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, 1999
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 August 6, 1999
Common Stock, $.01 per share par value 110,487,692 Shares
- --------------------------------------------------------------------------------
KANSAS CITY SOUTHERN INDUSTRIES, INC.
FORM 10-Q
JUNE 30, 1999
INDEX
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Introductory Comments 1
Consolidated Condensed Balance Sheets -
June 30, 1999 and December 31, 1998 2
Consolidated Condensed Statements of Income and Comprehensive Income -
Three and Six Months Ended June 30, 1999 and 1998 3
Computation of Basic and Diluted Earnings per Common Share 3
Consolidated Condensed Statements of Cash Flows -
Six Months Ended June 30, 1999 and 1998 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 31
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 6. Exhibits and Reports on Form 8-K 32
SIGNATURES 33
KANSAS CITY SOUTHERN INDUSTRIES, INC.
FORM 10-Q
JUNE 30, 1999
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, 1998, 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, 1999 are not necessarily indicative of the results
expected for the full year 1999.
2
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in Millions)
(Unaudited)
June 30, December 31,
1999 1998
ASSETS
Current Assets:
Cash and equivalents $ 139.3 $ 27.2
Investments in advised funds 114.2 149.1
Accounts receivable, net 234.4 208.4
Inventories 50.2 47.0
Other current assets 37.8 37.8
----------- -----------
Total current assets 575.9 469.5
Investments held for operating purposes 758.5 707.1
Properties (net of $593.6 and $567.1 accumulated
depreciation and amortization, respectively) 1,283.9 1,266.7
Intangibles and Other Assets, net 194.3 176.4
----------- -----------
Total assets $ 2,812.6 $ 2,619.7
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt due within one year $ 11.0 $ 10.7
Accounts and wages payable 134.6 125.8
Accrued liabilities 170.0 159.7
----------- -----------
Total current liabilities 315.6 296.2
----------- -----------
Other Liabilities:
Long-term debt 811.6 825.6
Deferred income taxes 433.9 403.6
Other deferred credits 126.1 128.8
----------- -----------
Total other liabilities 1,371.6 1,358.0
----------- -----------
Minority Interest in consolidated subsidiaries 33.7 34.3
----------- -----------
Stockholders' Equity:
Preferred stock 6.1 6.1
Common stock 1.1 1.1
Retained earnings 993.7 849.1
Accumulated other comprehensive income 90.8 74.9
----------- -----------
Total stockholders' equity 1,091.7 931.2
----------- -----------
Total liabilities and stockholders' equity $ 2,812.6 $ 2,619.7
============ ============
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,
1999 1998 1999 1998
Revenues $ 430.9 $ 322.6 $ 816.1 $ 618.3
Costs and expenses 273.4 200.3 515.9 388.8
Depreciation and amortization 22.3 17.9 43.4 34.7
---------- --------- ---------- ----------
Operating Income 135.2 104.4 256.8 194.8
Equity in net earnings (losses) of unconsolidated affiliates:
DST Systems, Inc. 10.8 7.5 21.5 15.0
Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. 0.5 (2.1) 1.0 (5.2)
Other 2.1 0.5 3.2 0.9
Interest expense (15.3) (16.2) (30.3) (33.6)
Other, net 5.3 15.2 11.1 21.8
---------- --------- ---------- ----------
Pretax Income 138.6 109.3 263.3 193.7
Income tax provision 49.8 40.9 94.7 72.4
Minority interest in
consolidated earnings 12.7 9.7 23.9 16.4
---------- --------- ---------- ----------
Net Income 76.1 58.7 144.7 104.9
Other comprehensive income, net of income tax:
Unrealized gain on securities 17.0 13.0 15.9 42.9
---------- --------- ---------- ----------
Comprehensive Income $ 93.1 $ 71.7 $ 160.6 $ 147.8
========== ========= ========== ==========
Computation of Basic and Diluted Earnings per Common Share
Basic Earnings per Common Share $ 0.69 $ 0.54 $ 1.31 $ 0.96
========== ========= ========== ==========
Diluted Earnings per Common Share $ 0.66 $ 0.51 $ 1.25 $ 0.92
========== ========= ========== ==========
Weighted Average Basic Common
Shares Outstanding (in thousands) 110,253 109,253 110,077 108,894
---------- ---------- ---------- ----------
Weighted Average Diluted Common
Shares Outstanding (in thousands) 114,133 113,303 113,933 112,809
---------- ---------- ---------- ----------
Cash Dividends Paid:
Per Preferred share $ .25 $ .25 $ .50 $ .50
Per Common share .04 .04 .08 .08
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,
1999 1998
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income $ 144.7 $ 104.9
Adjustments to net income:
Depreciation and amortization 43.4 34.7
Deferred income taxes 23.9 22.3
Equity in undistributed earnings (25.7) (10.7)
Distributions from equity investments 0.2 5.5
Gain on sale of equity investments and property (0.2) (14.4)
Minority interest in consolidated earnings 23.9 16.4
Changes in working capital items:
Accounts receivable (26.1) (21.6)
Inventories (3.3) (0.9)
Other current assets (1.8) (17.6)
Accounts and wages payable 5.1 (6.5)
Accrued liabilities 12.7 (23.1)
Prepaid commissions (17.7) -
Other, net (1.7) (0.2)
--------- ----------
Net 177.4 88.8
--------- ----------
INVESTING ACTIVITIES:
Property acquisitions (52.8) (40.2)
Proceeds from disposal of property 0.6 5.2
Investment in and loans with affiliates (14.0) (24.8)
Net sales (purchases) of short-term investments 39.5 (0.7)
Proceeds from disposal of investments - 10.3
Other, net 3.7 3.8
--------- ----------
Net (23.0) (46.4)
--------- ----------
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 31.8 53.8
Repayment of long-term debt (45.6) (105.0)
Proceeds from stock plans 35.5 23.0
Stock repurchased (23.7) (3.5)
Distributions to minority interest (28.5) (23.6)
Cash dividends paid (13.4) (13.4)
Other, net 1.6 1.6
--------- ----------
Net (42.3) (67.1)
--------- ----------
CASH AND EQUIVALENTS:
Net increase (decrease) 112.1 (24.7)
At beginning of year 27.2 33.5
--------- ----------
At end of period $ 139.3 $ 8.8
========= ==========
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 the management 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
subsidiary companies as of June 30, 1999 and December 31, 1998, the results of
operations for the three and six months ended June 30, 1999 and 1998, and cash
flows for the six months ended June 30, 1999 and 1998.
2. The accompanying consolidated condensed financial statements have been
prepared consistently with accounting policies described 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, 1998. The results of operations for
the three and six months ended June 30, 1999 are not necessarily indicative of
the results to be expected for the full year 1999. Certain 1998 information has
been restated to conform to the current period presentation.
3. As previously disclosed, the Company announced its intention to separate the
Transportation and Financial Services segments through a proposed dividend of
the stock of a new holding company for its Financial Services businesses (the
"Separation"). On July 12, 1999, the Company announced that the Internal Revenue
Service ("IRS") has issued a favorable tax ruling with respect to the Separation
and, subject to the consideration of relevant factors, management anticipates
completion of the Separation to occur before the end of 1999.
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 3,879,611 and 3,855,818,
respectively, for the three and six month periods ended June 30, 1999, and
4,049,731 and 3,915,046, respectively for the three and six month periods ended
June 30, 1998. For the three and six month periods ended June 30, 1999, the
weighted average of options to purchase 89,500 and 44,750 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. There were options to purchase 95,000 and
48,500 shares excluded in the diluted earnings per share calculations for the
three and six month periods ended June 30, 1998, respectively.
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 $1.1 million and $1.9 million for the three and six month
periods ended June 30, 1999, respectively, and $0.5 million and $0.9 million for
the three and six month periods ended June 30, 1998, respectively.
5. The Company's inventories ($50.2 million at June 30, 1999 and $47.0 million
at December 31, 1998) 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
50% voting control. Investments in unconsolidated affiliates at June 30, 1999
include, among others, equity interests in DST Systems, Inc. ("DST"), Grupo
Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), Southern
Capital Corporation, LLC ("Southern Capital"), Mexrail, Inc. ("Mexrail") and the
Panama Canal Railway Company.
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.
Combined condensed financial information of unconsolidated affiliates is shown
below:
Financial Condition (dollars in millions):
June 30, 1999 December 31, 1998
DST (a) Grupo TFM (b) Other DST (a) Grupo TFM (b) Other
Current assets $ 396.9 $ 138.3 $ 32.2 $ 375.8 $ 109.9 $ 33.1
Non-current assets 1,648.0 1,948.6 237.1 1,521.2 1,974.7 277.0
---------- ------------ -------- ---------- ----------- --------
Assets $ 2,044.9 $ 2,086.9 $ 269.3 $ 1,897.0 $ 2,084.6 $ 310.1
========== ============ ======== ========== =========== ========
Current liabilities $ 226.8 $ 265.4 $ 49.7 $ 268.6 $ 233.9 $ 48.6
Non-current liabilities 503.3 712.1 142.8 462.2 745.0 191.7
Minority interest - 343.5 - - 342.4 -
Equity of stockholders
and partners 1,314.8 765.9 76.8 1,166.2 763.3 69.8
---------- ------------ -------- ---------- ----------- --------
Liabilities and
equity $ 2,044.9 $ 2,086.9 $ 269.3 $ 1,897.0 $ 2,084.6 $ 310.1
========== ============ ======== ========== =========== ========
KCSI's investment $ 422.2 $ 286.0 $ 42.2 $ 376.0 $ 285.1 $ 38.6
========== ============ ======== ========== =========== ========
Operating Results (dollars in millions):
Three Months Six Months
Ended June 30, Ended June 30,
----------------------------- ------------------------------
1999 1998 1999 1998
----------------------------- ------------------------------
Revenues:
DST (a) $ 299.6 $ 269.8 $ 592.4 $ 535.8
Grupo TFM (b) 139.2 109.6 251.7 209.6
All others 20.1 20.2 44.8 46.3
---------- ---------- ---------- ---------
Total revenues $ 458.9 $ 399.6 $ 888.9 $ 791.7
========== ========== ========== =========
7
Operating costs and expenses:
DST (a) $ 248.2 $ 232.2 $ 491.1 $ 457.8
Grupo TFM (b) 100.0 96.6 188.7 187.3
All others 18.1 19.8 41.1 44.7
---------- ---------- ---------- ---------
Total operating costs and expenses $ 366.3 $ 348.6 $ 720.9 $ 689.8
========== ========== ========== =========
Net income:
DST (a) $ 33.4 $ 23.3 $ 67.0 $ 47.4
Grupo TFM (b) 1.2 (5.7) 2.6 (9.8)
All others 5.0 1.0 7.2 1.4
---------- ---------- ---------- ---------
Total net income $ 39.6 $ 18.6 $ 76.8 $ 39.0
========== ========== ========== =========
(a) The financial condition and operating results for DST reflect the merger of
a wholly-owned DST subsidiary with USCS International, Inc. ("USCS") on
December 21, 1998. Information for prior periods has been restated to
combine the historical results of DST and USCS. The merger was accounted
for by DST as a pooling of interests.
