FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from to
Commission File Number 1-4717
KANSAS CITY SOUTHERN
(Exact name of Company as specified in its charter)
DELAWARE 44-0663509
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
427 WEST 12TH STREET, KANSAS CITY, MISSOURI 64105
(Address of principal executive offices) (Zip Code)
(816) 983-1303 (Company's telephone
number, including area code)
NO CHANGES
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the Company (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the Company is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT JULY 31, 2003
COMMON STOCK, $.01 PER SHARE PAR VALUE 61,699,877 SHARES
- ------------------------------------------------------------------------------
KANSAS CITY SOUTHERN
FORM 10-Q
JUNE 30, 2003
INDEX
PAGE
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Introductory Comments 2
Consolidated Balance Sheets -
June 30, 2003 and December 31, 2002 3
Consolidated Statements of Income -
Three and Six Months Ended June 30, 2003 and 2002 4
Per Share Data 4
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2003 and 2002 5
Consolidated Statement of Changes in Stockholders' Equity -
Six Months Ended June 30, 2003 6
Notes to Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 29
ITEM 4. CONTROLS AND PROCEDURES 29
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 30
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 30
SIGNATURES 32
- ----------
KANSAS CITY SOUTHERN
FORM 10-Q
JUNE 30, 2003
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTRODUCTORY COMMENTS
The Consolidated Financial Statements included herein have been prepared by
Kansas City Southern (the "Company" or "KCS"), without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC"). Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America ("U.S. GAAP") have been condensed or omitted pursuant
to such rules and regulations, although the Company believes that the
disclosures are adequate to enable a reasonable understanding of the information
presented. These Consolidated Financial Statements should be read in conjunction
with the consolidated financial statements and the notes thereto, as well as
Management's Discussion and Analysis of Financial Condition and Results of
Operations, included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2002 and Management's Discussion and Analysis of Financial
Condition and Results of Operations included in this Form 10-Q. Results for the
six months ended June 30, 2003 are not necessarily indicative of the results
expected for the full year 2003.
KANSAS CITY SOUTHERN
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
June 30, December 31,
2003 2002
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 191.9 $ 19.0
Accounts receivable, net 112.7 114.9
Accounts receivable from related parties 4.1 3.6
Inventories 35.6 34.2
Other current assets 31.9 44.5
------------- -------------
Total current assets 376.2 216.2
------------- -------------
Investments 460.8 423.1
Properties (net of $716.1 and $682.9 accumulated
depreciation and amortization, respectively) 1,344.3 1,337.4
Goodwill 10.6 10.6
Other assets 24.6 21.5
------------- -------------
Total assets $ 2,216.5 $ 2,008.8
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt due within one year $ 10.0 $ 10.0
Accounts and wages payable 35.7 47.7
Accrued liabilities 141.9 128.6
------------- -------------
Total current liabilities 187.6 186.3
------------- -------------
Other Liabilities
Long-term debt 570.1 572.6
Deferred income taxes 396.6 392.8
Other liabilities and deferred credits 97.3 104.2
------------- -------------
Total other liabilities 1,064.0 1,069.6
------------- -------------
Stockholders' Equity
Preferred stock 6.5 6.1
Common stock 0.6 0.6
Retained earnings 851.7 748.5
Paid in capital 107.6 -
Accumulated other comprehensive loss (1.5) (2.3)
------------- -------------
Total stockholders' equity 964.9 752.9
------------- -------------
Total liabilities and stockholders' equity $ 2,216.5 $ 2,008.8
============= =============
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------------- ----------------------------------
2003 2002 2003 2002
---------------- ----------------- ----------------- ----------------
Revenues $ 146.3 $ 139.2 $ 286.5 $ 283.1
Costs and expenses
Compensation and benefits 47.5 46.5 98.0 95.9
Depreciation and amortization 16.0 14.6 31.9 29.5
Purchased services 15.2 13.9 30.3 27.9
Operating leases 14.2 13.8 28.5 27.3
Fuel 11.3 9.3 24.1 18.8
Casualties and insurance 8.4 7.2 16.5 15.1
Car hire 3.5 4.1 5.7 9.3
Other 16.0 15.3 30.5 31.4
---------------- ----------------- ----------------- ----------------
Total costs and expenses 132.1 124.7 265.5 255.2
Operating income 14.2 14.5 21.0 27.9
Equity in net earnings (losses) of unconsolidated affiliates:
Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (2.3) 13.0 4.6 17.8
Other (0.2) (1.3) (0.1) (1.2)
Gain on sale of Mexrail, Inc. - - - 4.4
Interest expense (11.7) (10.5) (23.2) (21.8)
Debt retirement costs - (4.3) - (4.3)
Other income 1.5 4.4 2.8 8.8
---------------- ----------------- ----------------- ----------------
Income before income taxes, and cumulative effect of
accounting change 1.5 15.8 5.1 31.6
Income tax provision 2.0 1.3 0.9 5.4
---------------- ----------------- ------------------ ---------------
Income (loss) before cumulative effect of accounting change (0.5) 14.5 4.2 26.2
Cumulative effect of accounting change, net of income taxes - - 8.9 -
---------------- ----------------- ------------------ ---------------
Net income (loss) $ (0.5) $ 14.5 $ 13.1 $ 26.2
Less: preferred stock dividends 1.3 0.1 1.4 0.1
---------------- ----------------- ------------------ ---------------
Net income (loss) available to common shareholders $ (1.8) $ 14.4 $ 11.7 $ 26.1
================ ================= ================== ===============
PER SHARE DATA
Basic earnings per common share
Income (loss) before cumulative effect
of accounting change $ (0.03) $ 0.24 $ 0.05 $ 0.44
Cumulative effect of accounting change, net of income
taxes - - 0.14 -
---------------- ----------------- ----------------------------------
Net income (loss) per basic share $ (0.03) $ 0.24 $ 0.19 $ 0.44
================ ================= ==================================
Diluted earnings per common share
Income (loss) before cumulative effect
of accounting change $ (0.03) $ 0.23 $ 0.05 $ 0.42
Cumulative effect of accounting change, net of income
taxes - - 0.14 -
---------------- ----------------- ----------------------------------
Net income (loss) per diluted share $ (0.03) $ 0.23 $ 0.19 $ 0.42
================ ================= ==================================
Weighted average common shares outstanding (in thousands)
Basic 61,649 60,095 61,525 59,918
Potential dilutive common shares - 2,232 1,397 2,148
---------------- ----------------- ----------------------------------
Diluted 61,649 62,327 62,922 62,066
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
Six Months
Ended June 30,
----------------------------
2003 2002
------------- -------------
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income $ 13.1 $ 26.2
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 31.9 29.5
Deferred income taxes 7.1 (1.1)
Equity in undistributed earnings of
unconsolidated affiliates (4.5) (16.6)
Gain on sale of Mexrail, Inc. - (4.4)
Gain on sale of assets (1.8) (8.9)
Cumulative effect of accounting change (8.9) -
Tax benefit realized upon exercise of stock options 0.9 1.0
Changes in working capital items
Accounts receivable 1.8 (2.4)
Inventories (1.4) (2.7)
Other current assets 4.0 34.6
Accounts and wages payable (10.3) (8.8)
Accrued liabilities 15.9 2.4
Other, net (0.9) 9.0
------------- -------------
Net cash provided by operating activities 46.9 57.8
------------- -------------
INVESTING ACTIVITIES:
Property acquisitions (32.6) (39.1)
Proceeds from disposal of property 7.7 16.1
Investment in and loans to affiliates (32.8) (3.5)
Proceeds from sale of Mexrail, Inc. - 31.4
Other, net (4.7) 1.1
------------- -------------
Net cash provided by (used for) investing
activities (62.4) 6.0
------------- -------------
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt - 200.0
Repayment of long-term debt (2.5) (263.4)
Issuance of preferred stock, net 193.2 -
Debt issuance costs - (5.4)
Proceeds from stock plans 2.1 3.7
Cash dividends paid (0.1) (0.1)
Other, net (4.3) 0.2
------------- -------------
Net cash provided by (used for) financing
activities 188.4 (65.0)
------------- -------------
CASH AND CASH EQUIVALENTS:
Net increase (decrease) in cash and cash
equivalents 172.9 (1.2)
At beginning of year 19.0 24.7
------------- -------------
At end of period $ 191.9 $ 23.5
============= =============
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN MILLIONS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
$1 Par Accumulated
$25 Par Cumulative $.01 Par Paid other
Preferred Preferred Common In Retained comprehensive
stock Stock stock Capital earnings income Total
(loss)
------------ ------------ ------------- ------------ ------------ ------------ -------------
Balance at December 31, 2002 $ 6.1 $ - $ 0.6 $ - $ 748.5 $ (2.3) $ 752.9
Comprehensive income:
Net income 13.1
Change in fair value of cash flow
hedge 0.2
Amortization of accumulated other
comprehensive income (loss)
related to interest rate swap 0.6
Comprehensive income 13.9
Preferred stock issued 0.4 107.6 85.2 193.2
Dividends on $25 Par Preferred Stock
($0.50/share) (0.1) (0.1)
Options exercised and stock subscribed 1.7 1.7
Stock plan shares issued from treasury 3.3 3.3
------------ ------------ ------------- ------------ ------------ ------------ -------------
Balance at June 30, 2003 $ 6.1 $ 0.4 $ 0.6 $ 107.6 $ 851.7 $ (1.5) $ 964.9
============ ============ ============= ============ ============ ============ =============
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ACCOUNTING POLICIES AND INTERIM FINANCIAL STATEMENTS. In the opinion of the
management of KCS, the accompanying unaudited consolidated financial
statements contain all adjustments (consisting of normal closing
procedures) necessary to present fairly the financial position of the
Company and its subsidiary companies as of June 30, 2003 and December 31,
2002, the results of its operations for the three and six months ended June
30, 2003 and 2002, its cash flows for the six months ended June 30, 2003
and 2002, and its changes in stockholders' equity for the six months ended
June 30, 2003. The accompanying consolidated financial statements have been
prepared consistently with accounting policies described in Note 2 to the
consolidated financial statements included in the Company's Annual Report
on Form 10-K as of and for the year ended December 31, 2002 except as
discussed herein in note 10. The results of operations for the three and
six-month periods ended June 30, 2003 are not necessarily indicative of the
results to be expected for the full year 2003. Certain comparative prior
year amounts in the consolidated financial statements have been
reclassified to conform to the current period presentation. These
reclassifications did not impact net income.
2. EARNINGS PER SHARE DATA. Basic earnings per common share is computed by
dividing income available to common shareholders by the weighted-average
number of common shares outstanding for the period. Diluted earnings per
share reflects the potential dilution that could occur if convertible
securities or stock options were converted into common stock or exercised.
The following is a reconciliation from the weighted average shares used for
the basic earnings per share computation to the diluted earnings per share
computation for the three and six months ended June 30, 2003 and 2002,
respectively (in thousands):
Three Months Six Months
Ended June 30, Ended June 30,
-------------------- ---------------------
2003 2002 2003 2002
--------- --------- ---------------------
Basic shares 61,649 60,095 61,525 59,918
Effect of dilution: Stock
options - 2,232 1,397 2,148
Effect of dilution: Convertible
preferred stock - - - -
--------- --------- ---------- ----------
Diluted shares 61,649 62,327 62,922 62,066
========= ========= ========== ==========
Shares excluded from diluted
computation 11,325 55 5,503 38
--------- --------- ---------- ----------
For the three and six months ended June 30, 2003, 8,926 and 4,463 shares,
respectively, related to the convertible preferred stock were excluded from
the computation because the inclusion of these shares would have been
antidilutive to earnings per share. Additionally, for the three months
ended June 30, 2003, no shares related to stock options were included in
the computation due to their antidilutive effect as a result of the net
loss for the period. For the six months ended June 30, 2003, 1,040 shares
related to stock options were excluded from the calculation of diluted
earnings per share because the exercise prices were greater than the
average market price of the common shares. For the three and six months
ended June 30, 2002, 55 and 38 shares respectively, were excluded from the
calculation of diluted earnings per share because the exercise prices were
greater than the average market price of the common shares. For the three
and six months ended June 30, 2003 and 2002, earnings per share were as
follows:
Three Months Six Months
Ended June 30, Ended June 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------- ------------- -----------------------------
Net income (loss) $ (0.5) $ 14.5 $ 13.1 $ 26.2
Less: preferred stock dividends 1.3 0.1 1.4 0.1
------------- ------------- ------------- --------------
Net income (loss) available to common
shareholders $ (1.8) $ 14.4 $ 11.7 $ 26.1
============= ============= ============= ==============
EARNINGS PER SHARE
Basic earnings per common share
Income (loss) before cumulative effect
of accounting change $ (0.03) $ 0.24 $ 0.05 $ 0.44
Cumulative effect of accounting change, net
of income taxes - - 0.14 -
------------- ------------- ------------- --------------
Net income (loss) per basic share $ (0.03) $ 0.24 $ 0.19 $ 0.44
============= ============= ============= ==============
Diluted earnings per common share
Income (loss) before cumulative effect
of accounting change $ (0.03) $ 0.23 $ 0.05 $ 0.42
Cumulative effect of accounting change, net
of income taxes - - 0.14 -
------------- ------------- ------------- --------------
Net income (loss) per diluted share $ (0.03) $ 0.23 $ 0.19 $ 0.42
============= ============= ============= ==============
3. INVESTMENTS. Investments in unconsolidated affiliates and certain other
investments accounted for under the equity method generally include all
entities in which the Company or its subsidiaries have significant
influence, but not more than 50% voting control. Investments in
unconsolidated affiliates at June 30, 2003 include, among others, equity
interests in Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V.
("Grupo TFM"), Southern Capital Corporation, LLC ("Southern Capital"),
Mexrail, and the Panama Canal Railway Company ("PCRC").
