-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Tm2yRNIv/+JuaDjGk1rqWlsGkAu9bbptuyq9hDwLtDGQlc6D5sFr8rJ/i5WWAzir d2wMIALw2uyXzKPhiW2V/Q== 0000054480-99-000015.txt : 19990817 0000054480-99-000015.hdr.sgml : 19990817 ACCESSION NUMBER: 0000054480-99-000015 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990816 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KANSAS CITY SOUTHERN INDUSTRIES INC CENTRAL INDEX KEY: 0000054480 STANDARD INDUSTRIAL CLASSIFICATION: RAILROADS, LINE-HAUL OPERATING [4011] IRS NUMBER: 440663509 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-04717 FILM NUMBER: 99693388 BUSINESS ADDRESS: STREET 1: 114 W 11TH ST CITY: KANSAS CITY STATE: MO ZIP: 64105 BUSINESS PHONE: 8169831303 MAIL ADDRESS: STREET 1: 114 WEST 11TH STREET CITY: KANSAS CITY STATE: MO ZIP: 64105 10-Q 1 FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 1999 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from to Commission File Number 1-4717 KANSAS CITY SOUTHERN INDUSTRIES, INC. (Exact name of Company as specified in its charter) Delaware 44-0663509 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 114 West 11th Street, Kansas City, Missouri 64105 (Address of principal executive offices) (Zip Code) (816) 983-1303 (Company's telephone number, including area code) No Changes (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the Company (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at August 6, 1999 Common Stock, $.01 per share par value 110,487,692 Shares - -------------------------------------------------------------------------------- KANSAS CITY SOUTHERN INDUSTRIES, INC. FORM 10-Q JUNE 30, 1999 INDEX Page PART I - FINANCIAL INFORMATION Item 1. Financial Statements Introductory Comments 1 Consolidated Condensed Balance Sheets - June 30, 1999 and December 31, 1998 2 Consolidated Condensed Statements of Income and Comprehensive Income - Three and Six Months Ended June 30, 1999 and 1998 3 Computation of Basic and Diluted Earnings per Common Share 3 Consolidated Condensed Statements of Cash Flows - Six Months Ended June 30, 1999 and 1998 4 Notes to Consolidated Condensed Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Qualitative and Quantitative Disclosures About Market Risk 31 PART II - OTHER INFORMATION Item 1. Legal Proceedings 32 Item 6. Exhibits and Reports on Form 8-K 32 SIGNATURES 33 KANSAS CITY SOUTHERN INDUSTRIES, INC. FORM 10-Q JUNE 30, 1999 PART I - FINANCIAL INFORMATION Item 1. Financial Statements INTRODUCTORY COMMENTS The Consolidated Condensed Financial Statements included herein have been prepared by Kansas City Southern Industries, Inc. ("Company" or "KCSI"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented. These Consolidated Condensed Financial Statements should be read in conjunction with the financial statements and the notes thereto, as well as Management's Discussion and Analysis of Financial Condition and Results of Operations, included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998, and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-Q. Results for the three and six months ended June 30, 1999 are not necessarily indicative of the results expected for the full year 1999. 2 KANSAS CITY SOUTHERN INDUSTRIES, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (Dollars in Millions) (Unaudited)
June 30, December 31, 1999 1998 ASSETS Current Assets: Cash and equivalents $ 139.3 $ 27.2 Investments in advised funds 114.2 149.1 Accounts receivable, net 234.4 208.4 Inventories 50.2 47.0 Other current assets 37.8 37.8 ----------- ----------- Total current assets 575.9 469.5 Investments held for operating purposes 758.5 707.1 Properties (net of $593.6 and $567.1 accumulated depreciation and amortization, respectively) 1,283.9 1,266.7 Intangibles and Other Assets, net 194.3 176.4 ----------- ----------- Total assets $ 2,812.6 $ 2,619.7 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Debt due within one year $ 11.0 $ 10.7 Accounts and wages payable 134.6 125.8 Accrued liabilities 170.0 159.7 ----------- ----------- Total current liabilities 315.6 296.2 ----------- ----------- Other Liabilities: Long-term debt 811.6 825.6 Deferred income taxes 433.9 403.6 Other deferred credits 126.1 128.8 ----------- ----------- Total other liabilities 1,371.6 1,358.0 ----------- ----------- Minority Interest in consolidated subsidiaries 33.7 34.3 ----------- ----------- Stockholders' Equity: Preferred stock 6.1 6.1 Common stock 1.1 1.1 Retained earnings 993.7 849.1 Accumulated other comprehensive income 90.8 74.9 ----------- ----------- Total stockholders' equity 1,091.7 931.2 ----------- ----------- Total liabilities and stockholders' equity $ 2,812.6 $ 2,619.7 ============ ============
See accompanying notes to consolidated condensed financial statements. 3 KANSAS CITY SOUTHERN INDUSTRIES, INC. CONSOLIDATED CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Dollars in Millions, Except per Share Data) (Unaudited)
Three Months Six Months Ended June 30, Ended June 30, 1999 1998 1999 1998 Revenues $ 430.9 $ 322.6 $ 816.1 $ 618.3 Costs and expenses 273.4 200.3 515.9 388.8 Depreciation and amortization 22.3 17.9 43.4 34.7 ---------- --------- ---------- ---------- Operating Income 135.2 104.4 256.8 194.8 Equity in net earnings (losses) of unconsolidated affiliates: DST Systems, Inc. 10.8 7.5 21.5 15.0 Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. 0.5 (2.1) 1.0 (5.2) Other 2.1 0.5 3.2 0.9 Interest expense (15.3) (16.2) (30.3) (33.6) Other, net 5.3 15.2 11.1 21.8 ---------- --------- ---------- ---------- Pretax Income 138.6 109.3 263.3 193.7 Income tax provision 49.8 40.9 94.7 72.4 Minority interest in consolidated earnings 12.7 9.7 23.9 16.4 ---------- --------- ---------- ---------- Net Income 76.1 58.7 144.7 104.9 Other comprehensive income, net of income tax: Unrealized gain on securities 17.0 13.0 15.9 42.9 ---------- --------- ---------- ---------- Comprehensive Income $ 93.1 $ 71.7 $ 160.6 $ 147.8 ========== ========= ========== ========== Computation of Basic and Diluted Earnings per Common Share Basic Earnings per Common Share $ 0.69 $ 0.54 $ 1.31 $ 0.96 ========== ========= ========== ========== Diluted Earnings per Common Share $ 0.66 $ 0.51 $ 1.25 $ 0.92 ========== ========= ========== ========== Weighted Average Basic Common Shares Outstanding (in thousands) 110,253 109,253 110,077 108,894 ---------- ---------- ---------- ---------- Weighted Average Diluted Common Shares Outstanding (in thousands) 114,133 113,303 113,933 112,809 ---------- ---------- ---------- ---------- Cash Dividends Paid: Per Preferred share $ .25 $ .25 $ .50 $ .50 Per Common share .04 .04 .08 .08 See accompanying notes to consolidated condensed financial statements.
4 KANSAS CITY SOUTHERN INDUSTRIES, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Dollars in Millions) (Unaudited)
Six Months Ended June 30, 1999 1998 CASH FLOWS PROVIDED BY (USED FOR): OPERATING ACTIVITIES: Net income $ 144.7 $ 104.9 Adjustments to net income: Depreciation and amortization 43.4 34.7 Deferred income taxes 23.9 22.3 Equity in undistributed earnings (25.7) (10.7) Distributions from equity investments 0.2 5.5 Gain on sale of equity investments and property (0.2) (14.4) Minority interest in consolidated earnings 23.9 16.4 Changes in working capital items: Accounts receivable (26.1) (21.6) Inventories (3.3) (0.9) Other current assets (1.8) (17.6) Accounts and wages payable 5.1 (6.5) Accrued liabilities 12.7 (23.1) Prepaid commissions (17.7) - Other, net (1.7) (0.2) --------- ---------- Net 177.4 88.8 --------- ---------- INVESTING ACTIVITIES: Property acquisitions (52.8) (40.2) Proceeds from disposal of property 0.6 5.2 Investment in and loans with affiliates (14.0) (24.8) Net sales (purchases) of short-term investments 39.5 (0.7) Proceeds from disposal of investments - 10.3 Other, net 3.7 3.8 --------- ---------- Net (23.0) (46.4) --------- ---------- FINANCING ACTIVITIES: Proceeds from issuance of long-term debt 31.8 53.8 Repayment of long-term debt (45.6) (105.0) Proceeds from stock plans 35.5 23.0 Stock repurchased (23.7) (3.5) Distributions to minority interest (28.5) (23.6) Cash dividends paid (13.4) (13.4) Other, net 1.6 1.6 --------- ---------- Net (42.3) (67.1) --------- ---------- CASH AND EQUIVALENTS: Net increase (decrease) 112.1 (24.7) At beginning of year 27.2 33.5 --------- ---------- At end of period $ 139.3 $ 8.8 ========= ==========
See accompanying notes to consolidated condensed financial statements. 5 KANSAS CITY SOUTHERN INDUSTRIES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 1. In the opinion of the management of Kansas City Southern Industries, Inc. ("Company"; "KCSI"), the accompanying unaudited consolidated condensed financial statements contain all adjustments (consisting of normal closing procedures) necessary to present fairly the financial position of the Company and its subsidiary companies as of June 30, 1999 and December 31, 1998, the results of operations for the three and six months ended June 30, 1999 and 1998, and cash flows for the six months ended June 30, 1999 and 1998. 2. The accompanying consolidated condensed financial statements have been prepared consistently with accounting policies described in Note 1 to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. The results of operations for the three and six months ended June 30, 1999 are not necessarily indicative of the results to be expected for the full year 1999. Certain 1998 information has been restated to conform to the current period presentation. 3. As previously disclosed, the Company announced its intention to separate the Transportation and Financial Services segments through a proposed dividend of the stock of a new holding company for its Financial Services businesses (the "Separation"). On July 12, 1999, the Company announced that the Internal Revenue Service ("IRS") has issued a favorable tax ruling with respect to the Separation and, subject to the consideration of relevant factors, management anticipates completion of the Separation to occur before the end of 1999. 4. The effect of stock options to employees represent the only difference between the weighted average shares used for the basic earnings per share computation compared to the diluted earnings per share computation. The total incremental shares from assumed conversion of stock options included in the computation of diluted earnings per share were 3,879,611 and 3,855,818, respectively, for the three and six month periods ended June 30, 1999, and 4,049,731 and 3,915,046, respectively for the three and six month periods ended June 30, 1998. For the three and six month periods ended June 30, 1999, the weighted average of options to purchase 89,500 and 44,750 shares of KCSI common stock, respectively, were excluded from the respective computation of diluted earnings per share because the exercise prices were greater than the average market prices of the common shares. There were options to purchase 95,000 and 48,500 shares excluded in the diluted earnings per share calculations for the three and six month periods ended June 30, 1998, respectively. The only adjustments that currently affect the numerator of the Company's diluted earnings per share computation include preferred dividends and potentially dilutive securities at subsidiaries and affiliates. These adjustments totaled $1.1 million and $1.9 million for the three and six month periods ended June 30, 1999, respectively, and $0.5 million and $0.9 million for the three and six month periods ended June 30, 1998, respectively. 5. The Company's inventories ($50.2 million at June 30, 1999 and $47.0 million at December 31, 1998) primarily consist of material and supplies related to rail transportation. Other components of inventories are not material. 6 6. Investments in unconsolidated affiliates and certain other investments accounted for under the equity method generally include all entities in which the Company or its subsidiaries have significant influence, but not more than 50% voting control. Investments in unconsolidated affiliates at June 30, 1999 include, among others, equity interests in DST Systems, Inc. ("DST"), Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), Southern Capital Corporation, LLC ("Southern Capital"), Mexrail, Inc. ("Mexrail") and the Panama Canal Railway Company. The Company is party to certain agreements with Transportacion Maritima Mexicana, S.A. de C.V. ("TMM") covering the Grupo TFM and Mexrail ventures. TMM (including its affiliates) owns approximately 38.4% of Grupo TFM and 51% of Mexrail. These agreements contain "change in control" provisions, provisions intended to preserve the Company's and TMM's proportionate ownership of the ventures, and super majority provisions with respect to voting on certain significant transactions. Such agreements also provide a right of first refusal in the event that either party initiates a divestiture of its equity interest in Grupo TFM or Mexrail. Under certain circumstances, such agreements could affect the Company's ownership percentage and rights in these equity affiliates. Combined condensed financial information of unconsolidated affiliates is shown below: Financial Condition (dollars in millions):
June 30, 1999 December 31, 1998 DST (a) Grupo TFM (b) Other DST (a) Grupo TFM (b) Other Current assets $ 396.9 $ 138.3 $ 32.2 $ 375.8 $ 109.9 $ 33.1 Non-current assets 1,648.0 1,948.6 237.1 1,521.2 1,974.7 277.0 ---------- ------------ -------- ---------- ----------- -------- Assets $ 2,044.9 $ 2,086.9 $ 269.3 $ 1,897.0 $ 2,084.6 $ 310.1 ========== ============ ======== ========== =========== ======== Current liabilities $ 226.8 $ 265.4 $ 49.7 $ 268.6 $ 233.9 $ 48.6 Non-current liabilities 503.3 712.1 142.8 462.2 745.0 191.7 Minority interest - 343.5 - - 342.4 - Equity of stockholders and partners 1,314.8 765.9 76.8 1,166.2 763.3 69.8 ---------- ------------ -------- ---------- ----------- -------- Liabilities and equity $ 2,044.9 $ 2,086.9 $ 269.3 $ 1,897.0 $ 2,084.6 $ 310.1 ========== ============ ======== ========== =========== ======== KCSI's investment $ 422.2 $ 286.0 $ 42.2 $ 376.0 $ 285.1 $ 38.6 ========== ============ ======== ========== =========== ========
Operating Results (dollars in millions):
Three Months Six Months Ended June 30, Ended June 30, ----------------------------- ------------------------------ 1999 1998 1999 1998 ----------------------------- ------------------------------ Revenues: DST (a) $ 299.6 $ 269.8 $ 592.4 $ 535.8 Grupo TFM (b) 139.2 109.6 251.7 209.6 All others 20.1 20.2 44.8 46.3 ---------- ---------- ---------- --------- Total revenues $ 458.9 $ 399.6 $ 888.9 $ 791.7 ========== ========== ========== ========= 7 Operating costs and expenses: DST (a) $ 248.2 $ 232.2 $ 491.1 $ 457.8 Grupo TFM (b) 100.0 96.6 188.7 187.3 All others 18.1 19.8 41.1 44.7 ---------- ---------- ---------- --------- Total operating costs and expenses $ 366.3 $ 348.6 $ 720.9 $ 689.8 ========== ========== ========== ========= Net income: DST (a) $ 33.4 $ 23.3 $ 67.0 $ 47.4 Grupo TFM (b) 1.2 (5.7) 2.6 (9.8) All others 5.0 1.0 7.2 1.4 ---------- ---------- ---------- --------- Total net income $ 39.6 $ 18.6 $ 76.8 $ 39.0 ========== ========== ========== =========
(a) The financial condition and operating results for DST reflect the merger of a wholly-owned DST subsidiary with USCS International, Inc. ("USCS") on December 21, 1998. Information for prior periods has been restated to combine the historical results of DST and USCS. The merger was accounted for by DST as a pooling of interests. (b) Grupo TFM is presented on a U.S. GAAP basis. 7. For purposes of the Statement of Cash Flows, the Company considers all short-term liquid investments with a maturity of generally three months or less to be cash equivalents. . Supplemental Cash Flow Information (in millions):
Six Months Ended June 30, 1999 1998 Interest paid $ 34.6 $ 36.2 Income taxes paid 52.3 39.0
Noncash Investing and Financing Activities: In first quarter 1998, the Company issued approximately 227,000 shares of KCSI common stock under the Tenth Offering of the Employee Stock Purchase Plan ("ESPP"). These shares, totaling a purchase price of approximately $3.0 million, were subscribed and paid for through employee payroll deductions in 1997. There were no shares of KCSI common stock issued under an offering of the ESPP during the first quarter of 1999. During second quarter 1998, in connection with Company's acquisition of Nelson Money Managers Plc ("Nelson"), the Company issued approximately 67,000 shares of KCSI common stock (valued at $3.2 million) to certain of the sellers of the Nelson shares. Also, notes payable of $4.9 million were recorded as part of the purchase price, payable by March 31, 2005, bearing interest at seven percent. Company subsidiaries and affiliates hold various investments which are accounted for as "available for sale" securities as defined by Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities". The Company records its proportionate share of any unrealized gains or losses related to these investments, net of deferred income taxes, in stockholders' equity as accumulated other comprehensive income. For the three and six month periods ended June 30, 1999, the Company recorded its proportionate share of the gain in market value of these investments of $27.5 million and $27.3 million, respectively, ($17.0 million and $15.9 million, respectively, net of deferred income taxes). For the three and six month periods ended June 30, 1998, the Company recorded its proportionate share of 8 the gain in market value of these investments from December 31, 1997 of $21.1 million and $69.7 million, respectively, ($13.0 million and $42.9 million, respectively, net of deferred income taxes). 8. In 1998, the Company adopted the provisions of Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards for the manner in which public business enterprises report information about operating segments in annual financial statements and requires disclosure of selected information about operating segments in interim financial reports issued to shareholders. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The adoption of SFAS 131 did not have a material impact on the disclosures of the Company. Pursuant to SFAS 131, the following provides selected interim financial information for the Transportation and Financial Services segments (in millions): Three Months Six Months Ended June 30, Ended June 30, 1999 1998 1999 1998
Revenues: Transportation $ 148.7 $ 152.9 $ 300.6 $ 305.4 Financial Services 282.2 169.7 515.5 312.9 ----------- ----------- ----------- ----------- KCSI Consolidated $ 430.9 $ 322.6 $ 816.1 $ 618.3 =========== =========== =========== =========== Net Income: Transportation $ 5.2 $ 9.4 $ 12.8 $ 18.6 Financial Services 70.9 49.3 131.9 86.3 ----------- ----------- ----------- ----------- KCSI Consolidated $ 76.1 $ 58.7 $ 144.7 $ 104.9 =========== =========== =========== ===========
June 30, December 31, 1999 1998 Total Assets: Transportation $ 1,891.5 $ 1,796.8 Financial Services 921.1 822.9 ----------- ----------- KCSI Consolidated $ 2,812.6 $ 2,619.7 =========== ===========