(b) Grupo TFM is presented on a U.S. GAAP basis.
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.
. Supplemental Cash Flow Information (in millions):
Six Months
Ended June 30,
1999 1998
Interest paid $ 34.6 $ 36.2
Income taxes paid 52.3 39.0
Noncash Investing and Financing Activities:
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. There
were no shares of KCSI common stock issued under an offering of the ESPP during
the first quarter of 1999.
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 seven percent.
Company subsidiaries and affiliates hold various 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 income
taxes, in stockholders' equity as accumulated other comprehensive income. For
the three and six month periods ended June 30, 1999, the Company recorded its
proportionate share of the gain in market value of these investments of $27.5
million and $27.3 million, respectively, ($17.0 million and $15.9 million,
respectively, net of deferred income taxes). For the three and six month periods
ended June 30, 1998, the Company recorded its proportionate share of
8
the gain in market value of these investments from December 31, 1997 of $21.1
million and $69.7 million, respectively, ($13.0 million and $42.9 million,
respectively, net of deferred income taxes).
8. In 1998, the Company adopted the provisions of 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 disclosure of 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. The adoption of SFAS 131 did not
have a material impact on the disclosures of the Company. Pursuant to SFAS 131,
the following provides selected interim financial information for the
Transportation and Financial Services segments (in millions):
Three Months Six Months
Ended June 30, Ended June 30,
1999 1998 1999 1998
Revenues:
Transportation $ 148.7 $ 152.9 $ 300.6 $ 305.4
Financial Services 282.2 169.7 515.5 312.9
----------- ----------- ----------- -----------
KCSI Consolidated $ 430.9 $ 322.6 $ 816.1 $ 618.3
=========== =========== =========== ===========
Net Income:
Transportation $ 5.2 $ 9.4 $ 12.8 $ 18.6
Financial Services 70.9 49.3 131.9 86.3
----------- ----------- ----------- -----------
KCSI Consolidated $ 76.1 $ 58.7 $ 144.7 $ 104.9
=========== =========== =========== ===========
June 30, December 31,
1999 1998
Total Assets:
Transportation $ 1,891.5 $ 1,796.8
Financial Services 921.1 822.9
----------- -----------
KCSI Consolidated $ 2,812.6 $ 2,619.7
=========== ===========
Sales between segments were not material for the three and six month periods
ended June 30, 1999 and 1998, respectively.
9. In June 1998, the Financial Accounting Standards Board ("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. Initially, the effective date of SFAS 133
was for all fiscal quarters for fiscal years beginning after June 15, 1999;
however, the FASB has deferred the effective date of SFAS 133 for one year so
that it will begin with all fiscal quarters of fiscal years beginning
9
after June 15, 2000. The FASB encourages early adoption of this standard;
however, the provisions of SFAS 133 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
investments in Grupo TFM and Nelson as market conditions change or exchange
rates fluctuate. Currently, the Company has no outstanding diesel fuel hedges or
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.
10. As disclosed in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998, prior to January 1, 1999, Mexico's economy was classified as
"highly inflationary" as defined in Statement of Financial Accounting Standards
No. 52 "Foreign Currency Translation" ("SFAS 52"). Accordingly, the U.S. dollar
was assumed to be Grupo TFM's functional currency, and any gains or losses from
translating Grupo TFM's financial statements into U.S. dollars were included in
the determination of its net income (loss). Equity earnings (losses) from Grupo
TFM included in the Company's results of operations reflected the Company's
share of such translation gains and losses.
Effective January 1, 1999, the Securities and Exchange Commission staff declared
that Mexico should no longer be considered a highly inflationary economy.
Accordingly, the Company performed an analysis under the guidance of SFAS 52 to
determine whether the U.S. dollar or the Mexican peso should be used as the
functional currency for financial accounting and reporting purposes for periods
subsequent to December 31, 1998. Based on the results of the analysis,
management believes that the U.S. dollar is the appropriate functional currency
to use for the Company's investment in Grupo TFM; therefore, the financial
accounting and reporting of the operating results of Grupo TFM will remain
consistent with prior periods.
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, 1998 other than as noted below
relating to the Bogalusa Cases.
Bogalusa Cases -
In July 1996, 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 the rail car
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, but under the car's capacity, when it was transported by
KCSR to interchange with the IC.
10
The trial of a group of twenty plaintiffs in the Mississippi lawsuits arising
from the chemical release commenced in the last week of March 1999. That trial
resulted in a jury verdict and judgment in favor of KCSR in June 1999. The jury
found that KCSR was not negligent and that the plaintiffs had failed to prove
that they were damaged. The trial of the Louisiana class action and the trial of
another group of Mississippi plaintiffs could both begin during the year 2000.
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, financial position and cash flows.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
The discussion set forth below and other portions of this Form 10-Q contain
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/A dated June 3, 1997, which is on file with the U.S.
Securities and Exchange Commission (File No.1-4717) and is hereby incorporated
by reference herein. Readers are strongly encouraged to consider these factors
when evaluating 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:
o The Kansas City Southern Railway Company ("KCSR"), a wholly-owned subsidiary
of the Company, operating a Class I Common Carrier railroad system;
o Gateway Western Railway Company ("Gateway Western"), an indirect wholly-owned
subsidiary of the Company, operating a regional railroad system;
o Southern Group, Inc., a wholly-owned subsidiary of KCSR, owning 100% of
Carland, Inc.;
o Equity investments in Southern Capital Corporation LLC ("Southern Capital"), a
50% owned joint venture, 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;
o Kansas City Southern Lines, Inc. ("KCSL"), a wholly-owned subsidiary of the
Company, serving as a holding company for transportation-related subsidiaries
and affiliates; and
o Various other consolidated subsidiaries.
12
Financial Services - The Financial Services segment consists of all subsidiaries
engaged in the management of investments for mutual funds, private and other
accounts, as well as any Financial Services-related investments. Included are:
o Stilwell Financial, Inc. ("Stilwell" - formerly FAM Holdings, Inc.), a
wholly-owned subsidiary of the Company, serving as a holding company for
financial services-related subsidiaries and affiliates (see below);
o Janus Capital Corporation ("Janus"), an 83% owned subsidiary, subject to
vesting of Janus restricted stock held by various Janus employees which
will reduce ownership to 82%;
o Berger Associates, Inc. ("Berger"), a 100% owned subsidiary;
o Nelson Money Managers Plc ("Nelson"), an 80% owned subsidiary;
o DST Systems, Inc. ("DST"), an approximate 32% owned equity investment; and
o Various other consolidated subsidiaries.
RECENT DEVELOPMENTS
Favorable IRS Tax Ruling for Planned Separation of the Company Business
Segments. As previously disclosed, the Company announced its intention to
separate the Transportation and Financial Services segments through a proposed
dividend of the stock of Stilwell, a new holding company for its Financial
Services businesses (the "Separation"). On July 12, 1999, the Company announced
that the Internal Revenue Service ("IRS") has issued a favorable ruling on the
Company's anticipated "tax-free" spin-off of its financial services companies.
Subject to the consideration of other relevant factors, management anticipates
completion of the Separation to occur before the end of 1999.
In March 1999, a number of Janus minority stockholders and members of Janus'
management, including its chief executive officer, certain directors and others
suggested that KCSI's Board of Directors ("Board") consider, as an alternative
to the planned Separation, a separate spin-off of Janus. The board of trustees
or directors of the Janus funds expressed support for the proposal put forth by
these minority stockholders and management personnel. Several members of this
group made a formal presentation to KCSI's Board to that effect on June 23,
1999. After reviewing and considering the information presented by this group,
KCSI's Board decided that proceeding with the Separation as planned and as
approved by the IRS would be in the best interests of KCSI and its stockholders.
Berger Management Realignment. In second quarter 1999, Berger realigned its
management team to improve Berger's long-term growth opportunities and
capitalize on the performance and discipline demonstrated by certain portfolio
managers. Berger appointed a new president and chief executive officer and
rearranged the management of several of its advised funds. Two existing Berger
portfolio managers assumed the responsibility for Berger's largest fund, the
Berger One Hundred Fund, which had assets under management of approximately $1.5
billion at June 30, 1999. Additionally, changes in portfolio management were
made for the Berger Balanced Fund and the Berger Select Fund.
