FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 November 5, 1999
Common Stock, $.01 per share par value 110,524,182 Shares
- --------------------------------------------------------------------------------
KANSAS CITY SOUTHERN INDUSTRIES, INC.
FORM 10-Q
SEPTEMBER 30, 1999
INDEX
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Introductory Comments 1
Consolidated Condensed Balance Sheets -
September 30, 1999 and December 31, 1998 2
Consolidated Condensed Statements of Income and Comprehensive Income -
Three and Nine Months Ended September 30, 1999 and 1998 3
Computation of Basic and Diluted Earnings per Common Share 3
Consolidated Condensed Statements of Cash Flows -
Nine Months Ended September 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 12
Item 3. Qualitative and Quantitative Disclosures About Market Risk 35
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 6. Exhibits and Reports on Form 8-K 36
SIGNATURES 37
KANSAS CITY SOUTHERN INDUSTRIES, INC.
FORM 10-Q
SEPTEMBER 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 nine
months ended September 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)
September 30, December 31,
1999 1998
ASSETS
Current Assets:
Cash and equivalents $ 171.7 $ 27.2
Investments in advised funds 151.1 149.1
Accounts receivable, net 248.6 208.4
Inventories 44.6 47.0
Other current assets 39.1 37.8
----------- -----------
Total current assets 655.1 469.5
Investments held for operating purposes 748.9 707.1
Properties (net of $609.9 and $567.1 accumulated
depreciation and amortization, respectively) 1,306.3 1,266.7
Intangibles and Other Assets, net 193.3 176.4
----------- -----------
Total assets $ 2,903.6 $ 2,619.7
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt due within one year $ 10.9 $ 10.7
Accounts and wages payable 154.5 125.8
Accrued liabilities 192.3 159.7
----------- -----------
Total current liabilities 357.7 296.2
----------- -----------
Other Liabilities:
Long-term debt 780.7 825.6
Deferred income taxes 430.2 403.6
Other deferred credits 130.6 128.8
----------- -----------
Total other liabilities 1,341.5 1,358.0
----------- -----------
Minority Interest in consolidated subsidiaries 43.6 34.3
----------- -----------
Stockholders' Equity:
Preferred stock 6.1 6.1
Common stock 1.1 1.1
Retained earnings 1,078.4 849.1
Accumulated other comprehensive income 75.2 74.9
----------- -----------
Total stockholders' equity 1,160.8 931.2
----------- -----------
Total liabilities and stockholders' equity $ 2,903.6 $ 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 Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
Revenues $ 460.3 $ 334.2 $ 1,276.4 $ 952.5
Costs and expenses 288.8 210.1 804.7 598.9
Depreciation and amortization 24.1 18.7 67.5 53.4
---------- --------- ---------- ----------
Operating Income 147.4 105.4 404.2 300.2
Equity in net earnings (losses)
of unconsolidated affiliates:
DST Systems, Inc. 10.9 7.7 32.4 22.7
Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. 3.8 1.8 4.8 (3.4)
Other 2.0 0.8 5.2 1.7
Interest expense (15.4) (17.1) (45.7) (50.7)
Other, net 10.6 4.2 21.7 26.0
---------- --------- ---------- ----------
Pretax Income 159.3 102.8 422.6 296.5
Income tax provision 57.3 38.2 152.0 110.6
Minority interest in
consolidated earnings 14.7 9.4 38.6 25.8
---------- --------- ---------- ----------
Net Income 87.3 55.2 232.0 160.1
Other comprehensive income, net of
income tax:
Unrealized holding gain (loss)
on securities (12.5) (26.9) 3.6 16.2
Less: reclassification adjustment
for gains included in net income (3.1) (0.1) (3.3) (0.3)
---------- --------- ---------- ----------
Comprehensive Income $ 71.7 $ 28.2 $ 232.3 $ 176.0
========== ========= ========== ==========
Computation of Basic and
Diluted Earnings per Common Share
Basic Earnings per Common Share $ 0.79 $ 0.50 $ 2.10 $ 1.47
========== ========= ========== ==========
Diluted Earnings per Common Share $ 0.75 $ 0.49 $ 2.01 $ 1.41
========== ========= ========== ==========
Weighted Average Basic Common
Shares Outstanding (in thousands) 110,485 109,493 110,204 109,083
---------- --------- ---------- ----------
Weighted Average Diluted Common
Shares Outstanding (in thousands) 114,094 113,311 113,978 112,966
---------- --------- ----------- ----------
Cash Dividends Paid:
Per Preferred share $ .25 $ .25 $ .75 $ .75
Per Common share .04 .04 .12 .12
See accompanying notes to consolidated condensed financial statements.
4
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Nine Months
Ended September 30,
1999 1998
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income $ 232.0 $ 160.1
Adjustments to net income:
Depreciation and amortization 67.5 53.4
Deferred income taxes 25.9 34.6
Equity in undistributed earnings (42.4) (15.3)
Gain on sale of equity investments and property (0.5) (15.4)
Minority interest in consolidated earnings 38.6 25.8
Employee deferred compensation expenses 2.0 4.4
Changes in working capital items:
Accounts receivable (40.2) (20.6)
Inventories 2.4 (5.7)
Other current assets 5.0 (17.5)
Accounts and wages payable 25.5 (4.5)
Accrued liabilities 40.6 (17.7)
Prepaid commissions (22.9) -
Other, net (7.0) (4.3)
--------- ----------
Net 326.5 177.3
--------- ----------
INVESTING ACTIVITIES:
Property acquisitions (94.2) (72.9)
Proceeds from disposal of property 1.0 7.5
Investment in and loans with affiliates (14.6) (24.4)
Net sales (purchases) of investments in advised funds 3.8 (17.5)
Proceeds from disposal of equity investments - 10.2
Other, net (2.2) (2.6)
--------- ----------
Net (106.2) (99.7)
--------- ----------
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 31.8 152.8
Repayment of long-term debt (76.7) (214.1)
Proceeds from stock plans 38.5 25.0
Stock repurchased (24.6) (2.7)
Distributions to minority stockholders of
consolidated subsidiaries (31.4) (27.8)
Cash dividends paid (17.8) (17.8)
Other, net 4.4 1.4
--------- ----------
Net (75.8) (83.2)
--------- ----------
CASH AND EQUIVALENTS:
Net increase (decrease) 144.5 (5.6)
At beginning of year 27.2 33.5
--------- ----------
At end of period $ 171.7 $ 27.9
========= ==========
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 September 30, 1999 and December 31, 1998, the results
of operations for the three and nine months ended September 30, 1999 and 1998,
and cash flows for the nine months ended September 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 nine months ended September 30, 1999 are not necessarily
indicative of the results to be expected for the full year 1999. Certain 1998
information has been reclassified to conform to the current period presentation.
3. Separation of 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 Financial, Inc.
("Stilwell"), a holding company for the Company's Financial Services businesses
(the "Separation"). On July 12, 1999, the Company announced that the Internal
Revenue Service ("IRS") issued a favorable tax ruling permitting the
Company to separate its Financial Services segment from its Transportation
segment. Prior to the Separation, however, KCSI intends to complete a
recapitalization of the Transportation business, which may delay completion of
the Separation until 2000.