Sales between segments were not material for the three and six month periods ended June 30, 1999 and 1998, respectively. 9. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative financial instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires recognition of all derivatives as either assets or liabilities measured at fair value. Initially, the effective date of SFAS 133 was for all fiscal quarters for fiscal years beginning after June 15, 1999; however, the FASB has deferred the effective date of SFAS 133 for one year so that it will begin with all fiscal quarters of fiscal years beginning 9 after June 15, 2000. The FASB encourages early adoption of this standard; however, the provisions of SFAS 133 should not be retroactively applied to financial statements of periods prior to adoption. The Company currently has a program to hedge against fluctuations in the price of diesel fuel purchases, and also enters into fuel purchase commitments from time to time. In addition, the Company continues to evaluate alternatives with respect to utilizing foreign currency instruments to hedge its U.S. dollar investments in Grupo TFM and Nelson as market conditions change or exchange rates fluctuate. Currently, the Company has no outstanding diesel fuel hedges or foreign currency hedges. The Company is reviewing the provisions of SFAS 133 and expects adoption by the required date. The adoption of SFAS 133 with respect to existing hedge transactions is not expected to have a material impact on the Company's results of operations, financial position or cash flows. 10. As disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 1998, prior to January 1, 1999, Mexico's economy was classified as "highly inflationary" as defined in Statement of Financial Accounting Standards No. 52 "Foreign Currency Translation" ("SFAS 52"). Accordingly, the U.S. dollar was assumed to be Grupo TFM's functional currency, and any gains or losses from translating Grupo TFM's financial statements into U.S. dollars were included in the determination of its net income (loss). Equity earnings (losses) from Grupo TFM included in the Company's results of operations reflected the Company's share of such translation gains and losses. Effective January 1, 1999, the Securities and Exchange Commission staff declared that Mexico should no longer be considered a highly inflationary economy. Accordingly, the Company performed an analysis under the guidance of SFAS 52 to determine whether the U.S. dollar or the Mexican peso should be used as the functional currency for financial accounting and reporting purposes for periods subsequent to December 31, 1998. Based on the results of the analysis, management believes that the U.S. dollar is the appropriate functional currency to use for the Company's investment in Grupo TFM; therefore, the financial accounting and reporting of the operating results of Grupo TFM will remain consistent with prior periods. 11. The Company has had no significant changes in its outstanding litigation or other contingencies from that previously reported in the Company's Annual Report on Form 10-K for the year ended December 31, 1998 other than as noted below relating to the Bogalusa Cases. Bogalusa Cases - In July 1996, the Kansas City Railway Company ("KCSR") was named as one of twenty-seven defendants in various lawsuits in Louisiana and Mississippi arising from the explosion of a rail car loaded with chemicals in Bogalusa, Louisiana on October 23, 1995. As a result of the explosion, nitrogen dioxide and oxides of nitrogen were released into the atmosphere over parts of that town and the surrounding area allegedly causing evacuations and injuries. Approximately 25,000 residents of Louisiana and Mississippi have asserted claims to recover damages allegedly caused by exposure to the chemicals. KCSR neither owned nor leased the rail car or the rails on which the rail car was located at the time of the explosion in Bogalusa. KCSR did, however, move the rail car from Jackson to Vicksburg, Mississippi, where it was loaded with chemicals, and back to Jackson where the car was tendered to the Illinois Central Railroad Company ("IC"). The explosion occurred more than 15 days after KCSR last transported the rail car. The car was loaded by the shipper in excess of its standard weight, but under the car's capacity, when it was transported by KCSR to interchange with the IC. 10 The trial of a group of twenty plaintiffs in the Mississippi lawsuits arising from the chemical release commenced in the last week of March 1999. That trial resulted in a jury verdict and judgment in favor of KCSR in June 1999. The jury found that KCSR was not negligent and that the plaintiffs had failed to prove that they were damaged. The trial of the Louisiana class action and the trial of another group of Mississippi plaintiffs could both begin during the year 2000. KCSR believes that its exposure to liability in these cases is remote. If KCSR were to be found liable for punitive damages in these cases, such a judgment could have a material adverse effect on the financial condition of the Company. 12. See the Recent Developments section of Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, for significant transactions and events that will have an impact on the Company's future results of operations, financial position and cash flows. 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW The discussion set forth below and other portions of this Form 10-Q contain comments not based upon historical fact. Such forward-looking comments are based upon information currently available to management and management's perception thereof as of the date of this Form 10-Q. Readers can identify these forward-looking comments by their use of such verbs as expects, anticipates, believes or similar verbs or conjugations of such verbs. The actual results of operations of Kansas City Southern Industries, Inc. ("Company" or "KCSI") could materially differ from those indicated in forward-looking comments. The differences could be caused by a number of factors or combination of factors including, but not limited to, those factors identified in the Company's Current Report on Form 8-K/A dated June 3, 1997, which is on file with the U.S. Securities and Exchange Commission (File No.1-4717) and is hereby incorporated by reference herein. Readers are strongly encouraged to consider these factors when evaluating any such forward-looking comments. The Company will not update any forward looking comments set forth in this Form 10-Q. The discussion herein is intended to clarify and focus on the Company's results of operations, certain changes in financial position, liquidity, capital structure and business developments for the periods covered by the consolidated condensed financial statements included under Item 1 of this Form 10-Q. This discussion should be read in conjunction with these consolidated condensed financial statements and the related notes thereto and is qualified by reference thereto. KCSI, a Delaware Corporation organized in 1962, is a diversified holding company with principal operations in rail transportation and financial asset management. The Company supplies its various subsidiaries with managerial, legal, tax, financial and accounting services, in addition to managing other "non-operating" and more passive investments. The Company's business activities by industry segment and principal subsidiary companies are: Transportation - The Transportation segment consists of all Transportation-related subsidiaries and investments, including: o The Kansas City Southern Railway Company ("KCSR"), a wholly-owned subsidiary of the Company, operating a Class I Common Carrier railroad system; o Gateway Western Railway Company ("Gateway Western"), an indirect wholly-owned subsidiary of the Company, operating a regional railroad system; o Southern Group, Inc., a wholly-owned subsidiary of KCSR, owning 100% of Carland, Inc.; o Equity investments in Southern Capital Corporation LLC ("Southern Capital"), a 50% owned joint venture, Grupo Tranportacion Ferroviaria Mexicana S.A. de C.V. ("Grupo TFM"), a 37% owned affiliate, Mexrail Inc. ("Mexrail"), a 49% owned affiliate along with its wholly-owned subsidiary, the Texas Mexican Railway Company ("Tex Mex"); and Panama Canal Railway Company, a 50% joint venture; o Kansas City Southern Lines, Inc. ("KCSL"), a wholly-owned subsidiary of the Company, serving as a holding company for transportation-related subsidiaries and affiliates; and o Various other consolidated subsidiaries. 12 Financial Services - The Financial Services segment consists of all subsidiaries engaged in the management of investments for mutual funds, private and other accounts, as well as any Financial Services-related investments. Included are: o Stilwell Financial, Inc. ("Stilwell" - formerly FAM Holdings, Inc.), a wholly-owned subsidiary of the Company, serving as a holding company for financial services-related subsidiaries and affiliates (see below); o Janus Capital Corporation ("Janus"), an 83% owned subsidiary, subject to vesting of Janus restricted stock held by various Janus employees which will reduce ownership to 82%; o Berger Associates, Inc. ("Berger"), a 100% owned subsidiary; o Nelson Money Managers Plc ("Nelson"), an 80% owned subsidiary; o DST Systems, Inc. ("DST"), an approximate 32% owned equity investment; and o Various other consolidated subsidiaries. RECENT DEVELOPMENTS Favorable IRS Tax Ruling for Planned Separation of the Company Business Segments. As previously disclosed, the Company announced its intention to separate the Transportation and Financial Services segments through a proposed dividend of the stock of Stilwell, a new holding company for its Financial Services businesses (the "Separation"). On July 12, 1999, the Company announced that the Internal Revenue Service ("IRS") has issued a favorable ruling on the Company's anticipated "tax-free" spin-off of its financial services companies. Subject to the consideration of other relevant factors, management anticipates completion of the Separation to occur before the end of 1999. In March 1999, a number of Janus minority stockholders and members of Janus' management, including its chief executive officer, certain directors and others suggested that KCSI's Board of Directors ("Board") consider, as an alternative to the planned Separation, a separate spin-off of Janus. The board of trustees or directors of the Janus funds expressed support for the proposal put forth by these minority stockholders and management personnel. Several members of this group made a formal presentation to KCSI's Board to that effect on June 23, 1999. After reviewing and considering the information presented by this group, KCSI's Board decided that proceeding with the Separation as planned and as approved by the IRS would be in the best interests of KCSI and its stockholders. Berger Management Realignment. In second quarter 1999, Berger realigned its management team to improve Berger's long-term growth opportunities and capitalize on the performance and discipline demonstrated by certain portfolio managers. Berger appointed a new president and chief executive officer and rearranged the management of several of its advised funds. Two existing Berger portfolio managers assumed the responsibility for Berger's largest fund, the Berger One Hundred Fund, which had assets under management of approximately $1.5 billion at June 30, 1999. Additionally, changes in portfolio management were made for the Berger Balanced Fund and the Berger Select Fund. Financial Services Companies contributed to Stilwell Financial, Inc. Effective July 1, 1999, KCSI contributed to Stilwell the investments in Janus, Berger, Nelson and DST, as well as certain other financial services-related assets, and Stilwell assumed all of KCSI's liabilities associated with the assets transferred. It is contemplated that Stilwell will be listed on the New York Stock Exchange and, at about the time of the Separation, will begin trading under the symbol "SV". 13 Voters approve plan for Intermodal facility at Richards-Gebaur Airbase. In a referendum on the August 3, 1999 ballot, Kansas City, Missouri voters approved a lease previously agreed to with the City of Kansas City, to establish an intermodal facility at the Richards-Gebaur Airbase, which is located adjacent to KCSR's main line. Subject to approval of the Federal Aviation Administration ("FAA") to close the existing airport, KCSR will initiate plans to relocate its Kansas City intermodal facility to Richards-Gebaur. Improvements are scheduled to begin immediately following FAA approval with a tentative schedule to begin operations as early as fourth quarter 2000. Management expects that the new facility will provide additional needed capacity as well as a strategic opportunity to serve as an international trade facility. Management plans for this facility to serve as a U.S. customs pre-clearance processing facility for freight moving along the fast-growing NAFTA corridor. This is expected to alleviate some of the congestion at the borders, resulting in more fluid service to KCSL's customers, as well as customers throughout the rail industry. KCSR expects to spend approximately $40 million for site improvements and infrastructure. Financing alternatives are currently being explored by management. Additionally, KCSR has negotiated a lease arrangement with the city of Kansas City, Missouri for a period of fifty years, subject to final FAA approval. Lease payments are expected to range between $400,000 and $700,000 per year and will be adjusted for inflation based on agreed-upon formulas. Management believes that with the addition of this facility, KCSR is positioned to increase its intermodal revenue base by attracting additional NAFTA traffic. Purchase of 50 New Locomotives for KCSR. During second quarter 1999, KCSR reached an agreement with General Electric ("GE") for the purchase of 50 new GE 4400 AC Locomotives with remote power capability. The addition of these state-of-the-art locomotives is expected to have a favorable impact on operations as a result of, among other things, the following: retirement of older locomotives with significant ongoing maintenance needs; decreased maintenance costs and improved fuel efficiency; better fleet utilization; increased hauling power eliminating the need for certain helper service; higher reliability and efficiency resulting in fewer train delays and less congestion. These locomotives are expected to be financed through operating leases with Southern Capital. As a result, operating lease expense is expected to increase beginning in fourth quarter 1999. KCSR expects, however, associated operating cost reductions through replacement of older locomotives with these new and more efficient AC locomotives. Delivery of these locomotives is expected in fourth quarter 1999. Panama Canal Railway Company. In January 1998, the Republic of Panama awarded KCSR and its joint venture partner, Mi-Jack Products, Inc., the concession to reconstruct and operate the Panama Canal Railway Company ("PCRC"). The 47-mile railroad runs parallel to the Panama Canal and, upon reconstruction, will provide international shippers with an important complement to the Panama Canal. The Company is currently in the process of finalizing its financing arrangements with the International Finance Corporation, a member of the World Bank Group, and expects to have the financing package completed by the end of September 1999. The total cost of the reconstruction project is estimated to be $70 million with the commitment from KCSR not to exceed $13 million. Reconstruction of PCRC's right-of-way is expected to begin in the fourth quarter of 1999 and be completed in late 2000. Commercial operations are projected to begin in late 2000 or early 2001. KSU Stock added to the S&P 500 Index. On March 26, 1999, Standard and Poors (S&P) Financial Information Services announced that it was adding Kansas City Southern Industries, Inc. to its S&P 500 index. KCSI was added to the S&P 500 Railroads Industry group after the close of trading on April 1, 1999. Management believes that the Company's addition to this index of leading U.S. companies will have a positive long-term impact on KCSI stock and help build the Company's shareholder base. 14 Approval of CN/IC merger. At a voting conference held on March 25, 1999, the Surface Transportation Board ("STB") unanimously approved the merger of Canadian National Railway ("CN") and Illinois Central Corp. ("IC"). The STB issued its written approval with an effective date of June 24, 1999, at which time the CN was permitted to exercise control over IC's operations and assets. As part of this approval, the STB imposed certain restrictions on the merger including a condition requiring that the CN/IC grant KCSR access to three additional shippers in the Geismar, Louisiana industrial area: Rubicon, Uniroyal and Vulcan. This is in addition to the three Geismar shippers (BASF, Borden and Shell) that KCSR will have access to as a result of its alliance agreement with CN/IC, as previously disclosed. Management believes the access to these Geismar shippers will provide the Company with additional revenue opportunities. The STB also denied a filing by the CN, IC and KCSR seeking trackage rights for the Gateway Western over several miles of UP and Norfolk Southern track in Springfield, Illinois. Foreign Exchange Matters. As disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 1998, prior to January 1, 1999, Mexico's economy was classified as "highly inflationary" as defined in Statement of Financial Accounting Standards No. 52 "Foreign Currency Translation" ("SFAS 52"). Accordingly, the U.S. dollar was assumed to be Grupo TFM's functional currency, and any gains or losses from translating Grupo TFM's financial statements into U.S. dollars were included in the determination of its net income (loss). Equity earnings (losses) from Grupo TFM included in the Company's results of operations reflected the Company's share of such translation gains and losses. Effective January 1, 1999, the Securities and Exchange Commission ("SEC") staff declared that Mexico should no longer be considered a highly inflationary economy. Accordingly, the Company performed an analysis under the guidance of SFAS 52 to determine whether the U.S. dollar or the Mexican peso should be used as the functional currency for financial accounting and reporting purposes for periods subsequent to December 31, 1998. Based on the results of the analysis, management believes that the U.S. dollar is the appropriate functional currency to use for the Company's investment in Grupo TFM; therefore, the financial accounting and reporting of the operating results of Grupo TFM will remain consistent with prior periods. Sale of loan portfolio by Southern Capital. On March 31, 1999, Southern Capital signed an agreement to sell its portfolio of non-rail assets to Textron Financial Corporation. The purchase price for these assets (comprised primarily of finance receivables in the amusement and other non-rail transportation industries) was approximately $52.8 million. The sale of these assets, which closed in April 1999, did not have a material impact on the Company's results of operations, cash flows or financial condition. Repurchase of stock. As disclosed in the Current Report on Form 8-K dated February 25, 1999, the Company repurchased 460,000 shares of its common stock from The DST Systems, Inc. Employee Stock Ownership Plan (the "DST ESOP") in a private transaction. The DST ESOP has previously sold to the Company other shares of KCSI stock which were part of the DST ESOP's assets as a result of DST's participation in the Company's employee stock ownership plan prior to DST's initial public offering in 1995. The shares were purchased at a price equal to the closing price per share of KCSI's common stock on the New York Stock Exchange on February 24, 1999. The shares are held in treasury for use in connection with the Company's various employee benefit plans. These repurchases are part of the 9,000,000 share repurchase program that the Company's Board of Directors authorized in 1996. Including this transaction, the Company has repurchased a total of approximately 4,100,000 shares under this program. 15 Option to Purchase Mexican Government's Ownership Interest in TFM, S.A. de C.V. ("TFM"). On January 28, 1999, the Company, along with other direct and indirect owners of TFM, entered into a preliminary agreement with the Mexican Government ("Government"). As part of that agreement, an option was granted to the Company, Transportacion Maritima Mexicana, S.A. de C.V. ("TMM") and Grupo Servia, S.A. de C.V. ("Grupo Servia") to purchase all or a portion of the Government's 20% ownership interest in TFM at a discount. The option to purchase all or a portion of the Government's interest expires on November 30, 1999. Under the initial agreement, the option to purchase up to 35% of the Government's stock was scheduled to expire on May 31, 1999, thus canceling the entire option agreement; however, this date has been extended by the Government. The parties are presently negotiating the final provisions and documentation pursuant to which the initial portion of the option would be exercised. If the option is fully exercised, the Company's additional cash investment is not expected to exceed $93 million. As part of this agreement and as a condition to exercise this option, the parties have agreed to settle the outstanding claims against the Government regarding a refund of Mexican Value Added Tax (VAT) payments. TFM has also agreed to sell to the Government a small section of redundant trackage for inclusion in another railroad concession. In addition, under the terms of the agreement, the Government would be released from its capital call obligations at the moment that the option is exercised in whole or in part. Furthermore, TFM, TMM, Grupo Servia and the Company have agreed to sell, in a public offering, a direct or indirect participation in at least the same percentage currently represented by the shares exercised in this option, by October 31, 2003, subject to market conditions. The option and the other described agreements are conditioned on the parties entering into a final written agreement and obtaining all necessary consents and authorizations. As of June 30, 1999, no portion of the option agreement and associated transactions had been completed by any of the parties. RESULTS OF OPERATIONS The Company's revenues, operating income and net income by industry segment are as follows (dollars in millions):
Three Months Six Months Ended June 30, Ended June 30, 1999 1998 1999 1998 --------- -------- --------- -------- Revenues: Transportation $ 148.7 $ 152.9 $ 300.6 $ 305.4 Financial Services 282.2 169.7 515.5 312.9 --------- -------- --------- -------- Total $ 430.9 $ 322.6 $ 816.1 $ 618.3 ========= ======== ========= ======== Operating Income: Transportation $ 19.7 $ 29.8 $ 44.1 $ 61.8 Financial Services 115.5 74.6 212.7 133.0 --------- -------- --------- -------- Total $ 135.2 $ 104.4 $ 256.8 $ 194.8 ========= ======== ========= ======== Net Income: Transportation $ 5.2 $ 9.4 $ 12.8 $ 18.6 Financial Services 70.9 49.3 131.9 86.3 --------- -------- --------- -------- Total $ 76.1 $ 58.7 $ 144.7 $ 104.9 ========= ======== ========= ========
