10-Q 1 form10q3q2002.txt 3RD QUARTER 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2002 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 (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.) 427 WEST 12TH STREET, KANSAS CITY, MISSOURI 64105 (Address of principal executive offices) (Zip Code) (816) 983-1303 (Company's telephone number, including area code) NO CHANGES (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the Company (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT OCTOBER 31, 2002 -------------------------------------------------------------------------------- COMMON STOCK, $.01 PER SHARE PAR VALUE 60,954,700 SHARES -------------------------------------------------------------------------------- KANSAS CITY SOUTHERN FORM 10-Q SEPTEMBER 30, 2002 INDEX PAGE PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Introductory Comments 2 Consolidated Balance Sheets - September 30, 2002 and December 31, 2001 3 Consolidated Statements of Income - Three and Nine Months Ended September 30, 2002 and 2001 4 Per Share Data 4 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2002 and 2001 5 Consolidated Statement of Changes in Stockholders' Equity - Nine Months Ended September 30, 2002 6 Notes to Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 16 ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK 28 ITEM 4. CONTROLS AND PROCEDURES 28 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 28 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 28 SIGNATURES 29 ---------- KANSAS CITY SOUTHERN FORM 10-Q SEPTEMBER 30, 2002 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INTRODUCTORY COMMENTS The Consolidated Financial Statements included herein have been prepared by Kansas City Southern (the "Company" or "KCS"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") 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 Financial Statements should be read in conjunction with the consolidated 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, 2001 (as amended), and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-Q. Results for the three and nine months ended September 30, 2002 are not necessarily indicative of the results expected for the full year 2002. KANSAS CITY SOUTHERN CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS) September 30, December 31, 2002 2001 ------------------ ------------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 35.5 $ 24.7 Accounts receivable, net 112.3 130.0 Inventories 35.3 27.9 Other current assets 38.3 71.8 ------------------ ------------------ Total current assets 221.4 254.4 ------------------ ------------------ Investments 404.6 386.8 Properties (net of $686.5 and $660.0 accumulated depreciation and amortization, respectively) 1,336.3 1,327.4 Goodwill 10.6 19.3 Other assets 22.8 23.0 ------------------ ------------------ Total assets $ 1,995.7 $ 2,010.9 ================== ================== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Debt due within one year $ 10.0 $ 46.7 Accounts and wages payable 40.3 50.4 Accrued liabilities 153.9 150.0 ------------------ ------------------ Total current liabilities 204.2 247.1 ------------------ ------------------ Other Liabilities Long-term debt 578.7 611.7 Deferred income taxes 374.3 370.2 Other liabilities and deferred credits 108.9 101.6 ------------------ ------------------ Total other liabilities 1,061.9 1,083.5 ------------------ ------------------ Stockholders' Equity Preferred stock 6.1 6.1 Common stock 0.6 0.6 Retained earnings 725.8 676.5 Accumulated other comprehensive loss (2.9) (2.9) ------------------ ------------------ Total stockholders' equity 729.6 680.3 ------------------ ------------------ Total liabilities and stockholders' equity $ 1,995.7 $ 2,010.9 ================== ==================
See accompanying notes to consolidated financial statements. KANSAS CITY SOUTHERN CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED) Three Months Nine Months Ended September 30, Ended September 30, ---------------------------------- ---------------------------------- 2002 2001 2002 2001 ---------------- ----------------- ---------------------------------- Revenues $ 137.6 $ 144.6 $ 418.0 $ 431.8 Costs and expenses Compensation and benefits 51.2 48.7 147.1 145.4 Depreciation and amortization 15.8 14.7 45.3 43.6 Purchased services 15.9 15.4 43.5 41.8 Operating leases 12.4 12.6 37.1 38.1 Fuel 8.9 11.5 27.7 35.3 Casualties and insurance 6.9 6.1 22.0 28.4 Car hire 5.6 3.5 14.9 15.7 Other 14.7 16.1 46.3 48.5 ---------------- ----------------- ----------------- ---------------- Total costs and expenses 131.4 128.6 383.9 396.8 Operating income 6.2 16.0 34.1 35.0 Equity in net earnings (losses) of unconsolidated affiliates: Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. 9.8 7.5 27.6 23.5 Other (0.7) (0.6) (1.9) (0.2) Gain on sale of Mexrail, Inc. - - 4.4 - Interest expense (11.5) (13.2) (33.3) (42.9) Other income 6.5 0.9 15.3 3.0 ---------------- ----------------- ----------------- ----------------- Income before income taxes, extraordinary item and cumulative effect of accounting change 10.3 10.6 46.2 18.4 Income tax provision (benefit) (0.3) 1.6 6.7 (1.6) ---------------- ----------------- ----------------- ----------------- Income before extraordinary item and cumulative effect of accounting change 10.6 9.0 39.5 20.0 Extraordinary item, net of income taxes - - (2.7) - Cumulative effect of accounting change, net of income taxes - - - (0.4) ---------------- ----------------- ----------------- ----------------- Net income $ 10.6 $ 9.0 $ 36.8 $ 19.6 ================ ================= ================= ================= PER SHARE DATA Basic earnings per Common share Income before extraordinary item and cumulative effect of accounting change $ 0.17 $ 0.15 $ 0.65 $ 0.34 Extraordinary item, net of income taxes - - (0.04) - Cumulative effect of accounting change, net of income taxes - - - (0.01) ---------------- ----------------- ----------------- ----------------- Total basic earnings per Common share $ 0.17 $ 0.15 $ 0.61 $ 0.33 ================ ================= ================= ================= Diluted earnings per Common share Income before extraordinary item and cumulative effect of accounting change $ 0.17 $ 0.15 $ 0.63 $ 0.33 Extraordinary item, net of income taxes - - (0.04) - Cumulative effect of accounting change, net of income taxes - - - (0.01) ---------------- ----------------- ----------------- ----------------- Total diluted earnings per Common share $ 0.17 $ 0.15 $ 0.59 $ 0.32 ================ ================= ================= ================= Weighted average Common shares outstanding (in thousands) Basic 60,481 58,656 60,123 58,442 Potential dilutive Common shares 1,972 2,515 2,090 2,492 ---------------- ----------------- ----------------- ----------------- Diluted 62,453 61,171 62,213 60,934 ================ ================= ================= ================= Dividends per Preferred share $ 0.25 $ 0.25 $ 0.75 $ 0.75
See accompanying notes to consolidated financial statements. KANSAS CITY SOUTHERN CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED) Nine Months Ended September 30, ------------------------------------- 2002 2001 ----------------- ----------------- CASH FLOWS PROVIDED BY (USED FOR): OPERATING ACTIVITIES: Net income $ 36.8 $ 19.6 Adjustments to reconcile net income to net cash Provided by operating activities Depreciation and amortization 45.3 43.6 Deferred income taxes 1.7 14.9 Equity in undistributed earnings of unconsolidated affiliates (25.7) (23.3) Distributions from unconsolidated affiliates - 3.0 Gain on sale of investments (9.3) - Gain on sale of property (10.0) (3.5) Tax benefit realized upon exercise of stock options 3.6 4.6 Changes in working capital items Accounts receivable 18.7 (6.4) Inventories (7.4) 5.2 Other current assets 35.8 7.6 Accounts and wages payable (10.3) (4.6) Accrued liabilities 5.9 (26.0) Other, net 8.9 (4.5) ---------------- ------------------ Net cash provided by operating activities 94.0 30.2 ---------------- ------------------ INVESTING ACTIVITIES: Property acquisitions (63.1) (42.2) Proceeds from disposal of property 17.5 15.0 Investment in and loans to affiliates (4.0) (6.1) Proceeds from sale of investments, net 31.7 - Other, net (1.3) (0.8) ---------------- ------------------ Net cash used for investing activities (19.2) (34.1) ---------------- ------------------ FINANCING ACTIVITIES: Proceeds from issuance of long-term debt 200.0 35.0 Repayment of long-term debt (264.8) (24.8) Debt issuance costs (5.5) (0.4) Proceeds from stock plans 7.7 5.6 Cash dividends paid (0.2) (0.2) Other, net (1.2) (5.9) ---------------- ------------------ Net cash provided by (used for) financing activities (64.0) 9.3 ---------------- ------------------ CASH AND CASH EQUIVALENTS: Net increase in cash and cash equivalents 10.8 5.4 At beginning of year 24.7 21.5 ---------------- ------------------ At end of period $ 35.5 $ 26.9 ================ ==================
See accompanying notes to consolidated financial statements. KANSAS CITY SOUTHERN CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DOLLARS IN MILLIONS, EXCEPT SHARE AMOUNTS) (UNAUDITED) Accumulated $25 Par $.01 Par Other Preferred Common Retained Comprehensive stock Stock Earnings income (loss) Total ------------------ --------------- ----------------- ---------------- ----------------- Balance at December 31, 2001 $ 6.1 $ 0.6 $ 676.5 $ (2.9) $ 680.3 Comprehensive income: Net income 36.8 Change in fair value of cash flow hedge (0.3) Amortization of accumulated other comprehensive income (loss) related to interest rate swap 0.3 Comprehensive income 36.8 Dividends (0.2) (0.2) Options exercised and stock subscribed 12.7 12.7 ------------------ --------------- ----------------- ---------------- ----------------- Balance at September 30, 2002 $ 6.1 $ 0.6 $ 725.8 $ (2.9) $ 729.6 ================== =============== ================= ================ =================
See accompanying notes to consolidated financial statements. KANSAS CITY SOUTHERN NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ACCOUNTING POLICIES AND INTERIM FINANCIAL STATEMENTS. In the opinion of the management of Kansas City Southern, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal closing procedures) necessary to present fairly the financial position of the Company and its subsidiary companies as of September 30, 2002 and December 31, 2001, the results of its operations for the three months and nine months ended September 30, 2002 and 2001, its cash flows for the nine months ended September 30, 2002 and 2001, and its changes in stockholders' equity for the nine months ended September 30, 2002. The accompanying consolidated financial statements have been prepared consistently with accounting policies described in Note 2 to the consolidated financial statements included in the Company's Annual Report on Form 10-K as of and for the year ended December 31, 2001 (as amended). The results of operations for the three and nine month periods ended September 30, 2002 are not necessarily indicative of the results to be expected for the full year 2002. Certain comparative prior year amounts in the consolidated financial statements have been reclassified to conform to the current period presentation. These reclassifications did not impact net income. 2. EARNINGS PER SHARE DATA. 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 following is a reconciliation from the weighted average shares used for the basic earnings per share computation and the diluted earnings per share computation for the three and nine months ended September 30, 2002 and 2001, respectively (in thousands): Three Months Nine Months Ended September 30, Ended September 30, ------------------------- -------------------------- 2002 2001 2002 2001 ------------- ------------ -------------------------- Basic shares 60,481 58,656 60,123 58,442 Effect of dilution: Stock options 1,972 2,515 2,090 2,492 ------------- ------------ ------------ ------------ Diluted shares 62,453 61,171 62,213 60,934 ============= ============ ============ ============ Shares excluded from diluted computation 175 79 83 44 ------------- ------------ ------------ ------------