The Company, it's Mexican partner, Grupo TMM, S.A. ("Grupo TMM"), and
certain of Grupo TMM's affiliates entered into an agreement on February 27,
2002 with TFM, S.A. de C.V. ("TFM") to sell to TFM all of the common stock
of Mexrail, Inc. ("Mexrail"), a former 49% unconsolidated affiliate of the
Company. Mexrail owns the northern half of the international railway bridge
at Laredo and all of the common stock of The Texas-Mexican Railway Company
("Tex-Mex"). The sale closed on March 27, 2002 and the Company received
approximately $31.4 million for its 49% interest in Mexrail. The Company
used the proceeds from the sale to reduce debt. Although the Company no
longer directly owned 49% of Mexrail, it retained an indirect ownership
through its ownership of Grupo TFM. The Company's share of the proceeds
from the sale of Mexrail to TFM exceeded the carrying value of the
Company's investment in Mexrail by $11.2 million. The Company recognized a
$4.4 million gain on the sale of Mexrail to TFM in the first quarter of
2002, while the remaining $6.8 of excess proceeds was deferred and is being
amortized into net income over 20 years.
The Company is party to certain agreements with Grupo TMM covering the
Grupo TFM joint venture. These agreements contain "change in control"
provisions, provisions intended to preserve the Company's and Grupo TMM's
proportionate ownership of the joint venture, and super-majority provisions
with respect to voting on certain significant transactions. Such agreements
also provide a right of first refusal in the event that either party
initiates a divestiture of its equity interest in Grupo TFM and a
prohibition on transfers to competitors. Under certain circumstances, such
agreements could affect the Company's ownership percentsage and rights in
these equity affiliates.
KCS AND TMM AGREE TO PLACE TFM, THE TEXAS MEXICAN RAILWAY COMPANY AND THE
KANSAS CITY SOUTHERN RAILWAY COMPANY UNDER COMMON CONTROL. On April 21,
2003, the Company and Grupo TMM announced a series of agreements,
including, among others, an acquisition agreement ("Aquisition
Agreement"), that have been approved by their respective boards of
directors, that will, following shareholder and regulatory approval, place
the Kansas City Southern Railway ("KCSR"), Tex-Mex, and TFM, under the
common control of a single transportation holding company, NAFTA Rail, to
be headquartered in Kansas City, Missouri. As part of this transaction,
subject to shareholder approval, KCS will change its name to NAFTA Rail.
On May 9, 2003, upon the terms and subject to the conditions of the
agreement to acquire Tex-Mex, on May 9, 2003, the Company acquired 51% of
the outstanding stock of Mexrail from TFM for $32.7 million. In addition,
the Company has an exclusive option until December 31, 2005 to purchase the
remaining outstanding shares of Mexrail as of the date of the exercise of
the option. The Company deposited the initial purchased shares of Mexrail
into an irrevocable voting trust pending obtaining approval by the Surface
Transportation Board ("STB") of KCS's request to acquire control of
Tex-Mex. Accordingly, this investment in Mexrail is being accounted for
under the equity method of accounting. TFM has a right to repurchase all of
the Mexrail stock acquired by the Company at any time for the purchase
price paid by the Company,
subject to any STB orders or directions. Upon any such repurchase, the
agreement automatically terminates. If not exercised within two years of
the date of the agreement, TFM's repurchase right expires.
The common control of KCSR and Tex-Mex under NAFTA Rail requires approval
of the the United States Department of Justice, ("Department of Justice")
and the STB in the United States. Additionally, the acquisition of Grupo
TFM shares by NAFTA Rail requires the approval of Mexico's Competition
Commission and the Foreign Investment Commission in Mexico. On June 25,
2003, the Company announced that it received formal written notice that
Mexico's Competition Commission ("the Commission") had approved the
proposed NAFTA Rail transaction. After a detailed review of the proposal,
the Commission found that NAFTA Rail fully complies with Mexico's
competition guidelines, and would in no way impede open competition within
the transportation sector. The Commission granted its approval without
conditions.
On July 31, 2003, the waiting period under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976 ("HSR") for the proposed NAFTA Rail transaction
expired without a formal request from Department of Justice for additional
information of documentary material, allowing KCS and Grupo TMM to
consummate the transaction without any further delays that could have
resulted from requests for additional information by the Department of
Justice under U.S. antitrust laws. Under the HSR process, the Department of
Justice had thirty days after notice was filed to issue a "second request"
asking for various documents and information from the HSR parties. The
waiting period expired without action by the Department of Justice.
In a related matter, On July 31, 2003, certain KCS senior executives
testified before the STB at a public hearing held to discuss and take
evidence on the Company's plans to place KCSR, Gateway Eastern Railway
Company, ("Gateway"), and Tex-Mex under the common control of KCS. This
public hearing was scheduled by the STB to allow KCS and the public to
comment on this transaction, which is separate from the TFM transaction.
The STB has published a procedural schedule that would result in a final
decision on the company's plan to place KCSR, Gateway and Tex-Mex under the
common control of KCS by October 17, 2003.
Upon consummation of the transactions contemplated by the series of
agreements referred to above, Mr. Michael R. Haverty, Chairman, President
and Chief Executive Officer of KCS, will serve as Chairman, President, and
Chief Executive Officer of NAFTA Rail. Mr. Jose Serrano, Chairman of the
Board and Chief Executive Officer of Grupo TMM, will serve as Vice Chairman
of NAFTA Rail and Chairman of TFM. Also joining the NAFTA Rail board of
directors will be Mr. Javier Segovia, President of Grupo TMM. The remainder
of the 10-person board will be made up of existing KCS directors. Mr. Mario
Mohar will remain as General Director of TFM.
Upon the terms and subject to the conditions of the agreement to acquire
Grupo TFM, TMM Multimodal, S.A. de C.V., a subsidiary of Grupo TMM, will
receive 18 million shares of Class A Convertible Common Stock of the
Company, representing, at the time of the agreement, approximately 22
percents (20% voting, 2% subject to voting restrictions) of the Company,
$200 million in cash (with the option to pay up to $80 million of the $200
million cash component due at closing to Grupo TMM with up to 6.4 million
additional shares of Company stock) and a potential incentsive payment of
between $100 million and $180 million based on the resolution of certain
future contingencies.
Subsequent to the date of the Acquisition Agreement, there have been
certain differences between the Company and Grupo TMM, derived from the
alleged actions or omissions of the parties. These differences have
resulted in the exchange of certain communications between the legal
advisors of the parties. No further actions have been taken at this time.
Condensed financial information of certain unconsolidated affiliates is
shown below. All amounts, including those for Grupo TFM, are presented
under U.S. GAAP. Financial information of immaterial unconsolidated
affiliates has been omitted:
FINANCIAL CONDITION (DOLLARS IN MILLIONS):
June 30, 2003 December 31, 2002
--------------------------------------- --------------------------------------
Southern Southern
PCRC Grupo TFM* Capital PCRC Grupo TFM Capital
------------ ------------ ------------- ------------ ------------ -------------
Current assets $ 4.6 $ 238.6 $ 5.9 $ 2.7 $ 265.2 $ 5.5
Non-current assets 84.4 2,066.0 133.3 88.2 2,061.3 139.4
------------ ------------ ------------- ------------ ------------ -------------
Assets $ 89.0 $ 2,304.6 $ 139.2 $ 90.9 $ 2,326.5 $ 144.9
============ ============ ============= ============ ============ =============
Current liabilities $ 4.9 $ 190.6 $ - $ 5.1 $ 147.3 $ -
Non-current liabilities 71.4 967.2 85.9 70.8 1,045.3 95.1
Minority interest - 350.7 - - 348.0 -
Equity of stockholders and partners 12.7 796.1 53.3 15.0 785.9 49.8
------------ ------------ ------------- ------------ ------------ -------------
Liabilities and equity $ 89.0 $ 2,304.6 $ 139.2 $ 90.9 $ 2,326.5 $ 144.9
============ ============ ============= ============ ============ =============
KCS's investment $ 6.4 $ 384.5 $ 26.7 $ 7.5 $ 380.1 $ 24.9
------------ ------------ ------------- ------------ ------------ -------------
* Includes Mexrail as a fully consolidated subsidiary
OPERATING RESULTS (DOLLARS IN MILLIONS):
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------- ----------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Revenues:
Grupo TFM* $ 176.6 $ 186.3 $ 345.1 $ 343.8
Southern Capital 7.9 7.5 15.9 15.0
PCRC 1.8 0.6 4.2 1.6
Mexrail - - - 13.3
Operating costs and expenses:
Grupo TFM* $ 143.8 $ 130.2 $ 280.5 $ 252.2
Southern Capital 6.9 6.4 13.9 12.1
PCRC 3.3 3.1 6.5 6.0
Mexrail - - - 13.3
Net income (loss):
Grupo TFM* $ (4.7) $ 35.0 $ 10.3 $ 48.0
Southern Capital 1.0 (0.7) 2.0 1.2
PCRC (1.5) (2.0) (2.3) (3.8)
Mexrail - - - -
* Includes Mexrail as a fully consolidated subsidiary as of April 2002.
4. NONCASH INVESTING AND FINANCING ACTIVITIES. The Company initiated the
Fourteenth Offering of KCS common stock under the Employee Stock Purchase
Plan ("ESPP") during 2002. Stock subscribed under the Fourteenth Offering
will be issued to employees in 2004 and is being paid for through employee
payroll deductions in 2003. During the first six months of 2003, the
Company has received approximately $1.4 million from payroll deductions
associated with the Fourteenth Offering of the ESPP. In the first quarter
of 2003, the Company issued approximately 337,917 shares of KCS common
stock under the Thirteenth Offering of the ESPP. These shares, totaling a
purchase price of approximately $3.5 million, were subscribed and paid for
through employee payroll deductions in 2002.
5. DERIVATIVE FINANCIAL INSTRUMENTS. The Company does not engage in the
trading of derivative instruments for speculative purposes but uses them
for risk management purposes only. The Company's objective is to manage its
fuel and interest rate risk through the use of derivative instruments as
deemed appropriate. At June 30, 2003, the Company was a party to six fuel
swap agreements for a notional amount of approximately 7.5 million gallons
of fuel. Under the terms of these swaps, the Company receives a variable
price based upon the average of the spot prices calculated on a monthly
basis as reported through a petroleum price reporting service.
A summary of the swap agreements to which KCSR was a party as of June 30,
2003 is as follows:
Trade Date Notional Amount Fixed pay per Expiration Date
gallon
---------------------------------------------------------------------------
November 14, 2002 1.3 million gallons 62.5(cents) December 31, 2003
March 18, 2003 1.9 million gallons 65.0(cents) December 31, 2004
March 21, 2003 0.6 million gallons 64.0(cents) June 30, 2004
April 11, 2003 0.6 million gallons 67.8(cents) September 30, 2003
April 11, 2003 0.6 million gallons 68.7(cents) December 31, 2003
April 11, 2003 2.5 million gallons 66.0(cents) December 31, 2004
Cash settlements of these swaps occur on a monthly basis on the fifth
business day of the month following the month in which the settlement is
calculated. These swaps, combined with the Company's forward purchase
policies, are designed to hedge the Company's exposure to movements in the
price of No. 2 Gulf Coast Heating Oil on which the Company's diesel fuel
prices are determined. Using these risk management strategies, the Company
is able to limit its risk to rising diesel fuel prices. As of June 30,
2003, the fair market value of the swaps was $0.4 million. For the years
ended December 31, 2002 and 2001, KCSR consumed 55.3 million gallons and
57.6 million gallons of fuel, respectively.
6. STOCK PLANS. Proceeds received from the exercise of stock options or
subscriptions are credited to the appropriate capital accounts in the year
they are exercised.
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation" ("SFAS 123") in October 1995. This statement allows companies
to continue under the approach set forth in Accounting Principles Board
Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25"), for
recognizing stock-based compensation expense in the financial statements,
but encourages companies to adopt the fair value method of accounting for
employee stock options. Under SFAS 123, companies must either record
compensation expense based on the estimated grant date fair value of stock
options granted or disclose the impact on net income as if they had adopted
the fair value method (for grants subsequent to December 31, 1994.) If KCS
had measured compensation cost for the KCS stock options granted to its
employees and shares subscribed by its employees under the KCS employee
stock purchase plan, under the fair value based method prescribed by SFAS
123, net income and earnings per share would have been as follows:
----------------------------------------------------------------------------
2003 2002 2003 2002
------------------ -------------------------------------- ------------------
NET INCOME (IN MILLIONS):
As reported $ (0.5) $ 14.5 $ 13.1 $ 26.2
Total stock-based compensation expense
determined under fair value method, net of
income taxes (0.6) (0.4) (1.0) (0.9)
------------------ -------------------------------------- ------------------
Pro forma $ (1.1) $ 14.1 $ 12.1 $ 25.3
EARNINGS PER BASIC SHARE:
As reported $ (0.03) $ 0.24 $ 0.19 $ 0.44
Pro forma $ (0.04) $ 0.23 $ 0.17 $ 0.42
EARNINGS PER DILUTED SHARE:
As reported $ (0.03) $ 0.23 $ 0.19 $ 0.42
Pro forma $ (0.04) $ 0.22 $ 0.17 $ 0.40
7. KANSAS CITY SOUTHERN RECIEVES APPROVAL OF AMENDMENT OF CREDIT AGREEMENT. On
April 3, 2003, the Company received approval of its request for an
amendment to certain provisions under its Amended and Restated Credit
Agreement from more than 96 percent of the lenders under the agreement. As
discussed in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002 as filed with the Securities and Exchange Commission, the
Mexican Government has the right to require Grupo TFM to purchase the
Mexican Government's interest in TFM on or after October 31, 2003. Should
Grupo TFM fail to purchase the Mexican Government's interest within 60 days
of notification by the Mexican Government of its obligation to buy, then
Grupo TMM and KCS, or either Grupo TMM or KCS, could be required to
purchase their respective portion, or all, as applicable, of the Mexican
Government's interest in TFM within 60 days following written notification
to Grupo TMM and KCS, or either Grupo TMM or KCS, of its or their
obligation to purchase. In addition, if the Mexican Government's interest
in TFM has not been purchased prior to the closure of the proposed NAFTA
Rail transaction to place KCSR, Tex-Mex, Gateway and TFM under common
control, KCS shall, as a condition precedent to, and contemporaneous with,
the closure of such transaction, enter into an agreement under which KCS
shall assume and
discharge Grupo TMM's obligation to purchase the Mexican Government's
interest in TFM. The Company requested an amendment to its Amended and
Restated Credit Agreement dated June 12, 2002, in order to provide
flexibility in structuring the funding for the transaction to acquire the
Mexican Government's interest in TFM. On April 28, 2003, the Company
entered into a second amendment to its Amended and Restated Credit
Agreement under which 93 percent of the lenders specifically approved the
Company's investment in further equity interests of Grupo TFM, in equity
interests representing 51% of Mexrail's issued and outstanding capital
stock and the use of the Company's cash to acquire Mexrail, in connection
with the proposed NAFTA Rail transaction to place KCSR, Tex-Mex and TFM
under common control (see note 3).
