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, 1998
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 July 31, 1998
Common Stock, $.01 per share par value 109,500,735
- -------------------------------------------------------------------------------
KANSAS CITY SOUTHERN INDUSTRIES, INC.
FORM 10-Q
JUNE 30, 1998
INDEX
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Introductory Comments 1
Consolidated Condensed Balance Sheets -
June 30, 1998 and December 31, 1997 2
Consolidated Condensed Statements of Income and Comprehensive Income -
Three and Six Months Ended June 30, 1998 and 1997 3
Computation of Basic and Diluted Earnings per Common Share 3
Consolidated Condensed Statements of Cash Flows -
Six Months Ended June 30, 1998 and 1997 4
Notes to Consolidated Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Qualitative and Quantitative Disclosures About Market Risk 23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
KANSAS CITY SOUTHERN INDUSTRIES, INC.
FORM 10-Q
JUNE 30, 1998
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
INTRODUCTORY COMMENTS
The Consolidated Condensed Financial Statements included herein have been
prepared by Kansas City Southern Industries, Inc. ("Company" or "KCSI"), 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, 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, 1997, 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, 1998 are not necessarily indicative of the results
expected for the full year 1998.
2
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in Millions)
June 30, December 31,
1998 1997
(Unaudited)
ASSETS
Current Assets:
Cash and equivalents $ 8.8 $ 33.5
Accounts receivable, net 200.2 177.0
Inventories 39.3 38.4
Other current assets 144.1 124.2
----------- -----------
Total current assets 392.4 373.1
Investments held for operating purposes 753.3 683.5
Properties (net of $545.7 and $518.6 accumulated
depreciation and amortization, respectively) 1,237.4 1,227.2
Intangibles and Other Assets, net 184.1 150.4
----------- -----------
Total assets $ 2,567.2 $ 2,434.2
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt due within one year $ 113.7 $ 110.7
Accounts and wages payable 104.4 109.0
Accrued liabilities 178.6 217.8
----------- -----------
Total current liabilities 396.7 437.5
----------- -----------
Other Liabilities:
Long-term debt 758.0 805.9
Deferred income taxes 391.9 332.2
Other deferred credits 132.9 132.1
----------- -----------
Total other liabilities 1,282.8 1,270.2
----------- -----------
Minority Interest in consolidated subsidiaries 22.9 28.2
----------- -----------
Stockholders' Equity:
Preferred stock 7.1 7.1
Common stock 1.1 1.1
Capital surplus 6.4 -
Retained earnings 956.5 839.3
Accumulated other comprehensive income 93.7 50.8
Shares held in trust (200.0) (200.0)
----------- -----------
Total stockholders' equity 864.8 698.3
----------- -----------
Total liabilities and stockholders' equity $ 2,567.2 $ 2,434.2
=========== ===========
See accompanying notes to consolidated condensed financial statements.
3
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Dollars in Millions, Except per Share Data)
(Unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
1998 1997 1998 1997
Revenues $ 322.6 $ 252.6 $ 618.3 $ 490.4
Costs and expenses 200.3 166.8 388.8 330.5
Depreciation and amortization 17.9 18.4 34.7 36.9
---------- --------- ---------- ----------
Operating Income 104.4 67.4 194.8 123.0
Equity in net earnings (losses) of unconsolidated affiliates:
DST Systems, Inc. 7.5 5.7 15.0 11.8
Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. (2.1) (3.0) (5.2) (3.0)
Other 0.5 1.2 0.9 1.8
Interest expense (16.2) (13.6) (33.6) (27.3)
Other, net 15.2 4.3 21.8 10.3
---------- --------- ---------- ----------
Pretax Income 109.3 62.0 193.7 116.6
Income tax provision 40.9 24.3 72.4 45.7
Minority interest in
consolidated earnings 9.7 5.9 16.4 10.6
---------- --------- ---------- ----------
Net Income 58.7 31.8 104.9 60.3
Other comprehensive income, net of tax:
Unrealized gain on securities 13.0 18.0 42.9 9.1
---------- --------- ---------- ----------
Comprehensive Income $ 71.7 $ 49.8 $ 147.8 $ 69.4
========== ========= ========== ==========
Computation of Basic and Diluted Earnings per Common Share
Basic Earnings per Common Share $ 0.54 $ 0.29 $ 0.96 $ 0.56
========== ========= ========== ==========
Diluted Earnings per Common Share $ 0.51 $ 0.29 $ 0.92 $ 0.55
========== ========= ========== ==========
Weighted Average Basic Common
Shares Outstanding (in thousands) 109,253 107,095 108,894 107,631
---------- ---------- ---------- ----------
Weighted Average Diluted Common
Shares Outstanding (in thousands) 113,303 109,518 112,809 109,944
---------- ---------- ---------- ----------
Cash Dividends Paid:
Per Preferred share $ .25 $ .25 $ .50 $ .50
Per Common share .04 .03 .08 .07
See accompanying notes to consolidated condensed financial statements.
4
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Six Months
Ended June 30,
1998 1997
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income $ 104.9 $ 60.3
Adjustments to net income:
Depreciation and amortization 34.7 36.9
Deferred income taxes 22.3 10.7
Equity in undistributed earnings (10.7) (10.6)
Distributions from equity investments 5.5 -
Gain on sale of equity investments and property (14.4) (1.7)
Changes in working capital items:
Accounts receivable (21.6) (14.9)
Inventories (0.9) 0.9
Other current assets (17.6) (4.6)
Accounts and wages payable (6.5) (17.6)
Accrued liabilities (23.1) 24.7
Other, net (7.4) (4.0)
---------- ----------
Net 65.2 80.1
--------- ----------
INVESTING ACTIVITIES:
Property acquisitions (40.2) (33.1)
Proceeds from disposal of property 5.2 4.3
Investment in and loans with affiliates (24.8) (298.9)
Net sales (purchases) of short-term investments (0.7) 27.1
Proceeds from disposal of investments 10.3 -
Other, net 3.8 8.0
--------- ----------
Net (46.4) (292.6)
---------- ----------
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 53.8 298.0
Repayment of long-term debt (105.0) (50.3)
Proceeds from stock plans 23.0 7.8
Stock repurchased (3.5) (42.4)
Cash dividends paid (13.4) (11.0)
Other, net 1.6 5.6
--------- ----------
Net (43.5) 207.7
---------- ----------
CASH AND EQUIVALENTS:
Net decrease (24.7) (4.8)
At beginning of year 33.5 22.9
--------- ----------
At end of period $ 8.8 $ 18.1
========= ==========
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 June 30, 1998 and December 31, 1997, the results of operations for the
three and six months ended June 30, 1998 and 1997, and cash flows for the six
months ended June 30, 1998 and 1997.
2. The results of operations for the three and six months ended June 30, 1998
and 1997 are not necessarily indicative of the results to be expected for the
full year 1998.
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, 1997.
On February 3, 1998, the Company announced the planned separation of its
Transportation and Financial Asset Management segments through a proposed
dividend of the stock of its Financial Asset Management businesses (the
"Spin-off"). The Spin-off is subject to obtaining a favorable tax ruling from
the Internal Revenue Service ("IRS") and other key factors. A tax ruling
request was filed with the IRS on February 27, 1998. The Company expects to
complete the Spin-off in 1998, subject to receipt of a favorable tax ruling.
A public offering of KCSI stock (i.e. the Transportation segment) using the
Company's Universal Shelf Registration Statement is anticipated to occur
subsequent to the Spin-off. Also subsequent to the Spin-off, the Company
anticipates effecting a reverse stock split, which was approved by a majority
vote of the Company's stockholders held at a special stockholder's meeting on
July 15, 1998.
