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, 2004
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, 2004
- --------------------------------------------------------------------------------
Common Stock, $.01 per share par value 62,674,383 Shares
- --------------------------------------------------------------------------------
KANSAS CITY SOUTHERN
FORM 10-Q
JUNE 30, 2004
INDEX
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Introductory Comments 2
Consolidated Balance Sheets -
June 30, 2004 and December 31, 2003 3
Consolidated Statements of Income -
Three and Six Months Ended June 30, 2004 and 2003 4
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2004 and 2003 5
Consolidated Statement of Changes in Stockholders' Equity -
Six Months Ended June 30, 2004 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Item 4. Controls and Procedures 26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES 28
- ----------
KANSAS CITY SOUTHERN
FORM 10-Q
JUNE 30, 2004
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. 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, 2003 and Management's Discussion and Analysis of Financial Condition and
Results of Operations included in this Form 10-Q. Results for the three and six
months ended June 30, 2004 are not necessarily indicative of the results
expected for the full year 2004.
KANSAS CITY SOUTHERN
CONSOLIDATED BALANCE SHEETS
(Dollars in millions, except share amounts)
June 30, December 31,
2004 2003
------------------ ------------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 156.5 $ 135.4
Accounts receivable, net 103.7 108.2
Accounts receivable from related parties 10.7 6.4
Inventories 44.7 36.8
Other current assets 25.9 21.3
------------------ ------------------
Total current assets 341.5 308.1
------------------ ------------------
Investments 446.8 442.7
Properties (net of $738.6 and $734.3 accumulated
depreciation and amortization, respectively) 1,401.6 1,362.5
Goodwill 10.6 10.6
Other assets 31.4 29.0
------------------ ------------------
Total assets $ 2,231.9 $ 2,152.9
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt due within one year $ 8.8 $ 9.9
Accounts and wages payable 50.7 45.5
Accrued liabilities 124.1 119.4
------------------ ------------------
Total current liabilities 183.6 174.8
------------------ ------------------
Other Liabilities
Long-term debt 563.9 513.5
Deferred income taxes 397.2 391.5
Other noncurrent liabilities and deferred credits 109.1 109.4
------------------ ------------------
Total other liabilities 1,070.2 1,014.4
------------------ ------------------
Stockholders' Equity:
$25 par, 4% noncumulative, Preferred stock, 840,000
shares authorized, 649,736 shares issued, 242,170
shares outstanding 6.1 6.1
$1 par, Cumulative Preferred stock, 400,000 shares
authorized, issued and outstanding at June 30, 2004
and December 31, 2003 0.4 0.4
$.01 par, Common stock, 400,000,000 shares authorized;
73,369,116 shares issued; 62,674,103 and 62,175,621
shares outstanding at June 30, 2004 and December 31,
2003, respectively 0.6 0.6
Paid in capital 115.9 110.9
Retained earnings 854.4 846.2
Accumulated other comprehensive income (loss) 0.7 (0.5)
------------------ ------------------
Total stockholders' equity 978.1 963.7
------------------ ------------------
Total liabilities and stockholders' equity $ 2,231.9 $ 2,152.9
================== ==================
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in millions, except share and per share data)
(Unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
----------------------------------- ----------------------------------
2004 2003 2004 2003
----------------- ----------------- ---------------- -----------------
Revenues $ 153.9 $ 146.3 $ 301.7 $ 286.5
Operating expenses
Compensation and benefits 52.2 47.5 103.0 98.0
Purchased services 15.4 15.2 31.0 30.3
Fuel 14.6 11.3 29.4 24.1
Equipment costs 11.6 15.4 24.6 29.4
Depreciation and amortization 13.1 16.0 25.9 31.9
Casualties and insurance 10.9 8.4 16.6 16.5
Other leases 3.0 2.3 5.7 4.8
Other 13.6 16.0 28.6 30.5
----------------- ----------------- ---------------- -----------------
Total operating expenses 134.4 132.1 264.8 265.5
----------------- ----------------- ---------------- -----------------
Operating income 19.5 14.2 36.9 21.0
Equity in net earnings of unconsolidated affiliates:
Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. 2.9 (2.3) 4.2 4.6
Other 0.3 (0.2) 0.4 (0.1)
Interest expense (10.9) (11.7) (21.7) (23.2)
Debt retirement costs - - (4.2) -
Other income 1.7 1.5 3.2 2.8
----------------- ----------------- ---------------- -----------------
Income before income taxes and cumulative effect of
accounting change 13.5 1.5 18.8 5.1
Income tax provision 4.3 2.0 6.2 0.9
----------------- ----------------- ---------------- -----------------
Income (loss) before cumulative effect of accounting change 9.2 (0.5) 12.6 4.2
Cumulative effect of accounting change, net of income taxes - - - 8.9
----------------- ----------------- ---------------- -----------------
Net income (loss) $ 9.2 $ (0.5) $ 12.6 $ 13.1
Preferred stock dividends 2.2 1.3 4.4 1.4
----------------- ----------------- ---------------- -----------------
Net income (loss) available to Common shareholders $ 7.0 $ (1.8) $ 8.2 $ 11.7
================= ================= ================ =================
Per Share Data
Basic earnings per Common share
Income (loss) before cumulative effect
of accounting change $ 0.11 $ (0.03) $ 0.13 $ 0.05
Cumulative effect of accounting change,
net of income taxes - - - 0.14
----------------- ----------------- ---------------- -----------------
Total basic earnings (loss) per Common share $ 0.11 $ (0.03) $ 0.13 $ 0.19
================= ================= ================ =================
Diluted earnings per Common share
Income (loss) before cumulative effect
of accounting change $ 0.11 $ (0.03) $ 0.13 $ 0.05
Cumulative effect of accounting change,
net of income taxes - - - 0.14
----------------- ----------------- ---------------- -----------------
Total diluted earnings (loss) per Common share $ 0.11 $ (0.03) $ 0.13 $ 0.19
================= ================= ================ =================
Weighted average Common shares outstanding (in thousands)
Basic 62,655 61,649 62,570 61,525
Potential dilutive Common shares 1,175 - 1,242 1,397
----------------- ----------------- ---------------- -----------------
Diluted 63,830 61,649 63,812 62,922
================= ================= ================ =================
See accompanying notes to consolidated financial statements.
KANSAS CITY SOUTHERN
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in millions)
(Unaudited)
Six Months
Ended June 30,
---------------------------------------
2004 2003
------------------ ------------------
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income $ 12.6 $ 13.1
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 25.9 31.9
Deferred income taxes 3.3 7.1
Equity in undistributed earnings of unconsolidated affiliates (4.6) (4.5)
Distributions from unconsolidated affiliates 8.8 -
Gain on sale of property (0.7) (1.8)
Cumulative effect of accounting change - (8.9)
Tax benefit realized upon exercise of stock options 0.9 0.9
Changes in working capital items:
Accounts receivable 0.2 1.8
Inventories (7.9) (1.4)
Other current assets (1.2) 4.0
Accounts and wages payable 4.9 (12.2)
Accrued liabilities 6.1 15.6
Other, net 2.0 (5.2)
------------------ ------------------
Net cash provided by operating activities 50.3 40.4
------------------ ------------------
INVESTING ACTIVITIES:
Property additions (66.3) (30.4)
Proceeds from disposal of property 1.9 7.7
Investment in and loans to affiliates (4.8) (32.8)
Other, net (5.0) (4.7)
------------------ ------------------
Net cash used for investing activities (74.2) (60.2)
------------------ ------------------
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 150.0 -
Repayment of long-term debt (100.6) (2.5)
Issuance of preferred stock, net - 193.2
Debt issuance costs (2.9) -
Proceeds from stock plans 2.9 2.1
Cash dividends paid (4.4) (0.1)
------------------ ------------------
Net cash provided by financing activities 45.0 192.7
------------------ ------------------
CASH AND CASH EQUIVALENTS:
Net increase in cash and cash equivalents 21.1 172.9
At beginning of year 135.4 19.0
------------------ ------------------
At end of period $ 156.5 $ 191.9
================== ==================
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 (Loss) Total
---------------------------------------------------------------------------------------------
Balance at December 31, 2003 $ 6.1 $ 0.4 $ 0.6 $ 110.9 $ 846.2 $ (0.5) $ 963.7
Comprehensive income:
Net income 12.6
Change in fair value of cash flow hedges 1.0
Amortization of accumulated other
comprehensive income (loss)
related to interest rate swaps 0.2
Comprehensive income 13.8
Dividends on $25 Par
Preferred Stock ($0.50/share) (0.1) (0.1)
Dividends on $1 Par Cumulative Preferred
Stock ($10.63/share) (4.3) (4.3)
Options exercised and stock subscribed 2.6 2.6
Stock plan shares issued from treasury 2.4 2.4
--------------------------------------------------------------------------------------------
Balance at June 30, 2004 $ 6.1 $ 0.4 $ 0.6 $ 115.9 $ 854.4 $ 0.7 $ 978.1
============================================================================================
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 recurring
adjustments) necessary to present fairly the financial position of the
Company and its subsidiary companies as of June 30, 2004 and December 31,
2003, the results of its operations for the three and six months ended June
30, 2004 and 2003, its cash flows for the six months ended June 30, 2004
and 2003, and its changes in stockholders' equity for the six months ended
June 30, 2004. 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, 2003. The results of
operations for the three and six month periods ended June 30, 2004 are not
necessarily indicative of the results to be expected for the full year
2004. For information regarding the Company's critical accounting policies
and estimates, please see Item 7 of the Company's Annual Report on Form
10-K "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Critical Accounting Policies and Estimates."