8. KCS ISSUES REDEEMABLE CUMULATIVE CONVERTIBLE PERPETUAL PREFERRED STOCK. On
May 5, 2003, the Company completed the sale of $200 million of Redeemable
Cumulative Convertible Perpetual Preferred Stock with a liquidation
preference of $500 per share in a private offering. The convertible
preferred stock offering was made only by means of an offering memorandum
pursuant to Rule 144A. Dividends on the convertible preferred stock will be
cumulative and will be payable quarterly at an annual rate of 4.25% of the
liquidation preference, when, as and if declared by the Company's board of
directors. Accumulated unpaid dividends will cumulate dividends at the same
rate as dividends cumulate on the convertible preferred stock. Each share
of the convertible preferred stock will be convertible, under certain
conditions, and subject to adjustment under certain conditions, into
33.4728 shares of the Company's common stock. On or after May 20, 2008, the
Company will have the option to redeem any or all of the preferred stock,
subject to certain conditions. Under certain circumstances, at the option
of the holders of the preferred stock, the Company may be required to
purchase shares of the convertible preferred stock from the holders. The
convertible preferred stock is redeemable at the option of a holder only in
the event of a "fundamental change," which is defined as "any transaction
or event (whether by means of an exchange offer, liquidation, tender offer,
consolidation, merger, combination, reclassification, recapitalization or
otherwise) in connection with which all or substantially all of the
Company's common stock is exchanged for, converted into, acquired for or
constitutes solely the right to receive common stock that is not listed on
a United States national securities exchange or approved for quotation on
the Nasdaq National Market or similar system. The practical effect of this
provision is to limit the Company's ability to eliminate a holder's ability
to convert the convertible preferred stock into common shares of a publicly
traded security through a merger or consolidation transaction. In no other
circumstances is the Company potentially obligated to redeem the
convertible preferred stock for cash. Accordingly, since the Company is in
a position to control whether the Company experiences a "fundamental
change," the convertible preferred stock is classified as permanent equity
capital.
The net proceeds from the offering of the convertible preferred stock are
expected to be used to pay a portion of the purchase price for the proposed
acquisition of a controlling interest of Grupo TFM. On August, 1, 2003, KCS
submitted a Form S-3 Registration Statement to the SEC to register for
resale by the holders the convertible preferred stock and the common stock
into which such preferred stock may be converted. This registration
statement is currently pending review by the SEC. KCS will not receive any
proceeds from the sale of the securities under this registration statement.
9. COMMITMENTS AND CONTINGENCIES. The Company has had no significant changes
in its outstanding litigation or other commitments and contingencies from
that previously reported in Note 11 of the Company's Annual Report on Form
10-K for the year ended December 31, 2002. The following provides an update
of the Houston cases.
HOUSTON CASES. In August 2000, KCSR and certain of its affiliates were
added as defendants in lawsuits pending in Jefferson and Harris Counties,
Texas. These lawsuits allege damage to approximately 3,000 plaintiffs as a
result of an alleged toxic chemical release from a tank car in Houston,
Texas on August 21, 1998. Litigation involving the shipper and the
delivering carrier had been pending for some time, but KCSR, which handled
the car during the course of its transport, had not previously been named a
defendant. On June 28, 2001, KCSR reached a final settlement with the 1,664
plaintiffs in the lawsuit filed in Jefferson County, Texas. In 2002, KCSR
settled with virtually all of the plaintiffs in the lawsuit filed in the
164th Judicial District Court of Harris County, Texas, for approximately
$0.3 million. The remaining plaintiffs have indicated that they intend to
retain new counsel, yet to date, KCS has not received any notice of new
counsel entering the case.
10. NEW ACCOUNTING PRONOUNCEMENTS. In June 2001, the FASB issued Statement No.
143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143
is effective for fiscal years beginning after June 15, 2002. Under SFAS
143, the fair value of a liability for an asset retirement obligation must
be recognized in the period in which it is incurred if a reasonable
estimate of the fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived
asset. KCSR, along with other Class I railroads, depreciates track
structure (rail, ties, and other track material) in accordance with
regulations promulgated by the STB. These regulations require KCSR to
depreciate track structure to a net salvage value (gross estimated salvage
value less estimated costs to remove the track
structure at the end of its useful life). For certain track structure such
as ties, with little or no gross salvage value, this practice ultimately
results in depreciating an asset below zero, and thus, in effect, results
in a liability. Under the requirements of SFAS 143, in the absence of a
legal obligation to remove the track structure, such accounting practice is
prohibited. The Company adopted the provisions of SFAS 143 in the first
quarter of 2003, and, as a result, reviewed its depreciation of track
structures to determine instances where the depreciation of removal costs
has resulted or would be expected (based on the current depreciation rate)
to result in the depreciation of an asset below zero when considering net
salvage value. As a result of this review, the Company estimated the excess
depreciation recorded on such assets and recorded this amount as a
reduction in accumulated depreciation of $14.5 million and as a cumulative
effect of an accounting change of $8.9 million (net of taxes of $5.6
million) as required by SFAS 143 in the first quarter of 2003.
Additionally, depreciation rates applied to certain track structure
elements that were previously yielding a negative salvage value have been
modified to comply with the provisions of SFAS 143. For the six months
ended June 30, 2003, this resulted in a reduction in depreciation expense
of approximately $0.7 million. Management currently estimates the net
effect of the adoption of SFAS 143 on full year depreciation expense to be
approximately $1.4 million.
A summary of the pro forma net income and earnings per share had SFAS 143
been applied retroactively is as follows:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------------------------
2003 2002 2003 2002
------------------------------------------------------
NET INCOME (IN MILLIONS)
As reported $ (0.5) $ 14.5 $ 13.1 $ 26.2
Pro forma $ (0.5) $ 14.9 $ 4.2 $ 26.8
EARNINGS PER BASIC
SHARE:
As reported $ (0.03) $ 0.24 $ 0.19 $ 0.44
Pro forma $ (0.03) $ 0.25 $ 0.05 $ 0.45
EARNINGS PER DILUTED
SHARE:
As reported $ (0.03) $ 0.23 $ 0.19 $ 0.42
Pro forma $ (0.03) $ 0.24 $ 0.05 $ 0.43
In December 2002, the FASB issued Statement No. 148 "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of FASB
Statement No. 123" ("SFAS 148"). SFAS 148 provides two additional
transition methods for entities that adopt the method of accounting for
stock-based compensation as defined in SFAS 123. Additionally, SFAS 148
amends the disclosure requirements of SFAS 123 to require disclosures in
interim financial statements regarding the method of accounting for
stock-based employee compensation and the effect of the method on results
of operations. The Company is currently evaluating the provisions of this
new accounting pronouncement and does not expect this pronouncement, if
adopted, to have a material impact on its consolidated results of
operations, financial position, or cash flows. See note 6 for interim
disclosures required under SFAS 148.
In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation
of Variable Interest Entities," ("FIN 46"). FIN 46 clarifies the
application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements" to certain variable interest entities created after January 31,
2003 as well as certain entities created prior to this date. The Company is
required to adopt this interpretation in the third quarter of 2003. The
Company has performed an initial assessment of its equity method investment
in Southern Capital for any potential impact this interpretation may have
on its accounting for Southern Capital as an equity investment. The Company
anticipates that FIN 46 will have no impact on the Company's accounting for
its investment in Southern Capital since, at inception, SCC had sufficient
funding and capital to absorb any expected losses.
11. CONDENSED CONSOLIDATING FINANCIAL INFORMATION. In September 2000, KCSR
issued $200 million of 9 1/2% senior notes due 2008. In addition, in June
2002, KCSR issued $200 million of 7 1/2% senior notes due 2009. Both of
these note issues are unsecured obligations of KCSR, however, they are also
jointly and severally and fully and unconditionally guaranteed on an
unsecured senior basis by KCS and certain of the subsidiaries (all of which
are wholly-owned) within the KCS consolidated group. For each of these note
issues, KCS registered exchange notes with the SEC that have substantially
identical terms and associated guarantees and all of the initial senior
notes for each issue have been exchanged for $200 million of registered
exchange notes for each respective note issue.
The accompanying condensed consolidating financial information has been
prepared and presented pursuant to SEC Regulation S-X Rule 3-10 "Financial
statements of guarantors and issuers of guaranteed securities registered or
being registered." This information is not intended to present the
financial position, results of operations and cash flows of the individual
companies or groups of companies in accordance with U.S. GAAP.
CONDENSED CONSOLIDATING STATEMENTS OF INCOME
Six months ended June 30, 2003 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
Revenues $ - $ 283.3 $ 9.7 $ 14.8 $ (21.3) $ 286.5
Costs and expenses 6.4 255.8 9.4 15.2 (21.3) 265.5
------------- ------------- ------------- ------------- -------------- -------------
Operating income (loss) (6.4) 27.5 0.3 (0.4) - 21.0
Equity in net earnings (losses)
of unconsolidated affiliates
and subsidiaries 8.8 4.6 - 4.5 (13.4) 4.5
Interest expense (0.3) (22.8) (0.1) - - (23.2)
Other income - 2.3 0.2 0.6 (0.3) 2.8
------------- ------------- ------------- ------------- -------------- -------------
Income (loss) before income
taxes and cumulative effect
of accounting change 2.1 11.6 0.4 4.7 (13.7) 5.1
Income tax provision (benefit) (2.1) 2.8 0.1 0.1 - 0.9
------------- ------------- ------------- ------------- -------------- -------------
Income (loss) before cumulative
effect of accounting change 4.2 8.8 0.3 4.6 (13.7) 4.2
Cumulative effect of accounting
change, net of income taxes 8.9 8.9 - - (8.9) 8.9
------------- ------------- ------------- ------------- -------------- -------------
Net income (loss) $ 13.1 $ 17.7 $ 0.3 $ 4.6 $ (22.6) $ 13.1
============= ============= ============= ============= ============== =============
Six months ended June 30, 2002 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
Revenues $ - $ 283.2 $ 9.3 $ 7.9 $ (17.3) $ 283.1
Costs and expenses 5.7 247.4 11.2 8.2 (17.3) 255.2
------------- ------------- ------------- ------------- -------------- -------------
Operating income (loss) (5.7) 35.8 (1.9) (0.3) - 27.9
Equity in net earnings (losses)
of unconsolidated affiliates
and subsidiaries 25.6 16.8 - 16.6 (42.4) 16.6
Gain on Sale of Mexrail 4.4 4.4 - - (4.4) 4.4
Interest expense (0.3) (21.0) (0.3) (0.2) - (21.8)
Debt retirement costs - (4.3) - - - (4.3)
Other, net 0.1 8.6 0.1 0.3 (0.3) 8.8
------------- ------------- ------------- ------------- -------------- -------------
Income (loss) before 24.1 40.3 (2.1) 16.4 (47.1) 31.6
income taxes
Income tax provision (benefit) (2.1) 8.7 (0.8) (0.4) - 5.4
------------- ------------- ------------- ------------- -------------- -------------
Net income (loss) $ 26.2 $ 31.6 $ (1.3) $ 16.8 $ (47.1) $ 26.2
============= ============= ============= ============= ============== =============
CONDENSED CONSOLIDATING BALANCE SHEETS
As of June 30, 2003 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
ASSETS
Current assets $ 214.7 $ 395.2 $ 12.4 $ 19.1 $ (265.2) $ 376.2
Investments 820.3 417.3 - 457.7 (1,234.5) 460.8
Properties, net 0.2 1,340.2 3.9 - - 1,344.3
Goodwill and other assets 6.3 28.9 1.6 6.5 (8.1) 35.2
------------- ------------- ------------- ------------- -------------- -------------
Total assets $ 1,041.5 $ 2,181.6 $ 17.9 $ 483.3 $ (1,507.8) $ 2,216.5
============= ============= ============= ============= ============== =============
LIABILITIES AND EQUITY
Current liabilities $ 4.4 $ 397.9 $ 4.5 $ 41.9 $ (261.1) $ 187.6
Long-term debt 1.2 568.2 0.7 - - 570.1
Payable to affiliates 32.9 - 0.7 - (33.6) -
Deferred income taxes 6.5 395.1 0.2 2.9 (8.1) 396.6
Other liabilities 31.6 42.2 4.2 23.4 (4.1) 97.3
Stockholders' equity 964.9 778.2 7.6 415.1 (1,200.9) 964.9
------------- ------------- ------------- ------------- -------------- -------------
Total liabilities and
equity $ 1,041.5 $ 2,181.6 $ 17.9 $ 483.3 $ (1,507.8) $ 2,216.5
============= ============= ============= ============= ============== =============
As of December 31, 2002 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
ASSETS
Current assets $ 43.3 $ 234.7 $ 17.6 $ 13.0 $ (92.4) $ 216.2
Investments 769.1 412.1 - 432.5 (1,190.6) 423.1