The Company reported second quarter 1999 earnings of $76.1 million, or $0.66 per diluted share, compared to $58.7 million, or $0.51 per diluted share in second quarter 1998. Consolidated second quarter 1999 revenues rose $108.3 million, or 33%, compared to the same 1998 period, fueling an increase in operating 16 income of $30.8 million (30%). The increase in revenues resulted from higher assets under management in the Financial Services segment, slightly offset by lower transportation revenues. Operating expenses increased approximately 36% quarter to quarter arising primarily from higher costs associated with the significant revenue growth in the Financial Services segment, as well as from an increase in KCSR operating costs. Second quarter 1999 depreciation and amortization expenses increased nearly 25%, chiefly because of higher depreciation in the Financial Services segment arising from 1998 infrastructure development. Equity earnings in unconsolidated affiliates improved $7.5 million due to higher contributions from DST and Grupo TFM. DST equity earnings increased $3.3 million, while earnings from Grupo TFM increased by $2.6 million (equity earnings of $0.5 million compared to equity losses of $2.1 million in second quarter 1998). Interest expense declined $0.9 million (6%) for the three months ended June 30, 1999 versus the comparable 1998 period due primarily to lower average debt balances. For the six months ended June 30, 1999, consolidated earnings were $144.7 million, or $1.25 per diluted share, versus $104.9 million, or $0.92 per diluted share in comparable 1998. Year to date 1999 consolidated revenues increased nearly 32% to $816.1 million compared to the same 1998 period, primarily due to the growth in assets under management in the Financial Services segment. These increased revenues led to a 32% improvement in operating income period to period. Operating expenses increased approximately 32% period to period arising from higher costs in both the Financial Services and Transportation segments as discussed above. Depreciation and amortization expenses for the six months ended June 30, 1999 increased 25% because of the1998 infrastructure development in the Financial Services segment. Year to date 1999 equity earnings of unconsolidated affiliates increased by $15 million because of earnings improvements at DST, Grupo TFM and Mexrail. Interest expense for the six months ended June 30, 1999 was nearly 10% lower than the comparable 1998 period primarily as a result of lower average debt balances. TRANSPORTATION Three Months Ended June 30, 1999 Compared With The Three Months Ended June 30, 1998
THREE MONTHS THREE MONTHS ENDED JUNE 30, 1999 ENDED JUNE 30, 1998 ------------------- ------------------- (in millions) Consolidated Consolidated KCSR Other Transportation KCSR Other Transportation Revenues $ 135.7 $ 13.0 $ 148.7 $ 138.6 $ 14.3 $ 152.9 Costs and expenses 102.0 12.6 114.6 95.8 12.9 108.7 Depreciation and amortization 12.7 1.7 14.4 12.7 1.7 14.4 -------- -------- --------- -------- -------- --------- Operating income (loss) 21.0 (1.3) 19.7 30.1 (0.3) 29.8 Equity in net earnings (losses) of unconsolidated affiliates Grupo TFM - 0.5 0.5 - (2.1) (2.1) Other 1.2 0.4 1.6 0.5 (0.3) 0.2 Interest expense (8.3) (6.3) (14.6) (9.1) (5.9) (15.0) Other, net 0.8 0.2 1.0 3.8 0.1 3.9 -------- --------- --------- -------- -------- --------- Pretax income (loss) 14.7 (6.5) 8.2 25.3 (8.5) 16.8 Income tax provision (benefit) 5.8 (2.8) 3.0 9.9 (2.5) 7.4 -------- -------- --------- -------- -------- --------- Net income (loss) $ 8.9 $ (3.7) $ 5.2 $ 15.4 $ (6.0) $ 9.4 ======== ========= ========= ======== ======== =========
17 The Transportation segment reported earnings of $5.2 million for the three months ended June 30, 1999 compared with $9.4 million for the three months ended June 30, 1998. This decrease in earnings was attributable to an approximate 34% decline in operating income arising from lower revenues and higher operating expenses. Also contributing to the decline was a one-time gain on the sale of a branch line in 1998 of $2.9 million ( $1.8 million after-tax). Partially offsetting the lower operating income was an improvement in equity earnings related to Grupo TFM, Mexrail and Southern Capital, as well as lower interest expense. Second quarter 1999 Transportation segment revenues totaled $148.7 million versus $152.9 million in 1998. This decline of nearly 3% was primarily driven by lower KCSR revenues. KCSR carloadings increased slightly quarter to quarter, but revenues declined 2% due to changes in traffic mix. Weakness in the higher margin coal and chemical commodity sectors were somewhat offset by growth in the intermodal/automotive business and agriculture/minerals products. Gateway Western revenues were also down slightly quarter to quarter due to lower volumes. The following is a summary of revenues and carloads for KCSR's major commodity groups: Carloads and Revenues Intermodal Units (in millions) (in thousands) Three months Three months ended June 30, ended June 30, 1999 1998 1999 1998 General commodities: Chemical and petroleum $ 32.8 $ 35.1 40.4 42.0 Paper and forest 25.7 27.1 41.5 43.0 Agricultural and mineral 24.4 21.9 34.0 32.1 Other 6.8 5.5 8.6 7.0 ----------- ---------- ---------- ----------- Total general commodities 89.7 89.6 124.5 124.1 Intermodal 12.9 11.9 55.1 47.6 Coal 26.6 30.0 45.7 52.5 ----------- ---------- ---------- ----------- Subtotal 129.2 131.5 225.3 224.2 Other 6.5 7.1 - - ----------- ---------- ---------- ----------- Total $ 135.7 $ 138.6 225.3 224.2 =========== ========== ========== ===========
Coal - Coal revenues declined $3.4 million, or 11.4%, for the three months ended June 30, 1999 compared with the three months ended June 30, 1998, as a result of lower unit coal traffic (decrease of approximately 7,000 carloads). The lower unit coal traffic was attributable to several factors: 1) Customer maintenance efforts for various periods during the second quarter, which temporarily shut down three utility plants served by KCSR. In addition, during January 1999, one of KCSR's customers, Kansas City Power and Light ("KCP&L"), had a major casualty at its Hawthorn plant, which is projected to be out of service until 2001. The extended outage is not expected to have a material effect on overall coal revenues as this plant represented approximately 5% of total coal tons hauled by KCSR in 1998 and is a short haul move; 2) KCSR experienced slower delivery times due to congestion and a track rehabilitation project; 3) KCSR reported record 1998 coal revenues - relatively low inventory levels in early 1998 coupled with an increase in capacity at certain utility customers led to an increase in demand during 1998, leading to record 1998 coal revenues. 1999 demand for coal has not reached these record 1998 levels. Partially offsetting these traffic declines was an increase in unit coal traffic to KCP&L's Amsterdam facility. As a result of the temporary closure of the Hawthorn facility, KCP&L increased its capacity at its Amsterdam plant. Although the increased capacity at Amsterdam has not equaled the volume lost as a result of the Hawthorn plant closure, 18 the Amsterdam plant is a longer haul for KCSR and thus, the related revenues generated per unit train are higher. Chemical and petroleum products - For the three months ended June 30, 1999, chemical and petroleum product revenues decreased $2.3 million, or 6.3%, compared with the same 1998 period. This was primarily a result of lower miscellaneous chemical revenues, which were down approximately 8.6% due in part to the expiration in late 1998 of the emergency service order in the Houston area, as well as a continuing decline in demand due to both domestic and international chemical market conditions. Also contributing to the decrease were plastics and petroleum coke revenues, which declined slightly quarter to quarter as a result of fewer carloads shipped and a decline in revenues per carload due to a change in traffic mix. Although carloads of soda ash increased slightly during second quarter 1999 as a result of a limited opportunity in the South American export market, soda ash revenues were still slightly lower due to the mix of traffic and length of hauls. Management expects soda ash revenues to remain somewhat weak during the remainder of 1999 due to an overall lack of demand. Paper and forest products - Paper and forest product revenues declined $1.4 million, or 5.2%, quarter to quarter, primarily because of volume declines in all major products. As discussed in the first quarter 1999 Form 10-Q, second quarter 1999 paper and forest product revenues remained essentially flat with first quarter 1999; however, management expects an increase in volume, including potential exports to Mexico, in the third and fourth quarters of 1999. Agricultural and mineral products - Agricultural and mineral product revenues increased 11.2%, to $24.4 million for the three months ended June 30, 1999 versus the comparable 1998 period. This increase resulted from higher carloads and revenue per carload for domestic grain movements, primarily because of an increase in demand at certain customers serving the poultry industry with shipment destinations serviced by KCSR. Also contributing to the increase was higher export grain revenues. These increases were partially offset by declines in non-metallic ores and stone, clay and glass revenues due primarily to volume declines. Intermodal and other - Intermodal and other revenues increased $2.3 million, or 13.2%, quarter to quarter. This increase is comprised of higher intermodal revenues of $1.0 million arising from more intermodal unit shipments (15.7%) quarter to quarter, as well as a significant increase in automotive revenues, which nearly tripled quarter to quarter. The increase in intermodal traffic is attributable to several factors including the alliance with the CN/IC and east-west intermodal traffic originating from the Norfolk Southern Corporation. Automotive traffic has increased, in part, due to an agreement reached with General Motors for automobile parts traffic originating in the upper midwest and terminating in Mexico. Management expects that both intermodal and automotive revenues will continue to increase for the foreseeable future as the alliance with CN/IC continues to mature. The Transportation segment's total operating expenses increased $5.9 million (4.8%), to $129.0 million for the three months ended June 30, 1999 from $123.1 million for the three months ended June 30, 1998. Second quarter KCSR operating expenses increased $6.2 million from 1998, primarily due to congestion on the KCSR. Higher expenses occurred in car hire, salaries and wages and costs relating to locomotive power. Higher car hire costs resulted from fewer KCSR cars and trailers being utilized by other railroads and higher employee costs arose from general wage increases and overtime hours by operating personnel. These increases were partially offset by reduced costs in casualties and insurance due to lower expenses related to derailments. Variable expenses as a percentage of revenues increased approximately 10% reflecting certain operating inefficiencies and the decline in higher margin unit coal and chemical traffic. Lower second quarter revenues coupled with higher operating expenses have resulted in a decrease in KCSR's operating income of $9.1 million quarter to quarter. KCSR's operating ratio, a common efficiency measure among 19 Class I rail carriers, increased to 84.1.% for the quarter compared with 78.1% in second quarter 1998 as a result of lower revenues and higher expenses. Operating losses for other transportation segment companies declined $1.0 million to a loss of $1.3 million for the second quarter of 1999 from a loss of $0.3 million for the comparable 1998 quarter primarily because of lower operating income at Gateway Western, which decreased over $0.9 million due to lower revenues and higher operating expenses. Lower Gateway Western revenues resulted from a decrease in haulage traffic, while higher costs were due primarily to salaries and wages and casualty costs. The Transportation segment recorded equity earnings of $2.1 million from unconsolidated affiliates for the three months ended June 30, 1999 compared to losses of $1.9 million for the three months ended June 30, 1998. The increase is attributed primarily to equity earnings from Grupo TFM, which had increased revenues of 27% and a pretax profit for the first time in its history. These continued operating improvements resulted in an operating ratio of 71.9% versus 88.1% in second quarter 1998. Results of Grupo TFM are reported on a U.S. GAAP basis. Mexrail recorded equity earnings of $0.5 million in second quarter 1999 versus losses of $0.4 million in the comparable 1998 period on improved revenues and lower costs. Equity earnings from Southern Capital improved by approximately $0.4 million quarter to quarter. Because the Company is required to report its equity in Grupo TFM under U.S. GAAP and Grupo TFM reports under International Accounting Standards, fluctuations in deferred income tax calculations will occur based on translation requirements and differences in accounting standards. The effects in these deferred income tax calculations may be significantly impacted by fluctuations in the relative value of the Mexican peso versus the U.S. dollar and can result in significant variances in the amount of equity earnings (losses) reported by the Company. Interest expense declined $0.4 million during second quarter 1999 compared to the same 1998 period, primarily as a result of lower average debt balances. Other, net decreased $2.9 million quarter to quarter attributable to KCSR's one-time gain of $2.9 million from the sale of a branch line in second quarter 1998. Six Months Ended June 30, 1999 Compared With The Six Months Ended June 30, 1998 SIX MONTHS SIX MONTHS ENDED JUNE 30, 1999 ENDED JUNE 30, 1998 ------------------- ------------------- (in millions)
Consolidated Consolidated KCSR Other Transportation KCSR Other Transportation Revenues $ 271.0 $ 29.6 $ 300.6 $ 274.3 $ 31.1 $ 305.4 Costs and expenses 198.5 29.3 227.8 189.7 25.5 215.2 Depreciation and amortization 25.3 3.4 28.7 25.3 3.1 28.4 -------- -------- --------- -------- -------- --------- Operating income (loss) 47.2 (3.1) 44.1 59.3 2.5 61.8 Equity in net earnings (losses) of unconsolidated affiliates Grupo TFM - 1.0 1.0 - (5.2) (5.2) Other 1.8 0.4 2.2 1.0 (0.7) 0.3 Interest expense (16.8) (11.8) (28.6) (18.2) (11.8) (30.0) Other, net 1.7 0.2 1.9 5.4 1.7 7.1 -------- --------- --------- -------- -------- --------- Pretax income (loss) 33.9 (13.3) 20.6 47.5 (13.5) 34.0 Income tax provision (benefit) 13.3 (5.5) 7.8 18.6 (3.2) 15.4 -------- --------- --------- -------- -------- --------- Net income (loss) $ 20.6 $ (7.8) $ 12.8 $ 28.9 $ (10.3) $ 18.6 ======== ========= ========= ======== ======== =========
20 The Transportation segment reported earnings of $12.8 million for the six months ended June 30, 1999 compared to $18.6 million for the comparable 1998 period. This decrease in earnings was attributable to an approximate 29% decline in operating income arising from lower revenues and higher operating expenses. Also contributing to the decline was a one-time gain on the sale of a branch line in 1998 of $2.9 million ($1.8 million after-tax) and other certain non-recurring gains in 1998. Partially offsetting the lower operating income was an improvement in equity earnings related to Grupo TFM, Mexrail and Southern Capital, as well as lower interest expense. Total revenues decreased $4.8 million, or 1.6%, to $300.6 million for the six months ended June 30, 1999, from $305.4 million for the six months ended June 30, 1998. Consistent with the second quarter 1999, this decline was driven primarily by lower KCSR revenues, which fell $3.3 million, or 1.2%, period to period. Although KCSR carloadings increased slightly period to period, revenues declined over 1% due to traffic mix. Weakness in the higher margin coal and chemical commodity sectors were somewhat offset by growth in the intermodal/automotive business and agriculture/minerals products. Also contributing to year to date 1999 results was a 7% drop in Gateway Western revenues based primarily on volume declines related to haulage traffic. The following is a summary of revenues and carloads for KCSR's major commodity groups:
Carloads and Revenues Intermodal Units (in millions) (in thousands) Six months Six months ended June 30, ended June 30, 1999 1998 1999 1998 General commodities: Chemical and petroleum $ 65.0 $ 69.7 80.5 83.9 Paper and forest 51.4 54.2 82.3 87.0 Agricultural and mineral 49.0 44.7 66.9 64.0 Other 11.7 11.4 14.7 14.6 ----------- ---------- ---------- ----------- Total general commodities 177.1 180.0 244.4 249.5 Intermodal 24.5 22.9 103.0 88.9 Coal 56.3 58.5 98.4 105.4 ----------- ---------- ---------- ----------- Subtotal 257.9 261.4 445.8 443.8 Other 13.1 12.9 - - ----------- ---------- ---------- ----------- Total $ 271.0 $ 274.3 445.8 443.8 =========== ========== ========== ===========
Coal - Coal revenues decreased $2.2 million, or 3.7%, for the six months ended June 30, 1999 compared to the six months ended June 30, 1998 as a result of lower unit coal traffic (decrease of approximately 7,000 carloads). This decrease in unit coal traffic is attributed to the same factors as those discussed above in second quarter analysis. Coal accounted for 21.8% and 22.4% of total carload revenues for the six months ended June 30, 1999 and 1998, respectively. Chemical and petroleum products - Chemical and petroleum product revenues decreased $4.7 million, or 6.7%, period to period primarily because of lower miscellaneous chemical and soda ash revenues. As discussed above in the second quarter analysis, miscellaneous chemical revenues declined due in part to the expiration of the emergency service order in the Houston area as well as a continuing decline in demand. Soda ash revenues declined primarily because of an overall weak export market due to the continuing difficulty in the economic climate in Asia and South America. Chemical and petroleum products accounted 21 for 25.2% of total carload revenues for the six months ended June 30, 1999 versus 26.6% for the six months ended June 30, 1998. Paper and forest products - Paper and forest product revenues decreased $2.8 million , or 5.3%, for the six months ended June 30, 1999 versus the comparable 1998 period primarily as a result of volume declines in all major products. Paper and forest products accounted for 19.9% and 20.8% of total carload revenues for the six months ended June 30, 1999 and 1998, respectively. Agricultural and mineral products - Agricultural and mineral product revenues increased $4.3 million, or 9.5%, period to period. Similar to trends discussed above in the second quarter analysis, this increase resulted from higher carloads and revenues per carload for domestic and export grain movements. These higher revenues were partially offset by declines in non-metallic ores and stone, clay and glass revenues due primarily to volume declines. Agricultural and mineral products accounted for 19.0% of total carload revenues for the six months ended June 30, 1999 compared with 17.1% for the comparable 1998 period. Intermodal and other - Intermodal and other revenues increased $1.9 million, or 5.8%, for the six months ended June 30, 1999 versus the comparable 1998 period. Similar to the second quarter trends discussed above, this improvement is comprised of higher intermodal revenues of $1.6 million, as well as a significant increase in automotive revenues period to period. These improvements were partially offset by a decline in other carload revenues of approximately $1.2 million as a result of weakness in the steel market arising from slower domestic oil production. Intermodal and other accounted for 14.1% of total carload revenues for the six months ended June 30, 1999 compared with 13.1% for the six months ended June 30, 1998. The Transportation segment's total operating expenses increased $12.9 million (5.3%), to $256.5 million for the six months ended June 30, 1999 from $243.6 million for the same 1998 period. KCSR operating costs for the period increased $8.8 million from 1998, primarily due to the same expense components as discussed above in the second quarter analysis. Lower year to date revenues coupled with higher operating expenses have resulted in a $12.1 million decrease in KCSR's operating income period to period and an operating ratio of 82.4% compared with 78.2% for the first half of 1998. Other Transportation operating costs also increased, primarily due to higher costs at Gateway Western resulting largely from an unusual $1.4 million March 1999 derailment and increased costs at various smaller Transportation companies. For year to date 1999, the Transportation segment recorded equity earnings from unconsolidated affiliates of $3.2 million compared with equity losses of $4.9 million for the same 1998 period. This increase was attributable primarily to improvements at Grupo TFM. For the six months ended June 30, 1999, the Company recorded equity earnings from Grupo TFM of $1.0 million compared with equity losses of $5.2 million for the six months ended June 30, 1998. This improvement at Grupo TFM reflects year to date revenue increases of 20% coupled with continued operating improvements. These factors have resulted in an operating ratio of 74.9% for the six months ended June 30, 1999 versus 89.3% for the same 1998 period. Also contributing to the increase was Mexrail, which recorded equity earnings of $0.4 million in the period versus losses of $0.9 million in the comparable 1998 period based on higher revenues and lower operating costs. Equity earnings from Southern Capital improved by approximately $0.5 million period to period, a portion of which relates to a gain on the sale of the loan portfolio. Interest expense declined $1.4 million during the six months ended June 30, 1999 compared to the same 1998 period, primarily as a result of lower average debt balances. Other, net decreased $5.2 million period to period attributable to KCSR's one-time gain of $2.9 million from the 1998 sale of a branch line and certain other non-recurring gains recorded in 1998. 22 FINANCIAL SERVICES Three Months Ended June 30, 1999 Compared With The Three Months Ended June 30, 1998 CONSOLIDATED FINANCIAL SERVICES (in millions) THREE MONTHS ENDED JUNE 30,
1999 1998 ------------------ ---------------- Revenues $ 282.2 $ 169.7 Costs and expenses 158.8 91.6 Depreciation and amortization 7.9 3.5 ------------- ------------- Operating income 115.5 74.6 Equity in net earnings of unconsolidated affiliates: DST Systems, Inc. 10.8 7.5 Other 0.5 0.3 Interest expense (0.7) (1.2) Other, net 4.3 11.3 ------------- ------------- Pretax income 130.4 92.5 Income tax provision 46.8 33.5 Minority interest 12.7 9.7 ------------- ------------- Net income $ 70.9 $ 49.3 ============= =============