Stilwell Registration Statement on Form 10. On August 19, 1999, the Company
reported that Stilwell filed a Registration Statement on Form 10 ("Form 10")
with the Securities and Exchange Commission ("SEC") in connection with KCSI's
proposed spin-off of its financial services business. The filing includes an
Information Statement which will be provided to KCSI shareholders after the Form
10 becomes effective. As is typical when filing a Form 10, the Company has
received comments from the SEC requesting clarification of certain items. The
Company is in the process of responding to the SEC comments and, in furtherance
of this objective, the Company filed Amendment #1 to the Stilwell Form 10 on
October 18, 1999. The Stilwell Form 10 has not been declared effective.
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 3,608,905 and 3,773,514,
respectively, for the three and nine month periods ended September 30, 1999, and
3,818,543 and 3,882,879, respectively for the three and nine month periods ended
September 30, 1998. For the three and nine month periods ended September 30,
1999, the weighted average of options to purchase 155,500 and 81,667 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. The weighted average of options to
purchase 95,000 and 64,000 shares were excluded in the diluted earnings per
share calculations for the three and nine month periods ended September 30,
1998, respectively.
6
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 $1.5 million and $3.4 million for the three and nine month
periods ended September 30, 1999, respectively, and $0.3 million and $1.2
million for the three and nine month periods ended September 30, 1998,
respectively.
5. The Company's inventories ($44.6 million at September 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 significant.
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 September 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):
September 30, 1999 December 31, 1998
DST (a) Grupo TFM (b) Other DST (a) Grupo TFM (b) Other
Current assets $ 452.9 $ 146.9 $ 33.0 $ 375.7 $ 109.9 $ 33.1
Non-current assets 1,555.0 1,933.5 227.4 1,521.2 1,974.7 277.0
---------- ------------ -------- ---------- ----------- --------
Assets $ 2,007.9 $ 2,080.4 $ 260.4 $ 1,896.9 $ 2,084.6 $ 310.1
========== ============ ======== ========== =========== ========
Current liabilities $ 265.3 $ 269.3 $ 40.8 $ 268.6 $ 233.9 $ 48.6
Non-current liabilities 467.2 686.6 139.3 462.1 745.0 191.7
Minority interest - 346.6 - - 342.4 -
Equity of stockholders
and partners 1,275.4 777.9 80.3 1,166.2 763.3 69.8
---------- ------------ -------- ---------- ----------- --------
Liabilities and
equity $ 2,007.9 $ 2,080.4 $ 260.4 $ 1,896.9 $ 2,084.6 $ 310.1
========== ============ ======== ========== =========== ========
KCSI's investment $ 407.9 $ 289.8 $ 44.0 $ 376.0 $ 285.1 $ 38.6
========== ============ ======== ========== =========== ========
7
Operating Results (dollars in millions):
Three Months Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
Revenues:
DST (a) $ 298.7 $ 268.8 $ 891.1 $ 804.6
Grupo TFM (b) 132.2 113.9 383.9 323.5
All others 21.6 21.2 66.4 67.5
---------- ---------- ---------- ---------
Total revenues $ 452.5 $ 403.9 $ 1,341.4 $ 1,195.6
========== ========== ========== =========
Operating costs and expenses:
DST (a) $ 250.4 $ 240.3 $ 741.5 $ 698.1
Grupo TFM (b) 104.5 94.0 293.2 281.3
All others 18.1 18.4 59.2 63.1
---------- ---------- ---------- ---------
Total operating costs and expenses $ 373.0 $ 352.7 $ 1,093.9 $ 1,042.5
========== ========== ========== =========
Net income (loss):
DST (a) $ 33.9 $ 17.7 $ 100.9 $ 65.1
Grupo TFM (b) 19.2 6.5 21.8 (3.3)
All others 3.5 0.7 10.7 2.1
---------- ---------- ---------- ---------
Total net income $ 56.6 $ 24.9 $ 133.4 $ 63.9
========== ========== ========== =========
(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 using U.S. generally accepted accounting principles
("GAAP").
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):
Nine Months
Ended September 30,
1999 1998
Interest paid $ 50.6 $ 57.4
Income taxes paid 81.6 57.2
In December 1998, Janus introduced the Janus World Funds plc, a group of
offshore multiclass funds domiciled in Dublin, Ireland modeled after certain of
the Janus Investment Funds. Through September 1999, more than 80% of sales were
made into the funds' class B shares, which require Janus to advance sales
commissions to various financial intermediaries. Payment of these commissions is
recorded as deferred commissions in the accompanying consolidated condensed
financial statements. These deferred commissions are amortized using the
sum-of-the-years digits methodology over four years, or when the B shares are
redeemed, if earlier. Early withdrawal charges received by Janus from redemption
of the B shares within four years of purchase reduce the unamortized deferred
commissions balance. Janus paid approximately $22.9 million in commissions and
recorded related amortization expense of $5.2 million during the nine months
ended September 30, 1999.
8
Noncash Investing and Financing Activities:
During the first quarter of 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 have been no shares of KCSI common stock issued under an offering
of the ESPP during the first three quarters of 1999. In connection with the
Eleventh Offering of the ESPP, the Company has received approximately $3.2
million in cash (through September 30, 1999) that will be used to purchase KCSI
common stock in January 2000.
The Company's Board of Directors declared a quarterly dividend of $4.4 million
in December 1998, payable in January 1999. Upon declaration, the Company reduced
retained earnings and recorded a liability for the required payment. In January
1999, the cash was paid to the Company's stockholders.
During the second quarter of 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 nine month periods ended September 30, 1999, the Company recorded
its proportionate share of the unrealized gain (loss) in market value of these
investments of ($19.9) million and $6.0 million, respectively, (($12.5) million
and $3.6 million, respectively, net of deferred income taxes). For the three and
nine month periods ended September 30, 1998, the Company recorded its
proportionate share of the unrealized gain (loss) in market value of these
investments of ($44.2) million and $26.2 million, respectively, (($26.9) million
and $16.2 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 Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
Revenues:
Transportation $ 149.1 $ 157.0 $ 449.7 $ 462.4
Financial Services 311.2 177.2 826.7 490.1
----------- ----------- ----------- -----------
KCSI Consolidated $ 460.3 $ 334.2 $ 1,276.4 $ 952.5
=========== =========== =========== ===========
9
Net Income:
Transportation $ 4.6 $ 11.6 $ 17.4 $ 30.2
Financial Services 82.7 43.6 214.6 129.9
----------- ---------- ----------- -----------
KCSI Consolidated $ 87.3 $ 55.2 $ 232.0 $ 160.1
=========== ========== =========== ===========
September 30, December 31,
1999 1998
Total Assets:
Transportation $ 1,887.5 $ 1,796.8
Financial Services 1,016.1 822.9
---------------- ---------------
KCSI Consolidated $ 2,903.6 $ 2,619.7
================ ===============
Sales between segments were not material for the three and nine month periods
ended September 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, in June 1999, the FASB issued Statement of Financial Accounting
Standards No. 137 "Accounting for Derivative Instruments and Hedging Activities
Deferral of the Effective Date of FASB Statement No. 133 - an amendment of FASB
Statement No. 133", which deferred the effective date of SFAS 133 for one year
so that it will be effective for all fiscal quarters of all fiscal years
beginning 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, and also enters into fuel purchase commitments from time to
time. During third quarter 1999, KCSR entered into a diesel fuel cap transaction
for 3,000,000 gallons at a cap price of $0.60 per gallon. The premium for this
transaction was $0.024 per gallon and the cap is effective from April 1, 2000
through June 30, 2000. 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 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 used as Grupo TFM's functional currency, and any gains or losses from
translating Grupo TFM's
10
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 Duncan Case and Bogalusa Cases.