4. The effect of stock options to employees represent the only difference
between the weighted average shares used for the basic earnings per share
computation compared to the diluted earnings per share computation. The total
incremental shares from assumed conversion of stock options included in the
computation of diluted earnings per share were 4,049,731 and 3,915,046,
respectively, for the three and six month periods ended June 30, 1998 and
2,421,342 and 2,312,241, respectively, for the same 1997 periods. For the
three and six month periods ended June 30, 1998, the weighted average of
options to purchase 95,000 and 48,500 shares of KCSI common stock,
respectively, were excluded from the respective computation of diluted
earnings per share because the exercise prices were greater than the average
market prices of the common shares. For the three and six month periods ended
June 30, 1997, the weighted average of options to purchase zero and 1,306
shares were excluded.
The only adjustments that currently affect the numerator of the Company's
diluted earnings per share computation include preferred dividends and
potentially dilutive securities at subsidiaries and affiliates. These
adjustments totaled $0.5 million and $0.9 million for the three and six month
periods ended June 30, 1998, respectively. Adjustments for the three and six
month periods ended June 30, 1997 were not material.
5. The Company's inventories ($39.3 million at June 30, 1998 and $38.4 million
at December 31, 1997) primarily consist of material and supplies related to
rail transportation. Other components of inventories are not material.
6
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
a 50% voting interest. Investments in unconsolidated affiliates at June 30,
1998 include equity interests in DST Systems, Inc., ("DST"- approximately
41%), Grupo Transportacion Ferroviaria Mexicana S.A. de C.V. ("Grupo TFM" -
37%), Southern Capital Corporation LLC ("Southern Capital - 50%) and Mexrail,
Inc., ("Mexrail" - 49%), as well as the Company's interests in other
companies.
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 38.5% 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.
Combined condensed financial information of unconsolidated affiliates is
shown below (dollars in millions):
Financial Condition:
June 30, 1998 December 31, 1997
DST Grupo TFM Other DST Grupo TFM Other
Current assets $ 255.7 $ 93.8 $ 31.6 $ 231.3 $ 114.7 $ 29.9
Non-current assets 1,376.4 1,959.5 274.3 1,124.1 1,990.4 255.1
---------- ---------- -------- ---------- --------- --------
Assets $ 1,632.1 $ 2,053.3 $ 305.9 $ 1,355.4 $ 2,105.1 $ 285.0
========== ========== ======== ========== ========= ========
Current liabilities $ 126.1 $ 171.4 $ 21.0 $ 141.0 $ 158.5 $ 13.2
Non-current liabilities 478.8 778.8 214.7 378.7 830.6 191.7
Minority Interest - 342.4 - - 345.4 -
Equity of stockholders
and partners 1,027.2 760.7 70.2 835.7 770.6 80.1
---------- --------- -------- ---------- --------- --------
Liabilities and
equity $ 1,632.1 $ 2,053.3 $ 305.9 $ 1,355.4 $ 2,105.1 $ 285.0
========== ========== ======== ========== ========= ========
Investment in uncon-
solidated affiliates $ 425.0 $ 283.3 $ 39.1 $ 345.3 $ 288.2 $ 44.6
========== ========== ======== ========== ========= ========
7
Operating Results:
Three Months Six Months
Ended June 30, Ended June 30,
----------------------------- ------------------------------
1998 1997 1998 1997
----------------------------- ------------------------------
Revenues:
DST $ 184.3 $ 155.4 $ 371.7 $ 314.1
Grupo TFM (a) 109.6 7.0 209.6 7.0
All others 20.2 17.0 46.3 32.8
---------- ---------- ---------- ---------
Total revenues $ 314.1 $ 179.4 $ 627.6 $ 353.9
========== ========== ========== =========
Operating costs and expenses:
DST $ 156.2 $ 134.4 $ 312.4 $ 269.4
Grupo TFM (a) 96.6 7.0 187.3 7.0
All others 19.8 13.6 44.7 27.2
---------- ---------- ---------- ---------
Total operating costs and expenses $ 272.6 $ 155.0 $ 544.4 $ 303.6
========== ========== ========== =========
Net income:
DST $ 17.5 $ 13.8 $ 36.1 $ 28.9
Grupo TFM (a) (5.7) (7.9) (9.8) (7.9)
All others 1.0 2.3 1.4 3.1
---------- ---------- ---------- ---------
Total net income $ 12.8 $ 8.2 $ 27.7 $ 24.1
========== ========== ========== =========
(a) The operating results provided for Grupo TFM for the three and six month
periods ended June 30, 1997 reflect its operation of TFM, S.A. de C.V.
("TFM" ) beginning on June 23, 1997.
7. For purposes of the Statement of Cash Flows, the Company considers all
short-term liquid investments with an initial maturity of generally three
months or less to be cash equivalents.
a. Supplemental Cash Flow Information (in millions):
Six Months
Ended June 30,
1998 1997
Interest paid (excluding capitalized interest) $ 36.2 $ 25.1
Income taxes paid 39.0 18.9
b. Noncash Investing and Financing Activities:
During second quarter 1998, in connection with Company's acquisition of
Nelson Money Managers PLC ("Nelson"), the Company issued approximately 67,000
shares of KCSI Common Stock (valued at $3.2 million) to certain of the
sellers of the Nelson shares. Also, notes payable of $4.9 million were
recorded as part of the purchase price, payable by March 31, 2005, bearing
interest at 7 percent. See Note 8 below for additional information.
In first quarter 1998, the Company issued approximately 227,000 shares of
KCSI common stock under the Tenth Offering of the Employee Stock Purchase
Plan ("ESPP"). These shares, totaling a purchase price of approximately $3.0
million, were subscribed and paid for through employee payroll deductions in
1997.
In first quarter 1997, the Company issued approximately 246,000 shares of
KCSI common stock under the Ninth Offering of the ESPP. These shares,
totaling a purchase price of approximately $3.1 million, were subscribed and
paid for through employee payroll deductions in 1996.
8
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. As of June 30, 1998, the unrealized gain, net
of deferred taxes, related to these investments increased $42.9 million from
December 31, 1997. The unrealized gain, net of deferred taxes, as of June 30,
1997, increased $9.1 million from December 31, 1996.
c. Additional Information:
During July 1998, the Company refinanced the $100 million, 5.75% Notes that
were due using borrowings under its lines of credit.
8. On April 20, 1998, the Company completed its acquisition of 80% of Nelson, an
investment advisor and manager based in the United Kingdom ("UK"). Nelson has
six offices throughout the UK and offers planning based asset management
services directly to private clients. Nelson manages approximately $1 billion
of assets. The acquisition, accounted for as a purchase, was completed using
a combination of cash, Company Common Stock and notes payable. The total
purchase price was approximately $32 million. The purchase price is in excess
of the book value of the net assets received and this excess has been
recorded in various intangible asset accounts. These intangible assets are
being amortized over periods ranging up to 20 years. Nelson, an indirect
subsidiary of FAM Holdings Inc., is consolidated in the Company's Financial
Asset Management segment. Nelson's revenues and expenses for the three and
six months ended June 30, 1998, were not material to the Company's results of
operations.
9. The Company's other comprehensive income consists primarily of unrealized
gains and losses relating to investments held by Financial Asset Management
subsidiaries and affiliates 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 as accumulated
other comprehensive income. The unrealized gain related to these investments
increased $70.0 and 15.4 million ( $42.9 and $9.1 million, net of deferred
taxes) for the six months ended June 30, 1998 and 1997, respectively, as a
result of unrealized gains related to these investments. The unrealized gain
related to these investments increased $21.4 and $30.0 million ( $13.0 and
$18.0 million, net of deferred taxes) for the three months ended June 30,
1998 and 1997, respectively.
10.In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131 "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131
establishes standards for the manner in which public business enterprises
report information about operating segments in annual financial statements
and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. SFAS
131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. SFAS 131 is effective for
financial statements for periods beginning after December 15, 1997; however,
in the initial year of application, SFAS 131 need not be applied to interim
financial statements. The Company is reviewing SFAS 131 and expects to adopt
it for the year ending December 31, 1998.
