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 September 30, 1997
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 INDUSTRIES, INC.
(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.)
114 West 11th 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at October 31, 1997
Common Stock, $.01 per share par value 107,627,371 Shares
KANSAS CITY SOUTHERN INDUSTRIES, INC.
FORM 10-Q
SEPTEMBER 30, 1997
INDEX
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Introductory Comments 1
Consolidated Condensed Balance Sheets -
September 30, 1997 and December 31, 1996 2
Consolidated Condensed Statements of Income -
Three and Nine Months Ended September 30, 1997 and 1996 3
Computation of Primary Earnings per Common Share 3
Consolidated Condensed Statements of Cash Flows -
Nine Months Ended September 30, 1997 and 1996 4
Notes to Consolidated Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURES 24
KANSAS CITY SOUTHERN INDUSTRIES, INC.
FORM 10-Q
SEPTEMBER 30, 1997
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
INTRODUCTORY COMMENTS
The Consolidated Condensed Financial Statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although the Company believes that the
disclosures are adequate to enable a reasonable understanding of the
information presented. These Consolidated Condensed Financial Statements
should be read in conjunction with the financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1996.
2
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in Millions)
(Unaudited)
September 30, December 31,
1997 1996
ASSETS
Current Assets:
Cash and equivalents $ 43.4 $ 22.9
Accounts receivable, net 173.7 138.1
Inventories 36.9 39.3
Other current assets 89.6 91.8
Total current assets 343.6 292.1
Investments held for operating purposes 679.7 335.2
Properties (net of $524.6 and $491.3 accumulated
depreciation and amortization, respectively) 1,269.3 1,219.3
Intangibles and Other Assets, net 238.3 237.5
Total assets $2,530.9 $2,084.1
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt due within one year $ 107.2 $ 7.6
Accounts and wages payable 99.7 102.6
Accrued liabilities 170.1 134.4
Total current liabilities 377.0 244.6
Other Liabilities:
Long-term debt 834.3 637.5
Deferred income taxes 359.9 337.7
Other deferred credits 137.0 129.8
Total other liabilities 1,331.2 1,105.0
Minority Interest in consolidated subsidiaries 22.1 18.8
Stockholders' Equity:
Preferred stock 7.1 7.1
Common stock 1.1 0.4
Capital surplus - -
Retained earnings 944.6 883.3
Net unrealized gain on investments 47.8 24.9
Shares held in trust (200.0) (200.0)
Total stockholders' equity 800.6 715.7
Total liabilities and stockholders' equity $2,530.9 $2,084.1
See accompanying notes to consolidated condensed financial statements.
3
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Dollars in Millions, Except per Share Data)
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
1997 1996 1997 1996
Revenues $273.6 $218.2 $764.0 $626.4
Costs and expenses 169.8 138.3 500.3 422.1
Depreciation and amortization 19.3 19.7 56.2 57.9
Operating Income 84.5 60.2 207.5 146.4
Equity in net earnings (losses) of
unconsolidated affiliates:
DST Systems, Inc. 5.6 56.3 17.4 63.2
Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. (2.3) - (5.3) -
Other 1.0 0.2 2.8 1.7
Interest expense (19.3) (16.1) (46.6) (43.2)
Other, net 4.4 2.4 14.7 12.3
Pretax Income 73.9 103.0 190.5 180.4
Income tax provision 25.4 22.5 71.1 50.7
Minority interest in
consolidated earnings 6.7 4.4 17.3 11.3
Net Income 41.8 76.1 102.1 118.4
Less: dividends on preferred stock 0.1 0.1 0.2 0.2
Net Income Applicable to
Common Stockholders $ 41.7 $ 76.0 $ 101.9 $ 118.2
Computation of Primary Earnings per Common Share
Weighted Average Primary Common
Shares Outstanding (in thousands) 110,802 114,012 110,253 116,406
Primary Earnings per Common Share $ 0.38 $ 0.67 $ 0.92 $ 1.02
Cash Dividends Paid:
Per Preferred share $ .25 $ .25 $ .75 $ .75
Per Common share .04 .03 .11 .10
See accompanying notes to consolidated condensed financial statements.
4
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Nine Months
Ended September 30,
1997 1996
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income $102.1 $118.4
Adjustments to net income:
Depreciation and amortization 56.2 57.9
Deferred income taxes 14.0 8.1
Equity in undistributed earnings (14.9) (61.1)
Changes in working capital items:
Accounts receivable (25.7) (0.1)
Inventories 4.0 3.9
Other current assets (2.0) 2.2
Accounts and wages payable (10.0) 2.3
Accrued liabilities 24.1 (64.8)
Other, net 2.4 0.6
Net 150.2 67.4
INVESTING ACTIVITIES:
Property acquisitions (57.1) (110.3)
Proceeds from disposal of property 5.8 3.6
Investment in and loans with affiliates (298.8) (24.8)
Net sales (purchases) of short-term investments 2.2 (31.5)
Proceeds from disposal of investments - 8.8
Other, net 8.8 4.1
Net (339.1) (150.1)
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 336.4 201.0
Repayment of long-term debt (82.0) (6.6)
Proceeds from stock plans 17.7 10.8
Stock repurchased (47.1) (120.3)
Cash dividends paid (15.4) (14.8)
Other, net (0.2) 3.3
Net 209.4 73.4
CASH AND EQUIVALENTS:
Net increase (decrease) 20.5 (9.3)
At beginning of year 22.9 31.8
At end of period $ 43.4 $ 22.5
See accompanying notes to consolidated condensed financial statements.
5
KANSAS CITY SOUTHERN INDUSTRIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1. In the opinion of Kansas City Southern Industries, Inc. ("Company"; "KCSI"),
the accompanying unaudited consolidated condensed financial statements contain
all adjustments (consisting of normal closing procedures) necessary to present
fairly the financial position of the Company and its subsidiaries as of
September 30, 1997 and December 31, 1996, the results of operations for the
three and nine months ended September 30, 1997 and 1996, and cash flows for
the nine months ended September 30, 1997 and 1996.
2. The results of operations for the three and nine months ended September 30,
1997 and 1996 are not necessarily indicative of the results to be expected for
the full year 1997.
3. The accompanying consolidated condensed financial statements have been
prepared consistently with accounting policies described more fully in Note 1
to the consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.
On July 29, 1997, the Company's Board of Directors authorized a 3-for-1 split
of the Company's common stock, which was effected in the form of a stock
dividend paid on September 16, 1997 to stockholders of record as of August 25,
1997. All share and per share data has been restated to reflect the stock
split.
The accumulation of the 1997 and 1996 first, second and third quarter Primary
Earnings per Common Share does not total the Primary Earnings per Common Share
for the nine months ended September 30, 1997 and 1996, respectively, as a
result of repurchases of Company common stock.
4. Effective January 1, 1997, the Company realigned its business segments to
better define the core industries in which it operates. The various
components comprising the segment formerly known as Corporate & Other have
been assigned to either the Transportation or Financial Asset Management
segment. Transportation consists of: The Kansas City Southern Railway
Company ("KCSR"); Southern Group, Inc.; Gateway Western Railway Company
("Gateway Western"); transportation-related KCSI Holding Company amounts;
and transportation-related subsidiaries and equity investments, including
Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM,"
formerly Transportacion Ferroviaria Mexicana S. de R.L. de C.V.), Southern
Capital Corporation, LLC ("Southern Capital"), and Mexrail, Inc.
("Mexrail"). Financial Asset Management includes Janus Capital Corporation
("Janus"), Berger Associates, Inc. ("Berger"), the Company's equity
interest in DST Systems, Inc. ("DST"), as well as Financial Asset Management-
related KCSI Holding Company amounts. Prior year's information has been
realigned to reflect the new segment approach.
During third quarter 1997, the Company formed Kansas City Southern Lines, Inc.
("KCSL") as a holding company for KCSR and all other transportation-related
subsidiaries and affiliates. KCSL was organized to provide separate control,
management and accountability for all transportation operations and
businesses.