Duncan Case -
In 1998, a jury in Beauregard Parish, Louisiana returned a verdict against KCSR
in the amount of $16.3 million. The Louisiana state case arose from a railroad
crossing accident which occurred at Oretta, Louisiana on September 11, 1994, in
which three individuals were injured. Of the three, one was injured fatally, one
was rendered quadriplegic and the third suffered less serious injuries.
Subsequent to the verdict, the trial court held that the plaintiffs were
entitled to interest on the judgment from the date the suit was filed, dismissed
the verdict against one defendant and reallocated the amount of that verdict to
the remaining defendants. The resulting total judgment against KCSR, together
with interest, was approximately $26.7 million at September 30, 1999.
On November 3, 1999 the Third Circuit Court of Appeals in Louisiana affirmed the
judgment. Review will now be sought in the Louisiana Supreme Court.
Independent trial counsel continues to express the opinion that the evidence
presented at trial established no negligent conduct on the part of KCSR and
expressed confidence that the verdict will ultimately be reversed. KCSR
management believes it has meritorious defenses in this case and that it will
ultimately prevail in appeal. If the verdict were to stand, however, the
judgment and interest are in excess of existing insurance coverage and could
have an adverse effect on the Company's consolidated results of operations and
financial position.
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.
11
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.
The trial of a group of twenty plaintiffs in the Mississippi lawsuits arising
from the chemical release 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. On September 30, 1999, Berger Associates, Inc. assigned and transferred its
operating assets and business to its subsidiary, Berger LLC, a limited liability
company. In addition, Berger Associates, Inc. changed its name to Stilwell
Management, Inc. ("Stilwell Management"). Stilwell Management owns 100% of the
preferred limited liability company interests and approximately 86% of the
regular limited liability company interests of Berger. The remaining 14% of
regular limited liability company interests was issued to key Stilwell
Management and Berger employees, resulting in a noncash compensation charge.
12
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 services. The
Company supplies its various subsidiaries with managerial, legal, tax, financial
and accounting services, in addition to managing other "non-operating" and more
passive investments.
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 Kansas City Southern Lines, Inc. ("KCSL"), a wholly-owned subsidiary of the
Company, serving as a holding company for transportation-related
subsidiaries and affiliates;
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; and
o Various other consolidated subsidiaries.
13
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 LLC ("Berger" - successor to the operating assets and business of
Berger Associates, Inc.), of which Stilwell indirectly owns 100% of the
Berger preferred limited liability company interests and approximately 86%
of the Berger regular limited liability company interests - see below;
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") issued a favorable tax ruling
permitting the Company to separate its Financial Services segment from its
Transportation segment. Prior to the Separation, however, KCSI intends to
complete a recapitalization of the Transportation business, which may delay
completion of the Separation until 2000.
On March 26, 1999, a number of Janus minority stockholders and employees of
Janus, including members of Janus' management, its chief executive officer, its
chief investment officer, portfolio managers and assistant portfolio managers
who own a material number of Janus shares, five of the six Janus directors and
others (the "Janus Minority Group") proposed that KCSI consider, in addition to
the Separation, a separate spin-off of Janus. Members of the Janus Minority
Group met with KCSI's Board of Directors ("Board") on June 23, 1999 and urged
the Board to consider their separate spin-off proposal.
The Boards of Trustees or Directors of the Janus Investment Fund, Janus Aspen
Series and Janus World Funds plc ("Trustees") expressed support on March 26,
1999 for the proposal of the Janus Minority Group. After further discussions
with Stilwell and members of the Janus Minority Group, the Trustees indicated
that they intended to remain neutral with respect to the differences between
Stilwell and the Janus Minority Group, but encouraged the parties to attempt to
resolve those differences.
After considering the information presented by the Janus Minority Group and
information provided by Stilwell management regarding the advantages and
disadvantages of the two methods of achieving the Separation, KCSI's Board
decided that the Separation should go forward on the basis originally
contemplated. In arriving at this decision, KCSI's Board took into consideration
a number of factors, including that: i) a favorable tax ruling on the Separation
had been received from the IRS; ii) the presentation by the Janus Minority Group
was not persuasive, in the Board's view, as to the advantages of the alternative
proposal as compared to the Separation; iii) there was a lack of certainty that
a favorable tax
14
ruling could be obtained in a timely manner, or at all, with respect to the
alternative proposal; and iv) the Separation was more consistent with the
strategic direction of Stilwell.
Stilwell files a Registration Statement on Form 10 with the Securities and
Exchange Commission. On August 19, 1999, the Company reported that Stilwell
filed a Registration Statement on Form 10 ("Form 10") with the Securities and
Exchange Commission ("SEC") in connection with KCSI's proposed spin-off of its
financial services business. The filing includes an Information Statement which
will be provided to KCSI shareholders after the Form 10 becomes effective. As is
typical when filing a Form 10, the Company has received comments from the SEC
requesting clarification of certain items. The Company is in the process of
responding to the SEC comments and, in furtherance of this objective, the
Company filed Amendment #1 to the Stilwell Form 10 on October 18, 1999. The
Stilwell Form 10 has not been declared effective.
Berger LLC Formation. On September 30, 1999, Berger Associates, Inc. assigned
and transferred its operating assets and business to its subsidiary, Berger LLC,
a limited liability company. In addition, Berger Associates, Inc. changed its
name to Stilwell Management, Inc. ("Stilwell Management"). Stilwell Management
owns 100% of the preferred limited liability company interests and approximately
86% of the regular limited liability company interests of Berger. The remaining
14% of regular limited liability company interests was issued to key Stilwell
Management and Berger employees, resulting in a noncash compensation charge.
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. 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. In
preparation for the planned separation of the Transportation and Financial
Services businesses, effective July 1, 1999, KCSI contributed to Stilwell its
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".
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 rail 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. 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 NAFTA corridor. This is expected to
alleviate some of the
15
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: 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, a 50% owned rail leasing joint venture. Southern Capital, through its
existing credit lines, already has the capital capacity to finance the purchase
of these new locomotives. As a result of this transaction, 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 to begin in November 1999 with completion of delivery by
the end of 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 November 1999.
The total cost of the reconstruction project is estimated to be $75 million with
the commitment from KCSR not to exceed $13 million. Reconstruction of PCRC's
right-of-way is expected to begin in late fourth quarter 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.
Access to Geismar, Louisiana Industrial Corridor. 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
16
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 used as 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. In April 1999, Southern Capital sold
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 proceeds were used to reduce outstanding indebtedness of the joint
venture as mandated by its loan agreement. The sale of these assets 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.