9
In February 1998, Statement of Financial Accounting Standards No. 132
"Employers' Disclosure about Pensions and Other Postretirement Benefits - an
amendment of FASB Statements No. 87, 88, and 106" ("SFAS 132") was issued.
SFAS 132 establishes standardized disclosure requirements for pension and
other postretirement benefit plans, requires additional information on
changes in the benefit obligations and fair values of plan assets that will
facilitate financial analysis, and eliminates certain disclosures that are no
longer useful. The standard does not change the measurement or recognition of
pension or postretirement benefit plans. The Company is reviewing SFAS 132
and expects to adopt it for the year ending December 31, 1998. SFAS 132 is
not expected to have a material impact on the Company's current disclosures.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). SFAS 133 establishes accounting and reporting standards for derivative
financial instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. It requires recognition of all
derivatives as either assets or liabilities measured at fair value. SFAS 133
is effective for all fiscal quarters of fiscal years beginning after June 15,
1999 and should not be retroactively applied to financial statements of
periods prior to adoption.
The Company currently has a program to hedge against fluctuations in the
price of diesel fuel purchases, and also enters into fuel purchase
commitments from time to time. In addition, the Company continues to evaluate
alternatives with respect to utilizing foreign currency instruments to hedge
its U.S. dollar investment in Grupo TFM and Nelson as market conditions
change or exchange rates fluctuate. Currently, the Company has no outstanding
foreign currency hedges. The Company is reviewing the provisions of SFAS 133
and expects adoption by the required date. The adoption of SFAS 133 with
respect to existing hedge transactions is not expected to have a material
impact on the Company's results of operations, financial position or cash
flows.
11.The Company has had no significant changes in its outstanding litigation or
other contingencies from that previously reported in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997. The following
provides an update concerning the Bogalusa Cases.
Bogalusa Cases
In July 1995, the Kansas City Railway Company ("KCSR") was named as one of
twenty-seven defendants in various lawsuits in Louisiana and Mississippi
arising from the explosion of a rail car loaded with chemicals in Bogalusa,
Louisiana on October 23, 1995. As a result of the explosion, nitrogen dioxide
and oxides of nitrogen were released into the atmosphere over parts of that
town and the surrounding area allegedly causing evacuations and injuries.
Approximately 25,000 residents of Louisiana and Mississippi have asserted
claims to recover damages allegedly caused by exposure to the chemicals.
KCSR neither owned nor leased the rail car or the rails on which it was
located at the time of the explosion in Bogalusa. KCSR, 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 KCSR last transported the rail car. The car was loaded by the shipper
in excess of its standard weight when it was transported by KCSR to
interchange with the IC.
The Mississippi lawsuit arising from the chemical release is scheduled for
trial in September 1998. KCSR sought dismissal of these suits in the trial
appellate courts, which was denied in each case. KCSR is considering seeking
review by the U.S. Supreme Court of those State Court denials.
10
KCSR believes that its exposure to liability in these cases is remote. If
KCSR were to be found liable for punitive damages in these cases, such a
judgment could have a material adverse effect on the financial condition of
the Company.
12.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.
11
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" or "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 (Files 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. 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 financial position, liquidity, capital
structure and business developments for the periods covered by the consolidated
condensed financial statements included under Item 1 of this Form 10-Q. This
discussion should be read in conjunction with these consolidated condensed
financial statements and the related notes thereto and is qualified by reference
thereto.
KCSI, a Delaware Corporation organized in 1962, is a diversified holding company
with principal operations in rail transportation and financial asset management.
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.
The Company's business activities by industry segment and principal subsidiary
companies are:
Transportation - The Transportation segment consists of all
transportation-related subsidiaries and investments, including:
* Kansas City Southern Railway Company ("KCSR"), a wholly-owned subsidiary of
the Company, operating a Class I Common Carrier railroad system;
* Gateway Western Railway Company ("Gateway Western"), a wholly-owned
subsidiary of KCS Transportation Company, a wholly-owned subsidiary of the
Company, operating a regional railroad system;
* Southern Group, Inc., a wholly-owned subsidiary of KCSR, owning 100% of
Carland, Inc. and managing the loan portfolio for Southern Capital
Corporation LLC ("Southern Capital"), a 50% owned joint venture;
* Equity investments in Southern Capital, Grupo Tranportacion Ferroviaria
Mexicana S.A. de C.V. ( "Grupo TFM") a 37% owned affiliate, Mexrail Inc.
("Mexrail"), a 49% owned affiliate along with its wholly-owned subsidiary,
the Texas Mexican Railway Company ("Tex-Mex"); and Panama Canal Railway
Company, a 50% joint venture;
* Various other consolidated subsidiaries;
* Kansas City Southern Lines, Inc. ("KCSL"), a wholly-owned subsidiary of the
Company, serving as a holding company for transportation-related entities;
12
Financial Asset Management - The Financial Asset Management 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 82% owned subsidiary;
* Berger Associates, Inc. ("Berger"), a 100% owned subsidiary;
* Nelson Money Managers PLC ("Nelson"), an 80% owned subsidiary as of
April 20, 1998 - see discussion in "Recent Developments" below.
* DST Systems, Inc. ("DST"), an approximate 41% owned equity investment;
* FAM Holdings, Inc. ("FAM Holdings"), a wholly-owned subsidiary of the
Company, formed on January 23, 1998 for the purpose of becoming a holding
company for financial asset management-related subsidiaries and affiliates.
RECENT DEVELOPMENTS
Planned Separation of the Company Business Segments. As previously disclosed,
the Company announced the planned separation of its Transportation and Financial
Asset Management segments through a proposed dividend of the stock of its
Financial Asset Management businesses (the "Spin-off"). The Spin-off is subject
to obtaining a favorable tax ruling from the Internal Revenue Service ("IRS")
and other key factors. A tax ruling request was filed with the IRS on February
27, 1998.
The Company expects to complete the Spin-off in 1998, subject to receipt of a
favorable tax ruling. A public offering of KCSI stock (i.e. the Transportation
segment) using the Company's Universal Shelf Registration Statement is
anticipated to occur subsequent to the Spin-off. Also subsequent to the
Spin-off, the Company anticipates effecting a reverse stock split, which was
approved by a majority vote of the Company's stockholders held at a special
stockholders' meeting on July 15, 1998.
Acquisition of Nelson Money Manager PLC ("Nelson"). On April 20, 1998, the
Company completed its acquisition of 80% of Nelson, an investment advisor and
manager based in the United Kingdom ("UK"). Nelson has six offices throughout
the UK and offers planning based asset management services directly to private
clients. Nelson manages approximately $1 billion of assets. The acquisition,
accounted for as a purchase, was completed using a combination of cash, Company
Common Stock and notes payable. The total purchase price was approximately $32
million. The purchase price is in excess of the book value of the net assets
received and this excess has been recorded in various intangible asset accounts.
These intangible assets are being amortized over periods ranging up to 20 years.
Nelson, an indirect subsidiary of FAM Holdings Inc., is consolidated in the
Company's Financial Asset Management segment. Nelson's revenues and expenses for
the three and six months ended June 30, 1998, were not material to the Company's
results of operations.
Houston Emergency Service Order. As disclosed in the 1997 Annual Report on Form
10-K, on October 31, 1997 the Surface Transportation Board ("STB") issued an
emergency service order which addressed the deteriorating quality of rail
service in the Western United States. Key measures in the STB order included
granting the Tex-Mex access to Houston shippers, 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 took effect on November
5, 1997 and was extended through August 2, 1998. In a decision released on July
31, 1998, the STB announced that it would not extend the emergency service order
in the Houston/Gulf Coast
13
region, citing improved conditions in Houston area rail service. This decision
provided for a "45-day wind down" period until September 17, during which the
Tex-Mex could provide service under the terms of the emergency service order.
The Company is currently evaluating the impact of this decision by the STB.