Certain prior year amounts have been reclassified to conform to the current
year presentation.
For the six months ended June 30, 2004, depreciation expense reflects the
results of a study performed by engineering consultants for the Company.
This study yielded longer estimates of depreciable lives, as well as higher
estimates of salvage values, based upon actual experience since the
previous study performed in 1999. The net impact of the application of
these new estimates is a decrease in depreciation expense for the six
months ended June 30, 2004 of approximately $6.4 million.
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 were converted into common stock or stock options were
exercised. The following is a reconciliation from the weighted average
shares used for the basic earnings per share computation to the shares used
for the diluted earnings per share computation for the three and six months
ended June 30, 2004 and 2003, respectively (in thousands):
Three Months Six Months
Ended June 30, Ended June 30,
--------------------------------- --------------------------------
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Basic shares 62,655 61,649 62,570 61,525
Effect of dilution: Stock options 1,175 - 1,242 1,397
Effect of dilution: Convertible preferred stock - - - -
--------------- --------------- --------------- ---------------
Diluted shares 63,830 61,649 63,812 62,922
=============== =============== =============== ===============
Shares excluded from diluted computation 14,000 11,325 14,000 5,503
--------------- --------------- --------------- ---------------
For the periods presented, shares related to the convertible preferred
stock were excluded from the computation of diluted earnings per share
because the inclusion of these shares would have been antidilutive to
earnings per share. Additionally, for each of the three and six month
periods ended June 30, 2004, 611 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 common
shares. 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 common shares. For the three months ended June 30, 2003, no
potentially dilutive shares were included in the computation due to the
antidilutive effect as a result of the net loss for the period.
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, 2004 include, among others, equity
interests in Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V.
("Grupo TFM"), Southern Capital Corporation, LLC ("Southern Capital"), and
the Panama Canal Railway Company ("PCRC").
The Company is party to certain agreements with Grupo TMM, S.A. ("Grupo
TMM") covering the joint ownership of Grupo TFM. These agreements contain
"change in control" provisions, provisions intended to preserve the
Company's and Grupo TMM's proportionate ownership of the joint venture, and
super-majority provisions with respect to voting on certain significant
transactions. Such agreements also provide a right of first refusal in the
event that either party initiates a divestiture of its equity interest in
Grupo TFM and a prohibition on transfers to competitors. Under certain
circumstances, such agreements could affect the Company's ownership
percentage and rights in these equity affiliates.
On April 20, 2003, the Company entered into an agreement with Grupo TMM and
other parties (the "Acquisition Agreement"), under which KCS ultimately
would acquire control of TFM, S.A., de C.V. ("TFM") through the purchase of
shares of common stock of Grupo TFM (the "Acquisition"). Grupo TFM holds an
80% economic interest in TFM and all of the shares of stock with full
voting rights of TFM. The remaining 20% economic interest in TFM is owned
by the Mexican government in the form of shares with limited voting rights.
KCS currently owns a 46.6% economic interest in Grupo TFM and 49.0% of the
shares of common stock of Grupo TFM entitled to full voting rights. The
Acquisition Agreement and other related agreements were designed to,
following KCS shareholder approval and regulatory approval, place The
Kansas City Southern Railway Company ("KCSR"), The Texas-Mexican Railway
Company ("Tex-Mex"), Gateway Eastern Railway Company ("Gateway Eastern")
and TFM, under the common control of a single transportation holding
company, NAFTA Rail, to be headquartered in Kansas City, Missouri. As part
of the Acquisition, subject to KCS shareholder approval, KCS is expected to
change its name to NAFTA Rail. For additional information regarding the
Acquisition Agreement, see Note 3 in the Notes to the Financial Statements
contained within Item 8 of the Company's Annual Report on Form 10-K for the
year ended December 31, 2003.
On August 18, 2003, Grupo TMM shareholders voted not to approve the sale of
Grupo TMM's interests in Grupo TFM to KCS. On August 23, 2003, Grupo TMM
sent a notice to KCS claiming to terminate the Acquisition Agreement
because the Grupo TMM shareholders had failed to approve the Acquisition
Agreement.
The March 19, 2004 Interim Award of the AAA International Centre for
Dispute Resolution Arbitration Panel found that the Acquisition Agreement
remains in full force and effect, until otherwise terminated according to
its terms or by law. Following that decision, the Company and Grupo TMM
agreed not to move immediately into the next phase of arbitration, but both
companies have reserved the right to proceed with the next phase of
arbitration at any time. In a stipulation signed by Grupo TMM and KCS and
accepted by the arbitration panel, the two companies have agreed to
discharge in good faith all of the obligations of the Acquisition
Agreement. However, consummation of the Acquisition is subject to certain
conditions, and the Company's management cannot predict whether or not KCS
will be able to complete the Acquisition.
As of June 30, 2004 and December 31, 2003, costs of approximately $13.0
million and $9.3 million, respectively, related to the Acquisition have
been deferred and are reported as "other assets" in the accompanying
consolidated balance sheets. A termination fee of $18 million is payable in
the event of termination of the Acquisition Agreement due to (i) a change
of control of either KCS or Grupo TMM, in which case the party experiencing
the change of control shall pay the termination fee to the other party, or
(ii) the failure of the stockholders of KCS or of Grupo TMM to approve the
Acquisition if at or prior to the meeting of such stockholders to approve
the Acquisition, the Board of Directors of KCS, in the case of the KCS
stockholders' meeting, or the Board of Directors of Grupo TMM, in the case
of the Grupo TMM stockholders' meeting, has failed to recommend or has
withdrawn and not reinstated its recommendation of the Acquisition, then
the party whose stockholders shall not have approved the Acquisition shall
pay the termination fee to the other party provided that the party not
experiencing the change of control, or whose stockholders were not the
stockholders failing to approve the Acquisition, has elected to terminate
the Acquisition Agreement. The Board of Directors of Grupo TMM is obligated
under the terms of the Acquisition Agreement to recommend (and not
withdraw) approval of the Acquisition. The Board of Directors of KCS is
also obligated to recommend approval of the Acquisition, but may withdraw
its recommendation under certain circumstances. Payment of a termination
fee pursuant to the terms of the Acquisition Agreement would not preclude,
limit or diminish any other rights or remedies a non-breaching party may
have under the Acquisition Agreement.
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, 2004 December 31, 2003
--------------------------------------- ---------------------------------------
Southern Southern
PCRC Grupo TFM Capital PCRC Grupo TFM Capital
------------- ------------ ------------ ------------ ------------ -------------
Current assets $ 3.4 $ 229.1 $ 3.6 $ 3.6 $ 225.7 $ 5.0
Non-current assets 83.6 2,116.5 110.6 84.2 2,111.8 127.3
------------- ------------ ------------ ------------ ------------ -------------
Assets $ 87.0 $ 2,345.6 $ 114.2 $ 87.8 $ 2,337.5 $ 132.3
============= ============ ============ ============ ============ =============
Current liabilities $ 9.2 $ 309.7 $ - $ 9.9 $ 362.7 $ 1.2
Non-current liabilities 70.6 856.1 66.5 68.9 806.7 75.0
Minority interest - 357.3 - - 354.9 -
Equity of stockholders and partners 7.2 822.5 47.7 9.0 813.2 56.1
------------- ------------ ------------ ------------ ------------ -------------
Liabilities and equity $ 87.0 $ 2,345.6 $ 114.2 $ 87.8 $ 2,337.5 $ 132.3
============= ============ ============ ============ ============ =============
KCS's investment $ 3.7 $ 396.3 $ 23.9 $ 4.5 $ 392.1 $ 28.0
------------- ------------ ------------ ------------ ------------ -------------
Operating Results (dollars in millions):
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------- ----------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Revenues:
Grupo TFM $ 184.9 $ 176.6 $ 352.4 $ 345.1
Southern Capital 6.0 7.9 12.0 15.9
PCRC 1.6 1.4 3.7 3.2
Operating expenses:
Grupo TFM $ 149.9 $ 147.4 $ 293.0 $ 287.7
Southern Capital 4.4 6.9 9.2 13.9
PCRC 2.1 2.0 4.2 4.0
Net income (loss):
Grupo TFM $ 6.3 $ (4.7) $ 9.2 $ 10.3
Southern Capital 7.6 1.0 8.8 2.0
PCRC (0.8) (1.5) (1.6) (2.3)
4. Noncash Investing and Financing Activities. The Company initiated the
Fifteenth Offering of KCS common stock under the Employee Stock Purchase
Plan ("ESPP") during 2003. Stock subscribed under the Fifteenth Offering
will be issued to employees in 2005 and is being paid for through employee
payroll deductions in 2004. During the first six months of 2004, the
Company has received approximately $1.3 million from payroll deductions
associated with the Fifteenth Offering of the ESPP. In the first quarter of
2004, the Company issued approximately 197,734 shares of KCS common stock
under the Fourteenth Offering of the ESPP. These shares, totaling a
purchase price of approximately $2.4 million, were subscribed and paid for
through employee payroll deductions in 2003.
5. Derivative Financial Instruments. The Company does not engage in the
trading of derivatives for speculative purposes but uses them for risk
management purposes only. The Company's objective for using derivative
instruments is to manage its fuel and interest rate risk. In general, the
Company enters into derivative transactions in limited situations based on
management's assessment of current market conditions and perceived risks.
Management intends to respond to evolving business and market conditions in
order to manage risks and exposures associated with the Company's various
operations, and in doing so, may enter into such transactions more
frequently as deemed appropriate.