17
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. Under the initial agreement, if the
option to purchase at least 35% of the Government's stock was not exercised
prior to May 31, 1999, the entire option expired; however, management of TFM has
advised the Company that the Government has extended the option to December 15,
1999, and that the Government may be willing to grant further extensions. The
parties are 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 conditionally agreed to settle the outstanding claims against the
Government regarding a refund of Mexican Value Added Tax (VAT) payments. TFM has
also conditionally 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, following the exercise of the option, 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 September 30, 1999, no portion of the option
agreement and associated transactions had been completed by any of the parties.
18
RESULTS OF OPERATIONS
The Company's revenues, operating income and net income by industry segment are
as follows (dollars in millions):
Three Months Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
Revenues:
Transportation $ 149.1 $ 157.0 $ 449.7 $ 462.4
Financial Services 311.2 177.2 826.7 490.1
----------- ----------- ----------- ----------
Total $ 460.3 $ 334.2 $ 1,276.4 $ 952.5
=========== =========== =========== ==========
Operating Income:
Transportation $ 14.6 $ 28.4 $ 58.7 $ 90.2
Financial Services 132.8 77.0 345.5 210.0
----------- ----------- ----------- ----------
Total $ 147.4 $ 105.4 $ 404.2 $ 300.2
=========== =========== =========== ==========
Net Income:
Transportation $ 4.6 $ 11.6 $ 17.4 $ 30.2
Financial Services 82.7 43.6 214.6 129.9
----------- ----------- ----------- ----------
Total $ 87.3 $ 55.2 $ 232.0 $ 160.1
=========== =========== =========== ==========
The Company reported third quarter 1999 earnings of $87.3 million, or $0.75 per
diluted share, compared to $55.2 million, or $0.49 per diluted share in third
quarter 1998. Consolidated third quarter 1999 revenues rose $126.1 million, or
38%, compared to the same 1998 period, fueling an increase in operating income
of $42.0 million (40%). This increase in revenues resulted from higher assets
under management in the Financial Services segment, slightly offset by lower
Transportation segment revenues. Operating expenses increased approximately 37%
quarter to quarter arising from higher costs associated with the significant
revenue growth in the Financial Services segment, as well as from an increase in
KCSR operating costs. Third quarter 1999 depreciation and amortization expenses
increased 29%, chiefly because of higher depreciation and amortization in the
Financial Services segment arising from 1998 and 1999 information technology and
customer service related infrastructure development. Equity earnings in
unconsolidated affiliates improved $6.4 million due primarily to increased
equity earnings from DST and Grupo TFM of $3.2 million and $2.0 million,
respectively. Interest expense declined $1.7 million (10%) for the three months
ended September 30, 1999 versus the comparable 1998 period due to lower average
debt balances.
For the nine months ended September 30, 1999, consolidated earnings were $232.0
million, or $2.01 per diluted share, versus $160.1 million, or $1.41 per diluted
share in comparable 1998. Year to date 1999 consolidated revenues increased 34%
to $1,276.4 million from $952.5 million during the same 1998 period, due to the
growth in assets under management in the Financial Services segment, offset by
lower Transportation segment revenues. These increased revenues led to a 35%
improvement in operating income period to period. Operating expenses, including
depreciation and amortization, increased approximately 34% period to period
arising from higher costs in both the Financial Services and Transportation
segments as discussed above. Year to date 1999 equity earnings of unconsolidated
affiliates more than doubled because of increased earnings at DST, Grupo TFM and
Mexrail. Interest expense for the nine months ended September 30, 1999 was 10%
lower than the comparable 1998 period primarily as a result of lower average
debt balances.
19
TRANSPORTATION
Three Months Ended September 30, 1999 Compared With Three Months Ended September 30, 1998
THREE MONTHS THREE MONTHS
ENDED SEPTEMBER 30, 1999 ENDED SEPTEMBER 30, 1998
------------------------ ------------------------
(in millions)
Consolidated Consolidated
KCSR Other Transportation KCSR Other Transportation
Revenues $ 138.3 $ 10.8 $ 149.1 $ 139.8 $ 17.2 $ 157.0
Costs and expenses 108.6 11.6 120.2 98.9 15.6 114.5
Depreciation and amortization 12.4 1.9 14.3 12.7 1.4 14.1
-------- -------- --------- -------- -------- ---------
Operating income (loss) 17.3 (2.7) 14.6 28.2 0.2 28.4
Equity in net earnings (losses)
of unconsolidated affiliates
Grupo TFM - 3.8 3.8 - 1.8 1.8
Other 0.5 0.8 1.3 0.4 (0.1) 0.3
Interest expense (8.2) (6.5) (14.7) (8.9) (6.4) (15.3)
Other, net 1.1 0.2 1.3 2.0 1.0 3.0
-------- -------- --------- -------- -------- ---------
Pretax income (loss) 10.7 (4.4) 6.3 21.7 (3.5) 18.2
Income tax provision (benefit) 4.2 (2.5) 1.7 8.5 (1.9) 6.6
-------- --------- --------- -------- -------- ---------
Net income (loss) $ 6.5 $ (1.9) $ 4.6 $ 13.2 $ (1.6) $ 11.6
======== ========= ========= ======== ======== =========
The Transportation segment reported earnings of $4.6 million for the three
months ended September 30, 1999 compared with $11.6 million for the three months
ended September 30, 1998. This decrease in earnings was attributable to an
approximate 49% decline in operating income arising from lower revenues and
higher operating expenses. Partially offsetting the lower operating income was
an improvement in equity earnings related to Grupo TFM and Mexrail, as well as
lower interest expense.
Transportation segment revenues for third quarter 1999 totaled $149.1 million
versus $157.0 million in comparable 1998. This decline of 5% resulted from lower
KCSR and Gateway Western revenues, as well as lower revenues at various other
smaller Transportation companies. KCSR carloadings increased 7% quarter to
quarter, but revenues declined 1% due to changes in the mix of commodities
traffic. Coal and intermodal revenues improved 2% and 20%, respectively;
however, this growth was offset by lower revenues in the chemical, agriculture
and paper product sectors. Gateway Western revenues declined approximately 26%
quarter to quarter as a result of volume declines arising from lower demand,
primarily in haulage traffic, metal products, miscellaneous chemical traffic and
grain/food products.
20
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 September 30, ended September 30,
1999 1998 1999 1998
General commodities:
Chemical and petroleum $ 32.3 $ 35.5 39.6 41.5
Paper and forest 26.3 28.3 42.1 44.9
Agricultural and mineral 21.4 23.2 31.3 31.8
Other 8.0 5.4 9.6 6.3
----------- ---------- ---------- -----------
Total general commodities 88.0 92.4 122.6 124.5
Intermodal 13.7 11.4 61.6 46.0
Coal 30.2 29.7 52.4 50.6
----------- ---------- ---------- -----------
Subtotal 131.9 133.5 236.6 221.1
Other 6.4 6.3 - -
----------- ---------- ---------- -----------
Total $ 138.3 $ 139.8 236.6 221.1
=========== ========== ========== ===========
Coal - Coal revenues increased approximately 2% for third quarter 1999
compared with third quarter 1998, primarily as a result of an increase in unit
coal carloads of approximately 4%. Increases in unit coal traffic during third
quarter 1999 were generally attributable to higher seasonal demand and hot
summer weather. These increases were partially offset by volume and revenue
declines resulting from slower delivery times because of KCSR congestion, as
well as from the closing of Kansas City Power and Light's ("KCP&L") Hawthorn
plant, which had a major casualty and is projected to be out of service until
July 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.
