lived Assets. The Company evaluates the recoverability of its ~~operating~~ properties when there is an indication that an asset value has been impaired. 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 related to the assets on an undiscounted basis. ~~At December 31, 2004, there~~There were no assets ~~which required~~requiring an impairment ~~adjustment.~~adjustment at December 31, 2006.

~~On February 24, 2005,~~

Fair Value of Financial Instruments. The Company’s financial instruments include cash and cash equivalents, accounts receivable, lease and contract receivables, accounts payable and long-term debt as described in Note 6.

The financial statement carrying value of the Company’s cash equivalents approximates fair value 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 ~~took one 28.5-mile branch line out~~and its subsidiaries for indebtedness with similar terms and average maturities, the fair value of ~~service for further assessment of track condition.~~long-term debt was $1,814.1 million and $1,938.6 million at December 31, 2006 and 2005, respectively. The financial statement carrying value was $1,757.0 million and $1,860.6 million at December 31, 2006 and 2005, respectively.

Environmental Liabilities. The Company ~~will~~records liabilities for remediation and restoration costs related to past activities when the Company’s obligation is probable and the costs can be ~~evaluating possible alternatives including, but~~reasonably estimated. Costs of future expenditures for environmental remediation are not ~~limited~~discounted to ~~repair, replacement, sale, abandonment, or a combination~~their present value. Recoveries of ~~the above. The results~~environmental remediation costs from other parties are recorded as assets when their receipt is deemed probable. Costs of ~~this evaluation could impact the 2005 financial results of the Company.~~

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~ongoing compliance activities related to current operations are expensed as incurred.

Casualty Claims. Casualty claims in excess of self-insurance levels are insured up to certain coverage amounts, depending on the type of claim and year of occurrence. The Company’s casualty liability reserve is based on a study by an independent third party actuarial firm performed on an undiscounted basis. The reserve 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 a reasonable estimate of aggregate future claims. Adjustments to the liability will be reflected as operating expenses in the period in which the adjustments are known. Legal fees related to casualty claims are recorded in operating expense in the period incurred.

~~For occupational injury claims, an assessment is made on a case-by-case basis~~

Pension and ~~a liability is established when management determines that it is probable~~Other Postretirement Benefits. The Company provides certain medical, life and reasonably estimable. In the case of incurred but not yet reported occupational injury claims, specifically asbestos related claims, management believes that a provision for such claims cannot be reasonably estimated as required by Statement of Financial Accounting Standard No. 5~~“Accounting for Contingencies.”(“SFAS 5”). This is due~~other postretirement benefits to ~~our low number of claims, the lack of detailed records of the population of potentially exposed~~certain active employees and retirees. The Company uses third party actuaries to assist in estimating liabilities and expenses for pension and other post retirement benefits. Estimate amounts are based on current and historical information, current information and estimates regarding future events and circumstances. Significant assumptions used in the ~~wide range~~valuation of ~~possible outcomes~~pension and other postretirement liabilities include the expected return on plan assets (if funded), discount rate, rate of ~~such claims. Management believes~~increase in compensation levels and the health care cost trend rate.

KCSM Employees’ Statutory Profit Sharing. KCSM is subject to employee statutory profit sharing requirements under Mexican law and calculates profit sharing liability as 10% of KCSM net taxable income, adjusted as prescribed by the Mexican income tax law. In calculating its net taxable income for statutory profit sharing purposes, KCSM previously deducted NOL carryforwards. The application of NOL carryforwards can result in a deferred profit sharing asset for a given period rather than a profit sharing liability. Due to decisions by the Mexican Supreme Court in 2005 declaring that ~~any type of estimate of the potential liability for asbestos related claims not yet reported would~~NOLs from previous years may not be ~~significant~~deducted, KCSM

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

changed the ~~Company’s financial condition or results~~method of ~~operations.~~calculating its statutory profit sharing liability. KCSM no longer deducts NOLs from prior years when calculating employee statutory profit sharing. This change required KCSM to write off its deferred tax assets related to statutory profit sharing resulting in a charge to operating expenses of $35.6 million in 2005, after purchase accounting adjustments.

~~Computer Software Costs.~~ ~~Costs incurred in conjunction with~~

Share-Based Compensation. Effective January 1, 2006, the purchase or development of computer software for internal use are capitalized. 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, 2003 and 2002, a total of approximately $59.7 million and $58.0 million, respectively, was capitalized (including a total of approximately $5.9 million of capitalized interest costs) for the transportation operating system, MCS, which was implemented in July 2002. There were no additional costs capitalized in 2004.

~~Fair Value of Financial Instruments.~~ ~~The Company’s financial instruments include cash and cash equivalents,~~Company accounts ~~receivable, lease and contract receivables, accounts payable and long-term debt.~~

~~The financial statement carrying value of the Company’s cash equivalents approximates fair value due to their short-term nature. Carrying value approximates fair value~~ for all ~~financial instruments~~share-based compensation in accordance with ~~six months or less to re-pricing or maturity and for financial instruments with variable interest rates. The Company estimates~~ the fair value recognition provisions 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 $704 million and $558 million at December 31, 2004 and 2003, respectively. The financial statement carrying value was $665 million and $523 million at December 31, 2004 and 2003, respectively.

~~Derivative Instruments.~~ Statement of Financial Accounting Standards No. ~~133,~~123R (Revised) “Share-Based Payments” (“SFAS 123R”). Under this method, compensation expense is measured at grant date based on the then fair value of the award and is recognized over the requisite service period in which the award is earned. The Company has elected to adopt SFAS 123R on a modified prospective basis, which requires that all new awards and modified awards after the effective date and any unvested awards at the effective date are recognized as compensation cost ratably over the option vesting period. SFAS 123R requires forfeitures to be estimated at the time of the grant and revised, if necessary, in subsequent periods should actual forfeitures differ from those estimates. In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior years have not been restated to reflect, and do not include, the impact of SFAS 123R.

Prior to the adoption of SFAS 123R, the Company accounted for share-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for ~~Derivative Instruments~~Stock Issued to Employees” (“APB 25”) and ~~Hedging Activities”~~followed the pro forma disclosure requirements set forth in Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (“SFAS ~~133”~~123”)~~, as amended, requires that derivatives be recorded~~. Under this method, compensation expense was recognized ratably over the option vesting period if an option exercise price was less than the market price of the stock at the date of grant. KCS’ practice was to set the option exercise price equal to the market price of the stock at the date of grant; therefore, no compensation expense was recognized for financial reporting purposes.

The following table illustrates the effect on net income and earnings per share if the ~~balance sheet as either assets or liabilities measured at fair value. Changes in~~Company had applied 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. KCS adopted therecognition provisions of SFAS ~~133, as amended, effective~~123 to share-based employee compensation prior to January 1, ~~2001.~~2006:


	2005			2004

Net income (in millions):
As reported	$	100.9		$	24.4
Additional stock-based compensation expense determined under fair value method, net of income taxes		(0.8	)		(1.6	)

Pro forma	$	100.1		$	22.8

Earnings per basic share:
As reported	$	1.21		$	0.25
Pro forma		1.20			0.22
Earnings per diluted share:
As reported	$	1.10		$	0.25
Pro forma		1.07			0.22

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 in Note 9.

The Company issues treasury stock to settle share-based awards. The Company does not intend to repurchase any shares in 2007 to provide shares to issue as share-based awards; however, management continually evaluates the appropriateness of the level of shares outstanding.

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

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

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

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.

Prior to the acquisition of a controlling interest in Grupo ~~TFM provides~~KCSM on April 1, 2005, Grupo KCSM provided deferred income taxes for the difference between the financial reporting and income tax bases of its assets and liabilities. ~~The Company records~~KCS recorded its proportionate share of these income taxes through its equity in Grupo ~~TFM’s~~KCSM’s earnings. ~~For all years presented,~~Since April 1, 2005, Grupo KCSM income taxes are reflected in the consolidated results. Although KCSM has generated book profits, it has incurred tax losses due primarily to the accelerated tax amortization of the concession rights. The Company has recognized a deferred income tax asset for the resulting net operating loss carryforwards. Management anticipates that such net operating loss carryforwards will be realized given the long carryforward period (through the year 2046) for amortization of the Concession, as well as the fact that KCSM expects to generate taxable income in the future. The Company’s tax projections take into consideration certain assumptions, some of which are under its control and others which are not. Key assumptions include inflation rates, currency fluctuations and future revenue growth. If the assumptions are not correct, a valuation allowance would have to be recognized on the deferred tax asset.

Prior to the acquisition of a controlling interest in Grupo KCSM on April 1, 2005, the Company ~~has~~did not ~~provided deferred~~provide U.S. federal income taxes for the temporary difference between the financial reporting basis and income tax basis of its investment in Grupo ~~TFM~~KCSM because Grupo ~~TFM is~~KCSM was a foreign corporate joint venture that iswas considered permanent in duration, and the Company ~~does~~did not expect the reversal of the temporary difference to occur in the foreseeable future.

~~Changes~~ Following the acquisition of ~~Interest~~control of Grupo KCSM in ~~Subsidiaries and Equity Investees.~~ ~~A change~~2005, the Company has not provided U.S. federal income taxes on the undistributed earnings of Grupo KCSM since the Company intends to reinvest such earnings indefinitely outside 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.United States.

~~Treasury Stock.~~ The excess of par over cost of the preferred shares held in Treasury is credited to paid in capital. 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 paid in capital.

~~Stock Plans.~~ ~~Proceeds received from the exercise of stock options or subscriptions are credited to the appropriate stockholders’ equity accounts in the year exercised.~~

Pursuant to Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), compensation expense is recognized ratably over the option vesting period to the extent that an option exercise price is less than the market price of the stock at the date of grant. KCS’s practice is to set the option exercise price equal to the market price of the stock at date of grant; therefore, no compensation expense is recognized for financial reporting purposes.

The Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”) in October 1995. This statement allows companies to continue under the approach set forth in 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

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

~~SFAS 123 (see additional information regarding SFAS 123R under “New Accounting Pronouncements”), net income and~~Earnings Per Share. Basic earnings per ~~share would have been as follows:~~

2004 2003 2002

Net income(In millions):

As reported $ 24.4 $ 12.2 $ 57.2
Total stock-based compensation expense determined under fair value method, net of income taxes (1.6 ) (1.8 ) (1.7 )

Pro forma 22.8 10.4 55.5
Earnings per Basic share:

As reported $ 0.25 $ 0.10 $ 0.94
Pro forma 0.22 0.07 0.92
Earnings per Diluted share:

As reported $ 0.25 $ 0.10 $ 0.91
Pro forma 0.22 0.07 0.88

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 8.

~~Earnings Per Share.~~ ~~Basic earnings per~~common share is computed by dividing income available to common shareholders by the ~~weighted-average~~weighted average number of common shares outstanding for the period. Diluted earnings per share ~~reflects~~reflect the potential dilution that could occur if convertible securities ~~and stock options~~ were converted into common stock or ~~exercised.~~

stock based awards were exercised or earned. The following ~~is a reconciliation from~~reconciles the weighted average shares used for the basic earnings per share computation to the ~~weighted average~~ shares used for the diluted earnings per share computation ~~for the three years ended~~at December 31 ~~2004 (in~~(in thousands):.

2004 2003 2002

Basic shares 62,715 61,725 60,336
Dilutive effect of stock options 1,268 — 1,982
Dilutive effect of convertible preferred stock — — —

Diluted shares 63,983 61,725 62,318

~~For the years ended December 31, 2004 and 2003, 13,389,120 and 8,926,080 potential~~


	2006		2005		2004

Basic shares		74,593		75,527		62,715
Additional weighted average shares attributable to convertible securities and stock options:
$9.0 million VAT/Put settlement payment due to JSIB		—		110		—
$47.0 million escrow note		1,667		1,439		—
VAT/Put settlement contingency payment		1,418		918		—
Convertible preferred stock		13,389		13,389		—
Stock options		1,266		1,358		1,268
Nonvested shares		53		6		—

Diluted shares		92,386		92,747		63,983

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

Potentially dilutive shares ~~respectively, related to the $1 par, 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C (“Convertible Preferred Stock”) were~~ excluded from the ~~computation~~calculation(in thousands):


	2006		2005		2004

Stock options where the exercise price is greater than the average market price of common shares		—		1		361
Convertible preferred stock series C which are anti-dilutive		—		—		13,389
Convertible preferred stock series D which are anti-dilutive		7,000		486		—

The following reconciles net income available to common shareholders for purposes of basic earnings per share to that for purposes of diluted earnings per share ~~because~~(in millions):


	2006		2005		2004

Net income available to common shareholders for purposes of computing basic earnings per share	$	89.4	$	91.4	$	15.7
Effect of dividends on conversion of convertible preferred stock		8.5		8.5		—
Effect of interest expense on conversion of $47.0 million escrow note		1.4		1.1		—
Effect of interest expense on conversion of note payable to TMM for VAT/Put settlement		0.8		0.6		—

Net income available to common shareholders for purposes of computing diluted earnings per share	$	100.1	$	101.6	$	15.7

New Accounting Pronouncements.

FIN 48. In June 2006, the ~~inclusion~~Financial Accounting Standards Board issued Interpretation 48“Accounting for Uncertainty in Income Taxes — an Interpretation of ~~these shares would have been anti-dilutive~~FASB Statement No. 109, Accounting for Income Taxes”(“FIN 48”),which clarifies the accounting for uncertainties in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to ~~earnings per share. For~~be taken in a tax return. The Interpretation requires that the ~~year ended December 31, 2003, 1,356,879 potential dilutive shares related to stock options were excluded from~~Company recognize in the ~~computation~~financial statements, the impact of ~~diluted earnings per share because~~a tax position, if that position is more likely than not of being sustained on audit, based on the inclusion of these shares would have been anti-dilutive to earnings per share. For the years ended December 31, 2004, 2003 and 2002, 361,500, 261,093 and 320,687 shares, respectively, related to stock options were excluded from the calculation of diluted earnings per share because the exercise prices were greater than the average market pricetechnical merits of the ~~common shares.~~position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure.

The ~~only adjustment that currently affects~~provisions of FIN 48 are effective beginning January 1, 2007, with the ~~numerator~~cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The estimated impact of the adoption of FIN 48 is subject to change due to potential changes in interpretation of FIN 48 by the FASB and other regulatory bodies. The Company is still monitoring this standard and evaluating the impact of adopting FIN 48; however, does not anticipate adoption will have a material impact on the Company’s ~~diluted earnings per share computation is preferred dividends. During 2004~~consolidated Financial Statements.

EITF06-3. In June 2006, the Financial Accounting Standards Board ratified Emerging Issues Task Force IssueNo. 06-3 “How Taxes Collected from Customers and ~~2003, preferred dividends~~Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation).” This standard allows companies to present in their statements of ~~$8.7 million~~operations any taxes assessed by a governmental authority that are directly imposed on revenue-producing transactions between a seller and ~~$5.9 million, respectively, were deducted~~a customer, such as sales, use, value-added and some excise taxes, on either a gross (included in revenues and costs) or a net (excluded from revenues) basis. This standard will be effective for the Company in interim periods and fiscal years beginning after December 15, 2006. The Company presents these transactions on a net ~~income~~basis and intends to ~~calculate basic earnings per share. Additionally, because~~continue this presentation in the ~~potentially dilutive shares relating to~~future, therefore the ~~Convertible Preferred Stock were anti-dilutive, these convertible preferred dividends ($8.5 million~~adoption of this standard will have no impact on its financial statements.

SFAS 158. In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 158 “Employers’ Accounting for Defined Benefit Pension and ~~$5.7 million earned during 2004 and 2003, respectively) were also deducted from net income to calculate diluted earnings per share. Additional preferred dividends of~~Other Postretirement

69
71

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)

~~$0.2 million were deducted from net income~~Plans — an Amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS 158”), which required the recognition of the overfunded or underfunded status of a defined benefit postretirement plan in ~~2004, 2003 and 2002 and were related~~the Company’s balance sheet on December 31, 2006. Additionally, the pronouncement eliminates the option for the Company to use a measurement date prior to the ~~$25 par, 4% noncumulative preferred stock.~~

~~Postretirement benefits.~~Company’s fiscal year end effective December 31, 2008. The Company ~~provides certain medical, life and other postretirement benefits~~adopted SFAS 158 effective December 31, 2006, which did not result in a significant impact to ~~certain retirees. The costs of such benefits are expensed over~~ the ~~estimated period of employment.~~Consolidated Financial Statements.

~~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 future expenditures for environmental remediation are not discounted to their present value. Recoveries of environmental remediation costs from others parties are recorded as assets when their receipt is deemed probable. Costs of ongoing compliance activities related to current operations are expensed as incurred.

~~New Accounting Pronouncements.~~


Note 3.	~~SFAS 123R~~Investments

In December 2004, the FASB issued Statement of Financial Accounting Standard No. 123 (Revised), “Share-Based Payments” (“SFAS 123R”), which is effective for the first interim period ending after June 15, 2005. Under SFAS 123R, the Company will be required to measure the cost of employee service received in exchange for awards of stock options based upon the fair value of the options as of their grant date. The cost of the employee service will be recognized as compensation cost ratably over the option vesting period. Currently, the Company recognizes compensation expense pursuant to APB 25, whereby compensation expense is recognized to the extent that an option price is less than the market price of the stock at the date of the grant (the “Intrinsic Value”). Because KCS’s practice is to set the option exercise price equal to the market price of the stock as of the date of the grant, no compensation expense is recognized for financial reporting purposes. SFAS 123R allows the use of either the Black-Scholes or a lattice option-pricing model to calculate the fair value of options. SFAS 123R allows either a Modified Prospective Application, which applies to new awards and modified awards after the effective date, and to any unvested awards as service is rendered on or after the effective date, or a Modified Retrospective Application, which would apply either to all prior years for which SFAS 123 was effective or to only prior interim periods in the year of adoption of SFAS 123R. Currently, the Company is evaluating these adoption alternatives and expects to complete this evaluation during the second quarter of 2005. As described above under “Stock Plans,” using the Black-Scholes method, the expense related to share based compensation would have been $1.6 million, $1.8 million and $1.7 million for the years ended December 31, 2004, December 31, 2003 and December 31, 2002, respectively. The impact on future operating results will be dependent on the type and extent of stock-based compensation to be issued as determined by the Company’s Compensation Committee and cannot be determined at this time.


	*~~EITF 04-08~~*

In October 2004, the Financial Accounting Standards Board’s Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 04-08 “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect of Diluted Earnings Per Share” (“EITF 04-08”), which was effective for reporting periods ending after December 15, 2004. EITF 04-08 requires contingently convertible securities to be included in the dilutive earnings per share calculation, if dilutive, regardless of whether the contingency has been met. As of December 31, 2004 and 2003, the Company’s Convertible Preferred Stock was anti-dilutive and, accordingly, was excluded from the dilutive earnings per share calculation.


	*~~SFAS 143~~*

KCS adopted Statement of Financial Accounting Standard No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”) effective for the year ended December 31, 2003. 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

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

reasonable estimate of the fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. KCSR, along with other Class I railroads, depreciates track structure (rail, ties, and other track material) in accordance with regulations promulgated by the STB. These regulations require KCSR to depreciate track structure to a net salvage value (gross estimated salvage value less estimated costs to remove the track structure at the end of its useful life). For certain track structure such as ties, with little or no gross salvage value, this practice ultimately results in depreciating an asset below a value of zero, and thus, in effect, results in recording a liability. Under the requirements of SFAS 143, in the absence of a legal obligation to remove the track structure, such accounting practice is prohibited. The Company adopted the provisions of SFAS 143 in the first quarter of 2003, and, as a result, reviewed its depreciation of track structures to determine instances where the depreciation of removal costs has resulted or would be expected (based on the current depreciation rate) to result in the depreciation of an asset below zero when considering net salvage value. As a result of this review, the Company estimated the excess depreciation recorded on such assets and recorded this amount as a reduction in accumulated depreciation of $14.5 million and as a cumulative effect of an accounting change of $8.9 million (net of taxes of $5.6 million) as required by SFAS 143 in the first quarter of 2003. Additionally, depreciation rates applied to certain track structure elements that were previously yielding a negative salvage value have been modified to comply with the provisions of SFAS 143. For the years ended December 31, 2004 and 2003, this resulted in a reduction in depreciation expense of approximately $1.4 million, net of tax, in each year.

~~A summary of the pro forma net income and earnings per share had SFAS 143 been applied retroactively is as follows:~~

2004 2003 2002

Net income(in millions)

As reported $ 24.4 $ 12.2 $ 57.2
Pro forma $ 24.4 $ 3.3 $ 58.6
Earnings per Basic share:

As reported $ 0.25 $ 0.10 $ 0.94
Pro forma $ 0.25 $ (0.04 ) $ 0.97
Earnings per Diluted share:

As reported $ 0.25 $ 0.10 $ 0.91
Pro forma $ 0.25 $ (0.04 ) $ 0.94


	*~~FIN 46(revised)~~*

In December 2003, the FASB issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”). The Company adopted FIN 46R effective for the year ended December 31, 2003. FIN 46R clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain variable interest entities by providing guidance on how a business entity should evaluate whether it has controlling financial interest in an entity through means other than voting rights and how the entity should be consolidated. FIN 46R replaces Interpretation No. 46 “Consolidation of Variable Interest Entities,” which was issued in January 2003. The Company performed an assessment of its equity method investments in Southern Capital and PCRC for any potential impact this interpretation may have on its accounting for these entities as equity investments. The adoption of FIN 46R had no material impact on the Company’s accounting for its investment in Southern Capital or PCRC since, at inception, these entities had sufficient funding and capital.

~~Significant Customer.~~ ~~Our largest coal customer, accounted for approximately 56.1% of our coal revenues and approximately 8.1% of our total revenues for the year ended December 31, 2004. The loss of all~~

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

~~or a significant part of this business, or a service outage at one the facilities that KCSR serves, could materially adversely affect our financial condition, results of operations and cash flows.~~

~~Grupo TFM and Mexrail Acquisition Costs~~

As further described in “Note 3 — KCS and TMM Enter Into Acquisition Agreement”, on December 15, 2004, the Company entered into the Amended and Restated Acquisition Agreement (“Acquisition Agreement”) with TMM and other parties under which KCS would acquire control of TFM through the purchase of shares of common stock of Grupo TFM (the “Acquisition”). Pending completion of the transactions to acquire Grupo TFM and Mexrail, the Company has capitalized those costs that are directly related to the acquisitions and will include them as part of the ultimate purchase price of the acquisitions. Specifically, these costs include external costs for due diligence, fees and support for the filing of regulatory documents, fees related to obtaining regulatory approvals, trustee fees associated with the regulatory review period, arbitration costs and legal fees associated with the enforcement of the Acquisition Agreement. No internal costs have been capitalized as acquisition costs. As of December 31, 2004 and 2003 costs of approximately $18.8 million and $9.3 million, respectively, related to the acquisitions of Grupo TFM and Mexrail have been deferred and are reported as “other assets” in the accompanying consolidated balance sheets. Should the Company determine that the Grupo TFM acquisition will not occur the capitalized costs related to that acquisition will be written off in the period in which the acquisition is abandoned.

~~Note 3. Investments~~

Investments, including investments in unconsolidated affiliates, ~~are as follows~~follow(in millions):

Percentage Carrying Value
Ownership as of
Company Name December 31, 2004 2004 2003

Grupo TFM 46.6 % $ 389.6 $ 392.1
Southern Capital 50.0 % 29.1 28.0
PCRC(a) 50.0 % 2.4 4.5
Mexrail 51.0 % 30.0 —
Other 33.8 18.1

$ 484.9 $ 442.7


	Percentage
	Ownership at			Carrying Value
Company	December 31, 2006			2006		2005

Southern Capital		50	%	$	29.2	$	27.9
PCRC		50	%		18.3		18.1
FTVM		25	%		13.9		10.9
Other					3.5		3.4

Total				$	64.9	$	60.3


~~(a)~~	~~The Company owns 50% of the outstanding voting common stock of PCRC.~~


	~~Grupo TFM~~

In July 1996, the Company and Transportación Maritima Mexicana, S.A. de C.V. (now Grupo TMM, S.A., “TMM”) 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 that directly links 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 Company (“UP”) at Laredo, Texas.

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~Southern Capital.

The Company and 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 $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.

At December 31, 2004, the Company’s investment in Grupo TFM was approximately $389.6 million. The Company’s interest in Grupo TFM is approximately 46.6%, with 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. As of December 31, 2004 and 2003, $2.5 million and $1.3 million, respectively, is reflected as a related party account receivable in the Company’s consolidated balance sheet related to this management services agreement. Total management fees billed to Grupo TFM were $1.3 million, $1.3 million and $1.2 million for the years ended December 31, 2004, 2003 and 2002, respectively. The Company accounts for its investment in Grupo TFM under the equity method.

The Company is party to certain agreements with TMM covering Grupo TFM, which contain “change of control” provisions, provisions intended to preserve the Company’s and TMM’s proportionate ownership of the venture, and super majority provisions with respect to voting on certain significant transactions. Such agreements also provide a right of first refusal in the event that either party initiates a divestiture of its equity interest in Grupo TFM. Under certain circumstances, such agreements could affect the Company’s ownership percentage and rights in these equity affiliates. All of these agreements terminate upon completion of the acquisition by the Company of the shares of Grupo TFM currently controlled by TMM.

~~KCS and TMM Enter Into Acquisition Agreement.~~ On December 15, 2004, the Company entered into the Acquisition Agreement with TMM and other parties under which KCS would acquire control of TFM through the purchase of shares of common stock of Grupo TFM. Grupo TFM holds an 80% economic interest in TFM and all of the shares of stock with full voting rights of TFM. The remaining 20% economic interest in TFM is owned by the Mexican government in the form of shares with limited voting rights. The Mexican government has put rights with respect to its TFM shares as discussed below. The obligations of KCS and TMM to complete the Acquisition are subject to a number of conditions which are discussed below.

The purpose of the Acquisition is to place TFM under the control of KCS, which already controls KCSR, Tex-Mex and Gateway Eastern. Management believes that common control of these railroads, which are already physically linked in an end-to-end configuration, will enhance competition and give shippers in the NAFTA trade corridor a strong transportation alternative as they make their decisions to move goods between the United States, Mexico and Canada. In addition, our management believes that this common control offers stockholders greater value through the operating efficiencies expected to come from common ownership and control.

Under the terms of the Acquisition Agreement, KCS would acquire all of TMM’s interest in Grupo TFM for $200.0 million in cash, 18 million shares of KCS common stock, $47.0 million in a two-year promissory note (the “Escrow Note”), and up to $110.0 million payable (“VAT Contingency Payment”) in a combination of cash and KCS common stock. Cash of $200.0 million has been deposited in a restricted escrow account. Both the $200.0 million cash and the 18 million shares of KCS common stock are payable at closing. The $47 million Escrow Note is subject to indemnification provisions of the Acquisition Agreement. The amount payable under the Escrow Note can be reduced by the amount of certain potential losses related to breaches of certain representations, warranties, or covenants in the Acquisition Agreement or claims relating thereto, or under other conditions specified in the Indemnity Escrow Agreement. An additional $110.0 million

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

~~could become payable upon the Final Resolution of the VAT Claim and Put, as defined in the Acquisition Agreement.~~

In connection with the Acquisition, KCS has entered into a consulting agreement with José F. Serrano International Business, S.A. de C.V., a consulting company controlled by Jose Serrano, Chairman of the Board of TMM, Grupo TFM and TFM, to become effective upon the closing of the Acquisition, pursuant to which it would provide consulting services to KCS in connection with the portion of the business of KCS in Mexico for a period of three years. As consideration for these services, the consulting company would receive an annual fee of $3,000,000. The Consulting Agreement requires KCS to deposit the total amount of fees payable under the Consulting Agreement ($9,000,000) in an escrow account to be held and released in accordance with the terms and conditions of the Consulting Agreement and the applicable escrow agreement.

On October 6, 2004, Mexico’s Foreign Investment Commission (“FIC”) notified KCS of its approval of KCS’s new application for authority to acquire TMM’s interest in TFM. This approval is necessary for a foreign company to become a majority owner of a Mexican railway company and remains valid until October 5, 2005. KCS’s notification with respect to the acquisition of the Grupo TFM shares was filed with the Mexican Competition Commission (“MCC” or the “Competition Commission”) on April 21, 2003. KCS received formal written notice that the MCC had approved the proposed consolidation, without conditions. Through a series of extensions received from MCC, KCS’s authority to purchase TMM’s interest in TFM remains valid through April 5, 2005. On January 25, 2005, the 30-day waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“HSR”) expired without a formal request from the U.S. Department of Justice (“DOJ”) for additional information or documentary material. This will allow KCS and TMM to complete the transaction without an antitrust challenge from the DOJ. With the extension of the Competition Commission approval, approval from the Mexican Foreign Investment Commission and completion of the HSR process, our shareholder approval of the issuance of the shares required under the Acquisition Agreement was the final condition precedent to completion of the proposed Acquisition. On March 29, 2005, at a special meeting of the KCS shareholders approval of the acquisition as described above was received. Closing on the acquisition is expected to occur on April 1, 2005.

~~Mexican Government’s Put Rights With Respect to TFM Stock.~~ Under the terms of the January 31, 1997 share purchase agreement through which Grupo TFM agreed to purchase the shares of TFM, as amended by the parties on June 9, 1997 (the “TFM Share Purchase Agreement”), the Mexican government has the right to compel the purchase of its 20% interest in TFM (referred to as the “Put”) by Grupo TFM following its compliance with the terms and conditions of the TFM Share Purchase Agreement. Upon exercise of the Put in accordance with the terms of the TFM Share Purchase Agreement, Grupo TFM would be obligated to purchase the TFM capital stock at the initial share price paid by Grupo TFM adjusted for interest and inflation. Prior to October 30, 2003, Grupo TFM filed suit in the Federal District Court of Mexico City seeking, among other things, a declaratory judgment interpreting whether Grupo TFM was obligated to honor its obligation under the TFM Share Purchase Agreement, as the Mexican government had not made any effort to sell the TFM shares subject to the Put prior to October 31, 2003. In its suit, Grupo TFM named TMM and KCS as additional interested parties. The Mexican Court has admitted Grupo TFM’s complaint and issued an injunction that blocked the Mexican government from exercising the Put. The Mexican government provided Grupo TFM with notice of its intention to sell its interest in TFM on October 30, 2003. Grupo TFM has responded to the Mexican government’s notice reaffirming its right and interest in purchasing the Mexican government’s remaining interest in TFM, but also advising the Mexican government that it would not take any action until its lawsuit seeking a declaratory judgment was resolved. In the event that Grupo TFM does not purchase the Mexican government’s 20% interest in TFM, TMM and KCS, or either of TMM or KCS alone, would, following notification by the Mexican government in accordance with the terms of the TFM Share Purchase Agreement, be obligated to purchase the Mexican government’s remaining interest in TFM. As this matter is currently the subject of litigation in Mexico to which the Mexican government, Grupo TFM, TMM and KCS are parties, KCS management does not believe it is likely that the

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

Mexican government will seek to exercise the Put until the litigation is resolved. On completion of the Acquisition, KCS will assume TMM’s rights and obligations to make any payment upon the exercise by the Mexican government of the Put and will indemnify TMM and its affiliates, and their respective officers, directors, employees and shareholders, against obligations or liabilities relating thereto. If KCS had been required to purchase this interest as of December 31, 2004, the total purchase price would have been approximately $468 million.

~~Value Added Tax (“VAT”) Lawsuit and VAT Contingency Payment under the Acquisition Agreement.~~ The VAT lawsuit (“VAT Claim”) arose out of the Mexican Treasury’s delivery of a VAT credit certificate to a Mexican governmental agency rather than to TFM in 1997. The face value of the VAT credit at issue is 2,111,111,790 pesos or approximately $189 million in U.S. dollars, based on current exchange rates. The amount of the VAT refund will, in accordance with Mexican law, reflect the face value of the VAT credit adjusted for inflation and interest from 1997.