On September 19, 1997, the Company announced its intention to separate its
Transportation segment from its Financial Asset Management segment. On
October 21, 1997, the Company announced that the separation would take the
form of an initial public offering of approximately 60% of KCSL's equity. The
offering is expected to occur early in 1998, subject to market conditions and
completion of regulatory review and other processes.
6
As a result of the Company's decision to commence an initial public offering
of KCSL, among other factors, management is in the process of performing a
detailed review of the various assets of all Company subsidiaries. This
review is being performed using the relevant accounting guidance (e.g.,
Statement of Financial Accounting Standards No. 121, Accounting Principles
Board Opinion No. 17), and under the established accounting policies described
more fully in Note 1 to the consolidated financial statements included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1996.
This review is expected to be completed during fourth quarter 1997.
5. The Company's inventories ($36.9 million at September 30, 1997 and $39.3
million at December 31, 1996) primarily consist of material and supplies
related to rail transportation. Other components of inventories are not
material.
6. 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 interest. Investments in unconsolidated affiliates at September
30, 1997 include equity interests in DST (approximately 41%), Grupo TFM (37%),
Southern Capital (50%) and Mexrail (49%), as well as the Company's interests
in other companies.
As more fully discussed in the Company's Annual Report on Form 10-K for the
year ended December 31, 1996, during first quarter 1997, Gateway Western was
accounted for under the equity method as a majority-owned subsidiary while the
Company awaited approval from the Surface Transportation Board ("STB") for the
acquisition of Gateway Western. The STB approved the Company's acquisition of
Gateway Western, effective May 5, 1997. Accordingly, the assets, liabilities,
revenues and expenses of Gateway Western are included in the Company's
consolidated financial statements. Additionally, the Company restated first
quarter 1997 to include Gateway Western as a consolidated subsidiary as of
January 1, 1997, and results of operations for the nine months ended September
30, 1997 reflect this restatement.
DST has a Stockholders' Rights Agreement, which includes provisions providing
that under certain circumstances following a "change in control" of KCSI, as
defined in DST's Stockholders' Rights Agreement, substantial dilution of the
Company's interest in DST could result. Additionally, the Company is party to
certain agreements with Transportacion Maritima Mexicana, S.A. de C.V. ("TMM")
covering the Grupo TFM and Mexrail ventures. TMM (including its affiliates)
owns approximately 38.4% of Grupo TFM and 51% of Mexrail. These agreements
contain "change in control" provisions, provisions intended to preserve the
Company's and TMM's proportionate ownership of the ventures, and super
majority provisions with respect to voting on certain significant
transactions. Such agreements also provide a right of first refusal in the
event that either party initiates a divestiture of its equity interest in
Grupo TFM or Mexrail. Under certain circumstances, such agreements could
affect the Company's ownership percentage and rights in these equity
affiliates.
7
Combined condensed financial information of unconsolidated affiliates is shown
below (dollars in millions):
Financial Condition:
September 30, 1997 December 31, 1996
DST Grupo TFM Other DST Grupo TFM Other
Current Assets $ 215.0 $ 102.3 $ 25.7 $ 201.3 $ 1.2 $ 34.4
Non-current assets 1,048.2 1,885.7 257.1 920.3 4.2 331.7
Assets $1,263.2 $1,988.0 $282.8 $1,121.6 $ 5.4 $ 366.1
Current liabilities$ 109.8 $ 93.2 $ 11.0 $ 125.7 $ 1.2 $ 27.2
Non-current
liabilities 348.0 1,106.7 196.2 300.7 - 267.7
Equity of stockholders
and partners 805.4 788.1 75.6 695.2 4.2 71.2
Liabilities and
equity $1,263.2 $1,988.0 $282.8 $1,121.6 $ 5.4 $ 366.1
Investment in
unconsolidated
affiliates $ 331.7 $ 296.0 $ 42.1 $ 283.5 $ 2.7 $ 39.7
Operating Results:
Three Months Nine Months
Ended September 30, Ended September 30,
1997 1996 1997 1996
Revenues:
DST $159.8 $ 139.6 $473.9 $427.0
Grupo TFM (a) 100.0 - 107.0 -
All others 17.8 8.1 50.6 23.3
Total revenues $277.6 $ 147.7 $631.5 $450.3
Operating costs and expenses:
DST $138.3 $ 137.8 $407.7 $388.7
Grupo TFM (a) 89.9 - 96.9 -
All others 18.4 8.3 45.6 22.0
Total operating costs
and expenses $246.6 $ 146.1 $550.2 $410.7
Net income:
DST $ 14.1 $ 138.6 $ 43.0 $155.4
Grupo TFM (a) (11.0) - (18.9) -
All others 0.8 (0.8) 3.9 (0.7)
Total net income $ 3.9 $ 137.8 $ 28.0 $154.7
(a) The operating results provided for Grupo TFM reflect its operation of TFM,
S.A. de C.V. ("TFM," formerly Ferrocarril del Noreste, S.A. de C.V.)
beginning on June 23, 1997. See discussion in Note 9 below.
8
7. For purposes of the Statement of Cash Flows, the Company considers all
short-term liquid investments with a maturity of generally three months or
less to be cash equivalents.
a.Supplemental Cash Flow Information (in millions):
Nine Months
Ended September 30,
1997 1996
Interest paid (excluding capitalized interest) $ 50.8 $ 52.7
Income taxes paid 44.5 106.9
The Company's income taxes paid for the nine months ended September 30, 1996
included the payment of federal and state income taxes resulting from the DST
initial public offering transactions, which occurred in fourth quarter 1995.
b.Noncash Investing and Financing Activities:
In first quarter 1997, the Company issued approximately 246,000 shares of KCSI
common stock under the Ninth Offering of the Employee Stock Purchase Plan
("ESPP"). These shares, totaling a purchase price of approximately $3.1
million, were subscribed and paid for through employee payroll deductions in
1996.
In first quarter 1996, the Company issued approximately 305,400 shares of KCSI
common stock under the Eighth Offering of the ESPP. These shares, totaling a
purchase price of approximately $3.8 million, were subscribed and paid for
through employee payroll deductions in 1994 and 1995.
Certain Company subsidiaries and affiliates hold investments which are
accounted for as "available for sale" securities as defined by Statement of
Financial Accounting Standards No. 115 "Accounting for Certain Investments in
Debt and Equity Securities." The Company records its proportionate share of
any unrealized gains or losses related to these investments, net of deferred
taxes, in stockholders' equity. The unrealized gain as of September 30, 1997,
net of deferred taxes, related to these investments increased $22.9 million
from December 31, 1996. The unrealized gain as of September 30, 1996, net of
deferred taxes, increased $12.4 million from December 31, 1995.
8. Statement of Financial Accounting Standards No. 128 "Earnings per Share"
("SFAS 128") was issued in February 1997, effective for financial statements
for interim and annual periods ending after December 15, 1997. The statement
specifies the computation, presentation and disclosure requirements for
earnings per share. The statement requires the computation of earnings per
share under two methods: "basic" and "diluted." Basic earnings per share is
computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding during the period. Diluted
earnings per share is computed giving effect to all dilutive potential common
shares that were outstanding during the period (i.e., the denominator used in
the basic calculation is increased to include the number of additional common
shares that would have been outstanding if the dilutive potential common
shares had been issued). SFAS 128 requires the Company to present basic and
diluted per share amounts for income from continuing operations and for net
income on the face of the income statement.
Although early adoption of SFAS 128 is not permitted, pro forma earnings per
share amounts may be disclosed in the notes to the financial statements.