Shares were excluded from the applicable periods diluted earnings per share computation because the exercise prices were greater than the average market price of the common shares. Preferred dividends, which were not material for the periods presented, are the only adjustments that affect the numerator of the diluted earnings per share computation. 3. INVESTMENTS. Investments in unconsolidated affiliates and certain other investments accounted for under the equity method generally include all entities in which the Company or its subsidiaries have significant influence, but not more than 50% voting control. Investments in unconsolidated affiliates at September 30, 2002 include, among others, equity interests in Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), Southern Capital Corporation, LLC ("Southern Capital"), and the Panama Canal Railway Company ("PCRC"). The Company, our Mexican partner, Grupo TMM, S.A. ("Grupo TMM"), and certain of Grupo TMM's affiliates entered into an agreement on February 27, 2002 with TFM, S.A. de C.V. ("TFM") to sell to TFM all of the common stock of Mexrail, Inc., ("Mexrail") a former 49% unconsolidated affiliate of the Company. Mexrail owns the northern half of the international railway bridge at Laredo and all of the common stock of The Texas-Mexican Railway Company ("Tex Mex"). The sale closed on March 27, 2002 and the Company received approximately $31.4 million for its 49% interest in Mexrail. The Company used the proceeds from the sale to reduce debt. Although the Company no longer directly owns 49% of Mexrail, it retains an indirect ownership through its ownership of Grupo TFM. The Company's share of the proceeds from the sale of Mexrail to TFM exceeded the carrying value of the Company's investment in Mexrail by $11.2 million. The Company recognized a $4.4 million gain on the sale of Mexrail to TFM in the first quarter of 2002, while the remaining $6.8 of excess proceeds was deferred and is being amortized into net income over 20 years. As discussed in note 8 below, on July 29, 2002, TFM completed the purchase of the Mexican government's 24.6% ownership of Grupo TFM for a purchase price of $256.1 million, and the shares purchased are held as treasury stock by TFM. This transaction results in an increase in the Company's ownership percentage of Grupo TFM from 36.9% to approximately 46.6%. Following this transaction, Grupo TMM (together with certain of its affiliates) owns approximately 48.5% of Grupo TFM and the Mexican government owns an effective interest of 4.9% in Grupo TFM due to its 20% minority interest in TFM. The Company is party to certain agreements with Grupo TMM covering the Grupo TFM joint venture. These agreements contain "change in control" provisions, provisions intended to preserve the Company's and Grupo TMM's proportionate ownership of the joint venture, 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 and a prohibition on transfers to competitors. Under certain circumstances, such agreements could affect the Company's ownership percentage and rights in these equity affiliates. Condensed financial information of certain unconsolidated affiliates is shown below. All amounts, including those for Grupo TFM, are presented under U.S. GAAP. Mexrail financial results were consolidated into the accounts of Grupo TFM effective April 1, 2002 and are not presented separately. The amounts reflected herein for Grupo TFM do not include the recognition of any recovery relating to the value of the Value Added Tax ("VAT") claim of Grupo TFM (See note 10). For purposes of recording equity in earnings of unconsolidated affiliate and investment in unconsolidated subsidiary, KCS has not recognized the value of the VAT credit certificate pending completion of the legal process. Financial information of immaterial unconsolidated affiliates has been omitted: FINANCIAL CONDITION (DOLLARS IN MILLIONS): September 30, 2002 December 31, 2001 -------------------------------- --------------------------------------------- Southern Southern PCRC Grupo TFM Capital Mexrail PCRC Grupo TFM Capital -------- ------------ --------- --------- ---------- ------------- --------- Current assets $ 5.1 $ 277.6 $ 13.0 $ 34.9 $ 3.6 $ 294.3 $ 2.5 Non-current assets 87.6 1,991.8 143.0 59.3 85.5 1,924.3 240.6 -------- ------------ --------- --------- ---------- ------------- --------- Assets $ 92.7 $ 2,269.4 $ 156.0 $ 94.2 $ 89.1 $ 2,218.6 $ 243.1 ======== ============ ========= ========= ========== ============= ========= Current liabilities $ 3.9 $ 128.0 $ 3.4 $ 42.8 $ 10.8 $ 350.8 $ 196.6 Non-current liabilities 71.9 1,049.9 104.0 27.5 55.3 593.8 - Minority interest - 339.6 - - - 376.3 - Equity of stockholders and partners 16.9 751.9 48.6 23.9 23.0 897.7 46.5 -------- ------------ --------- --------- ---------- ------------- --------- Liabilities and equity $ 92.7 $ 2,269.4 $ 156.0 $ 94.2 $ 89.1 $ 2,218.6 $ 243.1 ======== ============ ========= ========= ========== ============= ========= KCS's investment $ 15.0* $ 361.9 $ 24.3 $ 11.7 $ 13.9 $ 334.4 $ 23.2 -------- ------------ --------- --------- ---------- ------------- ---------
OPERATING RESULTS (DOLLARS IN MILLIONS): Three Months Nine Months Ended September 30, Ended September 30, ---------------------------- ---------------------------- 2002 2001 2002** 2001 ---------- ---------- ---------- ---------- Revenues: Mexrail $ - $ 11.7 $ 13.3 $ 40.8 PCRC 0.9 - 2.5 - Grupo TFM 175.3 168.1 519.1 496.0 Southern Capital 8.0 7.6 23.0 22.7 Operating costs and expenses: Mexrail $ - $ 13.6 $ 13.3 $ 44.2 PCRC 2.5 0.9 8.5 1.8 Grupo TFM 132.1 123.6 384.3 323.1 Southern Capital 7.1 6.4 19.2 19.6 Net income (loss): Mexrail $ - $ (0.7) $ 0.0 $ (1.5) PCRC (2.2) (0.3) (6.0) (0.6) Grupo TFM 23.1 20.1 71.1 63.6 Southern Capital 0.9 1.1 2.1 3.1 * Of this investment, approximately $9.0 million constitutes an investment in equity, while approximately $6.0 million is comprised of notes receivable from PCRC. ** Results for Mexrail are through March, 2002 only. Consolidated with Grupo TFM effective April 1, 2002.
4. NONCASH INVESTING AND FINANCING ACTIVITIES. The Company initiated the Thirteenth Offering of KCS common stock under the Employee Stock Purchase Plan ("ESPP") during 2001. Stock subscribed under the Thirteenth Offering will be issued to employees in 2003 and is being paid for through employee payroll deductions in 2002. During the first nine months of 2002, the Company has received approximately $2.4 million from payroll deductions associated with the Thirteenth Offering of the ESPP. In the first quarter of 2002, the Company issued approximately 611,107 shares of KCS common stock under the Twelfth Offering of the ESPP. These shares, totaling a purchase price of approximately $4.5 million, were subscribed and paid for through employee payroll deductions in 2001. 5. DERIVATIVE FINANCIAL INSTRUMENTS. The Company adopted the provisions of Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") effective January 1, 2001. As a result of this change in the method of accounting for derivative financial instruments, the Company recorded an after-tax charge to earnings of $0.4 million in the first quarter of 2001. This charge is presented as a cumulative effect of an accounting change in the accompanying consolidated financial statements and represents the ineffective portion of interest rate cap agreements that the Company held at the time of adoption of SFAS 133. These interest rate cap agreements, which expired during the first quarter of 2002, had a fair value of approximately zero at December 31, 2001 and were completely charged off during 2001. During the nine months ended September 30, 2002, the Company did not record any adjustments to income for derivative transactions. The Company does not currently have any derivative financial instruments outstanding. In addition, the Company records adjustments to its stockholders' equity (accumulated other comprehensive income (loss)) for its portion of the adjustment to the fair value of interest rate swap transactions to which Southern Capital, a 50% owned unconsolidated affiliate, is a participant. The Company also adjusts its investment in Southern Capital by the change in the fair value of these derivative instruments. During the nine months ended September 30, 2002, the Company recorded comprehensive income (loss) of ($0.3) million related to an adjustment to the fair value of interest rate swap transactions of Southern Capital. In conjunction with the refinancing transaction discussed below in note 6, Southern Capital terminated these interest rate swap transactions. As a result, Southern Capital will amortize the balance of accumulated other comprehensive income (loss) into interest expense over the former remaining life of the interest rate swap transactions. This charge will impact Southern Capital's interest expense by approximately $1.3 million in 2002, $2.4 million in 2003 and $0.9 million in each of 2004, 2005 and 2006. The Company is realizing the impact of this charge through a related reduction in equity earnings from Southern Capital and will amortize its balance in accumulated other comprehensive income (loss) to its investment in Southern Capital. During the nine months ended September 30, 2002, the Company recorded amortization of its balance in accumulated other comprehensive income (loss) of $0.3 million. 6. DEBT REFINANCING. During the second quarter of 2002, the Company completed several debt refinancing transactions as described below. SENIOR NOTES On June 12, 2002, KCSR issued $200 million of 7 1/2% senior notes due June 15, 2009 ("7 1/2% Notes") through a private offering pursuant to Rule 144A under the Securities Act of 1933 in the United States and Regulation S outside the United States ("Note Offering"). These notes are general unsecured obligations of Kansas City Southern Railway Company ("KCSR"), are guaranteed by the Company and certain of its subsidiaries, and contain certain covenants and restrictions customary for this type of debt instrument and for borrowers with similar credit ratings. Net proceeds from the Note Offering of $195.8 million, together with cash, were used to repay term debt under the Company's senior secured credit facility ("KCS Credit Facility") and certain other secured indebtedness of the Company. Debt issuance costs related to the Note Offering of approximately $4.4 million were deferred and are being amortized over the seven-year term of the 7 1/2% Notes. See "New Credit Agreement" below. KCS submitted a Form S-4 Registration Statement to the SEC on July 12, 2002, as amended on July 24, 2002, relative to an Exchange Offer for the $200 million 7 1/2% senior notes due 2009. On July 30, 2002, the SEC declared this Registration Statement effective thereby providing the opportunity for holders of the initial 7 1/2% Senior Notes due 2009 to exchange them for registered notes with substantially identical terms. All of the 7 1/2% Senior Notes due 2009 were exchanged for $200 million of registered notes due June 15, 2009. The registered notes bear a fixed annual interest rate to be paid semi-annually on June 15 and December 15 and are due June 15, 2009. NEW CREDIT AGREEMENT On June 12, 2002, in conjunction with the repayment of certain of the term loans under the KCS Credit Facility using the net proceeds received from the Note Offering, the Company amended and restated the KCS Credit Facility (the amended and restated credit agreement is referred to as the New Credit Agreement herein). The New Credit Agreement provides KCSR with a $150 million term loan ("Tranche B term loan"), which matures on June 12, 2008, and a $100 million revolving credit facility ("Revolver"), which matures on January 11, 2006. Letters of credit are also available under the Revolver up to a limit of $15 million. The proceeds from future borrowings under the Revolver may be used for working capital and for general corporate purposes. The letters of credit may be used for general corporate purposes. Borrowings under the New Credit Agreement are secured by substantially all of the Company's assets and are guaranteed by the majority of its subsidiaries. The Tranche B term loan and the Revolver bear interest at the London Interbank Offered Rate ("LIBOR") or an alternate base rate, as the Company shall select, plus an applicable margin. The applicable margin for the Tranche B term loan is 2% for LIBOR borrowings and 1% for alternate base rate borrowings. The applicable margin for the Revolver is based on the Company's leverage ratio (defined as the ratio of the Company's total debt to consolidated EBITDA (earnings before interest, taxes, depreciation and amortization, excluding the undistributed earnings of unconsolidated affiliates) for the prior four fiscal quarters). Based on the Company's leverage ratio as of September 30, 2002, the applicable margin was 2.25% per annum for LIBOR borrowings and 1.25% per annum for alternate base rate borrowings. The New Credit Agreement also requires the payment to the lenders of a commitment fee of 0.50% per annum on the average daily, unused amount of the Revolver and Tranche B term loan. Additionally, a fee equal to a per annum rate of 0.25% plus the applicable margin for LIBOR priced borrowings under the Revolver will be paid on any letter of credit issued under the Revolver. The New Credit Agreement contains certain provisions, covenants and restrictions customary for this type of debt and for borrowers with a similar credit rating. These provisions include, among others, restrictions on the Company's ability and its subsidiaries ability to 1) incur additional debt or liens; 2) enter into sale and leaseback transactions; 3) merge or consolidate with another entity; 4) sell assets; 5) enter into certain transactions with affiliates; 6) make investments, loans, advances, guarantees or acquisitions; 7) make certain restricted payments, including dividends, or make certain payments on other indebtedness; and 8) make capital expenditures. In addition, the Company is required to comply with certain financial ratios, including minimum interest expense coverage and leverage ratios. The New Credit Agreement also contains certain customary events of default. These covenants, along with other provisions, could restrict maximum utilization of the Revolver. Debt issuance costs related to the New Credit Agreement of approximately $1.1 million were deferred and are being amortized over the respective term of the loans. Extraordinary debt retirement costs associated with the prepayment of certain term loans under the KCS Credit Facility using proceeds from the Note Offering were approximately $4.3 million ($2.7 million, net of income taxes). SOUTHERN CAPITAL On June 25, 2002, Southern Capital refinanced the outstanding balance of its bridge loan through the issuance of approximately $167.6 million of pass through trust certificates and the sale of 50 locomotives. The pass through trust certificates are secured by the sold locomotives, all of the remaining locomotives and rolling stock owned by Southern Capital and rental payments payable by KCSR under the sublease of the sold locomotives and its leases of the equipment owned by Southern Capital. Payments of interest and principal of the pass through trust certificates, which are due semi-annually on June 30 and December 30 commencing on December 30, 2002 and ending on June 30, 2022, are insured under a financial guarantee insurance policy by MBIA Insurance Corporation. KCSR leases or subleases all of the equipment securing the pass through trust certificates. 