Financial Services Companies contributed to Stilwell Financial, Inc. Effective
July 1, 1999, KCSI contributed to Stilwell the investments in Janus, Berger,
Nelson and DST, as well as certain other financial services-related assets, and
Stilwell assumed all of KCSI's liabilities associated with the assets
transferred. It is contemplated that Stilwell will be listed on the New York
Stock Exchange and, at about the time of the Separation, will begin trading
under the symbol "SV".
13
Voters approve plan for Intermodal facility at Richards-Gebaur Airbase. In a
referendum on the August 3, 1999 ballot, Kansas City, Missouri voters approved a
lease previously agreed to with the City of Kansas City, to establish an
intermodal facility at the Richards-Gebaur Airbase, which is located adjacent to
KCSR's main line. Subject to approval of the Federal Aviation Administration
("FAA") to close the existing airport, KCSR will initiate plans to relocate its
Kansas City intermodal facility to Richards-Gebaur. Improvements are scheduled
to begin immediately following FAA approval with a tentative schedule to begin
operations as early as fourth quarter 2000. Management expects that the new
facility will provide additional needed capacity as well as a strategic
opportunity to serve as an international trade facility. Management plans for
this facility to serve as a U.S. customs pre-clearance processing facility for
freight moving along the fast-growing NAFTA corridor. This is expected to
alleviate some of the congestion at the borders, resulting in more fluid service
to KCSL's customers, as well as customers throughout the rail industry.
KCSR expects to spend approximately $40 million for site improvements and
infrastructure. Financing alternatives are currently being explored by
management. Additionally, KCSR has negotiated a lease arrangement with the city
of Kansas City, Missouri for a period of fifty years, subject to final FAA
approval. Lease payments are expected to range between $400,000 and $700,000 per
year and will be adjusted for inflation based on agreed-upon formulas.
Management believes that with the addition of this facility, KCSR is positioned
to increase its intermodal revenue base by attracting additional NAFTA traffic.
Purchase of 50 New Locomotives for KCSR. During second quarter 1999, KCSR
reached an agreement with General Electric ("GE") for the purchase of 50 new GE
4400 AC Locomotives with remote power capability. The addition of these
state-of-the-art locomotives is expected to have a favorable impact on
operations as a result of, among other things, the following: retirement of
older locomotives with significant ongoing maintenance needs; decreased
maintenance costs and improved fuel efficiency; better fleet utilization;
increased hauling power eliminating the need for certain helper service; higher
reliability and efficiency resulting in fewer train delays and less congestion.
These locomotives are expected to be financed through operating leases with
Southern Capital. As a result, operating lease expense is expected to increase
beginning in fourth quarter 1999. KCSR expects, however, associated operating
cost reductions through replacement of older locomotives with these new and more
efficient AC locomotives. Delivery of these locomotives is expected in fourth
quarter 1999.
Panama Canal Railway Company. In January 1998, the Republic of Panama awarded
KCSR and its joint venture partner, Mi-Jack Products, Inc., the concession to
reconstruct and operate the Panama Canal Railway Company ("PCRC"). The 47-mile
railroad runs parallel to the Panama Canal and, upon reconstruction, will
provide international shippers with an important complement to the Panama Canal.
The Company is currently in the process of finalizing its financing arrangements
with the International Finance Corporation, a member of the World Bank Group,
and expects to have the financing package completed by the end of September
1999. The total cost of the reconstruction project is estimated to be $70
million with the commitment from KCSR not to exceed $13 million. Reconstruction
of PCRC's right-of-way is expected to begin in the fourth quarter of 1999 and be
completed in late 2000. Commercial operations are projected to begin in late
2000 or early 2001.
KSU Stock added to the S&P 500 Index. On March 26, 1999, Standard and Poors
(S&P) Financial Information Services announced that it was adding Kansas City
Southern Industries, Inc. to its S&P 500 index. KCSI was added to the S&P 500
Railroads Industry group after the close of trading on April 1, 1999. Management
believes that the Company's addition to this index of leading U.S. companies
will have a positive long-term impact on KCSI stock and help build the Company's
shareholder base.
14
Approval of CN/IC merger. At a voting conference held on March 25, 1999, the
Surface Transportation Board ("STB") unanimously approved the merger of Canadian
National Railway ("CN") and Illinois Central Corp. ("IC"). The STB issued its
written approval with an effective date of June 24, 1999, at which time the CN
was permitted to exercise control over IC's operations and assets. As part of
this approval, the STB imposed certain restrictions on the merger including a
condition requiring that the CN/IC grant KCSR access to three additional
shippers in the Geismar, Louisiana industrial area: Rubicon, Uniroyal and
Vulcan. This is in addition to the three Geismar shippers (BASF, Borden and
Shell) that KCSR will have access to as a result of its alliance agreement with
CN/IC, as previously disclosed. Management believes the access to these Geismar
shippers will provide the Company with additional revenue opportunities. The STB
also denied a filing by the CN, IC and KCSR seeking trackage rights for the
Gateway Western over several miles of UP and Norfolk Southern track in
Springfield, Illinois.
Foreign Exchange Matters. As disclosed in the Company's Annual Report on Form
10-K for the year ended December 31, 1998, prior to January 1, 1999, Mexico's
economy was classified as "highly inflationary" as defined in Statement of
Financial Accounting Standards No. 52 "Foreign Currency Translation" ("SFAS
52"). Accordingly, the U.S. dollar was assumed to be Grupo TFM's functional
currency, and any gains or losses from translating Grupo TFM's financial
statements into U.S. dollars were included in the determination of its net
income (loss). Equity earnings (losses) from Grupo TFM included in the Company's
results of operations reflected the Company's share of such translation gains
and losses.
Effective January 1, 1999, the Securities and Exchange Commission ("SEC") staff
declared that Mexico should no longer be considered a highly inflationary
economy. Accordingly, the Company performed an analysis under the guidance of
SFAS 52 to determine whether the U.S. dollar or the Mexican peso should be used
as the functional currency for financial accounting and reporting purposes for
periods subsequent to December 31, 1998. Based on the results of the analysis,
management believes that the U.S. dollar is the appropriate functional currency
to use for the Company's investment in Grupo TFM; therefore, the financial
accounting and reporting of the operating results of Grupo TFM will remain
consistent with prior periods.
Sale of loan portfolio by Southern Capital. On March 31, 1999, Southern Capital
signed an agreement to sell its portfolio of non-rail assets to Textron
Financial Corporation. The purchase price for these assets (comprised primarily
of finance receivables in the amusement and other non-rail transportation
industries) was approximately $52.8 million. The sale of these assets, which
closed in April 1999, did not have a material impact on the Company's results of
operations, cash flows or financial condition.
Repurchase of stock. As disclosed in the Current Report on Form 8-K dated
February 25, 1999, the Company repurchased 460,000 shares of its common stock
from The DST Systems, Inc. Employee Stock Ownership Plan (the "DST ESOP") in a
private transaction. The DST ESOP has previously sold to the Company other
shares of KCSI stock which were part of the DST ESOP's assets as a result of
DST's participation in the Company's employee stock ownership plan prior to
DST's initial public offering in 1995.
The shares were purchased at a price equal to the closing price per share of
KCSI's common stock on the New York Stock Exchange on February 24, 1999. The
shares are held in treasury for use in connection with the Company's various
employee benefit plans.
These repurchases are part of the 9,000,000 share repurchase program that the
Company's Board of Directors authorized in 1996. Including this transaction, the
Company has repurchased a total of approximately 4,100,000 shares under this
program.
15
Option to Purchase Mexican Government's Ownership Interest in TFM, S.A. de C.V.
("TFM"). On January 28, 1999, the Company, along with other direct and indirect
owners of TFM, entered into a preliminary agreement with the Mexican Government
("Government"). As part of that agreement, an option was granted to the Company,
Transportacion Maritima Mexicana, S.A. de C.V. ("TMM") and Grupo Servia, S.A. de
C.V. ("Grupo Servia") to purchase all or a portion of the Government's 20%
ownership interest in TFM at a discount. The option to purchase all or a portion
of the Government's interest expires on November 30, 1999. Under the initial
agreement, the option to purchase up to 35% of the Government's stock was
scheduled to expire on May 31, 1999, thus canceling the entire option agreement;
however, this date has been extended by the Government. The parties are
presently negotiating the final provisions and documentation pursuant to which
the initial portion of the option would be exercised. If the option is fully
exercised, the Company's additional cash investment is not expected to exceed
$93 million.
As part of this agreement and as a condition to exercise this option, the
parties have agreed to settle the outstanding claims against the Government
regarding a refund of Mexican Value Added Tax (VAT) payments. TFM has also
agreed to sell to the Government a small section of redundant trackage for
inclusion in another railroad concession. In addition, under the terms of the
agreement, the Government would be released from its capital call obligations at
the moment that the option is exercised in whole or in part. Furthermore, TFM,
TMM, Grupo Servia and the Company have agreed to sell, in a public offering, a
direct or indirect participation in at least the same percentage currently
represented by the shares exercised in this option, by October 31, 2003, subject
to market conditions. The option and the other described agreements are
conditioned on the parties entering into a final written agreement and obtaining
all necessary consents and authorizations. As of June 30, 1999, no portion of
the option agreement and associated transactions had been completed by any of
the parties.