Accordingly, if the Company's earnings per share had been computed in
accordance with SFAS 128 for the three and nine months ended September 30,
1997 and 1996, pro forma earnings per share would have been as follows:
9
Three Months Nine Months
Ended September 30, Ended September 30,
1997 1996 1997 1996
Pro Forma Earnings per Share:
Basic $ 0.39 $ 0.68 $0.95 $1.03
Diluted 0.38 0.67 0.92 1.02
9. As discussed more fully in Notes 2 and 11 to the consolidated financial
statements included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1996, the Mexican Government ("Government") awarded to
Grupo TFM the right to purchase 80% of the common stock of TFM for
approximately 11.072 billion Mexican pesos (approximately $1.4 billion U.S.
based on the U.S. dollar/Mexican peso exchange rate on December 5, 1996). TFM
holds the concession to operate over Mexico's Northeast rail lines for the
next 50 years, with the option of a 50 year extension (subject to certain
conditions).
The remaining 20% of TFM was retained by the Government. The Government has
the option of selling its interest through a public offering, or selling it to
Grupo TFM after October 31, 2003 at the initial share price paid by Grupo TFM
plus interest computed at the Mexican Base Rate (the Unidad de Inversiones
(UDI) published by Banco de Mexico). In the event that Grupo TFM does not
purchase the Government's 20% interest in TFM, the Government may require TMM
and KCSI to purchase the Government's holdings in proportion to each partner's
respective ownership interest in Grupo TFM (without regard to the Government's
interest in Grupo TFM - see below).
On January 31, 1997, Grupo TFM paid the first installment of the purchase
price (approximately $565 million U.S. based on the U.S. dollar/Mexican peso
exchange rate) to the Government, representing approximately 40% of the
purchase price. This initial installment of the TFM purchase price was funded
by Grupo TFM through capital contributions from TMM and the Company. The
Company contributed approximately $297 million to Grupo TFM, of which
approximately $277 million was used by Grupo TFM as part of the initial
installment payment. The Company financed this contribution using borrowings
under existing lines of credit.
On June 23, 1997, Grupo TFM completed the purchase of 80% of TFM through the
payment of the remaining $835 million U.S. to the Government. This payment
was funded by Grupo TFM using a significant portion of the funds obtained
from: (i) senior secured term credit facilities ($325 million U.S.); (ii)
senior notes and discount debentures ($400 million U.S.); (iii) proceeds from
the sale of 24.6% of Grupo TFM to the Government (approximately $199 million
U.S. based on the U.S. dollar/Mexican peso exchange rate on June 23, 1997);
and (iv) additional capital contributions from TMM and the Company
(approximately $1.4 million from each partner). Additionally, Grupo TFM
entered into a $150 million revolving credit facility for general working
capital purposes. The Government's interest in Grupo TFM is in the form of
limited voting right shares, and the purchase agreement includes a call option
for TMM and the Company, which is exercisable at the original amount (in U.S.
dollars) paid by the Government plus interest based on one-year U.S. Treasury
securities.
In February and March 1997, the Company entered into two separate forward
contracts - $98 million in February 1997 and $100 million in March 1997 - to
purchase Mexican pesos in order to hedge against a portion of the Company's
exposure to fluctuations in the value of the Mexican peso versus the U.S.
dollar. In April 1997, the Company realized a $3.8 million pretax gain in
connection with these contracts. This gain was deferred, and has been
accounted for as a component of the Company's investment in Grupo TFM. These
contracts were intended to hedge only a portion of the Company's exposure
related to the final installment of the purchase price and not any other
transactions or balances.
Concurrent with the financing transactions, Grupo TFM, TMM and the Company
entered into a Capital Contribution Agreement ("Contribution Agreement") with
TFM, which includes a possible capital call of $150 million from TMM and the
Company if certain performance benchmarks, outlined in the
10
agreement, are not met. The Company would be responsible for approximately
$74 million of the capital call. The term of the Contribution Agreement is
three years. In a related agreement between Grupo TFM, TFM and the
Government, among others, the Government has agreed to contribute up to $37.5
million of equity capital to Grupo TFM if TMM and the Company are required to
contribute under the capital call provisions of the Contribution Agreement
prior to July 16, 1998. In the event the Government has not made any
contributions by such date, the Government has committed up to July 31, 1999
to make additional capital contributions to Grupo TFM (of up to an aggregate
amount of $37.5 million) on a proportionate basis with TMM and the Company if
capital contributions are required. Any capital contributions to Grupo TFM
from the Government would be used to reduce the contribution amounts required
to be paid by TMM and the Company pursuant to the Contribution Agreement.
Based on the completed financing arrangements for Grupo TFM, significant
additional contributions from the Company to Grupo TFM are not expected to be
necessary (except for the possible capital call discussed above). As of
September 30, 1997, Grupo TFM was in compliance with all provisions of the
Contribution Agreement; accordingly, no additional contributions from the
Company have been requested or made.
As of September 30, 1997, the Company's investment in Grupo TFM was
approximately $296 million. With the sale of 24.6% of Grupo TFM to the
Government, the Company's interest in Grupo TFM declined from 49% to
approximately 37% (with TMM and a TMM affiliate owning the remaining 38.4%).
The Company accounts for its investment in Grupo TFM under the equity method.
In connection with the Company's investment in Grupo TFM, a Mexican company,
matters arise with respect to financial accounting and reporting for foreign
currency transactions and for translating foreign currency financial
statements from Mexican pesos into U.S. dollars. The Company follows the
requirements outlined in Statement of Financial Accounting Standards No. 52
"Foreign Currency Translation" ("SFAS 52"), and related authoritative
guidance.
Mexico's economy is currently classified as "highly inflationary" as defined
in SFAS 52; accordingly, the U.S. dollar is Grupo TFM's functional currency,
and any gains or losses from translating its financial statements into U.S.
dollars will be included in the determination of its net income. Any equity
earnings or losses from Grupo TFM included in the Company's results of
operations will reflect the Company's share of such translation gains and
losses. The Company will evaluate existing alternatives with respect to
utilizing foreign currency instruments to hedge its U.S. dollar investment in
Grupo TFM as market conditions change or exchange rates fluctuate.
10.In accordance with Statement of Financial Accounting Standards No. 58
"Capitalization of Interest Cost in Financial Statements That Include
Investments Accounted for by the Equity Method" ("SFAS 58"), the Company has
capitalized interest incurred on the borrowings under its lines of credit
associated with the approximate $297 million capital contribution to Grupo TFM
(see Note 9 above). Pursuant to SFAS 58, once Grupo TFM assumed operational
control of TFM (June 23, 1997) and the planned principal operations of Grupo
TFM commenced, capitalization of interest by the Company ceased. Interest
capitalized by the Company for the nine months ended September 30, 1997
totaled $7.4 million.
11.In June 1997, Statement of Financial Accounting Standards No. 130 "Reporting
Comprehensive Income" ("SFAS 130") and Statement of Financial Accounting
Standards No. 131 "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131") were issued. SFAS 130 establishes standards for
reporting and disclosure of comprehensive income and its components in the
financial statements. SFAS 131 establishes standards for reporting
information about operating segments in the financial statements. The
reporting and disclosure required by these statements must be included in the
Company's financial statements beginning in 1998. The Company is reviewing
SFAS 130 and SFAS 131 and expects to adopt them by the required dates.
11
12. In July 1996, the Company was named as one of twenty-seven defendants in
various lawsuits in Louisiana and Mississippi arising from the explosion
of a rail car loaded with chemicals in Bogalusa, Louisiana on
October 23, 1995. As a result of the explosion, nitrogen dioxide and
oxides of nitrogen were released into the atmosphere over parts of that
town and the surrounding area causing evacuations and injuries.
Approximately 25,000 residents of Louisiana and Mississippi have asserted
claims to recover damages allegedly caused by exposure to the chemicals.
The Company neither owned nor leased the rail car or the rails on which it was
located at the time of the explosion in Bogalusa. The Company did, however,
move the rail car from Jackson to Vicksburg, Mississippi, where it was loaded
with chemicals, and back to Jackson where the car was tendered to the Illinois
Central Railroad Company ("IC"). The explosion occurred more than 15 days
after the Company last transported the rail car. The car was loaded in excess
of its standard weight when it was transported by the Company to interchange
with the IC.