Chemical and petroleum products - For the three months ended September
30, 1999, chemical and petroleum product revenues decreased $3.2 million, or
9.1%, compared with the same 1998 period. This resulted from revenue declines in
all major products within this commodity group. Miscellaneous chemical revenues
were down approximately 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 and
pricing pressures driven by competitive market dynamics. Lower demand for soda
ash, plastics and petroleum-related products resulted in a decrease in related
shipments during third quarter 1999. This decrease in shipments coupled with
lower revenue per carload due to a change in traffic mix and length of haul
resulted in lower revenues.
Paper and forest products - Paper and forest product revenues declined
$2.0 million, or 7.0%, during third quarter 1999 compared to third quarter 1998,
primarily because of volume declines in all major products. This decline relates
to the overall weakness in this market during 1999 as compared with 1998.
However, paper and forest product revenues for third quarter 1999 have increased
approximately $0.6 million compared with both the first and second quarters of
1999 and management expects a continued increase, including potential exports to
Mexico, in the fourth quarter of 1999 and into 2000.
Agricultural and mineral products - Agricultural and mineral product
revenues decreased 7.9%, to $21.4 million, for the three months ended September
30, 1999 versus the comparable 1998 period, resulting primarily from lower
carloads and revenue per carload for domestic grain movements, food products,
and
21
stone, clay and glass shipments. This decrease was primarily attributable to
lower demand during the third quarter and system congestion. Partially
offsetting these declines was an increase in export grain revenues, arising from
improvements in the export marketplace.
Intermodal and other - Intermodal and other revenues increased $4.9
million, or 29.2%, quarter to quarter. This increase is comprised of higher
intermodal revenues of $2.3 million arising from more intermodal unit shipments
(34.0%) quarter to quarter, as well as a significant increase in automotive
revenues, which increased $1.5 million (370%) 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 matures. KCSR increased certain intermodal
rates effective September 1, 1999 and closed two intermodal facilities on the
north-south route. Management expects these actions to improve the profitability
and operating efficiency of the intermodal business sector.
The Transportation segment's total operating expenses increased $5.9 million
(4.6%), to $134.5 million for the three months ended September 30, 1999 from
$128.6 million for the three months ended September 30, 1998. Third quarter KCSR
operating expenses increased $9.4 million from 1998, primarily due to system
congestion issues on the KCSR. System track maintenance work on the north-south
corridor, which began in second quarter 1999, continued throughout the third
quarter contributing to system capacity constraints and congestion. Also
contributing to capacity and congestion problems was the implementation of a new
dispatching system and turnover in certain experienced operations management
positions. These factors, coupled with two significant third quarter
derailments, led to higher expenses in car hire, salaries and wages (primarily
train crew overtime) casualties/insurance (derailments during third quarter
costing approximately $3.7 million) and costs relating to additional locomotive
power needs. Variable expenses as a percentage of KCSR revenues increased
approximately eight percentage points reflecting the congestion-related
operating inefficiencies and the decline in higher margin chemical traffic.
Lower third quarter revenues coupled with higher operating expenses resulted in
a decrease in KCSR's operating income of $10.9 million quarter to quarter and an
operating ratio, a common efficiency measure among Class I rail carriers, of
87.5% for the quarter compared with 79.8% in third quarter 1998.
The operations of other Transportation segment companies resulted in operating
losses of $2.7 million for third quarter 1999 compared with operating income of
$0.2 million during third quarter 1998. This decrease is primarily attributable
to lower operating income at Gateway Western, which decreased more than $2.0
million due to lower revenues as discussed previously. In addition, several
smaller Transportation companies experienced lower operating income arising
primarily because of volume-related revenue declines
The Transportation segment recorded equity earnings of $5.1 million from
unconsolidated affiliates for the three months ended September 30, 1999 compared
to equity earnings of $2.1 million for the three months ended September 30,
1998. The increase is attributed primarily to equity earnings from Grupo TFM,
which increased $2.0 million quarter to quarter. TFM revenues and operating
profits rose 16% and 38%, respectively, quarter to quarter. These continued
operating improvements resulted in an operating ratio for TFM of 79.2% versus
82.5% in third quarter 1998. Results of Grupo TFM are reported using U.S.
generally accepted accounting principles ("GAAP"). Mexrail recorded equity
earnings of $0.6 million in third quarter 1999 versus losses of $0.1 million in
the comparable 1998 period on improved revenues and lower costs.
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 of these
deferred
22
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 $0.6 million during third quarter 1999 compared to the
same 1998 period, primarily as a result of lower average debt balances.
Nine Months Ended September 30, 1999 Compared With The Nine Months Ended
September 30, 1998
NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, 1999 ENDED SEPTEMBER 30, 1998
------------------------ ------------------------
(in millions)
Consolidated Consolidated
KCSR Other Transportation KCSR Other Transportation
Revenues $ 409.3 $ 40.4 $ 449.7 $ 414.1 $ 48.3 $ 462.4
Costs and expenses 307.1 40.9 348.0 288.6 41.1 329.7
Depreciation and amortization 37.7 5.3 43.0 38.0 4.5 42.5
-------- -------- --------- -------- -------- ---------
Operating income (loss) 64.5 (5.8) 58.7 87.5 2.7 90.2
Equity in net earnings (losses)
of unconsolidated affiliates
Grupo TFM - 4.8 4.8 - (3.4) (3.4)
Other 2.3 1.2 3.5 1.4 (0.8) 0.6
Interest expense (25.0) (18.3) (43.3) (27.1) (18.2) (45.3)
Other, net 2.8 0.4 3.2 7.4 2.7 10.1
-------- -------- --------- -------- -------- ---------
Pretax income (loss) 44.6 (17.7) 26.9 69.2 (17.0) 52.2
Income tax provision (benefit) 17.5 (8.0) 9.5 27.1 (5.1) 22.0
-------- --------- --------- -------- -------- ---------
Net income (loss) $ 27.1 $ (9.7) $ 17.4 $ 42.1 $ (11.9) $ 30.2
======== ========= ========= ======== ======== =========
The Transportation segment reported earnings of $17.4 million for the nine
months ended September 30, 1999 versus $30.2 million for the comparable 1998
period. This decrease in earnings was attributable to a 35% 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 certain other 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 $12.7 million, or 2.7%, to $449.7 million for the nine
months ended September 30, 1999, from $462.4 million for the same 1998 period.
Consistent with the third quarter 1999, this decline resulted from lower KCSR
revenues, which fell $4.8 million, or 1.2%, period to period, as well as
declines in revenue at Gateway Western and various other smaller Transportation
companies. Although total KCSR carloadings increased approximately 2.6% period
to period, revenues declined over 1% due to traffic mix. Lower revenues in
paper/forest products, as well as the higher margin coal and chemical commodity
sectors were partially offset by growth in the intermodal and automotive
business sectors and agriculture/mineral products. Gateway Western revenues
declined nearly 14% period to period due to lower demand in haulage traffic,
miscellaneous chemicals, metal products and grain/food traffic as discussed
previously in the third quarter analysis.