RESULTS OF OPERATIONS
The Company's revenues, operating income and net income by industry segment are
as follows (dollars in millions):
Three Months Six Months
Ended June 30, Ended June 30,
1999 1998 1999 1998
--------- -------- --------- --------
Revenues:
Transportation $ 148.7 $ 152.9 $ 300.6 $ 305.4
Financial Services 282.2 169.7 515.5 312.9
--------- -------- --------- --------
Total $ 430.9 $ 322.6 $ 816.1 $ 618.3
========= ======== ========= ========
Operating Income:
Transportation $ 19.7 $ 29.8 $ 44.1 $ 61.8
Financial Services 115.5 74.6 212.7 133.0
--------- -------- --------- --------
Total $ 135.2 $ 104.4 $ 256.8 $ 194.8
========= ======== ========= ========
Net Income:
Transportation $ 5.2 $ 9.4 $ 12.8 $ 18.6
Financial Services 70.9 49.3 131.9 86.3
--------- -------- --------- --------
Total $ 76.1 $ 58.7 $ 144.7 $ 104.9
========= ======== ========= ========
The Company reported second quarter 1999 earnings of $76.1 million, or $0.66 per
diluted share, compared to $58.7 million, or $0.51 per diluted share in second
quarter 1998. Consolidated second quarter 1999 revenues rose $108.3 million, or
33%, compared to the same 1998 period, fueling an increase in operating
16
income of $30.8 million (30%). The increase in revenues resulted from higher
assets under management in the Financial Services segment, slightly offset by
lower transportation revenues. Operating expenses increased approximately 36%
quarter to quarter arising primarily from higher costs associated with the
significant revenue growth in the Financial Services segment, as well as from an
increase in KCSR operating costs. Second quarter 1999 depreciation and
amortization expenses increased nearly 25%, chiefly because of higher
depreciation in the Financial Services segment arising from 1998 infrastructure
development. Equity earnings in unconsolidated affiliates improved $7.5 million
due to higher contributions from DST and Grupo TFM. DST equity earnings
increased $3.3 million, while earnings from Grupo TFM increased by $2.6 million
(equity earnings of $0.5 million compared to equity losses of $2.1 million in
second quarter 1998). Interest expense declined $0.9 million (6%) for the three
months ended June 30, 1999 versus the comparable 1998 period due primarily to
lower average debt balances.
For the six months ended June 30, 1999, consolidated earnings were $144.7
million, or $1.25 per diluted share, versus $104.9 million, or $0.92 per diluted
share in comparable 1998. Year to date 1999 consolidated revenues increased
nearly 32% to $816.1 million compared to the same 1998 period, primarily due to
the growth in assets under management in the Financial Services segment. These
increased revenues led to a 32% improvement in operating income period to
period. Operating expenses increased approximately 32% period to period arising
from higher costs in both the Financial Services and Transportation segments as
discussed above. Depreciation and amortization expenses for the six months ended
June 30, 1999 increased 25% because of the1998 infrastructure development in the
Financial Services segment. Year to date 1999 equity earnings of unconsolidated
affiliates increased by $15 million because of earnings improvements at DST,
Grupo TFM and Mexrail. Interest expense for the six months ended June 30, 1999
was nearly 10% lower than the comparable 1998 period primarily as a result of
lower average debt balances.
TRANSPORTATION
Three Months Ended June 30, 1999 Compared With The Three Months Ended June 30, 1998
THREE MONTHS THREE MONTHS
ENDED JUNE 30, 1999 ENDED JUNE 30, 1998
------------------- -------------------
(in millions)
Consolidated Consolidated
KCSR Other Transportation KCSR Other Transportation
Revenues $ 135.7 $ 13.0 $ 148.7 $ 138.6 $ 14.3 $ 152.9
Costs and expenses 102.0 12.6 114.6 95.8 12.9 108.7
Depreciation and amortization 12.7 1.7 14.4 12.7 1.7 14.4
-------- -------- --------- -------- -------- ---------
Operating income (loss) 21.0 (1.3) 19.7 30.1 (0.3) 29.8
Equity in net earnings (losses)
of unconsolidated affiliates
Grupo TFM - 0.5 0.5 - (2.1) (2.1)
Other 1.2 0.4 1.6 0.5 (0.3) 0.2
Interest expense (8.3) (6.3) (14.6) (9.1) (5.9) (15.0)
Other, net 0.8 0.2 1.0 3.8 0.1 3.9
-------- --------- --------- -------- -------- ---------
Pretax income (loss) 14.7 (6.5) 8.2 25.3 (8.5) 16.8
Income tax provision (benefit) 5.8 (2.8) 3.0 9.9 (2.5) 7.4
-------- -------- --------- -------- -------- ---------
Net income (loss) $ 8.9 $ (3.7) $ 5.2 $ 15.4 $ (6.0) $ 9.4
======== ========= ========= ======== ======== =========
17
The Transportation segment reported earnings of $5.2 million for the three
months ended June 30, 1999 compared with $9.4 million for the three months ended
June 30, 1998. This decrease in earnings was attributable to an approximate 34%
decline in operating income arising from lower revenues and higher operating
expenses. Also contributing to the decline was a one-time gain on the sale of a
branch line in 1998 of $2.9 million ( $1.8 million after-tax). Partially
offsetting the lower operating income was an improvement in equity earnings
related to Grupo TFM, Mexrail and Southern Capital, as well as lower interest
expense.
Second quarter 1999 Transportation segment revenues totaled $148.7 million
versus $152.9 million in 1998. This decline of nearly 3% was primarily driven by
lower KCSR revenues. KCSR carloadings increased slightly quarter to quarter, but
revenues declined 2% due to changes in traffic mix. Weakness in the higher
margin coal and chemical commodity sectors were somewhat offset by growth in the
intermodal/automotive business and agriculture/minerals products. Gateway
Western revenues were also down slightly quarter to quarter due to lower
volumes.
The following is a summary of revenues and carloads for KCSR's major commodity
groups:
Carloads and
Revenues Intermodal Units
(in millions) (in thousands)
Three months Three months
ended June 30, ended June 30,
1999 1998 1999 1998
General commodities:
Chemical and petroleum $ 32.8 $ 35.1 40.4 42.0
Paper and forest 25.7 27.1 41.5 43.0
Agricultural and mineral 24.4 21.9 34.0 32.1
Other 6.8 5.5 8.6 7.0
----------- ---------- ---------- -----------
Total general commodities 89.7 89.6 124.5 124.1
Intermodal 12.9 11.9 55.1 47.6
Coal 26.6 30.0 45.7 52.5
----------- ---------- ---------- -----------
Subtotal 129.2 131.5 225.3 224.2
Other 6.5 7.1 - -
----------- ---------- ---------- -----------
Total $ 135.7 $ 138.6 225.3 224.2
=========== ========== ========== ===========
Coal - Coal revenues declined $3.4 million, or 11.4%, for the three
months ended June 30, 1999 compared with the three months ended June 30, 1998,
as a result of lower unit coal traffic (decrease of approximately 7,000
carloads). The lower unit coal traffic was attributable to several factors: 1)
Customer maintenance efforts for various periods during the second quarter,
which temporarily shut down three utility plants served by KCSR. In addition,
during January 1999, one of KCSR's customers, Kansas City Power and Light
("KCP&L"), had a major casualty at its Hawthorn plant, which is projected to be
out of service until 2001. The extended outage is not expected to have a
material effect on overall coal revenues as this plant represented approximately
5% of total coal tons hauled by KCSR in 1998 and is a short haul move; 2) KCSR
experienced slower delivery times due to congestion and a track rehabilitation
project; 3) KCSR reported record 1998 coal revenues - relatively low inventory
levels in early 1998 coupled with an increase in capacity at certain utility
customers led to an increase in demand during 1998, leading to record 1998 coal
revenues. 1999 demand for coal has not reached these record 1998 levels.
Partially offsetting these traffic declines was an increase in unit coal traffic
to KCP&L's Amsterdam facility. As a result of the temporary closure of the
Hawthorn facility, KCP&L increased its capacity at its Amsterdam plant. Although
the increased capacity at Amsterdam has not equaled the volume lost as a result
of the Hawthorn plant closure,
18
the Amsterdam plant is a longer haul for KCSR and thus, the related revenues
generated per unit train are higher.
Chemical and petroleum products - For the three months ended June 30,
1999, chemical and petroleum product revenues decreased $2.3 million, or 6.3%,
compared with the same 1998 period. This was primarily a result of lower
miscellaneous chemical revenues, which were down approximately 8.6% due in part
to the expiration in late 1998 of the emergency service order in the Houston
area, as well as a continuing decline in demand due to both domestic and
international chemical market conditions. Also contributing to the decrease were
plastics and petroleum coke revenues, which declined slightly quarter to quarter
as a result of fewer carloads shipped and a decline in revenues per carload due
to a change in traffic mix. Although carloads of soda ash increased slightly
during second quarter 1999 as a result of a limited opportunity in the South
American export market, soda ash revenues were still slightly lower due to the
mix of traffic and length of hauls. Management expects soda ash revenues to
remain somewhat weak during the remainder of 1999 due to an overall lack of
demand.
Paper and forest products - Paper and forest product revenues declined
$1.4 million, or 5.2%, quarter to quarter, primarily because of volume declines
in all major products. As discussed in the first quarter 1999 Form 10-Q, second
quarter 1999 paper and forest product revenues remained essentially flat with
first quarter 1999; however, management expects an increase in volume, including
potential exports to Mexico, in the third and fourth quarters of 1999.
Agricultural and mineral products - Agricultural and mineral product
revenues increased 11.2%, to $24.4 million for the three months ended June 30,
1999 versus the comparable 1998 period. This increase resulted from higher
carloads and revenue per carload for domestic grain movements, primarily because
of an increase in demand at certain customers serving the poultry industry with
shipment destinations serviced by KCSR. Also contributing to the increase was
higher export grain revenues. These increases were partially offset by declines
in non-metallic ores and stone, clay and glass revenues due primarily to volume
declines.