After several Mexican Fiscal Court and Mexican appellate court rulings during 2002 and 2003, on January 19, 2004, TFM received a Special Certificate from the Mexican Federal Treasury in the amount of $2.1 billion pesos. The Special Certificate delivered to TFM on January 19, 2004 has the same face amount as the original VAT refund claimed by TFM in 1997. TFM also filed a complaint against the Mexican government, seeking to have the amount of the Special Certificate adjusted to reflect interest and inflation in accordance with Mexican law. The Mexican Fiscal Court initially denied TFM’s claim. In a decision dated November 24, 2004, the Mexican Federal Appellate Court upheld TFM’s claim that it is entitled to inflation and interest from 1997 on the VAT refund. The Federal Appellate Court remanded the case to the Mexican Fiscal Court with instructions to enter a new order consistent with this decision. On January 26, 2005, the Mexican Fiscal Court issued from the bench an oral order implementing the Appellate Court decision. On February 18, 2005, TFM was served with the written order from the Mexican Fiscal Court.

Under the Acquisition Agreement, in the event of the Final Resolution of the VAT Claim and Put (as such term is defined in the Acquisition Agreement), KCS will be obligated to pay to TMM an additional amount (referred to as the “VAT Contingency Payment”) of up to $110 million payable in a combination of cash and KCS common stock. If the Acquisition is completed, KCS will assume TMM’s obligations to make any payment upon the successful exercise by the Mexican government of the Put and will indemnify TMM and its affiliates, and their respective officers, directors, employees and shareholders, against obligations or liabilities relating thereto.

~~1997 Tax Audit Summary.~~ TFM was served on January 19, 2004 with an official letter notifying TFM of the Mexican government’s preliminary findings and conclusions arising from its tax audit of TFM’s 1997 tax returns (“Tax Audit Summary”). In the Tax Audit Summary, the Mexican government notified TFM of its preliminary conclusion that the documentation provided by TFM in support of the VAT refund claim and depreciation of the TFM concession title, and the assets reported on TFM’s 1997 tax return do not comply with the formalities required by the applicable tax legislation. In addition, the Mexican government attached the Special Certificate pending resolution of the audit. TFM has advised that it has, within the time allowed by the Tax Audit Summary, contested the conclusions of the Mexican tax authorities, and it has filed a constitutional appeal against the Tax Audit Summary, alleging the process followed by the Mexican government violated TFM’s constitutional rights. On March 16, 2005, TFM was notified by the Mexican Fiscal Administration Service (~~“Servicio de Administración Tributaria”~~ ~~or the~~~~“SAT”~~) that it had finished its audit of TFM’s 1997 tax returns. The SAT had not yet assessed any penalties or taxes against TFM as a result of the audit. In the notice, the SAT stated that TFM did not supply documentation complying with the requirements of the Mexican fiscal code and, therefore, it was not entitled in its 1997 tax returns to depreciate and deduct the concession title, the railway equipment and other assets that were assets of TFM at the time that it was privatized in 1997. KCS and TMM continue discussions with the Mexican government to resolve the outstanding disputes between the parties.

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~


	~~Mexrail~~

On August 16, 2004, KCS, TMM and TFM entered into a new Stock Purchase Agreement (“New Mexrail Stock Purchase Agreement”). Pursuant to the terms of that agreement, KCS purchased from TFM 51% of the outstanding shares of Mexrail, a wholly-owned subsidiary of TFM, for $32.7 million and placed those shares into trust pending STB approval to exercise common control over KCSR, Gateway Eastern and Tex-Mex. Pending the STB’s approval, KCS recorded $2.7 million in losses “Equity in net earnings (losses) of unconsolidated affiliates” representing the Company’s 51% share of Mexrail’s losses for the period from August 16, 2004 through December 31, 2004. The Company’s management expects to complete an evaluation of the fair value of the assets and liabilities of Mexrail in the first quarter of 2005. The terms of the New Mexrail Stock Purchase Agreement are substantially similar to the May 9, 2003 Stock Purchase Agreement, but TFM does not have any right to repurchase the Mexrail shares sold to KCS and KCS has an option which, if not exercised on or before October 31, 2005, becomes an obligation on October 31, 2005, to purchase the remaining shares of Mexrail owned by TFM at a price of $31.4 million. The purchase option has been recorded as a related party payable and noncurrent asset on the balance sheet of KCS at December 31, 2004. On November 29, 2004, the STB approved our application for authority to control KCSR, Gateway Eastern and Tex-Mex which approval became effective on December 29, 2004. The shares representing 51% ownership of Mexrail were transferred by the trustee to KCS on January 1, 2005; accordingly KCS will consolidate Mexrail beginning January 1, 2005.

The Company has notes receivable of $19.5 million and $6.1 million as of December 31, 2004 and 2003, respectively, from Tex-Mex related to certain rehabilitation and maintenance projects. The notes receivable are interest bearing, $9.0 million at an annual rate of LIBOR plus 3% and $10.5 million at 5.5%, and are included as investments in the accompanying balance sheet.

The Company has an account receivable from related parties of $4.9 million as of December 31, 2004 and 2003, from Tex-Mex related to certain materials and services provided in the normal course of operations. Total amounts billed to Tex-Mex were $4.5 million, $4.7 million and $1.9 million for the years ended December 31, 2004, 2003 and 2002, respectively.


	~~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.~~Capital. Southern Capital’s principal operations are the acquisition of locomotives, rolling stock and other railroad equipment and the leasing ~~thereof to the Company.~~thereof. The Company holds a ~~50%~~fifty percent 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. Southern Capital has acquired additional equipment since its inception, all of which is leased to KCSR.

KCSR paid Southern Capital $26.5 million, $30.1 million and $32.5 million ~~$35.3 million~~in 2006, 2005 and ~~$28.7 million~~2004, respectively, under ~~these~~ operating ~~leases in 2004, 2003 and 2002, respectively.~~leases. 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~~equal to $2.7 million, $3.6 million and $4.4 million ~~$4.5 million~~in 2006, 2005 and ~~$4.5 million in~~ 2004, ~~2003~~respectively. In 2006, 2005 and ~~2002, respectively). During~~ 2004, the Company received cash dividends of $4.5 million, $8.3 million and $8.8 million, respectively, from Southern Capital. ~~No dividends were received from Southern Capital during 2003 or 2002.~~

During 2005 and 2004, Southern Capital recorded ~~a gain~~gains of ~~approximately~~$7.7 million and $6.0 million, respectively, related to the sale of locomotives to ~~KCSR.~~KCSR, but Southern Capital recorded no such gains in 2006. For purposes of recording its share of Southern Capital earnings, the Company has

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

recorded its share of the ~~gain~~gains as a reduction to the cost basis of the equipment acquired. As a result, the Company will recognize its equity in the ~~gain~~gains over the remaining depreciable life of the locomotives as a reduction of depreciation expense.

~~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,~~5, 2002, Southern Capital refinanced the outstanding balance of ~~this~~a bridge loan through the issuance of approximately $167.6 million of 5.7% pass through trust certificates and proceeds from the sale of 50 locomotives. Of this amount, $104.0 million iswas secured by all of the locomotives and rolling stock owned by Southern Capital (other than the 50 locomotives, which were sold, as discussed below) and rental payments payable by KCSR under the operating and financing 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,~~through 2022, are insured under a financial guarantee insurance policy by MBIA Insurance Corporation (“MBIA”). KCSR leases or subleases all of the equipment securing the pass through certificates.

The remaining amount of pass through trust certificates, approximately $63.6 million, was assigned to General Electric Corporation, ~~(“GE”),~~ the buyer of the 50 locomotives, and is secured by the sold ~~locomotives.~~locomotives and

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

rental payments payable by KCSR under the sublease. Southern Capital does not have the option, nor is it obligated to repurchase or redeem the lease receivable or related equipment on or prior to the expiration of the lease agreement entered into with KCSR at the time of the sale. Southern Capital does not guarantee the lease payments of KCSR and has no obligation to make such payments if KCSR should fail to do so. In the event of a default by KCSR, ~~a third party insurance company,~~ MBIA guarantees the outstanding debt and may seize the collateralized assets, or find a third party lessee to continue making the rental payments to satisfy the debt requirements.


	~~Panama Canal Railway Company~~

Panama Canal Railway Company.

~~In January 1998, the Republic of Panama awarded~~

PCRC, a joint venture ~~between~~company owed equally by KCS and Mi-Jack Products, Inc. ~~(“Mi-Jack”)~~, has the concession from the Republic of Panama to reconstruct and operate the Panama Canal Railway, a47-mile railroad located adjacent to the Panama Canal ~~which~~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.~~ Panarail operates and promotes commuter and tourist passenger service over the Panama Canal Railway. ~~Passenger service started during July 2001.~~

~~As of December 31, 2004, the~~

The Company has invested ~~approximately $23.9~~$31.5 million ($12.9 million of equity and $18.6 million of subordinated loans) toward the reconstruction and operations of the Panama Canal ~~Railway. This investment is comprised~~Railway as of ~~$12.9 million of equity and $11.0 million of subordinated loans. These~~December 31, 2006. The 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~~the reconstruction project with the International Finance Corporation (“IFC”), a member of the World Bank Group. The financing is comprised of a $5 million investment by IFC and senior loans through IFC in an aggregate amount of $39.4 million. Additionally, PCRC has $5.8 million of equipment loans and other capital leases totaling $2.0 million. IFC’s investment of $5 million in PCRC is comprised of non-voting preferred shares which pay a 10% cumulative dividend. On March 28, 2005, PCRC and the IFC finalized an agreement whereby PCRC would redeem the shares subscribed and owned by IFC pursuant to the IFC Subscription. Under the agreement, PCRC will pay to the IFC $10.5 million. These shares have a recorded value of $5.0 million and approximately $2.6 million in accrued unpaid dividends. When the transaction is completed, PCRC will record an additional cost of approximately $2.9 million to reflect the premium paid to IFC and, as a result, KCS expects to record its share

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

~~of this cost of approximately $1.5 million in recording its equity in earnings of PCRC in the first quarter of 2005.~~

Under the terms of the loan agreement with IFC, the Company is a guarantor for up to ~~$5.6~~$4.4 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%~~half of the outstanding senior loans. The Company is also a guarantor for up to ~~$1.4~~$0.5 million of the equipment loans and ~~approximately $100,000 relating to the other~~ capital leases, and has issued antwo irrevocable ~~letter~~letters of credit ~~in the amount of $1.5~~totaling approximately $2.0 million to fulfill the Company’s ~~50%~~fifty percent guarantee of ~~a $2.9~~approximately $4.0 million equipment loan. ~~The cost~~

Ferrocarril y Terminal del Valle de México, S.A. de C.V. (Mexico Valley Railway and Terminal or “FTVM”).

FTVM provides railroad services as well as ancillary services, including those related to interconnection, switching and haulage services in the greater Mexico City area. KCSM holds 25% of the ~~reconstruction totaled approximately $80 million.~~share capital of FTVM. The other shareholders of FTVM, each holding a 25% interest, are Ferrocarril Mexicano, S.A. de C.V. (“Ferromex”), Ferrocarril del Sureste, S.A. de C.V. (“Ferrosur”) and the Mexican government.

Pursuant to the concession, KCSM is required to grant rights to use portions of its track to Ferromex, Ferrosur and FTVM, and these companies are required to grant KCSM the rights to use portions of their tracks.

Financial Information.

Financial information of unconsolidated affiliates that the Company accounted for under the equity method is presented below(in ~~the following table.~~millions). Amounts, including those for Grupo ~~TFM,~~KCSM, are presented under U.S. GAAP. Certain prior year amounts have been reclassified to reflect amounts from applicable audited financial statements (~~in millions)~~.

As of and for the Twelve Months Ended
December 31, 2004

Grupo Southern
Mexrail TFM(1) Capital(2) PCRC

Investment in unconsolidated affiliates $ 30.0 $ 389.6 $ 29.1 $ 2.4
Equity in net assets of unconsolidated affiliates 27.1 375.0 29.1 2.4
Financial Condition:

Current assets $ 29.8 $ 252.7 $ 2.3 $ 4.2
Non-current assets 71.2 1,982.3 113.5 83.4

Assets $ 101.0 $ 2,235.0 $ 115.8 $ 87.6

Current liabilities $ 47.3 $ 211.5 $ 1.2 $ 10.7
Non-current liabilities 0.7 865.4 56.5 72.2
Minority interest — 353.3 — —
Equity of stockholders and partners 53.0 804.8 58.1 4.7

Liabilities and equity $ 101.0 $ 2,235.0 $ 115.8 $ 87.6

Operating results:

Revenues $ 60.1 $ 699.2 $ 22.7 $ 10.1

Costs and expenses $ 73.8 $ 593.1 $ 17.2 $ 9.2

Net income (loss) $ (7.9 ) $ (8.3 ) $ 11.8 $ (4.2 )


~~(1)~~	~~KCS equity in earnings of Grupo TFM excludes loss on sale of Mexrail to KCS of $4.2 million, net of tax and after minority interest.~~

~~(2)~~	~~KCS equity in earnings of Southern Capital excludes gain on sale of locomotives to KCSR of $6.0 million, net of tax.~~

78
73

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)

As of and for the Twelve Months
Ended December 31, 2003

Grupo Southern
TFM Capital PCRC(a)

Investment in unconsolidated affiliates $ 392.1 $ 28.0 $ 4.5
Equity in net assets of unconsolidated affiliates 378.9 28.0 4.5
Financial Condition:

Current assets $ 225.7 $ 5.0 $ 2.5
Non-current assets 2,111.8 127.3 85.3

Assets $ 2,337.5 $ 132.3 $ 87.8

Current liabilities $ 362.7 $ 1.2 $ 9.9
Non-current liabilities 806.7 75.0 68.9
Minority interest 354.9 — —
Equity of stockholders and partners 813.2 56.1 9.0

Liabilities and equity $ 2,337.5 $ 132.3 $ 87.8

Operating results:

Revenues $ 698.5 $ 31.3 $ 7.8

Costs and expenses $ 591.0 $ 27.6 $ 9.1

Net income (loss) $ 27.3 $ 3.6 $ (6.1 )

As of and for the Year ended

December 31, 2006
Southern
FTVM Capital PCRC

Investment in unconsolidated affiliates $ 13.9 $ 29.2 $ 18.3
Equity in net assets of unconsolidated affiliates 12.6 29.2 (0.3 )
Financial condition:

Current assets $ 46.4 $ 2.4 $ 5.4
Other assets 33.9 87.1 78.7

Assets $ 80.3 $ 89.5 $ 84.1

Current liabilities $ 13.5 $ — $ 14.6
Long-term liabilities 16.5 31.1 70.0
Equity of stockholders and partners 50.3 58.4 (0.5 )

Liabilities and equity $ 80.3 $ 89.5 $ 84.1

Operating results:

Revenues $ 60.5 $ 18.1 $ 19.0
Expenses 45.7 7.4 20.9

Net income (loss) $ 14.8 $ 10.7 $ (1.9 )


	As of and for the
	Nine Months		As of and for the
	Ended		Year Ended
	December 31, 2005		December 31, 2005
			Southern
	FTVM		Capital		PCRC

Investment in unconsolidated affiliates	$	10.9	$	27.9	$	18.1
Equity in net assets of unconsolidated affiliates		9.6		27.9		0.6
Financial condition:
Current assets	$	35.4	$	5.2	$	5.2
Other assets		28.1		92.8		81.5

Assets	$	63.5	$	98.0	$	86.7

Current liabilities	$	9.3	$	1.0	$	13.9
Long-term liabilities		15.8		41.2		71.5
Equity of stockholders and partners		38.4		55.8		1.3

Liabilities and equity	$	63.5	$	98.0	$	86.7

Operating results:
Revenues	$	55.3	$	27.4	$	17.5
Expenses		45.9		14.3		21.0

Net income (loss)	$	9.4	$	13.1	$	(3.5	)


~~(a)~~	~~Certain amounts have been reclassified as a result of audit adjustments.~~

As of and for the Twelve Months
Ended December 31, 2002

Grupo Southern
TFM Capital PCRC

Operating results:

Revenues $ 712.1 $ 31.0 $ 5.0

Costs and expenses $ 553.0 $ 26.4 $ 12.9

Net income (loss) $ 110.2 $ 2.7 $ (7.9 )

Kansas City Southern

~~The Company, Grupo TFM, and certain of their affiliates entered into an agreement on February 27, 2002 with TFM~~

Notes to ~~sell to TFM~~Consolidated Financial Statements — (Continued)

As of and for the Year Ended

December 31, 2004
Grupo
Southern

Mexrail KCSM Capital PCRC

Investment in unconsolidated affiliates $ 30.0 $ 389.6 $ 29.1 $ 13.4
Equity in net assets of unconsolidated affiliates 27.1 375.0 29.1 2.4
Financial condition:

Current assets $ 29.8 $ 252.7 $ 2.3 $ 4.2
Other assets 71.2 1,982.3 113.5 83.4

Assets $ 101.0 $ 2,235.0 $ 115.8 $ 87.6

Current liabilities 47.3 211.5 1.2 10.7
Long-term liabilities 0.7 865.4 56.5 72.2
Minority interest — 353.3 — —
Equity of stockholders and partners 53.0 804.8 58.1 4.7

Liabilities and equity $ 101.0 $ 2,235.0 $ 115.8 $ 87.6

Operating results:

Revenues $ 66.5 $ 701.8 $ 29.0 $ 10.1
Expenses 74.4 710.1 17.2 14.3

Net income (loss) $ (7.9 ) $ (8.3 ) $ 11.8 $ (4.2 )

KCSM purchased all of the ~~common stock~~shares of ~~Mexrail. The sale closed~~Mexrail from TMM and KCS on March 27, 2002. Accordingly for the period from January 1, 2004, through July 31, 2004, ~~and for years ended December 31, 2003 and 2002,~~ the results of Mexrail are consolidated into the results of Grupo ~~TFM.~~KCSM.

The effects of foreign currency transactions and capitalized interest prior to June 23, 1997, which are not recorded on Grupo TFM’s books, result in the difference between the carrying amount of the Company’s investment in Grupo TFM and the underlying equity in net assets. Additionally, the purchase by TFM of the Mexican government’s former 24.6% interest in Grupo 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 is being amortized against the Company’s equity in earnings from Grupo TFM over a 33 year period, which was the estimate of the average remaining useful life of Grupo TFM’s concession assets.

Note 4. Acquisitions

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

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.

~~Foreign Exchange Matters.~~In ~~connection~~accordance 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”)~~141 “Business Combinations”, the Company allocates the purchase price of its acquisitions to the tangible and ~~related authoritative guidance.~~intangible assets and liabilities of the acquired entity based on their fair values. The excess of the purchase price over the fair value is recorded as goodwill. The fair values assigned to assets acquired and liabilities are based on valuations prepared by independent third party appraisal firms, published market prices and management estimates.

Acquisition of Controlling Interest in Grupo ~~TFM uses~~KCSM.

April 1, 2005 — Acquisition Agreement. In furtherance of the ~~U.S. dollar as its functional currency. Equity earnings (losses) from~~Company’s strategy for expansion into Mexico, on December 15, 2004, the Company entered into the Amended and Restated Acquisition Agreement (the “Acquisition Agreement”) with TMM and other parties under which KCS would acquire control of KCSM through the purchase of shares of common stock of Grupo ~~TFM included~~KCSM. At the time, Grupo KCSM held an 80% interest in KCSM and all of the shares of stock with full voting rights of KCSM. The remaining 20% economic interest in KCSM was owned by the Mexican government in the ~~Company’s results~~form of ~~operations~~shares with limited voting rights.

Under the terms of the Acquisition Agreement, KCS acquired all of TMM’s 48.5% effective interest in Grupo KCSM on April 1, 2005, in exchange for $200.0 million in cash, 18 million shares of KCS common stock, and two-year promissory notes in the aggregate amount of $47.0 million (the “Escrow Notes”), as well as $27.5 million in transaction costs for a total purchase price of $594.4 million. The $47.0 million Escrow Notes are subject to reduction pursuant to the indemnification provisions of the Acquisition Agreement for

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

certain potential losses related to incorrect representations and warranties, or breaches of covenants in the Acquisition Agreement or claims relating thereto, or under other conditions specified in the Indemnity Escrow Agreement.

In exchange for the purchase price of $594.4 million, KCS acquired 48.5% of Grupo KCSM (or 38.8% of KCSM). On a preliminary basis, the excess of purchase price over the historical book value of the assets resulted in a net increase in the basis of the assets of $199.6 million. As a result of the ongoing valuation of certain assets and liabilities, during the fourth quarter of 2005, Grupo KCSM and KCSM recognized changes to the preliminary allocation of purchase price, which was pushed down by KCS. In addition, the KCS purchase price was increased $4.4 million, relating primarily to an increase in the estimates for severance and relocation costs.

In connection with the evaluation of the fair values of the assets and liabilities of Grupo KCSM, certain assets were identified as having little or no value to KCS as the acquiring company. Because KCS acquired only 48.5% of Grupo KCSM (or 38.8% of KCSM) in this transaction, the allocation of the excess purchase price over book value of net assets was limited to the acquired percentage. Accordingly, a reduction in the assets of Grupo KCSM was limited to the acquired percentage and any residual was charged to expense. Grupo KCSM operating expenses for the year ended December 31, 2005 included $39.5 million relating to decreases in the basis of certain assets, the most significant of which was the write off of a deferred employee profit sharing asset of $35.6 million as a result of legal rulings in Mexico.

September 12, 2005, Completion of VAT/Put Settlement. On September 12, 2005, the Company and its subsidiaries, KCSM and Grupo KCSM, along with TMM, entered into a settlement agreement with the Mexican government, resolving the controversies and disputes between the companies and the Mexican government concerning the payment of a value added tax (“VAT”) refund to KCSM and the obligation (“Put”) to purchase the remaining shares of KCSM owned by the Mexican government (the “VAT/Put Settlement”). As a result of the VAT/Put Settlement, KCS and its subsidiaries own 100% of Grupo KCSM and KCSM; the potential obligation of KCS, Grupo KCSM and TMM to acquire the Mexican government’s remaining 20% ownership of KCSM was eliminated; and the legal obligation of the Mexican government to issue the VAT refund to KCSM was satisfied. There was no cash exchanged between the parties to the settlement agreement. In addition, the parties entered into mutual releases of all existing and potential claims relating to the VAT refund and the Put obligation, and entered into an agreement to dismiss all of the existing litigation between the parties.

The VAT/Put Settlement had two separate impacts — first, the resolution of a pre-acquisition contingency related to the April 1, 2005, transaction and second, KCSM’s acquisition of the minority interest held by the Mexican government.

Resolution of Pre-Acquisition Contingencies.

Both the VAT refund claim and the Mexican government’s put rights were pre-acquisition contingencies. Accordingly, the impact of the acquired asset and the resulting liability was reflected as adjustments to the preliminary purchase accounting described above. Because there was no market for Grupo KCSM stock, management assessed the fair value of the government’s shares acquired in the settlement to be properly estimated as the pro rata equivalent of the fair value of Grupo KCSM stock paid to TMM under the Acquisition Agreement. Based on this assessment, the fair value of the Mexican government’s shares was determined to be $305.5 million.

Under the terms of the Acquisition Agreement, KCS acquired TMM’s 51% interest in the VAT refund claim as settled. Accordingly, the preliminary purchase accounting for the Grupo KCSM acquisition was adjusted to reflect as an asset the ~~Company’s~~fair value of the acquisition of TMM’s proportionate share of ~~any such translation gains~~the VAT refund claim of $155.8 million.

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

In accordance with the Acquisition Agreement, a contingent payment of an additional purchase price of $110.0 million became payable to TMM as a result of the final resolution of the VAT Claim and ~~losses that Grupo TFM records~~Put, which was to be settled in three parts: (i) $35.0 million in stock (shares determined based on the VWAP 20 days prior to the final resolution of the VAT Claim and Put, as defined in the ~~process~~Acquisition Agreement); (ii) $35.0 million in cash at time of ~~translating certain transactions~~final resolution of the VAT Claim and Put, as defined in the Acquisition Agreement; and (iii) up to an additional $40.0 million in stock (shares to be determined in accordance with the provisions of the Acquisition Agreement) payable no more than five years from the final closing date (April 1, 2005). The liability was non-interest bearing, therefore it was recorded at its present value based on a 5.0% discount rate, consistent with the stated rate of similar interest bearing notes in the Acquisition Agreement.

The remaining fair value of the Mexican ~~pesos~~government’s shares obtained in the VAT/Put Settlement, $149.7 million, was attributable to ~~U.S. dollars.~~

the previously existing 49% KCS interest in Grupo KCSM and was recorded as nonoperating income and was presented net of applicable legal, consulting and other fees of $17.8 million including, $9.0 million payable to JSIB, which became payable on final resolution of the VAT Claim and Put. The VAT/Put settlement gain was not taxable in Mexico. The Company ~~continues~~believes, based upon opinions of outside legal counsel and other factors, that the VAT/Put Settlement should not be taxable to ~~evaluate existing alternatives~~KCS for U.S. income tax purposes. Such position has not been examined by the taxing authority and it is possible that this position could be challenged. The amount of such tax would be material; however the Company believes that it would have the right to indemnification under the terms of the Acquisition Agreement.

KCSM Acquisition of Mexican Government Shares.

In connection with ~~respect~~the VAT/Put Settlement, the acquisition of the Mexican government’s interest was accounted for as a purchase. The aggregate carrying value of $375.6 million for the Mexican government shares (23.9% effective ownership — consisting of minority interest of $256.9 million and the Association in Participation Agreement with a book value of $118.7 million) exceeded the estimated fair value of this interest of $305.5 million representing the purchase price.

Purchase Price Allocation.

The allocation of the purchase price was finalized in 2006. Final adjustments to ~~utilizing foreign currency instruments to hedge its U.S. dollar investment in Grupo TFM as market conditions~~the purchase price allocation did not materially change the initial allocation or ~~exchange rates fluctuate. At~~financial results during the year. Settlement of severance and relocation was substantially completed during the year ended December 31, ~~2004, 2003~~2006.

Significant components of the allocation of the excess of the purchase price over the carrying value of the net assets acquired, including both the April 1, 2005, and ~~2002,~~ the ~~Company had no outstanding foreign currency hedging instruments.~~September 12, 2005, acquisitions, follow(in millions):

~~Results~~


Increase in current assets	$	10.6
Decrease in property and equipment		(29.0	)
Increase in concession assets		271.3
Increase in deferred income taxes		(81.9	)
Increase in other assets		83.6
Increase in current liabilities		(15.3	)
Increase in long-term liabilities		(111.5	)

Total	$	127.8

In addition, the existing excess in the carrying value of the Company’s investment over the book value of Grupo KCSM ($13.7 million) was recorded as an addition to property, plant and equipment, and Concession assets.

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

The following table summarizes the recorded fair values of the assets acquired and liabilities assumed at the dates of acquisition as adjusted for the above impacts(in millions):


Current assets	$	268.8
Property and equipment		532.6
Concession rights		1,383.1
Other assets		219.0

Total assets acquired	$	2,403.5

Current liabilities	$	288.3
Long-term debt		802.6
Other liabilities		128.2

Total liabilities acquired	$	1,219.1

Acquisition of Mexrail.

On August 16, 2004, KCS, TMM and KCSM entered into a new Stock Purchase Agreement. Pursuant to the terms of that agreement, KCS purchased from KCSM 51% of the outstanding shares of Mexrail, a wholly-owned subsidiary of KCSM, for $32.7 million and placed those shares into trust pending approval of the Surface Transportation Board (“STB”) to exercise common control over KCSR, the Gateway Eastern Railway Company (“Gateway Eastern”) and Tex-Mex. On November 29, 2004, the STB approved the Company’s application for authority to control KCSR, Gateway Eastern and Tex-Mex. The shares representing 51% ownership of Mexrail were transferred by the trustee to KCS, and KCS assumed control, on January 1, 2005.

The aggregate purchase price was $57.4 million including $32.7 million of cash with the remaining amount consisting of net receivables and payables with Mexrail and Grupo ~~TFM are reported under U.S. GAAP, while Grupo TFM reports its~~KCSM. The acquisition of Mexrail links KCSR physically to KCSM.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition on January 1, 2005(in millions):


Current assets	$	37.8
Property and equipment		108.2
Other assets		0.3

Total assets acquired	$	146.3

Current liabilities	$	59.7
Other liabilities		29.3

Total liabilities acquired	$	89.0

The allocation of the purchase price above reflected the final adjustments to the fair values of assets and liabilities of Mexrail. All severance reserves recorded for the Mexrail acquisition were expended prior to December 31, 2005.

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

Pro Forma Earnings. The following table reflects the pro forma financial results ~~under International Financial Reporting Standards (“IFRS”). Because~~for the ~~Company is required to report its equity~~twelve months ended December 31, 2005, as though the Grupo KCSM acquisition had occurred on January 1, 2005(unaudited, in millions except share and per share data):


	KCS and Mexrail		Grupo KCSM
	Historical and		Three Months
	Grupo KCSM		Ended
	Since April 1,		March 31,		Pro Forma
	2005		2005		Adjustments			Pro Forma

Revenues	$	1,352.0	$	170.1	$	—		$	1,522.1
Net income (loss)		100.9		0.1		(150.1	)		(49.1	)
Income (loss) from continuing operations available to common shareholders		91.4		0.1		(150.1	)		(58.6	)

Earnings (loss) per common share:
Basic	$	1.21						$	(0.74	)

Diluted		1.10							(0.74	)

Weighted average common shares outstanding(in thousands):
Basic		75,527				3,750			79,277

Diluted		92,747				(13,470	)		79,277

For purposes of comparison, pro forma earnings (losses) in Grupo TFM under U.S. GAAP and Grupo TFM reports under IFRS, 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) reportedwere reduced by the ~~Company.~~$131.9 million non-recurring, non-cash gain on the VAT/Put settlement.


Note 5.	Other Balance Sheet Captions

~~Note 4.~~

Other ~~Balance Sheet Captions~~

~~Accounts Receivable.~~ ~~Accounts receivable include~~Current Assets. Other current assets included the following items at December 31(in millions):

2004 2003

Accounts receivable $ 149.2 $ 125.0
Allowance for doubtful accounts (9.6 ) (10.4 )

Accounts receivable, net $ 139.6 $ 114.6

Bad debt expense $ 2.7 $ 1.9


	2006		2005

Prepaid expenses	$	16.4	$	10.1
Deferred income taxes		7.6		10.0
Deferred charge related to favorable railcar leases		11.3		11.3
Assets held for sale		47.9		—
Other		10.5		14.7

Other current assets, net	$	93.7	$	46.1

~~Other Current Assets.~~Kansas City Southern
~~Other current assets include the following items~~

Notes to Consolidated Financial Statements — (Continued)

Property and Equipment. Property and equipment and related accumulated depreciation are summarized below at December 31(in millions):

2004 2003

Deferred income taxes $ 13.8 $ 10.3
Prepaid expenses 3.8 2.9
Other 9.6 8.1

Total $ 27.2 $ 21.3


	2006		2005

Road properties	$	2,118.4	$	1,982.5
Equipment		468.4		388.0
Concession improvements		324.3		296.1
Computer software		76.1		71.8
Locomotives sale-leaseback		—		32.5
Other		38.9		166.7

Total		3,026.1		2,937.6
Accumulated depreciation		897.0		820.4

Net property and equipment		2,129.1		2,117.2
Construction in progress		323.1		181.1

Property and equipment, net	$	2,452.2	$	2,298.3

Depreciation of property and equipment totaled $93.8 million, $82.5 million, and $53.3 million, respectively, for 2006, 2005, and 2004.