The Financial Services segment contributed $70.9 million to KCSI's 1999 second quarter consolidated earnings versus $49.3 million in second quarter 1998. Exclusive of an after-tax $4.4 million one-time gain resulting from Janus' sale of IDEX Management, Inc. ("IDEX") in second quarter 1998, earnings improved 58% quarter to quarter. Average assets under management were 70% higher during second quarter 1999 than second quarter 1998 fueling a $112.5 and $40.9 million increase in revenues and operating income, respectively, over second quarter 1998. Assets under management increased $19.7 billion during second quarter 1999 as a result of net sales of $13.9 billion and market appreciation of $5.8 billion. Assets under management totaled $161.7 billion at June 30, 1999 ($155.8 billion at Janus; $4.7 billion at Berger; and $1.2 billion at Nelson) versus $113.5 billion at December 31, 1998 and $94.4 billion at June 30, 1998. See the brief discussions of Janus, Berger and Nelson separately below. Financial Services operating margins declined in second quarter 1999, primarily due to an increase in operating expenses to $166.7 million from $95.1 million in the prior year quarter. This increase reflects higher costs associated with the significant growth in revenues, as well as an increase in discretionary expenses. Higher expenses were evident in salaries and wages (primarily investment performance-based incentive compensation, an increased number of employees and associated training, and certain one-time severance costs), marketing and fulfillment, and alliance fees under mutual fund "supermarket" distribution arrangements based on a higher level of assets under management through these channels. 23 Second quarter 1999 equity earnings from DST increased to $10.8 million from $7.5 million in comparable 1998, primarily due to improved earnings in DST's financial services and output solutions segments, as well as from required capitalization of internal use software development costs in 1999. Consolidated DST revenues increased due to a higher number of shareowner accounts processed (totaling 53.3 million at June 30, 1999 versus 48.2 million at June 30, 1998), images produced (26.1% increase) and statements mailed (up 18.5%). DST's consolidated operating margins improved to 17% during second quarter 1999 versus 14% in comparable 1998. As noted above, Other, net was higher in second quarter 1998 due to an $8.8 million one-time gain recognized on the sale of the Janus equity investment in IDEX. Six Months Ended June 30, 1999 Compared With The Six Months Ended June 30, 1998 CONSOLIDATED FINANCIAL SERVICES (in millions) SIX MONTHS ENDED JUNE 30,
1999 1998 ------------------ ---------------- Revenues $ 515.5 $ 312.9 Costs and expenses 288.1 173.6 Depreciation and amortization 14.7 6.3 ------------- ------------- Operating income 212.7 133.0 Equity in net earnings of unconsolidated affiliates: DST Systems, Inc. 21.5 15.0 Other 1.0 0.6 Interest expense (1.7) (3.6) Other, net 9.2 14.7 ------------- ------------- Pretax income 242.7 159.7 Income tax provision 86.9 57.0 Minority interest 23.9 16.4 ------------- ------------- Net income $ 131.9 $ 86.3 ============= =============
For the six months ended June 30, 1999, Financial Services contributed $131.9 million to the Company's consolidated earnings, a 61% increase over comparable 1998, exclusive of the one-time gain on the IDEX sale. This increase was attributable to higher revenues (driven by growth in assets under management), operating income and equity earnings period to period. Year to date 1999 revenues increased 65% to $515.5 million versus $312.9 million for the six months ended June 30, 1998. Assets under management increased $48.2 billion during the first six months of 1999, driven by net sales of $27.0 billion and market appreciation of $21.2 billion. Shareowner accounts numbered nearly 3.8 million as of June 30, 1999 (an increase of 26% from December 31, 1998). Operating margins declined slightly period to period (from 42.5% to 41.3% for the first six months of 1999). Operating expenses increased to $302.8 million from $179.9 million in comparable 1998, primarily due to 24 the growth in revenues and continued infrastructure efforts. Higher expenses occurred in salaries and wages (see comment in quarterly review above), marketing and fulfillment and alliance distribution fees. These three components totaled approximately 44% of total Financial Services revenues during the six months ended June 30, 1999 versus approximately 42% in 1998. Additionally, infrastructure initiatives throughout 1998 and 1999 to ensure the ongoing quality and reliability of customer service resulted in higher depreciation and various other costs. Year to date 1999 equity earnings from DST increased 43% over the same period in 1998 as a result of the same operating trends affecting the quarter as discussed above. Additionally, DST's equity in earnings of unconsolidated affiliates improved in 1999 compared to 1998. Other, net decreased from comparable 1998 as discussed in the quarterly review above. Year to date 1999 interest expense declined from the same 1998 period due to lower average debt balances. A brief discussion of significant Janus, Berger and Nelson items during the six months ended June 30, 1999 follows: Janus Janus assets under management increased $47.5 billion (44%) during the six months ended June 30, 1999. Assets in the Janus Investment Funds, Janus Aspen Series and money market funds increased 44% from December 31, 1998. As of June 30, 1999, assets in the Janus World Funds Plc ("Janus World Funds") increased to $668 million from $65 million at December 31, 1998. Also, assets in private, institutional and sub-advised accounts grew 42% from year end 1998. Shareholder accounts increased nearly 30% during the first six months of 1999. These increases reflect ongoing favorable investment performance by various funds/portfolios within the Janus group of mutual funds, continued growth through net sales, as evidenced by second quarter 1999 net sales that exceeded the entire year for 1998, and competitive levels of expenses and fees compared to industry standards. Berger Berger assets under management increased 18% (to $4.7 billion) during the six months ended June 30, 1999, primarily due to market appreciation. While shareholder accounts declined approximately 10% (primarily in the Berger One Hundred Fund), new sales - primarily in Berger's newer fund offerings -- offset the cash outflows that accompanied shareholder departures. In connection with efforts to revitalize the core Berger funds (i.e., those introduced prior to 1997), certain senior management personnel changes were undertaken during second quarter 1999, resulting in approximately $1.7 million of one-time severance costs. Berger's investment in BBOI Worldwide LLC ("BBOI") continues to report increases in assets under management (up 27% from year end 1998 to $662 million at June 30, 1999) and net income. Berger and the Bank of Ireland Asset Management (U.S.) Limited ("Bank of Ireland") have executed a non-binding letter of intent pursuant to which, under certain conditions, BBOI will purchase Bank of Ireland's interest in BBOI. If consummated, this transaction would result in Berger owning all of BBOI. Nelson The Company acquired Nelson in April 1998. Accordingly, results for 1998 include only three months of activity compared to the six month period ended June 30, 1999. Nelson's assets under management increased 8% to (pound)751 million as of June 30, 1999 from (pound)696 million at December 31, 1998. Beginning in late first quarter 1999, Nelson initiated expansion efforts throughout the United Kingdom. This project will be ongoing and the Company expects that during this phase of Nelson's development, 25 Nelson will operate at a loss. These losses, however, are not expected to have a material impact on the Financial Services results of operations or financial position. TRENDS AND OUTLOOK The Company's second quarter and year to date 1999 diluted earnings per share ($0.66 and $1.25, respectively) increased 29% and 36%, respectively, compared to the same 1998 periods ($0.51 and $0.92, respectively). Revenue growth in the Financial Services segment for the first six months of 1999, partially offset by related increases in operating costs, resulted in nearly a 32% higher consolidated operating income period to period. While the Transportation segment experienced a decline in revenues, operating income and earnings for the second quarter and year to date 1999 periods, Grupo TFM results continued to improve due to revenue growth and operating improvements. Domestically, KCSR and Gateway Western results were affected by a decline in revenues and increased operating expenses due to congestion issues. These operational issues are being addressed by management. Continued growth in assets under management has fueled revenue, operating income and earnings growth in the Financial Services segment for both the second quarter and year to date 1999 periods. A current outlook for the Company's businesses for the remainder of 1999 is as follows (refer to the first paragraph of "Overview" section of this Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, regarding forward-looking comments): i) Transportation - Management expects that general commodities and intermodal traffic will continue to be largely dependent on economic trends within certain industries in the geographic region served by the railroads comprising the NAFTA Railway. Based on anticipated traffic levels, revenues for the remainder of 1999 are expected to increase slightly compared with revenues for the first six months of 1999, and essentially remain flat compared to revenues for the last six months of 1998. Management expects the NAFTA Railway to continue to provide an attractive service offering for shippers, and the Company believes it will realize continued benefits from traffic with Mexico, the CN/IC alliance and interchange traffic with the Norfolk Southern. Management is aggressively addressing certain cost issues to provide the framework for efficient and productive operations over the last half of the year. Variable costs are expected to continue at levels proportionate with revenue activity. ii) Financial Services - Future growth will be largely dependent on prevailing financial market conditions, relative performance of Janus, Berger and Nelson products, introduction and market reception of new products, as well as other factors, including changes in stock and bond markets, increases in the rate of return of alternative investment products, increasing competition as the number of mutual funds continues to grow, and changes in marketing and distribution channels. Based on a higher level of assets under management starting the third quarter, revenues for the remainder of 1999 are expected to exceed comparable prior year periods. Management expects ongoing Financial Services margin pressure challenges as efforts continue to ensure that the operational and administrative infrastructure consistently meets the high standards of quality and service historically provided to investors. Additionally, a higher rate of growth in costs compared to revenues is expected in connection with Nelson's efforts to expand its operations. iii) Equity Investments - The Company expects to continue to participate in the earnings/losses from its equity investments in DST, Grupo TFM, Southern Capital and Mexrail. As a result of the sale of the loan portfolio, equity earnings from Southern Capital are not expected to be significant. 26 LIQUIDITY AND CAPITAL RESOURCES Summary cash flow data is as follows (in millions): Six Months Ended June 30,
1999 1998 Cash flows provided by (used for): Operating activities $ 177.4 $ 88.8 Investing activities (23.0) (46.4) Financing activities (42.3) (67.1) ---------- ----------- Cash and equivalents: Net increase (decrease) 112.1 (24.7) At beginning of year 27.2 33.5 --------- ---------- At end of period $ 139.3 $ 8.8 ========= ==========
During the six months ended June 30, 1999, the Company's consolidated cash position increased $112.1 million from December 31, 1998. This increase resulted primarily from earnings, net sales of investments in advised funds by Janus and proceeds from the issuance of common stock under employee stock plans, partially offset by property acquisitions, net repayments of long-term debt, cash dividends and stock repurchases. Net operating cash inflows for the six months ended June 30, 1999 were $177.4 million compared to net operating cash inflows of $88.8 million in the same 1998 period. This $88.6 million improvement in operating cash flows was chiefly attributable to a 1998 payment of approximately $23 million related to the KCSR Union Productivity fund termination, higher 1999 year to date earnings and net changes in other working capital components, offset partially by payments of prepaid commissions in connection with the Janus World Funds B share arrangements. Net investing cash outflows were $23.0 million during the six months ended June 30, 1999 compared to $46.4 million of net investing cash outflows during the comparable 1998 period. This difference results primarily from a decrease in funds used for investment in affiliates and from fluctuations in investments in advised funds associated with the timing of Janus' dividend payments, partially offset by higher year to date 1999 capital expenditures. During the six months ended June 30, 1999, Janus and Berger had net sales of approximately $39.5 million from investments in advised funds compared with net purchases of these investments of $0.7 million during the same 1998 period. During the first six months of 1999, financing cash outflows were used primarily for the repayment of debt, stock repurchases and cash dividends, while financing cash inflows were generated from proceeds from issuance of long-term debt and proceeds from the issuance of common stock under stock plans. Net financing cash outflows of $42.3 million were used during the six months ended June 30, 1999 compared with $67.1 million used during the comparable 1998 period. This was due primarily to 1999 net repayments of long-term debt of $13.8 million compared with net repayments of $51.2 million during the same 1998 period and an increase in proceeds from the issuance of common stock of $12.5 million , partially offset by cash used for stock repurchases of $23.7 million versus $3.5 million in the first six months of 1998. Distributions to minority stockholders increased in 1999 versus 1998 due to higher earnings on which distributions were based. Cash flows from operations are expected to increase during the remainder of 1999 from positive operating income, which has historically resulted in favorable operating cash flows. Investing activities will continue to use significant amounts of cash. Future roadway improvement projects are expected to be funded by KCSR operating cash flow. Based on anticipated financing arrangements for Grupo TFM, significant 27 additional operational contributions from the Company to Grupo TFM are not expected to be necessary. However, there exists a possible approximate $74 million capital call if certain Grupo TFM benchmarks, as outlined in Grupo TFM's financing arrangements, are not met. Additionally, if circumstances develop in which a contribution may be requested by Grupo TFM, the Company will evaluate the contribution based on the merits of the specific underlying need. Further, as discussed above in "Recent Developments", the Company has the option to purchase a portion of the Mexican Government's 20% interest in TFM at a discount. Management anticipates using working capital and existing lines of credit to fund this transaction in the event it elects to exercise this option. Other financing alternatives are also being explored. In addition to operating cash flows, the Company has financing available through its various lines of credit with a maximum borrowing amount of $550 million (which includes $65 million of uncommitted facilities). As of June 30, 1999, $245 million was available under these lines of credit, $100 million of which is to be used solely by the Financial Services segment. In conjunction with the annual renewal of certain credit facilities during April and May 1999, the 364-day credit facility for KCSI was renewed at $75 million (previously $100 million) and the Financial Services 364-day credit facility was renewed at its previous amount of $100 million. Because of certain financial covenants contained in the credit agreements, however, maximum utilization of the Company's available lines of credit may be restricted. The Company also has a Universal Shelf Registration Statement ("Registration Statement") filed in September 1993, as amended in April 1996 for $500 million. The SEC declared the Registration Statement effective on April 22, 1996; however, no securities have been issued. Management expects that any net proceeds from the sale of securities under the Registration Statement would be added to the general funds of the Company and used principally for general corporate purposes, including working capital, capital expenditures, and acquisitions of or investments in businesses and assets. The Company believes its operating cash flows and available financing resources are sufficient to fund working capital and other requirements for the remainder of 1999. The Company's debt ratio (total debt as a percent of total debt plus equity) at June 30, 1999 was 43.0% compared to 47.3% at December 31, 1998. Company consolidated debt decreased $13.7 million from December 31, 1998 (to $822.6 million at June 30, 1999) as a result of repayments exceeding borrowings. Consolidated equity increased $160.5 million from December 31, 1998. This increase was due to net income of $144.7 million, the issuance of common stock under the Employee Stock Purchase Plan and other plans, and increases in unrealized gains on "available for sale" securities, partially offset by common stock repurchases (as discussed above in "Recent Developments") and dividends paid. This increase in equity coupled with a decrease in debt resulted in a lower debt ratio. Management anticipates that the debt ratio will continue to decrease during the remainder of 1999 as a result of debt repayments and profitable operations. Note, however, that unrealized gains on "available for sale" securities are contingent on market conditions and, thus, are subject to significant fluctuations in value. Significant declines in the value of these securities would negatively impact accumulated other comprehensive income and affect the Company's debt ratio. OTHER Year 2000. The Year 2000 discussion below contains forward-looking statements, including those concerning the Company's plans and expected completion dates, cost estimates, assessments of Year 2000 readiness for the Company as well as for third parties, and the potential risks of any failure on the part of the Company or third parties to be Year 2000 ready on a timely basis. Forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ from those projected. See the "Overview" section for additional information. 28 While the Company continues to evaluate and pursue discussions with its various customers, partners and vendors with respect to their preparedness for Year 2000 issues, no assurance can be made that all such parties will be Year 2000 ready. Additionally, while the Company cannot fully determine the impact, the inability to complete Year 2000 readiness for the Company's computer systems could result in significant difficulties in processing and completing fundamental transactions. In such events, the Company's results of operations, financial position and cash flows could be materially adversely affected. Many existing computer programs and microprocessors that use only two digits (rather than four) to identify a year could fail or create erroneous results with respect to dates after December 31, 1999 if not corrected to read all four digits. This computer program flaw is expected to affect all companies and organizations, either directly (through a company's own computer programs or systems that use computer programs, such as telephone systems) or indirectly (through customers and vendors of the company). These Year 2000 related issues are of particular importance to the Company. The Company depends upon its computer and other systems and the computers and other systems of third parties to conduct and manage the Company's Transportation and Financial Services businesses and the Company's products and services are heavily dependent upon using accurate dates in order to function properly. These Year 2000 related issues may also adversely affect the operations and financial performance of one or more of the Company's customers and suppliers. As a result, the failure of the Company's computer and other systems, products or services, the computer systems and other systems upon which the Company depends, or the Company's customers or suppliers to be Year 2000 ready could have a material adverse impact on the Company's results of operations, financial position and cash flows. The Company is unable to assess the extent or duration of that impact at this time, but it could be substantial. In 1997, the Company and its key subsidiaries formed project teams comprised of employees and third party consultants to identify and resolve the numerous issues surrounding the Year 2000, focusing primarily on information technology ("IT") systems, non-IT systems, and third party issues. The project teams also provide comprehensive corporate tracking, coordination and monitoring of all Year 2000 activities. As part of resolving any potential Year 2000 issues, the Company expects to: identify all computer systems, products, services and other systems (including systems provided by third parties) that must be modified; evaluate the alternatives available to make any identified systems, products or services Year 2000 ready (including modification, replacement or abandonment); complete the modifications and/or replacement of identified systems; and conduct adequate testing of the systems, products and services, including testing of certain key systems used by various North American railroads and interoperability testing with clients and key organizations in the financial services industry. The project teams meet regularly to discuss their progress and ensure that all issues and problems are identified and properly addressed. Meetings are regularly held with senior management and the Company's Board of Directors to keep them apprised of the progress of the Year 2000 project. The following provides a summary of each area and the progress toward identifying and resolving Year 2000 issues: IT Systems. In the Transportation segment, all internal IT systems, including mission critical systems and non-critical systems, have been analyzed and are in the process of being modified and tested for Year 2000 readiness. To date, management believes that approximately 99% of the necessary remediation and 99% of the testing has been completed. Final remediation and testing for certain non-critical support systems has been completed and management believes these systems are Year 2000 ready. Final remediation and testing of mission critical systems is scheduled for completion by the end of September 1999. 