Intermodal and other - Intermodal and other revenues increased $2.3
million, or 13.2%, quarter to quarter. This increase is comprised of higher
intermodal revenues of $1.0 million arising from more intermodal unit shipments
(15.7%) quarter to quarter, as well as a significant increase in automotive
revenues, which nearly tripled quarter to quarter. The increase in intermodal
traffic is attributable to several factors including the alliance with the CN/IC
and east-west intermodal traffic originating from the Norfolk Southern
Corporation. Automotive traffic has increased, in part, due to an agreement
reached with General Motors for automobile parts traffic originating in the
upper midwest and terminating in Mexico. Management expects that both intermodal
and automotive revenues will continue to increase for the foreseeable future as
the alliance with CN/IC continues to mature.
The Transportation segment's total operating expenses increased $5.9 million
(4.8%), to $129.0 million for the three months ended June 30, 1999 from $123.1
million for the three months ended June 30, 1998. Second quarter KCSR operating
expenses increased $6.2 million from 1998, primarily due to congestion on the
KCSR. Higher expenses occurred in car hire, salaries and wages and costs
relating to locomotive power. Higher car hire costs resulted from fewer KCSR
cars and trailers being utilized by other railroads and higher employee costs
arose from general wage increases and overtime hours by operating personnel.
These increases were partially offset by reduced costs in casualties and
insurance due to lower expenses related to derailments. Variable expenses as a
percentage of revenues increased approximately 10% reflecting certain operating
inefficiencies and the decline in higher margin unit coal and chemical traffic.
Lower second quarter revenues coupled with higher operating expenses have
resulted in a decrease in KCSR's operating income of $9.1 million quarter to
quarter. KCSR's operating ratio, a common efficiency measure among
19
Class I rail carriers, increased to 84.1.% for the quarter compared with 78.1%
in second quarter 1998 as a result of lower revenues and higher expenses.
Operating losses for other transportation segment companies declined $1.0
million to a loss of $1.3 million for the second quarter of 1999 from a loss of
$0.3 million for the comparable 1998 quarter primarily because of lower
operating income at Gateway Western, which decreased over $0.9 million due to
lower revenues and higher operating expenses. Lower Gateway Western revenues
resulted from a decrease in haulage traffic, while higher costs were due
primarily to salaries and wages and casualty costs.
The Transportation segment recorded equity earnings of $2.1 million from
unconsolidated affiliates for the three months ended June 30, 1999 compared to
losses of $1.9 million for the three months ended June 30, 1998. The increase is
attributed primarily to equity earnings from Grupo TFM, which had increased
revenues of 27% and a pretax profit for the first time in its history. These
continued operating improvements resulted in an operating ratio of 71.9% versus
88.1% in second quarter 1998. Results of Grupo TFM are reported on a U.S. GAAP
basis. Mexrail recorded equity earnings of $0.5 million in second quarter 1999
versus losses of $0.4 million in the comparable 1998 period on improved revenues
and lower costs. Equity earnings from Southern Capital improved by approximately
$0.4 million quarter to quarter.
Because the Company is required to report its equity in Grupo TFM under U.S.
GAAP and Grupo TFM reports under International Accounting Standards,
fluctuations in deferred income tax calculations will occur based on translation
requirements and differences in accounting standards. The effects in these
deferred income tax calculations may be significantly impacted by fluctuations
in the relative value of the Mexican peso versus the U.S. dollar and can result
in significant variances in the amount of equity earnings (losses) reported by
the Company.
Interest expense declined $0.4 million during second quarter 1999 compared to
the same 1998 period, primarily as a result of lower average debt balances.
Other, net decreased $2.9 million quarter to quarter attributable to KCSR's
one-time gain of $2.9 million from the sale of a branch line in second quarter
1998.
Six Months Ended June 30, 1999 Compared With The Six Months Ended June 30, 1998
SIX MONTHS SIX MONTHS
ENDED JUNE 30, 1999 ENDED JUNE 30, 1998
------------------- -------------------
(in millions)
Consolidated Consolidated
KCSR Other Transportation KCSR Other Transportation
Revenues $ 271.0 $ 29.6 $ 300.6 $ 274.3 $ 31.1 $ 305.4
Costs and expenses 198.5 29.3 227.8 189.7 25.5 215.2
Depreciation and amortization 25.3 3.4 28.7 25.3 3.1 28.4
-------- -------- --------- -------- -------- ---------
Operating income (loss) 47.2 (3.1) 44.1 59.3 2.5 61.8
Equity in net earnings (losses)
of unconsolidated affiliates
Grupo TFM - 1.0 1.0 - (5.2) (5.2)
Other 1.8 0.4 2.2 1.0 (0.7) 0.3
Interest expense (16.8) (11.8) (28.6) (18.2) (11.8) (30.0)
Other, net 1.7 0.2 1.9 5.4 1.7 7.1
-------- --------- --------- -------- -------- ---------
Pretax income (loss) 33.9 (13.3) 20.6 47.5 (13.5) 34.0
Income tax provision (benefit) 13.3 (5.5) 7.8 18.6 (3.2) 15.4
-------- --------- --------- -------- -------- ---------
Net income (loss) $ 20.6 $ (7.8) $ 12.8 $ 28.9 $ (10.3) $ 18.6
======== ========= ========= ======== ======== =========
20
The Transportation segment reported earnings of $12.8 million for the six months
ended June 30, 1999 compared to $18.6 million for the comparable 1998 period.
This decrease in earnings was attributable to an approximate 29% decline in
operating income arising from lower revenues and higher operating expenses. Also
contributing to the decline was a one-time gain on the sale of a branch line in
1998 of $2.9 million ($1.8 million after-tax) and other certain non-recurring
gains in 1998. Partially offsetting the lower operating income was an
improvement in equity earnings related to Grupo TFM, Mexrail and Southern
Capital, as well as lower interest expense.
Total revenues decreased $4.8 million, or 1.6%, to $300.6 million for the six
months ended June 30, 1999, from $305.4 million for the six months ended June
30, 1998. Consistent with the second quarter 1999, this decline was driven
primarily by lower KCSR revenues, which fell $3.3 million, or 1.2%, period to
period. Although KCSR carloadings increased slightly period to period, revenues
declined over 1% due to traffic mix. Weakness in the higher margin coal and
chemical commodity sectors were somewhat offset by growth in the
intermodal/automotive business and agriculture/minerals products. Also
contributing to year to date 1999 results was a 7% drop in Gateway Western
revenues based primarily on volume declines related to haulage traffic.
The following is a summary of revenues and carloads for KCSR's major commodity
groups:
Carloads and
Revenues Intermodal Units
(in millions) (in thousands)
Six months Six months
ended June 30, ended June 30,
1999 1998 1999 1998
General commodities:
Chemical and petroleum $ 65.0 $ 69.7 80.5 83.9
Paper and forest 51.4 54.2 82.3 87.0
Agricultural and mineral 49.0 44.7 66.9 64.0
Other 11.7 11.4 14.7 14.6
----------- ---------- ---------- -----------
Total general commodities 177.1 180.0 244.4 249.5
Intermodal 24.5 22.9 103.0 88.9
Coal 56.3 58.5 98.4 105.4
----------- ---------- ---------- -----------
Subtotal 257.9 261.4 445.8 443.8
Other 13.1 12.9 - -
----------- ---------- ---------- -----------
Total $ 271.0 $ 274.3 445.8 443.8
=========== ========== ========== ===========
Coal - Coal revenues decreased $2.2 million, or 3.7%, for the six
months ended June 30, 1999 compared to the six months ended June 30, 1998 as a
result of lower unit coal traffic (decrease of approximately 7,000 carloads).
This decrease in unit coal traffic is attributed to the same factors as those
discussed above in second quarter analysis. Coal accounted for 21.8% and 22.4%
of total carload revenues for the six months ended June 30, 1999 and 1998,
respectively.
Chemical and petroleum products - Chemical and petroleum product
revenues decreased $4.7 million, or 6.7%, period to period primarily because of
lower miscellaneous chemical and soda ash revenues. As discussed above in the
second quarter analysis, miscellaneous chemical revenues declined due in part to
the expiration of the emergency service order in the Houston area as well as a
continuing decline in demand. Soda ash revenues declined primarily because of an
overall weak export market due to the continuing difficulty in the economic
climate in Asia and South America. Chemical and petroleum products accounted
21
for 25.2% of total carload revenues for the six months ended June 30, 1999
versus 26.6% for the six months ended June 30, 1998.
Paper and forest products - Paper and forest product revenues decreased
$2.8 million , or 5.3%, for the six months ended June 30, 1999 versus the
comparable 1998 period primarily as a result of volume declines in all major
products. Paper and forest products accounted for 19.9% and 20.8% of total
carload revenues for the six months ended June 30, 1999 and 1998, respectively.
Agricultural and mineral products - Agricultural and mineral product
revenues increased $4.3 million, or 9.5%, period to period. Similar to trends
discussed above in the second quarter analysis, this increase resulted from
higher carloads and revenues per carload for domestic and export grain
movements. These higher revenues were partially offset by declines in
non-metallic ores and stone, clay and glass revenues due primarily to volume
declines. Agricultural and mineral products accounted for 19.0% of total carload
revenues for the six months ended June 30, 1999 compared with 17.1% for the
comparable 1998 period.
Intermodal and other - Intermodal and other revenues increased $1.9
million, or 5.8%, for the six months ended June 30, 1999 versus the comparable
1998 period. Similar to the second quarter trends discussed above, this
improvement is comprised of higher intermodal revenues of $1.6 million, as well
as a significant increase in automotive revenues period to period. These
improvements were partially offset by a decline in other carload revenues of
approximately $1.2 million as a result of weakness in the steel market arising
from slower domestic oil production. Intermodal and other accounted for 14.1% of
total carload revenues for the six months ended June 30, 1999 compared with
13.1% for the six months ended June 30, 1998.