During second quarter 1998, the KCSR and Tex-Mex, along with the Texas Railroad
Commission and several shipper advocate groups, filed the Houston Area Consensus
Plan ("Consensus Plan") with the STB. This Consensus Plan, which has been
accepted by the STB for consideration, seeks to provide the Tex-Mex with
permanent access to the Houston/Gulf Coast markets and to expand neutral
switching to hundreds of shippers. This plan is designed to provide Houston area
shippers with access to a competitive alternative for their rail service
provider. A response from the STB is not expected until fourth quarter 1998.
RESULTS OF OPERATIONS
Segment revenues, operating income and net income comparisons follow (dollars in
millions):
Three Months Six Months
Ended June 30, Ended June 30,
1998 1997 1998 1997
--------- -------- --------- --------
Revenues:
Transportation $ 152.9 $ 139.9 $ 305.4 $ 274.2
Financial Asset Management 169.7 112.7 312.9 216.2
--------- -------- --------- --------
Total $ 322.6 $ 252.6 $ 618.3 $ 490.4
========= ======== ========= ========
Operating Income:
Transportation $ 29.8 $ 14.1 $ 61.8 $ 28.1
Financial Asset Management 74.6 53.3 133.0 94.9
--------- -------- --------- --------
Total $ 104.4 $ 67.4 $ 194.8 $ 123.0
========= ======== ========= ========
Net Income:
Transportation $ 9.4 $ 0.3 $ 18.6 $ 3.3
Financial Asset Management 49.3 31.5 86.3 57.0
--------- -------- --------- --------
Total $ 58.7 $ 31.8 $ 104.9 $ 60.3
========= ======== ========= ========
The Company reported second quarter 1998 earnings of $58.7 million, or $0.51 per
diluted share, compared to $31.8 million, or $0.29 per diluted share in second
quarter 1997. Consolidated second quarter 1998 revenues increased $70 million,
or 28%, compared to the same period in 1997 as a result of improvements in both
of the Company's segments. Operating income for the three months ended June 30,
1998 increased 55% to $104.4 million versus comparable 1997, largely due to
higher revenues in both segments, together with overall lower operating expenses
for the Transportation segment. Total equity earnings in unconsolidated
affiliates increased $2.0 million, reflecting higher equity earnings from the
investment in DST coupled with a decrease in the losses related to the
investment in Grupo TFM. Interest expense for the three months ended June 30,
1998 was approximately 19% higher than comparable 1997 as a result of
indebtedness associated with the Company's investment in Grupo TFM ( interest
expense related to the Company's investment in Grupo TFM was capitalized during
the three and six month periods ended June 30, 1997).
For the six months ended June 30, 1998, consolidated earnings were $104.9
million, or $0.92 per diluted share, versus $60.3 million, or $0.55 per diluted
share in comparable 1997. Year to date 1998 consolidated revenues increased 26%
to $618.3 million compared to the same period in 1997, primarily due to the
growth in assets under management in the Financial Asset Management segment and
increased freight revenues in the Transportation segment. These increased
revenues, as well as lower operating expenses for the
14
Transportation segment for the six months ended 1998, led to a 58% improvement
in operating income. Year to date 1998 equity earnings of unconsolidated
affiliates increased by $.1 million, mainly because of earnings improvements at
DST, offset by an increase in the equity losses in Grupo TFM. Interest expense
for the six months ended June 30, 1998 was approximately 23% higher than
comparable 1997 primarily as a result of indebtedness related to Grupo TFM as
discussed above.
TRANSPORTATION
Three Months Ended June 30, 1998 Compared With The Three Months Ended
June 30, 1997
THREE MONTHS ENDED JUNE 30, 1998 THREE MONTHS ENDED JUNE 30, 1997
-------------------------------- --------------------------------
(in millions)
Holding Company Holding Company
and Transportation- and Transportation-
Related Consolidated Related Consolidated
KCSR Affiliates Transportation KCSR Affiliates Transportation
Revenues $ 138.6 $ 14.3 $ 152.9 $ 126.2 $ 13.7 $ 139.9
Costs and expenses 95.8 12.9 108.7 99.5 11.3 110.8
Depreciation and amortization 12.7 1.7 14.4 13.7 1.3 15.0
--------- --------- -------- --------- --------- --------
Operating income (loss) 30.1 (0.3) 29.8 13.0 1.1 14.1
Equity in net earnings (losses) of
unconsolidated affiliates:
Grupo TFM - (2.1) (2.1) - (3.0) (3.0)
Other 0.5 (0.3) 0.2 0.6 0.4 1.0
Interest expense (9.1) (5.9) (15.0) (9.5) (1.7) (11.2)
Other, net 3.8 0.1 3.9 0.6 0.3 0.9
--------- --------- -------- --------- --------- --------
Pretax income (loss) 25.3 (8.5) 16.8 4.7 (2.9) 1.8
Income tax provision (benefit) 9.9 (2.5) 7.4 2.1 (0.6) 1.5
--------- ---------- -------- --------- --------- --------
Net income (loss) $ 15.4 $ (6.0) $ 9.4 $ 2.6 $ (2.3) $ 0.3
========= ========== ======== ========= ========= ========
The Transportation segment reported earnings of $9.4 million for the three
months ended June 30, 1998, a $9.1 million increase over the three months ended
June 30, 1997. Exclusive of interest expense and equity losses from the
Company's investment in Grupo TFM of $4.9 and $3.1 million in second quarter
1998 and 1997, respectively, earnings improved $10.9 million for the period to
$14.3 million from $3.4 million. Increased earnings were largely because KCSR
more than quadrupled its net income quarter to quarter.
Total Transportation segment revenues increased $13.0 million, or 9.3%, to
$152.9 million for the three months ended June 30, 1998, from $139.9 million for
the three months ended June 30, 1997. This growth was driven primarily by higher
KCSR revenues, which grew $12.4 million, or nearly 10%, quarter to quarter. KCSR
revenues climbed to $138.6 million for the three months ended June 30, 1998 from
$126.2 million for the comparable 1997 period, primarily as a result of higher
carloads across all primary commodity groups, which in total increased 14.3%
(4.9% of increase relates to intermodal unit volume) to 224,169 from quarter to
quarter. The following is a summary of KCSR's major commodity groups:
Agricultural and mineral products - Agricultural and mineral product
revenues increased 4.4%, to $21.9 million for the three months ended June 30,
1998, from $21.0 million for the comparable 1997 period, primarily as a result
of higher carloads of food and non-metallic minerals, as well as increased
freight revenue per carload for food and metallic ore products. A portion of
these increases can be attributed to Mexican import and export traffic through
Grupo TFM.
Chemical and petroleum products - Chemical and petroleum product
revenues increased $2.6 million, or 8.0%, to $35.1 million for the three months
ended June 30, 1998, from $32.5 million for the three months ended June 30,
1997. Increased revenues resulted from higher miscellaneous chemicals and soda
ash
15
shipments and improved revenue per carload from plastic products, partially
offset by a reduction of petroleum product carloads. Higher miscellaneous
chemical shipments partially resulted from the growing economy, while the
increased revenue per carload for plastics resulted in part from a decreased
emphasis on certain low margin business.
Paper and forest products - Paper and forest product revenues increased
$1.1 million, or 4.2%, to $27.1 million for the three months ended June 30, 1998
from $26.0 million for the three months ended June 30, 1997. Increases in pulp,
paper and lumber revenues were partially offset by a decline in pulpwood and
plywood revenues. Improved lumber shipments have resulted from the strong home
building and remodeling market and pulp/paper increases are a result of paper
mill expansions.