Overhead Capitalization. KCS capitalizes certain overhead costs representing the indirect costs associated with construction and improvement projects. Overhead factors are periodically reviewed and adjusted to reflect current costs.

Concession Assets. As discussed in Note 1, the Mexican government granted KCSM the Concession to operate the northeast rail lines in Mexico. Concession assets and related amortization are summarized below at December 31(in millions):


	2006		2005

Road properties	$	1,231.4	$	1,227.6
Land		135.3		132.8
Other		32.3		41.2

Total		1,399.0		1,401.6
Accumulated amortization		95.7		41.2

Concession assets, net	$	1,303.3	$	1,360.4

Amortization of concession assets totaled $60.4 million and $44.9 million for 2006 and 2005.

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~Kansas City Southern

~~Properties.~~Notes to Consolidated Financial Statements — (Continued) ~~Properties and related accumulated depreciation and amortization are summarized below~~

Accrued Liabilities. Accrued liabilities included the following items at December 31(in millions):

2004 2003

Properties, at cost

Road properties $ 1,735.2 $ 1,663.3
Equipment 293.8 275.1
Computer software 68.3 64.6
Equipment under capital leases 4.1 6.6
Other 9.1 8.7

Total 2,110.5 2,018.3
Accumulated depreciation and amortization 755.3 734.3

Total 1,355.2 1,284.0
Construction in progress 68.8 78.5

Net Properties $ 1,424.0 $ 1,362.5

~~Accrued Liabilities.~~ ~~Accrued liabilities include the following items~~~~(in millions):~~

2004 2003

Claims reserves $ 35.1 $ 34.4
Prepaid freight charges due other railroads 30.5 19.7
Car hire per diem 9.2 9.0
Vacation accrual 9.9 10.1
Property and other taxes 7.2 5.2
Interest payable 5.9 6.6
Other 50.6 34.4

Total $ 148.4 $ 119.4


	2006		2005

Interest payable	$	16.7	$	17.9
Vacation accrual		13.2		12.6
Car hire per diem		27.2		28.1
Prepaid freight charges due other railroads		37.2		36.9
Claim reserves		88.9		55.1
Deferred credits related to unfavorable locomotive leases and maintenance contracts		9.7		9.7
Property and other taxes		32.4		24.8
Other		129.4		148.0

Accrued liabilities	$	354.7	$	333.1

~~Other Noncurrent Liabilities and Deferred Credits.~~ ~~Other noncurrent liabilities and deferred credits include the following items~~~~(in millions):~~

2004 2003

Claims reserves $ 39.9 $ 36.6
Accrued employee benefits 8.4 9.0
Deferred gain on sale of equipment to Southern Capital 8.7 13.7
Deferred gain on sale of Mexrail 5.9 6.1
Other 20.7 44.0

Total $ 83.6 $ 109.4

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~


Note 5.6.	Long-Term Debt

Indebtedness Outstanding. Long-term debt ~~and pertinent provisions follow~~follows at December 31(in millions):

2004 2003

KCS
$ 1.3 $ 1.3
KCSR

Borrowings pursuant to Amended 2004 Credit Facility
Revolving Credit Facility, variable interest rate at December 31, 2004 — 4.35%, due March 2007 — —
Term Loans, variable interest rate at December 31,2004 — 4.19%, due March 2008 249.2 98.5
7¹/2% Senior Notes, due June 15, 2009
200.0 200.0
9¹/2% Senior Notes, due October 1, 2008
200.0 200.0
Equipment Trust Certificates, 8.56% due serially to December 15, 2006 10.8 17.1
Capital Lease Obligations, 7.15% to 8.00%, due serially to September 30, 2009 1.5 1.9
Term Loans with State of Illinois, 3% to 5% due serially to 2009 2.2 2.8
Other
0.7 1.8

Total 665.7 523.4
Less: debt due within one year 9.9 9.9

Long-term debt $ 655.8 $ 513.5


	2006		2005

*KCS*
Debt obligations related to Grupo KCSM acquisition	$	83.3	$	158.7
Other debt obligations		0.2		0.2
*KCSR*
Revolving credit facility, variable interest rate, 6.850% at December 31, 2006, due 2011		90.0		92.0
Term loans, variable interest rate, 7.070% at December 31, 2006, due 2013		244.9		246.8
91/2% senior notes, due 2008		200.0		200.0
71/2% senior notes, due 2009		200.0		200.0
Capital lease obligations, 8.00%, due serially to 2009		0.8		1.1
Other debt obligations(iii)		12.7		32.0
*Tex-Mex*
RRIF loan, 4.29%, due serially to 2030		49.2		21.7
*KCSM*
Revolving credit facility, variable interest rate, due 2008		—		26.1
Term loans, variable interest rate, 7.475% at December 31, 2006, due 2008		46.7		76.0
101/4% senior notes, due 2007		4.0		150.0
121/2% senior notes, due 2012		178.6		178.3
93/8% senior notes, due 2012		460.0		460.0
75/8% senior notes, due 2013		175.0		—
Capital lease obligations, due serially to 2011		1.0		1.3
Fair market adjustment related to purchase accounting		10.6		16.4

Total		1,757.0		1,860.6
Less: Debt due within one year(i)(ii)		92.8		116.3

Long-term debt	$	1,664.2	$	1,744.3


(i)	Includes $1.9 million and $4.2 million at December 31, 2006 and 2005, respectively, of adjustments to reflect the fair value of the liabilities assumed in 2005.


(ii)	Includes current liability related to Grupo KCSM acquisition.

(iii)	In January 2006, $24.3 million of debt was repaid with locomotives through a non-cash transaction.

~~Amended 2004 Senior Secured Credit Facility.~~Kansas City Southern
~~During March 2004,~~

Notes to Consolidated Financial Statements — (Continued)

KCS Debt.

Debt Obligations Related to Grupo KCSM Acquisition. In connection with the acquisition of Grupo KCSM and the settlement of the VAT/Put, the Company ~~used~~recorded a $110.0 million liability payable to TMM in 2005. The liability was non-interest bearing, therefore it was recorded at its present value based on a 5% discount rate. At December 31, 2005, the Company recorded a current liability of $69.3 million to be settled upon final resolution of the Vat/Put, and $31.6 million as a non-current liability to be settled in 5 years.

On March 13, 2006, in settlement of the $110.0 million obligation, KCS paid $35 million in cash, issued 1,494,469 shares of KCS common stock at the volume weighted average price (“VWAP”) of $23.4197, as determined by the acquisition agreement, and issued a $40 million five-year non-interest bearing note. At December 31, 2006 the Company recorded a non-current liability of $32.4 million which will accrete at 5% annually until April 1, 2010 when payment of $40.0 million will be due.

Also, as part of the acquisition in 2005, KCS issued escrow notes totaling $47.0 million which are subject to reduction for certain potential losses related to breaches of certain representations, warranties or covenants in the acquisition agreement by TMM. The escrow notes are due April 1, 2007, and accrue interest at a stated rate of 5.0%. The principal and interest is payable in cash or in stock (shares to be determined based on ~~hand~~the VWAP 20 days prior to ~~repay approximately $98.5 million of debt relating to~~settlement) at the Company’s ~~former credit facility (“KCS~~discretion. At December 31, 2006 and 2005, the Company included $50.9 million as a current liability and $48.8 million as a non-current liability on the balance sheet, respectively.

At December 31, 2005, the Company recorded a $9.0 million one time incentive payment to JSIB, payable upon final resolution of the VAT/Put claim. On March 13, 2006, the Company paid $9.0 million in cash to JSIB.

KCSR Debt.

Revolving Credit ~~Facility”).~~Facility and Term Loans. On March 30, 2004, ~~the Company closed on~~KCSR entered into a ~~new~~ credit ~~facility (“~~agreement (the“2004 Credit ~~Facility”~~Agreement”)~~. The~~ which was amended during 2004 ~~Credit Facility consists of~~and 2005 to result in a ~~$100~~$125 million revolving credit facility ~~(“2004 Revolving Credit Facility”)~~ maturing on March 30, 2007, and a ~~$150~~$250 million ~~Term B~~term loan facility ~~(“Term B Loan Facility”)~~ maturing on March 30, 2008. The Term B Loan Facility was fully funded on the closing date and the proceeds are expected to be used to pay transaction costs and for other general corporate purposes, including additional investments in the Company’s Mexican affiliates. Up to $25.0 million of the 2004 Revolving Credit Facility is available for letters of credit and up to $15 million is available for swing line loans. The proceeds from future borrowings under the 2004 Revolving Credit Facility may be used for working capital and for general corporate purposes, including additional investments in the Company’s Mexican affiliates. The letters of credit may be used for general corporate purposes. Borrowings under the 2004 Credit Facility are secured by substantially all of the Company’s assets and are guaranteed by the majority of its subsidiaries.

~~The Term B Loan Facility and the 2004 Revolving Credit Facility bear~~amended term loan facility bore interest at the London Interbank Offered Rate (“LIBOR”) plus ~~an applicable margin or~~150 basis points. The amended revolving credit facility bore interest at ~~an alternative base rate~~the LIBOR plus an applicable margin. The applicable margin for the Term B Loan facility was 200 basis points over LIBOR for LIBOR borrowings. The applicable margin for the 2004 Revolving Credit Facility was set at 2.25% for LIBOR borrowings for the first six months and thereafter isa spread based on the Company’s leverage ratio ~~(defined~~ as defined in 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 and certain other non-cash charges) for the prior four fiscal quarters).

~~The~~ 2004 Credit ~~Facility requires~~Agreement. As of December 31, 2005, advances under the ~~payment~~revolving credit facility totaled $92.0 million and the term loan’s balance was $246.8 million. Revolver availability as of ~~a commitment fee of 0.50% per annum to~~December 31, 2005 was $33.0 million.

On April 28, 2006, KCS, KCSR and the ~~lenders on the average daily, unused~~other subsidiary guarantors named therein entered into an amended and restated credit agreement (the “2006 Credit Agreement”), in an aggregate amount of $371.1 million with The Bank of Nova Scotia and other lenders named in the 2006 Credit Agreement. Proceeds from the 2006 Credit Agreement were used to refinance the 2004 ~~Revolving~~ Credit ~~Facility. Additionally,~~Agreement. The 2006 Credit Agreement consists of (a) a ~~fee equal to the applicable margin for LIBOR priced borrowings under the 2004 Revolving Credit Facility will be paid on any~~$125.0 million revolving credit facility with a letter of credit ~~issued under~~sublimit of $25.0 million and swing line advances of up to $15.0 million, and (b) a $246.1 million term loan facility. The revolving credit facility bears interest at either LIBOR, or an alternate base rate, plus a spread based on the ~~2004 Revolving~~Company’s leverage ratio as defined in the 2006 Credit ~~Facility.~~Agreement. The term loan facility bears interest at either LIBOR plus 175 basis points or the alternative base rate plus 75 basis points. The maturity date for the revolving credit facility is April 28, 2011 and the maturity date of the term loan facility is April 28, 2013. The 2006 Credit Agreement contains covenants that restrict or prohibit certain actions, including, but not limited to, KCS’ ability to incur debt, create or suffer to exist liens, make prepayment of particular debt, pay dividends, make investments, engage in transactions with stockholders and affiliates, issue capital stock, sell certain assets, and engage in mergers and consolidations or in sale-leaseback transactions. In addition, KCS must meet certain consolidated interest coverage and leverage ratios. Failure to maintain compliance with the

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~Kansas City Southern

~~The 2004~~

Notes to Consolidated Financial Statements — (Continued)

covenants could constitute a default which could accelerate the payment of any outstanding amounts under the 2006 Credit ~~Facility contains certain provisions, covenants and restrictions customary for this type~~Agreement. Borrowings under the Credit Agreement are secured by substantially all of ~~debt and for borrowers with a similar credit rating. These provisions include, among others, restrictions on~~ the Company’s ~~ability~~domestic assets and are guaranteed by the majority of 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; or 8) make capital expenditures in excessdomestic subsidiaries. As of allowed amounts. In addition, the Company is required to comply with certain financial ratios, including minimum interest expense coverage and leverage ratios. The 2004 Credit Facility also contains certain customary events of default. These covenants, along with other provisions, could restrict maximum utilization of the 2004 Revolving Credit Facility. At December 31, ~~2004, KCS had available borrowing~~2006, advances under the ~~Revolving Credit Facility in the full amount of $100 million.~~

On December 22, 2004, the Company entered into an amendment and waiver of the 2004 Credit Facility. The credit agreement was amended to, among other things, increase the Term B Loan Facility by $100,000,000 to a total amount outstanding at December 31, 2004 of $249.2 million and decrease the borrowing spread by 25 basis points to 175 basis points for LIBOR borrowings. In addition, a waiver was granted that would allow KCSR to make an additional $55 million of capital expenditures during 2004 and 2005. The maturity date of the credit agreement was unchanged.

Approximately $3.8 million of debt issuance costs related to the 2004 Credit Facility (including the amendments) have been deferred and are being amortized over the respective terms of the loans. Debt retirement costs of approximately $4.2 million associated with the previous revolving credit facility totaled $90.0 million and the term ~~loan were recorded during the quarter ended March~~loans’ balance was $244.9 million. Revolver availability as of December 31, ~~2004.~~2006 was $35.0 million.

7¹/2%

On January 31, 2007, KCS provided written notice to the lenders under the 2006 Credit Agreement of certain representation and other defaults under the 2006 Credit Agreement arising from the potential defaults which existed under the KCSR indentures governing the Notes as described below. These defaults limited KCSR’s access to the revolving credit facility. In its notice of default, the Company also requested that the lenders waive these defaults. On February 5, 2007 the Company received a waiver of such defaults from all of the lenders under the 2006 Credit Agreement. The Company is currently not in default of the 2006 Credit Agreement and has access to the revolving credit facility.

Senior Notes.~~In June 2002,~~ KCSR ~~issued $200~~has outstanding $200.0 million of 79¹/2% senior unsecured notes issued during the third quarter of 2000 and due ~~June 15, 2009 (“~~October 1, 2008, and $200.0 million of 7¹/2% ~~Notes”). Net proceeds from the offering~~senior unsecured notes issued in June of ~~$195.8 million, together with cash, were used to repay term debt under the KCS Credit Facility~~2002 and ~~certain other secured indebtedness of the Company. The 7~~¹/2~~% Notes were subsequently exchanged for registered~~due June 12, 2009. These senior unsecured notes ~~with substantially identical terms. These registered notes~~ bear interest at a fixed annual ~~interest~~ rate ~~to be~~which is paid ~~semi-annually on June 15 and December 15 and are due June 15, 2009.~~semi-annually. These ~~registered~~senior notes are general unsecured obligations of KCSR but are guaranteed by ~~the Company~~KCS and certain of its domestic subsidiaries.

Consent Solicitation. On January 29, 2007, the Company commenced a consent solicitation to amend the indentures under which KCSR’s 91/2% Senior Notes due 2008 (the “91/2% Notes”) and 71/2% Senior Notes due 2009 (the “71/2% Notes” and together with the 91/2% Notes, the “Notes”) were issued. The purpose of the consent solicitation was to (i) resolve an inconsistency in the inclusion of certain expenses, but not the income, of restricted subsidiaries in the calculation of the consolidated coverage ratio under the indentures, (ii) amend the definition of refinancing indebtedness to allow the inclusion of certain related premiums, interest, fees and ~~contain~~expenses in permitted refinancing indebtedness and (iii) obtain waivers of any defaults arising from certain actions taken in the absence of such proposed amendments. On February 5, 2007, the Company obtained the requisite consents from the holders of each series of Notes to amend their respective indentures as described above and executed supplemental indentures containing such amendments and waivers.

Tex-Mex Debt.

RRIF Loan Agreement. On June 28, 2005, Tex-Mex entered into an agreement with Federal Railroad Administration (“FRA”) to borrow $50 million to be used for infrastructure improvements which are expected to increase efficiency and capacity in order to accommodate growing freight rail traffic related to the NAFTA corridor. At December 31, 2005, Tex-Mex had borrowed a net amount of $21.7 million under the loan agreement. Tex-Mex drew down the remaining $28.2 million during 2006. The note bears interest at 4.29% annually and the principal balance amortizes quarterly with a final maturity of July 13, 2030. The loan was made under the Railroad Rehabilitation and Improvement Financing (“RRIF”) Program administered by the FRA. The loan is guaranteed by Mexrail, which has issued a Pledge Agreement in favor of the lender equal to the gross revenues earned by Mexrail on per-car fees on traffic crossing the International Rail Bridge in Laredo, Texas.

On February 16, 2007, Tex-Mex and the FRA entered into amendment No. 1 and waiver No. 1 to the loan agreement, the purpose of which was to eliminate the obligation of Tex-Mex to provide audited annual financial statements to the FRA and to waive Tex-Mex’s failure to do so since entering into the loan agreement. To induce the FRA to agree to such amendment and waiver, the Company has agreed to provide the FRA with its audited annual financial statements and unaudited quarterly statements and has also agreed to guaranty the scheduled principal payment installments due to the FRA from Tex-Mex under the loan agreement on a rolling five-year basis.

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

KCSM Debt.

Revolving Credit Facility and Term Loans. On October 24, 2005, KCSM entered into a credit agreement (the “2005 KCSM Credit Agreement”) in an aggregate amount of $106.0 million, with a maturity of October 28, 2008. The 2005 KCSM Credit Agreement consisted of a $30.0 million revolving credit facility and a $76.0 million term loan facility secured by the locomotives and rail cars owned by KCSM’s subsidiary, Arrendadora. For dollar loans the facilities bear interest at LIBOR plus a spread based on KCSM’s leverage ratio as defined under the 2005 KCSM Credit Agreement. For peso loans the facilities bear interest at the TIIE rate plus a spread based on KCSM’s leverage ratio. Proceeds from the facilities were used primarily to pay down debt and for general corporate purposes. At December 31, 2005, advances under the revolving credit facility totaled $26.1 million, with $3.9 million remaining available under the facility. At December 31, 2006 there were no advances outstanding under the revolving credit facility and KCSM had $30.0 million of availability. On November 21, 2006, KCSM paid down $29.0 million of the term loan facility from the proceeds of its 75/8% senior notes offering. At December 31, 2006 and 2005, the term loans’ balance was $46.7 million and $76.0 million, respectively. The 2005 KCSM Credit Agreement contains covenants and restrictions similar to those in KCSR’s 2006 Credit Agreement.

On April 7, 2006, KCSM entered into an amendment and waiver (“Amendment and Waiver”) related to the 2005 KCSM Credit Agreement. The 2005 KCSM Credit Agreement was amended to (i) exclude certain payment obligations accrued under two locomotive maintenance agreements and under a track maintenance rehabilitation agreement from the definition of Indebtedness, (ii) eliminate certain minimum and multiple borrowing thresholds for peso borrowings under the revolving credit facility and (iii) eliminate the reporting requirement to provide unaudited consolidated financial statements for the fourth fiscal quarter. The Amendment and Waiver also waived certain reporting requirements, including the requirement of KCSM to provide audited consolidated financial statements 90 days after the end of the 2005 fiscal year, provided such reports were delivered by April 30, 2006, and compliance with the Consolidated Leverage Ratio obligations of Section 7.1(c) of the 2005 KCSM Credit Agreement for the four quarters ending December 31, 2005, if compliance therewith was calculated without giving effect to the amendment to the definition of “Indebtedness” in the Amendment and Waiver,providedthat KCSM was in compliance therewith after giving effect to the Amendment and Waiver. KCSM is not currently in default of the 2005 KCSM Credit Agreement and currently has access to the revolving credit facility.

101/4% Senior Notes. As of December 31, 2005, KCSM had outstanding $150.0 million of 101/4% unsecured senior notes issued in 1997 and due June 15, 2007 (the “KCSM 2007 Senior Notes”). On October 23, 2006, pursuant to an offer to purchase dated such date, KCSM commenced a cash tender offer and consent solicitation for any and all outstanding $150.0 million aggregate principal amount of the KCSM 2007 Senior Notes. The consent solicitation expired on November 3, 2006. KCSM received consents in connection with the tender offer and consent solicitation from holders of over 97% of the KCSM 2007 Senior Notes to amend the indenture under which the KCSM 2007 Senior Notes were issued (the “2007 Indenture”), to eliminate substantially all of the restrictive covenants included in the 2007 Indenture. The supplemental indenture relating to the KCSM 2007 Senior Notes containing the proposed changes (the “2007 Supplemental Indenture”) became effective on November 21, 2006. The tender offer expired at midnight, New York City time, on November 20, 2006 and KCSM purchased tendered notes on November 21, 2006, in accordance with the terms of the tender offer from proceeds received through the issuance of new 75/8% senior unsecured notes. On December 31, 2006, there was $4.0 million of KCSM 2007 Senior Notes outstanding.

121/2% Senior Notes. KCSM has outstanding $178.6 million of 121/2% senior unsecured notes issued in June 2002 and due June 15, 2012, which are redeemable at any time in the event of certain changes in Mexican tax law and at KCSM’s option after June 14, 2007, subject to certain limitations, at the following redemption prices (expressed in percentages of principal amount), plus any unpaid interest: 2007 — 106.250%, 2008 — 104.167%, 2009 — 102.083% and thereafter — 100.000%.

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

93/8% Senior Notes. KCSM has outstanding $460.0 million of 93/8% senior unsecured notes issued on April 19, 2005, and due May 1, 2012. The notes are redeemable at KCSM’s option at the following redemption prices (expressed in percentages of principal amount), plus any unpaid interest: 2009 — 104.688%, 2010 — 102.344% and thereafter — 100.000%. Subject to certain conditions, up to 35% of the principal of the notes is redeemable prior to May 1, 2008. In addition, the notes are redeemable, in whole but not in part, at KCSM’s option at their principal amount in the event of certain changes in the Mexican withholding tax rate.

75/8% Senior Notes. On November 21, 2006, KCSM issued $175.0 million of new 75/8% senior unsecured notes due December 1, 2013. Proceeds from the issuance were used to purchase $146.0 million of tendered KCSM 2007 Senior Notes and repay $29.0 million of term loans under the 2005 KCSM Credit Agreement. The notes are redeemable at KCSM’s option after November 30, 2010, subject to certain limitations, at the following redemption prices (expressed in percentages of principal amount), plus any unpaid interest: 2010 — 103.813%, 2011 — 101.906% and 2012 — 100.000%. Subject to certain conditions, up to 35% of the principal of the notes is redeemable prior to December 1, 2009. In addition, the notes are redeemable, in whole but not in part, at KCSM’s option at their principal amount in the event of certain changes in the Mexican withholding tax rate.

All of KCSM’s senior notes above are denominated in dollars and are unsecured, unsubordinated obligations, rank pari passu in right of payment with KCSM’s existing and future unsecured, unsubordinated obligations, are senior in right of payment to KCSM’s future subordinated indebtedness, and other than the 101/4% Senior Notes, are not guaranteed by Grupo KCSM.

Other Debt Provisions.

Other Agreements, Guarantees, Provisions and Restrictions. The Company has debt agreements customary for ~~this type~~these types of debt ~~instrument~~instruments and for borrowers with similar credit ~~ratings.~~

9¹/2~~% Senior Notes.~~~~During the third quarter of 2000, KCSR completed a $200 million offering 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 9~~¹/2% Notes were subsequently exchanged for registered notes with substantially identical terms. 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.

~~Debt issuance costs related to indebtedness have been deferred and are being amortized over the respective term of the loans.~~

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

~~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 $57.7 million, $57.2 million and $55.0 million for the years 2004, 2003 and 2002, respectively. Contingent rentals and sublease rentals were not significant. Minimum annual payments and present value thereof under existing capital leases, other debt maturities, and minimum annual rental commitments under non-cancelable operating leases are as follows (dollars in millions):

Capital Leases
Operating Leases
Long- Minimum Net
Term Lease Less Present Total Southern Third
Debt Payments Interest Value Debt Capital Party Total

2005 $ 9.5 $ 0.5 $ 0.1 $ 0.4 $ 9.9 $ 28.4 $ 28.1 $ 56.5
2006 8.6 0.4 0.1 0.3 8.9 23.4 21.2 44.6
2007 184.0 0.3 — 0.3 184.3 18.9 18.6 37.5
2008 261.1 0.3 — 0.3 261.4 19.3 16.4 35.7
2009 200.3 0.2 — 0.2 200.5 17.2 14.3 31.5
Later years 0.7 — — — 0.7 126.0 87.4 213.4

Total $ 664.2 $ 1.7 $ 0.2 $ 1.5 $ 665.7 $ 233.2 $ 186.0 $ 419.2

~~KCSR Indebtedness.~~ KCSR has purchased locomotives and rolling stock under equipment trust certificates and capitalized lease obligations. The equipment, which has been pledged as collateral for the related indebtedness, has an original cost of $132.0 million and a net book value of $59.0 million.

~~Other Agreements, Guarantees, Provisions and Restrictions.~~ ~~The Company has debt agreements~~ratings 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, 2004, 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.

Change in Control Provisions. 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.

~~Note 6. Income Taxes~~Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

Leases and Debt Maturities.

The Company leases transportation equipment, as well as office and other operating facilities under various capital and operating leases. Rental expenses under operating leases were $136.8 million, $103.0 million, and $57.7 million for the years ended December 31, 2006, 2005, and 2004, respectively. Contingent rentals and sublease rentals were not significant. Minimum annual payments and present value thereof under existing capital leases, other debt maturities and minimum annual rental commitments under non-cancelable operating leases follow(in millions):


			Capital Leases
	Long-		Minimum				Net				Operating Leases
	Term		Lease		Less		Present		Total		Southern		Third
Years	Debt		Payments		Interest		Value		Debt		Capital		Party		Total

2007(i)	$	92.2	$	0.7	$	0.1	$	0.6	$	92.8	$	18.8	$	104.8	$	123.6
2008		230.7		0.7		0.1		0.6		231.3		19.2		90.4		109.6
2009		204.1		0.5		—		0.5		204.6		17.0		78.9		95.9
2010		3.9		0.1		—		0.1		4.0		18.0		73.6		91.6
2011		126.4		—		—		—		126.4		13.0		63.3		76.3
Thereafter(ii)		1,097.9		—		—		—		1,097.9		94.8		366.8		461.6

Total	$	1,755.2	$	2.0	$	0.2	$	1.8	$	1,757.0	$	180.8	$	777.8	$	958.6


(i)		Includes current liability related to Grupo KCSM acquisition.

(ii)		Includes long-term liability related to Grupo KCSM acquisition.

In the normal course of business, the Company enters into long-term contractual requirements for future goods and services needed for the operations of the business. Such commitments are not in excess of expected requirements and are not reasonably likely to result in performance penalties or payments that would have a material adverse effect on the Company’s liquidity.


Note 7.	Income Taxes

Current income tax expense represents the amounts expected to be reported on the Company’s income tax return, and deferred tax expense or benefit represents the change in net deferred tax assets and liabilities. 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. Valuation allowances are used to reduce deferred tax assets to the amount considered likely to be realized.

84
86

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

Tax Expense. Income tax provision (benefit) consists of the following components(in millions):

2004 2003 2002

Current
Federal $ (12.4 ) $ (4.7 ) $ (15.3 )
State and local 0.1 0.3 0.4

Total current (12.3 ) (4.4 ) (14.9 )

Deferred
Federal 33.8 0.6 20.8
State and local 2.1 1.0 1.0

Total deferred 35.9 1.6 21.8

Total income tax provision (benefit) $ 23.6 $ (2.8 ) $ 6.9


	2006		2005			2004

Current:
Federal	$	4.0	$	11.2		$	(12.4	)
State and local		0.4		(1.3	)		0.1
Foreign		—		0.3			—

Total current		4.4		10.2			(12.3	)

Deferred:
Federal		12.7		(17.8	)		33.8
State and local		7.2		1.4			2.1
Foreign		21.1		(0.9	)		—

Total deferred		41.0		(17.3	)		35.9

Total income tax expense (benefit)	$	45.4	$	(7.1	)	$	23.6

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities ~~are as follows~~follow at December 31(in millions):

2004 2003

Liabilities:
Depreciation $ 455.8 $ 449.2
Investments 7.3 —
Other, net 4.6 2.6

Gross deferred tax liabilities 467.7 451.8

Assets:
Loss carryovers (16.5 ) (32.7 )
Book reserves not currently deductible for tax (36.5 ) (26.8 )
Vacation accrual (2.4 ) (2.7 )
Investments — (12.6 )
Other, net (4.0 ) (4.6 )

Gross deferred tax assets before valuation allowance (59.4 ) (79.4 )
Valuation allowance on loss carryovers 8.8 8.8

Gross deferred tax assets (50.6 ) (70.6 )

Net deferred tax liability $ 417.1 $ 381.2


	2006			2005

Liabilities:
Depreciation	$	571.2		$	565.2
Investments		13.4			16.2
Concession rights		256.7			277.5
Other, net		5.6			5.6

Gross deferred tax liabilities		846.9			864.5

Assets:
Loss carryovers		(480.7	)		(491.3	)
Book reserves not currently deductible for tax		(48.3	)		(57.4	)
Inventories and provisions		(33.1	)		(70.9	)
Vacation accrual		(3.8	)		(3.5	)
Other, net		(9.8	)		(3.9	)

Gross deferred tax assets before valuation allowance		(575.7	)		(627.0	)
Valuation allowance on loss carryovers		9.8			9.5

Gross deferred tax assets		(565.9	)		(617.5	)

Net deferred tax liability	$	281.0		$	247.0

85
87

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

Tax Rates. Differences between the Company’s effective income tax rates and the U.S. federal income tax statutory rates of 35% ~~are as follows~~follow(in millions):

2004 2003 2002

Income tax provision using the
Statutory rate in effect $ 16.8 $ 0.2 $ 21.4
Tax effect of
Earnings of equity investees 1.8 (4.3 ) (15.0 )
State and local income tax provision (benefit) 2.8 0.8 1.4
Other, net 2.2 0.5 (0.9 )

Total tax expense (benefit) $ 23.6 $ (2.8 ) $ 6.9

Effective tax rate 49.1 % (600.7 )% 11.3 %

~~Other, net for 2004 includes certain adjustments of prior year provision estimates resulting in a $1.1 million increase in tax expense.~~


	2006			2005			2004

Income tax provision using the Statutory rate in effect	$	54.1		$	26.7		$	16.8
Tax effect of:
Earnings (losses) of equity investees		(0.6	)		0.3			1.8
State and local income tax provision		3.9			0.1			2.8
Tax credits		(1.8	)		(2.4	)		—
Change in tax contingency		(2.8	)		—			—
Foreign exchange, tax rate and indexation adjustments		(4.9	)		4.3			—
Write off of deferred profit sharing		—			10.1			—
VAT/Put settlement		—			(42.3	)		—
Difference between U.S. and foreign tax rate		(3.1	)		(3.9	)		—
Foreign asset tax		—			0.3			—
Other, net(i)		0.6			(0.3	)		2.2

Income tax expense (benefit)	$	45.4		$	(7.1	)	$	23.6

Effective tax rate		29.4	%		(9.3	)%		49.1	%


(i)		2004 includes certain adjustments of prior year provision estimates resulting in a $1.1 million increase in tax expense.

Difference Attributable to ~~Grupo TFM~~KCSM Investment. At December 31, ~~2004,~~2006, the Company’s book basis exceeded the tax basis of its investment in ~~Grupo TFM~~KCSM by ~~$90.1~~$563 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~~KCSM the financial accounting 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.~~KCSM. 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,~~KCSM, as of December 31, ~~2004~~2006, the Company would incur gross federal income taxes of ~~$31.5~~$197.1 million, which might be partially ~~or fully~~ offset by Mexican income ~~taxes and could be available~~taxes.