Properties, net 0.2 1,333.2 3.9 0.1 - 1,337.4
Goodwill and other assets 1.6 30.5 1.7 8.1 (9.8) 32.1
------------- ------------- ------------- ------------- -------------- -------------
Total assets $ 814.2 $ 2,010.5 $ 23.2 $ 453.7 $ (1,292.8) $ 2,008.8
============= ============= ============= ============= ============== =============
LIABILITIES AND EQUITY
Current liabilities $ 7.2 $ 245.3 $ 9.1 $ 16.2 $ (91.5) $ 186.3
Long-term debt 1.2 569.6 1.8 - - 572.6
Payable to affiliates 12.8 - 0.6 - (13.4) -
Deferred income taxes 8.6 391.1 0.3 2.6 (9.8) 392.8
Other liabilities 31.5 44.7 4.0 25.1 (1.1) 104.2
Stockholders' equity 752.9 759.8 7.4 409.8 (1,177.0) 752.9
------------- ------------- ------------- ------------- -------------- -------------
Total liabilities and
equity $ 814.2 $ 2,010.5 $ 23.2 $ 453.7 $ (1,292.8) $ 2,008.8
============= ============= ============= ============= ============== =============
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Six months ended June 30, 2003 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
Net cash flows provided by (used
for) operating activities: $ (166.1) $ 199.7 $ (11.2) $ 20.3 $ 4.2 $ 46.9
------------- ------------- ------------- ------------- -------------- -------------
Investing activities:
Property acquisitions - (32.4) (0.2) - - (32.6)
Proceeds from disposal of
property - 7.7 - - - 7.7
Investments in and loans to
affiliates (32.7) (0.1) - (20.1) 20.1 (32.8)
Proceeds from sale of
investments - - - - - -
Other, net (5.3) - - 1.6 (1.0) (4.7)
------------- ------------- ------------- ------------- -------------- -------------
Net (38.0) (24.8) (0.2) (18.5) 19.1 (62.4)
------------- ------------- ------------- ------------- -------------- -------------
Financing activities:
Proceeds from issuance of
long-term debt - - - - - -
Repayment of long-term debt - (1.5) (1.0) - - (2.5)
Proceeds from loans from
affiliates 20.1 - - - (20.1) -
Repayment of loans from
affiliates - - - - - -
Issuance of preferred stock 193.2 - - - - 193.2
Debt issuance costs - - - - - -
Proceeds from stock plans 1.9 0.2 - - - 2.1
Cash dividends paid (0.1) - - - - (0.1)
Other, net - 0.2 0.2 (1.5) (3.2) (4.3)
------------- ------------- ------------- ------------- -------------- -------------
Net 215.1 (1.1) (0.8) (1.5) (23.3) 188.4
------------- ------------- ------------- ------------- -------------- -------------
Cash and cash equivalents:
Net increase (decrease) 11.0 173.8 (12.2) 0.3 - 172.9
At beginning of period (10.8) 17.4 11.8 0.6 - 19.0
------------- ------------- ------------- ------------- -------------- -------------
At end of period $ 0.2 $ 191.2 $ (0.4) $ 0.9 $ - $ 191.9
============= ============= ============= ============= ============== =============
Six months ended June 30, 2002 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Subsidiary Guarantor Guarantor Consolidating Consolidated
Parent Issuer Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
Net cash flows provided by (used
for) operating activities: $ (11.0) $ 56.9 $ 0.4 $ 7.1 $ 4.4 $ 57.8
------------- ------------- ------------- ------------- -------------- -------------
Investing activities:
Property acquisitions - (38.6) (0.5) - - (39.1)
Proceeds from disposal of
property - 16.1 - - - 16.1
Investments in and loans to
affiliates - - - (10.3) 6.8 (3.5)
Proceeds from sale of
investments - 31.4 - - - 31.4
Other, net - (0.4) 0.7 - 0.8 1.1
------------- ------------- ------------- ------------- -------------- -------------
Net - 8.5 0.2 (10.3) 7.6 6.0
------------- ------------- ------------- ------------- -------------- -------------
Financing activities:
Proceeds from issuance of
long-term debt - 200.0 - - - 200.0
Repayment of long-term debt (0.4) (261.8) (1.0) (0.2) - (263.4)
Proceeds from loans from
affiliates 7.3 - 0.1 - (7.4) -
Repayment of loans from
affiliates (0.5) - - - 0.5 -
Debt issuance costs - (5.4) - - - (5.4)
Proceeds from stock plans 3.7 - - - - 3.7
Cash dividends paid (0.1) - - - - (0.1)
Other, net - 2.2 0.3 2.8 (5.1) 0.2
------------- ------------- ------------- ------------- -------------- -------------
Net 10.0 (65.0) (0.6) 2.6 (12.0) (65.0)
------------- ------------- ------------- ------------- -------------- -------------
Cash and cash equivalents:
Net increase (decrease) (1.0) 0.4 - (0.6) - (1.2)
At beginning of period 1.3 23.2 - 0.2 - 24.7
------------- ------------- ------------- ------------- -------------- -------------
At end of period $ 0.3 $ 23.6 $ - $ (0.4) $ - $ 23.5
============= ============= ============= ============= ============== =============
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
THE DISCUSSION SET FORTH BELOW, AS WELL AS OTHER PORTIONS OF THIS FORM 10-Q,
CONTAINS FORWARD-LOOKING COMMENTS THAT ARE NOT BASED UPON HISTORICAL
INFORMATION. SUCH FORWARD-LOOKING COMMENTS ARE BASED UPON INFORMATION CURRENTLY
AVAILABLE TO MANAGEMENT AND MANAGEMENT'S PERCEPTION THEREOF AS OF THE DATE OF
THIS FORM 10-Q. READERS CAN IDENTIFY THESE FORWARD-LOOKING COMMENTS BY THE USE
OF SUCH VERBS AS EXPECTS, ANTICIPATES, BELIEVES OR SIMILAR VERBS OR CONJUGATIONS
OF SUCH VERBS. THE ACTUAL RESULTS OF OPERATIONS OF KANSAS CITY SOUTHERN ("KCS"
OR THE "COMPANY") COULD MATERIALLY DIFFER FROM THOSE INDICATED IN
FORWARD-LOOKING COMMENTS. THE DIFFERENCES COULD BE CAUSED BY A NUMBER OF FACTORS
OR COMBINATION OF FACTORS INCLUDING, BUT NOT LIMITED TO, THOSE FACTORS
IDENTIFIED IN THE COMPANY'S CURRENT REPORT ON FORM 8-K DATED DECEMBER 11, 2001,
WHICH IS ON FILE WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION (FILE NO.
1-4717) AND IS HEREBY INCORPORATED BY REFERENCE HEREIN. READERS ARE STRONGLY
ENCOURAGED TO CONSIDER THESE FACTORS WHEN EVALUATING FORWARD-LOOKING COMMENTS.
THE COMPANY WILL NOT UPDATE ANY FORWARD-LOOKING COMMENTS SET FORTH IN THIS FORM
10-Q.
THE DISCUSSION HEREIN IS INTENDED TO CLARIFY AND FOCUS ON THE COMPANY'S RESULTS
OF OPERATIONS, CERTAIN CHANGES IN ITS FINANCIAL POSITION, LIQUIDITY, CAPITAL
STRUCTURE AND BUSINESS DEVELOPMENTS FOR THE PERIODS COVERED BY THE CONSOLIDATED
FINANCIAL STATEMENTS INCLUDED UNDER ITEM 1 OF THIS FORM 10-Q. THIS DISCUSSION
SHOULD BE READ IN CONJUNCTION WITH THESE CONSOLIDATED FINANCIAL STATEMENTS AND
THE RELATED NOTES THERETO, AND IS QUALIFIED BY REFERENCE THERETO.
GENERAL
KCS, a Delaware corporation, is a holding company with principal subsidiaries
and affiliates including the following:
o The Kansas City Southern Railway Company ("KCSR"), a wholly-owned
subsidiary;
o Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), a
46.6% owned unconsolidated affiliate, which owns 80% of the common stock of
TFM, S.A. de C.V. ("TFM"). TFM owns 49% of Mexrail, Inc. ("Mexrail").
Mexrail owns 100% of The Texas-Mexican Railway Company ("Tex-Mex");
o Mexrail, a 51% owned unconsolidated affiliate, which wholly-owns the
Tex-Mex; KCS has acquired shares that are being held in an independent
voting trust pending Surface Transportation Board approval of the
transaction.
o Southern Capital Corporation, LLC ("Southern Capital"), a 50% owned
unconsolidated affiliate that leases locomotive and rail equipment to KCSR;
o Panama Canal Railway Company ("PCRC"), an unconsolidated affiliate of which
KCSR owns 50% of the common stock. PCRC owns all of the common stock of
Panarail Tourism Company ("Panarail").
KCS supplies its various subsidiaries with managerial, legal, tax, financial and
accounting services, in addition to managing other "non-operating" investments.
RECENT DEVELOPMENTS
RECENT JUDGMENT ON THE TFM VAT CLAIM. On July 9, 2003, Grupo TMM, S.A. ("Grupo
TMM"), and KCS, announced that TFM was formally notified by a three-judge panel
of the Court of the First Circuit ("Circuit Court") of its June 11, 2003
judgment, which granted TFM constitutional protection ("Amparo") against the
ruling of the Federal Tribunal of Fiscal and Administrative Justice ("Fiscal
Court") issued on December 6, 2002, which had denied TFM the right to receive
the Value Added Tax (VAT) refund. TFM initiated its claim for the VAT refund in
1997.
The Circuit Court's judgment ordered the Fiscal Court to vacate its December 6,
2002 resolution, and to issue a new resolution following the guidelines of the
Circuit Court's judgment. The Circuit Court found that the VAT refund
certificate had not been delivered to TFM, and confirmed the Fiscal Court's
determination that TFM has the right to receive the VAT refund certificate. The
Circuit Court's ruling states that the Treasury's decision denying delivery of
the VAT refund certificate to TFM violated the law, and it instructs that the
VAT reimbursement certificate be issued to TFM on the terms established by
Article 22 of the Federal Fiscal Code in effect at that time.
As a result of this ruling, the case has been remanded to the Fiscal Court, and
TFM has indicated it believes that the guidelines contained in the Circuit
Court's decision are clear. However, TFM cannot be certain of the final terms of
the new resolution to be issued by the Fiscal Court. In addition, a third party
claim or legal action could be brought against TFM as a consequence of the new
ruling to be issued by the Fiscal Court in compliance with the judgment of the
Circuit
Court. Should such an action or claim be brought against TFM, TFM has indicated
it believes it would have sufficient legal defenses. As of today, it
is not possible to determine when the Fiscal Court will issue its new ruling,
nor when TFM is likely to receive the VAT refund.
KCS AND TMM ANNOUNCE AGREEMENTS PLACING TFM, THE TEXAS MEXICAN RAILWAY COMPANY,
GATEWAY EASTERN RAILWAY COMPANY AND THE KANSAS CITY SOUTHERN RAILWAY COMPANY
UNDER COMMON CONTROL. On April 21, 2003, the Company and Grupo TMM announced a
series of agreements, including, among others, an acquisition agreement
(Acquisition Agreement"), that have been approved by their respective boards of
directors, that will, following shareholder and regulatory approval, place KCSR,
Tex-Mex, Gateway and TFM, under the common control of a single transportation
holding company, NAFTA Rail, to be headquartered in Kansas City, Missouri. As
part of this transaction, subject to shareholder approval, KCS will change its
name to NAFTA Rail.
On May 9, 2003, upon the terms and subject to the conditions of the agreement to
acquire Tex-Mex, the Company acquired 51% of the outstanding stock of Mexrail
from TFM for $32.7 million and placed the shares acquired in a voting trust
pending Surface Transportation Board ("STB") approval. In addition, the Company
has an exclusive option until December 31, 2005 to purchase the remaining
outstanding shares of Mexrail as of the date of the exercise of the option. The
Company deposited the initial purchased shares of Mexrail into an irrevocable
voting trust pending obtaining approval by the STB of KCS's request to acquire
control of Tex-Mex. TFM has a right to repurchase all of the Mexrail stock
acquired by the Company at any time for the purchase price paid by the Company,
subject to any STB orders or directions. Upon any such repurchase, the agreement
automatically terminates. If not exercised within two years of the date of the
agreement, TFM's repurchase right expires.
The common control of KCSR and Tex-Mex under NAFTA Rail requires approval of the
United States Department of Justice ("Department of Justice") and the STB in the
United States. Additionally, the acquisition of Grupo TFM shares by NAFTA Rail
requires the approval of Mexico's Competition Commission and the Foreign
Investment Commission in Mexico. On June 25, 2003, the Company announced that it
received formal written notice that Mexico's Competition Commission ("the
Commission") had approved the proposed NAFTA Rail transaction. After a detailed
review of the proposal, the Commission found that NAFTA Rail fully complies with
Mexico's competition guidelines, and would in no way impede open competition
within the transportation sector. The Commission granted its approval without
conditions.
On August 1, 2003, the Company announced that the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR") for the proposed
NAFTA Rail transaction had expired without a formal request from the Department
of Justice for additional information of documentary material, allowing KCS and
Grupo TMM to consummate the transaction without any further delays that could
have resulted from requests for additional information by the Department of
Justice under U.S. antitrust laws. Under the HSR process, the Department of
Justice had thirty days after notice was filed to issue a "second request"
asking for various documents and information from the HSR parties. The waiting
period officially expired on July 31, 2003, without action by the Department of
Justice.
In a related matter, on July 31, 2003, certain KCS senior executives testified
before the STB at a public hearing held to discuss and take evidence on the
Company's plans to place KCSR, Gateway, and Tex-Mex under the common control of
KCS. This public hearing was scheduled by the STB to allow KCS and the public to
comment on this transaction, which is separate from the TFM transaction. The STB
has published a procedural schedule that would result in a final decision on the
Company's plan to place KCSR, Gateway and Tex-Mex under the common control of
KCS by October 17, 2003.
Upon consummation of the transactions contemplated by the series of agreements
referred to above, Mr. Michael R. Haverty, Chairman, President and Chief
Executive Officer of KCS, will serve as Chairman, President, and Chief Executive
Officer of NAFTA Rail. Mr. Jose Serrano, Chairman of the Board and Chief
Executive Officer of Grupo TMM, will serve as Vice Chairman of NAFTA Rail and
Chairman of TFM. Also joining the NAFTA Rail board of directors will be Mr.