7. COMMITMENTS AND CONTINGENCIES. The Company has had no significant changes in its outstanding litigation or other commitments and contingencies from that previously reported in Note 11 of the Company's Annual Report on Form 10-K for the year ended December 31, 2001. The following provides an update of the Bogalusa cases. BOGALUSA CASES. In July 1996, 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 (plaintiffs) have asserted claims to recover damages allegedly caused by exposure to the released chemicals. On October 29, 2001, KCSR and representatives for its excess insurance carriers negotiated a settlement in principle with the plaintiffs for $22.3 million. The settlement was finalized with the execution of a Master Global Settlement Agreement ("MGSA") in early 2002. As of September 30, 2002, the Company had made $19.3 million of payments under the MGSA and remitted the final payment of $3.0 million on October 1, 2002. Additionally the Company has collected approximately $16.3 million from its excess insurance carriers for these cases and has an insurance receivable of $ 3.0 million recorded at September 30, 2002 related to the final payment. This is expected to be collected during the fourth quarter of 2002. 8. PURCHASE OF MEXICAN GOVERNMENT'S OWNERSHIP OF GRUPO TFM. KCS and Grupo TMM exercised their call option and, on July 29, 2002 completed the purchase of the Mexican government's 24.6% ownership of Grupo TFM. The Mexican government's ownership interest of Grupo TFM was purchased by TFM for a purchase price of $256.1 million, utilizing a combination of proceeds from an offering by TFM of debt securities, a credit from the Mexican government for the reversion of certain rail facilities and other resources. This transaction results in an increase in the Company's ownership percentage of Grupo TFM from 36.9% to approximately 46.6%. 9. NEW ACCOUNTING PRONOUNCEMENT. Effective January 1, 2002, the Company implemented Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 provides, among other things, that goodwill with an indefinite life shall no longer be amortized, but shall be evaluated for impairment on an annual basis. SFAS 142 also requires separate presentation of goodwill on the balance sheet and impairment losses are to be shown as a separate item on the income statement. Additionally, changes in the carrying amount of goodwill should be disclosed in the footnotes to the financial statements. SFAS 142 also requires various transitional disclosures until all periods presented reflect the provisions of SFAS 142. These transitional disclosures include the presentation of net income and earnings per share information adjusted to exclude amortization expense (including the related income tax effects) for all periods presented. These transitional disclosures are presented in the table below. The Company has presented its goodwill as a separate line item in the accompanying balance sheets. Additionally, the Company has performed its transitional goodwill impairment test and determined that existing goodwill is not impaired. During the nine months ended September 30, 2002, the Company's goodwill decreased $8.5 million due to the sale of Mexrail to TFM and $0.2 million due to the sale of Wyandotte Garage Corporation. Three Months Nine Months Ended September 30, Ended September 30, ------------------------ -------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ------------ (dollars in millions, except per share amounts) Reported net income $ 10.6 $ 9.0 $ 36.8 $ 19.6 Add back: Goodwill amortization - 0.2 - 0.5 ----------- ---------- ---------- ----------- Adjusted net income $ 10.6 $ 9.2 $ 36.8 $ 20.1 =========== ========== ========== =========== Reported diluted earnings per share $ 0.17 $ 0.15 $ 0.59 $ 0.32 Add back: Goodwill amortization - 0.00 - 0.01 ----------- ---------- ---------- ----------- Adjusted diluted earnings per share $ 0.17 $ 0.15 $ 0.59 $ 0.33 =========== ========== ========== ===========
10. FAVORABLE RULING IN VALUE ADDED TAX LAWSUIT. As previously announced in the Company's Current Report on Form 8-K dated October 11, 2002, a three judge panel of the Court of the First Circuit ("Federal Court") in Mexico City unanimously ruled in favor of Grupo TFM in its VAT lawsuit. The claim dates back to January 1997. By a unanimous decision, the three-judge panel of the Federal Court found that the ruling by the Superior Court of Federal Tribunal of Fiscal and Administrative Justice ("Fiscal Court") denying TFM's claim had violated TFM's constitutional rights. The Federal Court remanded the case back to the Fiscal Court with specific instructions to vacate its prior decision and enter a new decision consistent with the guidance provided by the Federal Court's ruling. The Federal Court ruling requires the fiscal authorities to issue the VAT credit certificate only in the name of the interested party, to issue the VAT credit certificate only in strict accordance with the terms of the fiscal code, and to deliver the VAT credit certificate only to the beneficiary. The new decision of the Fiscal Court must be issued in accordance with the guidelines of the Federal Court. The Company and Grupo TMM have been advised that the Federal Court's order is not subject to appeal by the Mexican government. However, the Fiscal Court's forthcoming decision may be challenged by either of the parties if such party believes that the new ruling does not comply with the order of the Federal Court. In addition, a third party who can establish that its rights have been adversely and improperly affected by the new ruling may seek to bring a claim against TFM, but TFM management has indicated to the Company that it believes it would prevail in any such action. The face value of the VAT credit certificate at issue is approximately $206 million, and the amount of any recovery will reflect that principal amount adjusted for inflation and interest accruals from 1997 in accordance with Mexican Law. For the three and nine months ended September 30, 2002, the amounts reported in the Company's consolidated financial statements as equity in net earnings of Grupo TFM of $9.8 million and $27.6 million, respectively, do not include the recognition of any recovery relating to the value of the VAT credit certificate which might be received. Based upon the language of the Federal Court's order and the advice of legal counsel, Grupo TMM and the Company remain optimistic about the ultimate outcome of this matter. However, the Company's independent accountants and outside legal counsel have advised, and management believes, that the recognition of any recovery relating to the VAT credit certificate, including the timing and final amount thereof, must await the conclusion of the legal process. 11. CONDENSED CONSOLIDATING FINANCIAL INFORMATION. In September 2000, KCSR issued $200 million of 9 1/2% senior notes due 2008. In addition, as discussed above in note 6, in June 2002, KCSR issued $200 million of 7 1/2% senior notes due 2009. Both of these note issues are an unsecured obligation of KCSR, however, they are also jointly and severally and fully and unconditionally guaranteed on an unsecured senior basis by KCS and certain of the subsidiaries (all of which are wholly-owned) within the KCS consolidated group. For each of these note issues, KCS registered exchange notes with the SEC that have substantially identical terms and associated guarantees and all of the initial senior notes for each issue have been exchanged for $200 million of registered exchange notes for each respective note issue. The accompanying condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 "Financial statements of guarantors and issuers of guaranteed securities registered or being registered." This information is not intended to present the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with U.S. GAAP. CONDENSED CONSOLIDATING STATEMENTS OF INCOME Nine months ended September 30, 2002 (dollars in millions) ------------------------------------------------------------------------------------ Non- Subsidiary Guarantor Guarantor Consolidating Consolidated Parent Issuer Subsidiaries Subsidiaries Adjustments KCS ------------- ------------- ------------- ------------- -------------- ------------- Revenues $ - $ 412.4 $ 20.7 $ 12.5 $ (27.6) $ 418.0 Costs and expenses 8.3 370.5 19.8 12.9 (27.6) 383.9 ------------- ------------- ------------- ------------- -------------- ------------- Operating income (loss) (8.3) 41.9 0.9 (0.4) - 34.1 Equity in net earnings (losses) of Unconsolidated affiliates and subsidiaries 36.9 32.3 (0.1) 25.8 (69.2) 25.7 Gain on sale of Mexrail 4.4 4.4 - - (4.4) 4.4 Interest expense (0.3) (32.6) (0.4) (0.2) 0.2 (33.3) Other income 5.0 2.6 7.5 0.4 (0.2) 15.3 ------------- ------------- ------------- ------------- -------------- ------------- Income (loss) before income taxes 37.7 48.6 7.9 25.6 (73.6) 46.2 Income tax provision (benefit) (1.8) 6.2 3.0 (0.7) - 6.7 ------------- ------------- ------------- ------------- -------------- ------------- Income (loss) before extraordinary item 39.5 42.4 4.9 26.3 (73.6) 39.5 Extraordinary item (2.7) (2.7) - - 2.7 (2.7) ------------- ------------- ------------- ------------- -------------- ------------- Net income $ 36.8 $ 39.7 $ 4.9 $ 26.3 $ (70.9) $ 36.8 ============= ============= ============= ============= ============== ============= Nine months ended September 30, 2001 (dollars in millions) ------------------------------------------------------------------------------------ Non- Subsidiary Guarantor Guarantor Consolidating Consolidated Parent Issuer Subsidiaries Subsidiaries Adjustments KCS ------------- ------------- ------------- ------------- -------------- ------------- Revenues $ - $ 422.4 $ 15.9 $ 13.0 $ (19.5) $ 431.8 Costs and expenses 9.8 379.5 14.1 12.9 (19.5) 396.8 ------------- ------------- ------------- ------------- -------------- ------------- Operating income (loss) (9.8) 42.9 1.8 0.1 - 35.0 Equity in net earnings (losses) of Unconsolidated affiliates and subsidiaries 26.7 24.8 (0.1) 24.1 (52.2) 23.3 Interest expense (0.5) (43.8) (0.5) (0.3) 2.2 (42.9) Other income 0.2 4.9 0.1 - (2.2) 3.0 ------------- ------------- ------------- ------------- -------------- ------------- Income (loss) before income taxes 16.6 28.8 1.3 23.9 (52.2) 18.4 Income tax provision (benefit) (3.4) 1.1 0.5 0.2 - (1.6) Income (loss) before cumulative effect of accounting change 20.0 27.7 0.8 23.7 (52.2) 20.0 ------------- ------------- ------------- ------------- -------------- ------------- Cumulative effect of accounting change, net of income taxes (0.4) (0.4) - - 0.4 (0.4) ------------- ------------- ------------- ------------- -------------- ------------- Net income $ 19.6 $ 27.3 $ 0.8 $ 23.7 $ (51.8) $ 19.6 ============= ============= ============= ============= ============== =============
CONDENSED CONSOLIDATING BALANCE SHEETS As of September 30, 2002 (dollars in millions) ------------------------------------------------------------------------------------ Non- Subsidiary Guarantor Guarantor Consolidating Consolidated Parent Issuer Subsidiaries Subsidiaries Adjustments KCS ------------- ------------- ------------- ------------- -------------- ------------- ASSETS Current assets $ 46.2 $ 241.9 $ 28.2 $ 9.2 $ (104.1) $ 221.4 Investments 742.7 434.2 - 411.4 (1,183.7) 404.6 Properties, net 0.2 1,300.0 36.1 - - 1,336.3 Goodwill and other assets 1.6 31.7 1.5 2.2 (3.6) 33.4 ------------- ------------- ------------- ------------- -------------- ------------- Total assets $ 790.7 $ 2,007.8 $ 65.8 $ 422.8 $ (1,291.4) $ 1,995.7 ============= ============= ============= ============= ============== ============= LIABILITIES AND EQUITY Current liabilities $ 8.8 $ 274.4 $ 7.0 $ 18.1 $ (104.1) $ 204.2 Long-term debt 1.3 575.7 1.7 - - 578.7 Payable to affiliates 10.1 - 0.6 - (10.7) - Deferred income taxes 9.6 362.5 4.9 1.2 (3.9) 374.3 Other liabilities 31.3 58.9 3.7 15.0 - 108.9 Stockholders' equity 729.6 736.3 47.9 388.5 (1,172.7) 729.6 ------------- ------------- ------------- ------------- -------------- ------------- Total liabilities and equity $ 790.7 $ 2,007.8 $ 65.8 $ 422.8 $ (1,291.4) $ 1,995.7 ============= ============= ============= ============= ============== ============= As of December 31, 2001 (dollars in millions) ------------------------------------------------------------------------------------ Non- Subsidiary Guarantor Guarantor Consolidating Consolidated Parent Issuer Subsidiaries Subsidiaries Adjustments KCS ------------- ------------- ------------- ------------- -------------- ------------- ASSETS Current assets $ 25.5 $ 223.4 $ 22.0 $ 6.6 $ (23.1) $ 254.4 Investments 701.4 413.6 - 376.4 (1,104.6) 386.8 Properties, net 0.3 1,287.1 38.2 1.8 - 1,327.4 Goodwill and other assets 1.7 40.4 1.7 0.1 (1.6) 42.3 ------------- ------------- ------------- ------------- -------------- ------------- Total assets $ 728.9 $ 1,964.5 $ 61.9 $ 384.9 $ (1,129.3) $ 2,010.9 ============= ============= ============= ============= ============== ============= LIABILITIES AND EQUITY Current liabilities $ 7.2 $ 252.3 $ 6.9 $ 3.8 $ (23.1) $ 247.1 Long-term debt 1.3 602.9 2.8 4.7 - 611.7 Payable to affiliates 4.8 - 0.6 - (5.4) - Deferred income taxes 9.5 350.9 5.2 6.2 (1.6) 370.2 Other liabilities 25.8 62.0 3.4 10.4 - 101.6 Stockholders' equity 680.3 696.4 43.0 359.8 (1,099.2) 680.3 ------------- ------------- ------------- ------------- -------------- ------------- Total liabilities and equity $ 728.9 $ 1,964.5 $ 61.9 $ 384.9 $ (1,129.3) $ 2,010.9 ============= ============= ============= ============= ============== =============