23
The following is a summary of revenues and carloads for KCSR's major commodity
groups:
Carloads and
Revenues Intermodal Units
(in millions) (in thousands)
Nine months Nine months
ended September 30, ended September 30,
1999 1998 1999 1998
General commodities:
Chemical and petroleum $ 97.2 $ 105.1 120.1 125.4
Paper and forest 77.7 82.5 124.4 131.9
Agricultural and mineral 70.4 68.0 98.2 95.8
Other 19.8 16.7 24.3 21.0
----------- ---------- ---------- ---------
Total general commodities 265.1 272.3 367.0 374.1
Intermodal 38.2 34.3 164.6 134.9
Coal 86.5 88.2 150.9 156.0
----------- ---------- ---------- ---------
Subtotal 389.8 394.8 682.5 665.0
Other 19.5 19.3 - -
----------- ---------- ---------- ---------
Total $ 409.3 $ 414.1 682.5 665.0
=========== ========== ========== =========
Coal - Coal revenues declined $1.7 million, or 1.9%, for the nine
months ended September 30, 1999 compared with the nine months ended September
30, 1998, as a result of lower unit coal traffic (decrease of approximately
5,000 carloads). A contributing factor to the year to date decline in coal
revenues has been the slower delivery times due to congestion on KCSR during
1999. In addition, demand for coal has not been as strong in 1999 as it was in
1998 - a year in which KCSR reported record coal revenues. Relatively low
inventory levels in early 1998 coupled with an increase in capacity at certain
utility customers led to high demand during 1998. Although demand for coal has
increased during the third quarter 1999 and is expected to remain strong during
fourth quarter, year to date demand has not reached the 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 as discussed in the third quarter analysis, 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, the Amsterdam plant is a longer haul for KCSR and thus, the related
revenues generated per unit train are higher. Coal accounted for 22.2% and 22.3%
of total carload revenues for the nine months ended September 30, 1999 and 1998,
respectively.
Chemical and petroleum products - Chemical and petroleum product
revenues decreased $7.9 million, or 7.5%, period to period primarily because of
lower miscellaneous chemical, plastics and soda ash revenues. As discussed
previously in the third 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 have
declined period to period primarily because of a decrease in export shipments
due to competitive market dynamics. Management expects this decline in exports
of soda ash to continue due to this competition. Chemical and petroleum products
accounted for 25.0% of total carload revenues for the nine months ended
September 30, 1999 versus 26.6% for the same 1998 period.
Paper and forest products - Paper and forest product revenues decreased
$4.8 million, or 5.9%, for the nine months ended September 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 20.9% of total
carload revenues for the nine months ended September 30, 1999 and 1998,
respectively.
24
Agricultural and mineral products - Agricultural and mineral product
revenues increased $2.4 million, or 3.5%, period to period. Strength in domestic
and export grain shipments during the nine months ended September 30, 1999 was
partially offset by declines in food, non-metallic ores and stone, clay and
glass revenues due primarily to volume declines and changes in traffic mix and
length of haul. Agricultural and mineral products accounted for 18.1% of total
carload revenues for the nine months ended September 30, 1999 compared with
17.2% for the same 1998 period.
Intermodal and other - Intermodal and other revenues increased $7.0
million, or 13.5%, for the nine months ended September 30, 1999 versus the
comparable 1998 period. Similar to the third quarter analysis, this improvement
is comprised mostly of higher intermodal revenues of $3.9 million, as well as a
$3.0 million increase in automotive revenues period to period. Also contributing
was an increase in military and other carloads. These increases were partially
offset by a decline in metal/scrap revenues of approximately $2 million arising
from weakness in the slab steel market as a result of slower domestic oil
production. Intermodal and other accounted for 14.8% of total carload revenues
for the period ended September 30, 1999 compared with 13.0% for the same 1998
period.
The Transportation segment's total operating expenses increased $18.8 million
(5.1%), to $391.0 million for the nine months ended September 30, 1999 from
$372.2 million for the same 1998 period. KCSR operating costs for the period
increased $18.2 million from 1998, primarily due to the same expense components
as discussed in the third quarter analysis. Lower year to date revenues coupled
with higher operating expenses have resulted in a $23.0 million decrease in
KCSR's operating income period to period and an operating ratio of 84.1%
compared with 78.7% for the nine months ended September 30, 1998.
For year to date 1999, the Transportation segment has recorded equity earnings
from unconsolidated affiliates of $8.3 million compared with equity losses of
$2.8 million for the same 1998 period. This increase was attributable primarily
to improvements at Grupo TFM and Mexrail. For the nine months ended September
30, 1999, the Company recorded equity earnings from Grupo TFM of $4.8 million
compared with equity losses of $3.4 million for the nine months ended September
30, 1998. This $8.2 million improvement at Grupo TFM reflects a year to date
revenue increase of 19% coupled with continued operating improvements. These
factors have resulted in a TFM operating ratio of 76.4% for the nine months
ended September 30, 1999 versus 86.9% for the same 1998 period. Mexrail
contributed equity earnings of $1.0 million for the nine months ended September
30, 1999 compared to equity losses of $1.0 million in the comparable 1998
period. This improvement resulted from higher revenues and lower operating
costs. Equity earnings from Southern Capital improved by approximately $0.6
million period to period, a portion of which relates to a gain on the sale of
the loan portfolio in 1999.
Interest expense declined $2.0 million during the nine months ended September
30, 1999 compared to the same 1998 period, primarily as a result of lower
average debt balances. Other, net decreased $6.9 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.
25
FINANCIAL SERVICES
Three Months Ended September 30, 1999 Compared With Three Months Ended September
30, 1998
THREE MONTHS
ENDED SEPTEMBER 30,
1999 1998
------------------ ------------------
(in millions)
Revenues $ 311.2 $ 177.2
Costs and expenses 168.6 95.6
Depreciation and amortization 9.8 4.6
------------- -------------
Operating income 132.8 77.0
Equity in net earnings of
unconsolidated affiliates:
DST Systems, Inc. 10.9 7.7
Other 0.7 0.5
Interest expense (0.7) (1.8)
Other, net 9.3 1.2
------------- -------------
Pretax income 153.0 84.6
Income tax provision 55.6 31.6
Minority interest 14.7 9.4
------------- -------------
Net income $ 82.7 $ 43.6
============= =============
The Financial Services segment contributed $82.7 million to KCSI's 1999 third
quarter consolidated earnings versus $43.6 million in third quarter 1998. This
90% growth in earnings resulted from a 76% and 72% increase in revenues and
operating income, respectively, quarter to quarter. These improvements were
driven by an 85% increase in average assets under management compared to third
quarter 1998.
Financial Services revenues grew to $311.2 million compared to $177.2 million in
third quarter 1998. Assets under management increased $9.4 billion, or 6%,
during third quarter 1999, totaling more than $171.1 billion as of September 30,
1999 ($165.0 billion at Janus; $4.9 billion at Berger; and $1.2 billion at
Nelson). Net sales were $7.9 billion during the three months ended September 30,
1999 versus $4.0 billion in the comparable prior period. Market appreciation was
$1.5 billion during third quarter 1999 compared to net depreciation of $9.9
billion in 1998. See the brief discussions of Janus, Berger and Nelson
separately below.