Fuel Derivative Transactions
At June 30, 2004, the Company was a party to five fuel swap agreements for
a notional amount of approximately 7.1 million gallons of fuel. Under the
terms of these swaps, the Company receives a variable price based upon an
average of the spot prices calculated on a monthly basis as reported
through a petroleum price reporting service and pays a fixed price
determined at the time the Company enters into the swap transaction. The
variable price the Company receives is approximately equal to the price the
Company pays in the market for locomotive fuel. By entering into these swap
transactions, the Company is able to fix the cost of fuel for the notional
amount of gallons hedged.
A summary of the swap agreements to which KCSR was a party as of June 30,
2004 follows:
Trade Dates Notional Amount Fixed pay per gallon Expiration Date
- ---------------------------- ----------------------- ----------------------------- ----------------------------
March 18, 2003 through June 30, 2004 through
October 31, 2003 7.1 million gallons 64(cent)- 69(cent) December 31, 2005
Cash settlements of these swaps occur on a monthly basis on the fifth
business day of the month following the month in which the settlement is
calculated. As of June 30, 2004, the fair market value of the benefit of
the swaps was $1.9 million. For the years ended December 31, 2003 and 2002,
KCSR consumed 55.4 million and 55.3 million gallons of fuel, respectively.
Fuel hedging transactions, including fuel swaps as well as forward purchase
commitments, resulted in a decrease in fuel expense of $0.9 million and
$0.2 million in the six months ended June 30, 2004 and 2003, respectively.
6. Stock Plans. Proceeds received from the exercise of stock options or
subscriptions are credited to the appropriate capital accounts in the
period they are exercised.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123 "Accounting for Stock-Based Compensation"
("SFAS 123") in October 1995. SFAS 123 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 their financial statements. Because
KCS's practice is to set the option price equal to the market price of the
stock at date of grant, no compensation expense is recognized under APB 25.
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 ESPP, under the fair value based
method prescribed by SFAS 123, net income and earnings per share would have
been as follows:
Three Months ended June 30, Six Months ended June 30,
--------------------------------------------------------------------------------
2004 2003 2004 2003
------------------ ------------------- ------------------- -------------------
Net income (in millions):
As reported $ 9.2 $ (0.5) $ 12.6 $ 13.1
Total stock-based compensation
expense determined under fair value
method, net of income taxes (0.4) (0.6) (0.9) (1.0)
------------------ ------------------- ------------------- -------------------
Pro forma $ 8.8 $ (1.1) $ 11.7 $ 12.1
Earnings per Basic share:
As reported $ 0.11 $ (0.03) $ 0.13 $ 0.19
Pro forma $ 0.11 $ (0.04) $ 0.12 $ 0.17
Earnings per Diluted share:
As reported $ 0.11 $ (0.03) $ 0.13 $ 0.19
Pro forma $ 0.10 $ (0.04) $ 0.12 $ 0.17
7. 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 9 of the Company's Annual Report on Form
10-K for the year ended December 31, 2003.
8. Other Post Employment Benefits. The Company provides certain medical, life
and other postretirement benefits other than pensions to its retirees. The
medical and life plans are available to employees not covered under
collective bargaining arrangements, who have attained age 60 and rendered
ten years of service. Individuals employed as of December 31, 1992 were
excluded from a specific service requirement. The medical plan is
contributory and provides benefits for retirees, their covered dependents
and beneficiaries. The medical plan provides for an annual adjustment of
retiree contributions, and also contains, depending on the plan coverage
selected, certain deductibles, co-payments, coinsurance and coordination
with Medicare. The life insurance plan is non-contributory and covers
retirees only. The Company's policy, in most cases, is to fund benefits
payable under these plans as the obligations become due. However, certain
plan assets (money market funds held in a life insurance company) exist
with respect to life insurance benefits. A life insurance company holds
these assets and the Company receives an investment return on these assets
based on the six-month Treasury Bill rate plus 25 basis points.
The Company's health care costs, excluding former Gateway Western Railway
Company ("Gateway Western") employees and certain former MidSouth Railroad
employees, are limited to the increase in the Consumer Price Index ("CPI")
with a maximum annual increase of 5%. Accordingly, health care costs in
excess of the CPI limit will be borne by the plan participants, and
therefore assumptions regarding health care cost trend rates are not
applicable.
Net periodic postretirement benefit cost included the following components
(in millions):
Three Months ended June 30, Six Months ended June 30,
------------------------------------------------------------------------------
2004 2003 2004 2003
------------------ ------------------- -------------------- -----------------
Service cost $ 0.1 $ 0.1 $ 0.2 $ 0.2
Interest cost 0.1 0.1 0.2 0.2
Expected return on plan assets - - - -
------------------ ------------------- -------------------- -----------------
Net periodic postretirement benefit cost $ 0.2 $ 0.2 $ 0.4 $ 0.4
================== =================== ==================== =================
Under collective bargaining agreements, KCSR participates in a
multi-employer benefit plan, which provides certain post-retirement health
care and life insurance benefits to eligible union employees and certain
retirees. Premiums under this plan are expensed as incurred and were $1.7
million in 2003. Based on existing rates, premium amounts are not expected
to change substantially during the remainder of 2004 compared to 2003.
9. New Credit Facility. During March 2004, the Company used cash on hand to
repay approximately $98.5 million of debt relating to the Company's former
credit facility. On March 30, 2004, the Company closed on a new credit
facility ("2004 Credit Facility"). The 2004 Credit Facility consists of a
$100 million revolving credit facility ("2004 Revolving Credit Facility")
maturing on March 30, 2007 and a $150 million Term B loan facility ("Term B
Loan Facility") maturing on March 30, 2008. The Term B Loan Facility was
fully funded on the closing date and the proceeds are expected to be used
to pay transaction costs and for other general corporate purposes,
including additional investments in the Company's Mexican affiliates. There
were no funds drawn under the previous revolving credit facility and the
full $100 million borrowing capacity under the 2004 Revolving Credit
Facility is currently available to the Company. Up to $25.0 million of the
2004 Revolving Credit Facility is available for letters of credit and up to
$15 million is available for swing line loans. The proceeds from future
borrowings under the 2004 Revolving Credit Facility may be used for working
capital and for general corporate purposes, including additional
investments in our Mexican affiliates. The letters of credit may be used
for general corporate purposes. Borrowings under the 2004 Credit Facility
are secured by substantially all of the Company's assets and are guaranteed
by the majority of its subsidiaries.
The Term B Loan Facility and the 2004 Revolving Credit Facility bear
interest at the London Interbank Offered Rate ("LIBOR") plus an applicable
margin or at an alternative base rate plus an applicable margin. The
applicable margin for the Term B Loan facility is 2% for LIBOR borrowings.
The applicable margin for the 2004 Revolving Credit Facility is set at
2.25% for LIBOR borrowings for the first six months and thereafter is based
on the Company's leverage ratio (defined as the ratio of the Company's
total debt to consolidated EBITDA (earnings before interest, taxes,
depreciation
and amortization, excluding the undistributed earnings of unconsolidated
affiliates and certain other non-cash charges) for the prior four fiscal
quarters).
The 2004 Credit Facility requires the payment of a commitment fee of 0.50%
per annum to the lenders on the average daily, unused amount of the 2004
Revolving Credit Facility. Additionally, a fee equal to the applicable
margin for LIBOR priced borrowings under the 2004 Revolving Credit Facility
will be paid on any letter of credit issued under the 2004 Revolving Credit
Facility.
The 2004 Credit Facility contains certain provisions, covenants and
restrictions customary for this type of debt and for borrowers with a
similar credit rating. These provisions include, among others, restrictions
on the Company's ability and its subsidiaries ability to 1) incur
additional debt or liens; 2) enter into sale and leaseback transactions; 3)
merge or consolidate with another entity; 4) sell assets; 5) enter into
certain transactions with affiliates; 6) make investments, loans, advances,
guarantees or acquisitions; 7) make certain restricted payments, including
dividends, or make certain payments on other indebtedness; or 8) make
capital expenditures in excess of allowed amounts. In addition, the Company
is required to comply with certain financial ratios, including minimum
interest expense coverage and leverage ratios. The 2004 Credit Facility
also contains certain customary events of default. These covenants, along
with other provisions, could restrict maximum utilization of the 2004
Revolving Credit Facility.
Approximately $2.9 million of debt issuance costs related to the 2004
Credit Facility have been deferred and are being amortized over the
respective terms of the loans. Debt retirement costs of approximately $4.2
million associated with the previous revolving credit facility and term
loan were recorded during the quarter ended March 31, 2004.
10. Transactions with Affiliates. On May 1, 2004, Southern Capital, a 50% owned
joint venture investment of the Company, concluded the sale of 74
locomotives to KCSR. These locomotives had previously been leased to KCSR
under a single lease agreement, which contained an option for KCSR to
purchase the locomotives. Upon the expiration of this lease on May 1, 2004,
KCSR exercised its option and purchased the locomotives for $14.3 million
resulting in a gain to Southern Capital of approximately $6.0 million. This
gain has been recognized by Southern Capital. The Company accounts for its
investment in Southern Capital under the equity method of accounting.
Accordingly, the Company has deferred recognition of its portion of the
gain of approximately $3.0 million and is instead amortizing this gain into
income as a reduction to depreciation expense over the depreciable lives of
the locomotives.