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS Nine months ended September 30, 2002 (dollars in millions) ------------------------------------------------------------------------------------ Non- Subsidiary Guarantor Guarantor Consolidating Consolidated Parent Issuer Subsidiaries Subsidiaries Adjustments KCS ------------- ------------- ------------- ------------- -------------- ------------- Net cash flows provided by (used for) operating activities: $ (14.1) $ 106.1 $ (6.6) $ 8.2 $ 0.4 $ 94.0 ------------- ------------- ------------- ------------- -------------- ------------- Investing activities: Property acquisitions - (61.4) (1.7) - - (63.1) Proceeds from disposal of property - 8.7 8.8 - - 17.5 Investments in and loans to affiliates - - - (9.3) 5.3 (4.0) Proceeds from sale of investments 1.4 31.4 - - (1.1) 31.7 Other, net - 0.3 - (2.2) 0.6 (1.3) ------------- ------------- ------------- ------------- -------------- ------------- Net 1.4 (21.0) 7.1 (11.5) 4.8 (19.2) ------------- ------------- ------------- ------------- -------------- ------------- Financing activities: Proceeds from issuance of long-term debt - 200.0 - - - 200.0 Repayment of long-term debt (0.4) (263.2) (1.0) (0.2) - (264.8) Proceeds from loans from affiliates 7.3 - 0.1 - (7.4) - Repayment of loans from affiliates (2.0) - - - 2.0 - Debt issuance costs - (5.5) - - - (5.5) Proceeds from stock plans 7.7 - - - - 7.7 Cash dividends paid (0.2) - - - - (0.2) Other, net - (6.2) 0.2 4.6 0.2 (1.2) ------------- ------------- ------------- ------------- -------------- ------------- Net 12.4 (74.9) (0.7) 4.4 (5.2) (64.0) ------------- ------------- ------------- ------------- -------------- ------------- Cash and cash equivalents: Net increase (decrease) (0.3) 10.2 (0.2) 1.1 - 10.8 At beginning of period 1.3 23.2 - 0.2 - 24.7 ------------- ------------- ------------- ------------- -------------- ------------- At end of period $ 1.0 $ 33.4 $ (0.2) $ 1.3 $ - $ 35.5 ============= ============= ============= ============= ============== ============= Nine months ended September 30, 2001 (dollars in millions) ------------------------------------------------------------------------------------ Non- Subsidiary Guarantor Guarantor Consolidating Consolidated Parent Issuer Subsidiaries Subsidiaries Adjustments KCS ------------- ------------- ------------- ------------- -------------- ------------- Net cash flows provided by (used for) operating activities: $ (7.7) $ 34.8 $ (3.6) $ 5.5 $ 1.2 $ 30.2 ------------- ------------- ------------- ------------- -------------- ------------- Investing activities: Property acquisitions - (41.3) (0.9) - - (42.2) Proceeds from disposal of property - 11.5 3.5 - - 15.0 Investments in and loans to affiliates - (2.0) - (7.3) 3.2 (6.1) Proceeds from sale of investments - - - - - - Other, net - (2.2) 1.7 - (0.3) (0.8) ------------- ------------- ------------- ------------- -------------- ------------- Net - (34.0) 4.3 (7.3) 2.9 (34.1) ------------- ------------- ------------- ------------- -------------- ------------- Financing activities: Proceeds from issuance of long-term debt - 35.0 - - - 35.0 Repayment of long-term debt - (23.6) (1.0) (0.2) - (24.8) Proceeds from loans from affiliates 1.7 - - - (1.7) - Debt issuance costs - (0.4) - - - (0.4) Proceeds from stock plans 5.6 - - - - 5.6 Cash dividends paid (0.2) - - - - (0.2) Other, net (0.3) (5.6) 0.3 2.1 (2.4) (5.9) ------------- ------------- ------------- ------------- -------------- ------------- Net 6.8 5.4 (0.7) 1.9 (4.1) 9.3 ------------- ------------- ------------- ------------- -------------- ------------- Cash and cash equivalents: Net increase (decrease) (0.9) 6.2 - 0.1 - 5.4 At beginning of period 1.5 19.4 0.1 0.5 - 21.5 ------------- ------------- ------------- ------------- -------------- ------------- At end of period $ 0.6 $ 25.6 $ 0.1 $ 0.6 $ - $ 26.9 ============= ============= ============= ============= ============== =============
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW THE DISCUSSION SET FORTH BELOW, AS WELL AS OTHER PORTIONS OF THIS FORM 10-Q, CONTAINS FORWARD-LOOKING COMMENTS THAT ARE NOT BASED UPON HISTORICAL INFORMATION. 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 THE 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 ("KCS" OR THE "COMPANY") COULD MATERIALLY DIFFER FROM THOSE INDICATED IN FORWARD-LOOKING COMMENTS. THE DIFFERENCES COULD BE CAUSED BY A NUMBER OF FACTORS OR COMBINATION OF FACTORS INCLUDING, BUT NOT LIMITED TO, THOSE FACTORS IDENTIFIED IN THE COMPANY'S CURRENT REPORT ON FORM 8-K DATED DECEMBER 11, 2001, 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 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 ITS FINANCIAL POSITION, LIQUIDITY, CAPITAL STRUCTURE AND BUSINESS DEVELOPMENTS FOR THE PERIODS COVERED BY THE CONSOLIDATED FINANCIAL STATEMENTS INCLUDED UNDER ITEM 1 OF THIS FORM 10-Q. THIS DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THESE CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES THERETO, AND IS QUALIFIED BY REFERENCE THERETO. GENERAL KCS is a Delaware corporation. KCS, formerly named Kansas City Southern Industries, Inc., is a holding company and its principal subsidiaries and affiliates include the following: o The Kansas City Southern Railway Company ("KCSR"), a wholly-owned subsidiary; o Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), a 46.6% owned unconsolidated affiliate, which owns 80% of the common stock of TFM, S.A. de C.V. ("TFM"). TFM wholly owns Mexrail, Inc. ("Mexrail"). Mexrail owns 100% of The Texas-Mexican Railway Company ("Tex Mex"); o Southern Capital Corporation, LLC ("Southern Capital"), a 50% owned unconsolidated affiliate that leases locomotive and rail equipment to KCSR; o Panama Canal Railway Company ("PCRC"), an unconsolidated affiliate of which KCSR owns 50% of the common stock. PCRC owns all of the common stock of Panarail Tourism Company ("Panarail"). KCS, as the holding company, supplies its various subsidiaries with managerial, legal, tax, financial and accounting services, in addition to managing other "non-operating" investments. RECENT DEVELOPMENTS FAVORABLE RULING IN VALUE ADDED TAX LAWSUIT. As previously announced in the Company's Current Report on Form 8-K dated October 11, 2002, a three judge panel of the Court of the First Circuit ("Federal Court") in Mexico City unanimously ruled in favor of Grupo TFM in its VAT lawsuit. The claim dates back to January 1997. By a unanimous decision, the three-judge panel of the Federal Court found that the ruling by the Superior Court of Federal Tribunal of Fiscal and Administrative Justice ("Fiscal Court") denying TFM's claim had violated TFM's constitutional rights. The Federal Court remanded the case back to the Fiscal Court with specific instructions to vacate its prior decision and enter a new decision consistent with the guidance provided by the Federal Court's ruling. The Federal Court ruling requires the fiscal authorities to issue the VAT credit certificate only in the name of the interested party, to issue the VAT credit certificate only in strict accordance with the terms of the fiscal code, and to deliver the VAT credit certificate only to the beneficiary. The new decision of the Fiscal Court must be issued in accordance with the guidelines of the Federal Court. The Company and Grupo TMM have been advised that the Federal Court's order is not subject to appeal by the Mexican government. However, the Fiscal Court's forthcoming decision may be challenged by either of the parties if such party believes that the new ruling does not comply with the order of the Federal Court. In addition, a third party who can establish that its rights have been adversely and improperly affected by the new ruling may seek to bring a claim against TFM, but TFM management has indicated to the Company that it believes it would prevail in any such action. The face value of the VAT credit certificate at issue is approximately $206 million, and the amount of any recovery will reflect that principal amount adjusted for inflation and interest accruals from 1997 in accordance with Mexican Law. For the three and nine months ended September 30, 2002, the amounts reported in the Company's consolidated financial statements as equity in net earnings of Grupo TFM of $9.8 million and $27.6 million, respectively, do not include the recognition of any recovery relating to the value of the VAT credit certificate which might be received. Based upon the language of the Federal Court's order and the advice of legal counsel, Grupo TMM and the Company remain optimistic about the ultimate outcome of this matter. However, the Company's independent accountants and outside legal counsel have advised, and management believes, that the recognition of any recovery relating to the VAT credit certificate, including the timing and final amount thereof, must await the conclusion of the legal process. PURCHASE OF MEXICAN GOVERNMENT'S OWNERSHIP OF GRUPO TFM. KCS and Grupo TMM exercised their call option and, on July 29, 2002, completed the purchase of the Mexican government's 24.6% ownership of Grupo TFM. The Mexican government's ownership interest of Grupo TFM was purchased by TFM for a purchase price of $256.1 million, utilizing a combination of proceeds from an offering by TFM of debt securities, a credit from the Mexican government for the reversion of certain rail facilities and other resources. This transaction resulted in an increase in the Company's ownership percentage of Grupo TFM from 36.9% to approximately 46.6%. DEBT REFINANCING. During the second quarter of 2002, the Company completed several debt refinancing transactions as described below. SENIOR NOTES On June 12, 2002, KCSR issued $200 million of 7 1/2% senior notes due June 15, 2009 ("7 1/2% Notes") through a private offering pursuant to Rule 144A under the Securities Act of 1933 in the United States and Regulation S outside the United States ("Note Offering"). These notes are general unsecured obligations of KCSR, are guaranteed by the Company and certain of its subsidiaries, and contain certain covenants and restrictions customary for this type of debt instrument and for borrowers with similar credit ratings. Net proceeds from the Note Offering of $195.8 million, together with cash, were used to repay term debt under the Company's senior secured credit facility ("KCS Credit Facility") and certain other secured indebtedness of the Company. Debt issuance costs related to the Note Offering of approximately $4.4 million were deferred and are being amortized over the seven-year term of the 7 1/2% Notes. See "New Credit Agreement" below. KCS submitted a Form S-4 Registration Statement to the SEC on July 12, 2002, as amended on July 24, 2002, relative to an Exchange Offer for the $200 million 7 1/2% senior notes due 2009. On July 30, 2002, the SEC declared this Registration Statement effective thereby providing the opportunity for holders of the initial 7 1/2% Senior Notes due 2009 to exchange them for registered notes with substantially identical terms. All of the 7 1/2% Senior Notes due 2009 were exchanged for $200 million of registered notes due June 15, 2009. The registered notes bear a fixed annual interest rate to be paid semi-annually on June 15 and December 15 and are due June 15, 2009. NEW CREDIT AGREEMENT On June 12, 2002, in conjunction with the repayment of certain of the term loans under the Company's senior secured credit facility ("KCS Credit Facility") using the net proceeds received from the Note Offering, the Company amended and restated the KCS Credit Facility (the amended and restated credit agreement is referred to as the New Credit Agreement herein). The New Credit Agreement provides KCSR with a $150 million term loan ("Tranche B term loan"), which matures on June 12, 2008, and a $100 million revolving credit facility ("Revolver"), which matures on January 11, 2006. Letters of credit are also available under the Revolver up to a limit of $15 million. The proceeds from future borrowings under the Revolver may be used for working capital and for general corporate purposes. The letters of credit may be used for general corporate purposes. Borrowings under the New Credit Agreement are secured by substantially all of the Company's assets and are guaranteed by the majority of its subsidiaries. The Tranche B term loan and the Revolver bear interest at the London Interbank Offered Rate ("LIBOR") or an alternate base rate, as the Company shall select, plus an applicable margin. The applicable margin for the Tranche B term loan is 2% for LIBOR borrowings and 1% for alternate base rate borrowings. The applicable margin for the Revolver is based on the Company's leverage ratio (defined as the ratio of the Company's total debt to consolidated EBITDA (earnings before interest, taxes, depreciation and amortization, excluding the undistributed earnings of unconsolidated affiliates) for the prior four fiscal quarters). Based on the Company's leverage ratio as of September 30, 2002, the applicable margin was 2.25% per annum for LIBOR borrowings and 1.25% per annum for alternate base rate borrowings. The New Credit Agreement also requires the payment to the lenders of a commitment fee of 0.50% per annum on the average daily, unused amount of the Revolver and Tranche B term loan. Additionally, a fee equal to a per annum rate of 0.25% plus the applicable margin for LIBOR priced borrowings under the Revolver will be paid on any letter of credit issued under the Revolver. The New Credit Agreement contains certain provisions, covenants and restrictions customary for this type of debt and for borrowers with a similar credit rating. These provisions include, among others, restrictions on the Company's ability and its subsidiaries ability to 1) incur additional debt or liens; 2) enter into sale and leaseback transactions; 3) merge or consolidate with another entity; 4) sell assets; 5) enter into certain transactions with affiliates; 6) make investments, loans, advances, guarantees or acquisitions; 7) make certain restricted