29 In addition, the IT hardware and software necessary to operate the mainframe computer and associated equipment are currently being evaluated for Year 2000 issues. A compilation of the hardware and software inventories was completed in 1998. The hardware and software, including the completion of integrated testing of the infrastructure software and network components, are expected to be Year 2000 ready by October 31, 1999. The IT systems (including mission critical and significant non-critical operating, accounting and supporting systems) and underlying hardware for the companies comprising the Financial Services segment have been analyzed and are being modified and tested for Year 2000 readiness. Management believes that virtually all of its mission critical systems and other systems have been tested and are believed to be Year 2000 ready. Any remaining remediation and testing is expected to be completed by the end of third quarter 1999. Non-IT Systems. All equipment that contains an internal clock or embedded micro-processor is being analyzed for Year 2000 readiness. This includes PC's, software, external data interfaces, fax machines, telephone systems, elevator systems, security and fire control systems, locomotives, signal and communications systems and other miscellaneous equipment. As of June 30, 1999, management believes that 98% of all PC's in the Transportation companies were Year 2000 ready. The remainder of the PC's are expected to be Year 2000 ready by August 31, 1999. In addition, all related software, customized programs and external data interfaces are being evaluated, modified and tested for Year 2000 readiness. This process is expected to be completed by September 30, 1999 for all software and custom programs and by October 31, 1999 for external data interfaces. Testing of other equipment such as locomotives, signals and communication systems and other equipment with internal clocks and embedded micro-processors has been completed and management believes these items are Year 2000 ready. As of June 30, 1999, replacement and/or upgrade efforts on the Financial Services hardware and software inventory is substantially completed, including network infrastructure and telecommunications technologies, with any minor areas expected to be finalized by September 30, 1999. Third Party Systems. Both segments of the Company depend heavily on third party systems in the operation of their businesses. As part of the Year 2000 project, significant third party relationships are being evaluated to determine the status of their Year 2000 readiness and the potential impact on the Company's operations if those significant third parties fail to become Year 2000 ready. Questionnaires have been sent to critical suppliers, major customers, key banking and financial institutions, utility providers and interchange railroads to determine the status of their Year 2000 readiness. The Transportation companies are also working with the Association of American Railroads ("AAR") and other AAR-member railroads to coordinate the testing and certification of the systems administered by the AAR. These systems, including interline settlement, shipment tracing and waybill processing are relied on by a number of North American railroads and their customers. Initial testing between railroads started during second quarter 1998 and these systems are expected to be Year 2000 ready on a timely basis. Similarly, the Financial Services entities are participating in various industry-wide efforts (e.g., trading and account maintenance, trade execution, confirmation, etc.) to facilitate testing of Year 2000 preparedness and reliability. Additionally, Janus and Berger are required to periodically report to the SEC their progress with respect to Year 2000 preparedness. 30 Based upon the responses received to the questionnaires and ongoing discussions with these third parties, the Company believes that the majority of the significant customers, banking and financial institutions, suppliers and interchange railroads are or will be Year 2000 ready in all material respects by mid-1999. The Company does not anticipate, however, performing significant independent testing procedures to verify that the information received by the Company from these third parties is accurate (except for the above mentioned industry-wide testing efforts). For those third parties who have not responded or who have expressed uncertainty as to their Year 2000 readiness, management is exploring alternatives to limit the impact this will have on the Company's operations and financial results. The Company will continue to monitor its third party relationships for Year 2000 issues. DST, an approximate 32% owned equity investment, provides various services to Janus and Berger. DST completed its review and evaluation of its mission critical U.S. shareowner accounting and U.S. portfolio accounting related products, services and internal systems and believes it achieved material Year 2000 readiness in such products, services and systems. DST anticipates internal readiness for all of its other mission critical systems and products by September 30, 1999. Additionally, DST intends on testing its systems with clients and other third parties for Year 2000 related issues as needed throughout 1999. As part of addressing its Year 2000 issues, DST has: i) formalized and tested contingency plans for its U.S. shareowner accounting and U.S. portfolio accounting business units; ii) is formalizing contingency plans for its other mission critical products, services and systems; and iii) intends to test such plans by October 31, 1999. DST has reviewed existing formal contingency plans for its two major data centers with respect to failures that could be caused by Year 2000 issues. Testing and Documentation Procedures. All material modifications to IT and non-IT systems are being documented and maintained by the project teams for purposes of tracking the Year 2000 project and as a part of the Company's due diligence process. All modified systems have been or are in the process of being tested for Year 2000 remediation, unit acceptance, system acceptance and user acceptance. The testing procedures used and the results of these tests are being documented and maintained as a part of the Year 2000 due diligence process. Year 2000 Risks. The Company continues to evaluate the principal risks associated with its IT and non-IT systems, as well as third party systems if they were not to be Year 2000 ready on a timely basis. Areas that could be affected include, but are not limited to, the ability to: accurately track pricing and trading information, obtain and process customer orders and investor transactions, properly track and record revenue movements (including train movements), order and obtain critical supplies, and operate equipment and control systems. These risks are presently under assessment, and the Company has no basis to form an estimate of costs or lost revenues and is unable to determine its impact on operations at this time. The Company believes, however, that the risks involved with the successful completion of its Year 2000 conversion relate primarily to available resources and third party readiness. The key factors to success include the proper quality and quantity of human and capital resources to address the complexity and costs of the project tasks. The Company has allocated substantial resources to the Year 2000 project and believes that it is adequately staffed by employees, consultants and contractors. The inability to complete Year 2000 readiness for the computer systems of the Company could result in significant difficulties in processing and completing fundamental transactions. In addition, the Company is taking precautions to ensure its third party relationships have been adequately addressed. Based on work performed and information received to date, the Company believes its key suppliers, customers and other significant third party relationships will be prepared for the Year 2000 in all material respects within an acceptable time frame (or that acceptable alternatives will be available); however, 31 management of the Company makes no assurances that all such parties will be Year 2000 ready within an acceptable time frame. In the event that the Company or key third parties are not Year 2000 ready, the Company's results of operations, financial position and cash flows could be materially adversely affected. Contingency Plans. The Company and its subsidiaries have spent a significant amount of time identifying alternative plans in the event that the Year 2000 project is not completed on a timely basis or otherwise does not meet anticipated needs. A business contingency planning specialist was hired by KCSR to design and implement contingency plans for critical business processes. Similarly, consulting professionals have been utilized by Janus, Berger and Nelson in connection with Year 2000 efforts, including contingency planning. Management expects that the contingency planning process will be completed by the end of October 1999. The Company is also making alternative arrangements in the event that critical suppliers, customers, utility providers and other significant third parties are not Year 2000 ready. In addition, information system black out periods have been scheduled at the various Company subsidiaries, generally from the beginning of the fourth quarter 1999 through the end of the first quarter 2000. During this period, the Year 2000 project team and other members of the information systems group will focus all of their efforts and time toward addressing Year 2000 related issues. No new project requests or hardware/software upgrades will be allowed during this time. Year 2000 Costs. To date, the Company has spent approximately $17 million in connection with ensuring that all Company and subsidiary computer programs are compatible with Year 2000 requirements. In addition, the Company anticipates future spending of approximately $5 million in connection with this process. Current accounting principles require all costs associated with Year 2000 issues to be expensed as incurred. A portion of these costs will not result in an increase in expense to the Company because existing employees and equipment are being used to complete the project. Item 3. Quantitative and Qualitative Disclosures About Market Risk. The Company has had no significant changes in its Quantitative and Qualitative Disclosures About Market Risk from that previously reported in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. 32 PART II - OTHER INFORMATION Item 1. Legal Proceedings Part I, Item 1. Financial Statements, Note 11 to the Consolidated Condensed Financial Statements of this Form 10-Q is hereby incorporated herein by reference. Item 6. Exhibits and Reports on Form 8-K a) Exhibits Exhibit 10.1 - Kansas City Southern Industries, Inc. 1991 Amended and Restated Stock Option Award and Performance Plan, as amended and restated effective as of May 6, 1999, is attached to this Form 10-Q as Exhibit 10.1 Exhibit 27.1 - Financial Data Schedule b) Reports on Form 8-K The Company filed a Current Report on Form 8-K dated July 12, 1999 under Item 5, reporting the favorable tax ruling received from the IRS related to the spin-off of the financial services companies. 33 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized and in the capacities indicated on August 13, 1999 Kansas City Southern Industries, Inc. /s/ Joseph D. Monello Joseph D. Monello Vice President and Chief Financial Officer (Principal Financial Officer) /s/ Louis G. Van Horn Louis G. Van Horn Vice President and Comptroller (Principal Accounting Officer) EX-10.1 2 1991 AMENDED AND RESTATED STOCK OPTION Kansas City Southern Industries, Inc. 1991 Amended and Restated Stock Option and Performance Award Plan (as amended and restated effective as of May 6, 1999) 2 Table of Contents Article Page 1. Amendment and Restatement, Effective Date, Objectives and Duration.........1 2. Definitions................................................................1 3. Administration.............................................................8 4. Shares Subject to the Plan and Maximum Awards.............................10 5. Eligibility and General Conditions of Awards..............................11 6. Stock Options.............................................................15 7. Stock Appreciation Rights and Limited Stock Appreciation Rights...........17 8. Restricted Shares.........................................................19 9. Performance Units and Performance Shares..................................20 10. Bonus Shares.............................................................21 11. Beneficiary Designation..................................................21 12. Deferrals................................................................21 13. Rights of Employees/Directors/Consultants................................21 14. Change of Control........................................................22 15. Amendment, Modification, and Termination.................................23 16. Withholding..............................................................23 17. Successors...............................................................24 18. Additional Provisions....................................................25 KANSAS CITY SOUTHERN INDUSTRIES, INC. 1991 AMENDED AND RESTATED STOCK OPTION AND PERFORMANCE AWARD PLAN (AS AMENDED AND RESTATED EFFECTIVE AS OF MAY 6, 1999) Article I. Amendment and Restatement, Effective Date, Objectives and Duration 1.1 Amendment and Restatement of the Plan. Kansas City Southern Industries, Inc., a Delaware corporation (the "Company"), hereby amends, restates and combines the Kansas City Southern Industries, Inc. 1991 Amended and Restated Stock Option and Performance Award Plan (as amended through September 18, 1997), the Kansas City Southern Industries, Inc. 1993 Directors' Stock Option Plan (the "1993 Plan"), the Kansas City Southern Industries, Inc. 1987 Stock Option Plan (as amended September 26, 1996) (the "1987 Plan") and the Kansas City Southern Industries, Inc. 1983 Stock Option Plan (as amended September 26, 1996) (the "1983 Plan"), as set forth herein, and as the same may be amended from time to time (the "Plan"). The Plan, as so amended, restated and combined, has been adopted by the Board of Directors of the Company (the "Board") and approved by the stockholders of the Company, and shall be effective as of July 15, 1998 (the "Effective Date"). 1.2 Objectives of the Plan. The Plan is intended to allow employees, directors and consultants of the Company and its Subsidiaries to acquire or increase equity ownership in the Company, thereby strengthening their commitment to the success of the Company and stimulating their efforts on behalf of the Company, and to assist the Company and its Subsidiaries in attracting new employees, directors and consultants and retaining existing employees, directors and consultants. The Plan also is intended to optimize the profitability and growth of the Company through incentives which are consistent with the Company's goals; to provide employees, directors and consultants with an incentive for excellence in individual performance; and to promote teamwork among employees, directors and consultants. 1.3 Duration of the Plan. The Plan shall remain in effect, subject to the right of the Board to amend or terminate the Plan at any time pursuant to Article 15 hereof, until all Shares subject to it shall have been purchased or acquired according to the Plan's provisions. However, in no event may an Incentive Stock Option be granted under the Plan on or after the date 10 years following the earlier of (i) the date the Plan was adopted and (ii) the date the Plan was approved by the stockholders of the Company. Article 2. Definitions Whenever used in the Plan, the following terms shall have the meanings set forth below: 2.1 "Article" means an Article of the Plan. 2.2 "Award" means Options (including Incentive Stock Options), Restricted Shares, Bonus Shares, stock appreciation rights (SARs), limited stock appreciation rights (LSARs), Performance Units or Performance Shares granted under the Plan. 2 2.3 "Award Agreement" means the written agreement by which an Award shall be evidenced. 2.4 "Board" has the meaning set forth in Section 1.1. 2.5 "Bonus Shares" means Shares that are awarded to a Grantee without cost and without restrictions in recognition of past performance (whether determined by reference to another employee benefit plan of the Company or otherwise) or as an incentive to become an employee, director or consultant of the Company or a Subsidiary. 2.6 "Cause" means, unless otherwise defined in an Award Agreement, (i) before the occurrence of a Change of Control, any one or more of the following, as determined by the Committee: (A) a Grantee's commission of a crime which, in the judgment of the Committee, resulted or is likely to result in damage or injury to the Company or a Subsidiary; (B) the material violation by the Grantee of written policies of the Company or a Subsidiary; (C) the habitual neglect or failure by the Grantee in the performance of his or her duties to the Company or a Subsidiary (but only if such neglect or failure is not remedied within a reasonable remedial period after Grantee's receipt of written notice from the Company which describes such neglect or failure in reasonable detail and specifies the remedial period); or (D) action or inaction by the Grantee in connection with his or her duties to the Company or a Subsidiary resulting, in the judgment of the Committee, in material injury to the Company or a Subsidiary; and (ii) from and after the occurrence of a Change of Control, the occurrence of any one or more of the following, as determined in the good faith and reasonable judgment of the Committee: (A) Grantee's conviction for committing an act of fraud, embezzlement, theft, or any other act constituting a felony involving moral turpitude or causing material damage or injury, financial or otherwise, to the Company; (B) a demonstrably willful and deliberate act or failure to act which is committed in bad faith, without reasonable belief that such action or inaction is in the best interests of the Company, which causes material damage or injury, financial or otherwise, to the Company (but only if such act or inaction is not remedied within 15 business days of 3 Grantee's receipt of written notice from the Company which describes the act or inaction in reasonable detail); or (C) the consistent gross neglect of duties or consistent wanton negligence by the Grantee in the performance of the Grantee's duties (but only if such neglect or negligence is not remedied within a reasonable remedial period after Grantee's receipt of written notice from the Company which describes such neglect or negligence in reasonable detail and specifies the remedial period). 