The Transportation segment's total operating expenses increased $12.9 million
(5.3%), to $256.5 million for the six months ended June 30, 1999 from $243.6
million for the same 1998 period. KCSR operating costs for the period increased
$8.8 million from 1998, primarily due to the same expense components as
discussed above in the second quarter analysis. Lower year to date revenues
coupled with higher operating expenses have resulted in a $12.1 million decrease
in KCSR's operating income period to period and an operating ratio of 82.4%
compared with 78.2% for the first half of 1998. Other Transportation operating
costs also increased, primarily due to higher costs at Gateway Western resulting
largely from an unusual $1.4 million March 1999 derailment and increased costs
at various smaller Transportation companies.
For year to date 1999, the Transportation segment recorded equity earnings from
unconsolidated affiliates of $3.2 million compared with equity losses of $4.9
million for the same 1998 period. This increase was attributable primarily to
improvements at Grupo TFM. For the six months ended June 30, 1999, the Company
recorded equity earnings from Grupo TFM of $1.0 million compared with equity
losses of $5.2 million for the six months ended June 30, 1998. This improvement
at Grupo TFM reflects year to date revenue increases of 20% coupled with
continued operating improvements. These factors have resulted in an operating
ratio of 74.9% for the six months ended June 30, 1999 versus 89.3% for the same
1998 period. Also contributing to the increase was Mexrail, which recorded
equity earnings of $0.4 million in the period versus losses of $0.9 million in
the comparable 1998 period based on higher revenues and lower operating costs.
Equity earnings from Southern Capital improved by approximately $0.5 million
period to period, a portion of which relates to a gain on the sale of the loan
portfolio.
Interest expense declined $1.4 million during the six months ended June 30, 1999
compared to the same 1998 period, primarily as a result of lower average debt
balances. Other, net decreased $5.2 million period to period attributable to
KCSR's one-time gain of $2.9 million from the 1998 sale of a branch line and
certain other non-recurring gains recorded in 1998.
22
FINANCIAL SERVICES
Three Months Ended June 30, 1999 Compared With The Three Months Ended June 30,
1998
CONSOLIDATED
FINANCIAL SERVICES
(in millions)
THREE MONTHS
ENDED JUNE 30,
1999 1998
------------------ ----------------
Revenues $ 282.2 $ 169.7
Costs and expenses 158.8 91.6
Depreciation and amortization 7.9 3.5
------------- -------------
Operating income 115.5 74.6
Equity in net earnings of
unconsolidated affiliates:
DST Systems, Inc. 10.8 7.5
Other 0.5 0.3
Interest expense (0.7) (1.2)
Other, net 4.3 11.3
------------- -------------
Pretax income 130.4 92.5
Income tax provision 46.8 33.5
Minority interest 12.7 9.7
------------- -------------
Net income $ 70.9 $ 49.3
============= =============
The Financial Services segment contributed $70.9 million to KCSI's 1999 second
quarter consolidated earnings versus $49.3 million in second quarter 1998.
Exclusive of an after-tax $4.4 million one-time gain resulting from Janus' sale
of IDEX Management, Inc. ("IDEX") in second quarter 1998, earnings improved 58%
quarter to quarter. Average assets under management were 70% higher during
second quarter 1999 than second quarter 1998 fueling a $112.5 and $40.9 million
increase in revenues and operating income, respectively, over second quarter
1998.
Assets under management increased $19.7 billion during second quarter 1999 as a
result of net sales of $13.9 billion and market appreciation of $5.8 billion.
Assets under management totaled $161.7 billion at June 30, 1999 ($155.8 billion
at Janus; $4.7 billion at Berger; and $1.2 billion at Nelson) versus $113.5
billion at December 31, 1998 and $94.4 billion at June 30, 1998. See the brief
discussions of Janus, Berger and Nelson separately below.
Financial Services operating margins declined in second quarter 1999, primarily
due to an increase in operating expenses to $166.7 million from $95.1 million in
the prior year quarter. This increase reflects higher costs associated with the
significant growth in revenues, as well as an increase in discretionary
expenses. Higher expenses were evident in salaries and wages (primarily
investment performance-based incentive compensation, an increased number of
employees and associated training, and certain one-time severance costs),
marketing and fulfillment, and alliance fees under mutual fund "supermarket"
distribution arrangements based on a higher level of assets under management
through these channels.
23
Second quarter 1999 equity earnings from DST increased to $10.8 million from
$7.5 million in comparable 1998, primarily due to improved earnings in DST's
financial services and output solutions segments, as well as from required
capitalization of internal use software development costs in 1999. Consolidated
DST revenues increased due to a higher number of shareowner accounts processed
(totaling 53.3 million at June 30, 1999 versus 48.2 million at June 30, 1998),
images produced (26.1% increase) and statements mailed (up 18.5%). DST's
consolidated operating margins improved to 17% during second quarter 1999 versus
14% in comparable 1998.
As noted above, Other, net was higher in second quarter 1998 due to an $8.8
million one-time gain recognized on the sale of the Janus equity investment in
IDEX.
Six Months Ended June 30, 1999 Compared With The Six Months Ended June 30, 1998
CONSOLIDATED
FINANCIAL SERVICES
(in millions)
SIX MONTHS
ENDED JUNE 30,
1999 1998
------------------ ----------------
Revenues $ 515.5 $ 312.9
Costs and expenses 288.1 173.6
Depreciation and amortization 14.7 6.3
------------- -------------
Operating income 212.7 133.0
Equity in net earnings of
unconsolidated affiliates:
DST Systems, Inc. 21.5 15.0
Other 1.0 0.6
Interest expense (1.7) (3.6)
Other, net 9.2 14.7
------------- -------------
Pretax income 242.7 159.7
Income tax provision 86.9 57.0
Minority interest 23.9 16.4
------------- -------------
Net income $ 131.9 $ 86.3
============= =============
For the six months ended June 30, 1999, Financial Services contributed $131.9
million to the Company's consolidated earnings, a 61% increase over comparable
1998, exclusive of the one-time gain on the IDEX sale. This increase was
attributable to higher revenues (driven by growth in assets under management),
operating income and equity earnings period to period.
Year to date 1999 revenues increased 65% to $515.5 million versus $312.9 million
for the six months ended June 30, 1998. Assets under management increased $48.2
billion during the first six months of 1999, driven by net sales of $27.0
billion and market appreciation of $21.2 billion. Shareowner accounts numbered
nearly 3.8 million as of June 30, 1999 (an increase of 26% from December 31,
1998).
Operating margins declined slightly period to period (from 42.5% to 41.3% for
the first six months of 1999). Operating expenses increased to $302.8 million
from $179.9 million in comparable 1998, primarily due to
24
the growth in revenues and continued infrastructure efforts. Higher expenses
occurred in salaries and wages (see comment in quarterly review above),
marketing and fulfillment and alliance distribution fees. These three components
totaled approximately 44% of total Financial Services revenues during the six
months ended June 30, 1999 versus approximately 42% in 1998. Additionally,
infrastructure initiatives throughout 1998 and 1999 to ensure the ongoing
quality and reliability of customer service resulted in higher depreciation and
various other costs.
Year to date 1999 equity earnings from DST increased 43% over the same period in
1998 as a result of the same operating trends affecting the quarter as discussed
above. Additionally, DST's equity in earnings of unconsolidated affiliates
improved in 1999 compared to 1998.
Other, net decreased from comparable 1998 as discussed in the quarterly review
above. Year to date 1999 interest expense declined from the same 1998 period due
to lower average debt balances.
A brief discussion of significant Janus, Berger and Nelson items during the six
months ended June 30, 1999 follows:
Janus
Janus assets under management increased $47.5 billion (44%) during the
six months ended June 30, 1999. Assets in the Janus Investment Funds,
Janus Aspen Series and money market funds increased 44% from December 31,
1998. As of June 30, 1999, assets in the Janus World Funds Plc ("Janus
World Funds") increased to $668 million from $65 million at December 31,
1998. Also, assets in private, institutional and sub-advised accounts
grew 42% from year end 1998. Shareholder accounts increased nearly 30%
during the first six months of 1999. These increases reflect ongoing
favorable investment performance by various funds/portfolios within the
Janus group of mutual funds, continued growth through net sales, as
evidenced by second quarter 1999 net sales that exceeded the entire year
for 1998, and competitive levels of expenses and fees compared to
industry standards.
Berger
Berger assets under management increased 18% (to $4.7 billion) during the
six months ended June 30, 1999, primarily due to market appreciation.
While shareholder accounts declined approximately 10% (primarily in the
Berger One Hundred Fund), new sales - primarily in Berger's newer fund
offerings -- offset the cash outflows that accompanied shareholder
departures. In connection with efforts to revitalize the core Berger
funds (i.e., those introduced prior to 1997), certain senior management
personnel changes were undertaken during second quarter 1999, resulting
in approximately $1.7 million of one-time severance costs.
Berger's investment in BBOI Worldwide LLC ("BBOI") continues to report
increases in assets under management (up 27% from year end 1998 to $662
million at June 30, 1999) and net income. Berger and the Bank of Ireland
Asset Management (U.S.) Limited ("Bank of Ireland") have executed a
non-binding letter of intent pursuant to which, under certain conditions,
BBOI will purchase Bank of Ireland's interest in BBOI. If consummated,
this transaction would result in Berger owning all of BBOI.
Nelson
The Company acquired Nelson in April 1998. Accordingly, results for 1998
include only three months of activity compared to the six month period
ended June 30, 1999. Nelson's assets under management increased 8% to
(pound)751 million as of June 30, 1999 from (pound)696 million at
December 31, 1998. Beginning in late first quarter 1999, Nelson initiated
expansion efforts throughout the United Kingdom. This project will be
ongoing and the Company expects that during this phase of Nelson's
development,
25
Nelson will operate at a loss. These losses, however, are not expected to
have a material impact on the Financial Services results of operations
or financial position.