Coal - Coal revenues increased $3.7 million, or 14.1%, to $30.0 million
for the three months ended June 30, 1998 from $26.3 million for the three months
ended June 30, 1997, as a result of significantly higher unit coal traffic
(increase of 11,805 carloads, or 29.6%). During 1997, one of KCSR's coal
customers experienced a plant shutdown for a substantial part of the first six
months of the year and another customer experienced operating problems. These
factors contributed to depressed revenues for the second quarter 1997. These
operating difficulties had been resolved by first quarter 1998, and thus, more
unit coal trains were shipped to these customers during second quarter 1998
compared with the same 1997 period. This increase in volume resulted in
additional revenues of approximately $2.6 million. The remainder of the revenue
increase results from increased capacity at several other plants served by KCSR.
Intermodal and other - Intermodal and other revenues increased $2.8
million, or 18.9%, to $17.4 million for the three months ended June 30, 1998,
from $14.6 million for the comparable 1997 period. This increase is comprised of
higher intermodal revenues of $1.5 million arising from more intermodal unit
shipments (25.4%) quarter to quarter.
Exclusive of depreciation and amortization expenses, the Transportation
segment's operating expenses decreased $2.1 million, or 1.9%, to $108.7 million
for the three months ended June 30, 1998 from $110.8 million for the three
months ended June 30, 1997. This decrease was fueled by operating efficiencies
at KCSR as it continues to focus on cost containment. Total KCSR second quarter
expenses were $3.7 million lower than second quarter 1997, and variable
operating expenses as a percentage of revenues decreased more than 7% from
second quarter 1997. Lower costs were experienced in salaries and wages, fuel
and lease expense. Salaries and wages decreased $2.2 million quarter to quarter
as a result of the termination of a union Productivity Fund, which occurred
during fourth quarter 1997, as well as lower overtime costs. Second quarter 1998
fuel expense decreased $0.7 million as compared with the same 1997 period
arising from a decrease in average fuel cost of 15% partially offset by an
increase in fuel usage of 8%. Second quarter 1998 lease expense decreased nearly
$1.5 million from second quarter 1997 due to the non-renewal of certain expired
trailer leases due to the more efficient usage of the trailer fleet, as well as
a shift toward utilizing more containers. These lower expenses were partially
offset by an increase in materials and supplies expense related to maintenance
on locomotives and equipment.
Depreciation and amortization expenses declined $0.6 million (4.0%) to $14.4
million for the three months ended June 30, 1998 from $15.0 million for the
comparable 1997 quarter. This decline resulted primarily from the reduction of
amortization and depreciation expense arising from the impairment of goodwill
and certain branch lines held for sale recorded during December 1997, the effect
of which was not realized until 1998. This decline was partially offset by
increased depreciation from property additions.
Driven by increased revenues and decreased operating expenses as discussed
above, the Transportation segment's operating income increased $15.7 million, or
111.3% to $29.8 million for the three months ended June 30, 1998 from $14.1
million for the three months ended June 30, 1997. KCSR's operating ratio for the
16
second quarter 1998 was 78.1% compared with 88.4% in second quarter 1997. This
significant improvement quarter to quarter highlights the improved margins
resulting from increased revenues and the continuing success of the Company's
cost containment efforts.
Operating income for the Holding Company and Transportation related affiliates
declined $1.4 million quarter to quarter as a result of higher holding company
expenses, particularly costs associated with efforts to obtain permanent rail
access to the Houston, Texas marketplace.
The Transportation segment recorded equity in net losses of $2.1 million from
its investment in Grupo TFM for the three months ended June 30, 1998 compared to
equity in net losses of $3.0 million for the three months ended June 30, 1997.
Grupo TFM losses for second quarter 1997 represent its results of operations
from June 23, 1997 and include a $2.6 million charge representing the Company's
proportionate share of a one-time charge recorded by Grupo TFM with respect to
financing-related fees.
Transportation segment interest expense increased $3.8 million, or 33.9%, to $15
million for the three months ended June 30, 1998 from $11.2 million for the
three months ended June 30, 1997 primarily as a result of indebtedness related
to the Company's investment in Grupo TFM (interest in 1997 related to Grupo TFM
was capitalized until operations commenced in late June, 1997). Other, net
increased to $3.9 million for the second quarter 1998 from $0.9 million for the
comparable 1997 period resulting primarily from a one-time gain of $2.9 million
from the sale of a branch line by KCSR.
Six Months Ended June 30, 1998 Compared With The Six Months Ended June 30, 1997
SIX MONTHS ENDED JUNE 30, 1998 SIX MONTHS ENDED JUNE 30, 1997
------------------------------------ -----------------------------------
(in millions)
Holding Company Holding Company
and Transportation- and Transportation-
Related Consolidated Related Consolidated
KCSR Affiliates Transportation KCSR Affiliates Transportation
Revenues $ 274.3 $ 31.1 $ 305.4 $ 247.2 $ 27.0 $ 274.2
Costs and expenses 189.7 25.5 215.2 193.0 22.6 215.6
Depreciation and amortization 25.3 3.1 28.4 27.3 3.2 30.5
--------- --------- -------- --------- --------- --------
Operating income 59.3 2.5 61.8 26.9 1.2 28.1
Equity in net earnings (losses) of
unconsolidated affiliates:
Grupo TFM - (5.2) (5.2) - (3.0) (3.0)
Other 1.0 (0.7) 0.3 1.1 0.4 1.5
Interest expense (18.2) (11.8) (30.0) (19.2) (3.4) (22.6)
Other, net 5.4 1.7 7.1 3.0 0.4 3.4
--------- --------- -------- --------- --------- --------
Pretax income (loss) 47.5 (13.5) 34.0 11.8 (4.4) 7.4
Income tax provision (benefit) 18.6 (3.2) 15.4 5.2 (1.1) 4.1
--------- ---------- -------- --------- --------- --------
Net income (loss) $ 28.9 $ (10.3) $ 18.6 $ 6.6 $ (3.3) $ 3.3
========= ========== ======== ========= ========= ========
The Transportation segment reported earnings of $18.6 million for the six months
ended June 30, 1998, a $15.3 million increase over the six months ended June 30,
1997. Exclusive of interest expense and equity losses from the Company's
investment in Grupo TFM of $10.7 and $3.1 million for the first six months of
1998 and 1997, respectively, earnings improved $22.9 million for the period to
$29.3 million from $6.4 million. Increased earnings were largely because KCSR
more than quadrupled its net income period to period.
Total revenues increased $31.2 million, or 11.4%, to $305.4 million for the six
months ended June 30, 1998, from $274.2 million for the six months ended June
30, 1997. This growth was driven primarily by higher
17
KCSR revenues, which grew $27.1 million, or nearly 11%, period to period. Also
contributing to the increase was Gateway Western revenues which increased $1.6
million, or 8%, for the six month period ended June 30, 1998 versus the
comparable 1997 period. KCSR revenues grew to $274.3 million for the six months
ended June 30, 1998 from $247.2 million for the same 1997 period, primarily as a
result of higher carloads across all primary commodity groups, which in total
increased 14.5% (4.4% of increase relates to intermodal unit volume) to 443,828
from period to period. The following is a summary of KCSR's major commodity
groups:
Agricultural and mineral products - Agricultural and mineral product
revenues increased 9.8%, to $44.7 million for the six months ended June 30,
1998, from $40.7 million for the comparable 1997 period primarily as a result of
higher carloads for export grain, food and non-metallic mineral products and
higher freight revenue per carload for export grain and food products. As
mentioned above in the second quarter analysis, a portion of these increases can
be attributed to the Mexican import and export traffic through Grupo TFM.
Agricultural and mineral products accounted for 17.1% of total carload revenues
for the six months ended June 30, 1998 compared with 17.3% for the comparable
1997 period.
Chemical and petroleum products - Chemical and petroleum product
revenues increased $4.3 million, or 6.5%, to $69.7 million for the six months
ended June 30, 1998, from $65.4 million for the six months ended June 30, 1997.