payments, including dividends, or make certain payments on other indebtedness; and 8) make capital expenditures. In addition, the Company is required to comply with certain financial ratios, including minimum interest expense coverage and leverage ratios. The New Credit Agreement also contains certain customary events of default. These covenants, along with other provisions, could restrict maximum utilization of the Revolver. Debt issuance costs related to the New Credit Agreement of approximately $1.1 million were deferred and are being amortized over the respective term of the loans. Extraordinary debt retirement costs associated with the prepayment of certain term loans under the KCS Credit Facility using proceeds from the Note Offering were approximately $4.3 million ($2.7 million, net of income taxes). SOUTHERN CAPITAL On June 25, 2002, Southern Capital refinanced the outstanding balance of its bridge loan through the issuance of approximately $167.6 million of pass through trust certificates and the sale of 50 locomotives. The pass through trust certificates are secured by the sold locomotives, all of the remaining locomotives and rolling stock owned by Southern Capital and rental payments payable by KCSR under the sublease of the sold locomotives and its leases of the equipment owned by Southern Capital. Payments of interest and principal of the pass through trust certificates, which are due semi-annually on June 30 and December 30 commencing on December 30, 2002 and ending on June 30, 2022, are insured under a financial guarantee insurance policy by MBIA Insurance Corporation. KCSR leases or subleases all of the equipment securing the pass through trust certificates. IMPLEMENTATION OF NEW TRANSPORTATION COMPUTER SYSTEM. On July 14, 2002, the Company initiated a switch-over from its legacy system operating platform to a Management Control System ("MCS") on KCSR. This state-of-the-art system is designed to provide better analytical tools for management to use in its decision-making processes. MCS, among other things, provides tracking of individual shipments across our rail system and compares that movement to the service sold to the customer. If a shipment falls behind schedule, MCS automatically generates alerts and action recommendations. The Company's depreciation expense is expected to increase by approximately $4.8 million per annum ($2.4 million in 2002) as a result of the implementation of MCS. As previously announced, the Company's third quarter and year to date results were impacted by higher operating costs and some temporary traffic diversions caused by congestion directly related to the implementation of MCS. The MCS implementation slowed the railroad as employees learned to respond to the data discipline demanded by this new system. Although management believes that the issues with the implementation of MCS have been largely resolved, the initial difficulties experienced by office and field personnel in transitioning to this new platform led to the congestion issues and operating inefficiencies during the third quarter 2002, which contributed to a decline in consolidated operating income. See Results of Operations below for a discussion of the impact on third quarter operations. SALE OF MEXRAIL, INC. TO TFM. The Company, Grupo TMM, and certain of Grupo TMM's affiliates entered into an agreement on February 27, 2002 with TFM to sell to TFM all of the common stock of Mexrail. Mexrail owns the northern half of the international railway bridge at Laredo, Texas and all of the common stock of the Tex Mex. The sale closed on March 27, 2002 and the Company received approximately $31.4 million for its 49% interest in Mexrail. The Company used the proceeds from the sale of Mexrail to reduce debt. Although the Company no longer directly owns 49% of Mexrail, it retains an indirect ownership through its ownership of Grupo TFM. The Company's proportionate share of the proceeds from the sale of Mexrail to TFM exceeded the carrying value of the Company's investment in Mexrail by $11.2 million. The Company recognized a $4.4 million gain on the sale of Mexrail to TFM in the first quarter of 2002, while the remaining $6.8 of excess proceeds was deferred and is being amortized over 20 years. COMPANY CHANGES NAME TO KANSAS CITY SOUTHERN. On May 2, 2002, at the Annual Meeting of Stockholders, the shareholders of the Company approved a proposal to amend the Certificate of Incorporation to change the name of the Company from "Kansas City Southern Industries, Inc." to "Kansas City Southern." The name change became effective on May 2, 2002 following the filing of the amended Certificate of Incorporation with the Secretary of State of the State of Delaware. The name change reflects the change in the Company's business and holdings following the spin-off of Stilwell Financial Inc. on July 12, 2000. By dropping "Industries, Inc." from the name, KCS will maintain the identification in the marketplace of the Company and KCSR, while emphasizing our focus on transportation rather than a variety of industries. The name change does not require a change in the security ticker symbol of KSU on the New York Stock Exchange. CHANGES TO MEXICAN TAX LAW. As discussed in the Company's Annual Report on Form 10-K for the year ended December 31, 2001, as amended by Amendment No. 1 on Form 10-K/A ("2001 Form 10-K"), effective January 1, 2002, Mexico implemented changes in its income tax laws. One of these changes reduced the Mexican corporate income tax rate from 35% to 32% in one-percent increments beginning in 2003, resulting in a 32% income tax rate in 2005. Accordingly, under accounting principles generally accepted in the United States of America ("U.S. GAAP"), Grupo TFM recorded the impact of this rate change during the first quarter of 2002. After consideration of minority interest, the impact of this rate change did not have a significant impact on the Company's equity in earnings of Grupo TFM for the first quarter of 2002. KCSR AND THE BURLINGTON NORTHERN AND SANTA FE RAILWAY COMPANY ("BNSF") FORM MARKETING ALLIANCE. On April 22, 2002, KCSR and BNSF entered into a marketing agreement forming a comprehensive joint marketing alliance to promote cooperation, revenue growth and extend market reach for both railroads in the United States and Canada. The marketing alliance is also designed to improve operating efficiencies for both KCSR and BNSF in key market areas, as well as provide customers with expanded service options. KCSR and BNSF will coordinate marketing and operational initiatives in a number of target markets. Similarly, KCSR and BNSF will also coordinate operations to provide improved and extended service options for grain customers. The marketing alliance is expected to allow the two railroads to be more responsive to shippers' requests for rates and service, whenever mutually advantageous. Coal and unit train operations are excluded from the marketing alliance, as well as any points where KCSR and BNSF are the only direct rail competitors. Movements to and from Mexico by either party are also excluded. Management believes this new marketing alliance will provide important opportunities to grow KCSR's revenue base, particularly in the chemical, grain and forest product markets, and provide both participants with expanded access to important markets and provide shippers with enhanced options and competitive alternatives. RESULTS OF OPERATIONS The following table summarizes the income statement components of the Company for the three and nine months ended September 30, 2002 and 2001 respectively, for use in the analysis below. See consolidated statements of income accompanying this Form 10-Q for other captions not presented in this table (IN MILLIONS): Three Months Nine Months Ended September 30, Ended September 30, ------------------------------- ------------------------------- 2002 2001 2002 2001 ---------------- -------------- --------------- --------------- Revenues $ 137.6 $ 144.6 $ 418.0 $ 431.8 Costs and expenses 131.4 128.6 383.9 396.8 ---------------- -------------- --------------- --------------- Operating income 6.2 16.0 34.1 35.0 Equity in net earnings (losses) of unconsolidated affiliates 9.1 6.9 25.7 23.3 Gain on sale of Mexrail, Inc. - - 4.4 - Interest expense (11.5) (13.2) (33.3) (42.9) Other income 6.5 0.9 15.3 3.0 ---------------- -------------- --------------- --------------- Income before income taxes, extraordinary item, and cumulative effect of accounting change 10.3 10.6 46.2 18.4 Income tax provision (benefit) (0.3) 1.6 6.7 (1.6) ---------------- -------------- --------------- --------------- Income before extraordinary item and cumulative effect of accounting change 10.6 9.0 39.5 20.0 Extraordinary item, net of income taxes - - (2.7) - Cumulative effect of accounting change, net of income taxes - - - (0.4) ---------------- -------------- --------------- --------------- Net income $ 10.6 $ 9.0 $ 36.8 $ 19.6 ================ ============== =============== ===============
The following table summarizes the revenues and carload statistics of KCSR for the three and nine months ended September 30, 2002 and 2001, respectively. Certain prior period amounts have been reclassified to reflect changes in the business groups and to conform to the current period presentation. Carloads and Revenues Intermodal Units -------------------------------------------- ------------------------------------------- (IN MILLIONS) (IN THOUSANDS) Three months Nine months Three months Nine months ended September 30, ended September 30, ended September 30, ended September 30, ----------- ---------- ----------- --------- ---------- ---------- --------- ----------- 2002 2001 2002 2001 2002 2001 2002 2001 ----------- ---------- ----------- --------- ---------- ---------- --------- ----------- General commodities: Chemical and petroleum $ 32.4 $ 30.4 $ 98.1 $ 93.8 35.6 34.0 109.3 111.8 Paper and forest 34.7 34.6 100.8 96.4 46.0 47.4 134.8 137.2 Agricultural and mineral 20.8 22.3 67.2 64.5 29.1 31.6 93.5 93.4 ----------- ---------- ----------- --------- ---------- ---------- ---------- ---------- Total general commodities 87.9 87.3 266.1 254.7 110.7 113.0 337.6 342.4 Intermodal and automotive 14.0 14.3 43.3 50.9 75.3 70.4 213.6 220.7 Coal 24.4 31.1 74.7 87.0 50.2 53.3 155.4 148.0 ----------- ---------- ----------- -------- ----------- --------- ----------- --------- Carload revenues and carload and intermodal units 126.3 132.7 384.1 392.6 236.2 236.7 706.6 711.1 Other rail-related revenues 10.0 10.0 28.8 30.4 ========== ========== ========== ========== ----------- ---------- ----------- --------- Total KCSR revenues 136.3 142.7 412.9 423.0 Other subsidiary revenues 1.3 1.9 5.1 8.8 ----------- ---------- ----------- --------- Total consolidated revenues $ 137.6 $ 144.6 $ 418.0 $ 431.8 =========== ========== =========== =========
The following table summarizes KCS's consolidated costs and expenses for the three and nine months ended September 30, 2002 and 2001, respectively. Certain prior period amounts have been reclassified to conform to the current year presentation. Three Months Nine Months Ended September 30, Ended September 30, ------------------------------- ------------------------------- 2002 2001 2002 2001 --------------- --------------- --------------- --------------- Compensation and benefits $ 51.2 $ 48.7 $ 147.1 $ 145.4 Depreciation and amortization 15.8 14.7 45.3 43.6 Purchased services 15.9 15.4 43.5 41.8 Operating leases 12.4 12.6 37.1 38.1 Fuel 8.9 11.5 27.7 35.3 Casualties and insurance 6.9 6.1 22.0 28.4 Car hire 5.6 3.5 14.9 15.7 Other 14.7 16.1 46.3 48.5 --------------- --------------- --------------- --------------- Total consolidated costs and expenses $ 131.4 $ 128.6 $ 383.9 $ 396.8 =============== =============== =============== ===============