TRENDS AND OUTLOOK
The Company's second quarter and year to date 1999 diluted earnings per share
($0.66 and $1.25, respectively) increased 29% and 36%, respectively, compared to
the same 1998 periods ($0.51 and $0.92, respectively). Revenue growth in the
Financial Services segment for the first six months of 1999, partially offset by
related increases in operating costs, resulted in nearly a 32% higher
consolidated operating income period to period. While the Transportation segment
experienced a decline in revenues, operating income and earnings for the second
quarter and year to date 1999 periods, Grupo TFM results continued to improve
due to revenue growth and operating improvements. Domestically, KCSR and Gateway
Western results were affected by a decline in revenues and increased operating
expenses due to congestion issues. These operational issues are being addressed
by management. Continued growth in assets under management has fueled revenue,
operating income and earnings growth in the Financial Services segment for both
the second quarter and year to date 1999 periods.
A current outlook for the Company's businesses for the remainder of 1999 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) Transportation - Management expects that general commodities and intermodal
traffic will continue to be largely dependent on economic trends within
certain industries in the geographic region served by the railroads
comprising the NAFTA Railway. Based on anticipated traffic levels, revenues
for the remainder of 1999 are expected to increase slightly compared with
revenues for the first six months of 1999, and essentially remain flat
compared to revenues for the last six months of 1998. Management expects
the NAFTA Railway to continue to provide an attractive service offering for
shippers, and the Company believes it will realize continued benefits from
traffic with Mexico, the CN/IC alliance and interchange traffic with the
Norfolk Southern. Management is aggressively addressing certain cost issues
to provide the framework for efficient and productive operations over the
last half of the year. Variable costs are expected to continue at levels
proportionate with revenue activity.
ii) Financial Services - Future growth will be largely dependent on prevailing
financial market conditions, relative performance of Janus, Berger and
Nelson products, introduction and market reception of new products, as well
as other factors, including changes in stock and bond markets, increases in
the rate of return of alternative investment products, increasing
competition as the number of mutual funds continues to grow, and changes in
marketing and distribution channels.
Based on a higher level of assets under management starting the third
quarter, revenues for the remainder of 1999 are expected to exceed
comparable prior year periods. Management expects ongoing Financial
Services margin pressure challenges as efforts continue to ensure that
the operational and administrative infrastructure consistently meets the
high standards of quality and service historically provided to investors.
Additionally, a higher rate of growth in costs compared to revenues is
expected in connection with Nelson's efforts to expand its operations.
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. As a result of the sale of the loan portfolio, equity
earnings from Southern Capital are not expected to be significant.
26
LIQUIDITY AND CAPITAL RESOURCES
Summary cash flow data is as follows (in millions):
Six Months
Ended June 30,
1999 1998
Cash flows provided by (used for):
Operating activities $ 177.4 $ 88.8
Investing activities (23.0) (46.4)
Financing activities (42.3) (67.1)
---------- -----------
Cash and equivalents:
Net increase (decrease) 112.1 (24.7)
At beginning of year 27.2 33.5
--------- ----------
At end of period $ 139.3 $ 8.8
========= ==========
During the six months ended June 30, 1999, the Company's consolidated cash
position increased $112.1 million from December 31, 1998. This increase resulted
primarily from earnings, net sales of investments in advised funds by Janus and
proceeds from the issuance of common stock under employee stock plans, partially
offset by property acquisitions, net repayments of long-term debt, cash
dividends and stock repurchases. Net operating cash inflows for the six months
ended June 30, 1999 were $177.4 million compared to net operating cash inflows
of $88.8 million in the same 1998 period. This $88.6 million improvement in
operating cash flows was chiefly attributable to a 1998 payment of approximately
$23 million related to the KCSR Union Productivity fund termination, higher 1999
year to date earnings and net changes in other working capital components,
offset partially by payments of prepaid commissions in connection with the Janus
World Funds B share arrangements.
Net investing cash outflows were $23.0 million during the six months ended June
30, 1999 compared to $46.4 million of net investing cash outflows during the
comparable 1998 period. This difference results primarily from a decrease in
funds used for investment in affiliates and from fluctuations in investments in
advised funds associated with the timing of Janus' dividend payments, partially
offset by higher year to date 1999 capital expenditures. During the six months
ended June 30, 1999, Janus and Berger had net sales of approximately $39.5
million from investments in advised funds compared with net purchases of these
investments of $0.7 million during the same 1998 period.
During the first six months of 1999, financing cash outflows were used primarily
for the repayment of debt, stock repurchases and cash dividends, while financing
cash inflows were generated from proceeds from issuance of long-term debt and
proceeds from the issuance of common stock under stock plans. Net financing cash
outflows of $42.3 million were used during the six months ended June 30, 1999
compared with $67.1 million used during the comparable 1998 period. This was due
primarily to 1999 net repayments of long-term debt of $13.8 million compared
with net repayments of $51.2 million during the same 1998 period and an increase
in proceeds from the issuance of common stock of $12.5 million , partially
offset by cash used for stock repurchases of $23.7 million versus $3.5 million
in the first six months of 1998. Distributions to minority stockholders
increased in 1999 versus 1998 due to higher earnings on which distributions were
based.
Cash flows from operations are expected to increase during the remainder of 1999
from positive operating income, which has historically resulted in favorable
operating 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 anticipated financing arrangements for
Grupo TFM, significant
27
additional operational contributions from the Company to Grupo TFM are not
expected to be necessary. However, there exists a possible approximate $74
million capital call 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. Further,
as discussed above in "Recent Developments", the Company has the option to
purchase a portion of the Mexican Government's 20% interest in TFM at a
discount. Management anticipates using working capital and existing lines of
credit to fund this transaction in the event it elects to exercise this option.
Other financing alternatives are also being explored.
In addition to operating cash flows, the Company has financing available through
its various lines of credit with a maximum borrowing amount of $550 million
(which includes $65 million of uncommitted facilities). As of June 30, 1999,
$245 million was available under these lines of credit, $100 million of which is
to be used solely by the Financial Services segment. In conjunction with the
annual renewal of certain credit facilities during April and May 1999, the
364-day credit facility for KCSI was renewed at $75 million (previously $100
million) and the Financial Services 364-day credit facility was renewed at its
previous amount of $100 million. 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 a Universal Shelf Registration Statement ("Registration
Statement") filed in September 1993, as amended in April 1996 for $500 million.
The SEC declared the Registration Statement effective on April 22, 1996;
however, no securities have been issued. Management expects that any net
proceeds from the sale of securities under the Registration Statement would be
added to the general funds of the Company and used principally for general
corporate purposes, including working capital, capital expenditures, and
acquisitions of or investments in businesses and assets. The Company believes
its operating cash flows and available financing resources are sufficient to
fund working capital and other requirements for the remainder of 1999.
The Company's debt ratio (total debt as a percent of total debt plus equity) at
June 30, 1999 was 43.0% compared to 47.3% at December 31, 1998. Company
consolidated debt decreased $13.7 million from December 31, 1998 (to $822.6
million at June 30, 1999) as a result of repayments exceeding borrowings.
Consolidated equity increased $160.5 million from December 31, 1998. This
increase was due to net income of $144.7 million, the issuance of common stock
under the Employee Stock Purchase Plan and other plans, and increases in
unrealized gains on "available for sale" securities, partially offset by common
stock repurchases (as discussed above in "Recent Developments") and dividends
paid. This increase in equity coupled with a decrease in debt resulted in a
lower debt ratio.
Management anticipates that the debt ratio will continue to decrease during the
remainder of 1999 as a result of debt repayments and profitable operations.
Note, however, that unrealized gains on "available for sale" securities 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 accumulated other comprehensive income and affect the
Company's debt ratio.
OTHER
Year 2000. The Year 2000 discussion below contains forward-looking statements,
including those concerning the Company's plans and expected completion dates,
cost estimates, assessments of Year 2000 readiness for the Company as well as
for third parties, and the potential risks of any failure on the part of the
Company or third parties to be Year 2000 ready on a timely basis.
Forward-looking statements involve a number of risks and uncertainties that
could cause actual results to differ from those projected. See the "Overview"
section for additional information.
28
While the Company continues to evaluate and pursue discussions with its various
customers, partners and vendors with respect to their preparedness for Year 2000
issues, no assurance can be made that all such parties will be Year 2000 ready.
Additionally, while the Company cannot fully determine the impact, the inability
to complete Year 2000 readiness for the Company's computer systems could result
in significant difficulties in processing and completing fundamental
transactions. In such events, the Company's results of operations, financial
position and cash flows could be materially adversely affected.
Many existing computer programs and microprocessors that use only two digits
(rather than four) to identify a year could fail or create erroneous results
with respect to dates after December 31, 1999 if not corrected to read all four
digits. This computer program flaw is expected to affect all companies and
organizations, either directly (through a company's own computer programs or
systems that use computer programs, such as telephone systems) or indirectly
(through customers and vendors of the company).
These Year 2000 related issues are of particular importance to the Company. The
Company depends upon its computer and other systems and the computers and other
systems of third parties to conduct and manage the Company's Transportation and
Financial Services businesses and the Company's products and services are
heavily dependent upon using accurate dates in order to function properly. These
Year 2000 related issues may also adversely affect the operations and financial
performance of one or more of the Company's customers and suppliers. As a
result, the failure of the Company's computer and other systems, products or
services, the computer systems and other systems upon which the Company depends,
or the Company's customers or suppliers to be Year 2000 ready could have a
material adverse impact on the Company's results of operations, financial
position and cash flows. The Company is unable to assess the extent or duration
of that impact at this time, but it could be substantial.