The lawsuits in Louisiana and Mississippi are in different stages of progress.
The Company filed motions seeking its dismissal in both the Louisiana and
Mississippi actions. The motion was denied in Mississippi and is being
appealed to the Mississippi Supreme Court. The motion awaits a hearing in
Louisiana. Management believes that the Company's exposure with regard to
liability in these cases is remote.
The Company has had no significant changes in other outstanding litigation or
contingencies from that previously reported in the Company's Annual Report on
Form 10-K for the year ended December 31, 1996.
13.See the Recent Developments section of Item 2, Management's Discussion and
Analysis of Financial Condition and Results of Operations, for significant
transactions and events that will have an impact on the Company's future
results of operations and financial position.
12
Item 2.Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
The discussion set forth below, as well as other portions of this Form 10-Q,
contains comments not based upon historical fact. 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 their 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 Industries, Inc.
("Company"; "KCSI") could materially differ from those indicated in forward-
looking comments. The differences could be caused by a number of
factors or combination of factors including, but not limited to,
those factors identified in the Company's Current Report on Form 8-K
dated November 12, 1996 and its amendment, Form 8-K/A dated
June 3, 1997, which have been filed with the U.S. Securities and Exchange
Commission (File No. 1-4717) and are hereby incorporated by reference herein.
Readers are strongly encouraged to consider these factors when evaluating any
such forward-looking comments.
KCSI, a Delaware Corporation organized in 1962, is a diversified holding
company with principal operations in rail transportation and financial
services. The Company supplies its various subsidiaries with managerial,
legal, tax, financial and accounting services, in addition to managing other
"non-operating" and more passive investments.
During third quarter 1997, the Company formed Kansas City Southern Lines, Inc.
("KCSL") as a holding company for The Kansas City Southern Railway Company
("KCSR") and all other transportation-related subsidiaries and affiliates. KCSL
was organized to provide separate control, management and accountability for
all transportation operations and businesses.
Effective January 1, 1997, the Company realigned its industry segments to more
clearly reflect the Company's focus on its core businesses. The various
components which formerly comprised the Corporate & Other segment were assigned
to either the Transportation or Financial Asset Management segment.
Accordingly, the Company's business activities by newly aligned industry
segment and principal subsidiary companies are:
Transportation - The Transportation segment consists of all transportation-
related subsidiaries and investments, including:
*KCSR, a wholly-owned subsidiary of the Company, operating a Class I Common
Carrier railroad system;
*Southern Group, Inc. ("SGI"), a wholly-owned subsidiary of KCSR, owning 100%
of Carland, Inc. ("Carland") and managing the loan portfolio for Southern
Capital Corporation, LLC ("Southern Capital," a 50% owned joint venture);
*Gateway Western Railway Company ("Gateway Western"), an indirect wholly-owned
subsidiary of the Company, operating a regional railroad system;
*Equity investments in Southern Capital, Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. ("Grupo TFM," formerly Transportacion Ferroviaria
Mexicana S. de R.L. de C.V., a 37% owned affiliate), and Mexrail, Inc.
("Mexrail," a 49% owned affiliate);
*Various other consolidated subsidiaries;
*KCSI Holding Company amounts.
Financial Asset Management - This segment consists of all subsidiaries engaged
in the management of investments for mutual funds, private and other accounts,
as well as any Financial Asset Management-related investments. Included are:
*Janus Capital Corporation ("Janus"), an 83% owned subsidiary;
*Berger Associates, Inc. ("Berger"), an 87% owned subsidiary;
*DST Systems, Inc. ("DST"), an approximate 41% owned equity investment;
*KCSI Holding Company amounts.
13
RECENT DEVELOPMENTS
Planned Public Offering of Transportation Business - On September 19, 1997, the
Company announced the planned separation of its Transportation and Financial
Asset Management segments. The form of the transaction will be an initial
public offering of approximately 60% of KCSL's equity. The public offering is
expected to occur early in 1998, subject to market conditions and completion of
regulatory review and other processes.
Operating Difficulties of the Union Pacific Railroad - As has been reported in
the press, the Union Pacific Railroad ("UP") has experienced recent
difficulties with its railroad operations, reportedly linked to its recent
acquisition of the Southern Pacific Railroad. The Company has the largest
interchange of rail traffic with the UP. The UP's difficulties have resulted
in overall traffic congestion of the U.S. railroad system and have impacted
the Company's ability to interchange traffic with UP, both for domestic and
international traffic (i.e., to and from Mexico). This system congestion has
resulted in certain equipment shortages due to the Company's rolling stock
being retained within the UP system for unusually extended periods of time,
for which UP remits car hire amounts. The Company has agreed to accept
certain UP trains as diversion of traffic to assist in the easing of the UP's
system congestion. For the nine months ended September 30, 1997, the Company
had received only one such diverted UP train. The amount of trains to be
diverted to the Company by UP, and the overall impact of the UP congestion
problems, is not expected to have a material effect on the Company's 1997
result of operations.
The Surface Transportation Board ("STB") issued an emergency service order on
October 31, 1997, addressing the deteriorating quality of rail service in the
Western United States. Key measures in the STB order, which is expected to
facilitate resolution of problems in the West, include the granting to the
Texas Mexican Railway ("Tex-Mex") access to Houston, Texas shippers, access to
trackage rights over the more direct Algoa Route south of Houston, and a
connection with the Burlington Northern Santa Fe Railroad at Flatonia, Texas.
The order takes effect on November 5, 1997 and extends for 30 days initially.
The STB plans another hearing for December 3, 1997 for a progress report from
UP officials. Tex-Mex is a wholly-owned subsidiary of Mexrail.
Mexico's Northeast Rail Lines - As disclosed previously, Grupo TFM, a joint
venture of the Company and Transportacion Maritima Mexicana, S.A. de C.V.
("TMM") was awarded the right to purchase 80% of the common stock of TFM, S.A.
de C.V. ("TFM," formerly Ferrocarril del Noreste, S.A. de C.V.) for
approximately 11.072 billion Mexican pesos (approximately $1.4 billion U.S.
based on the U.S. dollar/Mexican peso exchange rate on December 5, 1996). TFM
holds the concession to operate over Mexico's Northeast rail lines for the next
50 years, with the option of a 50 year extension (subject to certain
conditions).
As previously disclosed, the remaining 20% of TFM was retained by the Mexican
Government ("Government"). The Government has the option of selling its 20%
interest through a public offering, or selling it to Grupo TFM after October
31, 2003 at the initial share price paid by Grupo TFM plus interest computed
at the Mexican Base Rate (the Unidad de Inversiones (UDI) published by Banco de
Mexico). In the event that Grupo TFM does not purchase the Government's 20%
interest in TFM, the Government may require TMM and KCSI to purchase the
Government's holdings in proportion to each partner's respective ownership
interest in Grupo TFM (without regard to the Government's interest in Grupo TFM
- - see below).
On January 31, 1997, Grupo TFM paid the first installment of the purchase price
(approximately $565 million U.S. based on the U.S. dollar/Mexican peso exchange
rate) to the Government, representing approximately 40% of the purchase price.
This initial installment of the TFM purchase price was funded by Grupo TFM
through capital contributions from TMM and the Company. The Company
contributed approximately $297 million to Grupo TFM, of which approximately
$277 million was used by Grupo TFM as part of the initial installment payment.
The Company financed this contribution using borrowings under existing lines
of credit.