11. Condensed Consolidating Financial Information. KCSR has outstanding $200
million of 9 1/2% senior notes due 2008 and $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, 2004 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
Revenues $ - $ 299.7 $ 10.6 $ 6.7 $ (15.3) $ 301.7
Operating expenses 7.0 256.0 10.2 6.9 (15.3) 264.8
------------- ------------- ------------- ------------- -------------- -------------
Operating income (loss) (7.0) 43.7 0.4 (0.2) - 36.9
Equity in net earnings (losses)of
unconsolidated affiliates and
subsidiaries 17.3 4.6 - 3.9 (21.2) 4.6
Interest expense (0.3) (21.4) (0.2) - 0.2 (21.7)
Debt retirement costs - (4.2) - - - (4.2)
Other income 0.1 2.6 0.1 0.6 (0.2) 3.2
------------- ------------- ------------- ------------- -------------- -------------
Income (loss) before
income taxes 10.1 25.3 0.3 4.3 (21.2) 18.8
Income tax provision (benefit) (2.5) 8.5 0.1 0.1 - 6.2
------------- ------------- ------------- ------------- -------------- -------------
Net income (loss) $ 12.6 $ 16.8 $ 0.2 $ 4.2 $ (21.2) $ 12.6
============= ============= ============= ============= ============== =============
Six months ended June 30, 2003 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
Revenues $ - $ 283.3 $ 9.7 $ 14.8 $ (21.3) $ 286.5
Operating 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
============= ============= ============= ============= ============== =============
Condensed Consolidating Balance Sheets
As of June 30, 2004 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
ASSETS
Current assets $ 207.7 $ 345.2 $ 10.1 $ 11.2 $ (232.7) $ 341.5
Investments 820.0 437.1 - 433.3 (1,243.6) 446.8
Properties, net 0.6 1,397.2 3.8 - - 1,401.6
Goodwill and other assets 14.7 27.3 1.8 7.8 (9.6) 42.0
------------- ------------- ------------- ------------- -------------- -------------
Total assets $ 1,043.0 $ 2,206.8 $ 15.7 $ 452.3 $ (1,485.9) $ 2,231.9
============= ============= ============= ============= ============== =============
LIABILITIES AND EQUITY
Current liabilities $ 6.3 $ 372.1 $ 1.8 $ 36.0 $ (232.6) $ 183.6
Long-term debt 1.2 562.0 0.7 - - 563.9
Payable to affiliates 23.6 - 0.6 - (24.2) -
Deferred income taxes - 404.7 0.2 2.0 (9.7) 397.2
Other liabilities 33.8 57.1 4.7 13.6 (0.1) 109.1
Stockholders' equity 978.1 810.9 7.7 400.7 (1,219.3) 978.1
------------- ------------- ------------- ------------- -------------- -------------
Total liabilities and equity $ 1,043.0 $ 2,206.8 $ 15.7 $ 452.3 $ (1,485.9) $ 2,231.9
============= ============= ============= ============= ============== =============
As of December 31, 2003 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
ASSETS
Current assets $ 221.9 $ 285.3 $ 11.7 $ 15.1 $ (225.9) $ 308.1
Investments 801.4 431.1 - 452.4 (1,242.2) 442.7
Properties, net 0.2 1,358.5 3.8 - - 1,362.5
Goodwill and other assets 11.0 28.6 1.7 11.3 (13.0) 39.6
------------- ------------- ------------- ------------- -------------- -------------
Total assets $ 1,034.5 $ 2,103.5 $ 17.2 $ 478.8 $ (1,481.1) $ 2,152.9
============= ============= ============= ============= ============== =============
LIABILITIES AND EQUITY
Current liabilities $ 14.8 $ 346.7 $ 3.8 $ 35.4 $ (225.9) $ 174.8
Long-term debt 1.3 511.5 0.7 - - 513.5
Payable to affiliates 19.5 - 0.7 - (20.2) -
Deferred income taxes 3.3 398.5 0.2 2.5 (13.0) 391.5
Other liabilities 31.9 54.4 4.3 18.8 - 109.4
Stockholders' equity 963.7 792.4 7.5 422.1 (1,222.0) 963.7
------------- ------------- ------------- ------------- -------------- -------------
Total liabilities and equity $ 1,034.5 $ 2,103.5 $ 17.2 $ 478.8 $ (1,481.1) $ 2,152.9
============= ============= ============= ============= ============== =============
Condensed Consolidating Statements of Cash Flows
Six months ended June 30, 2004 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
Net cash flows provided by (used
for) operating activities: $ (28.1) $ 75.8 $ 0.7 $ 4.6 $ (2.7) $ 50.3
------------- ------------- ------------- ------------- -------------- -------------
Investing activities:
Property additions (0.5) (65.6) (0.2) - - (66.3)
Proceeds from disposal of property - 1.9 - - - 1.9
Investments in and loans to affiliates - (3.2) - (8.1) 6.5 (4.8)
Repayment of loans to affiliates - - - 2.4 (2.4) -
Other, net (3.5) (4.1) (0.1) - 2.7 (5.0)
------------- ------------- ------------- ------------- -------------- -------------
Net (4.0) (71.0) (0.3) (5.7) 6.8 (74.2)
------------- ------------- ------------- ------------- -------------- -------------
Financing activities:
Proceeds from issuance of
long-term debt - 150.0 - - - 150.0
Repayment of long-term debt - (99.6) (1.0) - - (100.6)
Proceeds from loans from affiliates 6.5 - - - (6.5) -
Repayment of loans from affiliates (2.4) - - - 2.4 -
Debt issuance costs - (2.9) - - - (2.9)
Proceeds from stock plans 2.9 - - - - 2.9
Cash dividends paid (4.4) - - - - (4.4)
------------- ------------- ------------- ------------- -------------- -------------
Net 2.6 47.5 (1.0) - (4.1) 45.0
------------- ------------- ------------- ------------- -------------- -------------
Cash and cash equivalents:
Net increase (decrease) (29.5) 52.3 (0.6) (1.1) - 21.1
At beginning of period 39.9 94.0 0.1 1.4 - 135.4
------------- ------------- ------------- ------------- -------------- -------------
At end of period $ 10.4 $ 146.3 $ (0.5) $ 0.3 $ - $ 156.5
============= ============= ============= ============= ============== =============
Six months ended June 30, 2003 (dollars in millions)
------------------------------------------------------------------------------------
Non-
Guarantor Guarantor Consolidating Consolidated
Parent KCSR Subsidiaries Subsidiaries Adjustments KCS
------------- ------------- ------------- ------------- -------------- -------------
Net cash flows provided by (used
for) operating activities: $ (166.3) $ 197.9 $ (11.0) $ 18.8 $ 1.0 $ 40.4
------------- ------------- ------------- ------------- -------------- -------------
Investing activities:
Property additions - (30.2) (0.2) - - (30.4)
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)
Other, net (5.3) - - 1.6 (1.0) (4.7)
------------- ------------- ------------- ------------- -------------- -------------
Net (38.0) (22.6) (0.2) (18.5) 19.1 (60.2)
------------- ------------- ------------- ------------- -------------- -------------
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) -
Issuance of preferred stock 193.2 - - - - 193.2
Proceeds from stock plans 2.1 - - - - 2.1
Cash dividends paid (0.1) - - - - (0.1)
Other, net - - - - - -
------------- ------------- ------------- ------------- -------------- -------------
Net 215.3 (1.5) (1.0) - (20.1) 192.7
------------- ------------- ------------- ------------- -------------- -------------
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
============= ============= ============= ============= ============== =============
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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 Annual Report on Form 10-K for the year ended
December 31, 2003, Item 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operation - Risk Factors" and "Cautionary Information"
which is on file with the U.S. Securities and Exchange Commission (File No.
1-4717) and which "Risk Factors" and "Cautionary Information" sections are
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.
CORPORATE OVERVIEW
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 total capital
stock of TFM, S.A. de C.V. ("TFM") and 100% of the stock of TFM entitled to
full voting rights. TFM wholly-owns Mexrail, Inc. ("Mexrail"). Mexrail owns
100% of The Texas-Mexican Railway Company ("Tex-Mex");
o Southern Capital Corporation, LLC ("Southern Capital"), a 50% owned
unconsolidated affiliate that leases locomotive and rail equipment to KCSR;
o Panama Canal Railway Company ("PCRC"), an unconsolidated affiliate of which
KCSR owns 50% of the common stock. PCRC owns all of the common stock of
Panarail Tourism Company ("Panarail").
KCS, as the holding company, supplies its various subsidiaries with managerial,
legal, tax, financial and accounting services, in addition to managing other
"non-operating" investments.
EXECUTIVE SUMMARY
OVERVIEW
KCS operates under one reportable business segment in the rail
transportation industry and KCSR, the Company's principal subsidiary, is the
smallest of the Class I railroads. The Company generates its revenues and cash
flows by providing its customers with freight delivery services both locally,
within our region, and throughout the United States, Mexico and Canada through
connections with our affiliates and other Class I rail carriers. Our customers
conduct business in a number of different industries, including
electric-generating utilities, chemical and petroleum products, paper and forest
products, agriculture and mineral products, automotive products and intermodal
transportation.
The Company uses its cash flows to support its operations and to invest in its
infrastructure. The rail industry is a capital-intensive industry, and the
Company's capital expenditures are a significant use of cash each year. For the
six months ended June 30, 2004, the Company's capital expenditures were
approximately $66.3 million and are projected to be approximately $30.0 million
during the remainder of 2004. A more detailed discussion of capital expenditures
is found in the "Liquidity and Capital Resources" section below.
Grupo TFM is an unconsolidated affiliate, and the Company uses the equity
accounting method to recognize its proportionate share of Grupo TFM's earnings.