Prior to ~~reduce federal~~the acquisition of a controlling interest in Grupo KCSM on April 1, 2005, Grupo KCSM provided deferred income taxes atfor the difference between the financial reporting and income tax bases of its assets and liabilities. KCS recorded its proportionate share of these income taxes through its equity in Grupo KCSM’s earnings. Since April 1, 2005, Grupo KCSM income taxes are reflected in the consolidated results. Although KCSM has generated book profits, it has incurred tax losses due primarily to the accelerated tax amortization of the Concession rights. The Company has recognized a deferred income tax asset for the resulting net operating loss carryforwards. Management anticipates that such ~~time.~~net operating loss carryforwards will be realized given the expiration dates (through the year 2046) of the loss carryforwards, as well as the fact that KCSM expects to generate taxable income in the future. Management’s tax projections take into consideration certain assumptions, some of which are under their control and others which are not. Key assumptions include inflation rates, currency fluctuations and future revenue growth. If management’s assumptions are not correct, a valuation allowance may have to be recognized on the deferred tax asset.

As described in Note 4, on September 12, 2005, the Company and its subsidiaries, KCSM and Grupo KCSM, along with TMM, entered into a settlement agreement with the Mexican government, resolving the controversies and disputes between the companies and the Mexican government concerning the payment of a value added tax (“VAT”) refund to KCSM and the obligation (“Put”) to purchase the remaining shares of

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

KCSM owned by the Mexican government (the “VAT/Put Settlement”). All Mexican income taxes on the VAT were paid as part of the VAT/Put Settlement. The Company believes, based upon opinions of outside legal counsel and other factors, that the VAT/Put Settlement is not taxable to KCS for U.S. income tax purposes.

Tax Carryovers. In the ~~years~~year ended December 31, ~~2003 and 2002,~~2005, the Company generated both U.S. federal and state net operating losses. The ~~2003~~ losses are carried forward 20 years for federal and from 5 to 20 years for state. ~~The 2002 federal loss was carried back to 2000, whereas the state losses have been carried forward.~~

Both the federal and state loss carryovers are analyzed each year to determine the likelihood of realization. The U.S. federal loss carryover at December 31, ~~2004~~2006, is ~~approximately $0.9~~$137.8 million and will expire beginning in ~~2023.~~2008. The Company believes the ~~Federal~~federal loss carryover ~~is more likely than not to~~will be realized.

The state loss carryovers arise from both combined and separately filed tax filings from as early as ~~1990.~~1991. The loss carryovers may expire as early as December 31, ~~2005~~2007, and as late as December 31, ~~2024.~~2026. The state loss carryover at December 31, ~~2004~~2006, is ~~$497.8~~$527.9 million ~~(about $16.2~~($16.0 million of tax), of which it is expected that ~~$271.4~~$203.6 million ~~(about $8.8~~($6.2 million of tax) will ~~expire without utilization, leaving $226.4 million (about $7.4 million of tax) expected to~~ be realized. Management believes that ~~deferred tax assets,~~state loss carryovers, net of the valuation allowance, will be ultimately realized.

The Mexico federal loss carryovers at December 31, 2006, are $1.5 billion (Mexican pesos of Ps16.2 billion) and will expire as early as 2015 and as late as 2046. The Company believes the Mexican loss carryovers will be realized.

Internal Revenue Service ~~reviews.~~ The IRS recently concluded reviews of the 1990-1996 tax years. The Company received $21.6 million in tax refunds ($37.6 million including interest) from adjustments arising in those years. The Company recognized interest income in the financial statements as an increase of $10.3 million to other income, an increase in deferred taxes of $21.5 million and an increase of $6.0 million in other liabilities (primarily interest and amounts due to former affiliates) offset by an increase in current tax expense of $0.2 million. The federal statute of limitations has closed for years prior to 1997.Reviews. The IRS is currently ~~in the process of~~ reviewing the consolidated federal income tax returns for the years 1997 through ~~1999. In addition, other taxing authorities are currently reviewing~~2002. A current income tax liability has been accrued for the ~~years 2000 through 2003.~~anticipated outcome. The Company

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

believes that adequate provision has been made for any adjustment (taxes and interest) that ~~might~~may be assessed for all open years. The federal statute of limitations has closed for years prior to 1997.


Note 8.	Stockholders’ Equity

~~Note 7. Stockholders’ Equity~~

~~Stockholders’ Equity.~~Information regarding the Company’s capital stock at December 31 ~~2004 and 2003~~ 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
$1 Par, Redeemable Cumulative Convertible
Perpetual Preferred Stock 400,000 400,000
$.01 Par, Common stock 400,000,000 73,369,116


	Shares
	Authorized		Shares Issued
	2006 and 2005		2006		2005

$25 par, 4% noncumulative, preferred stock		840,000		649,736		649,736
$1 par, preferred stock		2,000,000		—		—
$1 par, series A, preferred stock		150,000		—		—
$1 par, series B convertible, preferred stock		1,000,000		—		—
$1 par, series C redeemable cumulative convertible perpetual preferred stock		400,000		400,000		400,000
$1 par, series D cumulative convertible perpetual preferred stock		210,000		210,000		210,000
$.01 par, common stock		400,000,000		92,863,585		91,369,116

Shares outstanding at December 31:

2004 2003

$25 Par, 4% noncumulative, Preferred stock 242,170 242,170
$1 Par, Redeemable Cumulative Convertible Perpetual Preferred Stock 400,000 400,000
$.01 Par, Common stock 63,270,204 62,175,621

~~Stock Option Plans.~~ The Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan (as amended and restated effective May 5, 2004) 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 have been granted under this plan 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.


	2006		2005

$25 par, 4% noncumulative, preferred stock		242,170		242,170
$1 par, series C redeemable cumulative convertible perpetual preferred stock		400,000		400,000
$1 par, series D cumulative convertible perpetual preferred stock		210,000		210,000
$.01 par, common stock		75,920,333		73,412,081

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:

2004 2003 2002

Dividend Yield 0% 0% 0%
Expected Volatility 26% to 32% 33% to 41% 35% to 38%
Risk-free Interest Rate 2.17% to 3.91% 1.68% to 2.30% 2.16% to 3.88%
Expected Life 3-7 years 3-7 years 3 years

For the three years ended December 31, 2004, changes in these assumptions have resulted from changes in the risk free rate due to changing market conditions and changes in expected volatility that reflect an average of the most recent three years volatility of KCS common stock.

87
89

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~Kansas City Southern

~~Summary of Company’s Stock Option Plans.~~ ~~A summary of the status of the Company’s stock option plans as of December 31, 2004, 2003 and 2002 and changes during the years then ended is presented below.~~

2003 2002
2004
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price

Outstanding at January 1 4,612,863 $ 7.36 4,845,226 $ 6.35 5,821,315 $ 5.44
Exercised (894,832 ) 5.64 (769,782 ) 4.60 (1,265,418 ) 4.87
Canceled/ Expired (115,536 ) 12.27 (114,582 ) 10.67 (144,388 ) 6.15
Granted 590,247 14.67 652,001 12.15 433,717 14.25

Outstanding at December 31 4,192,742 $ 8.62 4,612,863 $ 7.36 4,845,226 $ 6.35

Exercisable at December 31 3,140,786 $ 6.93 3,807,886 $ 6.30 3,784,417 $ 5.63
Weighted–average fair value of options granted during the period $ 3.64 $ 4.86 $ 3.97

~~The following table summarizes information about stock options outstanding at December 31, 2004:~~

Outstanding Exercisable

Weighted- Weighted- Weighted-
Average Average Average
Shares Remaining Exercise Shares Exercise
Range of Exercise Prices Outstanding Contractual Life Price Exercisable Price

(years)
$.20 - 1 83,677 0.8 $ 0.94 83,677 $ 0.94
  1 - 2 88,755 2.4 1.35 88,755 1.35
  2 - 4 79,212 3.9 2.76 79,212 2.76
  4 - 7 2,209,725 5.5 5.76 2,209,725 5.76
  7 - 10 94,588 5.7 8.23 94,588 8.23
  10 - 13 839,305 7.9 12.35 306,745 11.84
  13 - 17 797,480 8.6 14.87 278,084 15.18

$.20 - 17 4,192,742 6.4 $ 8.62 3,140,786 $ 6.93

~~At December 31, 2004, shares available for future grants under the stock option plan were 785,305.~~

~~Stock Purchase Plan.~~ The Employee Stock Purchase Plan (“ESPP”), established in 1977, provides substantially all full-time employees of the Company, certain subsidiaries and certain other affiliated entities, with the right to subscribe to an aggregate of 11.4 million shares of common stock. For offerings under the Fifteenth and Fourteenth Offerings of the ESPP, the purchase price for shares were 85% of the average market price on either the exercise date or the offering date, whichever was lower, but in no event less than the par value of the shares. For offerings under the Sixteenth Offering, the purchase prices for shares was 90% of the average market price on either the exercise date or the offering date, whichever was lower, but in no event

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)

~~less than the par value of the shares. The following table summarizes activity related to the various ESPP offerings:~~

Received from
Date Shares Shares Employees*
Initiated Subscribed Price Issued Date Issued (in millions)

Sixteenth Offering 2004 119,384 $15.14 — — $ —
Fifteenth Offering 2003 242,589 $ 11.08 -$11.28 206,123 2004/2005 $ 2.3
Fourteenth Offering 2002 248,379 $ 9.27-$12.29 197,734 2003/2004 $ 2.4


*	~~Represents amounts received from employees through payroll deductions for share purchases under applicable offering.~~

~~At December 31, 2004, there were approximately 4.3 million shares available for future ESPP offerings.~~

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 Sixteenth, Fifteenth and Fourteenth Offerings, respectively: i) dividend yield of 0.00%, 0.00% and 0.00%; ii) expected volatility of 27%, 35% and 36%; iii) risk-free interest rate of 2.85%, 1.26% and 2.22%; and iv) expected life of one year. The weighted-average fair value of purchase rights granted under the Sixteenth, Fifteenth and Fourteenth Offerings of the ESPP were $2.96, $2.95 and $3.00, respectively.

Treasury Stock. Shares of common stock in Treasury and related activity ~~were as follows at December 31:~~follow:

2004 2003 2002

Balance at beginning of year 11,193,495 12,266,101 14,125,949
Shares issued to fund stock option exercises and subscriptions under employee stock purchase plans (1,094,583 ) (1,072,606 ) (1,859,848 )

Balance at end of year 10,098,912 11,193,495 12,266,101

2006 2005 2004

Balance at beginning of year 17,957,035 10,098,912 11,193,495
Shares purchased — 9,000,000 —
Shares issued to fund stock option exercises (617,107 ) (528,758 ) (889,803 )
Employee stock purchase plan shares issued (109,644 ) (205,928 ) (197,780 )
Nonvested shares issued (428,143 ) (442,632 ) (7,000 )
Nonvested shares forfeited 141,111 35,441 —

Balance at end of year 16,943,252 17,957,035 10,098,912

Series C Redeemable Cumulative Convertible Perpetual Preferred Stock. On May 5, 2003, the Company completed the sale of $200 million of Redeemable Cumulative Convertible Perpetual Preferred Stock (“~~Convertible~~Series C Preferred Stock”) with a liquidation preference of $500 per share in a private offering. ~~The Convertible Preferred Stock offering was made only by means of an offering memorandum pursuant to Rule 144A.~~ Dividends on the ~~Convertible~~Series C Preferred Stock are cumulative and ~~are~~ payable quarterly at an annual rate of 4.25% of the liquidation preference, ~~when,~~ as ~~and if~~ declared by the Company’s ~~board~~Board of ~~directors. Accumulated unpaid dividends will accumulate dividends at the same rate as dividends accumulate on the Convertible Preferred Stock.~~Directors. Each share of ~~the Convertible~~Series C Preferred Stock ~~will be~~is convertible ~~under certain conditions, and subject to adjustment under certain conditions,~~ into 33.4728 shares of the Company’s common stock. ~~On or after~~After May ~~20,~~19, 2008, the Company ~~will have the option to~~may redeem any or all of the ~~Convertible~~Series C Preferred Stock, subject to certain conditions. ~~Under certain circumstances, at the option of the holders of the Convertible Preferred Stock, the~~The Company may be required to ~~purchase shares of~~redeem the ~~Convertible~~Series C Preferred Stock from the ~~holders. The Convertible Preferred Stock is redeemable~~holders at ~~the~~their option ~~of a holder~~ only in the event of a “fundamental change,” which is defined as “any transaction or event (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) in connection with which all orif substantially all of the Company’s common stock is exchanged for or converted into ~~acquired for or constitutes solely the right to receive~~ common stock that is not listed on a ~~United States~~U.S. national securities exchange or ~~approved for quotation on~~ the ~~Nasdaq~~NASDAQ National

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

Market ~~or similar system.~~(a “fundamental change”). The practical effect of this provision is to limit the Company’s ability to eliminate a holder’s ability to convert the ~~Convertible~~Series C Preferred Stock into common shares of a publicly traded ~~security~~company through a merger or consolidation transaction. ~~In no other circumstances is the Company potentially obligated to redeem the Convertible Preferred Stock for cash.~~ Accordingly, since the Company is in a position to control whether the Company experiences a ~~“fundamental~~fundamental change,” the ~~Convertible~~Series C Preferred Stock is classified as permanent equity capital.

Series D Cumulative Convertible Perpetual Preferred Stock.On ~~August, 1, 2003,~~December 9, 2005, KCS ~~filed a Form S-3 Registration Statement with~~completed the ~~SEC to register for resale by the holders the~~sale and issuance of 210,000 shares of its 5.125% Series D Convertible Preferred Stock, par value $1.00 per share (“Series D Preferred Stock”). Each share of Series D Preferred Stock is convertible into 33.3333 shares of KCS common stock, subject to certain adjustments. Dividends on the Series D Preferred Stock are cumulative and payable quarterly in any combination of cash and KCS common stock, as declared by the KCS Board of Directors, at the rate of 5.125% per annum of the liquidation preference of $1,000. The Series D Preferred Stock ranks senior to the common stock and to each class or series of KCS capital stock that has terms that provide that such class or series will rank junior to the Series D Preferred Stock. After February 19, 2011, KCS may convert all of the Series D Preferred Stock into ~~which such preferred~~common stock ~~may be converted. On October 24, 2003, this Registration Statement, as amended, was declared effective~~at the then prevailing conversion rate, but only if the closing sale price of the common stock multiplied by the ~~SEC.~~conversion rate then in effect equals or exceeds 130% of the liquidation preference for 20 trading days during any consecutive 30 trading day period, and if KCS has ~~filed,~~paid all accumulated and unpaid dividends on the dividend payment date immediately preceding the forced conversion date.

Upon certain designated events (a “fundamental change”), holders of the Series D Preferred Stock may, subject to legally available funds, require KCS to redeem any or all of the shares, which KCS may pay in either cash, in shares of KCS stock or any combination thereof, at KCS’ option. Since KCS has the ability in this event to pay the redemption price in KCS common stock (which is not required to be registered), the Series D Preferred Stock is classified as permanent equity capital. The number of shares to be issued would be based upon the value of KCS common stock at that time but in no event will ~~continue to file, post-effective amendments to this Registration Statement as required by applicable rules and regulations. KCS will not receive any~~the number of shares issued on the occurrence of a fundamental change exceed 52.5 million shares.

On December 12, 2005, the Company used substantially all of the proceeds from the ~~sale~~Series D Preferred Stock offering to repurchase 9,000,000 shares of KCS common stock issued to TMM in April 2005 in

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

connection with the acquisition of KCSM. All of the ~~securities under this Registration Statement, as amended.~~9,000,000 shares were purchased at a price of $22.25 per share or $200.3 million. The Company does not have a formal program for the repurchase of any additional shares of its equity securities.

Dividend Restrictions. Following completion of the preparation of the 2005 financial statements of KCS, the Company determined that its Consolidated Coverage Ratio (as defined in the indentures for KCSR’s 71/2% senior notes and 91/2% senior notes) was less than 2.0:1. As a result, pursuant to the terms of each KCSR indenture, the Company was unable to pay cash dividends on its Series C Preferred Stock and dividends in cash or shares of KCS common stock on its Series D Preferred Stock. The dividends accumulate until such ratio increases to at least 2.0:1. See Note 16 for further discussion.

Stockholder Rights Plan. On September ~~19, 1995,~~27, 2005, the Board of Directors of the Company declared a dividend distribution of one ~~Right~~right for each outstanding share of the Company’s common stock to ~~the~~ stockholders of record as of the close of business on October 12, ~~1995.~~2005, replacing a previous Rights Agreement that expired on October 12, 2005. Each ~~Right~~right entitles the ~~registered holder~~stockholder to purchase from the Company ~~1/1,000th~~one one-thousandth of a share of Series A Preferred Stock or(or in ~~some~~certain circumstances, common stock, other securities, cash or other ~~assets as the case may be,~~assets), at a price of ~~$210~~$100 per share (both shares and price are subject to ~~adjustment.~~adjustment periodically to prevent dilution). The rights are traded with the Company’s common stock.

The Rights ~~which are automatically attached~~Plan has certain anti-takeover provisions that may cause substantial dilution to a person or group that attempts to acquire the ~~common stock, are not exercisable or transferable apart from~~Company without the ~~common stock until the tenth calendar day following the earlier to occur~~approval 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 moreDirectors. The Rights Plan will not interfere with any offer for all of the outstanding ~~shares~~common stock that has the approval of the Independent Directors. The rights will become excercisable after a non-approved person or group has acquired, or a tender offer is made for, 15% or more of the common stock of the Company ~~(or 15 percent~~(13% or more 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~~certain acquisitions by “Adverse Persons”). Right holders (other than the 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~~group) may then exercise their 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~~purchase price, ofand receive the ~~Right, that~~ number of shares of ~~the highest priority voting securities of the acquiring company~~Preferred Stock (or in certain ~~of its affiliates) that at the time of such transaction would have~~circumstances, common stock) having a market value of two times the ~~exercise~~purchase price of the ~~Right. The Rights expire on October 12, 2005, unless earlier redeemed by~~rights. Additionally, if the Company ~~as described below. In conjunction with~~is thereafter merged into another entity, or if more than 50% of the ~~Acquisition, KCS and the Rights Agent, will amend the Rights Agreement to, among other things, amend the definition~~Company’s consolidated assets or earning power is sold or transferred, holders of ~~“Acquiring Person” so that the Acquisition will not trigger~~ the rights ~~under~~may exercise their rights at the ~~Rights Agreement, dated September 19, 1995.~~

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 thethen current purchase price and receive common stock of the ~~Company,~~acquirer equal to two times the ~~Company~~purchase price of the rights. KCS may redeem the ~~Rights in whole, but not in part, at~~rights for $0.0025 per right until 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.triggering acquisition. The rights expire October 11, 2010.

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,

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

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 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.

Change in Control Provisions. 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.

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 aton December 31, ~~2004~~2006, 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.


Note 9.	Share-Based Compensation

Stock Option Plan. The Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan (as amended and restated effective May 5, 2004) (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 have been granted under the Plan at 100% of the average market price of the Company’s stock on the date of grant and generally have a 5 year cliff vesting period and are exercisable

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

over the 10 year contractual term, 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. The grant date fair value, less estimated forfeitures, is recorded to expense on a straight-line basis over the vesting period.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The weighted-average assumptions used were as follows:


	2006			2005			2004

Expected dividend yield		0	%		0	%		0	%
Expected volatility		37.84	%		26.78	%		29.66	%
Risk-free interest rate		4.96	%		3.41	%		2.75	%
Expected term(years)		6.83			5.50			3.43
Fair value at grant date	$	12.62		$	3.98		$	3.64

The Company has not historically paid dividends to common shareholders. The expected volatility is based on the historical volatility of the Company’s stock price over a term equal to the estimated life of the options. The risk-free interest rate is determined based on the U.S. Treasury rates approximating the expected life of the options granted, which represents the period of time the awards are expected to be outstanding and is based on the historical experience of similar awards.

The following table summarizes activity under the stock option plan:


				Weighted-		Weighted-
				Average		Average
				Exercise		Remaining		Aggregate
	Number of			Price		Contractual		Intrinsic
	Shares			per Share		Term		Value
						In years		In millions

Options outstanding at December 31, 2003		4,612,863		$	7.36
Granted		590,247			14.67
Exercised		(894,832	)		5.64
Forfeited or expired		(115,536	)		12.27

Options outstanding at December 31, 2004		4,192,742			8.62
Granted		104,200			17.51
Exercised		(554,869	)		6.88
Forfeited or expired		(34,680	)		10.54

Options outstanding at December 31, 2005		3,707,393			9.11
Granted		90,800			26.03
Exercised		(627,907	)		10.83
Forfeited or expired		(229,954	)		12.77

Options outstanding at December 31, 2006		2,940,332		$	8.98		4.59	$	58.8

Vested and expected to vest at December 31, 2006		2,929,307		$	8.94		4.57	$	58.7

Exercisable at December 31, 2006		2,499,144		$	7.74		4.16	$	53.1

Compensation expense of $0.6 million was recognized for stock option awards for the year ended December 31, 2006. The total income tax benefit recognized in the income statement for stock options was

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

$0.2 million. As described in Note 2, no compensation expense was recognized for the years ended December 31, 2005 and 2004 as the Company accounted for share-based compensation in accordance with APB 25 prior to the adoption of SFAS 123R on the modified prospective basis on January 1, 2006.

Additional information regarding stock option exercises appears in the table below(in millions):


	2006		2005		2004

Aggregate grant-date fair value of stock options vested	$	0.7	$	2.1	$	1.1
Intrinsic value of stock options exercised		11.4		9.7		10.8
Cash received from option exercises		6.7		3.8		5.0
Excess tax benefit realized from option exercises		0.2		—		—

As of December 31, 2006, $1.4 million of unrecognized compensation cost relating to nonvested stock options is expected to be recognized over a weighted-average period of 1.47 years. At December 31, 2006, there were 2,693,217 shares available for future grants under the Plan.

Nonvested Stock. The Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan provides for the granting of nonvested stock awards to officers and other designated employees. The grant date fair value is based on the average market price of the stock on the date of the grant. These awards are subject to forfeiture if employment terminates during the vesting period, which is generally five year cliff vesting for employees and one year for directors. The grant date fair value of nonvested shares, less estimated forfeitures, is recorded to compensation expense on a straight-line basis over the vesting period.

A summary of nonvested stock activity is as follows:


				Weighted-
				Average Grant		Aggregate
	Number of			Date		Intrinsic
	Shares			Fair Value		Value
						In millions

Nonvested stock at December 31, 2004		—		$	—
Granted		435,032			20.64
Vested		(7,440	)		18.56
Forfeited		(35,441	)		21.88

Nonvested stock at December 31, 2005		392,151			20.57
Granted		421,002			25.73
Vested		(58,469	)		20.17
Forfeited		(141,111	)		22.33

Nonvested stock at December 31, 2006		613,573		$	23.74	$	17.8

Compensation cost on nonvested stock was $3.1 million and $1.5 million for the years ended December 31, 2006 and 2005, respectively. The total income tax benefit recognized in the income statement for nonvested stock awards was $1.1 million and $0.5 million for the years ended December 31, 2006 and 2005, respectively.

As of December 31, 2006, $11.0 million of unrecognized compensation costs related to nonvested stock is expected to be recognized over a weighted — average period of 2.07 years. The fair value (at vest date) of shares vested during the year ended December 31, 2006, was $1.2 million.

Employee Stock Purchase Plan. The Employee Stock Purchase Plan (“ESPP”), established in 1977, provides substantially all full-time employees of the Company, certain subsidiaries and certain other affiliated entities, with the right to subscribe to an aggregate of 11.4 million shares of common stock. Employees may

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

elect to withhold an amount from payroll on the offering date in exchange for rights to purchase a fixed number of designated shares of the Company’s common stock. For offerings under the Eighteenth, Seventeenth and Sixteenth Offerings, the purchase prices for shares was equal to 90% of the average market price on either the exercise date or the offering date, whichever is lower. Under SFAS 123R, both the 10% discount in grant price and the 90% share option are valued to derive the award’s fair value. The awards vest and the expense is recognized ratably over one year. The following table summarizes activity related to the various ESPP offerings:


	Offering Date						Exercise Date						Received
			Purchase		Shares				Purchase		Shares		from
	Date		Price		Subscribed		Date Issued		Price		Issued		Employees(i)
													(In millions)

Eighteenth offering		October 31, 2006	$	25.97		101,737		—	$	—		—	$	—
Seventeenth offering		October 31, 2005		20.10		140,867		January 31, 2007		20.10		114,554		2.3
Sixteenth offering		October 29, 2004		15.14		119,384		January 24, 2006		15.14		109,062		1.7


(i)		Represents amounts received from employees through payroll deductions for share purchases under applicable offering.

The fair value of the ESPP stock purchase rights is estimated on the date of grant using the Black-Scholes option pricing model. The weighted average assumptions used were as follows:


	Eighteenth			Seventeenth			Sixteenth
	Offering			Offering			Offering

Expected dividends		0	%		0	%		0	%
Expected volatility		32	%		28	%		27	%
Risk free interest rate		4.99	%		4.15	%		2.85	%
Expected life(years)		1			1			1
Fair value at grant date	$	7.15		$	5.12		$	2.96

Compensation expense of $0.6 million was recognized for ESPP option awards for the year ended December 31, 2006. At December 31, 2006, there were 4.1 million remaining shares available for future ESPP offerings.

~~Note 8.~~
Note 10. Profit Sharing and Other Postretirement Benefits

Health and ~~Other Postretirement Benefits~~

Welfare. Certain U.S. employees that have met age and service requirements are eligible for life insurance coverage and medical benefits during retirement. The Company maintains various plans for the benefit of its employees as described below. For the years ended December 31, 2004, 2003 and 2002, the Company expensed $1.2 million, $0.9 million and $0.4 million, respectively, related to the KCS 401(k) and Profit Sharing Plan (the “401(k) Plan”). During 2004, 2003 and 2002, the Company did not recognize any expense relative to profit sharing or the ESOP.

~~401(k) and Profit Sharing Plan.~~ The 401(k) 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 5% of compensation in 2004 and 2003 and 3% of compensation during 2002. Qualified profit sharing plans are maintained for most employees not included in collective bargaining agreements. Contributions by 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. Theretiree medical plan is contributory and provides benefits ~~for~~to retirees, their covered dependents and beneficiaries. The ~~medical~~ plan provides for an annual ~~adjustment of~~adjustments to retiree contributions, and also contains, depending on the ~~plan~~ coverage selected, certain deductibles, co-payments, ~~coinsurance~~co-insurance, and coordination with Medicare. Certain management employees also maintain their status under a collective bargaining agreement, which permits them access to ~~postretirement~~post-retirement medical under the multiemployer plan described below. ~~Assumptions related to medical postretirement benefits plan were adjusted in 2004 to reflect the expected participation of these individuals in the multiemployer plan.~~ 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

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

become due. However, certain plan assets (money market funds held in a life insurance company) exist with respect to life insurance benefits. ~~A life insurance company holds these assets and~~

KCSM Union Pension. Under the provisions of a bargaining agreement for covered employees in Mexico, the Company ~~receives an investment return~~provides a substantive pension benefit in the form of a lump-sum post-retirement payment to retirees who leave the Company after age 60. The benefit to retirees is based on ~~these assets~~a statutory termination indemnity calculation under Mexico law which is based on the ~~six-month Treasury Bill rate plus 25 basis points.~~retiree’s salary at the time of retirement and the number of years of credited service. The Company’s practice is to fund benefits under this program as the obligations become due.

Kansas City Southern

~~Based upon current regulations, the Company’s plans are actuarially equivalent~~

Notes to ~~Medicare part D benefits; however, provisions within the plans contain retiree cost sharing features, which make any potential benefit to KCS from the subsidy entitlement unlikely to be material.~~Consolidated Financial Statements — (Continued)

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.

The Company uses ~~January 1~~December 31 as the measurement date for its ~~postretirement~~pension and post-retirement benefit obligations.

~~Assumptions~~Net Periodic Benefit Cost, Plan Obligations and Funded Status

Components of the net cost (benefit) for these plans were as follows for the years ended December 31(in millions):


	Health and Welfare								Pension
	2006			2005		2004			2006			2005(i)

Service cost	$	0.1		$	0.1	$	0.2		$	1.7		$	1.1
Interest cost		0.5			0.5		0.6			1.0			0.6
Expected return on plan assets		—			—		—			—			—
Actuarial (gain) loss (ii)		(0.7	)		0.1		(1.0	)		(2.6	)		0.7
Prior service credit (iii)		(0.3	)		—		—			—			—

Net periodic cost (benefit) recognized	$	(0.4	)	$	0.7	$	(0.2	)	$	0.1		$	2.4


(i)		The obligation related to the KCSM pension was acquired with the change in control and consolidation of KCSM beginning April 1, 2005. The pension cost presented for 2005 represents an estimated cost for the nine month period from April 1, 2005 through December 31, 2005. Prior to April 1, 2005, KCSM was accounted for as an equity method investee. The pension obligation was established during the finalization of purchase accounting (see Note 4). The pension costs since the date of acquisition have been included in the results for the year ended December 31, 2006.

(ii)		Net benefit costs above do not include a component for the amortization of actuarial gains or losses as the Company’s policy is to recognize such gains and losses immediately.

(iii)		During 2005, the Company revised its medical plan to exclude prescription drug coverage available under Medicare part D. This negative plan amendment generated an unrecognized prior service benefit of $2.3 million which is being amortized over the estimated remaining life of the affected participants of 9.5 years.

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

The following table reconciles the change in the benefit obligation, fair value of plan assets, change in the funded status, and the accrued benefit cost as of and for each of the years ended December 31(in millions):


	Health and Welfare						Pension
	2006			2005			2006			2005(i)

Benefit obligation at beginning of year	$	8.6		$	9.1		$	12.4		$	10.0
Obligation from acquisition of Mexrail		—			2.0			—			—
Plan amendment		—			(2.3	)		—			—
Service cost		0.1			0.1			1.7			1.1
Interest cost		0.5			0.5			1.0			0.6
Actuarial (gain) loss		(0.7	)		0.1			(2.6	)		0.7
Benefits paid, net of retiree contributions(ii)		(1.3	)		(0.9	)		(0.4	)		—

Benefit obligation at end of year		7.2			8.6			12.1			12.4

Fair value of plan assets at beginning of year		0.7			0.8
Actual return on plan assets		(0.1	)		0.1
Benefits paid, net of contributions (ii)		(0.1	)		(0.2	)

Fair value of plan assets at end of year		0.5			0.7

Funded status		(6.7	)		(7.9	)		(12.1	)		(12.4	)
Unrecognized prior service benefit (iii)		—			(2.3	)		—			—

Accrued benefit cost	$	(6.7	)	$	(10.2	)	$	(12.1	)	$	(12.4	)


(i)		The obligation related to the KCSM pension was acquired with the change in control and consolidation of KCSM beginning April 1, 2005. The beginning obligation presented for 2005 represents the obligation as of the acquisition on April 1, 2005 and the 2005 activity as presented is for the nine month period ended December 31, 2005.

(ii)		Benefits paid for the reconciliation of the benefit obligation include both medical and life insurance benefits, whereas benefits paid from the reconciliation of the funded status include only life insurance benefits. Plan assets relate only to life insurance benefits. Medical benefits are funded as obligations become due.

(iii)		The Company adopted the provisions of SFAS 158 for the year ended December 31, 2006. Accordingly, the unrecognized prior service benefit related to the plan amendment in 2005 ($2.1 million at December 31, 2006) was reclassified from liabilities and has been included as a component of accumulated other comprehensive income.

Assumptions

The assumptions ~~were~~ used to determine ~~postretirement~~benefit obligations and ~~net periodic~~costs are selected based on current and expected market conditions. Discount rates are selected based on low risk government bonds with cash flows approximating the timing of expected benefit ~~costs~~payments. The Mexico bond market is utilized for the KCSM pension obligation and the U.S. bond market is utilized for the U.S. health and welfare obligation. The expected rate of return on life insurance plan assets is determined using historical and forward looking returns for similar investments over the period that the benefits are expected to be paid.