14
On June 23, 1997, Grupo TFM completed the purchase of 80% of TFM through the
payment of the remaining $835 million U.S. to the Government. This payment was
funded by Grupo TFM using a significant portion of the funds obtained from: (i)
senior secured term credit facilities ($325 million U.S.); (ii) senior notes
and discount debentures ($400 million U.S.); (iii) proceeds from the sale of
24.6% of Grupo TFM to the Government (approximately $199 million U.S. based on
the U.S. dollar/Mexican peso exchange rate on June 23, 1997); and (iv)
additional capital contributions from TMM and the Company (approximately $1.4
million from each partner). Additionally, Grupo TFM entered into a $150
million revolving credit facility for general working capital purposes. The
Government's interest in Grupo TFM is in the form of limited voting right
shares, and the purchase agreement includes a call option for TMM and the
Company, which is exercisable at the original amount (in U.S. dollars) paid
by the Government plus interest based on one-year U.S. Treasury securities.
In February and March 1997, the Company entered into two separate forward
contracts - $98 million in February 1997 and $100 million in March 1997 - to
purchase Mexican pesos in order to hedge against a portion of the Company's
exposure to fluctuations in the value of the Mexican peso versus the U.S.
dollar. In April 1997, the Company realized a $3.8 million pretax gain in
connection with these contracts. This gain was deferred, and has been accounted
for as a component of the Company's investment in Grupo TFM. These contracts
were intended to hedge only a portion of the Company's exposure related to the
final installment of the purchase price and not any other transactions or
balances.
Concurrent with the financing transactions, Grupo TFM, TMM and the Company
entered into a Capital Contribution Agreement ("Contribution Agreement") with
TFM, which includes a possible capital call of $150 million from TMM and the
Company if certain performance benchmarks, outlined in the agreement, are not
met. The Company would be responsible for approximately $74 million of the
capital call. The term of the Contribution Agreement is three years. In a
related agreement between Grupo TFM, TFM and the Government, among others, the
Government has agreed to contribute up to $37.5 million of equity capital to
Grupo TFM if TMM and the Company are required to contribute under the capital
call provisions of the Contribution Agreement prior to July 16, 1998. In the
event the Government has not made any contributions by such date, the Govern-
ment has committed up to July 31, 1999 to make additional capital contributions
to Grupo TFM (of up to an aggregate amount of $37.5 million) on a proportionate
basis with TMM and the Company if capital contributions are required. Any
capital contributions to Grupo TFM from the Government would be used to reduce
the contribution amounts required to be paid by TMM and the Company pursuant to
the Contribution Agreement.
Based on the completed financing arrangements for Grupo TFM, significant
additional contributions from the Company to Grupo TFM are not expected to be
necessary (except for the possible capital call discussed above). As of
September 30, 1997, Grupo TFM was in compliance with all provisions of the
Contribution Agreement; accordingly, no additional contributions from the
Company have been requested or made.
As of September 30, 1997, the Company's investment in Grupo TFM was
approximately $296 million. With the sale of 24.6% of Grupo TFM to the
Government, the Company's interest in Grupo TFM declined from 49% to
approximately 37% (with TMM and a TMM affiliate owning the remaining 38.4%).
The Company accounts for its investment in Grupo TFM under the equity method.
Stock Split and 20% Increase in Quarterly Common Stock Dividend - On July 29,
1997, the Company's Board of Directors ("Board") authorized a 3-for-1 split in
the Company's common stock effected in the form of a stock dividend. The Board
also voted to increase the quarterly dividend 20% to $0.04 per share. Both
dividends were paid on September 16, 1997 to stockholders of record as of
August 25, 1997. Amounts reported in this Form 10-Q have been restated to
reflect the stock split.
Common Stock Repurchases - The Company's Board has authorized management to
repurchase a total of 33 million shares of KCSI common stock under two programs
- - the 1995 program for 24 million shares and the 1996 program for nine million
shares. During first quarter 1997, the Company purchased the final 2.4
15
million shares under the forward purchase contract disclosed in Note 8 to the
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1996. With these transactions, the
Company has repurchased approximately 27.3 million shares of its common shares,
completing the 1995 program and part of the 1996 program.
Gateway Western - KCS Transportation Company ("KCSTC," a wholly-owned
subsidiary of the Company) acquired beneficial ownership of the outstanding
stock of Gateway Western in December 1996. The stock acquired by KCSTC was
held in an independent voting trust until the Company received approval from
the STB on the Company's proposed acquisition of Gateway Western. The STB
issued its approval of the transaction effective May 5, 1997. Because the
Gateway Western stock was held in trust during first quarter 1997, the Company
accounted for Gateway Western under the equity method as a majority-owned
unconsolidated subsidiary. Upon STB approval of the acquisition, the Company
consolidated Gateway Western in the Transportation segment. Additionally, the
Company restated first quarter 1997 to include Gateway Western as a
consolidated subsidiary as of January 1, 1997, and results of operations for
the nine months ended September 30, 1997 reflect this restatement.
RESULTS OF OPERATIONS
Segment revenues, operating income and net income comparisons follow (dollars in
millions):
Three Months Nine Months
Ended September 30, Ended September 30,
1997 1996 1997 1996
Revenues:
Transportation (KCSL) $ 142.7 $ 132.2 $ 416.9 $ 392.8
Financial Asset Management 130.9 86.0 347.1 233.6
Total $ 273.6 $ 218.2 $ 764.0 $ 626.4
Operating Income:
Transportation (KCSL) $ 24.5 $ 22.7 $ 52.6 $ 49.6
Financial Asset Management 60.0 37.5 154.9 96.8
Total $ 84.5 $ 60.2 $ 207.5 $ 146.4
Net Income:
Transportation (KCSL) $ 3.0 $ 5.2 $ 6.3 $ 7.4
Financial Asset Management 38.8 70.9 95.8 111.0
Total $ 41.8 $ 76.1 $ 102.1 $ 118.4
The Company reported third quarter 1997 earnings of $41.8 million, or $0.38 per
share, compared to $76.1 million, or $0.67 per share in third quarter 1996.
Third quarter 1996 earnings include a one-time gain of approximately $47.7
million, or $0.42 per share (after-tax), from equity earnings in DST,
representing the Company's proportionate share of the gain recognized by DST in
connection with the merger of The Continuum Company, Inc. ("Continuum,"
formerly a DST equity investment) with Computer Sciences Corporation.
Exclusive of this one-time gain, the Company's earnings per share increased
52% over third quarter 1996. Consolidated third quarter 1997 revenues rose
25% compared to the same period in 1996 from improvements in both of the
Company's segments. Operating income for the three months ended September 30,
1997 increased 40% (to $84.5 million) versus comparable 1996, largely due to
higher revenues, together with lower proportionate growth in Financial
Asset Management operating expenses as compared to revenues. Equity earnings
in unconsolidated affiliates totaled $4.3 million in third quarter 1997,
which was significantly lower than the prior period due to the one-time gain
in 1996. Third quarter 1997 includes an estimated $2.3 million equity loss
from Grupo TFM, which more than offset increased equity earnings from
16
DST (exclusive of the Continuum gain) and other investments. Interest expense
for the three months ended September 30, 1997 was 20% higher than comparable
1996 from higher average debt balances in 1997 resulting from the investment in
Grupo TFM.
For the nine months ended September 30, 1997, consolidated earnings were $102.1
million, or $0.92 per share, versus $70.7 million, or $0.61 per share in
comparable 1996, exclusive of the one-time Continuum gain. Year to date 1997
consolidated revenues increased 22% to $764.0 million compared to the same
period in 1996, primarily due to the growth in assets under management in the
Financial Asset Management segment and the addition of Gateway Western
revenues.
Operating expenses for the nine months ended 1997 increased at a lower
proportionate rate than revenues compared to 1996, leading to a 42% improvement
in operating income. Year to date 1997 equity earnings of unconsolidated
affiliates increased over comparable 1996 (exclusive of the Continuum gain) due
to higher DST earnings, offset by estimated losses at Grupo TFM.