Linked to KCSR by Tex-Mex, TFM operates a strategically significant rail
corridor between Mexico and the United States. KCS management believes that its
investment in Grupo TFM is a strategic asset with substantial economic
potential.
As further described in Part II, Item 7 of the Company's Annual Report on Form
10-K for the year ended December 31, 2003 ("2003 Form 10-K"), on April 20, 2003,
the Company reached an agreement (the "Acquisition Agreement") with its partner,
Grupo TMM, S.A. ("Grupo TMM") and other parties to ultimately acquire control of
TFM through the purchase of Grupo TMM's shares of Grupo TFM (the "Acquisition").
The Company has been in dispute with Grupo TMM over Grupo TMM's attempt to
terminate the Acquisition Agreement, which dispute has been the subject of
binding arbitration. Following an interim award of the arbitration panel hearing
the dispute as described further in "Recent Developments," the Company and Grupo
TMM signed a stipulation agreeing to discharge in good faith all of the
obligations of the Acquisition Agreement. However, consummation of the
Acquisition is subject to certain conditions, and the Company's management
cannot predict whether or not KCS will be able to complete the Acquisition. The
Company is spending substantial time and financial resources to address these
uncertainties, as well as the Acquisition, and the ultimate resolution of these
items could have a material affect on the Company's results of operations,
financial condition and cash flows. Should the acquisition of Grupo TFM be
consummated in 2004, KCS would include the operating revenues and expenses of
Grupo TFM in its consolidated financial statements from the date of the
Acquisition.
SECOND QUARTER ANALYSIS
KCS' second quarter operating income exceeded the second
quarter of 2003 by $5.3 million. Revenues continued to increase in all commodity
groups, except paper and forest products, driven not only by volume, but also
through variable fuel surcharges and targeted rate increases. Management
believes that the volume growth currently being experienced by
the Company is indicative of an improving general economic environment. KCSR's
rail operation continues to rank favorably among the rest of the North American
rail industry as measured by industry benchmarks of average train velocity,
average terminal dwell time, and cars on line.
The improved operating efficiency indicated by the benchmarks is also being
demonstrated by significant reductions in equipment costs. The reductions in
equipment costs combined with reductions in depreciation expense (resulting from
revisions to estimated depreciable lives) were more than offset by increases in
compensation (resulting from more crew starts associated with higher traffic
volumes, as well as higher incentive compensation costs) and fuel costs
(principally price driven).
For the second quarter of 2004, Grupo TFM continued to contribute to the
Company's net income. For the three months ended June 30, 2004, equity in
earnings of Grupo TFM increased $5.2 million to $2.9 million compared to equity
in losses of Grupo TFM of $2.3 million for the same period in 2003. This
increase was the result of improved operating income for Grupo TFM, as revenues
improved $8.3 million to $184.9 million for the second quarter of 2004 compared
to $176.6 million for the second quarter of 2003. Additionally, Grupo TFM's
benefit for taxes increased $13.7 million to $4.8 million for the second quarter
of 2004 (calculated under U.S. GAAP) compared to a tax provision of $8.9 million
for the same period in 2003. These factors were partially offset by increases in
operating costs of $2.5 million to $149.9 million for the second quarter of 2004
from $147.4 million in the second quarter of 2003.
2004 OUTLOOK
The current outlook for the Company's business for the remainder of
2004 is included in the following discussion. The first paragraph above this
Item 2 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contains a discussion regarding forward-looking comments.
For the second half of 2004, management expects overall KCSR revenues to
continue to show year over year increases, building on the momentum gained in
the first half of 2004. Assuming normalized rail operations, variable costs and
expenses are expected to change proportionate to increases in revenue volumes.
Material changes in market conditions for fuel will impact KCSR's fuel costs. To
mitigate this risk, KCSR currently has approximately 13.6% of its projected fuel
usage hedged for the remainder of 2004 through purchase commitments, as well as
fuel swaps, both of which reduce the risk of the adverse impact of rising fuel
prices. Wage increases will be implemented for most of the employees covered
under collective bargaining agreements in the second half of 2004. Depreciation
expense will continue to reflect the favorable impact of the changes in
estimates implemented January 1, 2004 by approximately $3.0 million per quarter.
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 is unable to
predict the impact that a change in the value of the peso or a change in Mexican
inflation will have on the results of Grupo TFM.
RECENT DEVELOPMENTS
KCS adds New Director. On July 26, 2004, the Company announced that Robert J.
Druten had been elected to its Board of Directors. Mr. Druten currently serves
as Executive Vice President and Chief Financial Officer of Hallmark Cards, Inc.,
the world's largest publisher of greeting cards and related products. He serves
on the company's corporate executive council. He is also a member of the Board
of Directors of Crown Media Holdings, Inc. In addition, Mr. Druten is the
Chairman of the Board of Trustees of Entertainment Properties Trust and a member
of the Board of Directors of BHA Group, Inc.
KCS and Grupo TMM Agree to Stipulation. Following the March 19, 2004 Interim
Award of the AAA International Centre for Dispute Resolution Arbitration Panel,
which found that the Acquisition Agreement remains in force and is binding on
the Company and Grupo TMM unless otherwise terminated according to its terms or
by law, the Company and Grupo TMM agreed not to move immediately into the next
phase of arbitration. Both companies have reserved the right to proceed with the
next phase of arbitration at any time. In a stipulation signed by Grupo TMM and
KCS on April 4, 2004, and accepted by the arbitration panel, the two companies
have agreed to discharge in good faith all of the obligations of the Acquisition
Agreement signed April 20, 2003. For additional information regarding the
Acquisition Agreement, see Note 3 in the Notes to the Financial Statements
contained within Item 8 of the Company's 2003 Form 10-K.
Kansas City Southern Closes on New $250 Million Credit Facility. During March
2004, the Company used cash on-hand to repay approximately $98.5 million
relating to the Company's former credit facility. On March 30, 2004, the Company
closed on a new credit facility ("2004 Credit Facility"). The 2004 Credit
Facility consists of a $100 million revolving credit facility ("2004 Revolving
Credit Facility") maturing on March 30, 2007 and a $150 million Term B loan
facility ("Term B Loan Facility") maturing on March 30, 2008. The Term B Loan
Facility was fully funded on the closing date and the proceeds are expected to
be used to pay transaction costs and for other general corporate purposes,
including additional investments in the Company's Mexican affiliates. There were
no funds drawn under the previous revolving credit facility and the full $100
million borrowing capacity under the 2004 Revolving Credit Facility is currently
available to the Company. Up to $25 million of the 2004 Revolving Credit
Facility is available for letters of credit and up to $15 million is available
for swing line loans. The proceeds from future borrowings under the 2004
Revolving Credit Facility may be used for working capital and for general
corporate purposes, including additional investments in our Mexican affiliates.
The letters of credit may be used for general corporate purposes. Borrowings
under the 2004 Credit Facility are secured by substantially all of the Company's
assets and are guaranteed by the majority of its subsidiaries. For additional
information regarding the new credit facility, see note 9 to the consolidated
financial statements under Item 1 of this Form 10-Q.
RESULTS OF OPERATIONS
The following table summarizes the income statement components of the Company
for the three and six months ended June 30, 2004 and 2003, respectively (in
millions):
Three Months Six Months
Ended June 30, Ended June 30,
------------------------ ------------------------
2004 2003 2004 2003
------------ ----------- ------------ -----------
Revenues $ 153.9 $ 146.3 $ 301.7 $ 286.5
Operating expenses 134.4 132.1 264.8 265.5
------------ ----------- ------------ -----------
Operating income 19.5 14.2 36.9 21.0
Equity in net earnings of unconsolidated affiliates 3.2 (2.5) 4.6 4.5
Interest expense (10.9) (11.7) (21.7) (23.2)
Debt retirement costs - - (4.2) -
Other income 1.7 1.5 3.2 2.8
------------ ----------- ------------ -----------
Income before income taxes and
cumulative effect of accounting change 13.5 1.5 18.8 5.1
Income tax provision 4.3 2.0 6.2 0.9
------------ ----------- ------------ -----------
Income (loss) before cumulative effect of accounting change 9.2 (0.5) 12.6 4.2
Cumulative effect of accounting change, net of income taxes - - - 8.9
------------ ----------- ------------ -----------
Net income (loss) $ 9.2 $ (0.5) $ 12.6 $ 13.1
============ =========== ============ ===========
The following table summarizes consolidated KCS revenues, including the revenues
and carload statistics of KCSR, for the three and six months ended June 30, 2004
and 2003, 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,
-------------------------------------------- --------------------- ---------------------
2004 2003 2004 2003 2004 2003 2004 2003
----------- ---------- ---------- ---------- ----------- --------- ---------- ----------
General commodities:
Chemical and petroleum $ 33.8 $ 30.6 $ 65.7 $ 61.8 37.6 34.3 73.3 70.3
Paper and forest 38.3 38.4 75.0 72.3 46.5 47.4 92.7 92.2
Agricultural and mineral 30.0 27.2 60.7 52.4 36.6 35.3 74.6 68.7
----------- ---------- ---------- ---------- ----------- --------- ---------- ----------
Total general commodities 102.1 96.2 201.4 186.5 120.7 117.0 240.6 231.2
Intermodal and automotive 16.5 14.9 31.2 28.4 87.0 77.9 167.7 149.7
Coal 23.2 22.1 45.2 46.3 47.7 45.7 96.2 92.9
----------- ---------- ---------- ---------- ----------- --------- ---------- ----------
Carload revenues and carload
and intermodal units 141.8 133.2 277.8 261.2 255.4 240.6 504.5 473.8
=========== ========= ========== ==========
Other rail-related revenues 11.1 11.4 22.1 22.2
----------- ---------- ---------- ----------
Total KCSR revenues 152.9 144.6 299.9 283.4
Other subsidiary revenues 1.0 1.7 1.8 3.1
----------- ---------- ---------- ----------
Total consolidated
revenues $ 153.9 $ 146.3 $ 301.7 $ 286.5
=========== ========== ========== ==========
The following table summarizes KCS's consolidated operating expenses for the
three and six months ended June 30, 2004 and 2003, respectively. Certain prior
period amounts have been reclassified to conform to the current year
presentation.