Financial Services operating margins declined slightly in third quarter 1999 due
to an increase in operating expenses to $178.4 million from $100.2 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 occurred in the following key areas: i) salaries and
wages, resulting from investment performance-based incentive compensation, an
increase in the number of employees and associated training, and a one-time
noncash compensation charge resulting from the formation of Berger LLC, as
previously discussed; ii) marketing and fulfillment, resulting from efforts to
strengthen brand names and to capitalize on favorable investment performance;
and iii) alliance fees under mutual fund "supermarket" distribution
arrangements, resulting from an increase of more than 90% in average assets
under management through these channels quarter to quarter.
26
Third quarter 1999 equity earnings from DST increased to $10.9 million from $7.7
million in comparable 1998, primarily due to increased 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 11% due to a higher number of shareowner accounts
processed (growing to 54.8 million at September 30, 1999 from 49.8 million at
December 31, 1998), images produced (24.4% increase) and statements mailed (up
19.5%).
The $8.1 million increase in other income reported in Other, net is primarily
comprised of Janus and Berger realized gains resulting from the sale of
investments in advised funds.
Nine Months Ended September 30, 1999 Compared With Nine Months Ended September
30, 1998
NINE MONTHS
ENDED SEPTEMBER 30,
1999 1998
------------------ ------------------
(in millions)
Revenues $ 826.7 $ 490.1
Costs and expenses 456.7 269.2
Depreciation and amortization 24.5 10.9
------------- -------------
Operating income 345.5 210.0
Equity in net earnings of
unconsolidated affiliates:
DST Systems, Inc. 32.4 22.7
Other 1.7 1.1
Interest expense (2.4) (5.4)
Other, net 18.5 15.9
------------- -------------
Pretax income 395.7 244.3
Income tax provision 142.5 88.6
Minority interest 38.6 25.8
------------- -------------
Net income $ 214.6 $ 129.9
============= =============
For the nine months ended September 30, 1999, Financial Services contributed
$214.6 million to the Company's consolidated earnings, an $84.7 million increase
over comparable 1998. Exclusive of an after-tax $4.4 million gain resulting from
Janus' sale of IDEX Management, Inc. ("IDEX") in second quarter 1998, earnings
improved 71% period to period. Financial Services revenues reached $826.7
million, an increase of 69% over prior year, fueling a 65% increase in operating
income (to $345.5 million).
Net sales of $34.8 billion and appreciation of $22.8 billion resulted in a 51%
jump in assets under management during the nine months ended September 30, 1999.
Average assets under management for the current nine month period were 74%
higher than the same period in 1998. In addition, shareowner accounts grew more
than 33% during the nine months ended September 30, 1999, surpassing 4.0 million
as of period end.
A 72% increase in operating expenses through September 30, 1999 compared to 1998
resulted in slightly lower operating margins period to period (from 42.8% to
41.8%). Higher costs occurred in the same key expense components as noted in the
third quarter 1999 discussion. These three components - salaries and wages,
alliance distribution costs and marketing and fulfillment - were approximately
44% of total Financial
27
Services revenues during the nine months ended September 30, 1999 versus
approximately 42% in 1998 and 44% through June 30, 1999. Additionally,
information technology and customer service related infrastructure initiatives
throughout 1998 and 1999 to ensure the ongoing quality and reliability of
customer service resulted in higher depreciation and various other expenses.
Year to date 1999 equity earnings from DST totaled $32.4 million, a 43% increase
over the same period in 1998. This growth was driven by increased operating
earnings in DST's financial services and output solutions segments (partly due
to revenue growth of 11% and 17%, respectively), higher equity earnings of
unconsolidated DST affiliates and improved operating margins.
The 16% increase in Other, net is attributable to the following: i) realized
gains by Janus and Berger on the sale of short-term investments; ii) higher
interest income resulting from an increase in cash; and iii) gains resulting
from the issuance of Janus shares to certain of its employees, which reduced the
Company's ownership of Janus. Year to date 1998 includes the gain resulting from
Janus' sale of IDEX during the second quarter. 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 nine
months ended September 30, 1999 follows:
Janus
Janus assets under management increased $56.7 billion (52%) during the
nine months ended September 30, 1999. Since September 30, 1998, Janus
assets under management have nearly doubled and shareowner accounts have
grown by more than 40%, reflecting ongoing favorable investment
performance by the various funds/portfolios within the Janus group of
mutual funds, continued growth through net sales (the $34.6 billion
through September 1999 is equivalent to the combined total net sales for
years 1995 through 1998), and competitive levels of expenses and fees
compared to industry standards.
Berger
Berger assets under management increased 23% (to $4.9 billion) during the
nine months ended September 30, 1999 and 44% compared to the $3.4 billion
assets under management at September 30, 1998. Shareowner accounts
declined approximately 12% (primarily in the Berger One Hundred Fund)
during the nine months ended September 30, 1999; however, net sales of
$163 million - primarily in Berger's newer fund offerings -- offset the
cash outflows that accompanied shareowner 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 related costs.
Berger's investment in BBOI Worldwide LLC ("BBOI") continues to report
increases in assets under management 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 would purchase Bank of Ireland's interest in BBOI.
However, the parties have not entered into a definitive agreement and are
considering other alternatives, including a division of BBOI's assets
between Berger and Bank of Ireland with a dissolution of BBOI.
Nelson
The Company acquired Nelson in April 1998. Accordingly, results for 1998
include only six months of activity compared to the nine month period
ended September 30, 1999. Nelson's assets under management increased 8%
to (pound)750 million as of September 30, 1999 from (pound)696 million at
December
28
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, 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 third quarter and year to date 1999 diluted earnings per share
($0.75 and $2.01, respectively) increased 53% and 43%, respectively, compared to
the same 1998 periods ($0.49 and $1.41, respectively). Revenue growth in the
Financial Services segment for the first nine months of 1999, partially offset
by related increases in operating costs, resulted in a 35% higher consolidated
operating income period to period. While the Transportation segment experienced
a decline in revenues, operating income and earnings for the third quarter and
year to date 1999 periods, Grupo TFM results continued to improve due to revenue
growth and operating improvements. Domestically, KCSR results were affected by a
decline in revenues and increased operating expenses due to congestion issues,
while Gateway Western results were affected by volume-related revenue declines.