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

Weighted average assumptions used to determine benefit obligations were as follows for the years ended December 31:

2004 2003

Annual increase in CPI 2.50 % 2.25 %
Expected rate of return on life insurance plan assets 6.25 6.50
Discount rate 5.65 6.00


	Health and Welfare						Pension
	2006			2005			2006			2005

Discount rate		5.75	%		5.40	%		8.00	%		8.00	%
Rate of compensation increase		n/a			n/a			5.00	%		5.50	%

Weighted average assumptions used to determine net benefit cost for the periods were as follows for the years ended December 31:


	Health and Welfare						Pension
	2006			2005			2006			2005

Discount rate		5.40	%		5.65	%		8.00	%		8.00	%
Expected long-term rate of return on plan assets		3.00	%		6.25	%		n/a			n/a
Rate of compensation increase		n/a			n/a			5.00	%		5.50	%

The Company’s health care costs, excluding former Gateway Western ~~employees~~ and ~~certain former employees of the~~ MidSouth participants, 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~~trends are not applicable. The expected rate of return on life insurance plan assets is the return, over the period that benefits are expected to be paid. In determining the expected long-term rate of return, the Company considered forward looking information and historical returns for similar investments.

~~The assumed annual rate of increase in health care costs for Gateway Western employees and retirees under the Gateway Western plan is as follows:~~

2004 2003

Health care cost trend assumed for next year 10.00 % 10.25 %
Ultimate trend rate 5.00 5.25
Year that rate reaches the ultimate trend rate 2009 2008

~~An increase or decrease in~~following table presents the assumed health care cost ~~trend rates by one percent in 2004, 2003~~trends related to Gateway Western and 2002 would not have a significant impact on the accumulated postretirement benefit obligation or on the aggregate of the service and interest components of the net periodic postretirement benefit cost.Midsouth participants:

~~KANSAS CITY SOUTHERN~~


	2006			2005			2004

Health care trend rate for next year		9.00	%		10.00	%		10.25	%
Ultimate trend rate		5.00	%		5.00	%		5.25	%
Year that rate reaches ultimate rate		2010			2010			2009

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

~~Obligations, Funded Status and Components of Net Periodic Benefit Cost~~Cash Flows

~~A reconciliation of the accumulated postretirement benefit obligation, change in plan assets and funded status, respectively, at December 31 follows~~~~(in millions):~~

2004 2003

Accumulated postretirement benefit obligation at beginning of year $ 10.2 $ 10.0
Service cost 0.2 0.3
Interest cost 0.6 0.6
Actuarial (gain) loss (1.0 ) 0.2
Benefits paid, net of retiree contributions(i) (0.9 ) (0.9 )

Accumulated postretirement benefit obligation at end of year 9.1 10.2

Fair value of plan assets at beginning of year 1.0 1.0
Actual return on plan assets — 0.1
Benefits paid, net of retiree contributions(i) (0.2 ) (0.1 )

Fair value of plan assets at end of year 0.8 1.0
Funded status (8.3 ) (9.2 )
Unrecognized prior service cost (0.1 ) (0.1 )

Accrued benefit cost $ (8.4 ) $ (9.3 )


~~(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):~~

2004 2003 2002

Service cost $ 0.2 $ 0.3 $ 0.2
Interest cost 0.6 0.6 0.6
Expected return on plan assets — (0.1 ) (0.1 )

Net periodic postretirement benefit cost $ 0.8 $ 0.8 $ 0.7

The net periodic postretirement benefit costs outlined above do not include a component for the amortization of actuarial gains or losses as the Company has consistently recognized these gains and losses immediately. Actuarial (gains) losses recognized by the Company were ($1.0) million, $0.2 million and $1.0 million for 2004, 2003 and 2002, respectively. The amortization of unrecognized prior service cost was not material for the years ended December 31, 2004, 2003 and 2002, respectively.

~~Cash Flows~~

~~During 2005, the Company expects to contribute approximately $0.9 million to its other post retirement benefit plans in the form of benefit payments.~~

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

The following table represents benefit payments expected to be paid, which reflect expected future service, as appropriate, ~~are expected to be paid (in~~for each of the next five years and the aggregate five years thereafter(in millions):

Expected Future
Years Benefits Payments

2005 $ 0.9
2006 0.9
2007 0.8
2008 0.8
2009 0.8
2010 — 2014 $ 4.1

~~Multi-employer Plan~~


	Health and
Year	Welfare		Pension

2007	$	0.9	$	1.0
2008		0.9		0.3
2009		0.9		0.4
2010		0.8		0.5
2011		0.8		0.7
2012 — 2016		3.5		8.9

Multi-Employer Plan. 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 $2.6 million, $2.6 million, and $1.9 million ~~$1.7 million~~for the years ended December 31, 2006, 2005 and ~~$1.0 million for~~ 2004, ~~2003 and 2002,~~ respectively. Based on existing rates, premium amounts are not expected to change substantially in ~~2005~~2007 as compared to ~~2004.~~2006.

401(k) and Profit Sharing Plan. The Company sponsors the KCS 401(k) and Profit Sharing Plan (the “401(k) plan”), whereby participants can choose to make contributions in the form of salary deductions pursuant to section 401(k) of the Internal Revenue Code. The Company matches 401(k) contributions up to a

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

maximum of 5% of compensation. For the years ended December 31, 2006, 2005 and 2004, the Company expensed $1.5 million, $1.4 million, and $1.2 million, respectively, related to the KCS 401(k) and Profit Sharing Plan.


Note 11.	Commitments and Contingencies

~~Note 9. Commitments and Contingencies~~

Litigation. The Company is a party to various legal proceedings and administrative actions, all of which are of an ordinary, routine nature and incidental to its operations. Included in these proceedings are various tort claims brought by current and former employees for job related injuries and by third parties for injuries related to railroad operations. WeKCS aggressively ~~defend~~defends these matters and ~~have~~has established liability reserves which management believes are adequate to cover expected costs. Although it is not possible to predict the outcome of any legal proceeding, in the opinion of ~~the Company’s~~ management, other than those proceedings described in detail below, such proceedings and actions should not, individually, or in the aggregate, have a material adverse effect on the Company’s financial condition. However, a material adverse outcome in one or more of these proceedings could have a material adverse impact on the operating results of a particular period.

~~Stilwell Tax Dispute.~~Reinsurance Litigation. ~~On October 15, 2004, KCS~~As previously disclosed in the Company’s quarterly reports onForm 10-Q, insurance companies who provided insurance to the Company filed an action in federal court in Vermont (“Reinsurance Litigation”) seeking a declaration that they have no obligation to indemnify the Company concerning a particular casualty claim. That claim, styledKemp, et al v. The Kansas City Southern Railway Company, et al, was filed in the Circuit Court of Jackson County, Missouri (“Kemp Litigation”) and ~~Janus Capital Group Inc. (“Janus”), formerly Stilwell Financial Inc. (“Stilwell”), finalized~~went to trial in September 2006. The Company reached a settlement ~~agreement (“Release”), effecting~~with the plaintiffs in the Kemp Litigation. The Company also reached settlements with various parties, including several of the insurance companies involved in the Reinsurance Litigation, to indemnify the Company for a significant portion of the settlement. The Kemp settlement ~~of all disputes which arose on or before August 13, 2004 relating~~is fully reflected in the Company’s financial statements and the Company has no further risk associated with this litigation. The Company is, however, continuing the Reinsurance Litigation against certain other insurance companies, seeking to establish their obligation to indemnify the ~~spin-off of Stilwell from KCS on July 12, 2000 (the “Spin-off”). As part~~Company for their share of the settlement ~~all arbitration claims filed by the parties~~ with the American Arbitration Association were dismissed. This claim involved the entitlement to compensation expense deductions for federal income tax purposes, associated with the exercise of certain stock options issued by Stilwell (the “Substituted Options”) in connection with the Spin-off. Prior to the settlement, amounts related to the tax benefits of exercises of the Substituted Options were recorded as a noncurrent liability in the consolidated financial statements pending resolution of this dispute. As a result of this settlement, the Company reclassified approximately $27.1 million in tax benefits from previous exercises of the Substituted Options to additional paid in capital on the balance sheet. As previously disclosed, the settlement had no adverse consequences to the Company.Kemp.

Environmental Liabilities. The Company’s U.S. operations are subject to extensive federal, state and local environmental laws and regulations. The major U.S. 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~~liabilities 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

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

disposal of, hazardous substances. The Company does not ~~foresee~~believe 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 Company is, however, subject to environmental remediation costs as described below.

The Mexican operations are subject to Mexican federal and state laws and regulations relating to the protection of the environment through the establishment of standards for water discharge, water supply, emissions, noise pollution, hazardous substances and transportation and handling of hazardous and solid waste. The Mexican government may bring administrative and criminal proceedings and impose economic sanctions against companies that violate environmental laws, and temporarily or even permanently close non-complying facilities.

The risk of incurring environmental liability is inherent in the railroad industry. As part of serving the petroleum and chemicals industry, ~~KCSR~~the Company 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 partner in the Responsible ~~Care®~~Care^® program and, as a result, has initiated certain

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

additional environmental, health and safety programs. ~~KCSR~~The Company performs ongoing reviews and evaluations of the various environmental programs and issues within the Company’s operations, and, as necessary, takes actions intended 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~~Should the Company ~~becomes~~become subject to more stringent cleanup requirements at these sites, ~~discovers~~discover additional contamination, or ~~becomes~~become 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.

Environmental remediation expense was $3.1 million for the year ended December 31, 2006, and was included in purchased services expense on the consolidated statements of income. Additionally, as of December 31, 2006, KCS had a liability for environmental remediation of $7.8 million. This amount was derived from a range of reasonable estimates based upon the studies and site surveys described above and in accordance with SFAS 5.

Casualty Claim Reserves. The Company’s casualty and liability reserve for its U.S. business segment is based on a study by an independent third party actuarial firm performed on an undiscounted basis. The reserve 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 a reasonable estimate of aggregate future claims. Adjustments to the liability are reflected as operating expenses in the period in which the adjustments are known. Casualty claims in excess of self-insurance levels are insured up to certain coverage amounts, depending on the type of claim and year of occurrence. The activity in the reserve follows(in millions):


	2006			2005

Balance at beginning of year	$	103.9		$	52.8
Liability acquired in the Mexrail acquisition		—			13.9
Accruals, net (includes the impact of actuarial studies)		35.0			57.6
Payments		(21.5	)		(20.4	)

Balance at end of year	$	117.4		$	103.9

Based on an updated study of casualty reserves for data through November 30, 2006 and the settlement of the Kemp case; the reserves for FELA, third party, and occupational illness claims are reflected in the table above for the year ended December 31, 2006. The changes to the reserve in the current year reflect the Kemp settlements and favorable loss experience in 2006.

During the third quarter of 2005, the Company initiated a new comprehensive actuarial study of all of its casualty reserves. Based on that study, the reserves for FELA, third-party and occupational illness claims were

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

increased, resulting in a charge to third quarter operating income of $37.8 million. The charge reflects the impact of higher settlements for major FELA and third-party claims and significant increases in the frequency of these claims in 2004 and 2005. In addition, the charge includes reserves for occupational illness including asbestos-related claims that were established on an actuarial basis for the first time.

Based on the results of the actuarial study, reserves for FELA and third-party claims were increased $30.3 million. The majority of these increases are attributable to adverse experience occurring since the previous year’s study, including an increase in the number of new claims and adverse development in the dollar amount of potential settlements for many significant prior claims.

Management believes that its previous reserve estimates for those prior claims were reasonable based on the information available at the time. The Company is continuing its practice of accruing monthly for estimated claim costs at levels recommended by the actuarial study and evaluation of recent known trends, and those accruals have been increased accordingly.

Disputes Relating to Payments for the Use of Trackage and Haulage Rights and Interline Services. KCSM and Ferromex both initiated administrative proceedings seeking a determination by theSecretaria de Communicaciones y Transportes(“Secretariat of Communications and Transports” or “SCT”) of the rates that the companies should pay each other in connection with the use of trackage and haulage rights and interline and terminal services. The SCT, on March 13, 2002, issued rulings setting the rates for trackage and haulage rights. On August 5, 2002, the SCT issued a ruling setting the rates for interline and terminal services. KCSM and Ferromex appealed both rulings and, following trial and appellate court decisions, the Mexican Supreme Court on February 24, 2006, sustained KCSM’s appeal of the SCT’s trackage and haulage rights ruling, vacating the ruling and ordering the SCT to issue a new ruling consistent with the Court’s opinion. KCSM has not yet received the written opinion of the Mexican Supreme Court relating to the decision nor has the Mexican Supreme Court decided the interline and terminal services appeal. The Company believes that even if the rates set in 2002 become effective, there will be no material adverse effect on KCS’ results of operations. On October 2, 2006, KCS was served with a claim raised by Ferromex in which Ferromex asked for information concerning the interline traffic between KCSM and Ferromex, from January 1, 2002, through December 31, 2004, and an answer to this claim has been filed.

Disputes Relating to the Scope of the Mandatory Trackage Rights. The SCT issued rulings determining Ferromex’s trackage rights in Monterrey in 2002. KCSM and Ferromex both appealed the SCT’s rulings. KCSM obtained a favorable ruling at the administrative federal court level. Ferromex appealed the ruling. The case was remanded to the Administrative Federal Court with the instructions to consider additional arguments before issuing its ruling. KCSM is still awaiting that ruling, but does not expect the ruling to have a material adverse effect on its financial condition or results of operations.

Claims Asserted under the TMM Acquisition Agreement. As part of the acquisition of Grupo KCSM in 2005, KCS issued escrow notes totaling $47.0 million which are subject to reduction for certain potential losses related to incorrect representations and warranties or breaches of covenants in the Acquisition Agreement by TMM. On January 29, 2007, KCS advised TMM that KCS intended to assert claims for indemnification under the acquisition agreement related to representations and warranties made by TMM. On February 1, 2007, KCS received notice from TMM indicating that TMM would seek damages from KCS under the Acquisition Agreement, aggregating approximately $43 million as well as other unspecified damages. The parties are obligated under the Acquisition Agreement to attempt to resolve their differences informally and, if not successful, then to submit them to binding arbitration.

Acquisitions of Locomotives. KCSM entered into an agreement with General Electric Company (“GE”) on August 14, 2006, to acquire 30 locomotives at a cost of approximately $63.7 million. Of the 30 locomotives, KCSM has taken legal possession of 22 as of December 31, 2006 with the remainder to be completed and delivered in the first quarter of 2007. The 22 locomotives where legal possession has been

100

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

taken have been recorded as assets held for sale at year-end. Upon completion and delivery of all 30 units, the Company will enter into a sale-leaseback transaction with the locomotives.

On August 25, 2006, KCSR entered into an agreement with Electro-Motive Diesel, Inc. (“EMD”) to acquire 30 locomotives to be delivered June 2007 through September 2007 at a total cost of $61.5 million. The Company intends to finance the acquisitions with equipment lease financings treated as operating leases.

Letters of Intent. KCSR and KCSM entered into a letter of intent with GE on September 28, 2006, to acquire 80 locomotives to be delivered in late 2007 through August 2008 at an aggregate cost of approximately $160.8 million. KCSR intends to acquire 30 of these locomotives and KCSM intends to acquire the other 50. The letter of intent also provides KCSR and KCSM with an option to acquire an additional aggregate 40 locomotives for delivery in 2008. KCSR and KCSM each anticipates entering into purchase agreements with GE in the first quarter of 2007 with respect to the 80 locomotives. KCSR and KCSM entered into a letter of intent with EMD on November 29, 2006, to acquire 70 locomotives for delivery in October 2007 through April 2008 at an aggregate cost of approximately $140.9 million. KCSR intends to acquire 30 of these locomotives and KCSM intends to acquire the other 40. The Company intends to finance the acquisitions with equipment lease financings treated as operating leases.

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 $3.0 million of equipment loans. Further, if the Company or its partner ~~terminate~~terminates the concession contract without the consent of IFC, the Company is a guarantor for up to ~~50%~~half of the outstanding senior loans. See Note 3.

~~Commitment for Locomotive Purchase.~~ On February 15, 2005, KCSR entered into a purchase agreement with the Electro-Motive Division of General Motors Corporation (GM) to purchase new SD70ACe locomotives at a cost of approximately $55 million. KCSR expects the locomotives to be delivered in the fourth quarter of 2005. If KCSR fails to purchase the locomotives, GM is permitted to cancel the purchase agreement and KCSR must pay specified cancellation charges.


Note 12.	Derivative Instruments

~~Heavener Fueling Facility and Pipeline.~~ The Company has entered into an agreement to transport locomotive diesel fuel via pipeline into the Company’s fuel facility in Heavener, Oklahoma. The pipeline was completed and placed in service in May 2004. The contract provides that the Company will pay to the supplier transportation fees based on published tariff rates per barrel. The contract further requires that for a period of ten years after the pipeline is placed in service, the fees will be at least $1.5 million per year.

~~Note 10. Derivative Instruments and Purchase Commitments~~

~~Derivative Instruments.~~The Company does not engage in the trading of derivatives. The Company’s objective for using derivative instruments is to manage ~~its~~ fuel price risk and ~~mitigate the impact of fluctuations in fuel prices.~~currency fluctuations. In general, the Company enters into derivative transactions in limited situations

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

based on management’s assessment of current market conditions and perceived risks. ~~Management~~However, management 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 such transactions more frequently as deemed appropriate.


	*~~Fuel Derivative Transactions~~*

~~At December 31, 2004, the~~Fuel Derivative Transactions. The Company was a party to ~~one~~ fuel swap ~~agreement~~agreements for a notional amount of approximately 2.5 million gallons of fuel. Under the terms of this swap, the Company receives a variable price based upon an average of the spot prices calculated on a monthly basis as reported through a petroleum price reporting service and pays a fixed price determined at the time the Company entered into the swap transaction. The variable price the Company is receiving is approximately equal to the price the Company is paying in the market for locomotive fuel. By entering into swap transactions, the Company is able to fix the cost of fuel for the notional amount of gallons hedged.

~~A summary of the swap agreement to which KCSR was a party as of December 31, 2004 follows:~~

~~Trade Dates~~

~~Notional Amount~~

~~Fixed pay per gallon~~

~~Expiration Date~~

~~October 31, 2003~~

~~2.5 million gallons~~

~~68.0¢~~

~~December 31, 2005~~

Cash settlements of this swap occur on a monthly basis on the fifth business day of the month following the month for which the settlement is calculated. As of December 31, 2004, the fair market value of the benefit of the swap was $1.1 million. For the years ended December 31, 2004, 2003 and 2002, KCSR consumed 59.2 million, 55.4 million and 55.31.3 million gallons of fuel ~~respectively.~~on December 31, 2006. Fuel hedging transactions, including fuel swaps as well as forward purchase commitments, resulted in a decrease in fuel expense of $0.7 million, $2.4 million and $3.0 million ~~$1.1~~in 2006, 2005 and 2004, respectively. Subsequent to December 31, 2006, KCS entered into fuel swap agreements for 1.3 million gallons.

Foreign Exchange Contracts. The purpose of KCSM’s foreign exchange contracts is to limit the risks arising from exchange rate fluctuations in its Mexican peso-denominated monetary assets and ~~$0.4 million in 2004, 2003~~liabilities. Management determines the nature and ~~2002, respectively.~~


	*~~Southern Capital~~*

~~The Company records adjustments to its stockholders’ equity (accumulated other comprehensive income (loss)) for its portion~~quantity of ~~the adjustment to the fair value of derivative~~any hedging transactions ~~to which Southern Capital was a participant. The Company also adjusts its investment in Southern Capital by the change~~based upon net asset exposure and market conditions. On December 31, 2006, KCSM had one peso call option outstanding in the ~~fair value~~notational amount of ~~these derivative instruments. For the year ended~~$1.7 million based on an exchange rate per dollar of 14.50 Mexican pesos. The option expires May 30, 2007. On December 31, ~~2002,~~2005, KCSM had two Mexican peso call options in the ~~Company recorded a reduction to its stockholders equity (accumulated other comprehensive loss)~~notational amounts of approximately $0.3 million for its portion of the amount recorded by Southern Capital for the adjustment to the fair value of its interest rate swap transactions. The Company also reduced its investment in Southern Capital by the same amount.

During 2002, in conjunction with the refinancing of its debt, 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. The Company is recording the impact of this charge through a related reduction in equity earnings from Southern Capital and is amortizing the related accumulated other comprehensive income (loss) balance to its investment in Southern Capital. During the years ended December 31, 2004, 2003 and 2002, the Company recorded related amortization of $0.5 million, $1.2 million and ~~$0.7~~$1.7 million, based on the average exchange rate of 13.00 and 12.50 pesos per dollar, respectively. These options expired on September 6 and May 30, 2006, respectively.

Foreign Currency Balances. At December 31, 2006, KCSM had monetary assets and liabilities denominated in Mexican pesos of Ps2,304 million and Ps651 million, respectively. At December 31, 2005, KCSM had monetary assets and liabilities denominated in Mexican pesos of Ps1,088 million and Ps549 million, respectively. At December 31, 2006 and 2005, the exchange rate was 10.82 pesos per dollar and 10.64 pesos per dollar, respectively.

96
101

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)


Note ~~11.~~13.	Quarterly Financial Data (Unaudited)

2004

Fourth Third Second First
Quarter Quarter Quarter Quarter

(In millions, except per share amounts)
Revenues
$ 174.6 $ 163.2 $ 153.9 $ 147.8
Operating expenses 133.0 130.6 121.3 117.6
Depreciation and amortization 14.2 13.4 13.1 12.8

Operating income
27.4 19.2 19.5 17.4
Equity in net earnings (losses) of unconsolidated affiliates
Grupo TFM (8.5 ) 1.9 2.9 1.3
Other (1.7 ) (0.8 ) 0.3 0.1
Interest expense (11.4 ) (11.3 ) (10.9 ) (10.8 )
Debt retirement costs — — — (4.2 )
Other income 5.8 8.6 1.7 1.5

Income before income taxes
11.6 17.6 13.5 5.3
Income taxes provision 10.9 6.5 4.3 1.9

Net income
0.7 $ 11.1 $ 9.2 $ 3.4

Per Share Data

Total basic earnings (loss) per common share (0.02 ) $ 0.14 $ 0.11 $ 0.02

Total diluted earnings (loss) per common share (0.02 ) $ 0.14 $ 0.11 $ 0.02

Dividends per share: $25 par preferred stock
$ 0.25 $ 0.25 $ 0.25 $ 0.25
Dividends per share: $1 Par Convertible Preferred Stock(i)
$ 5.31 $ 5.31 $ 5.31 $ 5.31
Stock Price Ranges:

$25 Par Preferred — High $ 21.75 $ 21.35 $ 21.30 $ 21.50
                              — Low $ 20.50 $ 19.95 $ 19.52 $ 19.45
Common               — High $ 18.08 $ 15.53 $ 15.53 $ 15.35
                              — Low $ 15.22 $ 13.27 $ 12.60 $ 13.39


	Fourth		Third			Second			First
	In millions, except per share amounts

2006
Revenues	$	442.4	$	415.7		$	413.1		$	388.4
Operating income		88.2		77.3			77.5			61.3
Net income		40.6		31.3			24.1			12.9
Per share data:
Basic earnings per common share	$	0.48	$	0.35		$	0.26		$	0.11
Diluted earnings per common share		0.41		0.32			0.24			0.11
Dividends per share:
$25 par preferred stock	$	0.25	$	0.25		$	0.25		$	0.25
$1 par series C preferred stock		—		—			—			5.31
$1 par series D preferred stock		—		—			—			9.40
Stock price ranges:
$25 par preferred:
— High	$	23.65	$	23.50		$	23.75		$	23.50
— Low		22.75		22.25			22.00			22.00
Common:
— High	$	30.00	$	28.41		$	27.75		$	26.17
— Low		26.49		23.24			23.46			22.32
2005
Revenues	$	388.1	$	384.6		$	381.1		$	198.2
Operating income (loss)		47.7		(1.9	)		(8.3	)		24.8
Net income (loss)		5.2		112.7			(25.1	)		8.1
Per share data:
Basic earnings (loss) per common share	$	0.03	$	1.35		$	(0.33	)	$	0.09
Diluted earnings (loss) per common share		0.03		1.14			(0.33	)		0.09
Dividends per share:
$25 par preferred stock	$	0.25	$	0.25		$	0.25		$	0.25
$1 par series C preferred stock(i)		5.31		5.31			5.31			5.31
$1 par series D preferred stock		—		—			—			—
Stock price ranges:
$25 par preferred:
— High	$	23.50	$	23.50		$	23.50		$	24.00
— Low		22.00		22.60			22.00			21.45
Common:
— High	$	25.71	$	23.44		$	21.00		$	20.34
— Low		20.55		19.47			18.45			16.05


(i)		The ~~accumulation~~addition of ~~2004’s~~ four quarters of dividends on the $1 Par ~~Convertible~~ Preferred Stock ~~does~~Series C do not total the annual amount of $21.25, ~~for the year ended December 31, 2004~~ due to rounding.

97
102

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)

2003

Fourth Third Second First
Quarter Quarter Quarter Quarter

Revenues
$ 148.5 $ 146.3 $ 146.3 $ 140.2
Operating expenses 139.1 115.2 116.1 117.5
Depreciation and amortization 16.2 16.2 16.0 15.9

Operating income (loss)
(6.8 ) 14.9 14.2 6.8
Equity in net earnings (losses) of unconsolidated affiliates
Grupo TFM 6.1 1.6 (2.3 ) 6.9
Other (0.3 ) (0.9 ) (0.2 ) 0.1
Interest expense (11.6 ) (11.6 ) (11.7 ) (11.5 )
Other income 2.0 2.0 1.5 1.3

Income (loss) before income taxes and cumulative effect of accounting change
(10.6 ) 6.0 1.5 3.6
Income taxes provision (benefit) (5.4 ) 1.7 2.0 (1.1 )

Income (loss) before cumulative effect of accounting change
(5.2 ) 4.3 (0.5 ) 4.7
Cumulative effect of accounting change
— — — 8.9

Net income (loss)
$ (5.2 ) $ 4.3 $ (0.5 ) $ 13.6

Per Share Data(i)

Total basic earnings (loss) per common share $ (0.10 ) $ 0.02 $ (0.03 ) $ 0.22

Total diluted earnings (loss) per common share $ (0.10 ) $ 0.02 $ (0.03 ) $ 0.22

Dividends per share: $25 par preferred stock
$ 0.25 $ 0.25 $ 0.25 $ 0.25
Dividends per share: $1 Par Convertible Preferred Stock
$ 5.32 $ 5.90 $ — $ —
Stock Price Ranges:

$25 Par Preferred — High $ 20.00 $ 20.25 $ 20.00 $ 20.50
                              — Low $ 18.50 $ 18.75 $ 16.90 $ 17.25
Common               — High $ 14.97 $ 13.37 $ 12.78 $ 13.02
                              — Low $ 10.95 $ 10.60 $ 10.70 $ 10.65


~~(i)~~	~~The accumulation of 2003’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, 2003 due to rounding.~~


Note ~~12.~~14.	Condensed Consolidating Financial Information

As discussed in Note 5,6, KCSR has outstanding $200 million of 9¹/2% Notes due 2008 and $200 million of 7¹/2% Notes due 2009. ~~Both of these note issues~~These notes are unsecured obligations of KCSR, however, they are also jointly and severally and fully and unconditionally guaranteed on an unsecured senior basis by KCS and certain ~~of its subsidiaries (all of which are wholly-owned) within the KCS consolidated group.~~wholly-owned domestic subsidiaries. For each of these note issues, KCSR 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(in millions)has been prepared and presented pursuant to SECRegulation ~~S-X Rule~~S-XRule 3-10 “Financial statements of guarantors and affiliates whose securities

~~KANSAS CITY SOUTHERN~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)~~

collateralize an issue registered or being registered.” This condensed information is not intended to present the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with U.S. GAAP.