Three Months Six Months
Ended June 30, Ended June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Compensation and benefits $ 52.2 $ 47.5 $ 103.0 $ 98.0
Purchased services 15.4 15.2 31.0 30.3
Fuel 14.6 11.3 29.4 24.1
Equipment costs 11.6 15.4 24.6 29.4
Depreciation and amortization 13.1 16.0 25.9 31.9
Casualties and insurance 10.9 8.4 16.6 16.5
Other leases 3.0 2.3 5.7 4.8
Other 13.6 16.0 28.6 30.5
--------------- --------------- --------------- ---------------
Total consolidated operating expenses $ 134.4 $ 132.1 $ 264.8 $ 265.5
=============== =============== =============== ===============
Net Income. Net income for the three months ended June 30, 2004 was $9.2 million
(11(cent) per diluted share) compared to a net loss of $0.5 million (3(cent) per
diluted share) for the same period in 2003. This $9.7 million quarter to quarter
improvement resulted from a $7.6 million increase in operating revenues, a $5.2
million increase in equity in earnings of Grupo TFM, and $0.5 million higher
equity in earnings of other unconsolidated affiliates combined with a $0.8
million decrease in interest expense. These factors were partially offset by a
$2.3 million increase in operating expenses and a $2.3 million increase in the
provision for income taxes.
For the six months ended June 30, 2004, net income was $12.6 million (13(cent)
per diluted share) compared to $13.1 million (19(cent) per diluted share) for
the same period in 2003. This $0.5 million decrease was primarily the result of
the impact of the cumulative effect of a change in accounting principle of $8.9
million (net of income taxes of $5.6 million) in the year to date period ended
June 30, 2003. On a comparative basis with the six months ended June 30, 2003,
net income for year to date 2004 was favorably impacted by increases in
operating revenues of $15.2 million, equity in earnings of other unconsolidated
subsidiaries of $0.5 million and other income of $0.4 million, as well as
decreases in interest expense of $1.5 million and operating expenses of $0.7
million. Net income was reduced by a $5.3 million increase in the provision for
income taxes, debt retirement costs of $4.2 million attributable to the
write-off of the unamortized balance of debt issuance costs related to retired
debt and a $0.4 million decline in equity in earnings from Grupo TFM.
Revenues. Consolidated revenues for the three and six months ended June 30, 2004
increased $7.6 million (5.2%) and $15.2 million (5.3%), respectively, to $153.9
million and $301.7 million, respectively, compared to $146.3 million and $286.5
million, respectively, for the same periods in 2003. For the quarter ended June
30, 2004, KCSR experienced revenue increases in coal, chemical and petroleum
products, agriculture and mineral products, as well as intermodal traffic, while
paper and forest products revenue remained relatively flat. For the six months
ended June 30, 2004, KCSR experienced revenue increases in chemical and
petroleum products, agriculture and mineral products, paper and forest products
and intermodal traffic, while coal revenue decreased. These increases in revenue
were the result of higher carloadings for most commodity groups, as well as
longer hauls, targeted price improvements, and fuel surcharges. Fuel surcharges
accounted for $1.6 million and $3.4 million of the increase in revenues for the
three and six months ended June 30, 2004, respectively, compared to the same
periods in 2003. The following discussion provides an analysis of KCSR revenues
by commodity group for the quarter and year-to-date periods ended June 30, 2004.
Chemical and petroleum products. Revenues for the chemical and petroleum
products for the three and six months ended June 30, 2004 increased $3.2 million
(10.3%) and $3.9 million (6.4%), respectively, compared to the three and six
months ended June 30, 2003. For the three months ended June 30, 2004, KCSR
recorded higher revenues for all commodities within the chemical and petroleum
products group. Revenue increases for inorganic chemicals and plastics were
primarily the result of rate adjustments while agri-chemicals, industrial gases
and organic chemicals benefited from these rate increases as well as higher
traffic volumes driven by optimism in the economy. For the six months ended June
30, 2004, increases in revenue for agri-chemicals, industrial gases, organic
chemicals, and petroleum products were partially offset by decreases in
inorganic chemical and plastics product. These increases were the result of
higher traffic volume from both new and existing customers, as well as rate
increases. Decreases in revenue for inorganic chemical products and plastic
products for the six months ended June 30, 2004 were primarily the result of the
lower production stemming from the continued high cost of natural gas as a
feedstock and energy source for producers. Revenues for chemical and petroleum
products accounted for 23.8% and 23.0% of carload revenues for the three months
ended June 30, 2004 and 2003, respectively, and 23.7% of carload revenues for
both the six months ended June 30, 2004 and 2003.
Paper and forest products. For the three months ended June 30, 2004,
revenues for paper and forest products were relatively flat, decreasing only
$0.1 million compared to the three months ended June 30, 2003. For the six
months ended June 30, 2004, revenues for paper and forest products increased
$2.7 million (3.7%) compared to the six months ended June 30, 2003. Revenues
increases for pulp and paper, scrap paper, and lumber and plywood products
during both the quarter and year to date periods ended June 30, 2004 versus the
comparable prior year periods were offset by revenue declines for pulpwood, logs
and chips, metal, scrap and military and other traffic. Pulpwood, paper and
lumber product, and scrap paper product revenues increased due to rate increases
and increased volume attributed to higher production and service improvements.
Military and other carloads, which had experienced an increase during the three
months ended March 31, 2004, decreased during the three months ended June 30,
2004, resulting in a net decrease in revenue for the six months ended June 30,
2004. This decrease was primarily the result of temporary decreases in certain
military training exercises at installations serviced by KCSR. Declines in
revenues for logs and chips products for the three and six months ended June 30,
2004 were primarily related to decreased demand for rail transportation by
shippers resulting from a change in product mix for these customers. Revenues
for metal and scrap product were relatively flat for the three and six months
ended June 30, 2004 compared to the same periods in 2003. Paper and forest
products revenue accounted for 27.0% and 28.8% of carload revenues for the three
months ended June 30, 2004 and 2003, respectively, and 27.0% and 27.7% of
carload revenues for the six months ended June 30, 2004 and 2003, respectively.
Agricultural and mineral products. For the three and six months ended June
30, 2004, agricultural and mineral product revenues increased $2.8 million
(10.2%) and $8.3 million (16.0%), respectively, compared to the three and six
months ended June 30, 2003. Domestic grain revenues increased during the quarter
and year to date 2004 periods as a result of an increase in the production
volumes of domestic grain receivers on KCSR's line. Export grain revenues rose
versus comparable 2003 periods as a result of increased volumes related to the
shipment of the current year harvest to the Gulf of Mexico combined with strong
increases in export volumes to Mexico. Ores and minerals revenue during the
quarter and year to date 2004 periods increased as a result of higher production
by certain customers, as well as certain targeted rate increases. Decreases in
food and kindred products revenues during the quarter and year to date 2004
periods were primarily the result of a reduction in export shipments.
Agricultural and mineral products revenue accounted for 21.2% and 20.4% of
carload revenues for the three months ended June 30, 2004 and 2003, respectively
and 21.9% and 20.0% of carload revenues for the six months ended June 30, 2004
and 2003, respectively.
Intermodal and automotive. Intermodal and automotive revenues for the three
and six months ended June 30, 2004 increased $1.6 million (10.8%) and $2.8
million (9.6%), respectively, compared to the three and six months ended June
30, 2003. These increases were primarily a result of increased domestic
intermodal traffic due to higher volume by existing customers, as well as the
generation of new intermodal business. Automotive traffic for the three and six
months ended June 30, 2004 decreased primarily as a result of a change in the
traffic mix and destination of certain shippers. Intermodal and automotive
product revenue accounted for 11.7% and 11.2% of carload revenues for the three
months ended June 30, 2004 and 2003, respectively, and 11.2% and 10.9% of
carload revenues for the six months ended June 30, 2004 and 2003, respectively.
Coal. For the three months ended June 30, 2004, coal revenues increased
$1.1 million (5.3%) compared to the same period in 2003. Scheduled maintenance
outages by certain KCSR electric utility customers occurred in the first quarter
of 2004. During 2003, most of these outages occurred in the second quarter. For
the six months ended June 30, 2004, coal revenues decreased $1.1 million (2.5%)
compared to the same period in 2003, primarily as a result of lower volumes at
certain electric generating stations. Coal revenue accounted for 16.4% and 16.6%
of carload revenues for the three months ended June 30, 2004 and 2003,
respectively, and 16.3% and 17.7% of carload revenues for the six months ended
June 30, 2004 and 2003, respectively.
Other. Other rail related revenues for the three and six months ended June
30, 2004 decreased $0.3 million (2.6%) and $0.1 million (0.4%), respectively,
compared to the three and six months ended June 30, 2003. For the quarter ended
June 30, 2004, this decrease was primarily the result of lower haulage and
demurrage revenue, while switching revenue remained relatively flat. For the six
months ended June 30, 2004, a decrease in demurrage revenue was partially offset
by higher switching and haulage revenue.