NET INCOME. Net income for the three months ended September 30, 2002 was $10.6 million (17(cent) per diluted share) compared to $9.0 million (15(cent) per diluted share) for the three months ended September 30, 2001. This $1.6 million quarter to quarter increase was primarily the result of a $5.6 million increase in other income, $2.3 million increase in equity in earnings from Grupo TFM, a $1.9 million reduction in the provision (benefit) for income taxes, and a $1.7 million decrease in interest expense. These factors, which led to an increase in net income were partially mitigated by a $7.0 million decline in consolidated revenue, a $2.8 million increase in consolidated operating expenses and a $0.1 million increase in losses associated with other unconsolidated affiliates (PCRC and Southern Capital). For the nine months ended September 30, 2002, net income increased $17.2 million to $36.8 million (59(cent) per diluted share) from $19.6 million (32(cent) per diluted share) for the nine months ended September 30, 2001. This increase was primarily the result of a $12.9 million decline in consolidated operating expenses, a $12.3 million increase in other income, a $9.6 million decrease in interest expense, a $4.4 million gain realized on the sale of Mexrail to TFM, and a $4.1 million increase in equity in net earnings of Grupo TFM. This year to date increase was partially offset by a $13.8 million decline in consolidated revenue, an $8.3 million increase in the provision for income taxes, and a $1.7 million decline in equity in net earnings (losses) of other unconsolidated affiliates. Additionally, net income for the nine months ended September 30, 2002 includes extraordinary debt retirement costs of $2.7 million (after-tax) associated with the early retirement of term debt in June 2002. Net income for the nine months ended September 30, 2001 includes a $0.4 million charge relating to the implementation of Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). REVENUES. Consolidated revenues for the three and nine months ended September 30, 2002 declined $7.0 million and $13.8 million to $137.6 million and $418.0 million, respectively, compared to $144.6 million and $431.8 million for the three and nine months ended September 30, 2001, respectively. During the third quarter of 2002, KCSR experienced revenue growth in several commodity groups, including chemical and petroleum products, certain forest products and intermodal traffic compared to the third quarter of 2001, continuing the positive revenue trends noted for these commodities during the first half of 2002 and in spite of the MCS related difficulties encountered this quarter. The increase in revenue for these shipments was driven by volume gains, increased length of haul and price improvements in key traffic lanes. KCS management believes that revenues for these commodities as well as certain other traffic would have improved even further during the quarter, but were adversely affected by lower carloadings arising from MCS related congestion. These quarter to quarter revenue improvements were offset by comparatively lower revenues for coal, automotive and grain business. As a result, third quarter 2002 revenues for KCSR were $6.4 million lower than the comparable prior year quarter. For the nine months ended September 30, 2002, revenue from KCSR declined $10.1 million compared to the nine months ended September 30, 2001, primarily as a result of lower coal and automotive revenues as well as MCS related issues in the third quarter. These declines were partially offset by revenue increases in chemical and petroleum products, agriculture and minerals, paper and forest products and intermodal and haulage services. The following discussion provides an analysis of KCSR revenues by commodity group for the quarter and year to date ended September 30, 2002. CHEMICAL AND PETROLEUM PRODUCTS. Revenues for chemical and petroleum products for the three and nine months ended September 30, 2002 increased $2.0 million (6.6%) and $4.3 million (4.6%), respectively, compared to the same periods in 2001. These increases resulted from a combination of higher traffic volumes for certain commodities in this business group, together with targeted rate increases and longer hauls due to gateway changes. Higher revenues for gases and organic product for the three and nine months ended September 30, 2002 were primarily the result of production increases by certain customers. Increased inorganic revenues were the result of increased access to production facilities in Geismar, Louisiana as well as new business previously shipped by other rail carriers. Increases in the production of PVC and plastic pellet products yielded higher plastics product revenue for the three and nine months ended September 30, 2002 compared to the same periods in 2001. These quarterly and year to date increases were partially offset by decreases in agrichemical and petroleum product revenue as a result of lower industrial production due to the continued slowdown in the U.S. economy. Chemical and petroleum products revenue accounted for 25.7% and 22.9% of carload revenues for the three months ended September 30, 2002 and 2001, respectively, and 25.6% and 23.9% of carload revenues for the nine months ended September 30, 2002 and 2001, respectively. PAPER AND FOREST PRODUCTS. Revenues for paper and forest products for the three and nine months ended September 30, 2002 increased $0.1 million (0.3%) and $4.4 million (4.6%) compared to the same periods in 2001. For the three months ended September 30, 2002, higher revenues in pulp and paper, lumber and plywood and metal/scrap were mostly offset by revenue declines in pulpwood/logs/chips, and military/other carloads. For the nine months ended September 30, 2002, increases in revenues for pulp and paper and lumber/plywood were partially mitigated by decreases in all other paper and forest products revenues. The increases in pulp and paper product revenues for the quarter and year to date were the result of production growth in the paper industry. Increases in revenues for lumber and plywood products reflect continued strength in the home building market and an increase in housing starts. Lower revenues for pulpwood, logs and chips products and metal and scrap products for the three and nine months ended September 30, 2002 were primarily the result of declines in industrial production as a result of the continued slowdown of the U.S. economy. These decreases were partially offset by targeted rate increases. Paper and forest products revenue accounted for 27.4% and 26.1% of carload revenues for the three months ended September 30, 2002 and 2001, respectively, and 26.2% and 24.6% of carload revenues for the nine months ended September 30, 2002 and 2001, respectively. AGRICULTURAL AND MINERAL PRODUCTS. Revenues for agricultural and mineral products decreased $1.5 million for the three months ended September 30, 2002 compared to the same period in 2001. For the nine months ended September 30, 2002, however, revenues for this commodity group increased $2.7 million compared to the same period in 2001. For the three months ended September 30, 2002, increases in revenues for food products and stone, clay and glass products partially mitigated revenue declines in all other agricultural and mineral products. For the nine months ended September 30, 2002, increases in revenues for domestic and export grain, food, and stone, clay and glass products were partially offset by declines in revenues for ores and minerals products. Revenue increases for domestic grain resulting from certain rate increases and longer hauls were partially offset by lower domestic demand. For the nine months ended September 30, 2002, export grain increased over the same period in 2001 primarily as a result of higher demand from Mexico and other export markets in the first quarter of 2002. Increases in revenue for stone, clay and glass product were primarily the result of higher production by two customers as well as targeted rate increases and longer hauls. Agricultural and mineral products revenue accounted for 16.5% and 16.8% of carload revenues for the three months ended September 30, 2002 and 2001, respectively, and 17.5% and 16.4% of carload revenues for the nine months ended September 30, 2002 and 2001, respectively. INTERMODAL AND AUTOMOTIVE. Intermodal and automotive revenues combined decreased $0.3 million and $7.6 million for the three and nine months ended September 30, 2002, respectively, compared to the same periods in 2001. Automotive revenues declined $1.6 million and $10.0 million for the three and nine months ended September 30, 2002, respectively, compared to the same periods in 2001. These declines were a result of the loss of certain Ford business in the third quarter of 2001 due to competitive pricing from another railroad as well as the impact of the continued weakness of the U.S. economy on the automotive industry resulting in a 65.4% and 61.0% decline in carload volumes for the three and nine-month periods ended September 30, 2002, respectively, for automotive traffic. Intermodal revenues increased $1.3 million and $2.4 million for the three and nine months ended September 30, 2002, respectively, compared to the same periods in 2001. Both the quarter to quarter and year to date increases were the result of increases in domestic carloads as well as international traffic moving to Mexico. Intermodal and automotive revenue accounted for 11.1% and 10.8% of carload revenues for the three months ended September 30, 2002 and 2001, respectively, and 11.3% and 13.0% of carload revenues for the nine months ended September 30, 2002 and 2001, respectively. COAL. Coal revenues decreased $6.7 million and $12.3 million for the three and nine month periods ended September 30, 2002, respectively, compared to the same periods in 2001. Coal revenues for both periods were significantly impacted by a rate reduction at our largest utility customer and the loss of a coal customer in April 2002 due to the expiration of a contract. The effect of these revenue declines were partially mitigated by increases in year-to-date carload volume due to higher demand at certain utility customers and as a result of the re-opening of a utility plant in Kansas City that had been out of service since July of 1999. Coal revenue accounted for 19.3% and 23.4% of carload revenues for the quarters ended September 30, 2002 and 2001, respectively, and 19.4% and 22.2% of carload revenues for the nine months ended September 30, 2002 and 2001, respectively. OTHER. Other rail related revenues remained relatively flat for the three months ended September 30, 2002, and decreased $1.6 million for the nine months ended September 30, 2002, compared to the same periods in 2001. These fluctuations were primarily due to higher haulage and other revenues partially offset by declines in switching and demurrage revenues. COSTS AND EXPENSES. Consolidated costs and expenses increased $2.8 million for the three months ended September 30, 2002 and decreased $12.9 million for the nine months ended September 30, 2002 compared to the same periods in 2001. The quarter to quarter increase was primarily the result of higher KCSR expenses of $5.8 million and lower expenses at certain other subsidiaries of $3.0 million. The year to date decrease was primarily the result of lower KCSR expenses of $9.1 million partially offset by lower expenses at certain other subsidiaries of $3.8 million. Third quarter and year to date costs were impacted by higher costs associated with the implementation of MCS. The categories most affected were compensation and benefits, depreciation, purchased services, and car hire. See further discussion below. COMPENSATION AND BENEFITS. Consolidated compensation and benefits expense increased $2.5 million and $1.7 million for the three and nine month periods ended September 30, 2002, respectively, compared to the same periods in 2001. The quarterly and year to date increases resulted primarily from higher overtime and crew costs as a result of congestion related to the implementation of MCS in the third quarter of 2002. Additionally, compensation costs were impacted by the implementation of an increase in certain union wages in the third quarter of 2002 as well as higher health insurance related costs. These increases were partially offset by declines arising from lower employee counts, the automation of certain locomotive crew functions, a favorable adjustment related to an accrual for retroactive wage increases to union employees, which was not provided for in the national labor union contract and lower railroad retirement taxes. The year to date increase in compensation and benefits expense was also affected by the impact of a $2.0 million reduction in retirement-based costs for certain union employees recorded in the first quarter of 2001. Additionally, the year to date increase was partially mitigated by the effect of workforce reduction costs of $1.3 million also recorded in the first quarter of 2001. DEPRECIATION AND AMORTIZATION. Consolidated depreciation and amortization expense was $15.8 million and $45.3 million for the three and nine months ended September 30, 2002, respectively, compared to $14.7 million and $43.6 million for the three and nine months ended September 30, 2001, respectively. The increase in depreciation expense for both the quarter and year to date periods resulted primarily from the implementation of MCS, which increased depreciation expense by $1.2 million. (See "Recent Developments" above.) PURCHASED SERVICES. Consolidated purchased services expense for the three and nine months ended September 30, 2002 increased $0.5 million and $1.7 million, respectively, to $15.9 million and $43.5 million compared to $15.4 million and $41.8 million for the same periods in 2001. The quarter to quarter increase was primarily the result of higher environmental and legal costs as well as higher costs associated with employee training related to the implementation of MCS. This increase was partially mitigated by a $1.0 million legal settlement received during the third quarter 2002, in addition to the higher costs described for the third quarter. Year to date purchased service costs were also impacted by higher locomotive and car repair costs contracted to third parties as well as other general purchased services. These year to date increases were partially mitigated by insurance and legal settlements totaling approximately $2.9 million. OPERATING LEASES. Consolidated operating lease expense for the three and nine months ended September 30, 2002 decreased $0.2 million and $1.0 million respectively to $12.4 million and $37.1 million compared to $12.6 million and $38.1 million for the same periods in 2001. Both the quarter and year to date decreases were the result of the expiration of certain leases that have not been renewed due to continued changes in fleet utilization. These decreases were somewhat mitigated by increases in costs associated with the lease for the Company's new corporate headquarters building. FUEL. Consolidated fuel expense for the three and nine months ended September 30, 2002 decreased $2.6 million and $7.6 million, respectively, to $8.9 million and $27.7 million compared to $11.5 million and $35.3 million for the same periods in 2001. The $2.6 million quarter to quarter decrease was the result of a 13.1% decrease in the average cost per gallon of fuel combined with a 10.4% decline in fuel consumption. The $7.6 million year to date decrease in fuel expense was the result of an 18.3% decrease in the average cost per gallon of fuel combined with a 3.9% decline in fuel consumption. CASUALTIES AND INSURANCE. Consolidated casualties and insurance expense for the three months ended September 30, 2002 increased $0.8 million compared to the same period in 2001. This quarter to