TRANSPORTATION (KCSL)
Three Months Ended Three Months Ended
September 30, 1997 September 30, 1996
(in millions)
Holding Holding
Company and Company and
Transpor- Consol- Transpor- Consol-
tation- idated tation- idated
Related Trans- Related Trans-
KCSR Affiliates portation KCSR Affiliates portation
Revenues $ 128.5 $ 14.2 $ 142.7 $ 125.5 $ 6.7 $ 132.2
Costs and expenses 92.5 10.1 102.6 86.6 6.6 93.2
Depreciation and
amortization 13.6 2.0 15.6 15.1 1.2 16.3
Operating income
(loss) 22.4 2.1 24.5 23.8 (1.1) 22.7
Equity in net
earnings (losses)
of unconsolidated
affiliates:
Grupo TFM - (2.3) (2.3) - - -
Other 0.5 0.4 0.9 - 0.1 0.1
Interest expense (9.4) (7.6) (17.0) (12.2) (1.9) (14.1)
Other, net 0.8 (0.1) 0.7 1.1 (0.3) 0.8
Pretax income
(loss) 14.3 (7.5) 6.8 12.7 (3.2) 9.5
Income tax provision
(benefit) 6.3 (2.5) 3.8 5.5 (1.2) 4.3
Net income
(loss) $ 8.0 $ (5.0) $ 3.0 $ 7.2 $ (2.0) $ 5.2
The Transportation segment contributed $3.0 million to the Company's third
quarter 1997 earnings versus $5.2 million in third quarter 1996. Exclusive of
the Company's equity in the estimated net losses of, and interest expense
associated with, its investment in Grupo TFM, Transportation third quarter 1997
earnings were $7.7 million, 48% higher than 1996. This increase is
attributable to higher KCSR net income, the inclusion of Gateway Western
results in 1997, and 1996 non-recurring allocated Holding Company costs
related to the Company's efforts with respect to the Union Pacific/Southern
Pacific merger ("UP/SP merger").
KCSR third quarter 1997 revenues increased 2% over comparable 1996, primarily
from a $2.4 million increase in domestic grain business on volume gains.
Revenue improvements were also evident in chemical/petroleum, paper/forest
products and unit coal. While total KCSR revenues increased over third
quarter 1996, revenue carloadings decreased 1% quarter to quarter. This
improvement in average revenue per carload is generally attributable to
traffic mix and length of haul. Third quarter 1997 Holding Company and
Transportation-Related Affiliates revenues increased over 1996 due to the
inclusion of Gateway Western (consolidated effective January 1, 1997), offset
partially by reduced revenues as a result of the dissolution of Southern
Leasing Corporation ("SLC") in connection with the formation of the Southern
Capital joint venture in October 1996.
17
Third quarter 1997 Transportation operating expenses increased 8% compared to
third quarter 1996. KCSR experienced a 4% increase in operating expenses,
primarily from higher operating lease expenses (payments to Southern Capital),
partially offset by reduced depreciation as a result of the contribution and
sale of rail property to the Southern Capital joint venture. While total third
quarter 1997 KCSR operating expenses were higher than 1996, variable expenses
as a percentage of revenues declined by 2%. This result highlights KCSR's
efforts to maintain (or reduce) controllable cost components given anticipated
revenue levels.
Holding Company and Transportation-Related Affiliates costs and expenses
increased over third quarter 1996 due to the inclusion of Gateway Western
activity in 1997. The increase would have been higher if not for the non-
recurring costs incurred in third quarter 1996 related to the UP/SP merger as
discussed above, together with reduced costs and expenses due to the
dissolution of SLC.
During third quarter 1997, the Company recorded $2.3 million in estimated
equity losses associated with its investment in Grupo TFM. KCSR recorded
$0.5 million of equity income, reflecting KCSR's 50% share of Southern Capital
third quarter earnings.
Interest expense increased $2.9 million from third quarter 1996 because of
interest associated with the indebtedness incurred to fund the Grupo TFM
investment, partially offset by reduced interest due to the repayment of KCSR,
Carland and SGI debt using proceeds from the Southern Capital transaction.
Nine Months Ended Nine Months Ended
September 30, 1997 September 30, 1996
(in millions)
Holding Holding
Company and Company and
Transpor- Consol- Transpor- Consol-
tation- idated tation- idated
Related Trans Related Trans-
KCSR Affiliates portation KCSR Affiliates portation
Revenues $ 375.7 $ 41.2 $ 416.9 $ 370.4 $ 22.4 $ 392.8
Costs and expenses 285.5 32.7 318.2 272.0 23.0 295.0
Depreciation and
amortization 40.9 5.2 46.1 44.6 3.6 48.2
Operating income
(loss) 49.3 3.3 52.6 53.8 (4.2) 49.6
Equity in net
earnings (losses)
of unconsolidated
affiliates:
Grupo TFM - (5.3) (5.3) - - -
Other 1.6 0.8 2.4 - 1.0 1.0
Interest expense (28.6) (11.0) (39.6) (36.5) (2.5) (39.0)
Other, net 3.8 0.3 4.1 2.7 (0.8) 1.9
Pretax income
(loss) 26.1 (11.9) 14.2 20.0 (6.5) 13.5
Income tax provision
(benefit) 11.5 (3.6) 7.9 8.5 (2.4) 6.1
Net income
(loss) $ 14.6 $ (8.3) $ 6.3 $ 11.5 $ (4.1) $ 7.4
The Transportation segment contributed $14.0 million to the Company's earnings
for the nine months ended September 30, 1997, exclusive of estimated equity
losses in, and interest expense associated with, Grupo TFM, compared to $7.4
million for the same period in 1996. This increase in earnings was
attributable to higher earnings from KCSR as a result of reduced interest
expense, the inclusion of Gateway Western in 1997 and the UP/SP merger costs
incurred in 1996.
Transportation revenues increased 6% compared to 1996. This increase was
primarily attributable to the inclusion of Gateway Western revenues in 1997,
together with a $5.3 million increase in KCSR revenues. The KCSR revenue gain
was largely due to increased domestic grain revenues, particularly corn, as
well as improved export grain, chemicals and petroleum products, and paper/
forest products. Similar to third quarter 1997, carloadings for year to date
1997 were down, yet revenue has increased due to the mix of traffic and length
of haul improvements, as well as a greater focus on higher margin traffic.
Holding Company and Transportation-Related Affiliates revenues reflect the
Gateway Western revenues, offset partially by the lack of SLC revenues in 1997.
18
Year to date 1997 Transportation operating expenses increased 6% versus the
same period in 1996. While total year to date 1997 KCSR costs and expenses
increased over 1996, variable operating expenses decreased, including
reductions in salaries and wages, fringe benefits, and supplies.
Additionally, depreciation and amortization decreased by 8% for the
reasons discussed above. These reductions were offset by higher
fuel costs due to usage and fixed equipment lease charges to Southern Capital.
Higher operating expenses from Holding Company and Transportation-Related
Affiliates were attributable to the inclusion of Gateway Western, offset by the
lack of SLC costs in 1997 and the 1996 non-recurring UP/SP merger costs.
The Transportation segment reported equity losses from unconsolidated
affiliates for the nine months ended September 30, 1997, reflecting the
Company's estimated proportionate share of Grupo TFM's 1997 net loss.
Year to date 1997 Transportation interest expense increased from 1996 as
discussed above. Interest expense related to the indebtedness incurred in
connection with the Company's investment in Grupo TFM was capitalized until the
final installment of the TFM purchase price was made (June 23, 1997). Other,
net increased for the nine months ended September 30, 1997 due to a one time
pretax gain of $1.6 million recorded in first quarter 1997 resulting from the
sale of track by KCSR.