Condensed Consolidating Statements of Income

December 31, 2004

Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

(Dollars in millions)
Revenues $ — $ 635.2 $ 20.5 $ 14.1 $ (30.3 ) $ 639.5
Operating expenses 14.7 529.0 19.1 23.5 (30.3 ) 556.0

Operating income (loss) (14.7 ) 106.2 1.4 (9.4 ) — 83.5
Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries 35.1 (0.8 ) — (3.9 ) (34.9 ) (4.5 )
Interest expense (0.8 ) (43.6 ) (0.4 ) — 0.4 (44.4 )
Other income 0.3 16.3 — 1.4 (0.4 ) 17.6
Debt retirement costs — (4.2 ) — — — (4.2 )

Income (loss) before income taxes 19.9 73.9 1.0 (11.9 ) (34.9 ) 48.0
Income tax provision (benefit) (4.5 ) 31.0 0.4 (3.3 ) — 23.6

Net income $ 24.4 $ 42.9 $ 0.6 $ (8.6 ) $ (34.9 ) $ 24.4

December 31, 2003

Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

(Dollars in millions)
Revenues $ — $ 575.0 $ 21.5 $ 15.4 $ (30.6 ) $ 581.3
Operating expenses 13.5 517.7 20.9 30.7 (30.6 ) 552.2

Operating income (loss) (13.5 ) 57.3 0.6 (15.3 ) — 29.1
Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries 12.5 11.7 — 11.1 (24.3 ) 11.0
Interest expense (0.6 ) (45.8 ) (0.5 ) — 0.5 (46.4 )
Other income 0.1 5.9 0.1 1.2 (0.5 ) 6.8

Income (loss) before income taxes (1.5 ) 29.1 0.2 (3.0 ) (24.3 ) 0.5
Income tax provision (benefit) (4.8 ) 7.2 0.1 (5.3 ) — (2.8 )

Income before cumulative effect of accounting change 3.3 21.9 0.1 2.3 (24.3 ) 3.3
Cumulative effect of accounting change, net of income taxes 8.9 8.9 — — (8.9 ) 8.9

Net income $ 12.2 $ 30.8 $ 0.1 $ 2.3 $ (33.2 ) $ 12.2


	2006
							Guarantor			Non-Guarantor			Consolidating			Consolidated
	Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

Revenues	$	—		$	789.3		$	10.0		$	881.3		$	(20.9	)	$	1,659.7
Operating expenses		16.7			631.7			19.5			708.4			(20.9	)		1,355.4

Operating income (loss)		(16.7	)		157.6			(9.5	)		172.9			—			304.3
Equity in net earnings (losses) of unconsolidated affiliates		130.2			(1.7	)		—			4.9			(126.1	)		7.3
Interest expense		(5.7	)		(65.1	)		(1.7	)		(96.1	)		1.4			(167.2	)
Debt retirement costs		—			(2.2	)		—			(2.6	)		—			(4.8	)
Foreign exchange loss		—			—			—			(3.7	)		—			(3.7	)
Other income		0.7			10.7			—			8.7			(1.4	)		18.7

Income (loss) before income taxes and minority interest		108.5			99.3			(11.2	)		84.1			(126.1	)		154.6
Income tax expense (benefit)		(0.7	)		32.1			(4.3	)		18.3			—			45.4
Minority interest		0.3			—			—			—			—			0.3

Net income (loss)	$	108.9		$	67.2		$	(6.9	)	$	65.8		$	(126.1	)	$	108.9

99
103

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)

December 31, 2002

Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

(Dollars in millions)
Revenues $ — $ 567.4 $ 18.1 $ 38.3 $ (57.6 ) $ 566.2
Operating 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

2005
Guarantor
Non-Guarantor
Consolidating
Consolidated

Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

Revenues $ — $ 725.9 $ 21.9 $ 637.1 $ (32.9 ) $ 1,352.0
Operating expenses 19.1 650.7 22.9 629.9 (32.9 ) 1,289.7

Operating income (loss) (19.1 ) 75.2 (1.0 ) 7.2 — 62.3
Equity in net earnings (losses) of unconsolidated affiliates 127.1 1.6 — (4.1 ) (121.7 ) 2.9
Interest income (expense) (5.7 ) (58.5 ) 2.4 (73.3 ) 1.6 (133.5 )
Debt retirement costs — — — (4.4 ) — (4.4 )
Foreign exchange gain — — — 3.5 — 3.5
VAT/Put settlement gain (loss), net (9.0 ) — — 140.9 — 131.9
Other income 2.2 6.3 0.1 6.3 (1.6 ) 13.3

Income before income taxes and minority interest 95.5 24.6 1.5 76.1 (121.7 ) 76.0
Income tax expense (benefit) (5.4 ) 1.7 0.2 (3.6 ) — (7.1 )
Minority interest — — — (17.8 ) — (17.8 )

Net income $ 100.9 $ 22.9 $ 1.3 $ 97.5 $ (121.7 ) $ 100.9

~~Condensed Consolidating Balance Sheets~~

As of December 31, 2004

Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

(Dollars in millions)
ASSETS
Current assets $ 13.7 $ 231.9 $ 12.5 $ 13.2 $ (17.7 ) $ 253.6
Investments held for operating purposes and investments in subsidiaries 878.6 436.5 — 420.1 (1,250.3 ) 484.9
Properties, net 0.2 1,420.0 3.8 — — 1424.0
Restricted escrow account for Grupo TFM acquisition 200.0 — — — — 200.0
Goodwill and other assets 51.9 26.2 1.7 11.0 (12.7 ) 78.1

Total assets $ 1,144.4 $ 2,114.6 $ 18.0 $ 444.3 $ (1,280.7 ) $ 2,440.6

LIABILITIES AND EQUITY
Current liabilities $ 79.0 $ 143.1 $ 1.8 $ 39.6 $ (17.7 ) $ 245.8
Long-term debt 0.2 654.9 0.7 — — 655.8
Payable to affiliates 17.1 — 0.7 — (17.8 ) —
Deferred income taxes 19.7 422.3 0.2 1.4 (12.7 ) 430.9
Other liabilities 3.9 57.8 6.5 15.4 — 83.6
Stockholders’ equity 1,024.5 836.5 8.1 387.9 (1,232.5 ) 1,024.5

Total liabilities and equity $ 1,144.4 $ 2,114.6 $ 18.0 $ 444.3 $ (1,280.7 ) $ 2,440.6


	2004
							Guarantor			Non-Guarantor			Consolidating			Consolidated
	Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

Revenues	$	—		$	635.2		$	20.5		$	14.1		$	(30.3	)	$	639.5
Operating expenses		14.7			529.0			19.1			23.5			(30.3	)		556.0

Operating income (loss)		(14.7	)		106.2			1.4			(9.4	)		—			83.5
Equity in net earnings (losses) of unconsolidated affiliates		35.1			(0.8	)		—			(3.9	)		(34.9	)		(4.5	)
Interest expense		(0.8	)		(43.6	)		(0.4	)		—			0.4			(44.4	)
Other income		0.3			16.3			—			1.4			(0.4	)		17.6
Debt retirement costs		—			(4.2	)		—			—			—			(4.2	)

Income (loss) before income taxes		19.9			73.9			1.0			(11.9	)		(34.9	)		48.0
Income tax expense (benefit)		(4.5	)		31.0			0.4			(3.3	)		—			23.6

Net income (loss)	$	24.4		$	42.9		$	0.6		$	(8.6	)	$	(34.9	)	$	24.4

~~100~~104

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)

As of December 31, 2003

Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

(Dollars in millions)
ASSETS
Current assets $ 221.9 $ 285.3 $ 11.7 $ 15.1 $ (225.9 ) $ 308.1
Investments held for operating purposes and investments in subsidiaries 801.4 431.1 — 452.4 (1,242.2 ) 442.7
Properties, net 0.2 1,358.5 3.8 — — 1,362.5
Goodwill and other assets 11.0 28.6 1.7 11.3 (13.0 ) 39.6

Total assets $ 1,034.5 $ 2,103.5 $ 17.2 $ 478.8 $ (1,481.1 ) $ 2,152.9

LIABILITIES AND EQUITY
Current liabilities $ 14.8 $ 346.7 $ 3.8 $ 35.4 $ (225.9 ) $ 174.8
Long-term debt 1.3 511.5 0.7 — — 513.5
Payable to affiliates 19.5 — 0.7 — (20.2 ) —
Deferred income taxes 3.3 398.5 0.2 2.5 (13.0 ) 391.5
Other liabilities 31.9 54.4 4.3 18.8 — 109.4
Stockholders’ equity 963.7 792.4 7.5 422.1 (1,222.0 ) 963.7

Total liabilities and equity $ 1,034.5 $ 2,103.5 $ 17.2 $ 478.8 $ (1,481.1 ) $ 2,152.9

Condensed Consolidating Balance Sheets


	December 31, 2006
							Guarantor		Non-Guarantor			Consolidating			Consolidated
	Parent			KCSR			Subsidiaries		Subsidiaries			Adjustments			KCS

*Assets:*
Current assets	$	4.8		$	253.4		$	4.8	$	355.8		$	(12.8	)	$	606.0
Investments held for operating purposes and affiliate investment		1,952.3			429.9			—		450.8			(2,768.1	)		64.9
Property and equipment, net		0.6			1,163.7			227.9		1,060.5			(0.5	)		2,452.2
Concession assets, net		—			—			—		1,303.3			—			1,303.3
Other assets		5.0			31.4			—		174.5			—			210.9

Total assets	$	1,962.7		$	1,878.4		$	232.7	$	3,344.9		$	(2,781.4	)	$	4,637.3

*Liabilities and equity:*
Current liabilities	$	353.4		$	(229.5	)	$	140.1	$	386.1		$	(12.7	)	$	637.4
Long-term debt		0.2			733.4			0.6		897.6			—			1,631.8
Payables to affiliates		32.4			—			—		—			—			32.4
Deferred income taxes		(10.4	)		361.0			76.5		(9.8	)		—			417.3
Other liabilities		4.7			94.5			13.0		123.8			(0.3	)		235.7
Minority interest		—			31.4			—		100.3			(31.4	)		100.3
Stockholders’ equity		1,582.4			887.6			2.5		1,846.9			(2,737.0	)		1,582.4

Total liabilities and equity	$	1,962.7		$	1,878.4		$	232.7	$	3,344.9		$	(2,781.4	)	$	4,637.3


	December 31, 2005
						Guarantor			Non-Guarantor		Consolidating			Consolidated
	Parent			KCSR		Subsidiaries			Subsidiaries		Adjustments			KCS

*Assets:*
Current assets	$	2.4		$	476.1	$	20.3		$	233.3	$	(265.3	)	$	466.8
Investments held for operating purposes and affiliate investment		1,715.4			435.8		—			464.2		(2,555.1	)		60.3
Property and equipment, net		0.1			1,334.0		239.3			724.9		—			2,298.3
Concession assets, net		—			—		—			1,360.4		—			1,360.4
Other assets		10.9			19.6		5.3			218.0		(16.0	)		237.8

Total assets	$	1,728.8		$	2,265.5	$	264.9		$	3,000.8	$	(2,836.4	)	$	4,423.6

*Liabilities and equity:*
Current liabilities	$	202.2		$	141.0	$	240.2		$	257.8	$	(267.5	)	$	573.7
Long-term debt		0.2			738.1		0.6			925.0		—			1,663.9
Payables to affiliates		98.1			—		0.7			26.6		(45.0	)		80.4
Deferred income taxes		(3.5	)		424.6		(0.5	)		4.5		(15.9	)		409.2
Other liabilities		5.6			110.5		14.6			139.5		—			270.2
Stockholders’ equity		1,426.2			851.3		9.3			1,647.4		(2,508.0	)		1,426.2

Total liabilities and equity	$	1,728.8		$	2,265.5	$	264.9		$	3,000.8	$	(2,836.4	)	$	4,423.6

~~101~~
105

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)

Condensed Consolidating Statements of Cash Flows

December 31, 2004

Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

(Dollars in millions)
Net cash flows provided by (used for) operating activities:
Excluding intercompany activity $ (11.5 ) $ 156.2 $ 1.9 $ (3.9 ) $ — $ 142.7
Intercompany activity 236.6 (239.7 ) (0.2 ) 3.3 — —

Net cash flows provided by (used for) operating activities: $ 225.1 $ (83.5 ) $ 1.7 $ (0.6 ) $ — $ 142.7
Investing activities:
Property acquisitions — (116.7 ) (0.5 ) — — (117.2 )
Proceeds from disposal of property — 4.9 — — — 4.9
Funding of restricted escrow account (200.0 ) — — — — (200.0 )
Investments in and loans to affiliates (41.7 ) (10.5 ) — (9.3 ) 6.5 (55.0 )
Proceeds from sale of investments 0.4 — — 0.1 — 0.5
Repayment of loans to affiliates — — — 8.8 (8.8 ) —
Other, net (9.6 ) (0.4 ) — — — (10.0 )

Net (250.9 ) (122.7 ) (0.5 ) (0.4 ) (2.3 ) (376.8 )

Financing activities:
Proceeds from issuance of long-term debt — 250.0 — — — 250.0
Repayment of long-term debt — (106.6 ) (1.0 ) — — (107.6 )
Proceeds of loans from affiliates 6.5 — — — (6.5 ) —
Repayment of loans from affiliates (8.8 ) — — — 8.8 —
Debt issuance costs — (3.8 ) — — — (3.8 )
Proceeds from stock plans 7.4 — — — — 7.4
Cash dividends paid (8.7 ) — — — — (8.7 )

Net (3.6 ) 139.6 (1.0 ) — 2.3 137.3

Cash and cash equivalents:
Net increase (decrease) (29.4 ) (66.6 ) 0.2 (1.0 ) — (96.8 )
At beginning of period 39.9 94.0 0.1 1.4 — 135.4

At end of period $ 10.5 $ 27.4 $ 0.3 $ 0.4 $ — $ 38.6


	2006
							Guarantor			Non-Guarantor			Consolidating			Consolidated
	Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

*Operating activities:*
Excluding intercompany activity	$	(148.7	)	$	225.4		$	81.5		$	128.0		$	(18.7	)	$	267.5
Intercompany activity		187.7			(145.3	)		(80.5	)		19.4			18.7			—

Net cash provided		39.0			80.1			1.0			147.4			—			267.5

*Investing activities:*
Capital expenditures		—			(93.1	)		—			(148.7	)		—			(241.8	)
Proceeds from disposal of property		—			26.9			—			3.1			—			30.0
Contribution from NS for MSLLC (net of change in restricted contribution)		—			—			—			79.5			—			79.5
Property investments in MSLLC		—			—			—			(37.8	)		—			(37.8	)
Other restricted cash		—			—			—			(3.0	)		—			(3.0	)
Proceeds from sales of investments, net		—			8.2			—			—			—			8.2
Investments in and loans to affiliates		—			—			—			(1.1	)		—			(1.1	)

Net cash used		—			(58.0	)		—			(108.0	)		—			(166.0	)

*Financing activities:*
Proceeds from issuance of long- term debt		—			410.2			—			206.1			—			616.3
Repayment of long-term debt		(44.0	)		(409.3	)		(0.1	)		(205.1	)		—			(658.5	)
Debt issuance costs		—			(7.5	)		—			(8.4	)		—			(15.9	)
Proceeds from stock plans		8.6			—			—			—			—			8.6
Dividends paid		(4.3	)		—			—			—			—			(4.3	)
Excess tax benefit realized from options exercised		.2			—			—			—			—			.2

Net cash used		(39.5	)		(6.6	)		(0.1	)		(7.4	)		—			(53.6	)

Cash and cash equivalents:
Net increase (decrease)		(0.5	)		15.5			0.9			32.0			—			47.9
At beginning of year		0.7			20.7			(0.9	)		10.6			—			31.1

At end of year	$	0.2		$	36.2		$	—		$	42.6		$	—		$	79.0

~~102~~
106

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)

December 31, 2003

Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

(Dollars in millions)
Net cash flows provided by (used for) operating activities: $ (130.9 ) $ 209.2 $ (10.4 ) $ — $ 0.1 $ 68.0

Investing activities:
Property acquisitions — (83.6 ) (0.4 ) — — (84.0 )
Proceeds from disposal of property — 15.0 — — — 15.0
Investments in and loans to affiliates (41.8 ) (6.1 ) — (28.6 ) 36.1 (40.4 )
Proceeds from sale of investments 32.7 — — — — 32.7
Repayment of loans to affiliates — — — 20.7 (20.7 ) —
Other, net (9.3 ) — — — — (9.3 )

Net (18.4 ) (74.7 ) (0.4 ) (7.9 ) 15.4 (86.0 )

Financing activities:
Proceeds from issuance of long-term debt — — — — — —
Repayment of long-term debt — (58.2 ) (1.0 ) — — (59.2 )
Proceeds of loans from affiliates 27.4 — — — (27.4 ) —
Repayment of loans from affiliates (20.7 ) — — — 20.7 —
Issuance of preferred stock, net 193.0 — — — — 193.0
Proceeds from stock plans 5.1 0.2 — — — 5.3
Cash dividends paid (4.7 ) — — — — (4.7 )
Other, net — — — 8.8 (8.8 ) —

Net 200.1 (58.0 ) (1.0 ) 8.8 (15.5 ) 134.4

Cash and cash equivalents:
Net increase (decrease) 50.8 76.5 (11.8 ) 0.9 — 116.4
At beginning of period (10.8 ) 17.5 11.8 0.5 — 19.0

At end of period $ 40.0 $ 94.0 $ — $ 1.4 $ — $ 135.4

2005
Guarantor
Non-Guarantor
Consolidating
Consolidated

Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

Operating activities:

Excluding intercompany activity $ (1.1 ) $ 107.4 $ 11.3 $ 61.2 $ — $ 178.8
Intercompany activity 17.3 (14.9 ) (8.9 ) 6.5 — —

Net cash provided 16.2 92.5 2.4 67.7 — 178.8

Investing activities:

Capital expenditures — (170.9 ) (3.5 ) (101.3 ) — (275.7 )
Proceeds from disposal of property — 5.7 — 0.6 — 6.3
Proceeds from investment sales — (8.0 ) — — — (8.0 )
Investments in and loans to affiliates (9.9 ) (16.3 ) — 8.0 7.7 (10.5 )
Acquisition costs (10.1 ) — — — — (10.1 )
Cash of Mexrail at acquisition — — — 3.0 — 3.0
Cash of KCSM at acquisition — — — 5.5 — 5.5
Repayment of loans to affiliates — 10.1 — 4.2 (14.3 ) —

Net cash used (20.0 ) (179.4 ) (3.5 ) (80.0 ) (6.6 ) (289.5 )

Financing activities:

Proceeds from issuance of long- term debt — 20.3 — 624.4 — 644.7
Repayment of long-term debt (1.0 ) 62.7 — (583.2 ) — (521.5 )
Capital contribution — — — 5.5 (5.5 ) —
Proceeds of loans from affiliates 5.2 — — — (5.2 ) —
Repayment of loans from affiliates (6.7 ) — — (10.6 ) 17.3 —
Debt issuance costs — (2.9 ) — (13.6 ) — (16.5 )
Proceeds from stock plans 1.7 — — — — 1.7
Repurchase of common stock (200.4 ) — — — — (200.4 )
Issuance of preferred stock, net proceeds 203.9 — — — — 203.9
Dividends paid (8.7 ) — — — — (8.7 )

Net cash provided (used) (6.0 ) 80.1 — 22.5 6.6 103.2

Cash and cash equivalents:

Net increase (decrease) (9.8 ) (6.8 ) (1.1 ) 10.2 — (7.5 )
At beginning of year 10.5 27.5 0.2 0.4 — 38.6

At end of year $ 0.7 $ 20.7 $ (0.9 ) $ 10.6 $ — $ 31.1

~~103~~107

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~Notes to Consolidated Financial Statements — (Continued)

December 31, 2002

Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

(Dollars in millions)
Net cash flows provided by (used for) operating activities: $ (27.9 ) $ 96.7 $ 13.3 $ 11.1 $ 0.6 $ 93.8

Investing activities:
Property acquisitions — (77.2 ) (0.7 ) — — (77.9 )
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 — — — (0.5 ) — (0.5 )

Net (1.6 ) (27.8 ) (0.7 ) (13.5 ) 10.6 (33.0 )

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 of 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 — — — 3.0 (3.0 ) —

Net 17.4 (74.7 ) (0.8 ) 2.8 (11.2 ) (66.5 )

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

2004
Guarantor
Non-Guarantor
Consolidating
Consolidated

Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

Operating activities:

Excluding intercompany activity $ (11.5 ) $ 156.2 $ 1.9 $ (3.9 ) $ — $ 142.7
Intercompany activity 236.6 (239.7 ) (0.2 ) 3.3 — —

Net cash provided (used) 225.1 (83.5 ) 1.7 (0.6 ) — 142.7

Investing activities:

Capital expenditures — (116.7 ) (0.5 ) — — (117.2 )
Proceeds from disposal of property — 4.9 — — — 4.9
Other restricted cash (200.0 ) — — — — (200.0 )
Investments in and loans to affiliates (41.7 ) (10.5 ) — (9.3 ) 6.5 (55.0 )
Proceeds from investment sales 0.4 — — 0.1 — 0.5
Repayment of loans to affiliates — — — 8.8 (8.8 ) —
Other, net (9.6 ) (0.4 ) — — — (10.0 )

Net cash used (250.9 ) (122.7 ) (0.5 ) (0.4 ) (2.3 ) (376.8 )

Financing activities:

Proceeds from issuance of long- term debt — 250.0 — — — 250.0
Repayment of long-term debt — (106.6 ) (1.0 ) — — (107.6 )
Proceeds of loans from affiliates 6.5 — — — (6.5 ) —
Repayment of loans from affiliates (8.8 ) — — — 8.8 —
Debt issuance costs — (3.8 ) — — — (3.8 )
Proceeds from stock plans 7.4 — — — — 7.4
Dividends paid (8.7 ) — — — — (8.7 )

Net cash provided (used) (3.6 ) 139.6 (1.0 ) — 2.3 137.3

Cash and cash equivalents:

Net increase (decrease) (29.4 ) (66.6 ) 0.2 (1.0 ) — (96.8 )
At beginning of year 39.9 94.0 0.1 1.4 — 135.4

At end of year $ 10.5 $ 27.4 $ 0.3 $ 0.4 $ — $ 38.6


Note 15.	Segment Reporting

The accompanying segment reporting information(in millions)has been prepared and presented pursuant to Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information.” Operating units are defined as either U.S. or Mexico segments. Appropriate eliminations of revenue and reclassifications of operating revenues and expenses have been recorded in deriving

~~104~~108

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

consolidated data. The U.S. segment consists primarily of KCSR and Tex-Mex. The Mexico segment consists of Grupo KCSM, KCSM and Arrendadora.


	2006
	U.S.		��	Mexico		Elimination			Consolidated

Revenue	$	885.7		$	774.0	$	—		$	1,659.7

Operating expenses:
Compensation and benefits		264.3			123.4		—			387.7
Purchased services		82.8			131.0		1.4			215.2
Fuel		140.8			112.8		—			253.6
Equipment costs		82.7			97.0		—			179.7
Depreciation and amortization		65.7			89.3		—			155.0
Casualties and insurance		44.9			8.5		—			53.4
KCSM employees’ statutory profit sharing		—			5.9		—			5.9
Other		78.9			27.4		(1.4	)		104.9

Total operating expenses		760.1			595.3		—			1,355.4

Operating income	$	125.6		$	178.7	$	—		$	304.3

Income before income taxes and minority interest	$	133.5		$	87.2	$	(66.1	)	$	154.6

Total assets	$	3,464.7		$	2,465.4	$	(1,292.8	)	$	4,637.3
Total liabilities		1,750.6			1,204.0		—			2,954.6
Capital expenditures		125.7			116.1		—			241.8


	2005
	U.S.		Mexico		Elimination			Consolidated

Revenue	$	804.4	$	547.6	$	—		$	1,352.0

Operating expenses:
Compensation and benefits		244.8		95.6		—			340.4
Purchased services		84.6		108.7		1.8			195.1
Fuel		123.8		83.1		—			206.9
Equipment costs		68.9		80.9		—			149.8
Depreciation and amortization		60.0		67.7		—			127.7
Casualties and insurance		88.7		14.7		—			103.4
KCSM employees’ statutory profit sharing		—		41.1		—			41.1
Other		88.5		38.6		(1.8	)		125.3

Total operating expenses		759.3		530.4		—			1,289.7

Operating income	$	45.1	$	17.2	$	—		$	62.3

Income before income taxes and minority interest	$	90.0	$	85.4	$	(99.4	)	$	76.0

Total assets	$	3,271.2	$	2,418.3	$	(1,265.9	)	$	4,423.6
Total liabilities		1,849.4		1,215.5		(67.5	)		2,997.4
Capital expenditures		203.7		72.0		—			275.7

109

Kansas City Southern

Notes to Consolidated Financial Statements — (Continued)

Note 16. Subsequent Events

Preferred Stock Dividends. On January 12, 2007, the Company declared a cash dividend on the Series C Preferred Stock and a stock dividend on the Series D Preferred Stock for dividends in arrears that were due May 15, 2006, August 15, 2006 and November 15, 2006, and the dividend payment due February 15, 2007. The dividends were paid on February 15, 2007, to stockholders of record on February 5, 2007. The Company also declared a cash dividend on the 4%, noncumulative Preferred Stock, payable April 3, 2007, to stockholders of record on March 12, 2007.

Consent Solicitation. On January 29, 2007, KCSR commenced a consent solicitation to amend the indentures under which KCSR’s 91/2% Senior Notes due 2008 (“91/2% Notes”) and 71/2% Senior Notes due 2009 (“71/2% Notes”) were issued. The purpose of the consent solicitation was to (i) resolve an inconsistency in the inclusion of certain expenses, but not the income, of restricted subsidiaries in the calculation of the consolidated coverage ratio under the indentures, (ii) amend the definition of refinancing indebtedness to allow the inclusion of certain related premiums, interest, fees and expenses in permitted refinancing indebtedness and (iii) obtain waivers of any defaults arising from certain actions taken in the absence of such proposed amendments. On February 5, 2007, KCSR obtained the requisite consents from the holders of each series of Notes to amend their respective indentures as described above and executed supplemental indentures containing such amendments and waivers.

Credit Facility Waiver. On January 31, 2007, KCS provided written notice to the lenders under the 2006 Credit Agreement of certain representation and other defaults under the 2006 Credit Agreement arising from the potential defaults which existed under KCSR indentures as described above. These defaults limited KCSR’s access to the revolving credit facility. In its notice of default, the Company also requested that the lenders waive these defaults. On February 5, 2007 the Company received a waiver of such defaults from all of the lenders under the 2006 Credit Agreement. The Company is currently not in default of the 2006 Credit Agreement and has access to the revolving credit facility.

110

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure


~~Item 9.~~	*~~Changes in and Disagreements with Accountants on Accounting and Financial Disclosure~~*

~~There were no disagreements with accountants on accounting~~

None.

Item 9A. Controls and ~~financial disclosure matters.~~Procedures


~~Item 9(a).~~	*~~Controls and Procedures~~*

(a) Disclosure 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 inRules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the fiscal year for which this annual report onForm 10-K is filed. 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~~filed or ~~submits~~submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to ~~the Company’s~~ management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required ~~disclosure.~~disclosures.

(b) Changes in Internal Control over Financial Reporting

There ~~has~~have been no ~~change~~changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter (the fourth quarter in the case of ~~the fiscal year for which this~~an annual ~~report on Form 10-K is filed~~report) that ~~has~~have materially affected, or isare reasonably likely to materially affect, the Company’s internal control over financial reporting.

(c) Internal Control over Financial Reporting ~~Controls and Procedures~~

The report of management on the Company’s internal control over financial reporting (as defined in ~~Rules~~Rule 13a-15(f) and15d-15(f) under the Exchange Act) is included as “Management’s Report on Internal Control ~~Over~~over Financial Reporting” in Item 8.

KPMG LLP, the independent registered public accounting firm that audited the Company’s financial statements contained herein, has issued an attestation report on management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, ~~2004.~~2006. The attestation report is included in Item 8.


~~Item 9(b).~~	*~~Other Information~~*

~~None.~~

~~Part III~~Item 9B. Other Information

None.

Part III

The Company has incorporated by reference certain responses to the Items of this Part III pursuant toRule 12b-23 under the Exchange Act and General Instruction G(3) toForm 10-K. The Company’s definitive proxy statement for the annual meeting of stockholders scheduled for May ~~5, 2005~~3, 2007 (“Proxy Statement”), will be filed no later than 120 days after December 31, ~~2004.~~2006.


Item 10.	*Directors, ~~and~~ Executive Officers ~~of the Company~~and Corporate Governance*

(a) Directors of the Company

The ~~information set forth in response to Item 401~~sections of ~~Regulation S-K under~~ the ~~heading~~Company’s definitive proxy statement for the 2007 annual meeting of stockholders entitled “Proposal 1 — Election of Two Directors” and “The Board of Directors” ~~in the Company’s Proxy Statement is~~are incorporated ~~herein~~ by reference in partial response to this Item 10.

111

~~105~~

(b) Executive Officers of the Company

~~The information set forth in response to Item 401 of Regulation S-K under~~

See “Executive Officers of ~~the Company,” an unnumbered Item~~KCS and Subsidiaries” in Part I, ~~(immediately following~~ Item 4 ~~Submission of Matters to a Vote of Security Holders),~~ of this ~~Form 10-K,~~annual report incorporated by reference herein for information about the executive officers of the Company.

The section of the Company’s definitive proxy statement for the 2007 annual meeting of stockholders entitled “Board Committees — The Audit Committee” is incorporated ~~herein~~ by reference in partial response to this Item 10.

~~(c)~~

(d) Compliance with Section 16(a) of the Exchange Act

The ~~information set forth in~~ response to Item 405 ofRegulation S-K under ~~the heading~~ “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s ~~Proxy Statement~~definitive proxy statement for the 2007 annual meeting of stockholders is incorporated ~~herein~~ by reference in partial response to this Item 10.

~~(d)~~

(e) Code of Ethics

The Company has adopted a Code of Business Conduct and Ethics ~~(the “Code~~(“Code of Ethics”) that applies to directors, officers (including, among others, the ~~Company’s~~ principal executive officer, principal financial officer and principal accounting ~~officer or controller, or persons performing similar functions)~~officer) and employees. The Company has posted its Code of Ethics on its ~~Internet~~ website ~~at www.kcsi.com. The Company~~(www.kcsouthern.com) and will ~~also~~ post on ~~this Internet~~its website any amendments to, or waivers from, a provision of its Code of Ethics that applies to the Company’s principal executive officer, principal financial officer or principal accounting officer ~~or controller, or persons performing similar functions~~ as required by applicable rules and regulations. The Code of Ethics is available, in print, upon written request to the Corporate Secretary, P.O. Box 219335, Kansas City, Missouri64121-9335.

~~(e)~~

(f) Annual Certification to the New York Stock Exchange

~~KCS’s~~

KCS’ common stock is listed on the New York Stock Exchange (“NYSE”). As a result, ~~KCS’s~~the Chief Executive Officer is required to make annually, and he ~~has~~ made on May ~~24, 2004,~~22, 2006, a CEO’s Annual Certification to the New York Stock Exchange in accordance with Section 303A.12 of the NYSE Listed Company Manual stating that he was not aware of any violations by KCS of the NYSE corporate governance listing standards.


Item 11.	*Executive Compensation*

The ~~information set forth in response to Item 402~~sections of ~~Regulation S-K under~~the Company’s definitive proxy statement for the 2007 annual meeting of stockholders entitled “Non-Management Director Compensation,” “Compensation Committee Report,” “Compensation Discussion and Analysis,” “Management ~~Compensation”~~Compensation Tables,” and ~~“The Board of Directors~~“Board Committees — The Compensation Committee — Compensation ~~of Directors” in the Company’s Proxy Statement, (other than the Compensation~~Committee Interlocks and ~~Organization Committee Report on Executive Compensation and the Stock Performance Graph), is~~Insider Participation” are incorporated ~~herein~~ by reference in response to this Item 11.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters


~~Item 12.~~	*~~Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters~~*

The ~~information set forth in response to Item 403~~section 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~~definitive proxy statement for the 2007 annual meeting of stockholders entitled “Beneficial Ownership” is incorporated ~~herein~~ by reference in partial response to this Item 12.

112

~~106~~

Equity Compensation Plan ~~Information~~Information.

The following table provides information as of December 31, ~~2004~~2006, about ~~our~~the common stock that may be issued upon the exercise of options, warrants and rights, as well as shares remaining available for future issuance under ~~our~~the Company’s existing equity compensation plans.

Number of Securities
Weighted-Average Remaining Available for
Exercise Price of Future Issuance under
Number of Securities to be Outstanding Equity Compensation
Issued upon Exercise of Options, Plans (Excluding
Outstanding Options, Warrants and Securities Reflected in
Plan Category Warrants and Rights Rights Column (a)(1)

(a) (b) (c)

Equity compensation plans approved by security holders 4,192,742 $ 8.62 5,093,872
Equity compensation plans not approved by security holders 0 0 0

Total 4,192,742 $ 8.62 5,093,872

Number of Securities

Remaining Available

Number of Securities

for Future Issuance

to be Issued

Weighted-Average

Under Equity Compensation

Upon Exercise of

Exercise Price of

Plans — Excluding

Outstanding Options,

Securities Reflected in

Plan Category

Warrants and Rights

the First Column(i)

Equity compensation plans:

Approved by security holders

2,940,332

8.98

6,895,114

Not approved by security holders

—

Total

2,940,332

8.98

6,895,114


~~(1)~~ (i)		Includes ~~4,308,567~~4,201,897 shares available for issuance under the Employee Stock Purchase ~~Plan. In addition, includes 785,305~~Plan and 2,693,217 shares available for issuance under the 1991 Plan as awards in the form of ~~Restricted~~Nonvested Shares, Bonus Shares, Performance Units or Performance Shares or issued upon the exercise of Options (including ISOs), stock appreciation rights or limited stock appreciation rights awarded under the 1991 Plan.

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, and Director Independence*

The ~~information set forth in response to Item 404~~sections of ~~Regulation S-K under~~ the ~~heading “Compensation~~Company’s definitive proxy statement for the 2007 annual meeting of stockholders entitled “Insider Disclosures,” “The Board of Directors — Non-Management Director Independence” and “Board Committees — The Compensation Committee — Compensation Committee Interlocks and Insider ~~Participation; Certain Relationships and Related Transactions” in the Company’s Proxy Statement is~~Participation” are incorporated ~~herein~~ by reference in response to this Item 13.


Item 14.	*Principal Accountant Fees and Services*

~~Information concerning principal accounting fees and services under~~

The sections of the ~~heading “Audit Matters~~Company’s definitive proxy statement for the 2007 annual meeting of stockholders entitled “Board Committees — ~~Principal Accounting Firm Fees” and “The Board of Directors — The~~the Audit Committee” ~~in the Company’s Proxy Statement is hereby~~and “Independent Registered Public Accounting Firm” are incorporated by reference in response to this Item 14.

~~107~~

Part IV


Item 15.	*Exhibits and Financial Statement Schedules ~~and Reports on Form 8-K~~*

~~(a) List of Documents filed as part of this Report~~


(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 appear in Part II Item 8, Financial Statements and Supplementary Data, of thisForm 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 thisForm 10-K.