2.7 "Change of Control" means, unless otherwise defined in an Award Agreement, any one or more of the following: (i) the acquisition or holding by any person, entity or "group" (within the meaning of Section 13(d)(3) or 14(d)(2) of the 1934 Act), other than by the Company or any Subsidiary or any employee benefit plan of the Company or a Subsidiary, of beneficial ownership (within the meaning of Rule 13d-3 under the 1934 Act) of 20% or more of the then-outstanding Common Stock or the then-outstanding Voting Power of the Company; provided, however, that no Change of Control shall occur solely by reason of any such acquisition by a corporation with respect to which, after such acquisition, more than 60% of both the then-outstanding common shares and the then-outstanding Voting Power of such corporation are then beneficially owned, directly or indirectly, by the persons who were the beneficial owners of the then-outstanding Common Stock and Voting Power of the Company immediately before such acquisition, in substantially the same proportions as their respective ownership, immediately before such acquisition, of the then-outstanding Common Stock and Voting Power of the Company; or (ii) individuals who, as of the Effective Date, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least 75% of the Board; provided that any individual who becomes a director after the Effective Date whose election or nomination for election by the Company's stockholders was approved by at least 75% of the Incumbent Board (other than an election or nomination of an individual whose initial assumption of office is in connection with an actual or threatened "election contest" relating to the election of the directors of the Company (as such terms are used in Rule 14a-11 under the 1934 Act) or "tender offer" (as such term is used in Section 14(d) of the 1934 Act) or a proposed Extraordinary Transaction (as defined below)) shall be deemed to be a member of the Incumbent Board; or (iii) approval by the stockholders of the Company of any one or more of the following: (A) a merger, reorganization, consolidation or similar transaction (any of the foregoing, an "Extraordinary Transaction") with respect to which persons who were the respective beneficial owners of the then- outstanding Common Stock and Voting Power of the Company immediately before such Extraordinary Transaction would not, if such Extraordinary Transaction were to be consummated immediately after such stockholder approval (but otherwise in accordance with the terms presented in writing to the stockholders of the Company for their 4 approval), beneficially own, directly or indirectly, more than 60% of both the then-outstanding common shares and the then-outstanding Voting Power of the corporation resulting from such Extraordinary Transaction, in substantially the same proportions as their respective ownership, immediately before such Extraordinary Transaction, of the then-outstanding Common Stock and Voting Power of the Company, (B) a liquidation or dissolution of the Company, or (C) the sale or other disposition of all or substantially all of the assets of the Company in one transaction or a series of related transactions. 2.8 "Change of Control Value" means the Fair Market Value of a Share on the date of a Change of Control. 2.9 "Code" means the Internal Revenue Code of 1986, as amended from time to time, and regulations and rulings thereunder. References to a particular section of the Code include references to successor provisions of the Code or any successor code. 2.10 "Committee," "Plan Committee" and "Management Committee" have the meaning set forth in Article 3. 2.11 "Common Stock" means the common stock, $.01 par value, of the Company. 2.12 "Company" has the meaning set forth in Section 1.1. 2.13 "Covered Employee" means a Grantee who, as of the date that the value of an Award is recognizable as taxable income, is one of the group of "covered employees," within the meaning of Code Section 162(m). 2.14 "Disability" means, unless otherwise defined in an Award Agreement, for purposes of the exercise of an Incentive Stock Option after Termination of Affiliation, a disability within the meaning of Section 22(e)(3) of the Code, and for all other purposes, means total disability as determined for purposes of the long term disability plan of KCSI or any Subsidiary or other employer of the Grantee and disability shall be deemed to occur for purposes of the Plan on the date such determination of disability is made. 2.15 "Disqualifying Disposition" has the meaning set forth in Section 6.4. 2.16 "Effective Date" has the meaning set forth in Section 1.1. 2.17 "Eligible Person" means (i) any employee (including any officer) of the Company or any Subsidiary, including any such employee who is on an approved leave of absence, layoff, or has been subject to a disability which does not qualify as a Disability, (ii) any director of the Company or any Subsidiary and (iii) any person performing services for the Company or a 5 Subsidiary in the capacity of a consultant. 2.18 "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time. References to a particular section of the Exchange Act include references to successor provisions. 2.19 "Extraordinary Transaction" has the meaning set forth in Section 2.7. 2.20 "Fair Market Value" means (A) with respect to any property other than Shares, the fair market value of such property determined by such methods or procedures as shall be established from time to time by the Committee, and (B) with respect to Shares, unless otherwise determined by the Committee, as of any date, (i) the average of the high and low trading prices on the date of determination on the New York Stock Exchange (or, if no sale of Shares was reported for such date, on the next preceding date on which a sale of Shares was reported); (ii) if the Shares are not listed on the New York Stock Exchange, the average of the high and low trading prices of the Shares on such other national exchange on which the Shares are principally traded or as reported by the National Market System, or similar organization, or if no such quotations are available, the average of the high bid and low asked quotations in the over-the-counter market as reported by the National Quotation Bureau Incorporated or similar organizations; or (iii) in the event that there shall be no public market for the Shares, the fair market value of the Shares as determined by the Committee. 2.21 "Freestanding SAR" means an SAR that is granted independently of any other Award. 2.22 "Good Reason" means, unless otherwise defined in an Award Agreement, the occurrence after a Change of Control, without a Grantee's prior written consent, of any one or more of the following: (i) the assignment to the Grantee of any duties which result in a material adverse change in the Grantee's position (including status, offices, titles, and reporting requirements), authority, duties, or other responsibilities with the Company, or any other action of the Company which results in a material adverse change in such position, authority, duties, or responsibilities, other than an insubstantial and inadvertent action which is remedied by the Company promptly after receipt of notice thereof given by the Grantee, (ii) any relocation of the Grantee of more than 40 miles from the place where the Grantee was located at the time of the Change of Control, or (iii) a material reduction or elimination of any component of the Grantee's rate of compensation, including (x) base salary, (y) any incentive payment or (z) benefits or perquisites which the Grantee was receiving immediately prior to a Change of Control. 2.23 "Grant Date" has the meaning set forth in Section 5.2. 6 2.24 "Grantee" means an individual who has been granted an Award. 2.25 "Incentive Stock Option" means an option granted under Article 6 of the Plan that is intended to meet the requirements of Section 422 of the Code or any successor provisions thereto. 2.26 "including" or "includes" means "including, without limitation," or "includes, without limitation," respectively. 2.27 "LSAR" means a limited stock appreciation right. 2.28 "Mature Shares" means Shares for which the holder thereof has good title, free and clear of all liens and encumbrances, and which such holder either (i) has held for at least six months or (ii) has purchased on the open market. 2.29 "Minimum Consideration" means $.01 per Share or such other amount that is from time to time considered to be capital for purposes of Section 154 of the Delaware General Corporation Law. 2.30 "Option" means an option granted under Article 6 of the Plan. 2.31 "Option Price" means the price at which a Share may be purchased by a Grantee pursuant to an Option. 2.32 "Option Term" means the period beginning on the Grant Date of an Option and ending on the expiration date of such Option, as specified in the Award Agreement for such Option and as may, consistent with the provisions of the Plan, be extended from time to time by the Committee prior to the expiration date of such Option then in effect. 2.33 "Outside Director" means a member of the Board who is not an employee of the Company or any Subsidiary. 2.34 "Performance-Based Exception" means the performance-based exception from the tax deductibility limitations of Code Section 162(m). 2.35 "Performance Period" has the meaning set forth in Section 9.2. 2.36 "Performance Share" or "Performance Unit" has the meaning set forth in Article 9. 2.37 "Period of Restriction" means the period during which the transfer of Restricted Shares is limited in some way (the length of the period being based on the passage of time, the achievement of performance goals, or upon the occurrence of other events as determined by the Committee), and the Shares are subject to a substantial risk of forfeiture, as provided in 7 Article 8. 2.38 "Person" shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) thereof. 2.39 "Plan" has the meaning set forth in Section 1.1. 2.40 "Required Withholding" has the meaning set forth in Article 16. 2.41 "Restricted Shares" means Shares that are subject to forfeiture if the Grantee does not satisfy the conditions specified in the Award Agreement applicable to such Shares. 2.42 "Retirement" means for any Grantee who is an employee, Termination of Affiliation by the Grantee upon either (i) having both attained age fifty-five (55) and completed at least ten (10) years of service with the Company or a Subsidiary or (ii) meeting such other requirements as may be specified by the Committee. 2.43 "Rule 16b-3" means Rule 16b-3 promulgated by the SEC under the Exchange Act, as amended from time to time, together with any successor rule, as in effect from time to time. 2.44 "SAR" means a stock appreciation right. 2.45 "SEC" means the United States Securities and Exchange Commission, or any successor thereto. 2.46 "Section" means, unless the context otherwise requires, a Section of the Plan. 2.47 "Section 16 Person" means a person who is subject to potential liability under Section 16(b) of the 1934 Act with respect to transactions involving equity securities of the Company. 2.48 "Share" means a share of Common Stock. 2.49 "Strike Price" of any SAR shall equal, for any Tandem SAR (whether such Tandem SAR is granted at the same time as or after the grant of the related Option), the Option Price of such Option, or for any other SAR, 100% of the Fair Market Value of a Share on the Grant Date of such SAR; provided that the Committee may specify a higher Strike Price in the Award Agreement. 2.50 "Subsidiary" means, for purposes of grants of Incentive Stock Options, a corporation as defined in Section 424(f) of the Code (with the Company being treated as the employer corporation for purposes of this definition) and, for all other purposes, a United States or foreign corporation with respect to which the Company owns, directly or indirectly, 50% (or such lesser 8 percentage as the Committee may specify, which percentage may be changed from time to time and may be different for different entities) or more of the Voting Power of such corporation. 2.51 "Tandem SAR" means an SAR that is granted in connection with a related Option, the exercise of which shall require cancellation of the right to purchase a Share under the related Option (and when a Share is purchased under the related Option, the Tandem SAR shall similarly be canceled). 2.52 "Termination of Affiliation" occurs on the first day on which an individual is for any reason no longer providing services to the Company or any Subsidiary in the capacity of an employee, director or consultant, or with respect to an individual who is an employee or director of, or consultant to, a corporation which is a Subsidiary, the first day on which such corporation ceases to be a Subsidiary. 2.53 "10% Owner" means a person who owns capital stock (including stock treated as owned under Section 424(d) of the Code) possessing more than 10% of the total combined voting power of all classes of capital stock of the Company or any Subsidiary. 2.54 "Voting Power" means the combined voting power of the then-outstanding securities of a corporation entitled to vote generally in the election of directors. Article 3. Administration 3.1 Committee. (a) Subject to Article 15, and to Section 3.2, the Plan shall be administered by the Board, or a committee appointed by the Board to administer the Plan ("Plan Committee"). To the extent the Board considers it desirable to comply with or qualify under Rule 16b-3 or meet the Performance-Based Exception, the Plan Committee shall consist of two or more directors of the Company, all of whom qualify as "outside directors" as defined for purposes of the regulations under Code Section 162(m) and "non-employee directors" within the meaning of Rule 16b-3. The number of members of the Plan Committee shall from time to time be increased or decreased, and shall be subject to such conditions, in each case as the Board deems appropriate to permit transactions in Shares pursuant to the Plan to satisfy such conditions of Rule 16b-3 and the Performance-Based Exception as then in effect. (b) The Board or the Plan Committee may appoint and delegate to another committee ("Management Committee") any or all of the authority of the Board or the Plan Committee, as applicable, with respect to Awards to Grantees other than Grantees who are Section 16 Persons at the time any such delegated authority is exercised. (c) Any references herein to "Committee" are references to the Board, or the Plan Committee or the Management Committee, as applicable. 9 3.2 Powers of Committee. Subject to the express provisions of the Plan, the Committee has full and final authority and sole discretion as follows: (i) to determine when, to whom and in what types and amounts Awards should be granted and the terms and conditions applicable to each Award, including the benefit payable under any SAR, Performance Unit or Performance Share, and whether or not specific Awards shall be granted in connection with other specific Awards, and if so whether they shall be exercisable cumulatively with, or alternatively to, such other specific Awards; (ii) to determine the amount, if any, that a Grantee shall pay for Restricted Shares, whether to permit or require the payment of cash dividends thereon to be deferred and the terms related thereto, when Restricted Shares (including Restricted Shares acquired upon the exercise of an Option) shall be forfeited and whether such shares shall be held in escrow; (iii) to construe and interpret the Plan and to make all determinations necessary or advisable for the administration of the Plan; (iv) to make, amend, and rescind rules relating to the Plan, including rules with respect to the exercisability and nonforfeitability of Awards upon the Termination of Affiliation of a Grantee; (v) to determine the terms and conditions of all Award Agreements (which need not be identical) and, with the consent of the Grantee, to amend any such Award Agreement at any time, among other things, to permit transfers of such Awards to the extent permitted by the Plan; provided that the consent of the Grantee shall not be required for any amendment which (A) does not adversely affect the rights of the Grantee, or (B) is necessary or advisable (as determined by the Committee) to carry out the purpose of the Award as a result of any new or change in existing applicable law; (vi) to cancel, with the consent of the Grantee, outstanding Awards and to grant new Awards in substitution therefor; (vii) to accelerate the exercisability (including exercisability within a period of less than six months after the Grant Date) of, and to accelerate or waive any or all of the terms and conditions applicable to, any Award or any group of Awards for any reason and at any time, including in connection with a Termination of Affiliation; (viii) subject to Sections 1.3 and 5.3, to extend the time during which any Award or group of Awards may be exercised; (ix) to make such adjustments or modifications to Awards to Grantees working outside the United States as are advisable to fulfill the purposes of the Plan or to comply with applicable local law; 10 (x) to impose such additional terms and conditions upon the grant, exercise or retention of Awards as the Committee may, before or concurrently with the grant thereof, deem appropriate, including limiting the percentage of Awards which may from time to time be exercised by a Grantee; and (xi) to take any other action with respect to any matters relating to the Plan for which it is responsible. All determinations on all matters relating to the Plan or any Award Agreement may be made in the sole and absolute discretion of the Committee, and all such determinations of the Committee shall be final, conclusive and binding on all Persons. No member of the Committee shall be liable for any action or determination made with respect to the Plan or any Award. Article 4. Shares Subject to the Plan and Maximum Awards 4.1 Number of Shares Available for Grants. Subject to adjustment as provided in Section 4.2, the number of Shares hereby reserved for issuance under the Plan shall be equal to the sum of (i) 25,200,000 and (ii) the total number of Shares subject to Awards granted under the 1993 Plan, 1987 Plan and 1983 Plan that are outstanding as of the Effective Date; and the number of Shares for which Awards may be granted to any Grantee on any Grant Date, when aggregated with the number of Shares for which Awards have previously been granted to such Grantee in the same calendar year, shall not exceed the greater of (i) one percent (1%) of the total Shares outstanding as of such Grant Date or (ii) 1,300,000; provided, however, that the total number of Shares for which Awards may be granted to any Grantee in any calendar year shall not exceed 2,000,000. If any Shares subject to an Award granted hereunder are forfeited or such Award otherwise terminates without the issuance of such Shares or of other consideration in lieu of such Shares, the Shares subject to such Award, to the extent of any such forfeiture or termination shall again be available for grant under the Plan. If any Shares (whether subject to or received pursuant to an Award granted hereunder, purchased on the open market, or otherwise obtained) are withheld, applied as payment, or sold pursuant to procedures approved by the Committee and the proceeds thereof applied as payment in connection with the exercise of an Award or the withholding of taxes related thereto, such Shares, to the extent of any such withholding or payment, shall again be available or shall increase the number of Shares available, as applicable, for grant under the Plan. The Committee may from time to time determine the appropriate methodology for calculating the number of Shares issued pursuant to the Plan. Shares issued pursuant to the Plan may be treasury Shares or newly-issued Shares. 4.2 Adjustments in Authorized Shares. In the event that the Committee determines that any dividend or other distribution (whether in the form of cash, Shares, other securities, or other property), recapitalization, stock split, reverse stock split, subdivision, consolidation or reduction of capital, reorganization, merger, scheme of arrangement, split-up, spin-off or combination involving the Company or repurchase or exchange of Shares or other rights to purchase Shares or other securities of the Company, or other similar corporate transaction or event affects the Shares such that any adjustment is determined by the Committee to be appropriate in order to 11 prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan, then the Committee shall, in such manner as it may deem equitable, adjust any or all of (i) the number and type of Shares (or other securities or property) with respect to which Awards may be granted, (ii) the number and type of Shares (or other securities or property) subject to outstanding Awards, and (iii) the grant or exercise price with respect to any Award or, if deemed appropriate, make provision for a cash payment to the holder of an outstanding Award or the substitution of other property for Shares subject to an outstanding Award; provided, in each case that with respect to Awards of Incentive Stock Options no such adjustment shall be authorized to the extent that such adjustment would cause the Plan to violate Section 422(b)(1) of the Code or any successor provision thereto; and provided further, that the number of Shares subject to any Award denominated in Shares shall always be a whole number. Article 5. Eligibility and General Conditions of Awards 5.1 Eligibility. The Committee may grant Awards to any Eligible Person, whether or not he or she has previously received an Award. 5.2 Grant Date. The Grant Date of an Award shall be the date on which the Committee grants the Award or such later date as specified by the Committee. 5.3 Maximum Term. The Option Term or other period during which an Award may be outstanding shall under no circumstances extend more than 10 years after the Grant Date, and shall be subject to earlier termination as herein provided; provided, however, that any deferral of a cash payment or of the delivery of Shares that is permitted or required by the Committee pursuant to Article 12 may, if so permitted or required by the Committee, extend more than 10 years after the Grant Date of the Award to which the deferral relates. 5.4 Award Agreement. To the extent not set forth in the Plan, the terms and conditions of each Award (which need not be the same for each grant or for each Grantee) shall be set forth in an Award Agreement. 