quarter increase was primarily the result of costs associated with derailments that occurred in the third quarter of 2002, partially mitigated by the receipt of a legal settlement of $1.5 million. For the nine months ended September 30, 2002, consolidated casualties and insurance expense declined $6.4 million. During the first quarter of 2001, the Company incurred approximately $8.5 million in increased costs related to several significant derailments and the settlement of a significant personal injury claim. In 2002, derailment and claims costs have been normalized compared to 2001. The year to date reduction also reflects the impact of a $1.4 million insurance settlement received in the second quarter of 2002. CAR HIRE. Consolidated car hire expense for the three months ended September 30, 2002 increased $2.1 million to $5.6 million compared to $3.5 million for the same period in 2001. This increase was due to a higher number of freight cars from other railroads on the Company's rail line as a result of increased congestion resulting from the implementation of MCS (see "Recent Developments" above), partially mitigated by a greater number of KCSR freight cars being used by other railroads. For the nine months ended September 30, 2002, consolidated car hire expense decreased $0.8 million to $14.9 million compared to $15.7 million for the same period in 2001. For the first and second quarters of 2002, KCSR's railway operations were more efficient and less congested than the third quarter because of the MCS related congestion. Additionally, KCSR's operations during the first six months of 2002 were more efficient than the first half of 2001 when an unusual number of derailments, line washouts and floods had a significant adverse effect upon the Company's domestic operations. Accordingly, these factors led to an overall decline in car hire costs for the nine months ended September 30, 2002 compared to the same period in 2001. OPERATING INCOME AND KCSR OPERATING RATIO. Consolidated operating income for the three months ended September 30, 2002 decreased $9.8 million to $6.2 million compared to $16.0 million for the same period in 2001. This decrease was the result of a $7.0 million decline in revenue combined with a $2.8 million increase in operating expenses. For the three months ended September 30, 2002, the operating ratio for KCSR was 94.2% compared to 85.9% for the same period in 2001. Consolidated operating income for the nine months ended September 30, 2002 decreased $0.9 million to $34.1 million compared to $35.0 million for the same period in 2001. This decrease was the result of a $13.8 million decline in revenue partially mitigated by a $12.9 million decline in operating expenses. For both the nine months ended September 30, 2002 and 2001, the operating ratio for KCSR was 89.3%. INTEREST EXPENSE. Consolidated interest expense for the three and nine months ended September 30, 2002 declined $1.7 million (12.9%) and $9.6 million (22.4%), respectively, compared to the same periods in 2001. These decreases were the result of lower interest rates combined with lower debt balances, as debt balances declined $96.1 million from $684.8 million at September 30, 2001 to $588.7 million at September 30, 2002. OTHER INCOME. For the three and nine months ended September 30, 2002, the Company's other income increased $5.6 million and $12.3 million, respectively, compared to the same periods in 2001. The quarter to quarter increase was primarily the result of an approximate $4.9 gain on the sale of the Company's interest in Wyandotte Garage Corporation. Additionally, other income for the nine months ended September 30, 2002 includes a total gain of approximately $7.3 million on the sale of certain non-operating properties. During the nine months ended September 30, 2001, there were no significant gains on the sale of non-operating property. INCOME TAX EXPENSE. For the three months ended September 30, 2002, the Company reported an income tax benefit of $0.3 million compared to an income tax provision of $1.6 for the same period in 2001. This decrease in income tax expense was primarily the result of a decrease in the Company's domestic operating income partially offset by the gain recorded on the sale of the Company's investment in Wyandotte Garage Corporation and lower interest costs. For the nine months ended September 30, 2002, the Company's income tax provision was $6.7 million compared to an income tax benefit of $1.6 million for the same period in 2001. This increase was primarily the result of gains on the sale of the Company's investments in Mexrail and Wyandotte Garage Corporation as well as the sale of other non-operating assets combined with lower interest costs compared to the same period in 2001. These factors, which led to an increase in income tax expense, were partially offset by lower domestic operating income. EQUITY IN NET EARNINGS (LOSSES) OF UNCONSOLIDATED AFFILIATES. For the three months ended September 30, 2002, the Company recorded equity in net earnings of unconsolidated affiliates of $9.1 million compared to $6.9 million for the same period in 2001. This $2.2 million quarter to quarter increase resulted primarily from a $2.3 million increase in equity in earnings from Grupo TFM. Exclusive of the results from Mexrail, which was consolidated into Grupo TFM effective April 1, 2002, third quarter 2002 Grupo TFM revenues declined approximately 3% compared to the third quarter of 2001 and operating expenses decreased approximately 4% (under U.S. GAAP). Third quarter 2002 results for Grupo TFM include a $14.2 million deferred tax benefit (calculated under U.S. GAAP) compared to a deferred tax benefit of $12.0 million in the same period in 2001. This variance was caused primarily by fluctuations in the peso exchange rate and tax benefits derived from the impact of inflation in Mexico. The Company reports its equity in Grupo TFM under U.S. GAAP while Grupo TFM reports under International Accounting Standards ("IAS"). Because the Company is required to report its equity in earnings (losses) in Grupo TFM under U.S. GAAP and Grupo TFM reports under IAS, differences in deferred income tax calculations and the classification of certain operating expense categories occur. Additionally, as discussed in "Recent Developments" above, the Company's equity in earnings of Grupo TFM does not include the recognition of the value of the VAT credit certificate. Equity in losses from other unconsolidated affiliates were $0.7 million for the third quarter of 2002 compared to $0.6 million for the third quarter of 2001. For both periods, losses from the operations of the Panama Canal Railway Company ("PCRC") were partially offset by earnings from Southern Capital Corporation ("Southern Capital"). PCRC is currently not operating at full capacity due to delays in the completion of expansion at the port of Balboa in Panama. The Balboa port expansion is expected to be complete by the summer of 2003, at which time the revenues of PCRC are anticipated to increase, which is expected to improve the financial performance of PCRC. For the nine months ended September 30, 2002, the Company recorded equity in net earnings of unconsolidated affiliates of $25.7 million compared to $23.3 million in the same period of 2001. Equity in earnings from Grupo TFM increased approximately $4.1 million compared to the same period in 2001. In 2001, however, equity in earnings from Grupo TFM reflected the Company's proportionate share ($9.1 million) of the income recorded by Grupo TFM related to the reversion of certain concession assets to the Mexican government. Exclusive of this 2001 income, the Company's year to date 2002 equity in earnings from Grupo TFM increased $13.2 compared to the same period in 2001. Exclusive of Mexrail's results for the nine months ended September 30, 2002, Grupo TFM's revenues were essentially unchanged compared to the same period in 2001, while operating expenses (under U.S. GAAP) were almost 5% lower (exclusive of the 2001 reversion income.) For the nine months ended September 30, 2002, Grupo TFM's results include a $44.6 million deferred tax benefit (calculated under U.S. GAAP) compared to a deferred tax expense of $12.6 million in the same period in 2001. This variance was caused by several factors, including a deferred tax expense recorded in 2001 related to the income from the line reversion, the weakening of the peso exchange rate, as well as tax benefits derived from the impact of Mexican inflation in 2002. The fluctuation in the peso exchange rate also contributed to a $14.4 million exchange loss for the year to date 2002 compared to an exchange loss of $3.0 million for the same period in 2001. Equity in losses from the Company's other unconsolidated affiliates increased to $1.9 million for the nine months ended September 30, 2002 compared to $0.2 million for the same period in 2001. In 2002, losses associated with PCRC were $2.9 million compared to $1.0 million in 2001. As mentioned above, PCRC is not operating at full capacity as initially planned due to the delay in completion of the port expansion at Balboa. During 2001, losses were primarily related to the start-up of operations at PCRC. Additionally, the Company reported equity losses from Mexrail of $0.7 million in 2001 compared to essentially a break-even amount for 2002 prior to its sale to TFM. These losses were offset by equity earnings from Southern Capital of $1.0 million and $1.5 million for the nine months ended September 30, 2002 and 2001, respectively. EXTRAORDINARY ITEM, NET OF INCOME TAXES. In the accompanying consolidated financial statements for the nine months ended September 30, 2002, KCS reported an extraordinary charge of $2.7 million (after-tax) related to the debt refinancing transaction discussed above in "Recent Developments - Debt Refinancing". CUMULATIVE EFFECT OF ACCOUNTING CHANGE. The Company adopted the provisions of SFAS 133 effective January 1, 2001. As a result of this change in the method of accounting for derivative financial instruments, the Company recorded an after-tax charge to earnings of $0.4 million in the first quarter of 2001. This charge is presented as a cumulative effect of an accounting change in the accompanying consolidated financial statements. TRENDS AND OUTLOOK During the first half of 2002, the Company was able to improve its profitability and reduce its debt despite the continued economic slowdown in North America. While consolidated revenue for the first half of 2002 declined 2.4% primarily as a result of the slowdown in the U.S. economy and reduced coal revenues, efforts to maintain the Company's cost structure proved effective as operating income for the first half of 2002 increased compared to the same periods in 2001. In the third quarter of 2002, however, the Company's progress toward improving profitability was impacted by congestion throughout the Company's U.S. rail network and reduced operating efficiency primarily as a result of the implementation of MCS (See "Recent Developments" above). In the third quarter of 2002, increased congestion caused some customer service delays and resulted in higher expenses for certain categories including car hire, regular and overtime wages, certain equipment charges and other MCS implementation related expenses. These congestion related factors also contributed to lower revenues for the third quarter, which also declined due to the continued impact of the economic slowdown and lower coal revenues arising from a contractual rate reduction at one of the Company's major coal customers. These factors also contributed to the Company's year to date results as operating income for the year to date fell 2% compared to the same period in 2001. While the Company's third quarter and year to date operations were negatively impacted by the implementation of MCS, the Company began to experience an improvement in operations in the month of September, with less congestion and more efficient train movements. Additionally, other factors contributed to an improvement in third quarter and year to date net income compared to 2001 periods. Equity in net earnings from Grupo TFM improved 30.6% quarter to quarter and 191.6% year to date (after adjusting for the Company's $9.1 million share of the income recorded by Grupo TFM related to the reversion of certain concession assets to the Mexican government during 2001). Interest costs for the quarter and year to date periods continued to decline compared to prior year periods as a result of lower debt balances and lower interest rates. Further, during 2002, the Company realized gains on the sale of certain investments and assets. In the first quarter of 2002, the Company realized a gain of $4.4 million on the sale of its investment in Mexrail to TFM and in the third quarter of 2002, the Company realized a gain of $4.9 million on the sale of its investment in Wyandotte Garage Corporation. For the nine months ended September 30, 2002, the Company realized additional gains of approximately $7.3 million on the sale of other non-operating assets. During the nine months ended September 30, 2001, there were no significant gains on the sale of non-operating property. The Company's third quarter 2002 diluted earnings per share increased 13.3% compared to the same period in 2001 while the Company's year to date 2002 diluted earnings per share increased 84.4% compared to the same period in 2001. The Company's investment in Grupo TFM continues to contribute to the Company's net income. Equity in earnings from Grupo TFM increased $2.3 million in the third quarter of 2002 and $13.2 million (exclusive of $9.1 million related to the reversion of certain concession assets to the Mexican government) for year to date 2002 compared to the respective periods in 2001. The Company's increased ownership percentage of