113

(3) List of Exhibits

(a) Exhibits

The Company has attached or incorporated by reference herein certain exhibits as specified below pursuant toRule 12b-32 under the Exchange Act.


~~(2)~~	~~Plan of acquisition, reorganization, arrangement, liquidation or~~ ~~succession~~

2 .1 Amended and Restated Acquisition Agreement, dated as of December 15, 2004, by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., KCS Acquisition Subsidiary, Inc., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (the “Amended Acquisition Agreement”), which is filed as Exhibit 10.1 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (Commission File No. 1-4717), is incorporated herein by reference as Exhibit 2.1

2 .2 First Amendment to Rights Agreement, is attached hereto as Exhibit 2.2

2 .3 Stockholders’ Agreement by and among KCS, Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and certain stockholders of Grupo TMM, S.A (the “Stockholders’ Agreement”), which is filed as Exhibit 10.3 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (Commission File No. 1-4717), is incorporated herein by reference as Exhibit 2.3

2 .4 Registration Rights Agreement by and among KCS, Grupo TMM, S.A., TMM Multimodal, S.A. de C.V. and certain stockholders of Grupo TMM, S.A. (the “Acquisition Registration Rights Agreement”), which is filed as Exhibit 10.4 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (Commission File No. 1-4717), is incorporated herein by reference as Exhibit 2.4

2 .5 Consulting Agreement by and between KCS and José F. Serrano International Business, S.A. de C.V. (the “Consulting Agreement”), which is filed as Exhibit 10.5 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (Commission File No. 1-4717), is incorporated herein by reference as Exhibit 2.5

2 .6 Marketing and Services Agreement by and among KCSR, TMM Logistics, S.A. de C.V. and TFM, S.A. de C.V. (the “Marketing and Services Agreement”), which is filed as Exhibit 10.6 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (Commission File No. 1-4717), is incorporated herein by reference as Exhibit 2.6

~~(3) Articles of Incorporation and Bylaws~~

Exhibit

Description

  (2) Plan of acquisition, reorganization, arrangement, liquidation or succession
2 .1 Amended and Restated Acquisition Agreement, dated as of December 15, 2004, by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., KCS Acquisition Subsidiary, Inc., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and Grupo Transportación Ferroviaria Mexicana, S.A. de C.V. (currently known as Grupo KCSM, S.A. de C.V. (“Grupo KCSM”)) (the “Amended Acquisition Agreement”), filed as Exhibit 10.1 to the Company’s Current Report onForm 8-K filed on December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 2.1.
2 .2 Stockholders’ Agreement by and among KCS, Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and certain stockholders of Grupo TMM, S.A (the “Stockholders’ Agreement”), filed as Exhibit 10.3 to the Company’s Current Report onForm 8-K filed on December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 2.2.
2 .3 Registration Rights Agreement by and among KCS, Grupo TMM, S.A., TMM Multimodal, S.A. de C.V. and certain stockholders of Grupo TMM, S.A. (the “Acquisition Registration Rights Agreement”), filed as Exhibit 10.4 to the Company’s Current Report onForm 8-K filed on December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 2.3.
2 .4 Consulting Agreement by and between KCS and José F. Serrano International Business, S.A. de C.V. (the “Consulting Agreement”), filed as Exhibit 10.5 to the Company’s Current Report onForm 8-K filed on December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 2.4.
2 .5 Marketing and Services Agreement by and among KCSR, TMM Logistics, S.A. de C.V. and TFM, S.A. de C.V. (currently known as Kansas City Southern de México, S. de R.L. de C.V. (“KCSM”)) (the “Marketing and Services Agreement”), filed as Exhibit 10.6 to the Company’s Current Report onForm 8-K filed on December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 2.5.
2 .6 Rights Agreement, dated as of September 29, 2005, by and between KCS and UMB Bank, n.a. (the “2005 Rights Agreement”), filed as Exhibit 10.1 to the Company’s Current Report onForm 8-K filed on October 3, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 2.6.
2 .7 Registration Rights Agreement, dated November 21, 2006, among Kansas City Southern de México, S.A. de C.V. (currently known as Kansas City Southern de México, S. de R.L. de C.V. (“KCSM”)), Morgan Stanley & Co. Incorporated, Banc of America Securities LLC, BBVA Securities Inc., BMO Capital Markets Corp., and Scotia Capital (USA) Inc. (the “2006 Registration Rights Agreement”), filed as Exhibit 4.3 to the Company’s Current Report onForm 8-K filed on November 28, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 2.7.
  (3) Articles of Incorporation and Bylaws
Articles of Incorporation
3 .1 Exhibit 3.1 to the Company’s Registration Statement onForm S-4 originally filed July 12, 2002 (RegistrationNo. 333-92360), as amended and declared effective on July 30, 2002 (the “2002S-4 Registration Statement”), Restated Certificate of Incorporation, is incorporated herein by reference as Exhibit 3.1.
Bylaws
3 .2 The Amended and Restated By-Laws of Kansas City Southern, as amended on January 18, 2007, are attached to thisForm 10-K as Exhibit 3.2.
  (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 the Company’s Restated Certificate of Incorporation. (See Exhibit 3.1).

114

~~108~~

~~Articles of Incorporation~~

Exhibit

Description

4 .2 Article I, Sections 1, 3 and 11 of Article II, Article V and Article VIII of the Company’s Bylaws. (See Exhibit 3.2).
4 .3 Indenture, dated July 1, 1992, between Kansas City Southern and The Chase Manhattan Bank (the “1992 Indenture”) filed as Exhibit 4 to the Company’s Shelf Registration of $300 million of Debt Securities onForm S-3 filed June 19, 1992 (RegistrationNo. 33-47198) and as Exhibit 4(a) to the Company’sForm S-3 filed March 29, 2003 (RegistrationNo. 33-60192) registering $200 million of Debt Securities, is incorporated herein by reference as Exhibit 4.3.
4 .3.1 Supplemental Indenture, dated December 17, 1999, with respect to the 7% Debentures Due December 15, 2025 issued pursuant to the 1992 Indenture, filed as Exhibit 4.5.4 to the Company’sForm 10-K for the fiscal year ended December 31, 1999 (File No 1-4717), is incorporated herein by reference as Exhibit 4.3.1.
4 .4 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”), filed as Exhibit 4.1 to the Company’s Registration Statement onForm S-4 originally filed on January 25, 2001 (RegistrationNo. 333-54262), as amended and declared effective on March 15, 2001 (the “2001S-4 Registration Statement”), is incorporated herein by reference as Exhibit 4.4.
4 .4.1 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, filed as Exhibit 4.1.1 to the Company’s 2001S-4 Registration Statement (RegistrationNo. 333-54262), is incorporated herein by reference as Exhibit 4.4.1.
4 .4.2 Second Supplemental Indenture, dated as of June 10, 2005, to the 2000 Indenture, among the Company, KCSR, and certain other subsidiaries of the Company and The Bank of New York, as Trustee, filed as Exhibit 10.1 to the Company’s Quarterly Report onForm 10-Q for the period ended June 30, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 4.4.2.
4 .4.3 Third Supplemental Indenture, dated as of February 5, 2007, to the 2000 Indenture, among the Company, KCSR, certain other subsidiaries of the Company and the Bank of New York Trust Company, N.A., as Trustee, is attached to thisForm 10-K as Exhibit 4.4.3
4 .4.4 Form of Exchange Note (included as Exhibit B to Exhibit 4.4 of thisForm 10-K).
4 .5 Exchange and Registration Rights Agreement, dated as of September 27, 2000, among the Company, KCSR, and certain other subsidiaries of the Company, filed as Exhibit 4.3 to the Company’s 2001S-4 Registration Statement (RegistrationNo. 333-54262), is incorporated herein by reference as Exhibit 4.5.
4 .6 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 “June 12, 2002 Indenture”), filed as Exhibit 4.1 to the 2002S-4 Registration Statement (RegistrationNo. 333-92360), is incorporated herein by reference as Exhibit 4.6.
4 .6.1 Form of Face of Exchange Note, included as Exhibit B to Exhibit 4.7 and filed as Exhibit 4.2 to the 2002S-4 Registration Statement (RegistrationNo. 333-92360), is incorporated herein by reference as Exhibit 4.6.1.
4 .6.2 Supplemental Indenture, dated June 10, 2005, to the June 12, 2002 Indenture among the Company, KCSR, and certain other subsidiaries of the Company, and U.S. Bank National Association, as Trustee, filed as Exhibit 10.2 to the Company’s Quarterly Report onForm 10-Q for the period ended June 30, 2005, is incorporated herein by reference as Exhibit 4.6.2.
4 .6.3 Second Supplemental Indenture, dated as of February 5, 2007, to the June 12, 2002 Indenture among the Company, KCSR, and certain other subsidiaries of the Company, and U.S. Bank National Association, as Trustee, is attached to thisForm 10-K as Exhibit 4.6.3.
4 .7 Certificate of Designations of 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C, filed as Exhibit 3.1(b) to the Company’s Quarterly Report onForm 10-Q for the period ended March 31, 2003 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 4.7.
115

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 The By-Laws of Kansas City Southern, as amended and restated to March 8,2004, filed as Exhibit 3.2 to the Company’s Form 10-K for the year ended December 31, 2003 (Commission File No. 1-4717), is incorporated herein by reference as Exhibit 3.2

~~(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 the Company’s Restated Certificate of Incorporation (See Exhibit 3.1)

4 .2 Article I, Sections 1, 3 and 11 of Article II, Article V and Article VIII of KCS’s Bylaws (See Exhibit 3.2)

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 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

~~109~~

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

4 .9 Certificate of Designations, which is filed as Exhibit 3.1(b) to KCS’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 4.9

4 .10 Exhibit 4.5 to the Company’s Registration Statement on Form S-3 originally filed on August 1, 2003 (Registration No. 333-107573), as amended and declared effective on October 24, 2003 (the “2003 S-3 Registration Statement”), Registration Rights Agreement dated May 5, 2003 among KCS, Morgan Stanley & Co. Incorporated and Deutsche Bank Securities Inc., is hereby incorporated by reference as Exhibit 4.10.


~~(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 * Directors Deferred Fee Plan, adopted August 20, 1982, as amended and restated effective January 1, 2005, is attached hereto as Exhibit 10.7

10 .8.1 * Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan, as amended and restated effective as of March 14, 2005 is attached hereto as Exhibit 10.8.1

10 .8.2 * Form of Non-Qualified Stock Option Award Agreement for employees under the 1991 Amended and Restated Stock Option and Performance Award Plan, is attached hereto as Exhibit 10.8.2

10 .8.3 * Form of Non-Qualified Stock Option Award Agreement for Directors under the 1991 Amended and Restated Stock Option and Performance Award Plan, is attached hereto as Exhibit 10.8.3

10 .8.4 * Form of Non-Qualified Stock Option Award agreement for employees under the 1991 Amended and Restated Stock Option and Performance Award Plan (referencing threshold dates), is attached hereto Exhibit 10.8.4

10 .8.5 * Form of Restricted Shares Award Agreement (graded vesting) under the 1991 Amended and Restated Stock Option and Performance Award Plan, is attached hereto as Exhibit 10.8.5

10 .8.6 * Form of Restricted Shares Award Agreement (cliff vesting) under the 1991 Amended and Restated Stock Option and Performance Award Plan, which is attached as Exhibit 10.1 to the Company’s Form 8-K filed on March 18, 2005 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.8.6

~~110~~

10 .8.7 * Form of Restricted Shares Award Agreement under the 1991 Amended and Restated Stock Option and Performance Award Plan (applicable to restricted shares to be purchased), is attached hereto as Exhibit 10.8.7

10 .9.1* Kansas City Southern 401(k) and Profit Sharing Plan (Amended and Restated Effective April 1, 2002), which is attached as Exhibit 10.10.1 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.9.1

10 .9.2* 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, which is attached as Exhibit 10.10.2 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.9.2

10 .9.3* Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), dated June 30, 2003 and effective as of January 1, 2001, which is attached as Exhibit 10.10.3 to the Company’s Form 10-K for the year ended December 31, 2003 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.9.3

10 .9.4* Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), dated December 3, 2003 and effective as of January 1, 2003, which is attached as Exhibit 10.10.4 to the Company’s Form 10-K for the year ended December 31, 2003 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.9.4

10 .10 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 10.10

10 .11* 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 10.11

10 .12* 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 10.12

10 .12.1* First Amendment to Employment Agreement, dated March 14, 2003, by and among the Company, KCSR, and Ronald G. Russ, which is attached as Exhibit 10.14.1 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.12.1

10 .13* Employment Agreement, dated September 1, 2001, by and between the Company, KCSR and Jerry W. Heavin, which is attached as Exhibit 10.15 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.13

10 .13.1* First Amendment to Employment Agreement, dated March 14, 2003, by and among the Company, KCSR and Jerry W. Heavin, which is attached as Exhibit 10.15.1 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.13.1

10 .14* Employment Agreement, dated January 1, 2005, between KCS and Arthur L. Shoener, filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K/A filed on February 14, 2005 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.14

10 .15* Employment Agreement, dated February 2, 2005, between KCS and James S. Brook, filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 15, 2005 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.15

10 .16* Employment Agreement dated, January 1, 2001, between KCS and Jay M. Nadlman is attached hereto as Exhibit 10.16

10 .16.1* Addendum to Employment Agreement, dated August 18, 2004, between KCS and Jay M. Nadlman is attached hereto as Exhibit 10.16.1

~~111~~

10 .17* Kansas City Southern Executive Plan, as amended and restated January 1, 2005, is attached hereto as Exhibit 10.17

10 .18* The Kansas City Southern Annual Incentive Plan, which is attached as Exhibit 10.20 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.18

10 .19 Credit Agreement dated as of March 30, 2004 among KCSR, KCS, the subsidiary guarantors, the lenders party thereto, The Bank of Nova Scotia (“BNS”), Morgan Stanley Senior Funding, Inc. (“Morgan Stanley”) and Harris Trust and Savings Bank, which is attached as Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended March 31, 2004 (Commission File No. 1-4717), is incorporated herein by reference as Exhibit 10.19

10 .19.1 Security Agreement dated March 30, 2004 from KCS, KCSR and certain other subsidiaries of KCS to The Bank of Nova Scotia as Collateral Agent is attached hereto as Exhibit 10.19.1

10 .19.2 Amendment and Waiver No. 1 to the Credit Agreement and Amendment No. 1 to the Security Agreement among KCSR, KCS, the subsidiary guarantors, the lenders party thereto and The Bank of Nova Scotia, dated as of December 22, 2004, which is attached as Exhibit 10.1 to the Company’s Form 8-K filed on December 29, 2004 (Commission File No. 1-4717), is incorporated herein by reference as Exhibit 10.19.2

10 .20 The 2000 Indenture (See Exhibit 4.5)

10 .21 Supplemental Indenture, dated as of January 29, 2001, to the 2000 Indenture (See Exhibit 4.5.1)

10 .22 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 10.22

10 .23 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 10.23

10 .24 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 10.24

10 .25 The 2002 Indenture (See Exhibit 4.8)

10 .26* 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, which are attached as Exhibit 10.36 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), are hereby incorporated by reference as Exhibit 10.26

10 .27* 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, which are attached as Exhibit 10.37 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), are hereby incorporated by reference as Exhibit 10.27

10 .28.1* Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), which is attached as Exhibit 10.38 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.28.1

10 .28.2* Amendment to the Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), dated June 30, 2003 and effective as of January 1, 2001, which is attached as Exhibit 10.38.2 to the Company’s Form 10-K for the year ended December 31, 2003 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.28.2

~~112~~

10 .28.3* Amendment to the Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), dated December 3, 2003 and effective as of January 1, 2003, attached as Exhibit 10.38.3 to the Company’s Form 10-K for the year ended December 31, 2003, is hereby incorporated by reference as Exhibit 10.28.3

10 .29 Placement Agreement dated April 29, 2003 by and among the Company, Morgan Stanley & Co. Incorporated and Deutsche Bank Securities Inc., which is attached as Exhibit 10 to the Company’s Form 10-Q for the quarter ended June 30, 2003, is hereby incorporated by reference as Exhibit 10.29

10 .30 The Amended Acquisition Agreement (See Exhibit 2.1)

10 .31 The Stockholders’ Agreement (See Exhibit 2.3)

10 .32 The Acquisition Registration Rights Agreement (See Exhibit 2.4)

10 .33 The Consulting Agreement (See Exhibit 2.5)

10 .34 The Marketing and Services Agreement (See Exhibit 2.6)

10 .35 Form of Indemnity Escrow Note (as defined in the Amended Acquisition Agreement), filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed December 21, 2004 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.35

10 .36 Form of VAT Escrow Note (as defined in the Amended Acquisition Agreement), filed as Exhibit 10.7 to the Company’s Current Report on Form 8-K filed December 21, 2004 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.36

10 .37 Closing Escrow Agreement by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., KCS Acquisition Subsidiary, Inc., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.8 to the Company’s Current Report on Form 8-K filed December 21, 2004 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.37

10 .38 Indemnity Escrow Agreement by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Multimodal, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.9 to the Company’s Current Report on Form 8-K filed December 21, 2004 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.38

10 .39 VAT Escrow Agreement by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., KCS Acquisition Subsidiary, Inc., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.10 to the Company’s Current Report on Form 8-K filed December 21, 2004 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.39

10 .40 Consulting Compensation Escrow Agreement by and among KCS, Jose F. Serrano International Business, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.11 to the Company’s Current Report on Form 8-K filed December 21, 2004 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.40

10 .41 Agreement of Assignment and Assumption of Rights, and Agency Agreement with Undisclosed Principal, Duties and Obligations, filed as Exhibit 10.12 to the Company’s Current Report on Form 8-K filed December 21, 2004 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.41


~~(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)~~

~~113~~

Exhibit

Description

4 .8 Registration Rights Agreement dated May 5, 2003 among KCS, Morgan Stanley & Co. Incorporated and Deutsche Bank Securities Inc., filed as Exhibit 4.5 to the Company’s Registration Statement onForm S-3 originally filed on August 1, 2003 (RegistrationNo. 333-107573), as amended and declared effective on October 24, 2003 (the “2003S-3 Registration Statement”), is incorporated herein by reference as Exhibit 4.8.
4 .9 Certificate of Designations of 5.125% Cumulative Convertible Perpetual Preferred Stock, Series D, filed as Exhibit 4.1 to the Company’s Current Report onForm 8-K, filed on December 15, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 4.9.
4 .10 Indenture, dated as of June 16, 1997, among KCSM, Grupo TFM, S.A. de C.V.(currently known as Grupo KCSM, S.A. de C.V. (“Grupo KCSM”)), as guarantor, The Bank of New York, as trustee, and Bankers Trust Luxembourg, S.A., as a Paying Agent, covering up to $150,000,000 of TFM’s 10.25% Senior Notes due 2007 (the “1997 Indenture”), filed as Exhibit 4.10 to the Company’s Registration Statement onForm S-1 originally filed on November 20, 2006 (RegistrationNo. 333-138831), as amended and declared effective on December 4, 2006 (the “2006S-1 Registration Statement”), is incorporated herein by reference as Exhibit 4.10.
4 .10.1 First Supplemental Indenture, dated as of May 21, 2002, among KCSM, Grupo KCSM, as guarantor, The Bank of New York, as trustee, and Deutsche Bank Luxembourg S.A., as the paying agent, to the 1997 Indenture, filed as Exhibit 4.11 to 2006S-1 Registration Statement (RegistrationNo. 333-138831), is incorporated herein by reference as Exhibit 4.10.1.
4 .10.2 Second Supplemental Indenture, dated November 21, 2006, among Kansas City Southern de México, S.A. de C.V., as issuer, The Bank of New York, as trustee, Deutsche Bank Luxembourg S.A., as paying agent and Grupo KCSM, S.A. de C.V., as guarantor, to the 1997 Indenture, filed as Exhibit 4.1 to the Company’s Current Report onForm 8-K filed on November 28, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 4.10.2.
4 .11 Indenture, dated as of June 13, 2002, between TFM and The Bank of New York, as Trustee, covering up to $180,000,000 of TFM’s 12.50% Senior Notes due 2012 (the “June 13, 2002 Indenture”), filed as Exhibit 4.12 to the 2006S-1 Registration Statement (RegistrationNo. 333-138831), is incorporated herein by reference as Exhibit 4.11.
4 .12 Indenture, dated as of April 19, 2005, between TFM and The Bank of Nova Scotia Trust Company of New York, covering up to $460,000,000 of TFM’s 93/8% Senior Notes due 2012 (the “2005 Indenture”), filed as Exhibit 4.13 to the 2006S-1 Registration Statement (RegistrationNo. 333-138831), is incorporated herein by reference as Exhibit 4.12.
4 .13 Indenture, dated November 21, 2006, between Kansas City Southern de Mexico, S.A. de C.V. and U.S. Bank National Association, as trustee and paying agent (the “2006 Indenture”), filed as Exhibit 4.2 to the Company’s Current Report onForm 8-K filed on November 28, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 4.13.
(10) Material Contracts
10 .1 Form of Officer Indemnification Agreement attached as Exhibit 10.1 to the Company’sForm 10-K for the fiscal year ended December 31, 2001 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.1.
10 .2 Form of Director Indemnification Agreement attached as Exhibit 10.2 to the Company’sForm 10-K for the fiscal year ended December 31, 2001 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.2.
10 .3 Description of the Company’s 1991 incentive compensation plan, filed as Exhibit 10.4 to the Company’sForm 10-K for the fiscal year ended December 31, 1990 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.3.
10 .4 Directors Deferred Fee Plan, adopted August 20, 1982, as amended and restated effective January 1, 2005, filed as Exhibit 10.7 to the Company’sForm 10-K for the fiscal year ended December 31, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.4.
116


~~(16)~~	~~Letter Re Change in Certifying Accountant~~ ~~(Inapplicable)~~


	~~(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 Consent of KPMG LLP is attached to this Form 10-K as Exhibit 23.1

23 .2 Consent of PricewaterhouseCoopers is attached to this Form 10-K as Exhibit 23.2


~~(24)~~	~~Power of Attorney~~ ~~(Inapplicable)~~

~~(31) Rule 13a-14(a)/15d-14(a) Certifications~~

31 .1 Certification of Michael R. Haverty, Chief Executive Officer of the Company, is attached hereto as Exhibit 31.1

31 .2 Certification of Ronald G. Russ, Chief Financial Officer of the Company, is attached hereto as Exhibit 31.2

~~(32) Section 1350 Certifications~~

32 .1 Certification Pursuant to 18 U.S.C. Section 1350 of Michael R. Haverty, Chief Executive Officer of the Company, and Ronald G. Russ, Chief Financial Officer of the Company, is attached hereto as Exhibit 32

~~(99) Additional Exhibits~~

99 .1 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, 2004 and 2003 and for each of the three years in the period ended December 31, 2004 as listed under Item 15(a)(2) herein, are included in this Form 10-K as Exhibit 99.1


*	~~Represents a management contract or a compensatory plan or arrangement~~

~~114~~

Exhibit

Description

10 .5 Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan, as amended and restated effective as of May 5, 2005 (the “Amended 1991 Plan”), filed as Exhibit 10.1 to the Company’s Current Report onForm 8-K, filed on May 11, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.5.
10 .5.1 Form of Non-Qualified Stock Option Award Agreement for employees under the Amended 1991 Plan, filed as Exhibit 10.8.2 to the Company’sForm 10-K for the fiscal year ended December 31, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.5.1.
10 .5.2 Form of Non-Qualified Stock Option Award Agreement for Directors under the Amended 1991 Plan, filed as Exhibit 10.8.3 to the Company’sForm 10-K for the fiscal year ended December 31, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.5.2.
10 .5.3 Form of Non-Qualified Stock Option Award agreement for employees under the Amended 1991 Plan (referencing threshold dates), filed as Exhibit 10.8.4 to the Company’sForm 10-K for the fiscal year ended December 31, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.5.3.
10 .5.4 Form of Restricted Shares Award and Performance Shares Award Agreement under the Amended 1991 Plan, is attached to thisForm 10-K as Exhibit 10.5.4.
10 .5.5 Form of Restricted Shares Award Agreement (graded vesting) under the Amended 1991 Plan, filed as Exhibit 10.2 to the Company’s Current Report onForm 8-K, filed on May 11, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.5.5.
10 .5.6 Form of Restricted Shares Award Agreement (cliff vesting) under the Amended 1991 Plan, filed as Exhibit 10.1 to the Company’sForm 8-K filed on March 18, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.5.6.
10 .5.7 Form of Restricted Shares Award Agreement under the Amended 1991 Plan (applicable to restricted shares to be purchased), filed as Exhibit 10.8.7 to the Company’sForm 10-K for the fiscal year ended December 31, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.5.7.
10 .6 Kansas City Southern 401(k) and Profit Sharing Plan (as amended and restated, effective April 1, 2002) (the “Amended 401(k) and Profit Sharing Plan”), filed as Exhibit 10.10.1 to the Company’sForm 10-K for the fiscal year ended December 31, 2002 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.6.
10 .6.1 First Amendment to the Amended 401(k) and Profit Sharing Plan, effective January 1, 2003, filed as Exhibit 10.10.2 to the Company’sForm 10-K for the fiscal year ended December 31, 2002 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.6.1.
10 .6.2 Amendment to the Amended 401(k) and Profit Sharing Plan, dated June 30, 2003 and effective as of January 1, 2001, filed as Exhibit 10.10.3 to the Company’sForm 10-K for the fiscal year ended December 31, 2003 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.6.2.
10 .6.3 Amendment to the Amended 401(k) and Profit Sharing Plan, dated December 3, 2003 and effective as of January 1, 2003, filed as Exhibit 10.10.4 to the Company’sForm 10-K for the fiscal year ended December 31, 2003 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.6.3.
10 .7 Assignment, Consent and Acceptance Agreement, dated August 10, 1999, by and among the Company, DST Systems, Inc. and Stilwell Financial Inc., filed as Exhibit 10.10 to the Company’s 2001S-4 Registration Statement (RegistrationNo. 333-54262), is incorporated herein by reference as Exhibit 10.7.
10 .8 Employment Agreement, as amended and restated January 1, 2001, by and among the Company, KCSR and Michael R. Haverty, filed as Exhibit 10.12 to the Company’sForm 10-K for the fiscal year ended December 31, 2001 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.8.
10 .9 Employment Agreement, dated January 1, 2005, between KCSR and Arthur L. Shoener, filed as Exhibit 10.1 to the Company’s Current Report onForm 8-K/A filed on February 14, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.9.
10 .10 Employment Agreement, dated May 15, 2006, between KCSR and Patrick J. Ottensmeyer, attached as Exhibit 10.1 to the Company’s Current Report onForm 8-K, filed on June 12, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.10.
117

Exhibit

Description

10 .11 Employment Agreement, dated May 15, 2006, between KCSR, KCS and Daniel W. Avramovich, attached as Exhibit 10.2 to the Company’s Current Report onForm 8-K, filed on June 12, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.11.
10 .12 Employment Agreement, dated June 7, 2006, between KCSR and Michael K. Borrows, attached as Exhibit 10.1 to the Company’s Current Report onForm 8-K, filed September 15, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.12.
10 .13 Kansas City Southern Executive Plan, as amended and restated January 1, 2005, filed as Exhibit 10.17 to the Company’sForm 10-K for the fiscal year ended December 31, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.13.
10 .14 The Kansas City Southern Annual Incentive Plan, as approved by the Company’s Compensation Committee on January 17, 2007, is attached to thisForm 10-K as Exhibit 10.14.
10 .15 Security Agreement dated March 30, 2004 from KCS, KCSR and certain other subsidiaries of KCS to The Bank of Nova Scotia as Collateral Agent, filed as Exhibit 10.19.1 to the Company’sForm 10-K for the fiscal year ended December 31, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.15.
10 .15.1 Amendment No. 1 to the Security Agreement among KCSR, KCS, the subsidiary guarantors, the lenders party thereto and The Bank of Nova Scotia, dated as of December 22, 2004, filed as Exhibit 10.1 to the Company’s Current Report onForm 8-K filed on December 29, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.15.1.
10 .15.2 Amended and Restated Credit Agreement, dated April 28, 2006 among KCSR, KCS, the subsidiary guarantors, the lenders party thereto, The Bank of Nova Scotia, Morgan Stanley Senior Funding, Inc., Harris Bank, N.A., LaSalle Bank National Association and Bank of Tokyo-Mitsubishi UFJ Trust Company, and Scotia Capital, filed as Exhibit 10.1 to the Company’sForm 10-Q for the period ended March 31, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.15.2.
10 .16 The 1992 Indenture. (See Exhibit 4.3).
10 .16.1 The Supplemental Indenture, dated as of December 17, 1999, to the 1992 Indenture. (See Exhibit 4.3.1).
10 .17 The 2000 Indenture. (See Exhibit 4.4).
10 .17.1 The Supplemental Indenture, dated as of January 29, 2001, to the 2000 Indenture. (See Exhibit 4.4.1).
10 .17.2 The Second Supplemental Indenture, dated as of June 10, 2005, to the 2000 Indenture. (See Exhibit 4.4.2).
10 .17.3 The Third Supplemental Indenture, dated as of February 5, 2007, to the 2000 Indenture. (See Exhibit 4.4.3).
10 .18 Intercompany Agreement, dated as of August 16, 1999, between the Company and Stilwell Financial Inc., filed as Exhibit 10.23 to the Company’s 2001S-4 Registration Statement (RegistrationNo. 333-54262), is incorporated herein by reference as Exhibit 10.18.
10 .19 Tax Disaffiliation Agreement, dated as of August 16, 1999, between the Company and Stilwell Financial Inc., filed Exhibit 10.24 to the Company’s 2001S-4 Registration Statement (RegistrationNo. 333-54262), is incorporated herein by reference as Exhibit 10.19.
10 .20 Lease Agreement, as amended, between The Kansas City Southern Railway Company and Broadway Square Partners LLP dated June 26, 2001, filed as Exhibit 10.34 to the Company’sForm 10-K for the fiscal year ended December 31, 2001 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.20.
10 .21 The June 12, 2002 Indenture. (See Exhibit 4.6).
10 .21.2 The Supplemental Indenture, dated as of June 10, 2005, to the June 12, 2002 Indenture. (See Exhibit 4.6.2).
10 .21.3 The Second Supplemental Indenture, dated as of February 5, 2007, to the June 12, 2002 Indenture (See Exhibit 4.6.3).
118

Exhibit

Description

10 .22 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, filed as Exhibit 10.36 to the Company’sForm 10-K for the fiscal year ended December 31, 2002 (FileNo. 1-4717), are incorporated herein by reference as Exhibit 10.22.
10 .23 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, filed as Exhibit 10.37 to the Company’sForm 10-K for the fiscal year ended December 31, 2002 (FileNo. 1-4717), are incorporated herein by reference as Exhibit 10.23.
10 .24 Kansas City Southern Employee Stock Ownership Plan (as amended and restated, effective April 1, 2002) (the “Amended Employee Stock Ownership Plan”), filed as Exhibit 10.38 to the Company’sForm 10-K for the fiscal year ended December 31, 2002 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.24.
10 .24.1 Amendment to the Amended Employee Stock Ownership Plan, dated June 30, 2003 and effective as of January 1, 2001, filed as Exhibit 10.38.2 to the Company’sForm 10-K for the fiscal year ended December 31, 2003 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.24.1.
10 .24.2 Amendment to the Amended Employee Stock Ownership Plan, dated December 3, 2003 and effective as of January 1, 2003, filed as Exhibit 10.38.3 to the Company’sForm 10-K for the fiscal year ended December 31, 2003 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.24.2.
10 .25 Placement Agreement, dated April 29, 2003, by and among the Company, Morgan Stanley & Co. Incorporated and Deutsche Bank Securities Inc., filed as Exhibit 10 to the Company’sForm 10-Q for the period ended June 30, 2003 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.25.
10 .26 The Amended Acquisition Agreement. (See Exhibit 2.1).
10 .27 The Stockholders’ Agreement. (See Exhibit 2.2).
10 .28 The Acquisition Registration Rights Agreement. (See Exhibit 2.3).
10 .29 The Consulting Agreement. (See Exhibit 2.4).
10 .30 The Marketing and Services Agreement. (See Exhibit 2.5).
10 .31 The 2005 Rights Agreement. (See Exhibit 2.6).
10 .32 Form of Indemnity Escrow Note (as defined in the Amended Acquisition Agreement), filed as Exhibit 10.2 to the Company’s Current Report onForm 8-K filed December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.32.
10 .33 Form of VAT Escrow Note (as defined in the Amended Acquisition Agreement), filed as Exhibit 10.7 to the Company’s Current Report onForm 8-K filed December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.33.
10 .34 Closing Escrow Agreement by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., KCS Acquisition Subsidiary, Inc., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.8 to the Company’s Current Report onForm 8-K filed December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.34.
10 .35 Indemnity Escrow Agreement by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Multimodal, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.9 to the Company’s Current Report onForm 8-K filed December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.35.
119