Javier Segovia, President of Grupo TMM. The remainder of the 10-person board
will be made up of existing KCS directors. Mr. Mario Mohar will remain as
General Director of TFM.
Upon the terms and subject to the conditions of the agreement to acquire Grupo
TFM, TMM Multimodal, S.A. de C.V., a subsidiary of Grupo TMM, will receive 18
million shares of Class A Convertible Common Stock of the Company, representing,
at the time of the agreement, approximately 22% (20% voting, 2% subject to
voting restrictions) of the Company, $200 million in cash (with the option to
pay up to $80 million of the $200 million cash component due at closing to Grupo
TMM with up to 6.4 million additional shares of Company stock) and a potential
incentsive payment of between $100 million and $180 million based on the
resolution of certain future contingencies. Grupo TFM owns 80% of
the common stock of TFM and all the shares entitled to full voting rights. The
Mexican Government owns the remaining 20% of TFM.
Subsequent to the date of the Acquisition Agreement, there have been certain
differences between the Company and Grupo TMM, derived from the alleged actions
or omissions of the parties. These differences have resulted in the exchange of
certain communications between the legal advisors of the parties. No further
actions have been taken at this time.
THOMAS A. MCDONNELL NAMED TO BOARD OF DIRECTORS. On March 19, 2003, the Company
announced that Thomas A. McDonnell, President and Chief Executive Officer of DST
Systems, Inc. had been named to its board of directors. Mr. McDonnell began his
career with Kansas City Southern Railway in 1968. In 1969, he moved to DST
Systems, Inc. From 1983 to October 1995, he served as a director of Kansas City
Southern Industries, Inc. (now KCS). From December 1989 through October 1995, he
served as a director of The Kansas City Southern Railway Company. From September
1983 through October 1995, he served as executive vice president of Kansas City
Southern Industries, Inc. (now KCS).
KANSAS CITY SOUTHERN RECEIVES APPROVAL OF AMENDMENT OF CREDIT AGREEMENT. On
April 3, 2003, the Company received approval of its request for an amendment to
certain provisions under its Amended and Restated Credit Agreement from more
than 96 percent of the lenders under the agreement. As discussed in the
Company's Annual Report on Form 10-K for the year ended December 31, 2002 as
filed with the Securities and Exchange Commission, the Mexican Government has
the right to require Grupo TFM to purchase the Mexican Government's interest in
TFM on or after October 31, 2003. Should Grupo TFM fail to purchase the Mexican
Government's interest within 60 days of notification by the Mexican Government
of its obligation to buy, then Grupo TMM and KCS, or either Grupo TMM or KCS,
could be required to purchase their respective portion, or all, as applicable,
of the Mexican Government's interest in TFM within 60 days following written
notification to Grupo TMM and KCS, or either Grupo TMM or KCS, of its or their
obligation to purchase. In addition, if the Mexican Government's interest in TFM
has not been purchased prior to the closure of the proposed NAFTA Rail
transaction contemplated by the Acquisition Agreement, KCS shall, as a condition
precedent to, and contemporaneous with, the closure of such transaction, enter
into an agreement under which KCS shall assume and discharge Grupo TMM's
obligation to purchase the Mexican Government's interest in TFM. The Company
requested an amendment to its Amended and Restated Credit Agreement dated June
12, 2002, in order to provide flexibility in structuring the funding for the
transaction to acquire the Mexican Government's interest in TFM. On April 28,
2003, the Company entered into a second amendment to its Amended and Restated
Credit Agreement under which 93 percent of the lenders specifically approved the
Company's investment in further equity interests of Grupo TFM, in equity
interests representing 51% of Mexrail's issued and outstanding capital stock and
the use of the Company's cash to acquire Mexrail, in connection with the
proposed NAFTA Rail transaction to place KCSR, Tex-Mex and TFM under common
control (see above).
KCS ISSUES REDEEMABLE CUMULATIVE CONVERTIBLE PERPETUAL PREFERRED STOCK. On May
5, 2003, the Company completed the sale of $200 million of Redeemable Cumulative
Convertible Perpetual Preferred Stock with a liquidation preference of $500 per
share in a private offering. The convertible preferred stock offering was made
only by means of an offering memorandum pursuant to Rule 144A. Dividends on the
convertible preferred stock will be cumulative and will be payable quarterly at
an annual rate of 4.25% of the liquidation preference, when, as and if declared
by the Company's board of directors. Accumulated unpaid dividends will cumulate
dividends at the same rate as dividends cumulate on the convertible preferred
stock. Each share of the convertible preferred stock will be convertible, under
certain conditions, and subject to adjustment under certain conditions, into
33.4728 shares of the Company's common stock. On or after May 20, 2008, the
Company will have the option to redeem any or all of the preferred stock,
subject to certain conditions. Under certain circumstances, at the option of the
holders of the preferred stock, the Company may be required to purchase shares
of the convertible preferred stock from the holders. The convertible preferred
stock is redeemable at the option of a holder only in the event of a
"fundamental change," which is defined as "any transaction or event (whether by
means of an exchange offer, liquidation, tender offer, consolidation, merger,
combination, reclassification, recapitalization or otherwise) in connection with
which all or substantially all of the Company's common stock is exchanged for,
converted into, acquired for or constitutes solely the right to receive common
stock that is not listed on a United States national securities exchange or
approved for quotation on the Nasdaq National Market or similar system. The
practical effect of this provision is to limit the Company's ability to
eliminate a holder's ability to convert the convertible preferred stock into
common shares of a publicly traded security through a merger or consolidation
transaction. In no other circumstances is the Company potentially obligated to
redeem the convertible preferred stock for cash. Accordingly, since the Company
is in a position to control whether the Company experiences a "fundamental
change," the convertible preferred stock is classified as permanent equity
capital.
The net proceeds from the offering of the convertible preferred stock are
expected to be used to pay a portion of the purchase price for the proposed
acquisition of a controlling interest of Grupo TFM. On August, 1, 2003, KCS
submitted a Form S-3 Registration Statement to the SEC to register for resale by
the holders the convertible preferred stock and the common stock into which such
preferred stock may be converted. This registration statement is currently
pending review by the SEC. KCS will not receive any proceeds from the sale of
the securities under this registration statement.
RESULTS OF OPERATIONS
The following table summarizes the income statement components of the Company
for the three and six months ended June 30, 2003 and 2002, respectively, for use
in the analysis below. Certain prior period amounts have been reclassified to
conform to the current period presentation (IN MILLIONS):
Three Months Six Months
Ended June 30, Ended June 30,
--------------------- ----------------------
2003 2002 2003 2002
--------------------- ----------------------
Revenues $ 146.3 $ 139.2 $ 286.5 $ 283.1
Costs and expenses 132.1 124.7 265.5 255.2
---------- ---------- ---------- -----------
Operating income 14.2 14.5 21.0 27.9
Equity in net earnings (losses) of
unconsolidated affiliates (2.5) 11.7 4.5 16.6
Gain on sale of Mexrail, Inc. - - - 4.4
Interest expense (11.7) (10.5) (23.2) (21.8)
Debt retirement costs - (4.3) - (4.3)
Other income 1.5 4.4 2.8 8.8
---------- ---------- ---------- -----------
Income before income taxes and
cumulative effect of accounting
change 1.5 15.8 5.1 31.6
Income tax provision 2.0 1.3 0.9 5.4
--------------------- ---------- -----------
Income before cumulative effect
of accounting change (0.5) 14.5 4.2 26.2
Cumulative effect of accounting
change, net of income taxes - - 8.9 -
---------- ---------- ----------------------
Net income (loss) $ (0.5)$ 14.5 $ 13.1 $ 26.2
========== ========== ========== ===========
The following table summarizes consolidated KCS revenues, including the revenues
and carload statistics of KCSR, for the three and six months ended June 30, 2003
and 2002, respectively. Certain prior period amounts have been reclassified to
reflect changes in the business groups and to conform to the current period
presentation.
Carloads and
Revenues Intermodal Units
-------------------------------------------- -------------------------------------------
(IN MILLIONS) (IN THOUSANDS)
Three months Six months Three months Six months
ended June 30, ended June 30, ended June 30, ended June 30,
-------------------------------------------- --------------------- ---------------------
2003 2002 2003 2002 2003 2002 2003 2002
-------------------------------------------- --------------------- ---------------------
General commodities:
Chemical and petroleum $ 30.6 $ 33.8 $ 61.8 $ 65.7 34.3 37.8 70.3 73.7
Paper and forest 38.4 34.1 72.3 66.1 47.4 45.0 92.2 88.9
Agricultural and mineral 27.2 23.8 52.4 49.0 35.3 31.4 68.7 64.4
-------------------------------------------- --------------------- ---------------------
Total general commodities 96.2 91.7 186.5 180.8 117.0 114.2 231.2 227.0
Intermodal and automotive 14.9 15.9 28.4 30.8 77.9 74.2 149.7 143.7
Coal 22.1 21.5 46.3 50.3 45.7 46.6 92.9 105.1
-------------------------------------------- --------------------- ---------------------
Carload revenues and carload
and intermodal units 133.2 129.1 261.2 261.9 240.6 235.0 473.8 475.8
===================== =====================
Other rail-related revenues 11.4 8.4 22.2 17.5
--------------------------------------------
Total KCSR revenues 144.6 137.5 283.4 279.4
Other subsidiary revenues 1.7 1.7 3.1 3.7
--------------------------------------------
Total consolidated
revenues $ 146.3 $ 139.2 $ 286.5 $ 283.1
============================================
The following table summarizes KCS's consolidated costs and expenses for the
three and six months ended June 30, 2003 and 2002, respectively. Certain prior
period amounts have been reclassified to conform to the current year
presentation. (in millions)
Three Months Six Months
Ended June 30, Ended June 30,
---------------------- ----------------------
2003 2002 2003 2002
---------------------- ----------------------
Compensation and benefits $ 47.5 $ 46.5 $ 98.0 $ 95.9
Depreciation and amortization 16.0 14.6 31.9 29.5
Purchased services 15.2 13.9 30.3 27.9
Operating leases 14.2 13.8 28.5 27.3
Fuel 11.3 9.3 24.1 18.8
Casualties and insurance 8.4 7.2 16.5 15.1
Car hire 3.5 4.1 5.7 9.3
Other 16.0 15.3 30.5 31.4
---------------------- ----------------------
Total consolidated costs and
expenses $ 132.1 $ 124.7 $ 265.5 $ 255.2
====================== ======================
NET INCOME (LOSS). KCS recorded a net loss for the three months ended June 30,
2003 of $0.5 million (3(cents) per diluted share) compared to net income of
$14.5 million (23(cents) per diluted share) for the three months ended June 30,
2002. For the second quarter of 2003, KCS experienced a $7.1 million increase in
consolidated revenues and a $1.1 million improvement in the equity in losses of
other unconsolidated affiliates (PCRC and Southern Capital). However, a $15.3
million decrease in equity in earnings of Grupo TFM, a $7.4 million increase in
consolidated operating expenses, a $2.9 million decrease in other income, a $1.2
million increase in interest expense, and a $0.7 million increase in the
provision for income taxes contributed to a net loss for the quarter. This
quarter to quarter decrease in net income was also partially offset by debt
retirement costs of $4.3 million reported in the three months ended June 30,
2002. Because of the net loss experienced in the second quarter of 2003, 1.4
million shares related stock options were excluded from the earnings per share
calculation due to their antidilutive effects on diluted earnings per share.
Net income for the six months ended June 30, 2003 was $13.1 million (19(cents)
per diluted share) compared to $26.2 million (42(cents) per diluted share) for
the six months ended June 30, 2002. This $13.1 million decline in net income was
primarily the result of a $13.2 million decrease in equity in earnings of Grupo
TFM, a $10.3 million increase in consolidated operating expenses, a $6.0 million
decrease in other income, a $1.4 increase in interest expense as well as the
effect of the $4.4 million gain on the sale of Mexrail recorded in the six
months ended June 30, 2002. These factors, which led to a period to period
decrease in net income, were partially offset by a one-time benefit of $8.9
million (net of taxes of $5.6 million) reported during the six months ended June
30, 2003 relating to the cumulative effect of an accounting change, a $4.5
million decrease in the provision for income taxes, the effect of $4.3 million
in debt retirement costs reported in the six months ended June 30, 2002, a $3.4
million increase in consolidated revenues, and a $1.1 million improvement in the
equity in net losses of other unconsolidated affiliates (PCRC and Southern
Capital).
REVENUES. Consolidated revenues for the three and six months ended June 30, 2003
increased $7.1 million and $3.4 million to $146.3 million and $286.5 million,
respectively compared to $139.2 million and $283.1 million for the three and six
months ended June 30, 2002, respectively. During the second quarter of 2003,
KCSR experienced revenue growth in the majority of its commodity groups,
including coal, agricultural and mineral products, paper and forest products,
and intermodal traffic compared to the second quarter of 2002. These increases
were generally driven by increased production and customer demand, increased
consumption of certain goods, as well as increased import and export trade.
These increases were partially offset by revenue declines in certain chemical
and petroleum products as a result of continued high prices for petroleum and
natural gas, which has led to reduced production. Revenues for the second
quarter of 2003 include approximately $1.4 million related to reductions of
certain customer allowances and reserves. The revenue increase for the six
months ended June 30, 2003 resulted from similar trends noted during the second
quarter of 2003. The following discussion provides an analysis of KCSR revenues
by commodity group for the quarter and year to date ended June 30, 2003.
CHEMICAL AND PETROLEUM PRODUCTS. Revenues for chemical and petroleum
products for the three and six months ended June 30, 2003 continue to be
impacted by, among other factors, the sluggish U.S. economy and decreased $3.2
million (9.5%) and $3.9 million (5.9%), respectively, compared to the same
periods in 2002. For both the quarter and six months ended June 30, 2003, lower
revenues for agri-chemicals, organic products, petroleum and plastic products
were partially offset by improved revenues for gases and inorganic products.