Similar to trends experienced in second quarter 1998 as discussed above, this
increase results from higher traffic from miscellaneous chemicals and soda ash
shipments and higher revenue per carload from plastic products, partially offset
by a reduction of petroleum product carloads. Chemical and petroleum products
accounted for 26.6% of total carload revenues for the six months ended June 30,
1998 versus 27.7% for the six months ended June 30, 1997.
Paper and forest products - Paper and forest product revenues increased
$1.9 million , or 3.7%, to $54.2 million for the six months ended June 30, 1998
from $52.3 million for the six months ended June 30, 1997. These improvements
mirror the trends discussed above in the second quarter analysis and result from
higher pulp, paper and lumber revenues, partially offset by a decline in
pulpwood and plywood revenues. Paper and forest products accounted for 20.8% and
22.2% of total carload revenues for the six months ended June 30, 1998 and 1997,
respectively.
Coal - Coal revenues increased $10.6 million, or 22.1%, to $58.5
million for the six months ended June 30, 1998 from $47.9 million for the
comparable 1997 period, as a result of significantly higher unit coal traffic
(increase of 26,479 carloads, or 34.4%). During the first six months of 1997,
unit coal revenues were affected by unplanned outages at utilities served by
KCSR as discussed above, as well as first quarter weather problems affecting
carriers and mines originating the coal. During the first half of 1998, there
were no significant outages or weather problems affecting coal delivery. As a
result, during the six months ended June 30, 1998, more unit coal trains were
shipped to customers that had experienced outages during 1997 resulting in
increased revenues of approximately $4.2 million. In addition, 1998 results
reflect the addition of a utility customer that was not served by KCSR during
the first three months of 1997. The remainder of the revenue increase results
from increased capacity at several plants served by KCSR. Coal accounted for
22.4% and 20.3% of total carload revenues for the six months ended June 30, 1998
and 1997, respectively.
Intermodal and other - Intermodal and other revenues increased $4.8
million, or 16.1%, to $34.3 million for the six months ended June 30, 1998, from
$29.5 million for the comparable 1997 period. This improvement is primarily the
result of higher intermodal revenues of $3.2 million arising from increased
intermodal traffic of 24.2% period to period. Intermodal and other accounted for
13.1% of total carload revenues for the six months ended June 30, 1998 compared
with 12.5% for the six months ended June 30, 1997.
18
Exclusive of depreciation and amortization expenses, the Transportation
segment's operating expenses decreased $0.4 million to $215.2 million for the
six months ended June 30, 1998 from $215.6 million for the six months ended June
30, 1997. This decrease was fueled by operating efficiencies at KCSR as it
continues to focus on cost containment. Total KCSR year to date expenses were
$3.3 million lower than the comparable 1997 period, and variable operating
expenses as a percentage of revenues decreased more than 7% from the six months
ended June 30, 1997. Lower costs were experienced in salaries and wages, fuel,
lease and casualties expense. Salaries and wages decreased $2.0 million period
to period as a result of the termination of a union Productivity Fund, which
occurred during fourth quarter 1997, as well as lower overtime costs. Year to
date 1998 fuel expense decreased $1.3 million as compared with the same 1997
period arising from a decrease in average fuel cost of over 16% partially offset
by an increase in fuel usage of nearly 10%. Similar to the trends noted during
second quarter 1998 as discussed above, lease expense for the first six months
of 1998 decreased $1.9 million as compared to the same 1997 period. Casualties
expense declined nearly $1.0 million period to period as a result of a costly
1997 train derailment, which escalated 1997 expense. These lower expenses were
partially offset by an increase in materials and supplies expense related to
maintenance on locomotives and equipment.
Depreciation and amortization expenses declined $2.1 million (6.9%) to $28.4
million for the six months ended June 30, 1998 from $30.5 million for the
comparable 1997 period. This decline resulted primarily from the reduction of
amortization and depreciation expense arising from the impairment of goodwill
and certain branch lines held for sale recorded during December 1997, the effect
of which was not realized until 1998. This decline was partially offset by
increased depreciation from property additions.
Operating income increased $33.7 million, or 119.9% to $61.8 million for the six
months ended June 30, 1998 from $28.1 million for the six months ended June 30,
1997, as a result of increased revenues and decreased operating expenses as
discussed above. KCSR's operating ratio for the first six months of 1998 was
78.2% compared with 87.9% for the six months ended June 30, 1997. This
significant improvement period to period highlights the improved margins
resulting from increased revenues and the continuing success of the Company's
cost containment efforts.
The Transportation segment recorded equity in net losses of $5.2 million from
its investment in Grupo TFM for the six months ended June 30, 1998 compared to
equity in net losses of $3.0 million for the six months ended June 30, 1997.
Grupo TFM losses for the six months ended June 30, 1997 represent its results of
operations from June 23, 1997 and include a $2.6 million charge representing the
Company's proportionate share of a one-time charge recorded by Grupo TFM with
respect to financing-related fees.
Interest expense increased $7.4 million, or 32.7%, to $30.0 million for the six
months ended June 30, 1998 from $22.6 million for the six months ended June 30,
1997 primarily as a result of indebtedness related to the Company's investment
in Grupo TFM (interest in 1997 related to Grupo TFM was capitalized until
operations commenced in late June, 1997). Other, net increased to $7.1 million
for the first six months of 1998 from $3.4 million for the comparable 1997
period resulting primarily from a one-time gain of $2.9 million from the sale of
a branch line.
19
FINANCIAL ASSET MANAGEMENT
Three Months Ended June 30, 1998 Compared With The Three Months Ended
June 30, 1997
THREE MONTHS ENDED JUNE 30, 1998 THREE MONTHS ENDED JUNE 30, 1997
-------------------------------- --------------------------------
(in millions)
Holding Company Holding Company
Janus and FAM- Janus and FAM-
and Related Consolidated and Related Consolidated
Berger Affiliates FAM Berger Affiliates FAM
Revenues $ 166.1 $ 3.6 $ 169.7 $ 113.1 $ (0.4) $ 112.7
Costs and expenses 84.0 7.6 91.6 54.6 1.4 56.0
Depreciation and amortization 3.0 0.5 3.5 3.3 0.1 3.4
--------- --------- -------- --------- --------- --------
Operating income (loss) 79.1 (4.5) 74.6 55.2 (1.9) 53.3
Equity in net earnings of
unconsolidated affiliates:
DST Systems, Inc. - 7.5 7.5 - 5.7 5.7
Other 0.3 - 0.3 0.2 - 0.2
Interest income (expense) (1.7) 0.5 (1.2) (1.7) (0.7) (2.4)
Other, net 10.4 0.9 11.3 1.3 2.1 3.4
--------- --------- -------- --------- --------- --------
Pretax income 88.1 4.4 92.5 55.0 5.2 60.2
Income tax provision (benefit) 34.4 (0.9) 33.5 22.0 0.8 22.8
Minority interest 9.7 - 9.7 5.9 - 5.9
--------- --------- -------- --------- --------- --------
Net income $ 44.0 $ 5.3 $ 49.3 $ 27.1 $ 4.4 $ 31.5
========= ========= ======== ========= ========= ========
Financial Asset Management contributed $49.3 million to KCSI's 1998 second
quarter consolidated earnings, an increase of 56% over comparable 1997. Average
assets under management by Janus and Berger were 49% higher during second
quarter 1998 than second quarter 1997 leading to a $57.0 and $21.3 million
increase in revenues and operating income, respectively, over second quarter
1997.
Assets under management increased $9.1 billion during second quarter 1998 as a
result of net sales of $2.8 billion and market appreciation of $6.3 billion.
Assets under management totaled $93.3 billion at June 30, 1998 ($89.1 billion at
Janus; $4.2 billion at Berger) versus $71.6 billion at December 31, 1997 and
$63.6 billion at June 30, 1997. See discussion of Janus and Berger activity
separately below.