Operating Expenses. Consolidated operating expenses for the three months ended
June 30, 2004 increased $2.3 million (1.7%) compared to the three months ended
June 30, 2003. This increase was the result of higher operating expenses at KCSR
of approximately $4.2 million, partially offset by decreased operating expenses
at certain other subsidiaries of $1.9 million.
Compensation and Benefits. For the three and six months ended June 30,
2004, consolidated compensation and benefits expense increased $4.7 million and
$5.0 million, respectively, compared to the same periods in 2003. The period
over period increases were primarily the result of certain increases in wage and
salary rates, increased crew starts related to higher traffic volume and an
increase in incentive compensation costs, offset by lower employee headcount.
Average headcount for the six months ended June 30, 2004 was 2,691 compared to
2,705 for the same period in 2003.
Purchased Services. Consolidated purchased services expense for the three
and six months ended June 30, 2004 increased $0.2 million (1.3%) and $0.7
million (2.3%), respectively, compared to the same periods in 2003. For the
three and six months ended June 30, 2004, this increase was primarily the result
of higher legal costs related to the settlement of claims. For the six months
ended June 30, 2004, increases also related to infrastructure and equipment
repairs performed by outside parties.
Fuel. For the three months ended June 30, 2004, consolidated fuel expense
increased $3.3 million (29.2%) compared to the three months ended June 30, 2003.
This quarter to quarter increase was the result of a 24.2% increase in the
average price per gallon (exclusive of the impact of hedging gains), as well as
a 6.8% increase in fuel consumption. These factors, which led to an increase in
fuel expense, were partially offset by fuel cost savings of $0.7 million as a
result of the Company's fuel hedging program. Fuel cost represented
approximately 10.9% of operating expenses for the three months ended June 30,
2004 compared to 8.6% of operating costs and expenses for the three months ended
June 30, 2003.
For the six months ended June 30, 2004, consolidated fuel expense increased
$5.3 million (22.0%) compared to the six months ended June 30, 2003. This year
to date increase was the result of a 16.5% increase in the average price per
gallon (exclusive of the impact of hedging gains), as well as a 6.0% increase in
consumption, offset by a savings of $0.9 million as a result of the Company's
fuel hedging program. For the six months ended June 30, 2004, fuel expense
represented 11.1% of the Company's operating expenses compared to 9.1% of
operating expenses for the same period in 2003.
Equipment Costs. For the three and six months ended June 30, 2004,
consolidated equipment costs decreased $3.8 million (24.7%) and $4.8 million
(16.3%), respectively, versus the same periods in 2003. These decreases were the
result of reductions in net car hire expense resulting from continued
improvements in rail operations. Partially offsetting these savings were higher
lease costs related to an increase in KCSR locomotives and freight cars and
other leased rolling stock as a result of increased traffic.
Depreciation and Amortization. Consolidated depreciation and amortization
expense for the three and six months ended June 30, 2004 decreased $2.9 million
(18.1%) and $6.0 million (18.8%), respectively, compared to the three and six
months ended June 30, 2003. For both the quarter and year to date ended June 30,
2004, these decreases were primarily the result of changes in depreciable lives
and salvage values based on a recent depreciation study, which has been approved
by the Surface Transportation Board and which took effect on January 1, 2004.
Casualties and Insurance. Consolidated casualties and insurance expense for
the three and six months ended June 30, 2004 increased $2.5 million and $0.1
million, respectively, compared to the same periods in 2003. These increases
were primarily the result of costs associated with certain derailments that
occurred during the second quarter of 2004. Approximately $0.8 million in
insurance settlements were received during the second quarter of 2004, reducing
casualty expense. For the year to date period ended June 30, 2004, the Company
has received approximately $3.2 million in insurance settlements.
Other Leases. Consolidated other lease expense for the three and six months
ended June 30, 2004 increased $0.7 million (30.4%) and $0.9 million (18.8%),
respectively, compared to the three and six months ended June 30, 2003. These
increases were primarily the result of additional lease expense associated with
certain maintenance of way equipment.
Other Expense. For the three and six months ended June 30, 2004,
consolidated other expense decreased $2.4 million (15.0%) and $1.9 million
(6.2%), respectively, compared to the same periods in 2003. For both periods,
these decreases were primarily the result of declines in materials and supplies
expense partially offset by increases in other taxes and other expenses.
Additionally, for the six months ended June 30, 2004, the decrease in other
expense was partially offset by a $2.1 million increase in the provision for
doubtful accounts.
Operating Income and KCS Operating Ratio. Consolidated operating income for
the three months ended June 30, 2004 increased $5.3 million to $19.5 million
compared to $14.2 million for the same period in 2003. This increase was the
result of a $7.6 million increase in revenue, partially offset by a 2.3 million
increase in operating expenses. For the three months ended June 30, 2004, the
consolidated operating ratio for KCS was 87.3% compared to 90.3% for the three
months ended June 30, 2003. For the six months ended June 30, 2004, consolidated
operating income increased $15.9 million to $36.9 million compared to $21.0
million for the same period in 2003. This increase was the result of a $15.2
million increase in revenue combined with a $0.7 million decrease in operating
expenses. For the six months ended June 30, 2004, the consolidated operating
ratio for KCS was 87.8% compared to 92.7% for the same period in 2003.
Interest Expense. Consolidated interest expense for the three and six months
ended June 30, 2004 decreased $0.8 million (6.8%) and $1.5 million (6.5%),
respectively, compared to the same periods in 2003. For both the quarter and
year to date, this decrease in interest expense was the result of lower debt
balances coupled with slightly lower interest rates. Consolidated debt balances
declined $7.4 million from $580.1 million at June 30, 2003 to $572.7 million at
June 30, 2004.
Debt Retirement Costs. During the six months ended June 30, 2004, the Company
recorded $4.2 million of debt retirement costs resulting from the write-off of
the unamortized balance of debt issuance costs associated with early retirement
of the Company's previous credit facility.
Other Income. The Company's other income for the three and six months ended June
30, 2004 increased $0.2 million and $0.4 million, respectively, compared to the
same periods in 2003. These increases were primarily the result of fluctuations
in gains on sales of non-operating property.
Income Tax Expense. Consolidated income tax expense for the three and six months
ended June 30, 2004 was $4.3 million and $6.2 million, respectively, compared to
$2.0 million and $0.9 million, respectively, for the same periods in 2003. For
both the quarter and year to date, the increases were the result of higher
domestic operating income, decreased interest expense and increases in other
income.
Equity in Net Earnings (Losses) of Unconsolidated Affiliates. For the second
quarter of 2004, the Company recorded equity in earnings of unconsolidated
affiliates of $3.2 million compared to equity in losses of unconsolidated
affiliates of $2.5 million in the second quarter of 2003. This $5.7 million
increase was primarily the result of an increase in equity in net earnings from
Grupo TFM of $5.2 million. For the second quarter of 2004, Grupo TFM's revenues
increased $8.3 million to $184.9 million compared to revenues of $176.6 million
for the second quarter of 2003. Grupo TFM's operating expenses for the second
quarter of 2004 increased $2.5 million to $149.9 million from $147.4 million for
the second quarter of 2003. As a result, Grupo TFM's operating income increased
$5.8 million to $35.0 million from $29.2 million for the second quarter of 2003.
Results for the second quarter of 2004 for Grupo TFM also include a $4.8 million
deferred income tax benefit (calculated under accounting principles generally
accepted in the United States of America - "U.S. GAAP") compared to a deferred
income tax provision of $8.9 million in the second quarter of 2003. This
increase in the deferred income tax benefit of $13.7 million was the result of
fluctuations in the peso exchange rate and tax benefits derived from the impact
of inflation in Mexico and had a significant impact on the Company's equity in
earnings from Grupo TFM. The Company reports its equity in Grupo TFM under U.S.
GAAP, while Grupo TFM reports under International Financial Reporting Standards
("IFRS").
For the year to date period ended June 30, 2004, the Company recorded $4.2
million in equity in earnings of Grupo TFM compared to $4.6 million for the same
period in 2003. For year to date 2004, Grupo TFM's revenues increased $7.3
million to $352.4 million compared to $345.1 million for the same period in
2003. This increase in Grupo TFM's operating revenues was partially offset by a
$5.3 million increase in operating expenses yielding an increase of $2 million
in Grupo TFM's operating income to $59.4 million for the year to date ended June
30, 2004 compared to $57.4 million for the same period in 2003. Results for the
six months ended June 30, 2004 for Grupo TFM also include a $12.0 million
deferred income tax benefit (U.S. GAAP) compared to a $14.1 million deferred
income tax benefit for the same period in 2003. This decrease in the deferred
tax benefit contributed to a decrease in the net earnings of Grupo TFM for the
six months ended June 30, 2004 compared to the same period in 2003.
For the three and six months ended June 30, 2004, equity in earnings from other
unconsolidated affiliates was $0.3 million and $0.4 million, respectively,
compared to equity in losses from other unconsolidated affiliates of $0.2
million and $0.1 million for the same periods in 2003. For the three and six
months ended June 30, 2004, losses from the operations of PCRC were $0.8 million
and $1.6 million, respectively, compared to $1.5 million and $2.3 million,
respectively, for the same periods in 2003. These losses were partially offset
by earnings from Southern Capital. For the three and six months ended June 30,
2004, earnings for Southern Capital were $7.6 million and $8.8 million,
respectively, compared to $1.0 million and $2.0 million, respectively, for the
same periods in 2003. These increases of $6.6 million and $6.8 million,
respectively, were primarily the result of the recognition by Southern Capital
of an approximate $6.0 million gain related to the sale of locomotives to KCSR
in the second quarter of 2004. For purposes of recording its share of Southern
Capital earnings, the Company has recorded its share of the gain as a reduction
to the cost basis of the equipment acquired. As a result, the Company will
recognize its equity in the gain over the remaining depreciable life of the
locomotives as a reduction of depreciation expense.