FINANCIAL ASSET MANAGEMENT
Three Months Ended Three Months Ended
September 30, 1997 September 30, 1996
(in millions)
Holding Holding
Company and Company and
Janus FAM- Consol- Janus FAM- Consol-
and Related idated and Related idated
Berger Affiliates FAM Berger Affiliates FAM
Revenues $ 131.5 $ (0.6) $ 130.9 $ 85.9 $ 0.1 $ 86.0
Costs and expenses 66.7 0.5 67.2 43.5 1.6 45.1
Depreciation and
amortization 3.3 0.4 3.7 3.2 0.2 3.4
Operating income
(loss) 61.5 (1.5) 60.0 39.2 (1.7) 37.5
Equity in net
earnings of
unconsolidated
affiliates:
DST Systems, Inc. - 5.6 5.6 - 56.3 56.3
Other 0.1 - 0.1 - 0.1 0.1
Interest expense (1.5) (0.8) (2.3) (1.5) (0.5) (2.0)
Other, net 2.7 1.0 3.7 1.1 0.5 1.6
Pretax income 62.8 4.3 67.1 38.8 54.7 93.5
Income tax provision
(benefit) 24.9 (3.3) 21.6 15.6 2.6 18.2
Minority interest 6.7 - 6.7 4.4 - 4.4
Net income $ 31.2 $ 7.6 $ 38.8 $ 18.8 $ 52.1 $ 70.9
Financial Asset Management contributed $38.8 million to KCSI's 1997 third
quarter consolidated earnings, an increase of 67% over comparable 1996,
exclusive of the one-time gain from the Continuum merger. Average assets under
management by Janus and Berger were 58% higher during third quarter 1997 than
third quarter 1996, leading to a $44.9 and $22.5 million increase in revenues
and operating income, respectively, over third quarter 1996.
Assets under management increased $8.4 billion during third quarter 1997 as a
result of net fund sales of $2.9 billion and market appreciation of $5.5
billion. Assets under management totaled $72.0 billion at September 30, 1997
($67.9 billion at Janus; $4.1 billion at Berger) versus $47.0 billion at
September 30, 1996.
While revenues for the third quarter 1997 increased 52% over comparable 1996,
costs and expenses increased at a lower proportionate rate, resulting in an
improved operating margin. This improved margin (2% higher than third quarter
1996) was primarily attributable to increased average shareholder balances.
19
Third quarter 1997 equity earnings from DST totaled $5.6 million, significantly
lower than 1996 as a result of the gain from the Continuum merger. Exclusive
of this gain, equity earnings from DST increased 24%, primarily due to
higher mutual fund, portfolio accounting, output processing and other
revenues, together with improved operating margins compared to third
quarter 1996.
Nine Months Ended Nine Months Ended
September 30, 1997 September 30, 1996
(in millions)
Holding Holding
Company and Company and
Janus FAM- Consol- Janus FAM- Consol-
and Related idated and Related idated
Berger Affiliates FAM Berger Affiliates FAM
Revenues $ 348.2 $ (1.1) $ 347.1 $ 233.8 $ (0.2) $ 233.6
Costs and expenses 178.9 3.2 182.1 122.3 4.8 127.1
Depreciation and
amortization 9.5 0.6 10.1 9.3 0.4 9.7
Operating income
(loss) 159.8 (4.9) 154.9 102.2 (5.4) 96.8
Equity in net
earnings of
unconsolidated
affiliates:
DST Systems, Inc. - 17.4 17.4 - 63.2 63.2
Other 0.4 - 0.4 - 0.7 0.7
Interest expense (4.7) (2.3) (7.0) (4.2) - (4.2)
Other, net 4.3 6.3 10.6 2.8 7.6 10.4
Pretax income 159.8 16.5 176.3 100.8 66.1 166.9
Income tax provision
(benefit) 63.3 (0.1) 63.2 40.7 3.9 44.6
Minority interest 17.3 - 17.3 11.3 - 11.3
Net income $ 79.2 $ 16.6 $ 95.8 $ 48.8 $ 62.2 $ 111.0
For the nine months ended September 30, 1997, Financial Asset Management
contributed $95.8 million to the Company's consolidated earnings, a 51%
increase over the same period in 1996, exclusive of the Continuum gain.
Higher earnings were attributable to a 49% increase in revenues (driven by
growth in assets under management), a 60% increase in operating income and
higher equity earnings.
Assets under management increased $21.7 billion during the nine months ended
September 30, 1997 from net fund sales and market appreciation. Shareowner
accounts numbered more than 2.8 million as of September 30, 1997 (a 5% increase
from December 31, 1996).
Equity earnings from DST increased 53% over year to date 1996 (exclusive of the
Continuum gain), largely due to the Company's proportionate share of a first
quarter 1996 non-recurring charge recorded by DST related to Continuum.
Exclusive of this first quarter charge, DST's 1997 earnings reflect the same
trends noted in third quarter 1997.
Year to date 1997 interest expense increased due to higher average KCSI Holding
Company allocated debt balances during third quarter 1997, reflecting
repurchases of KCSI common stock in first quarter 1997.
A brief discussion of Janus and Berger activity during the nine months ended
September 30, 1997 follows:
Janus
Janus continued to report growth in assets under management - a 45% increase
from December 31, 1996. This increase is attributable to several factors,
including, among others: (i) the investment performance of the Janus group of
mutual funds, as evidenced by approximately 50% of (separately tracked) Janus
fund products ranking in the first quartile when compared to their respective
peer categories based on product performance over a rolling one-year period
through September 30, 1997 (using data from Lipper Analytical Services, Inc.);
(ii) growth through new investment money - approximately 46% of the growth in
assets under management was due to net sales; and (iii) individual fund
performance, particularly the Janus Overseas Fund and Janus Worldwide Fund,
combining for $14.3 billion in assets under management as of September 30,
1997 compared to $4.8 billion at September 30, 1996.
20
Berger
In September 1997, Berger launched the Berger Balanced Fund, which closed with
$7.5 million in assets under management as of September 30, 1997. In February
1997, Berger assumed the advisory contract for the Omni Fund, renaming it The
Berger Small Cap Value Fund ("Small Cap"). At September 30, 1997, assets
under management for the Small Cap fund totaled approximately $114 million.
Also, the Berger/BIAM International Fund (introduced in fourth quarter 1996)
increased its assets under management to $124 million as of September 30,
1997. Exclusive of these new funds, assets under management of Berger's core
funds increased approximately $130 million from December 31, 1996, reflecting
market appreciation in excess of net redemptions during the nine months ended
September 30, 1997.
In January 1997, KCSI's ownership in Berger increased to approximately 87%
(from 80%) due to Berger's repurchase of its common stock (for treasury) from
a minority shareholder. The Company recorded $8.7 million in intangibles in
connection with this transaction, which will be amortized over 15 years.
TRENDS AND OUTLOOK
The Company reported a 52% improvement in third quarter 1997 earnings per share
compared to third quarter 1996. Year to date 1997 earnings per share were 51%
higher than the same period in 1996. Third quarter and year to date 1997
earnings from the Financial Asset Management segment reflect continued growth
in assets under management and revenues, as well as improved operating margins.
The Transportation segment continued its earnings improvement (exclusive of the
estimated equity losses and interest expense associated with Grupo TFM),
reporting higher net income in third quarter 1997 than in either previous
quarter in 1997 and comparable 1996.
A current outlook for the Company's businesses for the fourth quarter of 1997
is as follows (refer to the first paragraph of "Overview" section of this
Item 2, Management's Discussion and Analysis of Financial Condition and
Results of Operations, regarding forward-looking comments):
i) KCSR - General commodities and intermodal traffic will continue to be
largely dependent on economic trends within certain industries in the
geographic region served by KCSR (as evidenced by the increase in domestic
grain revenues during 1997 due to a strong corn crop). (I) Based on
anticipated traffic levels, including consideration of recent rail mergers,
fourth quarter 1997 revenues are expected exceed third quarter 1997. (I)
Variable costs and expenses are expected to continue at levels proportionate
with revenue expectations. (I) Unlike the first nine months of 1997, in
which equipment lease costs exceeded comparable 1996 periods, lease costs in
fourth quarter 1997 should be relatively comparable with the prior period
because the Southern Capital joint venture was formed in fourth quarter
1996. Interest expense is expected to be higher in fourth quarter 1997 than
comparable 1996 due to expense associated with the indebtedness incurred to
finance the $297 million investment in Grupo TFM. (I)
ii) As a result of the Company's decision to commence an initial public
offering of KCSL, among other factors, management is in the process of
performing a detailed review of the various assets of all Company
subsidiaries. This review is being performed using the relevant accounting
guidance (e.g., Statement of Financial Accounting Standards No. 121,
Accounting Principles Board Opinion No. 17), and under the established
accounting policies described more fully in Note 1 to the consolidated
financial statements included in the Company's Annual Report on Form 10-K
for the year ended December 31, 1996. This review is expected to be
completed during fourth quarter 1997.