Second quarter 1998 FAM operating expenses increased to $95.1 million from $59.4
million in the prior year quarter, primarily due to the rapid revenue growth
during the period. Higher expenses were evident in salaries and wages (primarily
investment performance-based incentive compensation), marketing and fulfillment,
and alliance fees under mutual fund "supermarket" distribution arrangements.
Second quarter 1998 equity earnings from DST increased to $7.5 million from $5.7
million in comparable 1997, primarily due to higher mutual fund, output
processing and other revenues, as well as continued revenue and earnings
improvements in DST's international operations. In addition, operating margins
increased from 13.5% for second quarter 1997 to 15.2% for second quarter 1998.
Nelson results are included as part of Holding Company and FAM-Related
Affiliates. Nelson revenues during second quarter 1998 were approximately $3.6
million. Nelson operating expenses, coupled with higher FAM holding company
costs (e.g., consulting and legal fees associated with efforts to effect the
Spin-off), comprise the increase in operating expenses within the Holding
Company and FAM-Related Affiliates component.
20
Financial Asset Management interest expense for the second quarter 1998
decreased over comparable 1997 as a result of lower average debt balances during
second quarter 1998, primarily due to repayments using cash dividends from
Janus. Other, net increased from prior year second quarter due to an $8.8
million one-time gain recognized on the sale of the Janus equity investment in
IDEX Management ("IDEX") during the second quarter 1998.
Six Months Ended June 30, 1998 Compared With The Six Months Ended June 30, 1997
SIX MONTHS ENDED JUNE 30, 1998 SIX MONTHS ENDED JUNE 30, 1997
------------------------------ ------------------------------
(in millions)
Holding Company Holding Company
Janus and FAM- Janus and FAM-
and Related Consolidated and Related Consolidated
Berger Affiliates FAM Berger Affiliates FAM
Revenues $ 309.3 $ 3.6 $ 312.9 $ 216.7 $ (0.5) $ 216.2
Costs and expenses 163.1 10.5 173.6 112.2 2.7 114.9
Depreciation and amortization 5.6 0.7 6.3 6.2 0.2 6.4
--------- --------- -------- --------- --------- --------
Operating income (loss) 140.6 (7.6) 133.0 98.3 (3.4) 94.9
Equity in net earnings of
unconsolidated affiliates:
DST Systems, Inc. - 15.0 15.0 - 11.8 11.8
Other 0.6 - 0.6 0.3 - 0.3
Interest expense (3.2) (0.4) (3.6) (3.2) (1.5) (4.7)
Other, net 12.2 2.5 14.7 1.6 5.3 6.9
--------- --------- -------- --------- --------- --------
Pretax income 150.2 9.5 159.7 97.0 12.2 109.2
Income tax provision (benefit) 58.8 (1.8) 57.0 38.4 3.2 41.6
Minority interest 16.4 - 16.4 10.6 - 10.6
--------- --------- -------- --------- --------- --------
Net income $ 75.0 $ 11.3 $ 86.3 $ 48.0 $ 9.0 $ 57.0
========= ========= ======== ========= ========= ========
For the six months ended June 30, 1998, Financial Asset Management contributed
$86.3 million to the Company's consolidated earnings, a 51% increase over the
same period in 1997. This increase was attributable to higher revenues (driven
by growth in assets under management), operating income and equity earnings.
Year to date 1998 revenues increased 45% to $312.9 million and operating income
40% to $133.0 million compared to the six months ended June 30, 1997. Assets
under management increased $21.7 billion during the first six months of 1998,
driven by net sales of $5.1 billion and market appreciation of $16.6 billion.
Shareowner accounts numbered nearly 2.9 million as of June 30, 1998 (a 6%
increase from December 31, 1997).
Year to date 1998 operating expenses increased to $179.9 million from $121.3
million in comparable 1997. This increase is indicative of the rapid revenue
growth experienced throughout 1997 and the first half of 1998. Higher expenses
were evident in salaries and wages (see comment in quarterly review above),
marketing and fulfillment, alliance distribution fees and costs attributable to
expenditures for Year 2000 compliance and efforts to effect the Spin-off.
Year to date 1998 equity earnings from DST increased 27% over the same period in
1997 as a result of the same operating trends affecting the quarter as discussed
above. Also, U.S. mutual fund shareowner accounts serviced by DST totaled 48.2
million at June 30, 1998, an increase of 7.1% from December 31, 1997 and 13.7%
from June 30, 1997.
21
Year to date 1998 interest expense decreased and other, net increased from
comparable 1997 as discussed in the quarterly review above. Also contributing to
the improvement in other, net was increased interest income during the six
months ended June 30, 1998 resulting from higher levels of income-producing
short-term investments held by Janus and Berger.
A brief discussion of Janus and Berger activity during the six months ended June
30, 1998 follows:
Janus
Janus continues to report growth in assets under management - a 31%
increase from December 31, 1997. Assets in the Janus Advised Funds (i.e.,
Janus No-Load, Aspen Series and WRL Series) increased 32% from December
31, 1997. Also, assets in private, institutional and sub-advised accounts
grew 27% from year end 1997. These increases are attributable to several
factors, including, among others: (i) the investment performance of the
Janus group of mutual funds, as evidenced by 85% of (separately tracked)
Janus funds ranking in the first quartile when compared to their
respective peer categories based on product performance over a rolling
one-year period through June 30, 1998 (using data from Lipper Analytical
Services, Inc.); (ii) continued growth through new monies, particularly a
result of increasing marketing efforts during the first half of 1998; and
(iii) competitive levels of expenses and fees compared to industry
standards.
Berger
Berger introduced four new funds during fourth quarter 1997, the Berger
Small Cap Value Fund, the Berger Balanced Fund, the Berger Mid Cap Fund
and the Berger Select Fund. As of June 30, 1998 these four funds had
combined assets under management of $283 million (an 82% increase since
December 31, 1997) and the latter three ranked in the first quartile of
their respective peer groups for the first two quarters of 1998. In
addition, the Berger/BIAM International Fund has increased assets under
management for each month during 1998, reaching $428.4 million at June
30, 1998 (which is more than twice the amount of assets managed as of
December 31, 1997).
TRENDS AND OUTLOOK
The Company reported a 76% improvement in second quarter 1998 diluted earnings
per share compared to second quarter 1997. Year to date 1998 diluted earnings
per share were 67% higher than the same period in 1997. Second quarter and year
to date 1998 earnings from the Financial Asset Management segment reflect
continued growth in assets under management resulting in significantly higher
revenues and operating income for both periods. Despite equity losses from Grupo
TFM of $2.1 and $5.2 million for the three and six month periods ended June 30,
1998, the Transportation segment continued its earnings improvement, raising net
income by $9.1 and $15.3 million compared to the three and six months ended June
30, 1997, respectively, largely attributable to KCSR, which quadrupled its net
income for both the three and six months ended June 30, 1998.
A current outlook for the Company's businesses for the remainder of 1998 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. Based on anticipated traffic levels,
revenues are expected to experience growth during the remainder of 1998.
Variable costs and expenses are expected to continue at levels
proportionate with revenue activity.
22
ii) Financial Asset Management - Future growth will be largely dependent on
prevailing financial market conditions, the relative performance of
Janus, Berger and Nelson products, the introduction and market reception
of new products, as well as other factors. Based on the higher level of
assets under management starting the third quarter 1998, revenues for the
remainder of 1998 are expected to exceed comparable prior year periods.
Costs and expenses are expected to continue at operating levels
consistent with the rate of growth, if any, in revenues.
iii) Equity Investments - The Company expects to continue to participate in
the earnings/losses from its equity investments in DST, Grupo TFM,
Southern Capital and Mexrail. The Company expects to report equity losses
from Grupo TFM during the remainder of 1998 as it continues its efforts
to develop the potential of the Mexico's Northeast rail lines.