Lower revenues for agri-chemicals for the three and six months ended June 30,
2003 were primarily the result of continued lower production by customers. These
decreases were partially offset by increased sulfuric acid and fertilizer
movements to Mexico. Lower petroleum product revenues for the three and six
months ended June 30, 2003 resulted from the continued weakness in the North
American economy as well as the adverse effects of high natural gas prices
(both a feedstock and a source of energy for producers)on petroleum production.
Plastics revenues declined for both the quarter and year to date ended June 30,
2003 compared to the same 2002 period due to the loss of a customer. Increases
in revenue for gases and inorganic products were primarily the result of
increased production by certain customers as well as increases in customer
demand. Chemical and petroleum products revenue accounted for 23.0% and 26.2% of
carload revenues for the three months ended June 30, 2003 and 2002,
respectively, and 23.7% and 25.1% of carload revenues for the six months ended
June 30, 2003 and 2002, respectively.
PAPER AND FOREST PRODUCTS. Revenues for paper and forest products for the
three and six months ended June 30, 2003 increased $4.3 million (12.6%) and $6.2
million (9.4%), respectively, compared to the same periods in 2002. For the
three months ended June 30, 2003, KCSR experienced higher revenues for pulp and
paper, scrap paper, pulpwood/logs/chips, lumber and plywood and military/other
carloads while metal and scrap product revenue was relatively flat. For the six
months ended June 30, 2003, higher revenues for pulp and paper, scrap paper,
pulpwood/logs/chips, lumber and plywood and metal/scrap product were partially
offset by decreases in military/other carloads. Increased revenues for pulp and
paper products as well as scrap paper primarily resulted from increases in
production by papermills, while increases in lumber and plywood products were
the result of continued improvements in the housing and homebuilding industry
due to strong housing starts. Increases in revenues for pulpwood/logs/chips for
the three and six-month periods ended June 30, 2003 resulted from higher
production by certain customers. Military and other carloads were relatively
flat quarter to quarter, but decreased $0.5 million for the six months ended
June 30, 2003 compared to the same period in 2002 as a result of certain
military training exercises, for which KCSR handles equipment transportation,
being cancelled due to the associated military buildup and deployment of troops
to the Middle East. Metal and scrap products revenue increased for the six
months ended June 30, 2003 as a result of increases in consumption as well as
increases in exports to Mexico. Paper and forest products revenue accounted for
28.8% and 26.4% of carload revenues for the three months ended June 30, 2003 and
2002, respectively, and 27.7% and 25.2% of carload revenues for the six months
ended June 30, 2003 and 2002, respectively.
AGRICULTURAL AND MINERAL PRODUCTS. Revenues for agricultural and mineral
products for the three and six months ended June 30, 2003 increased $3.4 million
(14.3%) and $3.4 million (6.9%), respectively, compared to the same periods in
2002. For the three and six months ended June 30, 2003, KCSR experienced revenue
growth for domestic grain products, export grain products, food products, ore
and mineral products as well as stone, clay and glass products. Revenue
increases for domestic grain products were primarily the result of a new
contract with an existing customer yielding longer hauls and therefore, an
increase in KCSR's related revenue. These increases were partially offset by the
effects of continued declines in poultry production, reducing the demand for
grain shipments to the Company's poultry producing customers. Increases in
revenues for export grain reflects higher volume of grain exports to Mexico. For
the three months ended June 30, 2003, export grain revenue growth was also
impacted by growth in the movement of Canadian wheat to Mexico. Increases in
revenues for food products were the result of a new contract with an existing
customer yielding increased carloads as well as longer hauls. Food product
revenues were also higher due to record beer shipments from Mexico into the
United States and Canada. Revenue increases for ores and minerals products were
the result of increased demand from producers. Agricultural and mineral products
revenue accounted for 20.4% and 18.4% of carload revenues for the three months
ended June 30, 2003 and 2002, respectively, and 20.0% and 18.7% of carload
revenues for the six months ended June 30, 2003 and 2002, respectively.
INTERMODAL AND AUTOMOTIVE. Intermodal and automotive revenues for the three
and six months ended June 30, 2003 declined $1.0 million (6.3%) and $2.4 million
(7.8%), respectively compared to the same periods in 2002. Automotive revenues
declined $1.4 million and $3.7 million, respectively, for the three and six
months ended June 30, 2003 compared to the same periods in 2002 as the loss of
certain Ford and General Motors traffic in the second quarter of 2002 was fully
realized in 2003. Revenue declines in automotive were also negatively impacted
by the effects of the sluggish economy on the automotive industry as a whole.
Automotive revenue losses were partially mitigated by the effect of revenues
associated with parts traffic obtained in the first quarter of 2003. Intermodal
revenues for the three and six months ended June 30, 2003 increased as a result
of increased intermodal traffic, associated with Norfolk Southern Railway
Company and CSX Corporation. Intermodal and automotive revenue accounted for
11.2% and 12.3% of carload revenues for the three months ended June 30, 2003 and
2002, respectively, and 10.9% and 11.8% of carload revenues for the six months
ended June 30, 2003 and 2002, respectively.
COAL. Coal revenues for the three months ended June 30, 2003 increased $0.6
million (2.8%) compared to the same period in 2002 while decreasing $4.0 million
(7.9%) for the six months ended June 30, 2003 compared to the same period in
2002. The quarter to quarter increase in coal revenues was primarily the result
of increased customer demand.
Additionally, revenue per-carload improved as a result of the use of aluminum
cars, which are capable of greater hauling capacity. These increases in revenue
were partially offset by reduced shipments to certain power generating stations
as a result of scheduled maintenance shutdowns. For the six months ended June
30, 2003, coal revenues decreased as a result of the loss of a coal customer in
April of 2002 as well as a decline in net tons shipped due to lower customer
demand. Coal revenues were also impacted by scheduled maintenance shutdowns in
2003, which where longer in duration compared to the same period in 2002. These
factors, which led to a reduction in coal revenues for the six months ended June
30, 2003, were partially offset by the effects of higher per-carload revenues as
discussed above. Coal revenue accounted for 16.6% and 16.7% of carload revenues
for the three months ended June 30, 2003 and 2002, respectively, and 17.7% and
19.2% of carload revenues for the six months ended June 30, 2003 and 2002,
respectively.
OTHER. Other rail related revenues for the three and six months ended June
30, 2003 increased $3.0 million and $4.7 million, respectively compared to the
same periods in 2002. These increases were primarily the result of higher
demurrage revenue of $0.8 million and $2.2 million, respectively, as well as
higher switching revenue of $0.4 million and $0.5 million, respectively, which
partially resulted from improved operating efficiencies associated with the
implementation of the Company's transportation operating platform, Management
Control System ("MCS") in third quarter 2002. Haulage revenue was relatively
flat for the three and six months ended June 30, 2003 compared to the same
periods in 2002.
COSTS AND EXPENSES. Consolidated costs and expenses for the three and six months
ended June 30, 2003 increased $7.4 million (5.9%) and $10.3 million (4.0%),
respectively, compared to the same periods in 2002. For the three months ended
June 30, 2003, this increase was the result of higher operating expenses at KCSR
of approximately $6.3 million as well as higher operating expenses at certain
other subsidiaries of $1.1 million. For the six months ended June 30, 2003, this
increase was the result of higher operating expenses at KCSR of approximately
$12.1 million, partially offset by lower operating expenses at certain other
subsidiaries of $1.8 million. Operating expenses for the three and six months
ended June 30, 2003 were most significantly impacted by increases in fuel costs.
See further discussion below for a more comprehensive discussion of operating
expenses.
COMPENSATION AND BENEFITS. Consolidated compensation and benefits expense
increased $1.0 million and $2.1 million, respectively for the three and six
months ended June 30, 2003 to $47.5 million and $98.0 million, respectively,
from $46.5 million and $95.9 million for the same periods in 2002. These
increases were primarily the result of an increase in certain union wage rates
as a result of the settlement of certain contracts in the third quarter of 2002,
higher health insurance related costs, and slightly higher crew starts on
increased traffic volumes but mitigated by more efficient train operations.
DEPRECIATION AND AMORTIZATION. Consolidated depreciation and amortization
expense was $16.0 million and $31.9 million for the three and six months ended
June 30, 2003, respectively, compared to $14.6 million and $29.5 million for the
three and six months ended June 30, 2002, respectively. The increase in
depreciation expense for both the quarter and year to date periods resulted
primarily from the implementation of MCS, which increased depreciation expense
for the three and six months ended June 30, 2003 by approximately $1.2 million
and $2.4 million, respectively.
PURCHASED SERVICES. Consolidated purchased services expense for the three
and six months ended June 30, 2003 increased $1.3 million and $2.4 million,
respectively, to $15.2 million and $30.3 million, respectively, compared to
$13.9 million and $27.9 million, respectively, for the same periods in 2002. For
both the quarter and year to date, these increases were primarily the result of
increased legal expenses related to the settlement of certain casualty claims as
well as additional lift fees incurred due to increased intermodal traffic and
higher car and locomotive repairs being performed by outside parties. Quarter to
quarter purchased services were also impacted by the effect of an insurance
recovery credit of approximately $1.8 million realized in the second quarter
of 2002.
OPERATING LEASES. Consolidated operating lease expense for the three and
six months ended June 30, 2003 increased $0.4 million and $1.2 million,
respectively, to $14.2 million and $28.5 million, respectively, from $13.8
million and $27.3 million, respectively, for the same periods in 2002. These
increases were partially related to the lease of maintenance vehicles and work
equipment, which in prior periods were owned by KCSR. These increases were
partially mitigated by reduced expense related to other equipment leases due to
better fleet utilization. Additionally, for the six months ended June 30, 2003,
operating leases increased partially as a result of the timing of the lease for
the Company's new corporate headquarters building. The Company began leasing
this facility in the second quarter of 2002.
FUEL. Consolidated fuel expense for the three and six months ended June 30,
2003 increased $2.0 million and $5.3 million, respectively, to $11.3 million and
$24.1 million, respectively, compared to $9.3 million and $18.8 million,
respectively, for the same periods in 2002. The $2.0 million quarter to quarter
increase was the result of a 24% increase in
the average price per gallon of fuel (adjusted for the effects of the Company's
fuel hedging program). This increase was partially mitigated by a 1.3% decrease
in fuel consumption. The $5.3 million year to date increase was the result of a
33% increase in the average price per gallon of fuel (adjusted for the effects
of the Company's fuel hedging program) partially mitigated by the effects of a
3.5% decrease in fuel consumption. Fuel cost represented approximately 8.6% and
9.1%, espectively, of consolidated costs and expenses for the three and six
months ended June 30, 2003 compared to 7.5% and 7.4%, respectively, for the same
periods in 2002.
CASUALTIES AND INSURANCE. Consolidated casualties and insurance expense for
the three and six months ended June 30, 2003 increased $1.2 million and $1.4
million, respectively, to $8.4 million and $16.5 million, respectively, compared
to $7.2 million and $15.1 million, respectively, for the same periods in 2002.
This increase was primarily the result of higher insurance costs, partially
offset by reduced personal injury, equipment damage and derailment expenses. On
a comparative basis, casualties and insurance expense for the three and six
months ended June 30, 2003 was also impacted by the effect of an insurance
recovery of $1.1 million in the second quarter of 2002.
CAR HIRE. Consolidated net car hire expense was $3.5 million and $5.7
million, respectively, for the three and six months ended June 30, 2003 compared
to $4.1 million and $9.3 million, respectively, for the same periods in 2002.
This decrease in net car hire expense for both the three and six-month periods
ended June 30, 2003 was the result of an increase in the number of KCSR freight
cars being used by other railroads due to improved fleet utilization associated
with the implementation of MCS. This decrease for both periods was partially
offset by the impact of an increase in the number of freight cars from other
railroads on the Company's rail line.
OTHER EXPENSES. Consolidated other expenses for the three months ended June
30, 2003 increased $0.7 million to $16.0 million from $15.3 million for the same
period in 2002. This increase was primarily the result of higher cost of sales
related to the Company's tie treating facility and an increase in other employee
related expenses. For the six months ended June 30, 2003, other expenses
decreased $0.9 million to $30.5 million from $31.4 million for the same period
in 2002, primarily due to lower materials and supplies expense.
OPERATING INCOME AND KCS OPERATING RATIO. Consolidated operating income for
the three months ended June 30, 2003 decreased $0.3 million to $14.2 million
from $14.5 million for the same period in 2002, resulting from a $7.4 million
increase in operating expenses partially offset by a $7.1 million increase in
revenue. For the six months ended June 30, 2003, consolidated operating income
decreased $6.9 million to $21.0 million from $27.9 million for the same period
in 2002. This decrease was the result of a $10.3 million increase in operating
expenses partially offset by a $3.4 million increase in revenues. For the three
months ended June 30, 2003 and 2002, the consolidated operating ratio for KCS
was 90.3% and 89.6%, respectively. For the six months ended June 30, 2003 and
2002, the consolidated operating ratio for KCS was 92.7% and 90.1%,
respectively.
INTEREST EXPENSE. Consolidated interest expense for the three and six months
ended June 30, 2003 increased $1.2 million and $1.4 million, respectively, to
$11.7 million and $23.2 million, respectively, from $10.5 million and $21.8
million, respectively, for the same periods in 2002. Interest expense rose in
each of these periods due to higher interest rates arising from a shift to more
fixed rate debt in June 2002, partially offset by the impact of lower debt
balances. Consolidated debt balances declined $14.9 million from $595.0 million
at June 30, 2002 to $580.1 million at June 30, 2003.
DEBT RETIREMENT COSTS. Net income for the three and six months ended June 30,
2002 includes debt retirement costs of $4.3 million related to the debt
refinancing during the second quarter of 2002.
OTHER INCOME. For the three and six months ended June 30, 2003 consolidated
other income decreased $2.9 million and $6.0 million, respectively, compared to
the same periods in 2002. These declines were primarily due to substantially
lower gains on the sale of non-operating property during the quarter and
year-to-date periods ended June 30, 2003 compared to the same 2002 periods.