Exhibit

Description

10 .36 VAT Escrow Agreement by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., KCS Acquisition Subsidiary, Inc., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.10 to the Company’s Current Report onForm 8-K filed December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.36.
10 .37 Consulting Compensation Escrow Agreement by and among KCS, Jose F. Serrano International Business, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.11 to the Company’s Current Report onForm 8-K filed December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.37.
10 .38 Agreement of Assignment and Assumption of Rights, and Agency Agreement with Undisclosed Principal, Duties and Obligations, filed as Exhibit 10.12 to the Company’s Current Report onForm 8-K filed December 21, 2004 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.38.
10 .39 Underwriting Agreement, dated December 5, 2005, between the Company and Morgan Stanley & Co. Incorporated, filed as Exhibit 99.2 to the Company’s Current Report onForm 8-K, filed December 6, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.39.
10 .40 Underwriting Agreement, dated December 5, 2005, among the Company, Grupo TMM, S.A. and Morgan Stanley & Co. Incorporated, filed as Exhibit 99.3 to the Company’s Current Report onForm 8-K, filed December 6, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.40.
10 .41 Transaction Agreement, dated December 1, 2005, among the Company, KCSR, Norfolk Southern Corporation and The Alabama Great Southern Railroad Company (the “Transaction Agreement”), filed as Exhibit 10.46 to the Company’sForm 10-K for the fiscal year ended December 31, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.41.
10 .41.1 Amendment No. 1 to the Transaction Agreement dated as of January 17, 2006, filed as Exhibit 10.47 to the Company’sForm 10-K for the fiscal year ended December 31, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.41.1.
10 .41.2 Amendment No. 2 to the Transaction Agreement dated as of May 1, 2006, filed as Exhibit 10.2 to the Company’s Quarterly Report onForm 10-Q for the period ended March 31, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.41.2.
10 .42 Participation Agreement, dated as of December 20, 2005, among KCSR, KCSRTrust 2005-1 (acting through Wilmington Trust Company, as owner trustee) (“2005 Trust”), GS Leasing (KCSR2005-1) LLC, Wells Fargo Bank Northwest, National Association, Export Development Canada, and KfW, filed as Exhibit 10.48 to the Company’sForm 10-K for the fiscal year ended December 31, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.42.
10 .43 Equipment and Lease Agreement, dated as of December 20, 2005, by and between KCSR and the 2005 Trust, filed as Exhibit 10.49 to the Company’sForm 10-K for the fiscal year ended December 31, 2005 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.43.
10 .44 Participation Agreement, dated as of August 2, 2006, among KCSR, KCSRTrust 2006-1 (acting through Wilmington Trust Company, as owner trustee) (“2006 Trust”), HSH Nordbank AG, New York Branch, Wells Fargo Bank Northwest, National Association, and DVB Bank AG, filed as Exhibit 10.4 to the Company’sForm 10-Q for the period ended September 30, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.44.
10 .45 Equipment and Lease Agreement, dated as of August 2, 2006, by and between KCSR and the 2006 Trust, filed as Exhibit 10.4 to the Company’sForm 10-Q for the period ended September 30, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.45.
10 .46 Limited Liability Company Agreement of Meridian Speedway, LLC by and between the Alabama Great Southern Railroad Company and Kansas City Southern dated May 1, 2006, filed as Exhibit 10.3 to the Company’sForm 10-Q for the period ended March 31, 2006, (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.46.
120

Exhibit

Description

10 .47 Underwriting Agreement, dated December 4, 2006, among the Company, Morgan Stanley & Co. Incorporated, and Grupo TMM, S.A., filed as Exhibit 1.1 to the Company’s Current Report onForm 8-K, filed December 5, 2006 (FileNo. 1-4717), is incorporated herein by reference as Exhibit 10.47.
10 .48 The 1997 Indenture. (See Exhibit 4.10).
10 .48.1 The First Supplemental Indenture, dated as of May 21, 2002, to the 1997 Indenture. (See Exhibit 4.10.1).
10 .48.2 The Second Supplemental Indenture, dated November 21, 2006, to the 1997 Indenture. (See Exhibit 4.10.2).
10 .49 The June 13, 2002 Indenture. (See Exhibit 4.11).
10 .51 The 2006 Indenture. (See Exhibit 4.13).
10 .52 The 2006 Registration Rights Agreement. (See Exhibit 2.7).
10 .53 Credit Agreement, dated October 24, 2005, among the Company, as borrower, Arrendadora TFM, S.A. de C.V., as guarantor, Bank of America, N.A. as administrative agent, BBVA Bancomer, as collateral agent, and BBVA Securities, Inc. and Banc of America Securities, LLC as arrangers (the “2005 Credit Agreement”), filed as Exhibit 10.9 to KCSM’s Registration Statement onForm S-4 originally filed on November 8, 2005 (RegistrationNo. 333-129566), is attached to thisForm 10-K as Exhibit 10.53.
10 .53.1 Amendment No. 1 and Waiver No. 1, dated April 7, 2006, to the 2005 Credit Agreement, filed as Exhibit 10.10 to KCSM’sForm 10-K for the fiscal year ended December 31, 2005, is attached to thisForm 10-K as Exhibit 10.53.1.
10 .54 Lease Agreement between KCSR and Louisiana Southern Railroad, Inc., dated September 25, 2005, filed as Exhibit 10.5 to the Company’sForm 10-Q for the period ended June 30, 2005, is incorporated herein by reference as Exhibit 10.54.
10 .55 Lease Agreement between KCSR and Alabama Southern Railroad, Inc., dated September 25, 2005, filed as Exhibit 10.6 to the Company’sForm 10-Q for the period ended June 30, 2005, is incorporated herein by reference as Exhibit 10.55.
10 .56 Lease Agreement between KCSR and Arkansas Southern Railroad, Inc., dated September 25, 2005, filed as Exhibit 10.7 to the Company’sForm 10-Q for the period ended June 30, 2005, is incorporated herein by reference as Exhibit 10.56.
10 .57 Lease Agreement between KCSR and Arkansas Southern Railroad, Inc., dated September 25, 2005, filed as Exhibit 10.8 to the Company’sForm 10-Q for the period ended June 30, 2005, is incorporated herein by reference as Exhibit 10.57.
10 .58 Lease Agreement between KCSR and Louisiana Southern Railroad, Inc., dated September 25, 2005, filed as Exhibit 10.9 to the Company’sForm 10-Q for the period ended June 30, 2005, is incorporated herein by reference as Exhibit 10.58.
(12) Statements Re Computation of Ratios
12 .1 The Computation of Ratio of Earnings to Fixed Charges prepared pursuant to Item 601(b)(12) ofRegulation S-K is attached to thisForm 10-K as Exhibit 12.1.
(21) Subsidiaries of the Company
21 .1 The list of the Subsidiaries of the Company prepared pursuant to Item 601(b)(21) ofRegulation S-K is attached to thisForm 10-K as Exhibit 21.1.
(23) Consents of Experts and Counsel
23 .1 Consent of KPMG LLP is attached to thisForm 10-K as Exhibit 23.1.
23 .2 Consent of PricewaterhouseCoopers is attached to thisForm 10-K as Exhibit 23.2.
23 .3 Consent of KPMG Cárdenas Dosal, S.C. is attached to thisForm 10-K as Exhibit 23.3.
(24) Power of Attorney (included on the signature page)
31 .1 Certification of Michael R. Haverty, Chief Executive Officer of the Company, is attached to thisForm 10-K as Exhibit 31.1.
121

Exhibit

Description

31 .2 Certification of Patrick J. Ottensmeyer, Chief Financial Officer of the Company, is attached to thisForm 10-K as Exhibit 31.2.
(32) Section 1350 Certifications
32 .1 Certification pursuant to 18 U.S.C. Section 1350 of Michael R. Haverty, Chief Executive Officer of the Company, is attached to thisForm 10-K as Exhibit 32.1.
32 .2 Certification pursuant to 18 U.S.C. Section 1350 of Patrick J. Ottensmeyer, Chief Financial Officer of the Company, is attached to thisForm 10-K as Exhibit 32.2.
(99) Additional Exhibits
99 .1 The consolidated balance sheet of Grupo TFM, S.A. de C.V. and subsidiaries as of December 31, 2004 and 2005 and the related consolidated statements of income, cash flows and changes in stockholders’ equity for the two years in the period ended December 31, 2004, and the consolidated statements of income, cash flows and changes in stockholders’ equity for the three months ended March 31, 2005 (“Predecessor”) and the nine months ended December 31, 2005 (“Successor”) including the notes thereto and the reports of the independent registered public accounting firms thereon, attached to the 2006S-1 Registration Statement (RegistrationNo. 333-138831) as Exhibit 99.1, is incorporated herein by reference as Exhibit 99.1.
122

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~~

Kansas City Southern


	By:	/s/ ~~M.R.~~Michael R. Haverty



	~~M.R. Haverty~~
	~~Chairman, President, Chief Executive~~
	~~Officer and Director~~

~~March 29, 2005~~

Michael R. Haverty

Chairman of the Board and

Chief Executive Officer and Director

February 26, 2007

POWER OF ATTORNEY

Know all people by these presents, that each person whose signature appears below constitutes and appoints Michael R. Haverty and Patrick J. Ottensmeyer, and each of them, his or her true and lawfulattorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any amendments to this annual report onForm 10-K, and to file the same, with all exhibits thereto, with the Securities and Exchange Commission, granting unto saidattorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he or she might or could do in person, hereby confirming all that saidattorneys-in-fact and agents or either of them, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

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 29, 2005.~~February 26, 2007.


Signature				Capacity

/s/ Michael R. Haverty Michael R. Haverty				Chairman of the Board and Chief Executive Officer and Director


~~/s/ M.R. Haverty~~ ~~M.R. Haverty~~				~~Chairman, President, Chief Executive Officer~~ ~~and Director~~

/s/ Arthur L. Shoener Arthur L. Shoener				~~Executive Vice~~KCS President and Chief Operating Officer and Director

/s/ ~~R.G. Russ~~Patrick J. Ottensmeyer ~~R.G. Russ~~Patrick J. Ottensmeyer				Executive Vice President and Chief Financial Officer (Principal Financial Officer)

/s/ ~~James S. Brook~~Michael K. Borrows ~~James S. Brook~~Michael K. Borrows				Vice President Financial Reporting and ~~Comptroller~~Tax (Principal Accounting Officer)

/s/ ~~A.E.~~A. Edward Allinson ~~A.E.~~A. Edward Allinson				Director

/s/ Robert J. Druten Robert J. Druten				Director

/s/ ~~M.G. Fitt~~James R. Jones ~~M.G. Fitt~~James R. Jones				Director

123


Signature				Capacity

/s/ ~~J.R. Jones~~ ~~J.R. Jones~~				~~Director~~

~~/s/ T.~~Thomas A. McDonnell T.Thomas A. McDonnell				Director

/s/ K.Karen L. Pletz K.Karen L. Pletz				Director

/s/ ~~R.E.~~Rodney E. Slater ~~R.E.~~Rodney E. Slater				Director

124

~~115~~

~~KANSAS CITY SOUTHERN~~Kansas City Southern

~~2004 FORM~~2006Form 10-K ~~ANNUAL REPORT~~ Annual Report

~~INDEX TO EXHIBITS~~Index to Exhibits

Regulation S-K
Exhibit Item 601(b)
No. Document Exhibit No.

2.2 First Amendment to Rights Agreement 2

10.7* Directors Deferred Fee Plan, adopted August 20, 1982, as amended and restated effective January 1, 2005 10

10.8. 1* Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan, as amended and restated effective as of March 14, 2005 10

10.8. 2* Form of Non-Qualified Stock Option Award Agreement for employees under the 1991 Amended and Restated Stock Option and Performance Award Plan 10

10.8. 3* Form of Non-Qualified Stock Option Award Agreement for Directors under the 1991 Amended and Restated Stock Option and Performance Award Plan 10

10.8. 4* Form of Non-Qualified Stock Option Award Agreement for employees under the 1991 Amended and Restated Stock Option and Performance Award Plan (referencing threshold dates) 10

10.8. 5* Form of Restricted Shares Award Agreement (graded vesting) under the 1991 Amended and Restated Stock Option and Performance Award Plan 10

10.8. 7* Form of Restricted Shares Award Agreement under the 1991 Amended and Restated Stock Option and Performance Award Plan (applicable to restricted shares to be purchased) 10

10.16 * Employment Agreement dated, January 1, 2001, between KCS and Jay M. Nadlman 10

10.16 .1* Addendum to Employment Agreement, dated August 18, 2004, between KCS and Jay M. Nadlman 10

10.17 * Kansas City Southern Executive Plan (As Amended and Restated January 1, 2005) 10

10.19 .1 Security Agreement dated March 30, 2004 from KCS, KCSR and certain other subsidiaries of KCS to The Bank of Nova Scotia as Collateral Agent 10

12.1 Computation of Ratio of Earnings to Fixed Charges 12

21.1 Subsidiaries of the Company 21

23.1 Consent of KPMG LLP 23

23.2 Consent of PricewaterhouseCoopers

31.1 Certification of Michael R. Haverty 31

31.2 Certification of Ronald G. Russ 31

32.1 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 — Michael R. Haverty and Ronald G. Russ 32

99.1 Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. combined and consolidated financial statements as of December 31, 2004 and 2003 and for each of the three years in the period ended December 31, 2004 99


*	~~Represents a management contract or a compensatory plan or arrangement~~

Regulation S-K
Item 601(b)
Exhibit

Document

Exhibit

2 .7 Registration Rights Agreement 2
3 .2 Amended and Restated By-Laws of Kansas City Southern 3
4 .4.3 Third Supplemental Indenture to the 2000 Indenture 4
4 .6.3 Second Supplemental Indenture to the June 12, 2002 Indenture 4
10 .5.4 Form of Restricted Shares Award and Performance Shares Award Agreement under the Amended 1991 Plan 10
10 .14 Kansas City Southern Annual Incentive Plan 10
10 .53 The 2005 Credit Agreement 10
10 .53.1 Amendment No. 1 and Waiver No. 1, dated April 7, 2006, to the 2005 Credit Agreement 10
12 .1 Computation of Ratio of Earnings to Fixed Charges 12
21 .1 Subsidiaries of the Company 21
23 .1 Consent of KPMG LLP 23
23 .2 Consent of PricewaterhouseCoopers 23
23 .3 Consent of KPMG Cárdenas Dosal, S.C. 23
31 .1 Certification of Michael R. Haverty pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 31
31 .2 �� Certification of Patrick J. Ottensmeyer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31
32 .1 Certification of Michael R. Haverty pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002. 32
32 .2 Certification of Patrick J. Ottensmeyer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32
The above exhibits are not included in thisForm 10-K, but are

on file with the Securities and Exchange Commission

125

~~116~~


~~(Mark One)~~ þ
þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the fiscal year ended December 31, ~~2004~~2006
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the transition period from to


Delaware	~~44-0663509~~
(State or other jurisdiction of incorporation or organization)	~~(I.R.S. Employer~~ ~~Identification No.)~~

427 West ~~12th~~12^th Street Kansas City, Missouri (Address of principal executive offices)		44-0663509 (I.R.S. Employer Identification No.) 64105 (Zip Code)


Title of Each Class		Name of Each Exchange on Which Registered

Preferred Stock, Par Value $25 Per Share, 4%, Noncumulative		New York Stock Exchange
Common Stock, $.01 Per Share Par Value		New York Stock Exchange


~~Document~~		~~Part of Form 10-K into Which Incorporated~~

~~Company’s Definitive Proxy Statement for the 2005 Annual Meeting of Stockholders, which will be filed no later than 120 days after December 31, 2004~~		~~Parts I, III~~


	~~Percentage of KCSR~~
~~Commodity Group~~	~~Revenues in 2004~~

MARKETS SERVED Chemical and Petroleum. KCS transports chemical and petroleum		~~21.2~~	%
~~Forest~~ products via tank and ~~metals~~		~~26.7~~	%
~~Agricultural~~hopper cars to markets in the Southeast and ~~mineral~~		~~19.7~~	%
~~Intermodal~~Northeast United States and ~~automotive~~		~~10.5~~	%
~~Coal~~		~~14.5~~	%
~~Other~~		~~7.4~~	%


	•	~~Southern Capital Corporation,~~Meridian Speedway, LLC (“~~Southern Capital”~~MSLLC”), a ~~50%~~ninety percent owned ~~unconsolidated~~consolidated affiliate that ~~leases locomotive~~owns the former KCSR rail line between Meridian, Mississippi and Shreveport, Louisiana, which is the portion of the KCSR rail line between Dallas, Texas and Meridian known as the “Meridian Speedway.” Norfolk Southern Corporation (“NS”) through its wholly-owned subsidiary, The Alabama Great Southern Railroad Company, owns the remaining ten percent of MSLLC. Ultimately KCS will own seventy percent and NS will own thirty percent of MSLLC upon the contribution of additional capital by NS to MSLLC;


	•	PABTEX GP, LLC, a wholly-owned and consolidated owner of a bulk materials handling facility with deep-water access to the Gulf of Mexico at Port Arthur, Texas that stores and transfers petroleum coke and soda ash from trucks and rail ~~equipment~~cars to ~~KCSR;~~ships, primarily for export;

	•	Trans-Serve, Inc. (doing business as Superior Tie and Timber), a wholly-owned and consolidated operator of a railroad wood tie treatment facility;

	•	Transfin Insurance, Ltd., a ~~single-parent~~wholly-owned and consolidated captive insurance company, providing property, general liability and certain other insurance coverage to KCS and its subsidiaries and affiliates;

	•	~~Trans-Serve, Inc., (d/b/a Superior Tie and Timber — “ST&T”~~Southern Capital Corporation, LLC (“Southern Capital”), ~~an owner/operator of~~ a ~~railroad wood tie treating facility;~~fifty percent owned unconsolidated affiliate that leases locomotives and rail equipment; and

	•	~~PABTEX GP, LLC~~Ferrocarril y Terminal del Valle de México, S.A. de C.V. (“~~Pabtex”~~FTVM”) ~~located~~, a twenty five percent owned unconsolidated affiliate that provides railroad services as well as ancillary services in ~~Port Arthur, Texas. Pabtex is an owner of a bulk materials handling facility with deep-water access to~~ the ~~Gulf of~~greater Mexico ~~that stores and transfers petroleum coke and soda ash from trucks and rail cars to ships, primarily for export.~~City area.


	~~Strategic Alliance with Canadian National and Illinois Central.~~


	~~Chemical~~throughout Mexico through interchanges with other rail carriers. Primary traffic includes plastics, petroleum, oils, petroleum coke, rubber and ~~Petroleum~~


	miscellaneous chemicals. Forest Products and ~~Metals~~Metals. KCS’ rail lines run through the heart of the Southeast United States timber-producing region. The Company believes that		2006 Revenues Business Mix


	~~Railroad Retirement Act and Railroad Retirement Improvement Act~~


	•	quarterly variations in operating results;

	•	operating results that vary from the expectations of management, securities analysts, ratings agencies and investors;

	•	changes in expectations as to future financial performance, including financial estimates by securities analysts, ratings agencies and investors;

	•	developments generally affecting the railroad industry;

	•	announcements by KCS or its competitors of significant contracts, acquisitions, joint marketing relationships, joint ventures or capital commitments;

	•	the assertion or resolution of significant claims or proceedings against KCS;

	•	KCS’ dividend policy and restrictions on the payment of dividends;

	•	future sales of KCS’ equity or equity-linked securities;

	•	the issuance of common stock in payment of dividends on preferred stock or upon conversion of preferred stock; and

	•	general domestic and international economic conditions.


	2004			2003			2002

Route miles — main and branch line		3,108			3,108			3,109
Total track miles		4,353			4,351			4,359
Miles of welded rail in service		2,322			2,309			2,261
Main line welded rail (%)		61	%		61	%		61	%
Cross ties replaced		292,843			280,226			232,993


Average Age (in years):	2004		2003		2002

Wood ties in service		16.4		16.7		16.0
Rail in main and branch line		31.9		31.0		29.9
Road locomotives		26.0		25.5		24.6
All locomotives		26.9		26.5		25.6


Average age (in years):	2006		2005		2004

Road locomotives		22.9		25.2		26.0
All locomotives		23.9		26.1		26.9


	*~~Owned Network~~*


	~~Tex-Mex~~


	*~~Significant Investments~~*


	~~Grupo TFM~~


	Under		Track Usage
	Concession		Rights		Total

Main track		2,645		541		3,186
Sidings under centralized traffic control		116		—		116
Spurs, yard tracks and other sidings		481		—		481

Total		3,242		541		3,783


	2006				2005
	Leased		Owned		Leased		Owned

Locomotives		113		344		75		323

Rolling stock:
Box cars		1,068		1,166		1,278		1,187
Gondolas		2,520		1,817		2,922		1,824
Hopper cars		2,416		570		2,518		580
Flat cars (intermodal and other)		262		557		261		557
Auto racks		1,552		—		1,556		—
Tank cars		522		71		611		71
Other		—		65		—		55

Total		8,340		4,246		9,146		4,274


Item 4.	*Submission of Matters to a Vote of Security Holders*


~~Name~~	~~Age~~		~~Position(s)~~

~~Michael R. Haverty~~		60	~~Chairman of the Board, President and Chief Executive Officer~~
~~Arthur L. Shoener~~		58	~~Executive Vice President and Chief Operating Officer~~
~~Ronald G. Russ~~		50	~~Executive Vice President and Chief Financial Officer~~
~~Robert B. Terry~~		48	~~Senior Vice President and General Counsel~~
~~Jerry W. Heavin~~		53	~~Senior Vice President~~Chief Executive Officer — 62 — ~~International Engineering of KCSR~~
~~Owen Zidar~~		47	~~Vice President — Sales and Marketing of KCSR~~
~~Warren K. Erdman~~		46	~~Vice President — Corporate Affairs~~
~~Paul J. Weyandt~~		52	~~Vice President and Treasurer~~
~~James S. Brook~~		54	~~Vice President and Comptroller~~
~~Jay M. Nadlman~~		44	~~Associate General Counsel and Corporate Secretary~~
~~Gerald K. Davies~~		60	~~Former Executive Vice President and Chief Operating Officer (Retired)~~


Item 5.	*Market for ~~KCS’s~~KCS’ Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities*


	2001		2002		2003		2004		2005		2006
Kansas City Southern		100.00		84.93		101.34		125.48		172.89		205.10
S & P 500		100.00		77.90		100.24		111.15		116.61		135.03
Dow Jones Transportation Average		100.00		102.66		132.37		170.34		189.53		204.43


~~(a)~~(i)		Amounts reflect the consolidation of Mexrail effective January 1, 2005, and KCSM effective April 1, 2005.

(ii)		Income from continuing operations before cumulative effect of accounting change and minority interest for the years ended December 31, 2005, 2004, 2003 ~~2002~~ and ~~2001~~2002 include certain unusual operating expenses and other income as further described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — ~~“Results~~Results of Operations.” These costs and other income include charges for casualty claims, costs related to the acquisitions of Grupo KCSM and Mexrail, hurricane related charges, costs related to the implementation of the Management Control System (“MCS”), benefits received from the settlement of certain legal and insurance claims, severance costs and expenses associated with legal verdicts against KCS, and gains recorded on the sale of operating ~~property, among others. Other~~and non-operating ~~income includes gains recorded on sale of non-operating properties~~property and investments.

~~(b)~~		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 affiliates 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.

~~(c)~~		For the year ended December 31, 2003, the ratio of earnings to fixed charges was less than 1:1. The ratio of earnings to fixed charges would have been 1:1 if a deficiency of $18.2 million was eliminated.


	As Reported			All			Non-GAAP
	2005			Differences			2005

Revenues	$	1,352.0			170.1		$	1,522.1
Depreciation and amortization		127.7			18.4			146.1
Casualties and insurance		103.4			(34.8	)		68.6
KCSM employees’ statutory profit sharing		41.1			(35.1	)		6.0
Other operating expenses		1,017.5			105.8			1,123.3

Total operating expenses		1,289.7			54.3			1,344.0

Operating income (loss)		62.3			115.8			178.1
VAT/Put settlement gain, net		131.9			(131.9	)		—
Other income (expense)		(118.2	)		(29.2	)		(147.4	)

Income before income taxes		76.0			(45.3	)		30.7

Income tax (benefit)		(7.1	)		17.8			10.7
Minority interest		17.8			(16.1	)		1.7

Net income		100.9			(79.2	)		21.7

Preferred stock dividends		9.5			—			9.5

Net income available to common shareholders		91.4			(79.2	)		12.2

Diluted Shares		92,747						77,002
Diluted EPS	$	1.10					$	0.16


(a)		For purpose of consistency, the Company uses the format of EBITDA specified in its bank covenants which also excludes non-cash earnings from unconsolidated subsidiaries.


	2005			2006

Free Cash Flow	$	(119.4	)	$	97.2
Proceeds from issuance of long-term debt		644.7			616.3
Repayment of long-term debt		(521.5	)		(658.5	)
Other financing activities		(11.3	)		(7.1	)

GAAP Net Increase (Decrease) in cash and cash equivalents	$	(7.5	)	$	47.9


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*


					Increase (decrease)

	2003		2002		In Dollars			Percentage

Compensation and benefits	$	197.8	$	197.8	$	—			0.0	%
Purchased services		63.5		59.6		3.9			6.5	%
Fuel		47.4		38.4		9.0			23.4	%
Equipment costs		57.4		67.6		(10.2	)		(15.1	)%
Depreciation and amortization		64.3		61.4		2.9			4.7	%
Casualties and insurance		56.4		25.2		31.2			123.8	%
Other leases		9.8		7.1		2.7			38.0	%
Other		55.6		61.1		(5.5	)		(9.0	)%

Total consolidated operating expenses	$	552.2	$	518.2	$	34.0			6.6	%


			Payments Due by Period

			Less than						More Than
Contractual Obligations	Total		1 Year		1-3 Years		3-5 Years		5 Years

	(Dollars in millions)
Long-term debt (including capital lease obligations)	$	665.7	$	9.9	$	193.2	$	461.9	$	0.7
Operating leases		426.0		56.5		87.0		69.1		213.4
Locomotive Purchase Commitments		55.0		55.0		—		—		—
Purchase Commitment to Grupo TFM for remaining 49% interest in Mexrail		31.4		31.4		—		—		—
Other contractual obligations(a)		67.8		11.9		8.0		8.0		39.9

Total contractual obligations	$	1,245.9	$	164.7	$	288.2	$	539.0	$	254.0


	Payments Due by Period
			Less Than		1-3		3-5
	Total		1 Year		Years		Years		Thereafter


Long-term debt (including interest and capital lease obligations)(i)	$	2,496.7	$	243.4	$	697.6	$	351.0	$	1,204.7
Operating leases		958.6		123.6		205.5		167.9		461.6
Other contractual obligations(ii)		508.7		89.3		130.6		94.8		194.0

Total contractual obligations	$	3,964.0	$	456.3	$	1,033.7		613.7	$	1,860.3


~~(a)~~ (i)		Includes current and long-term liability related to Grupo KCSM acquisition.

(ii)		Other contractual obligations include purchase commitments and certain maintenance agreements.


Capital Expenditure Category	2004		2003		2002

	(Dollars in millions)
Track infrastructure	$	57.2	$	52.9	$	40.4
Locomotives, freight cars and other equipment		22.6		14.9		15.3
Facilities and capacity projects		27.4		6.8		16.2
Information technology		5.4		3.8		6.0
Other		4.6		5.6		—

Total capital expenditures	$	117.2	$	84.0	$	77.9


	KCSR Maintenance

	Way and Structure					Equipment

			Percent of					Percent of
	Amount		Revenue			Amount		Revenue

2004	$	46.4		7.3	%	$	39.6		6.2	%
2003		41.1		7.1			42.5		7.3
2002		43.6		7.7			48.2		8.5


		2004			2003

Debt due within one year		$	9.9		$	9.9
Long-term debt			655.8			513.5

	Total debt		665.7			523.4
Stockholders’ equity			1,024.5			963.7

Total debt plus equity		$	1,690.2		$	1,487.1

Total debt as a percent of
	Total debt plus equity (“debt ratio”)		39.4	%		35.2	%


	2006			2005

Debt due within one year(i)	$	92.8		$	116.3
Long-term debt(ii)		1,664.2			1,744.3

Total debt		1,757.0			1,860.6
Stockholders’ equity		1,582.4			1,426.2

Total debt plus equity	$	3,339.4		$	3,286.8

Debt ratio(total debt as a percent of total debt plus equity)		52.6	%		56.6	%


			2004		2003

			Dollars in millions,
			except share and per
			share amounts
ASSETS
Current Assets:
	Cash and cash equivalents		$	38.6	$	135.4
	Accounts receivable, net (Note 4)			131.4		108.2
	Accounts receivable from related parties			8.2		6.4
	Inventories			48.2		36.8
	Other current assets (Note 4)			27.2		21.3

		Total current assets		253.6		308.1

Investments (Note 3)				484.9		442.7
Properties, net (Note 4)				1,424.0		1,362.5
Goodwill				10.6		10.6
Restricted funds — escrow account for Grupo TFM acquisition				200.0		—
Other assets				67.5		29.0

	Total assets		$	2,440.6	$	2,152.9


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
	Debt due within one year (Note 5)		$	9.9	$	9.9
	Accounts and wages payable			52.8		45.5
	Payable to related parties			34.7		—
	Accrued liabilities (Note 4)			148.4		119.4

		Total current liabilities		245.8		174.8

Other Liabilities
	Long-term debt (Note 5)			655.8		513.5
	Deferred income taxes (Note 6)			430.9		391.5
	Other noncurrent liabilities and deferred credits (Note 4)			83.6		109.4
	Commitments and contingencies (Notes 3,5,6,7,8,9,10)			—		—

		Total other liabilities		1,170.3		1,014.4

Stockholders’ Equity (Notes 2,7):
	$25 par, 4% noncumulative, Preferred stock, 840,000 shares authorized, 649,736 shares issued, 242,170 shares outstanding at December 31, 2004 and 2003			6.1		6.1
	$1 par, Cumulative Preferred stock, 400,000 shares authorized, issued and outstanding at December 31, 2004 and 2003			0.4		0.4
	$.01 par, Common stock, 400,000,000 shares authorized; 73,369,116 shares issued; 63,270,204 and 62,175,621 shares outstanding at December 31, 2004 and 2003, respectively			0.6		0.6
	Paid in capital			155.3		110.9
	Retained earnings			861.9		846.2
	Accumulated other comprehensive income (loss)			0.2		(0.5	)

		Total stockholders’ equity		1,024.5		963.7

	Total liabilities and stockholders’ equity		$	2,440.6	$	2,152.9