(I) See the first paragraph of "Overview" section of Item 2,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, regarding forward-looking comments
21
iii) Financial Asset Management - Future growth will be largely dependent
on prevailing financial market conditions, relative performance of Janus'
and Berger's products, introduction and market reception of new
products, as well as other factors. (I) Fourth quarter 1997 revenues and
earnings for the Financial Asset Management segment will be impacted by
overall market declines experienced in late October 1997. Costs and
expenses should continue at operating levels consistent with the rate of
growth, if any, in revenues. (I)
iv)Equity Investments - The Company will continue to participate in the
earnings from its equity investments in DST, Southern Capital and Mexrail.
(I) However, the Company expects to report equity losses from Grupo TFM
during the initial period of its operation of Mexico's Northeast rail
lines.(I)
LIQUIDITY AND CAPITAL RESOURCES
Summary cash flow data is as follows (in millions):
Nine Months
Ended September 30,
1997 1996
Cash flows provided by (used for):
Operating activities $150.2 $ 67.4
Investing activities (339.1) (150.1)
Financing activities 209.4 73.4
Cash and equivalents:
Net increase (decrease) 20.5 (9.3)
At beginning of year 22.9 31.8
At end of period $ 43.4 $ 22.5
During the nine months ended September 30, 1997, the Company's cash position
increased $20.5 million from December 31, 1996. This increase was caused
primarily by positive operating cash flows, offset by cash used for property
acquisitions and Company common stock repurchases.
Year to date 1997 operating cash flows increased $82.8 million compared to the
same period in 1996. This increase was chiefly attributable to the 1996
payment of approximately $74 million in federal and state income taxes
resulting from the taxable gains associated with the DST public stock offering
completed in November 1995, offset partially by changes in other working
capital components.
Investing expenditures for the nine months ended September 30, 1997 included
the Company's approximate $297 million capital contribution to Grupo TFM and
KCSR road property additions. Cash from investing activities was generated
primarily from the sale of short-term investments by Janus and proceeds from
the disposal of property.
Financing cash flows were generated through borrowings under credit lines in
excess of repayments, essentially to fund the Grupo TFM capital contribution
and the repurchase of approximately $47.1 million of Company common stock
during 1997.
Cash flows from operations are expected to increase during the remainder of
1997 from positive operating income, which has historically resulted in
favorable cash flows. (I) Investing activities will continue to use
significant amounts of cash. Future roadway improvement projects are expected
to be funded by KCSR operating cash flow.(I) Based on the completion of
financing for Grupo TFM, significant additional contributions from the Company
to Grupo TFM are not expected to be necessary. (I) However, as discussed
earlier, there exists a possible capital call ($74 million) if certain Grupo
TFM benchmarks are not met.
(I) See the first paragraph of "Overview" section of Item 2, Management's
Discussion and Analysis of Financial Condition and Results of
Operations, regarding forward-looking comments
22
As discussed in the Recent Developments section above, TMM and the
Company could be required to purchase the Mexican Government's interest in
TFM in proportion to each partner's respective ownership interest in
Grupo TFM (without regard to the Mexican Government's interest in
Grupo TFM). Also, the Mexican Government's interest in Grupo TFM
may be called by TMM and the Company, exercisable at the original
amount (in U.S. dollars) paid by the Government plus interest based on
one-year U.S. Treasury securities.
In addition to operating cash flows, the Company has financing available
through its various lines of credit (with a maximum borrowing amount of $560
million, of which $225 million was available at September 30, 1997). Because
of certain financial covenants contained in the credit agreements, however,
maximum utilization of the Company's available lines of credit may be
restricted. The Company also has the ability to issue $500 million of
securities under a Universal Shelf Registration Statement ("Registration
Statement") filed in September 1993, as amended in April 1996. The Securities
and Exchange Commission declared the Registration Statement effective on
April 22, 1996; however, no securities have been issued.
The Company believes its operating cash flows and available financing resources
are sufficient to fund working capital and other requirements for the remainder
of 1997, as well as other potential business opportunities that the Company is
currently pursuing. (I)
The Company's debt ratio (total debt as a percent of total debt plus equity) at
September 30, 1997 was 54.0% compared to 47.4% at December 31, 1996. Company
consolidated debt increased $296.4 million from December 31, 1996 (to $941.5
million at September 30, 1997), primarily as a result of borrowings to fund the
Grupo TFM capital contribution and for the repurchase of common stock, together
with the consolidation of Gateway Western indebtedness. Consolidated equity
increased $84.9 million from December 31, 1996. This increase was primarily
due to net income and a positive non-cash equity adjustment related to
unrealized gains on "available for sale" securities held by affiliates, offset
partially by common stock repurchases. The higher increase in debt, however,
resulted in an increase in the debt ratio from December 31, 1996.
During May 1997, Standard & Poor's Corporation ("S&P") and Moody's Investing
Service ("Moody's") issued opinions of the Company's credit and senior secured
debt ratings. S&P lowered its rating on the Company to BBB- from BBB+, but
commented that the Company's outlook is stable. According to S&P, the reduced
rating was a result of the Company's increased debt levels to fund share
repurchases and its investment in the Mexican Northeast rail lines, combined
with increased competitive pressures on the Company's core U.S. railroad
operations. Moody's confirmed as unchanged its previous rating of the Company
at Baa2. According to Moody's, this decision was based on the Company's
diversified nature of businesses and the considerable strength of a number of
assets whose market value exceeds book value.
Subsequent to the Company's announcement to separate its Transportation and
Financial Asset Management segments, both S&P and Moody's placed the Company on
"watch" until the details of the form of the separation and the capital
structure of each remaining entity are determined.
(I) See the first paragraph of "Overview" section of Item 2, Management's
Discussion and Analysis of Financial Condition and Results of Operations,
regarding forward-looking comments
23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Part I, Item 1. Financial Statements, Note 12 to the Consolidated Condensed
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 3.1 - The Company's By-Laws, as amended and restated as
of May 1, 1997, are attached to this Form 10-Q as Exhibit 3.1
Exhibit 27.1 - Financial Data Schedule
b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated July 9, 1997
reporting the payment of the remaining 60% of the purchase price for TFM,
S.A. de C.V. (formerly Ferrocarril del Noreste, S.A. de C.V.), who holds
the concession to operate Mexico's Northeast rail lines, by Grupo
Transportacion Ferroviaria Mexicana, S.A. de C.V. (formerly Transportacion
Ferroviaria Mexicana S. de R.L. de C.V.), a joint venture of the Company
and Transportacion Maritima Mexicana, S.A. de C.V.
The Company filed a Current Report on Form 8-K dated July 29, 1997
reporting the announcement of a 3-for-1 split in the Company's common
stock to be effected in the form of a stock dividend and a 20% increase in
the quarterly dividend.
The Company filed a Current Report on Form 8-K dated September 19, 1997
reporting the announcement that the Company intended on separating its
Transportation and Financial Asset Management businesses.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized and in the capacities indicated on
November 4, 1997.
Kansas City Southern Industries, Inc.
/s/ Joseph D. Monello
Joseph D. Monello
Vice President and Chief Financial Officer
(Principal Financial Officer)
/s/ Louis G. Van Horn
Louis G. Van Horn
Vice President and Comptroller
(Principal Accounting Officer)