5.5 Restrictions on Share Transferability. The Committee may impose such restrictions on any Shares acquired pursuant to the exercise or vesting of an Award as it may deem advisable, including restrictions under applicable federal securities laws. 5.6 Termination of Affiliation. Except as otherwise provided in an Award Agreement, and subject to the provisions of Section 14.1, the extent to which the Grantee shall have the right to exercise, vest in, or receive payment in respect of an Award following Termination of Affiliation shall be determined in accordance with the following provisions of this Section 5.6. (a) For Cause. If a Grantee has a Termination of Affiliation for Cause, (i) the Grantee's Restricted Shares that are forfeitable shall thereupon be forfeited, subject to the provisions of Section 8.4 regarding repayment of certain amounts to the Grantee; and (ii) any unexercised Option, LSAR or SAR, and any Performance Share or Performance Unit with 12 respect to which the Performance Period has not ended as of the date of such Termination of Affiliation, shall terminate effective immediately upon such Termination of Affiliation. (b) On Account of Death or Disability. If a Grantee has a Termination of Affiliation on account of death or Disability, then: (i) the Grantee's Restricted Shares that were forfeitable shall thereupon become nonforfeitable; (ii) any unexercised Option or SAR, whether or not exercisable on the date of such Termination of Affiliation, may be exercised, in whole or in part, within the first 12 months after such Termination of Affiliation (but only during the Option Term) by the Grantee or, after his or her death, by (A) his or her personal representative or the person to whom the Option or SAR, as applicable, is transferred by will or the applicable laws of descent and distribution, or (B) the Grantee's beneficiary designated in accordance with Article 11; and (iii) the benefit payable with respect to any Performance Share or Performance Unit with respect to which the Performance Period has not ended as of the date of such Termination of Affiliation on account of death or Disability shall be equal to the product of the Fair Market Value of a Share as of the date of such Termination of Affiliation or the value of the Performance Unit specified in the Award Agreement (determined as of the date of such Termination of Affiliation), as applicable, multiplied successively by each of the following: (1) a fraction, the numerator of which is the number of months (including as a whole month any partial month) that have elapsed since the beginning of such Performance Period until the date of such Termination of Affiliation and the denominator of which is the number of months (including as a whole month any partial month) in the Performance Period; and (2) a percentage determined by the Committee that would be earned under the terms of the applicable Award Agreement assuming that the rate at which the performance goals have been achieved as of the date of such Termination of Affiliation would continue until the end of the Performance Period, or, if the Committee elects to compute the benefit after the end of the Performance Period, the Performance Percentage, as determined by the Committee, attained during the Performance Period. (c) On Account of Retirement. If a Grantee has a Termination of Affiliation on account of Retirement, then: (i) the Grantee's Restricted Shares that were forfeitable shall thereupon become nonforfeitable; (ii) any unexercised Option or SAR, whether or not exercisable on the date of such Termination of Affiliation, may be exercised, in whole or in part, within the first five years 13 after such Termination of Affiliation (but only during the Option Term) by the Grantee or, after his or her death, by (A) his or her personal representative or the person to whom the Option or SAR, as applicable, is transferred by will or the applicable laws of descent and distribution, or (B) the Grantee's beneficiary designated in accordance with Article 11; and (iii) the benefit payable with respect to any Performance Share or Performance Unit with respect to which the Performance Period has not ended as of the date of such Termination of Affiliation on account of Retirement shall be equal to the product of the Fair Market Value of a Share as of the date of such Termination of Affiliation or the value of the Performance Unit specified in the Award Agreement (determined as of the date of such Termination of Affiliation), as applicable, multiplied successively by each of the following: (1) a fraction, the numerator of which is the number of months (including as a whole month any partial month) that have elapsed since the beginning of such Performance Period until the date of such Termination of Affiliation and the denominator of which is the number of months (including as a whole month any partial month) in the Performance Period; and (2) a percentage determined by the Committee that would be earned under the terms of the applicable Award Agreement assuming that the rate at which the performance goals have been achieved as of the date of such Termination of Affiliation would continue until the end of the Performance Period, or, if the Committee elects to compute the benefit after the end of the Performance Period, the Performance Percentage, as determined by the Committee, attained during the Performance Period. (d) Any Other Reason. If a Grantee has a Termination of Affiliation for any reason other than for Cause, death, Disability or Retirement, then: (i) the Grantee's Restricted Shares, to the extent forfeitable on the date of the Grantee's Termination of Affiliation, shall be forfeited on such date; (ii) any unexercised Option or SAR, to the extent exercisable immediately before the Grantee's Termination of Affiliation, may be exercised in whole or in part, not later than three months after such Termination of Affiliation (but only during the Option Term) by the Grantee or, after his or her death, by (A) his or her personal representative or the person to whom the Option or SAR, as applicable, is transferred by will or the applicable laws of descent and distribution, or (B) the Grantee's beneficiary designated in accordance with Article 11; and (iii) any Performance Shares or Performance Units with respect to which the Performance Period has not ended as of the date of such Termination of Affiliation shall terminate immediately upon such Termination of Affiliation. 14 5.7 Nontransferability of Awards. (a) Except as provided in Section 5.7(c) below, each Award, and each right under any Award, shall be exercisable only by the Grantee during the Grantee's lifetime, or, if permissible under applicable law, by the Grantee's guardian or legal representative or by a transferee receiving such Award pursuant to a qualified domestic relations order (a "QDRO") as defined in the Code or Title I of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), or the rules thereunder. (b) Except as provided in Section 5.7(c) below, no Award (prior to the time, if applicable, Shares are issued in respect of such Award), and no right under any Award, may be assigned, alienated, pledged, attached, sold or otherwise transferred or encumbered by a Grantee otherwise than by will or by the laws of descent and distribution (or in the case of Restricted Shares, to the Company) or pursuant to a QDRO, and any such purported assignment, alienation, pledge, attachment, sale, transfer or encumbrance shall be void and unenforceable against the Company or any Subsidiary; provided, that the designation of a beneficiary shall not constitute an assignment, alienation, pledge, attachment, sale, transfer or encumbrance. (c) To the extent and in the manner permitted by the Committee, and subject to such terms, conditions, restrictions or limitations that may be prescribed by the Committee, a Grantee may transfer an Award (other than an Incentive Stock Option) to (i) a spouse, sibling, parent, child (including an adopted child) or grandchild (any of which, an "Immediate Family Member") of the Grantee; (ii) a trust, the primary beneficiaries of which consist exclusively of the Grantee or Immediate Family Members of the Grantee; or (iii) a corporation, partnership or similar entity, the owners of which consist exclusively of the Grantee or Immediate Family Members of the Grantee. 5.8 Cancellation and Rescission of Awards. Unless the Award Agreement specifies otherwise, the Committee may cancel, rescind, suspend, withhold, or otherwise limit or restrict any unexercised Award at any time if the Grantee is not in compliance with all applicable provisions of the Award Agreement and the Plan or if the Grantee has a Termination of Affiliation for Cause. 5.9 Loans and Guarantees. The Committee may, subject to applicable law, (i) allow a Grantee to defer payment to the Company of all or any portion of the Option Price of an Option or the purchase price of Restricted Shares, or (ii) cause the Company to loan to the Grantee, or guarantee a loan from a third party to the Grantee for, all or any portion of the Option Price of an Option or the purchase price of Restricted Shares or all or any portion of any taxes associated with the exercise of, nonforfeitability of, or payment of benefits in connection with, an Award. Any such payment deferral, loan or guarantee by the Company shall be on such terms and conditions as the Committee may determine. 15 Article 6. Stock Options 6.1 Grant of Options. Subject to the terms and provisions of the Plan, Options may be granted to any Eligible Person in such number, and upon such terms, and at any time and from time to time as shall be determined by the Committee. Without in any manner limiting the generality of the foregoing, the Committee may grant to any Eligible Person, or permit any Eligible Person to elect to receive, an Option in lieu of or in substitution for any other compensation (whether payable currently or on a deferred basis, and whether payable under this Plan or otherwise) which such Eligible Person may be eligible to receive from the Company or a Subsidiary. 6.2 Award Agreement. Each Option grant shall be evidenced by an Award Agreement that shall specify the Option Price, the Option Term, the number of shares to which the Option pertains, the time or times at which such Option shall be exercisable and such other provisions as the Committee shall determine. 6.3 Option Price. The Option Price of an Option under this Plan shall be determined by the Committee, and shall be equal to or more than 100% of the Fair Market Value of a Share on the Grant Date; provided, however, that any Option that is (x) granted to a Grantee in connection with the acquisition ("Acquisition"), however effected, by the Company of another corporation or entity ("Acquired Entity") or the assets thereof, (y) associated with an option to purchase shares of stock of the Acquired Entity or an affiliate thereof ("Acquired Entity Option") held by such Grantee immediately prior to such Acquisition, and (z) intended to preserve for the Grantee the economic value of all or a portion of such Acquired Entity Option ("Substitute Option") may, to the extent necessary to achieve such preservation of economic value, be granted with an Option Price that is less than 100% of the Fair Market Value of a Share on the Grant Date. 6.4 Grant of Incentive Stock Options. At the time of the grant of any Option, the Committee may designate that such Option shall be made subject to additional restrictions to permit it to qualify as an "incentive stock option" under the requirements of Section 422 of the Code. Any Option designated as an Incentive Stock Option shall, to the extent required by Section 422 of the Code: (i) if granted to a 10% Owner, have an Option Price not less than 110% of the Fair Market Value of a Share on its Grant Date; (ii) be exercisable for a period of not more than 10 years (five years in the case of an Incentive Stock Option granted to a 10% Owner) from its Grant Date, and be subject to earlier termination as provided herein or in the applicable Award Agreement; (iii) not have an aggregate Fair Market Value (as of the Grant Date of each Incentive Stock Option) of the Shares with respect to which Incentive Stock Options (whether granted under the Plan or any other stock option plan of the Grantee's employer or any parent or Subsidiary thereof ("Other Plans")) are exercisable for the first time by such Grantee during any 16 calendar year, determined in accordance with the provisions of Section 422 of the Code, which exceeds $100,000 (the "$100,000 Limit"); (iv) if the aggregate Fair Market Value of the Shares (determined on the Grant Date) with respect to the portion of such grant which is exercisable for the first time during any calendar year ("Current Grant") and all Incentive Stock Options previously granted under the Plan and any Other Plans which are exercisable for the first time during the same calendar year ("Prior Grants") would exceed the $100,000 Limit be exercisable as follows: (A) the portion of the Current Grant which would, when added to any Prior Grants, be exercisable with respect to Shares which would have an aggregate Fair Market Value (determined as of the respective Grant Date for such options) in excess of the $100,000 Limit shall, notwithstanding the terms of the Current Grant, be exercisable for the first time by the Grantee in the first subsequent calendar year or years in which it could be exercisable for the first time by the Grantee when added to all Prior Grants without exceeding the $100,000 Limit; and (B) if, viewed as of the date of the Current Grant, any portion of a Current Grant could not be exercised under the preceding provisions of this Section during any calendar year commencing with the calendar year in which it is first exercisable through and including the last calendar year in which it may by its terms be exercised, such portion of the Current Grant shall not be an Incentive Stock Option, but shall be exercisable as an Option which is not an Incentive Stock Option at such date or dates as are provided in the Current Grant; (v) be granted within 10 years from the earlier of the date the Plan is adopted or the date the Plan is approved by the stockholders of the Company; and (vi) by its terms not be assignable or transferable other than by will or the laws of descent and distribution and may be exercised, during the Grantee's lifetime, only by the Grantee; provided, however, that the Grantee may, in any manner permitted by the Plan and specified by the Committee, designate in writing a beneficiary to exercise his or her Incentive Stock Option after the Grantee's death. Any Option designated as an Incentive Stock Option shall also require the Grantee to notify the Committee of any disposition of any Shares issued pursuant to the exercise of the Incentive Stock Option under the circumstances described in Section 421(b) of the Code (relating to certain disqualifying dispositions) (any such circumstance, a "Disqualifying Disposition"), within 10 days of such Disqualifying Disposition. Notwithstanding the foregoing and Section 3.2(v), the Committee may, without the consent of the Grantee, at any time before the exercise of an Option (whether or not an Incentive Stock Option), take any action necessary to prevent such Option from being treated as an Incentive Stock Option. 17 6.5 Payment. Options granted under this Article 6 shall be exercised by the delivery of a written notice of exercise to the Company, setting forth the number of Shares with respect to which the Option is to be exercised, accompanied by full payment for the Shares made by any one or more of the following means subject to the approval of the Committee: (a) cash, personal check or wire transfer; (b) Mature Shares, valued at their Fair Market Value on the date of exercise; (c) Restricted Shares held by the Grantee for at least six months prior to the exercise of the Option, each such Share valued at the Fair Market Value of a Share on the date of exercise; (d) subject to applicable law, pursuant to procedures approved by the Committee, through the sale of the Shares acquired on exercise of the Option through a broker-dealer to whom the Grantee has submitted an irrevocable notice of exercise and irrevocable instructions to deliver promptly to the Company the amount of sale or loan proceeds sufficient to pay for such Shares, together with, if requested by the Company, the amount of federal, state, local or foreign withholding taxes payable by Grantee by reason of such exercise; or (e) when permitted by the Committee, payment may also be made in accordance with Section 5.9. If any Restricted Shares ("Tendered Restricted Shares") are used to pay the Option Price, a number of Shares acquired on exercise of the Option equal to the number of Tendered Restricted Shares shall be subject to the same restrictions as the Tendered Restricted Shares, determined as of the date of exercise of the Option. Article 7. Stock Appreciation Rights and Limited Stock Appreciation Rights 7.1 Grant of SARs. Subject to the terms and conditions of the Plan, SARs may be granted to any Eligible Person at any time and from time to time as shall be determined by the Committee. The Committee may grant Freestanding SARs, Tandem SARs, or any combination thereof. The Committee shall determine the number of SARs granted to each Grantee (subject to Article 4), the Strike Price thereof, and, consistent with Section 7.2 and the other provisions of the Plan, the other terms and conditions pertaining to such SARs. 7.2 Exercise of Tandem SARs. Tandem SARs may be exercised for all or part of the Shares subject to the related Award upon the surrender of the right to exercise the equivalent portion of the related Award. A Tandem SAR may be exercised only with respect to the Shares for which its related Award is then exercisable. 18 Notwithstanding any other provision of this Plan to the contrary, with respect to a Tandem SAR, (i) the Tandem SAR will expire no later than the expiration of the underlying Option; (ii) the value of the payout with respect to the Tandem SAR may be for no more than 100% of the difference between the Option Price of the underlying Option and the Fair Market Value of the Shares subject to the underlying Option at the time the Tandem SAR is exercised; and (iii) the Tandem SAR may be exercised only when the Fair Market Value of the Shares subject to the Option exceeds the Option Price of the Option. 7.3 Payment of SAR Amount. Upon exercise of an SAR, the Grantee shall be entitled to receive payment from the Company in an amount determined by multiplying: (a) the excess of the Fair Market Value of a Share on the date of exercise over the Strike Price; by (b) the number of Shares with respect to which the SAR is exercised; provided that the Committee may provide in the Award Agreement that the benefit payable on exercise of an SAR shall not exceed such percentage of the Fair Market Value of a Share on the Grant Date as the Committee shall specify. As determined by the Committee, the payment upon SAR exercise may be in cash, in Shares which have an aggregate Fair Market Value (as of the date of exercise of the SAR) equal to the amount of the payment, or in some combination thereof, as set forth in the Award Agreement. 7.4 Grant of LSARs. Subject to the terms and conditions of the Plan, LSARs may be granted to any Eligible Person at any time and from time to time as shall be determined by the Committee. Each LSAR shall be identified with a Share subject to an Option or SAR held by the Grantee, which may include an Option or SAR previously granted under the Plan. Upon the exercise, expiration, termination, forfeiture or cancellation of the Option or SAR with which an LSAR is identified, such LSAR shall terminate. 7.5 Exercise of LSARs. Each LSAR shall automatically be exercised upon a Change of Control which has not been approved by the Incumbent Board. The exercise of an LSAR shall result in the cancellation of the Option or SAR with which such LSAR is identified, to the extent of such exercise. 7.6 Payment of LSAR Amount. Within 10 business days after the exercise of an LSAR, the Company shall pay to the Grantee, in cash, an amount equal to the difference between: (a) the greatest of (i) the Change of Control Value, (ii) the Fair Market Value of a Share on the date occurring during the 180-day period immediately preceding the date of the Change of Control on which such Fair Market Value is the 19 greatest, or (iii) such other valuation amount, if any, as may be determined pursuant to the provisions of the applicable Award Agreement; minus (b) either (i) in the case of an LSAR identified with an Option, the Option Price of such Option or (ii) in the case of an LSAR identified with an SAR, the Strike Price of such SAR. Article 8. Restricted Shares 8.1 Grant of Restricted Shares. Subject to the terms and provisions of the Plan, the Committee, at any time and from time to time, may grant Restricted Shares to any Eligible Person in such amounts as the Committee shall determine. 8.2 Award Agreement. Each grant of Restricted Shares shall be evidenced by an Award Agreement that shall specify the Period(s) of Restriction, the number of Restricted Shares granted, and such other provisions as the Committee shall determine. The Committee may impose such conditions and/or restrictions on any Restricted Shares granted pursuant to the Plan as it may deem advisable, including restrictions based upon the achievement of specific performance goals (Company-wide, divisional, Subsidiary and/or individual), time-based restrictions on vesting, and/or restrictions under applicable securities laws. 8.3 Consideration. The Committee shall determine the amount, if any, that a Grantee shall pay for Restricted Shares, which shall be (except with respect to Restricted Shares that are treasury shares) at least the Minimum Consideration for each Restricted Share. Such payment shall be made in full by the Grantee before the delivery of the shares and in any event no later than 10 business days after the Grant Date for such shares. 