Cumulative Effect of Accounting Change. The Company adopted the provisions of
SFAS 143 effective January 1, 2003. As a result, the Company changed its method
of accounting for removal costs of certain track structure assets and recorded a
one-time benefit of $8.9 million (net of income taxes of $5.6 million) during
the first quarter of 2003. This change is reported as a cumulative effect of an
accounting change in the accompanying consolidated statement of income.
LIQUIDITY AND CAPITAL RESOURCES
Summary cash flow data for the Company is as follows (in millions):
Six Months
Ended June 30,
-------------------------------
2004 2003
------------- -------------
Cash flows provided by (used for):
Operating activities $ 50.3 $ 40.4
Investing activities (74.2) (60.2)
Financing activities 45.0 192.7
------------- -------------
Cash and cash equivalents:
Net increase 21.1 172.9
At beginning of year 135.4 19.0
------------- -------------
At end of period $ 156.5 $ 191.9
============= =============
During the six months ended June 30, 2004, the Company's consolidated cash
position increased $21.1 million from December 31, 2003, primarily as a result
of operating cash inflows, proceeds from the issuance of long-term debt and the
proceeds from employee stock plans. These increases were partially offset by
debt repayments and property additions. Net operating cash inflows were $50.3
million and $40.4 million for the six months ended June 30, 2004 and 2003,
respectively. The $9.9 million increase in operating cash flows was primarily
attributable to increased income as well as changes in working capital balances,
resulting mainly from the timing of certain payments and receipts. The change in
the accrued liabilities balance was primarily related to the timing of payments
for accrued interest and accrued operating leases.
Net investing cash outflows were $74.2 million and $60.2 million for the six
months ended June 30, 2004 and 2003, respectively. This $14.0 million increase
in net cash outflows was primarily a result of a $35.9 million period to period
increase in capital expenditures (arising from the purchase of locomotives from
Southern Capital in the second quarter of 2004 and continued capacity
improvements) and a $5.8 million decrease in proceeds from the disposal of
property. These factors, which led to an increase in net cash outflows from
investing activities, were partially offset by a $28.0 million decrease in net
investments and loans to affiliates.
For the first half of 2004, net financing cash inflows were $45.0 million
compared to $192.7 million for the first half of 2003. This $147.7 million
decrease was primarily the effect of approximately $193 million of net proceeds
received from the issuance of preferred stock in the first half of 2003 and
$100.6 million related to the repayment of long-term debt during year to date
2004. These declines were partially offset by the proceeds received from the
issuance of debt under the 2004 Credit Facility of $150 million.
Management expects cash flows from operations to be positive throughout the
remainder of 2004 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. Future roadway improvement projects will continue to be primarily
funded by operating cash flows.
The Company's consolidated ratio of debt to total capitalization was 36.9% and
35.2% at June 30, 2004 and December 31, 2003, respectively.
In addition to operating cash flows, the Company has financing available under
the 2004 Revolving Credit Facility with a maximum borrowing amount of $100
million. As of June 30, 2004, all $100 million was available under the 2004
Revolving Credit Facility. The 2004 Revolving Credit Facility contains, among
other provisions, various financial covenants. As a result of certain financial
covenants contained in the 2004 Revolving Credit Facility, maximum utilization
of the Company's 2004 Revolving Credit Facility may be restricted. See "Recent
Developments - Kansas City Southern Closes on New $250 Million Credit Facility"
for further discussion of the 2004 Credit Facility.
Capital improvements for KCSR roadway track structures have historically been
funded with cash flows from operations and external debt. The Company has
historically used equipment trust certificates for major purchases of
locomotives and rolling stock, while using internally generated cash flows or
leasing for other equipment. Through its Southern Capital joint venture, the
Company has the ability to finance railroad equipment.
The following table summarizes the cash capital expenditures by type.
Six Months
Ended June 30,
----------------------------------------
Capital Expenditure Category (dollars in millions) 2004 2003
------------------- --------------------
Track infrastructure $ 41.9 $ 22.8
Locomotives, freight cars and other equipment 18.7 3.1
Information technology 1.3 1.3
Facilities and improvements 1.6 0.4
Other 2.8 2.8
------------------- --------------------
Total capital expenditures $ 66.3 $ 30.4
=================== ====================
The Company has entered into an agreement to secure the transportation of
locomotive diesel fuel via pipeline into the Company's fuel facility in
Heavener, Oklahoma. The pipeline was completed and placed in service in May
2004. The contract provides that the Company will pay to the supplier
transportation fees based on published tariff rates per barrel. The contract
further requires that for a period of ten years after the pipeline is placed in
service, the fees will be at least $1.5 million per year.
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 $500.0 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 Company's Annual Report on Form 10-K for the year ended
December 31, 2003 - "Recent Developments - Mexican Government's Put Rights with
Respect to TFM Stock," Grupo TMM and KCS, or either Grupo TMM or KCS, could be
required to purchase the Mexican government's interest in TFM. If KCS and Grupo
TMM, or either KCS or Grupo TMM individually, had been required to purchase the
Mexican government's 20% interest in TFM, the total purchase price would have
been approximately $463.8 million as of June 30, 2004. The Company is exploring
various alternatives for financing this transaction. It is anticipated that this
financing, if necessary, can be accomplished using the Company's ability to
access the capital markets. No commitments for such financing have been obtained
at this time.
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 2004. Also, if necessary, management believes it will be
able to fund the cash requirements of the Acquisition using existing cash
resources and availability under the 2004 Revolving Credit Facility. Management
also believes that, if necessary, the Company could obtain financing to fund the
purchase of the Mexican government's 20% interest in TFM. The Company's
operating cash flows and financing alternatives, however, can be impacted by
various factors, some of which are outside of the Company's control. For
example, if the Company were to experience a substantial reduction in revenues
or a substantial increase in operating costs or other liabilities, its operating
cash flows could be significantly reduced. Additionally, the Company is subject
to economic factors surrounding capital markets and the Company's ability to
obtain financing under reasonable terms is subject to market conditions.
Further, the Company's cost of debt can be impacted by independent rating
agencies, which assign debt ratings based on certain credit measurements, such
as interest coverage and leverage ratios. During March 2004, Moody's Investors
Service downgraded the debt ratings of KCS while Standard & Poor's left the debt
ratings unchanged. This reduction in the Company's debt ratings did not have any
impact on the Company's interest rates or financial covenant ratios, but could
adversely impact borrowing costs in the future.
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, 2003.
Item 4. Controls and Procedures
As of the end of the fiscal quarter for which this Quarterly Report on Form 10-Q
is filed, the Company's Chief Executive Officer and Chief Financial Officer have
reviewed and evaluated the effectiveness of the Company's disclosure controls
and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")). 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 have not been any significant changes in the Company's internal controls
or in other factors that could significantly affect these controls subsequent to
the date of their evaluation. There were no significant deficiencies or material
weaknesses in the internal controls, and therefore no corrective actions were
taken.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Part I, Item 1. "Financial Statements", Note 7 to the Consolidated Financial
Statements of this Form 10-Q is hereby incorporated herein by reference.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
Exhibit 32.1 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 file a Current Report on Form 8-K, dated April 1, 2004,
under Items 5 and 7 of such form, announcing that on March 30, 2004,
the Company had closed on a new credit facility.
The Company filed a Current Report on Form 8-K, dated April 4, 2004,
under Items 5 and 7 of such form, with respect to a stipulation
entered into by KCS and Grupo TMM in connection with the arbitration
proceeding before the AAA International Centre for Dispute Resolution.
The Company filed a Current Report on Form 8-K, dated April 5, 2004,
under Items 5 and 7 of such form, announcing the Mexican Federal
Competition Commission granted an extension for its ruling granting
authority for the sale of Grupo TMM's interest in Grupo TFM to KCS.
The Company furnished a Current Report on Form 8-K, dated April 6,
2004, under Items 7 and 9 of such form, announcing the date, time and
other relevant information regarding the Company's first quarter
presentation and conference call of its financial results for the
three months ended March 31, 2004. The information included in this
Current Report on Form 8-K was furnished pursuant to Item 9 and shall
not be deemed to be filed.
The Company filed a Current Report on Form 8-K, dated April 12, 2004,
under Items 5 and 7 of such form, clarifying certain issues contained
in the stipulation agreement between KCS and Grupo TMM.
The Company furnished a Current Report on Form 8-K, dated April 29,
2004, under Items 7 and 12 of such form, announcing KCS's first
quarter 2004 earnings and operating results and schedules regarding
certain financial information discussed at the Company's first quarter
2004 analyst presentation and conference call. The information
furnished in this Current Report on Form 8-K pursuant to item 12 shall
not be deemed to be filed.
The Company furnished a Current Report on Form 8-K, dated May 18,
2004, under Items 7 and 9 of such form, providing pro forma financial
information of the Company, as of, and for the three months ended,
March 31, 2004, and for the year ended December 31, 2003, that was
included in the Post-Effective Amendment No. 6 to the Company's
registration statement on Form S-3 filed May 18, 2004.
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 5, 2004.
Kansas City Southern
/s/ Ronald G. Russ
------------------------------------------------
Ronald G. Russ
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)