KCSR's operational issues are currently being addressed by management and
improvement is expected to begin in the fourth quarter 1999. In the Financial
Services segment, continued growth in assets under management has fueled
revenue, operating income and earnings growth for both the third 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 and the
expected reduction of congestion during fourth quarter 1999, revenues for
the remainder of 1999 are expected to remain generally flat compared to the
fourth quarter 1998. Transportation management is disappointed with the
operating results during 1999, but believes that the NAFTA Railway
continues to provide an attractive service for shippers. The Company
expects to realize benefits from traffic with Mexico, the CN/IC alliance
and interchange traffic with the Norfolk Southern. Management is addressing
certain cost issues and capital needs in an effort to alleviate the
congestion. As an example, three new sidings have recently been added on
KCSR's north-south route, with an additional three sidings to be completed
during the fourth quarter. The addition of these sidings is expected to
improve capacity and help ease congestion. Further, the track maintenance
on the north-south corridor was completed during September 1999 and thus,
the congestion caused by this work is expected to ease. Additionally, as
mentioned previously, KCSR expects to improve locomotive efficiency through
the 50 new GE A/C 4400 locomotives to be received during November and
December of 1999. Transportation management anticipates that these
actions, among others, will provide the framework for more efficient and
productive operations over the last quarter of 1999 and into 2000.
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.
29
Based on a higher level of assets under management starting the fourth
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.
LIQUIDITY AND CAPITAL RESOURCES
Summary cash flow data is as follows (in millions):
Nine Months
Ended September 30,
1999 1998
Cash flows provided by (used for):
Operating activities $ 326.5 $ 177.3
Investing activities (106.2) (99.7)
Financing activities (75.8) (83.2)
--------- ----------
Cash and equivalents:
Net increase (decrease) 144.5 (5.6)
At beginning of year 27.2 33.5
--------- ----------
At end of period $ 171.7 $ 27.9
========= ==========
During the nine months ended September 30, 1999, the Company's consolidated cash
position increased $144.5 million from December 31, 1998. This increase resulted
primarily from earnings 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 nine months ended September 30, 1999 were $326.5 million
compared to net operating cash inflows of $177.3 million in the same 1998
period. This $149.2 million improvement was chiefly attributable to higher 1999
year to date earnings, a 1998 payment of approximately $23 million related to
the KCSR Union Productivity fund termination, 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 $106.2 million during the nine months ended
September 30, 1999 compared to $99.7 million of net investing cash outflows
during the comparable 1998 period. This difference results primarily from higher
year to date 1999 capital expenditures and a decrease in proceeds received from
the disposal of property and investments, partially offset by 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. During the
nine months ended September 30, 1999, Janus and Berger had net sales of
approximately $3.8 million from investments in advised funds compared with net
purchases of these investments of $17.5 million during the same 1998 period.
During the first nine 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
30
financing cash outflows of $75.8 million were used during the nine months ended
September 30, 1999 compared with $83.2 million used during the comparable 1998
period. This was due primarily to 1999 net repayments of long-term debt of $44.9
million compared with net repayments of $61.3 million during the same 1998
period and an increase in proceeds from the issuance of common stock of $13.5
million, partially offset by cash used for stock repurchases of $24.6 million
versus $2.7 million in the first nine months of 1998. Distributions to minority
stockholders of consolidated subsidiaries 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 internally generated KCSR operating cash flow. Based on anticipated financing
arrangements for Grupo TFM, significant 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 $600 million
(which includes $55 million of uncommitted facilities). As of September 30,
1999, $297 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
September 30, 1999 was 40.6% compared to 47.3% at December 31, 1998. Company
consolidated debt decreased $44.7 million from December 31, 1998 (to $791.6
million at September 30, 1999) as a result of repayments exceeding borrowings.
Consolidated equity increased $229.6 million from December 31, 1998, primarily
due to net income of $232.0 million during the period. 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.
31
Significant declines in the value of these securities would negatively impact
accumulated other comprehensive income and affect the Company's debt ratio.
As discussed previously in "Recent Developments", the Transportation segment has
certain projects in process including reconstruction of the Panama Canal
Railway, development of Richards-Gebaur as an intermodal facility and the
purchase of 50 new A/C 4400 locomotives from GE. Management anticipates using
working capital and existing lines of credit to fund the investments in PCRC and
Richards-Gebaur. The locomotives are being purchased by Southern Capital and
will be leased by KCSR through operating leases. These operating leases are
expected to be funded through KCSR's internally generated cash flows.
As discussed previously, prior to the Separation of the Transportation and
Financial Services businesses, KCSI intends to complete a recapitalization of
the Transportation business, which may delay completion of the Separation until
2000. Management is currently exploring various alternatives with respect to the
recapitalization. Further, as part of the Separation, KCSI expects to
renegotiate the existing revolving credit facilities.
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.
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.
32
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, modified and tested for Year 2000 readiness. Management believes
that all of the necessary remediation and testing has been completed for
mission critical systems as well as certain non-critical support systems
and management believes these systems are Year 2000 ready. Mission critical
systems will be re-certified during the fourth quarter by repeating the
required testing.
In addition, the IT hardware and software necessary to operate the
mainframe computer and associated equipment has been evaluated and tested
for Year 2000 issues. The hardware and software, including the completion
of integrated testing of the infrastructure software and network
components, was completed in October 1999 and management believes that the
hardware and software are Year 2000 ready.
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
1999.
Non-IT Systems. All equipment that contains an internal clock or embedded
micro-processor has been 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 September 30, 1999, management believes that all PC's in the
Transportation companies are Year 2000 ready. In addition, all related
software, customized programs and external data interfaces have been
evaluated, modified and tested and are believed to be Year 2000 ready.
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 September 30, 1999, replacement and/or upgrade efforts on the
Financial Services hardware and software inventory are substantially
complete, including network infrastructure and telecommunications
technologies.
33
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 final testing is currently being performed on the Interline
Settlement System. This testing is scheduled to be completed during fourth
quarter 1999.
Similarly, the Financial Services entities have participated 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.
Based upon the responses received to the questionnaires and ongoing
discussions with these third parties, the Company believes that, as of
September 30, 1999, the majority of significant customers, banking and
financial institutions, suppliers and interchange railroads are Year 2000
ready in all material respects. 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, 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 also believes it has achieved internal readiness
for all of its other mission critical systems. 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 formalized and tested contingency plans for its U.S.
shareowner accounting and U.S. portfolio accounting business units, as well
as for its other mission critical products, services and systems. 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 tested for Year 2000
remediation, unit acceptance, system acceptance and user acceptance. The testing
procedures used and the results of these tests have been or 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
34
(including train movements), order and obtain critical supplies, and operate
equipment and control systems. Management believes these risks are minimal based
on the results of the modification of the systems and testing for Year 2000
readiness. However, should problems arise with respect to Year 2000 issues, 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. Management believes its computer systems and
related operating equipment are Year 2000 ready in all material respects;
however, should unanticipated problems occur related to Year 2000 readiness for
the computer systems of the Company, significant difficulties in processing and
completing fundamental transactions could result.
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 are prepared for the Year 2000
in all material respects; however, 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 has assisted KCSR
in the design and implementation of 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 believes that the contingency planning process is virtually
complete and any remaining plans will be finalized by the end of 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, the Company is currently in an information system black out period,
which has been scheduled at the various Company subsidiaries, generally from
October 4, 1999 to March 4, 2000. During this period, the Year 2000 project team
and other members of the information systems group are focusing 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 $19 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 $2 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.
35
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.
36
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 27.1 - Financial Data Schedule
b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated August 19, 1999
under Item 5, reporting the filing of a Registration on Form 10 by
Stilwell Financial, Inc. in connection with the Company's proposed
spin-off of its financial services business.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized and in the capacities indicated on November 12, 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)