Grupo TFM resulting from the purchase of the Mexican government's ownership of Grupo TFM partially contributed to these period to period increases, and is expected to increase equity earnings from Grupo TFM in future periods. The Company reduced its debt balance by approximately $69.7 million during the first nine months of 2002 and $96.1 million over the last twelve months resulting in a debt balance of $588.7 million at September 30, 2002. A current outlook for the Company's businesses for the remainder of 2002 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): As previously discussed, management expects coal revenues for the fourth quarter of 2002 to decline compared to the fourth quarter of 2001, as a result of a contractual rate reduction at SWEPCO, as well as the loss of business due to the expiration of a contract that was not renewed. Except as outlined herein, variable costs and expenses are expected to be proportionate with revenue activity, assuming normalized rail operations. Fuel prices are expected to fluctuate subject to market conditions. To mitigate the market risk associated with fuel, the Company currently has approximately 40% of its remaining budgeted fuel usage for 2002 under purchase commitments, which lock in a specific price. Casualty expenses are expected to be lower in the fourth quarter of 2002 compared to the fourth quarter of 2001 based on the Company's continued focus and success on safety issues and the claim settlement approach implemented during 2001. Insurance costs are expected to rise as the insurance industry continues to respond to the September 11, 2001 terrorist attacks and health care costs are also expected to be higher in 2002 based on the market trends. These increases are expected to be offset by declines in certain railroad retirement costs as described further in "Recent Developments - New Railroad Retirement Improvement Act" of the Company's 2001 Form 10-K. Depreciation expense is expected to increase for the fourth quarter of 2002 due to the implementation of MCS while operating lease expense is expected to remain relatively flat. The Company expects to continue to participate in the earnings/losses from its equity investments in Grupo TFM, Southern Capital and PCRC. Due to the variability of factors affecting the Mexican economy, management can make no assurances as to the impact that a change in the value of the peso or a change in Mexican inflation will have on the results of Grupo TFM. LIQUIDITY AND CAPITAL RESOURCES Summary cash flow data for the Company is as follows (IN MILLIONS): Nine Months Ended September 30, ------------------------------- 2002 2001 ------------- ------------- Cash flows provided by (used for): Operating activities $ 94.0 $ 30.2 Investing activities (19.2) (34.1) Financing activities (64.0) 9.3 ------------- ------------- Cash and cash equivalents: Net (decrease) increase 10.8 5.4 At beginning of year 24.7 21.5 ------------- ------------- At end of period $ 35.5 $ 26.9 ============= ============= During the nine months ended September 30, 2002, the Company's consolidated cash position increased $10.8 million from December 31, 2001, primarily as a result of operating cash inflows, proceeds from the sale of certain investments (Mexrail and Wyandotte) and from the sale of certain non-operating property, and proceeds from the issuance of long-term debt. These increases were partially mitigated by debt repayments and property acquisitions. Net operating cash inflows were $94.0 million and $30.2 million for the nine months ended September 30, 2002 and 2001, respectively. The $63.8 million increase in operating cash flows was primarily attributable to higher net income and changes in working capital balances, comprised mainly of the receipt of income tax refunds during the first nine months of 2002 and the timing of payments and receipts. Net investing cash outflows were $19.2 million and $34.1 million for the nine months ended September 30, 2002 and 2001, respectively. This $14.9 million difference was driven by proceeds received from the sale of certain Company investments of $31.7 million and a $2.5 million increase in proceeds received from the disposal of property. These cash inflows were partially offset by a $20.9 million increase in capital expenditures period to period. For the nine months ended September 30, 2002, financing cash outflows were used primarily to repay long-term debt and to fund debt issuance costs associated with the $200 million Note Offering in June 2002. Cash inflows were generated from proceeds from the Note Offering and from the issuance of common stock under employee stock plans. For the first nine months of 2002, net financing cash outflows were $64.0 million compared to net financing cash inflows of $9.3 million for the first nine months of 2001. This difference was primarily due to net repayments of long-term debt of $64.8 million during the first nine months of 2002 compared to net borrowings of $10.2 million during the first nine months of 2001. Management expects cash flows from operations to be positive throughout the remainder of 2002 as a result of operating income, which has historically resulted in positive operating cash flows. Investing activities are projected to use significant amounts of cash for capital expenditures. Future roadway improvement projects will continue to be primarily funded by operating cash flows or, secondarily, through borrowings under the Company's line of credit. The Company's consolidated ratio of debt to total capitalization was 44.7% and 49.2% at September 30, 2002 and December 31, 2001, respectively. The Company's debt decreased $69.7 million from $658.4 million at December 31, 2001 to $588.7 million at September 30, 2002 as a result of net repayments of long-term debt. This decrease in debt was coupled with an increase in the Company's stockholders' equity of $49.3 million to $729.6 million at September 30, 2002. This increase was due primarily to net income of $36.8 million and the issuance of common stock under employee stock plans. Management anticipates that the ratio of debt to total capitalization will continue to decline slightly during the remainder of 2002 as debt continues to be reduced and equity increases. In addition to operating cash flows, the Company has financing available under a Revolver with a maximum borrowing amount of $100 million. As of September 30, 2002, all $100 million was available under the Revolver. The New Credit Agreement contains, among other provisions, various financial covenants. As a result of certain financial covenants contained in the credit agreement, maximum utilization of the Company's Revolver may be restricted. The Company was in full compliance with all covenant provisions of the credit agreement at September 30, 2002 and expects to be in compliance at the end of 2002 and for the foreseeable future. See "Recent Developments - Debt Refinancing". As discussed in "Recent Developments- Debt Refinancing", on June 12, 2002, KCSR used the net proceeds from the Note Offering of $195.8 million, together with cash, to repay term debt under the KCS Credit Facility and certain other secured indebtedness of the Company. The 7 1/2% Notes are general unsecured obligations of KCSR, are guaranteed by the Company and certain of its subsidiaries, and contain certain covenants and restrictions customary for this type of debt instrument and for borrowers with similar credit ratings. The Company filed a Universal Shelf Registration Statement on Form S-3 ("Initial Shelf" - Registration No. 33-69648) in September 1993, as amended in April 1996, for the offering of up to $500 million in aggregate amount of securities. The SEC declared the Initial Shelf effective on April 22, 1996; however, no securities have been issued thereunder. The Company has carried forward $200 million aggregate amount of unsold securities from the Initial Shelf to a Shelf Registration Statement filed on Form S-3 ("Second Shelf" - Registration No. 333-61006) on May 16, 2001 for the offering of up to $450 million in aggregate amount of securities. The SEC declared the Second Shelf effective on June 5, 2001. Securities in the aggregate amount of $300 million remain available under the Initial Shelf and securities in the aggregate amount of $450 million remain available under the Second Shelf. To date, no securities have been issued under either the Initial Shelf or Second Shelf. As discussed in the 2001 Form 10-K, Grupo TMM and KCS, or either Grupo TMM or KCS, could be required to purchase the Mexican government's interest in TFM. However, this provision is not exercisable prior to October 31, 2003 without the consent of Grupo TFM. If KCS and Grupo TMM, or either KCS or Grupo TMM alone had been required to purchase the Mexican government's 20% interest in TFM as of September 30, 2002, the total purchase price would have been approximately $485.7 million. The Company believes, based on current expectations, that its cash and other liquid assets, operating cash flows, access to capital markets, borrowing capacity, and other available financing resources are sufficient to fund anticipated operating, capital and debt service requirements and other commitments through 2002. However, the Company's operating cash flows and financing alternatives can be impacted by various factors, some of which are outside of the Company's control. For example, if the Company were to experience a substantial reduction in revenues or a substantial increase in operating costs or other liabilities, its operating cash flows could be significantly reduced. Additionally, the Company is subject to economic factors surrounding capital markets and the Company's ability to obtain financing under reasonable terms is subject to market conditions. Further, the Company's cost of debt relative to potential future debt financing transactions could be impacted by independent rating agencies, which assign debt ratings based on certain credit measurements such as interest coverage and leverage ratios. OTHER NEW ACCOUNTING PRONOUNCEMENT. In April 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). SFAS 145, among other things, rescinds Statement of Accounting Standards No. 4, "Reporting Gains and Losses from Extinguishment of Debt ("SFAS 4"), which provided that gains and losses from the extinguishment of debt were to be reported as extraordinary items in the statement of income. The provisions of SFAS 145 relating to the rescission of SFAS 4 are effective for fiscal years beginning after May 15, 2002. The Company has reviewed the provisions of SFAS 145 and determined that, upon adoption, all items currently reported as extraordinary items in the Company's Consolidated Statements of Income will be reclassified to a separate line item presented above `income before income taxes'. The related income taxes, which were previously presented net with the extraordinary item, will be presented as a component of the income tax provision. The Company may elect to adopt the provisions of SFAS 145 before its required effective date. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. There have been no significant changes in the Company's Quantitative and Qualitative Disclosures About Market Risk from that previously reported in the Annual Report on Form 10-K for the year ended December 31, 2001. ITEM 4. CONTROLS AND PROCEDURES The Company's management, including the Chief Executive Officer and the Chief Financial Officer, have conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in internal controls, or in factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Part I, Item 1. Financial Statements, Note 7 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 (3) Articles of Incorporation and Bylaws BYLAWS 3.2 Bylaws of Kansas City Southern, as amended and restated to September 24, 2002, is attached to this Form 10-Q as Exhibit 3.2. (99) Additional exhibits Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 b) Reports on Form 8-K The Company furnished a Current Report on Form 8-K dated July 11, 2002 under Item 5 of such form, announcing that the Company had adopted Financial Accounting Standards No. 142. The Company furnished a Current Report on Form 8-K dated July 3, 2002 announcing its second quarter meeting, conference call. The information included in this Current Report on Form 8-K was furnished pursuant to Item 9 and shall not be deemed to be filed. The Company furnished a Current Report on Form 8-K dated July 25, 2002 reporting its second quarter 2002 operating results. The information included in this Current Report on Form 8-K was furnished pursuant to Item 9 and shall not be deemed to be filed. The Company furnished a Current Report on Form 8-K dated September 25, 2002 announcing its third quarter earnings will be impacted by implementation of its new transportation management system. The information included in this Current Report on Form 8-K was furnished pursuant to Item 9 and shall not be deemed to be filed. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized and in the capacities indicated on November 12, 2002. Kansas City Southern /S/ RONALD G. RUSS ------------------------------------------------------ Ronald G. Russ Senior 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) CERTIFICATION I, Michael R. Haverty, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Kansas City Southern; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 /S/ MICHAEL R. HAVERTY ----------------------------------- Michael R. Haverty Chairman, President and Chief Executive Officer CERTIFICATION I, Ronald G. Russ, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Kansas City Southern; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 /S/ RONALD G. RUSS -------------------------------------------- Ronald G. Russ Senior Vice President and Chief Financial Officer