In 1997, the Company and its key subsidiaries formed project teams comprised of
employees and third party consultants to identify and resolve the numerous
issues surrounding the Year 2000, focusing primarily on information technology
("IT") systems, non-IT systems, and third party issues. The project teams also
provide comprehensive corporate tracking, coordination and monitoring of all
Year 2000 activities. As part of resolving any potential Year 2000 issues, the
Company expects to: identify all computer systems, products, services and other
systems (including systems provided by third parties) that must be modified;
evaluate the alternatives available to make any identified systems, products or
services Year 2000 ready (including modification, replacement or abandonment);
complete the modifications and/or replacement of identified systems; and conduct
adequate testing of the systems, products and services, including testing of
certain key systems used by various North American railroads and
interoperability testing with clients and key organizations in the financial
services industry. The project teams meet regularly to discuss their progress
and ensure that all issues and problems are identified and properly addressed.
Meetings are regularly held with senior management and the Company's Board of
Directors to keep them apprised of the progress of the Year 2000 project.
The following provides a summary of each area and the progress toward
identifying and resolving Year 2000 issues:
IT Systems. In the Transportation segment, all internal IT systems,
including mission critical systems and non-critical systems, have been
analyzed and are in the process of being modified and tested for Year 2000
readiness. To date, management believes that approximately 99% of the
necessary remediation and 99% of the testing has been completed. Final
remediation and testing for certain non-critical support systems has been
completed and management believes these systems are Year 2000 ready. Final
remediation and testing of mission critical systems is scheduled for
completion by the end of September 1999.
29
In addition, the IT hardware and software necessary to operate the
mainframe computer and associated equipment are currently being evaluated
for Year 2000 issues. A compilation of the hardware and software
inventories was completed in 1998. The hardware and software, including the
completion of integrated testing of the infrastructure software and network
components, are expected to be Year 2000 ready by October 31, 1999.
The IT systems (including mission critical and significant non-critical
operating, accounting and supporting systems) and underlying hardware for
the companies comprising the Financial Services segment have been analyzed
and are being modified and tested for Year 2000 readiness. Management
believes that virtually all of its mission critical systems and other
systems have been tested and are believed to be Year 2000 ready. Any
remaining remediation and testing is expected to be completed by the end of
third quarter 1999.
Non-IT Systems. All equipment that contains an internal clock or embedded
micro-processor is being analyzed for Year 2000 readiness. This includes
PC's, software, external data interfaces, fax machines, telephone systems,
elevator systems, security and fire control systems, locomotives, signal
and communications systems and other miscellaneous equipment.
As of June 30, 1999, management believes that 98% of all PC's in the
Transportation companies were Year 2000 ready. The remainder of the PC's
are expected to be Year 2000 ready by August 31, 1999. In addition, all
related software, customized programs and external data interfaces are
being evaluated, modified and tested for Year 2000 readiness. This process
is expected to be completed by September 30, 1999 for all software and
custom programs and by October 31, 1999 for external data interfaces.
Testing of other equipment such as locomotives, signals and communication
systems and other equipment with internal clocks and embedded
micro-processors has been completed and management believes these items are
Year 2000 ready.
As of June 30, 1999, replacement and/or upgrade efforts on the Financial
Services hardware and software inventory is substantially completed,
including network infrastructure and telecommunications technologies, with
any minor areas expected to be finalized by September 30, 1999.
Third Party Systems. Both segments of the Company depend heavily on third
party systems in the operation of their businesses. As part of the Year
2000 project, significant third party relationships are being evaluated to
determine the status of their Year 2000 readiness and the potential impact
on the Company's operations if those significant third parties fail to
become Year 2000 ready. Questionnaires have been sent to critical
suppliers, major customers, key banking and financial institutions, utility
providers and interchange railroads to determine the status of their Year
2000 readiness.
The Transportation companies are also working with the Association of
American Railroads ("AAR") and other AAR-member railroads to coordinate the
testing and certification of the systems administered by the AAR. These
systems, including interline settlement, shipment tracing and waybill
processing are relied on by a number of North American railroads and their
customers. Initial testing between railroads started during second quarter
1998 and these systems are expected to be Year 2000 ready on a timely
basis.
Similarly, the Financial Services entities are participating in various
industry-wide efforts (e.g., trading and account maintenance, trade
execution, confirmation, etc.) to facilitate testing of Year 2000
preparedness and reliability. Additionally, Janus and Berger are required
to periodically report to the SEC their progress with respect to Year 2000
preparedness.
30
Based upon the responses received to the questionnaires and ongoing
discussions with these third parties, the Company believes that the
majority of the significant customers, banking and financial institutions,
suppliers and interchange railroads are or will be Year 2000 ready in all
material respects by mid-1999. The Company does not anticipate, however,
performing significant independent testing procedures to verify that the
information received by the Company from these third parties is accurate
(except for the above mentioned industry-wide testing efforts). For those
third parties who have not responded or who have expressed uncertainty as
to their Year 2000 readiness, management is exploring alternatives to limit
the impact this will have on the Company's operations and financial
results. The Company will continue to monitor its third party relationships
for Year 2000 issues.
DST, an approximate 32% owned equity investment, provides various services
to Janus and Berger. DST completed its review and evaluation of its mission
critical U.S. shareowner accounting and U.S. portfolio accounting related
products, services and internal systems and believes it achieved material
Year 2000 readiness in such products, services and systems. DST anticipates
internal readiness for all of its other mission critical systems and
products by September 30, 1999. Additionally, DST intends on testing its
systems with clients and other third parties for Year 2000 related issues
as needed throughout 1999. As part of addressing its Year 2000 issues, DST
has: i) formalized and tested contingency plans for its U.S. shareowner
accounting and U.S. portfolio accounting business units; ii) is formalizing
contingency plans for its other mission critical products, services and
systems; and iii) intends to test such plans by October 31, 1999. DST has
reviewed existing formal contingency plans for its two major data centers
with respect to failures that could be caused by Year 2000 issues.
Testing and Documentation Procedures. All material modifications to IT and
non-IT systems are being documented and maintained by the project teams for
purposes of tracking the Year 2000 project and as a part of the Company's due
diligence process. All modified systems have been or are in the process of being
tested for Year 2000 remediation, unit acceptance, system acceptance and user
acceptance. The testing procedures used and the results of these tests are being
documented and maintained as a part of the Year 2000 due diligence process.
Year 2000 Risks. The Company continues to evaluate the principal risks
associated with its IT and non-IT systems, as well as third party systems if
they were not to be Year 2000 ready on a timely basis. Areas that could be
affected include, but are not limited to, the ability to: accurately track
pricing and trading information, obtain and process customer orders and investor
transactions, properly track and record revenue movements (including train
movements), order and obtain critical supplies, and operate equipment and
control systems. These risks are presently under assessment, and the Company has
no basis to form an estimate of costs or lost revenues and is unable to
determine its impact on operations at this time.
The Company believes, however, that the risks involved with the successful
completion of its Year 2000 conversion relate primarily to available resources
and third party readiness. The key factors to success include the proper quality
and quantity of human and capital resources to address the complexity and costs
of the project tasks. The Company has allocated substantial resources to the
Year 2000 project and believes that it is adequately staffed by employees,
consultants and contractors. The inability to complete Year 2000 readiness for
the computer systems of the Company could result in significant difficulties in
processing and completing fundamental transactions.
In addition, the Company is taking precautions to ensure its third party
relationships have been adequately addressed. Based on work performed and
information received to date, the Company believes its key suppliers, customers
and other significant third party relationships will be prepared for the Year
2000 in all material respects within an acceptable time frame (or that
acceptable alternatives will be available); however,
31
management of the Company makes no assurances that all such parties will be Year
2000 ready within an acceptable time frame.
In the event that the Company or key third parties are not Year 2000 ready, the
Company's results of operations, financial position and cash flows could be
materially adversely affected.
Contingency Plans. The Company and its subsidiaries have spent a significant
amount of time identifying alternative plans in the event that the Year 2000
project is not completed on a timely basis or otherwise does not meet
anticipated needs. A business contingency planning specialist was hired by KCSR
to design and implement contingency plans for critical business processes.
Similarly, consulting professionals have been utilized by Janus, Berger and
Nelson in connection with Year 2000 efforts, including contingency planning.
Management expects that the contingency planning process will be completed by
the end of October 1999. The Company is also making alternative arrangements in
the event that critical suppliers, customers, utility providers and other
significant third parties are not Year 2000 ready.
In addition, information system black out periods have been scheduled at the
various Company subsidiaries, generally from the beginning of the fourth quarter
1999 through the end of the first quarter 2000. During this period, the Year
2000 project team and other members of the information systems group will focus
all of their efforts and time toward addressing Year 2000 related issues.
No new project requests or hardware/software upgrades will be allowed during
this time.
Year 2000 Costs. To date, the Company has spent approximately $17 million in
connection with ensuring that all Company and subsidiary computer programs are
compatible with Year 2000 requirements. In addition, the Company anticipates
future spending of approximately $5 million in connection with this process.
Current accounting principles require all costs associated with Year 2000 issues
to be expensed as incurred. A portion of these costs will not result in an
increase in expense to the Company because existing employees and equipment are
being used to complete the project.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company has had no significant changes in its Quantitative and Qualitative
Disclosures About Market Risk from that previously reported in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998.
32
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 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit 10.1 - Kansas City Southern Industries, Inc. 1991
Amended and Restated Stock Option Award and
Performance Plan, as amended and restated effective
as of May 6, 1999, is attached to this Form 10-Q as
Exhibit 10.1
Exhibit 27.1 - Financial Data Schedule
b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated July 12, 1999
under Item 5, reporting the favorable tax ruling received from the IRS
related to the spin-off of the financial services companies.
33
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, 1999
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)