8.4 Effect of Forfeiture. If Restricted Shares are forfeited, and if the Grantee was required to pay for such shares or acquired such Restricted Shares upon the exercise of an Option, the Grantee shall be deemed to have resold such Restricted Shares to the Company at a price equal to the lesser of (x) the amount paid by the Grantee for such Restricted Shares, or (y) the Fair Market Value of a Share on the date of such forfeiture. The Company shall pay to the Grantee the required amount as soon as is administratively practical. Such Restricted Shares shall cease to be outstanding, and shall no longer confer on the Grantee thereof any rights as a stockholder of the Company, from and after the date of the event causing the forfeiture, whether or not the Grantee accepts the Company's tender of payment for such Restricted Shares. 8.5 Escrow; Legends. The Committee may provide that the certificates for any Restricted Shares (x) shall be held (together with a stock power executed in blank by the Grantee) in escrow by the Secretary of the Company until such Restricted Shares become nonforfeitable or are forfeited and/or (y) shall bear an appropriate legend restricting the transfer of such Restricted Shares. If any Restricted Shares become nonforfeitable, the Company shall 20 cause certificates for such shares to be issued without such legend. Article 9. Performance Units and Performance Shares 9.1 Grant of Performance Units and Performance Shares. Subject to the terms of the Plan, Performance Units or Performance Shares may be granted to any Eligible Person in such amounts and upon such terms, and at any time and from time to time, as shall be determined by the Committee. 9.2 Value/Performance Goals. Each Performance Unit shall have an initial value that is established by the Committee at the time of grant. Each Performance Share shall have an initial value equal to the Fair Market Value of a Share on the date of grant. The Committee shall set performance goals which, depending on the extent to which they are met, will determine the number or value of Performance Units or Performance Shares that will be paid out to the Grantee. For purposes of this Article 9, the time period during which the performance goals must be met shall be called a "Performance Period." 9.3 Earning of Performance Units and Performance Shares. Subject to the terms of this Plan, after the applicable Performance Period has ended, the holder of Performance Units or Performance Shares shall be entitled to receive a payout based on the number and value of Performance Units or Performance Shares earned by the Grantee over the Performance Period, to be determined as a function of the extent to which the corresponding performance goals have been achieved. If a Grantee is promoted, demoted or transferred to a different business unit of the Company during a Performance Period, then, to the extent the Committee determines the performance goals or Performance Period are no longer appropriate, the Committee may adjust, change or eliminate the performance goals or the applicable Performance Period as it deems appropriate in order to make them appropriate and comparable to the initial performance goals or Performance Period. 9.4 Form and Timing of Payment of Performance Units and Performance Shares. Payment of earned Performance Units or Performance Shares shall be made in a lump sum following the close of the applicable Performance Period. The Committee may pay earned Performance Units or Performance Shares in the form of cash or in Shares (or in a combination thereof) which have an aggregate Fair Market Value equal to the value of the earned Performance Units or Performance Shares at the close of the applicable Performance Period. Such Shares may be granted subject to any restrictions deemed appropriate by the Committee. The form of payout of such Awards shall be set forth in the Award Agreement pertaining to the grant of the Award. As determined by the Committee, a Grantee may be entitled to receive any dividends declared with respect to Shares which have been earned in connection with grants of Performance Units or Performance Shares but not yet distributed to the Grantee. In addition, a 21 Grantee may, as determined by the Committee, be entitled to exercise his or her voting rights with respect to such Shares. Article 10. Bonus Shares Subject to the terms of the Plan, the Committee may grant Bonus Shares to any Eligible Person, in such amount and upon such terms and at any time and from time to time as shall be determined by the Committee. The terms of such Bonus Shares shall be set forth in the Award Agreement pertaining to the grant of the Award. Article 11. Beneficiary Designation Each Grantee under the Plan may, from time to time, name any beneficiary or beneficiaries (who may be named contingently or successively) to whom any benefit under the Plan is to be paid in case of his or her death before he or she receives any or all of such benefit. Each such designation shall revoke all prior designations by the same Grantee, shall be in a form prescribed by the Company, and will be effective only when filed by the Grantee in writing with the Company during the Grantee's lifetime. In the absence of any such designation, benefits remaining unpaid at the Grantee's death shall be paid to the Grantee's estate. Article 12. Deferrals The Committee may permit or require a Grantee to defer receipt of the payment of cash or the delivery of Shares that would otherwise be due by virtue of the exercise of an Option or SAR, the lapse or waiver of restrictions with respect to Restricted Shares, the satisfaction of any requirements or goals with respect to Performance Units or Performance Shares, or the grant of Bonus Shares. If any such deferral is required or permitted, the Committee shall establish rules and procedures for such deferrals. Except as otherwise provided in an Award Agreement, any payment or any Shares that are subject to such deferral shall be made or delivered to the Grantee upon the Grantee's Termination of Affiliation. Article 13. Rights of Employees/Directors/Consultants 13.1 Employment. Nothing in the Plan shall interfere with or limit in any way the right of the Company to terminate any Grantee's employment, directorship or consultancy at any time, nor confer upon any Grantee the right to continue in the employ or as a director or consultant of the Company. 13.2 Participation. No employee, director or consultant shall have the right to be selected to receive an Award under the Plan, or, having been so selected, to be selected to receive a future Award. 22 Article 14. Change of Control 14.1 Change of Control. Except as otherwise provided in an Award Agreement, if a Change of Control occurs, then: (i) the Grantee's Restricted Shares that were forfeitable shall thereupon become nonforfeitable; (ii) any unexercised Option or SAR, whether or not exercisable on the date of such Change of Control, shall thereupon be fully exercisable and may be exercised, in whole or in part; and (iii) the Company shall immediately pay to the Grantee, with respect to any Performance Share or Performance Unit with respect to which the Performance Period has not ended as of the date of such Change of Control, a cash payment equal to the product of (A) in the case of a Performance Share, the Change of Control Value or (B) in the case of a Performance Unit, the value of the Performance Unit specified in the Award Agreement, as applicable, multiplied successively by each of the following: (1) a fraction, the numerator of which is the number of whole and partial months that have elapsed between the beginning of such Performance Period and the date of such Change of Control and the denominator of which is the number of whole and partial months in the Performance Period; and (2) a percentage equal to a greater of (x) the target percentage, if any, specified in the applicable Award Agreement or (y) the maximum percentage, if any, that would be earned under the terms of the applicable Award Agreement assuming that the rate at which the performance goals have been achieved as of the date of such Change of Control would continue until the end of the Performance Period. 14.2 Pooling of Interests Accounting. If the Committee determines, prior to a sale or merger of the Company that the Committee determines is reasonably likely to occur, that the grant or exercise of Options, SARs or LSARs would preclude the use of pooling of interests accounting ("pooling") after the consummation of such sale or merger and that such preclusion of pooling would have a material adverse effect on such sale or merger, the Committee may (a) make any adjustments in such Options, SARs or LSARs prior to the sale or merger that will permit pooling after the consummation of such sale or merger or (b) cause the Company to pay the benefits attributable to such Options, SARs or LSARs (including for this purpose not only the spread between the then Fair Market Value of the Shares subject to such Options, SARs or LSARs and the Option Price or Strike Price applicable thereto, but also the additional value of such Options, SARs, or LSARs in excess of such spread, as determined by the Committee) in the form of Shares if such payment would not cause the transaction to remain or become ineligible for pooling; provided, however, no such adjustment or payment may be made that would adversely affect in any material way any such Options, SARs or LSARs without the consent of 23 the affected Grantee. Article 15. Amendment, Modification, and Termination 15.1 Amendment, Modification, and Termination. Subject to the terms of the Plan, the Board may at any time and from time to time, alter, amend, suspend or terminate the Plan in whole or in part without the approval of the Company's stockholders. The Board may delegate to the Plan Committee any or all of the authority of the Board under Section 15.1 to alter, amend suspend or terminate the Plan. 15.2 Adjustment of Awards Upon the Occurrence of Certain Unusual or Nonrecurring Events. The Committee may make adjustments in the terms and conditions of, and the criteria included in, Awards in recognition of unusual or nonrecurring events (including the events described in Section 4.2) affecting the Company or the financial statements of the Company or of changes in applicable laws, regulations, or accounting principles, whenever the Committee determines that such adjustments are appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan; provided that no such adjustment shall be authorized to the extent that such authority would be inconsistent with the Plan's meeting the requirements of the Performance-Based Exception. 15.3 Awards Previously Granted. Notwithstanding any other provision of the Plan to the contrary, no termination, amendment, or modification of the Plan shall adversely affect in any material way any Award previously granted under the Plan, without the written consent of the Grantee of such Award. Article 16. Withholding 16.1 Withholding (a) Mandatory Tax Withholding. (1) Whenever under the Plan, Shares are to be delivered upon exercise or payment of an Award or upon Restricted Shares becoming nonforfeitable, or any other event with respect to rights and benefits hereunder, the Company shall be entitled to require (i) that the Grantee remit an amount in cash, or if determined by the Committee, Mature Shares, sufficient to satisfy all federal, state, local and foreign tax withholding requirements related thereto ("Required Withholding"), (ii) the withholding of such Required Withholding from compensation otherwise due to the Grantee or from any Shares or other payment due to the Grantee under the Plan or (iii) any combination of the foregoing. 24 (2) Any Grantee who makes a Disqualifying Disposition or an election under Section 83(b) of the Code shall remit to the Company an amount sufficient to satisfy all resulting Required Withholding; provided that, in lieu of or in addition to the foregoing, the Company shall have the right to withhold such Required Withholding from compensation otherwise due to the Grantee or from any Shares or other payment due to the Grantee under the Plan. (b) Elective Share Withholding. (1) Subject to subsection 16.1(b)(2), a Grantee may elect the withholding ("Share Withholding") by the Company of a portion of the Shares subject to an Award upon the exercise of such Award or upon Restricted Shares becoming non-forfeitable or upon making an election under Section 83(b) of the Code (each, a "Taxable Event") having a Fair Market Value equal to (i) the minimum amount necessary to satisfy Required Withholding liability attributable to the Taxable Event; or (ii) with the Committee's prior approval, a greater amount, not to exceed the estimated total amount of such Grantee's tax liability with respect to the Taxable Event. (2) Each Share Withholding election shall be subject to the following conditions: (A) any Grantee's election shall be subject to the Committee's discretion to revoke the Grantee's right to elect Share Withholding at any time before the Grantee's election if the Committee has reserved the right to do so in the Award Agreement; (B) the Grantee's election must be made before the date (the "Tax Date") on which the amount of tax to be withheld is determined; and (C) the Grantee's election shall be irrevocable. 16.2 Notification Under Code Section 83(b). If the Grantee, in connection with the exercise of any Option, or the grant of Restricted Shares, makes the election permitted under Section 83(b) of the Code to include in such Grantee's gross income in the year of transfer the amounts specified in Section 83(b) of the Code, then such Grantee shall notify the Company of such election within 10 days of filing the notice of the election with the Internal Revenue Service, in addition to any filing and notification required pursuant to regulations issued under Section 83(b) of the Code. The Committee may, in connection with the grant of an Award or at any time thereafter prior to such an election being made, prohibit a Grantee from making the election described above. Article 17. Successors All obligations of the Company under the Plan with respect to Awards granted hereunder 25 shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation, or otherwise of all or substantially all of the business and/or assets of the Company. Article 18. Additional Provisions 18.1 Gender and Number. Except where otherwise indicated by the context, any masculine term used herein also shall include the feminine, the plural shall include the singular and the singular shall include the plural. 18.2 Severability. If any part of the Plan is declared by any court or governmental authority to be unlawful or invalid, such unlawfulness or invalidity shall not invalidate any other part of the Plan. Any Section or part of a Section so declared to be unlawful or invalid shall, if possible, be construed in a manner which will give effect to the terms of such Section or part of a Section to the fullest extent possible while remaining lawful and valid. 18.3 Requirements of Law. The granting of Awards and the issuance of Shares under the Plan shall be subject to all applicable laws, rules, and regulations, and to such approvals by any governmental agencies or stock exchanges as may be required. Notwithstanding any provision of the Plan or any Award, Grantees shall not be entitled to exercise, or receive benefits under, any Award, and the Company shall not be obligated to deliver any Shares or other benefits to a Grantee, if such exercise or delivery would constitute a violation by the Grantee or the Company of any applicable law or regulation. 18.4 Securities Law Compliance. (a) If the Committee deems it necessary to comply with any applicable securities law, or the requirements of any stock exchange upon which Shares may be listed, the Committee may impose any restriction on Shares acquired pursuant to Awards under the Plan as it may deem advisable. All certificates for Shares delivered under the Plan pursuant to any Award or the exercise thereof shall be subject to such stop transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the SEC, any stock exchange upon which Shares are then listed, any applicable securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. If so requested by the Company, the Grantee shall make a written representation to the Company that he or she will not sell or offer to sell any Shares unless a registration statement shall be in effect with respect to such Shares under the Securities Act of 1993, as amended, and any applicable state securities law or unless he or she shall have furnished to the Company evidence satisfactory to the Company that such registration is not required. (b) If the Committee determines that the exercise or nonforfeitability of, or delivery of benefits pursuant to, any Award would violate any applicable provision of securities laws or the listing requirements of any stock exchange upon which any of the Company's equity 26 securities are listed, then the Committee may postpone any such exercise, nonforfeitability or delivery, as applicable, but the Company shall use all reasonable efforts to cause such exercise, nonforfeitability or delivery to comply with all such provisions at the earliest practicable date. 18.5 No Rights as a Stockholder. A Grantee shall not have any rights as a stockholder of the Company with respect to the Shares (other than Restricted Shares) which may be deliverable upon exercise or payment of such Award until such shares have been delivered to him or her. Restricted Shares, whether held by a Grantee or in escrow by the Secretary of the Company, shall confer on the Grantee all rights of a stockholder of the Company, except as otherwise provided in the Plan or Award Agreement. At the time of a grant of Restricted Shares, the Committee may require the payment of cash dividends thereon to be deferred and, if the Committee so determines, reinvested in additional Restricted Shares. Stock dividends and deferred cash dividends issued with respect to Restricted Shares shall be subject to the same restrictions and other terms as apply to the Restricted Shares with respect to which such dividends are issued. The Committee may provide for payment of interest on deferred cash dividends. 18.6 Nature of Payments. Awards shall be special incentive payments to the Grantee and shall not be taken into account in computing the amount of salary or compensation of the Grantee for purposes of determining any pension, retirement, death or other benefit under (a) any pension, retirement, profit-sharing, bonus, insurance or other employee benefit plan of the Company or any Subsidiary or (b) any agreement between (i) the Company or any Subsidiary and (ii) the Grantee, except as such plan or agreement shall otherwise expressly provide. 18.7 Performance Measures. Unless and until the Committee proposes for stockholder vote and stockholders approve a change in the general performance measures set forth in this Section 18.7, the performance measure(s) to be used for purposes of such Awards shall be chosen from among the following: (a) Earnings (either in the aggregate or on a per-share basis); (b) Net income (before or after taxes); (c) Operating income; (d) Cash flow; (e) Return measures (including return on assets, equity, or sales); (f) Earnings before or after either, or any combination of, taxes, interest or depreciation and amortization; (g) Gross revenues; 27 (h) Share price (including growth measures and stockholder return or attainment by the Shares of a specified value for a specified period of time); (i) Reductions in expense levels in each case, where applicable, determined either on a Company-wide basis or in respect of any one or more business units; (j) Net economic value; or (k) Market share. Any of the foregoing performance measures may be applied, as determined by the Committee, on the basis of the Company as a whole, or in respect of any one or more Subsidiaries or divisions of the Company or any part of a Subsidiary or division of the Company that is specified by the Committee. The Committee may adjust the determinations of the degree of attainment of the preestablished performance goals; provided, however, that Awards which are designed to qualify for the Performance-Based Exception may not be adjusted upward without the approval of the Company's stockholders (the Committee may adjust such Awards downward). In the event that applicable tax and/or securities laws change to permit Committee discretion to alter the governing performance measures without obtaining stockholder approval of such changes, and still qualify for the Performance-Based Exception, the Committee shall have sole discretion to make such changes without obtaining stockholder approval. 18.8 Governing Law. The Plan, and all agreements hereunder, shall be construed in accordance with and governed by the laws of the State of Delaware other than its laws respecting choice of law. EX-27.1 3 FDS --
5 THIS SCHEDULE, SUBMITTED AS EXHIBIT 27.1 TO FORM 10-Q, CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AND STATEMENT OF INCOME OF KANSAS CITY SOUTHERN INDUSTRIES, INC., COMMISSION FILE NUMBER 1-4717, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 6-MOS DEC-31-1999 JUN-30-1999 139,300,000 114,200,000 234,400,000 0 50,200,000 575,900,000 1,877,500,000 593,600,000 2,812,600,000 315,600,000 811,600,000 0 6,100,000 1,100,000 1,084,500,000 2,812,600,000 0 816,100,000 0 559,300,000 0 0 30,300,000 263,300,000 94,700,000 144,700,000 0 0 0 144,700,000 1.31 1.25
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