LIQUIDITY AND CAPITAL RESOURCES
Summary cash flow data is as follows (in millions):
Six Months
Ended June 30,
1998 1997
Cash flows provided by (used for):
Operating activities $ 65.2 $ 80.1
Investing activities (46.4) (292.6)
Financing activities (43.5) 207.7
--------- ----------
Cash and equivalents:
Net decrease (24.7) (4.8)
At beginning of year 33.5 22.9
--------- ----------
At end of period $ 8.8 $ 18.1
========= ==========
During the six months ended June 30, 1998, the Company's cash position decreased
$24.7 million from December 31, 1997. This decrease was caused primarily by cash
used for property acquisitions, debt repayments and the purchase of Nelson,
offset partially by positive operating cash flows, borrowings and proceeds from
the sale of a branch line property by KCSR and the equity investment in IDEX by
Janus.
Year to date 1998 operating cash flows decreased $14.9 million compared to the
same period in 1997. This decrease was chiefly attributable to the $24.2 million
payment during first quarter 1998 related to the termination of a union
Productivity Fund and increases in accounts receivable and other current assets,
offset partially by increased net income and changes in other working capital
components.
Cash flows used for investing activities for the six months ended June 30, 1998
were $246.2 million lower compared with the same 1997 period. Investing
expenditures for the six months ended June 30, 1998 were primarily comprised of
the investment in Nelson and KCSR property additions. Cash flows used for the
six months ended June 30, 1997 included the Company's approximate $277 million
capital contribution to Grupo TFM made during the first quarter 1997. Cash
received from investing activities was generated primarily from the sale of the
equity investment in IDEX by Janus and from property disposals.
Financing cash flows were used primarily for the repayment of long-term debt and
dividends, partially offset by borrowings to fund the KCSR Union Productivity
Fund termination and the Nelson acquisition, as well as proceeds from the
issuance of common stock under stock plans. Financing cash flows for the first
six months of 1998 decreased $251.2 million from the comparable 1997 period due
to $298.0 million of borrowings under credit lines in 1997 used primarily to
fund the Grupo TFM capital contribution.
23
Cash flows from operations are expected to increase during the remainder of 1998
from positive operating income, which has historically resulted in favorable
cash flows. Investing activities will continue to use significant amounts of
cash. Future roadway improvement projects are expected to be funded by KCSR
operating cash flow. Based on the financing arrangements for Grupo TFM,
significant additional contributions from the Company to Grupo TFM are not
expected to be necessary. However, there exists a possible capital call ($74
million) if certain Grupo TFM benchmarks, as outlined in Grupo TFM's financing
arrangements, are not met. Additionally, if circumstances develop in which a
contribution may be requested by Grupo TFM, the Company will evaluate the
contribution based on the merits of the specific underlying need.
In addition to operating cash flows, the Company has financing available through
its various lines of credit (with a maximum borrowing amount of $660 million, of
which $399 million was available at June 30, 1998). Included in the these
various lines of credit is a $100 line of credit obtained during second quarter
1998 for the purpose of providing FAM Holdings with its own credit facility.
Because of certain financial covenants contained in the credit agreements,
however, maximum utilization of the Company's available lines of credit may be
restricted. During July 1998, the Company refinanced the $100 million 5.75%
Notes that were due using borrowings under its lines of credit. 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. As discussed earlier, subsequent to the planned Spin-off (which is
subject to favorable IRS tax ruling), a portion of the Registration Statement
may be used to sell additional shares of KCSI common stock. The Company believes
its operating cash flows and available financing resources are sufficient to
fund working capital and other requirements for the remainder of 1998.
The Company's debt ratio (total debt as a percent of total debt plus equity) at
June 30, 1998 was 50.2% compared to 56.8% at December 31, 1997. Company
consolidated debt decreased $44.9 million from December 31, 1997 (to $871.7
million at June 30, 1998) primarily as a result of repayments of debt exceeding
borrowings. Consolidated equity increased $166.5 million from December 31, 1997
primarily as a result of net income of $104.9 million, a $42.9 million non-cash
equity adjustment related to unrealized gains on "available for sale" securities
held by affiliates and stock options exercised, offset partially by common stock
repurchases and dividends paid. The increase in equity coupled with the decrease
in debt resulted in a decrease in the debt ratio from December 31, 1997.
Management anticipates that the debt ratio will continue to decrease slightly
during the remainder of 1998 as a result of continued debt repayments and
profitable operations. Note, however, that unrealized gains on "available for
sale" securities, which are included, net of deferred taxes, as a component of
stockholders' equity, are contingent on market conditions and thus, are subject
to significant fluctuations in value. Significant declines in the value of these
securities would negatively impact stockholders' equity and increase the
Company's debt ratio.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable
24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Part I, Item 1. Financial Statements, Note 11 to the Consolidated Condensed
Financial Statements of this Form 10-Q is hereby incorporated herein by
reference.
Item 4. Submission of Matters to a Vote of Security Holders
a) The Company held a Special Meeting of Stockholders ("Special Meeting")
on July 15, 1998 to vote on four proposals, including an Amendment to
the Company's Certificate of Incorporation to Effect a Reverse Stock
Split, contingent upon market conditions and the completion of the
Spin-off of the Financial Asset Management segment. A total of
82,584,039 shares of the Common Stock, $.01 per share par value, and
Preferred Stock, par value $25.00 per share, or 75.4% of the outstanding
voting stock on the record date, was represented at the Special Meeting,
thereby constituting a quorum. These shares voted together as a single
class.
b) Proxies for the meeting were solicited pursuant to Regulation 14A.
Listed below is each of the matters voted on at the Company's Annual
Meeting. Each of these matters is fully described in the Company's
Definitive Proxy Statement for the Special Meeting. The voting was as
follows:
Total
Shares
Approval of an Amendment
to KCSI's Certificate of Incorporation
to Effect a Reverse Stock Split (Contingent upon Spin-off)
For 78,670,743
Against 3,478,407
Abstentions 434,889
Non-votes -
----------------
Total 82,584,039
Approval of the Berger Associates, Inc.
Stock Option Plan
For 75,792,317
Against 5,845,781
Abstentions 945,941
Non-votes -
----------------
Total 82,584,039
Approval of the FAM Holdings, Inc. 1998 Long
Term Incentive Stock Plan
For 74,093,832
Against 7,164,902
Abstentions 1,325,305
Non-votes -
----------------
Total 82,584,039
25
Approval of KCSI's Amended and Restated
1991 Stock Option and Performance Award Plan
For 52,004,334
Against 29,706,692
Abstentions 873,013
Non-votes -
----------------
Total 82,584,039
Based upon the majority of affirmative votes of total outstanding shares at the
record date, the proposal for Approval of an Amendment to KCSI's Certificate of
Incorporation to Effect a Reverse Stock Split passed.
Based upon the majority of affirmative votes of the shares present at the
Special Meeting required for approval, each of the other matters passed.
Item 5. Other Information
The Securities Exchange Commission ("SEC") recently amended its proxy rules to
require a registrant, such as the Company, to disclose the date after which
stockholder proposals that are not to be included in the Company's proxy
statement are considered "untimely" for proxy solicitation purposes. Under the
Company's By-laws, in order for such a stockholder proposal to be timely and
otherwise validly brought before the Company's 1999 Annual Meeting of
Stockholders, a stockholder must notify the Company's Corporate Secretary no
earlier than February 2, 1999 and no later than March 19, 1999 (assuming a
meeting date of May 4, 1999). The calculation of this notice period and By-law
requirement for the contents of such notice are set forth in the Company's 1998
proxy statement, which can be obtained by contacting the SEC's Public Reference
Branch or in the SEC's EDGAR database accessible through the SEC's website on
the World Wide Web at www.sec.gov.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit 27.1 - Financial Data Schedule
b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated April 20, 1998
under Items 5 and 9, reporting the acquisition of Nelson Money
Managers PLC, a United Kingdom based investment management company,
using a combination of cash, Company Common Stock and notes payable.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized and in the capacities indicated on August 13, 1998.
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)