Gains recorded on the sale of non-operating property were $3.5 million and $6.8
million for the three and six months ended June 30, 2002, respectively. During
the three and six months ended June 30, 2003, there were no significant gains on
the sale of non-operating property.
INCOME TAX EXPENSE. The consolidated income tax provision for the three months
ended June 30, 2003 was $2.0 million compared to $1.3 million for the same
period in 2002. This increase in the income tax provision was primarily the
result of the impact of debt retirement costs recorded in the second quarter of
2002 partially offset by lower domestic operating income, a decline in other
income and higher interest costs. For the six months ended June 30, 2003, the
consolidated income tax provision was $0.9 million compared to $5.4 million for
the same period in 2002. This decrease in the income tax provision was primarily
the result of reduced domestic operating income as well as the impact of the
gain on the sale of
Mexrail recorded in the six months ended June 30, 2002 and a decline in other
income for the six months ended June 30, 2003. This decrease was partially
offset by the impact of debt retirement costs recorded in the same period in
2002. Exclusive of equity earnings in Grupo TFM, the consolidated effective
income tax rate for the three and six months ended June 30, 2003 was
approximately 53% and 180% respectively, compared to 46% and 39%, respectively,
for the same periods in 2002. This variance in the effective tax rate was
primarily the result of changes in associated book/tax temporary differences,
the level of pre-tax income, and the impact of permanent book/tax differences on
the effective rate computation.
EQUITY IN NET EARNINGS (LOSSES) OF UNCONSOLIDATED AFFILIATES. For the three
months ended June 30, 2003, KCS recorded equity in net earnings (losses) of
unconsolidated affiliates of ($2.5) million compared to equity in net earnings
(losses) of unconsolidated affiliates of $11.7 million for the same period in
2002. This $14.2 million quarter to quarter decrease resulted primarily from a
$15.3 million decrease in equity in net earnings (losses) from Grupo TFM. Grupo
TFM's earnings for the second quarter of 2003 were adversely impacted by a $42.5
million increase in the U.S. GAAP deferred tax provision, which primarily
resulted from the strengthening of the Mexican peso compared to the United
States dollar during 2003 as well as lower future Mexican corporate tax rates.
These rate changes had the effect of reducing Grupo TFM's deferred tax asset,
thus increasing Grupo TFM's deferred tax provision. Grupo TFM's deferred tax
assets are the result of prior year net operating losses for income tax
purposes. For the three months ended June 30, 2003, revenues for Grupo TFM
declined approximately $9.7 million (5%) compared to the same period in 2002 due
partially to the weakening of the Mexican peso versus the United States dollar
on a year over year basis. Operating expenses for Grupo TFM for the three months
ended June 30, 2003 increased $11.2 million (12%) primarily as a result of an
$11.0 million increase in the deferred profit-sharing expense as well as a $4.0
million (33%) increase in fuel expense. The Company's equity in earnings
(losses) of Grupo TFM was also impacted by the Company's increased ownership of
Grupo TFM to 46.6% from 36.9%, which the Company obtained indirectly in July
2002 as a result of the purchase by TFM of the Mexican government's 24.6%
ownership of Grupo TFM. Interest expense for Grupo TFM increased approximately
$7.2 million for the three months ended June 30, 2003 compared to the same
period in 2002 primarily as a result of increased debt costs related to the
acquisition of the Mexican government's ownership of Grupo TFM.
For the six months ended June 30, 2003, KCS recorded equity in earnings of
unconsolidated affiliates of $4.5 million compared to $16.6 million for the same
period in 2002. This $12.1 million year to year decrease resulted primarily from
a $13.2 million decrease in equity in earnings from Grupo TFM. For the six
months ended June 30, 2003, Grupo TFM's earnings were adversely impacted by a
$24.8 million decrease in deferred income tax benefits as calculated under U.S.
GAAP. Also impacting Grupo TFM's earnings for the six months ended June 30, 2003
was a $12.0 million decrease in revenues as well as a $15.0 million increase in
operating expenses. Revenues for Grupo TFM were adversely affected by the
devaluation of the Mexican peso against the United States dollar on a year over
year basis which resulted in a reduction of revenues of approximately $21.9
million period to period, as well as a 23% decrease in automotive product
revenue related to lower North American automotive sales. The Company's equity
in earnings of Grupo TFM for the six months ended June 30, 2003 was also
affected by the Company's increased ownership percentsage of Grupo TFM. For the
six months ended June 30, 2003, interest expense for Grupo TFM increased
approximately $15.4 million compared to the same period in 2002 primarily as a
result of increased debt costs related to the acquisition of the Mexican
government's ownership of Grupo TFM.
The Company reports its equity in Grupo TFM under U.S. GAAP while Grupo TFM
reports under International Accounting Standards ("IAS"). Because the Company is
required to report its equity in earnings (losses) in Grupo TFM under U.S. GAAP
and Grupo TFM reports under IAS, differences in deferred income tax calculations
and the classification of certain operating expense categories occur.
For the three and six months ended June 30, 2003, equity in losses from other
unconsolidated affiliates was $0.2 million and $1.3 million, respectively,
compared to $1.3 million and $1.2 million for the three and six months ended
June 30, 2002, respectively. For the three and six months ended June 30, 2003,
losses from the operations of the PCRC were $1.5 million and $2.3 million
respectively, compared to $2.0 million and $3.8 million, respectively, for the
same periods in 2002. These losses were partially offset by earnings from
Southern Capital. For the three and six months ended June 30, 2003, earnings for
Southern Capital were $1.0 million and $2.0 million, respectively, compared to a
loss of $0.7 and net earnings of $1.2 million, respectively, for the same
periods in 2002. PCRC is currently not operating at full capacity due to delays
in the completion of expansion at the port of Balboa in Panama. Phase I of the
Balboa port expansion is expected to be completed near the end of 2003, at which
time the revenues of PCRC are anticipated to increase, which is expected to
improve the financial performance of PCRC.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE. The Company adopted the provisions of
Statement of Financial Accounting Standard ("SFAS 143") effective January 1,
2003. As a result, the Company changed its method of accounting for removal
costs of certain track structure assets and recorded a one-time benefit of $8.9
million (net of income taxes of $5.6 million) for the first quarter of 2003.
This change is reported as a cumulative effect of an accounting change in the
accompanying consolidated financial statements.
TRENDS AND OUTLOOK
For the second quarter and year to date ended June 30, 2003, consolidated
revenue for the Company increased compared to the same periods in 2002 as
certain commodity segments experienced revenue growth despite an economy that
has experienced only limited improvement within certain sectors. The Company's
consolidated operating expenses also increased during the quarter and
year-to-date periods ended June 30, 2003. As a result, the Company's operating
income for the second quarter and year to date ended June 30, 2003 was lower by
$0.3 million and $6.9 million, respectively, compared to the same periods in
2002. For both the second quarter and year to date, increases in the Company's
consolidated operating expenses were driven primarily by increases in fuel
costs, legal fees and increased insurance costs.
Equity in earnings from unconsolidated affiliates was significantly impacted by
reductions in earnings from Grupo TFM for both the quarter and year to date
ended June 30, 2003 due mostly to deferred income tax calculations under U.S.
GAAP related to the U.S. dollar/Mexican peso exchange rate as well as future
Mexican income tax rates. Also affecting earnings from Grupo TFM was a reduction
in revenues coupled with an increase in operating expenses for both the quarter
and year to date periods ended June 30, 2003. These factors, as well as an
increased ownership percentsage in Grupo TFM as a result of the purchase, by
TFM, of the Mexican government's 24.6% ownership of Grupo TFM led to a decrease
in equity in earnings (losses) from unconsolidated affiliates.
Additionally, for the year to date ended June 30, 2003, net income was favorably
affected by a one-time benefit of $8.9 million (net of income taxes of $5.6
million), related to the cumulative effect resulting from a required change in
the method of accounting for removal costs of certain railroad track structures.
These factors contributed to the Company's second quarter and year to date ended
June 30, 2003 diluted earnings per share, which decreased 113% and 55% to
(3(cents)) and 19(cents) per diluted share, respectively, from 23(cents) and
42(cents) per diluted share, respectively, for the same periods in 2002.
A current outlook for the Company's businesses for the remainder of 2003 is as
follows: (refer to the first paragraph of "Overview" section of this Item 2,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, regarding forward-looking comments)
For the second half of 2003, management will continue to focus on improving
domestic operations. As discussed in "Recent Developments - KCS and TMM Announce
Agreements Placing TFM, The Texas Mexican Railway Company, Gateway Eastern
Railway Company and The Kansas City Southern Railway Company Under Common
Control," management has announced a series of agreements that have been
approved by the respective boards of directors of the Company and Grupo TMM,
that will, following shareholder and regulatory approval, place KCSR, Tex-Mex,
Gateway Eastern, and TFM under the common control of a single transportation
holding company, NAFTA Rail, to be headquartered in Kansas City, Missouri.
Management expects common control of these three railroads, which are already
physically linked in an end-to-end configuration, to improve operating
efficiency and competition by giving shippers in the NAFTA trade corridor a
stronger transportation alternative.
Management expects overall KCSR revenues to increase slightly for the second
half of 2003 compared to the same period in 2002. Except as discussed herein,
assuming normalized rail operations, management expects KCSR's variable costs
and expenses to be proportionate with revenue activity. Fuel prices will
fluctuate subject to market conditions. To mitigate the market risk associated
with fuel, KCSR currently has approximately 19% of its remaining budgeted fuel
usage hedged for 2003 through purchase commitments as well as fuel swaps, both
of which reduce the risk of the adverse impact of rising fuel prices. Insurance
costs are expected to rise commensurate with market conditions.
The Company expects to continue to participate in the earnings/losses from its
equity investments in Grupo TFM, Southern Capital and PCRC. Due to the
variability of factors affecting the Mexican economy, management can make no
assurances as to the impact that a change in the value of the Mexican peso or a
change in Mexican inflation will have on the results of Grupo TFM. In addition,
upon consummation of the transactions to place KCSR, TFM and Tex-Mex under
common control, if it occurs, the Company expects to consolidate the results of
operations of TFM and Tex-Mex into its consolidated financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Summary cash flow data for the Company is as follows (IN MILLIONS):
Six Months
Ended June 30,
----------------------
2003 2002
---------- ----------
Cash flows provided by (used for):
Operating activities $ 46.9 $ 57.8
Investing activities (62.4) 6.0
Financing activities 188.4 (65.0)
---------- ----------
Cash and cash equivalents:
Net increase (decrease) 172.9 (1.2)
At beginning of year 19.0 24.7
---------- ----------
At end of period $ 191.9 $ 23.5
========== ==========
During the six months ended June 30, 2003, the Company's consolidated cash
position increased $172.9 million from December 31, 2002, primarily as a result
of the issuance of preferred stock, operating cash inflows, proceeds from the
disposal of property and the proceeds from employee stock plans. These increases
were partially offset by investments in affiliates, debt repayments, property
acquisitions and to pay a portion of the investment in Mexrail. Net operating
cash inflows were $46.9 million and $57.8 million for the six months ended June
30, 2003 and 2002, respectively. The $10.9 million decrease in operating cash
flows was primarily attributable to changes in working capital balances,
resulting mainly from the timing of payments and receipts, partially offset by
net income as adjusted for non-cash items.
Net investing cash inflows (outflows) were ($62.4) million and $6.0 million for
the six months ended June 30, 2003 and 2002, respectively. This $68.4 million
decrease was primarily a result of proceeds received from the sale of Mexrail of
$31.4 million during the first quarter of 2002 and by a $32.7 million investment
to purchase 51% of Mexrail during the second quarter of 2003. Additionally,
proceeds from the sale of property for the six months ended June 30, 2003 were
$8.4 million less than for the same period in 2002. These factors, which led to
a decrease in net investing cash flows, were partially offset by a $6.5 million
decline in cash outflows for capital expenditures for the six months ended June
30, 2003.
Net financing cash inflows for the first six months of 2003 were $188.4 million
compared to net financing cash outflows of $65.0 million for the first six
months of 2002. This difference was primarily due to the issuance of preferred
stock of $193.2 during the second quarter of 2003 as well as net repayments of
long-term debt of $63.4 million during the first six months of 2002 compared to
net repayments of long-term debt of $2.5 million during the first six months of
2003.
Management expects cash flows from operations to be positive throughout the
remainder of 2003 as a result of operating income, which has historically
resulted in positive operating cash flows. Investing activities are projected to
use significant amounts of cash for capital expenditures and investments in
subsidiaries pending regulatory approval of the acquisition of Grupo TMM's
interest in Grupo TFM. Future roadway improvement projects will continue to be
primarily funded by operating cash flows or, secondarily, through borrowings
under the Company's line of credit.
The Company's consolidated ratio of debt to total capitalization was 37.5% and
43.6% at June 30, 2003 and December 31, 2002, respectively. The Company's debt
decreased $2.5 million from $582.6 million at December 31, 2002 to $580.1
million at June 30, 2003 as a result of net repayments of long-term debt. This
decrease in debt was coupled with an increase in the Company's stockholders'
equity of $212.0 million to $964.9 million at June 30, 2003. This increase was
due primarily to the issuance of preferred stock of $193.2 million, net income
of $13.1 million and the issuance of common stock under employee stock plans.
In addition to operating cash flows, the Company has financing available under a
senior secured revolving credit facility ("Credit Facility") with a maximum
borrowing amount of $100 million. As of June 30, 2003, all $100 million was
available under the Credit Facility. The Amended and Restated Credit Agreement
contains, among other provisions, various financial covenants. As a result of
certain financial covenants contained in the Amended and Restated Credit
Agreement, maximum utilization of the Company's Credit Facility may be
restricted.
On May 5, 2003, the Company issued $200 million of Redeemable Cumulative
Convertible Perpetual Preferred Stock with a liquidation preference of $500 per
share in a private offering. The net proceeds from the offering of the
convertible preferred stock are expected to be used to pay a portion of the
purchase price for the proposed acquisition of a controlling interest of Grupo
TFM. On August, 1, 2003, KCS submitted a Form S-3 Registration Statement to the
SEC to register for resale by the holders the convertible preferred stock and
the common stock into which such preferred stock may be
converted. This registration statement is currently pending review by the SEC.
KCS will not receive any proceeds from the sale of the securities under this
registration statement. If the acquisition of the controlling interest of Grupo
TFM were not completed, the Company would explore alternative uses of the cash
receipts realized from the issuance of the Redeemable Cumulative Convertible
Perpetual Preferred Stock in the private offering.
The Company filed a Universal Shelf Registration Statement on Form S-3 ("Initial
Shelf" - Registration No. 33-69648) in September 1993, as amended in April 1996,
for the offering of up to $500 million in aggregate amount of securities. The
SEC declared the Initial Shelf effective on April 22, 1996; however, no
securities have been issued thereunder. The Company has carried forward $200
million aggregate amount of unsold securities from the Initial Shelf to a Shelf
Registration Statement filed on Form S-3 ("Second Shelf" - Registration No.
333-61006) on May 16, 2001 for the offering of up to $450 million in aggregate
amount of securities. The SEC declared the Second Shelf effective on June 5,
2001. Securities in the aggregate amount of $300 million remain available under
the Initial Shelf and securities in the aggregate amount of $450 million remain
available under the Second Shelf. To date, no securities have been issued under
either the Initial Shelf or Second Shelf.
As discussed in the 2002 Form 10-K, if on October 31, 2003, the Mexican
Government has not sold all of its capital stock in TFM, Grupo TFM is obligated
to purchase the capital stock at the initial share price paid by Grupo TFM,
adjusted for Mexican inflation and changes in the U.S. Dollar/Mexican Peso
exchange rate. Should Grupo TFM fail to purchase the interest within 60 days of
notification by the Mexican Government of its obligation to buy, then Grupo TMM
and KCS, or either Grupo TMM or KCS, could be required to purchase their
respective portion, or all, as applicable, of the Mexican Government's interest
in TFM within 60 days following written notification to Grupo TMM and KCS, or
either Grupo TMM or KCS, of its or their obligation to purchase. In addition, if
the Mexican Government's interest in TFM has not been purchased prior to the
closure of the proposed NAFTA Rail transaction contemplated by the Acquisition
Agreement, KCS shall, as a condition precedent to, and contemporaneous with, the
closure of such transaction, enter into an agreement under which KCS shall
assume and discharge Grupo TMM's obligation to purchase the Mexican Government's
interest in TFM. If KCS and Grupo TMM, or either KCS or Grupo TMM alone had been
required to purchase the Mexican Government's 20% interest in TFM, the total
purchase price would have been approximately $490 million as of June 30, 2003.
Based upon public disclosures made by Grupo TMM, they are not in a position to
make this purchase. The Company is exploring various alternatives for financing
the acquisition of the Mexican Government's interest in TFM. It is anticipated
that this financing, if necessary, can be accomplished using the Company's
ability to access the capital markets. No commitments for such financing have
been obtained at this time. As discussed in "Recent Developments - Kansas City
Southern Receives Approval of Amendment of Credit Agreement," more than 96% of
the Company's lenders amended the Company's Amended and Restated Credit
Agreement dated June 12, 2002. The Company requested the amendment to existing
financial covenants in its Amended and Restated Credit Agreement in order to
provide flexibility in structuring the funding for the transaction to acquire
the Mexican Government's interest in TFM. The Company sought this amendment in
order to maintain its cash position while analyzing financing alternatives. On
April 28, 2003, the Company entered into a second amendment to its Amended and
Restated Credit Agreement under which 93% of the lenders specifically approved
the Company's investment in further equity interests of Grupo TFM, in equity
interests representing 51% of Mexrail's issued and outstanding capital stock and
the use of the Company's cash to acquire Mexrail, in connection with the
proposed NAFTA Rail transaction to place KCSR, Tex-Mex and TFM under common
control.
The Company believes, based on current expectations, that its cash and other
liquid assets, operating cash flows, access to capital markets, borrowing
capacity, and other available financing resources are sufficient to fund
anticipated operating, capital and debt service requirements and other
commitments through 2003. However, the Company's operating cash flows and
financing alternatives can be impacted by various factors, some of which are
outside of the Company's control. For example, if the Company were to experience
a substantial reduction in revenues or a substantial increase in operating costs
or other liabilities, its operating cash flows could be significantly reduced.
Additionally, the Company is subject to economic factors surrounding capital
markets and the Company's ability to obtain financing under reasonable terms is
subject to market conditions. Further, the Company's cost of debt relative to
potential future debt financing transactions could be impacted by independent
rating agencies, which assign debt ratings based on certain credit measurements
such as interest coverage and leverage ratios.
OTHER
NEW ACCOUNTING PRONOUNCEMENTS. In June 2001, the FASB issued Statement No. 143,
"Accounting for Asset Retirement Obligations". SFAS 143 is effective for fiscal
years beginning after June 15, 2002. Under SFAS 143, the fair value of a
liability for an asset retirement obligation must be recognized in the period in
which it is incurred if a reasonable estimate of the fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. KCSR, along with other Class I railroads, depreciates
track structure (rail, ties, and other track material) in accordance with
regulations promulgated by the STB. These regulations require KCSR to depreciate
track structure to a net salvage value (gross estimated salvage value less
estimated costs to remove the track structure at the end of its useful life).
For certain track structure such as ties, with little or no gross salvage value,
this practice ultimately results in depreciating an asset below zero, and thus,
in effect, results in a liability. Under the requirements of SFAS 143, in the
absence of a legal obligation to remove the track structure, such accounting
practice is prohibited. The Company adopted the provisions of SFAS 143 in the
first quarter of 2003, and, as a result, reviewed its depreciation of track
structures to determine instances where the depreciation of removal costs has
resulted or would be expected (based on the current depreciation rate) to result
in the depreciation of an asset below zero when considering net salvage value.
As a result of this review, the Company estimated the excess depreciation
recorded on such assets and recorded this amount as a reduction in accumulated
depreciation of $14.5 million and as a cumulative effect of an accounting change
of $8.9 million (net of taxes of $5.6 million) as required by SFAS 143 in the
first quarter of 2003. Additionally, depreciation rates applied to certain track
structure elements that were previously yielding a negative salvage value have
been modified to comply with the provisions of SFAS 143. For the six months
ended June 30, 2003, this resulted in a decrease in depreciation expense of
approximately $0.7 million. Management currently estimates the net effect of the
adoption of SFAS 143 on full year depreciation expense to be approximately $1.4
million.
In December 2002, the FASB issued Statement No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123" ("SFAS 148"). SFAS 148 provides two additional transition methods for
entities that adopt the method of accounting for stock-based compensation as
defined in FASB Statement No. 123. Additionally, the statement amends the
disclosure requirements of SFAS 123 to require disclosures in interim financial
statements regarding the method of accounting for stock-based employee
compensation and the effect of the method on results of operations. The Company
is currently evaluating the provisions of SFAS 148 and does not expect this
pronouncement, if adopted, to have a material impact on its consolidated results
of operations, financial position, or cash flows.
In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of
Variable Interest Entities," ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to
certain variable interest entities created after January 31, 2003 as well as
certain entities created prior to this date. The Company is required to adopt
this interpretation in the third quarter of 2003. The Company has performed an
initial assessment of its equity method investment in Southern Capital for any
potential impact this interpretation may have on its accounting for Southern
Capital as an equity investment. The Company anticipates that FIN 46 will have
no impact on the Company's accounting for its investment in Southern Capital
since, at inception, SCC had sufficient funding and capital to absorb any
expected losses.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
There have been no significant changes in the Company's Quantitative and
Qualitative Disclosures About Market Risk from that previously reported in the
Annual Report on Form 10-K for the year ended December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer have reviewed
and evaluated the effectiveness of the Company's disclosure controls and
procedures (as defined in Rules 13a-15(c) and 15d-15(c) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")), as of the end of the
period covered by this Quarterly Report on Form 10-Q. Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer have concluded that the
Company's current disclosure controls and procedures are effective to ensure
that information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission rules and forms, and include controls and procedures designed to
ensure that information required to be disclosed by the Company in such reports
is accumulated and
communicated to the Company's management, including the Chief Executive Officer
and Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure.
There has been no change in the Company's internal control over financial
reporting that occurred during the fiscal quarter for which this quarterly
report on Form 10-Q is filed that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Part I, Item 1. Financial Statements, note 9 to the Consolidated Financial
Statements of this Form 10-Q is hereby incorporated herein by reference.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On May 5, 2003, the Company completed the sale of $200 million (400,000 shares)
of 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C,
with a liquidation preference of $500 per share in a private offering under Rule
144A to qualified institutional buyers. Net proceeds to the Company were $193
million after discounts to the initial purchasers of $7 million and other
expenses of the offering. Dividends on the convertible preferred stock will be
cumulative and will be payable quarterly at an annual rate of 4.25% of the
liquidation preference, when, as and if declared by the Company's board of
directors. Accumulated unpaid dividends will cumulate dividends at the same rate
as dividends cumulate on the convertible preferred stock. Each share of the
convertible preferred stock will be convertible, under certain conditions, and
subject to adjustment under certain conditions, into 33.4728 shares of the
Company's common stock. Conversion rights arise only upon the occurrence of the
following: (i) the closing sale price of the Company common stock exceeds a
specified level for a specified period; (ii) upon certain credit rating
downgrades; (iii) upon the convertible preferred stock trading below a certain
level for a specified period; (iv) upon notice of redemption; and (v) upon the
occurrence of certain corporate transactions. On or after May 20, 2008, the
Company will have the option to redeem any or all of the preferred stock,
subject to certain conditions. Under certain circumstances, at the option of the
holders of the preferred stock, the Company may be required to purchase shares
of the convertible preferred stock from the holders. The net proceeds from the
offering of the convertible preferred stock are expected to be used to pay a
portion of the purchase price for the proposed acquisition of a controlling
interest of Grupo TFM.
On August, 1, 2003, KCS submitted a Form S-3 Registration Statement to the SEC
to register for resale by the holders the convertible preferred stock and the
common stock into which such preferred stock may be converted. This registration
statement is currently pending review by the SEC. KCS will not receive any
proceeds from the sale of the securities under this registration statement.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit 4 Registration Rights Agreement dated May 5, 2003 among KCS, Morgan
Stanly & Co. Incorporated and Deutsche Bank Securities Inc.,
which is attached as Exhibit 4.5 to the Company's Registration
Statement on Form S-3 (Registration No. 333-107573) filed on
August 1, 2003, is hereby incorporated by reference as Exhibit 4.
Exhibit 10 Placement Agreement, dated April 29, 2003, by and among Kansas
City Southern and Morgan Stanley & Co. Incorporated and Deutsche
Bank Securities Inc., as the initial purchasers of the Company's
4.25% Redeemable Cumulative Convertible Perpetual Preferred
Stock, Series C
Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
Exhibit 32 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on April 7, 2003, under
Item 5 of such form, announcing that more than 96 percents of the lenders
under its Amended and Restated Credit Agreement approved the Company's
request for waiver of the financial covenants under the agreement.
The Company furnished a Current Report on Form 8-K on April 8, 2003
announcing its first quarter 2003 meeting, conference call. The
information included in this Current Report on Form 8-K was furnished
pursuant to Item 9 and shall not be deemed to be filed.
The Company filed a Current Report on Form 8-K on April 22, 2003, under
Item 5 of such form, announcing a series of agreements that have been
approved by their respective boards of directors of the Company and Grupo
TMM, S.A., that will, following shareholder and regulatory approval, place
The Kansas City Southern Railway Company, the Texas Mexican Railway
Company, and TFM, S.A., de C.V. under the common control of a single
transportation holding company, NAFTA Rail, to be headquartered in Kansas
City, Missouri. As part of the transaction, KCS will change its name to
NAFTA Rail, which will trade on the New York Stock Exchange.
The Company filed a Current Report on Form 8-K on May 1, 2003, under Item
5 of such form, announcing the company's intent to sell shares of
Redeemable Cumulative Convertible Perpetual Preferred Stock in a private
offering. On April 30, 2003, KCS announced it had entered into an
agreement, subject to standard closing conditions, to sell $175 million of
Redeemable Cumulative Convertible Perpetual Preferred Stock in a private
offering pursuant to Rule 144A. In addition, the Company granted the
initial purchasers an option to purchase up to an additional $25 million
of the preferred stock.
The Company furnished a Current Report on Form 8-K on May 1, 2003
reporting its first quarter 2003 operating results. The information
included in this Current Report on Form 8-K was furnished pursuant to Item
9 and Item 12 and shall not be deemed to be filed.
The Company furnished a Current Report on Form 8-K on May 2, 2003
reporting information included in its private offering memorandum under
Rule 144A. The securities offered in such private placement were not
registered under the Securities Act of 1933, as amended, and may not be
offered or sold in the United States absent registration or an applicable
exemption from registration requirements. The information furnished under
this Item 9 did not constitute an offer to sell, or the solicitation of an
offer to buy, any security. The information included in this Current
Report on Form 8-K was furnished pursuant to Item 9 and shall not be
deemed to be filed.
The Company filed a Current Report on Form 8-K on May 5, 2003, under Item
5 of such form, announcing ratings by certain rating agencies of its
Redeemable Cumulative Convertible Perpetual Preferred Stock private
offering. Additionally, the Company announced under the same Item 5 of
such form, that the initial purchasers in the Redeemable Cumulative
Convertible Perpetual Preferred Stock private offering exercised their
option to purchase an additional $25 million of such preferred stock.
The Company filed a Current Report on Form 8-K on June 26, 2003, under
Item 5 of such form, announcing that it had received formal written notice
that Mexico's Competition Commission had approved the proposed NAFTA Rail
transaction.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized and in the capacities indicated on August 13, 2003.
Kansas City Southern
/S/ RONALD G. RUSS
----------------------------------------------------
Ronald G. Russ
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
/S/ LOUIS G. VAN HORN
----------------------------------------------------
Louis G. Van Horn
Vice President and Comptroller
(Principal Accounting Officer)