10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

¨ 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 incorporation or organization)	(I.R.S. Employer Identification No.)

427 West 12th Street, Kansas City, Missouri	64105
(Address of principal executive offices)	(Zip Code)

Company’s telephone number, including area code    (816) 983-1303

Securities registered pursuant to Section 12 (b) of the Act:

Title of each class	Name of each exchange on which registered
Preferred Stock, Par Value $25 Per Share, 4%, Noncumulative	New York Stock Exchange
Common Stock, $.01 Per Share Par Value	New York Stock Exchange

Securities registered pursuant to Section 12 (g) of the Act:    None

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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Company’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the Company is an accelerated filer (as defined in Exchange Act Rule 12b-2)  YES  x    NO  ¨

Company Stock.    The Company’s common stock is listed on the New York Stock Exchange under the symbol “KSU.” As of June 30, 2003, the aggregate market value of the voting and non-voting common stock held by non-affiliates of the Company was approximately $742 million (amount computed based on closing prices of common stock on New York Stock Exchange). As of February 27, 2004, 62,633,808 shares of common stock and 242,170 shares of voting preferred stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the following documents are incorporated herein by reference into Part of the Form 10-K as indicated:

Document	Part of Form 10-K into which incorporated
Company’s Definitive Proxy Statement for the 2004 Annual Meeting of Stockholders, which will be filed no later than 120 days after December 31, 2003	Parts I, III

KANSAS CITY SOUTHERN

2003 FORM 10-K ANNUAL REPORT

Table of Contents

		Page
	PART I
Item 1.	Business	1
Item 2.	Properties	14
Item 3.	Legal Proceedings	16
Item 4.	Submission of Matters to a Vote of Security Holders	17
	Executive Officers of the Company	17
	PART II
Item 5.	Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	19
Item 6.	Selected Financial Data	20
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	58
Item 8.	Financial Statements and Supplementary Data	60
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	106
Item 9A.	Controls and Procedures	106
	PART III
Item 10.	Directors and Executive Officers of the Company	107
Item 11.	Executive Compensation	107
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	107
Item 13.	Certain Relationships and Related Transactions	108
Item 14.	Principal Accountant Fees and Services	108
	PART IV
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	109
	Signatures	118

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Part I

Item 1. Business

COMPANY OVERVIEW

Kansas City Southern (“KCS” or the “Company”), a Delaware corporation, is a holding company with principal operations in rail transportation.

KCS, along with its subsidiaries and affiliates, owns and operates a uniquely positioned North American rail network strategically focused on the growing north/south freight corridor that connects key commercial and industrial markets in the central United States with major industrial cities in Mexico. The Company’s principal subsidiary, The Kansas City Southern Railway Company (“KCSR”), which was founded in 1887, is one of seven Class I railroads in the United States (railroads with annual revenues of at least $272 million, as indexed for inflation). KCSR serves a ten-state region in the midwest and southern parts of the United States and has the shortest north/south rail route between Kansas City, Missouri and several key ports along the Gulf of Mexico in Louisiana, Mississippi and Texas.

The Company’s rail network also includes an equity investment in Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”), a 46.6% owned unconsolidated affiliate, which owns 80% of the stock of TFM, S.A. de C.V. (“TFM”). TFM operates a strategically significant corridor between Mexico and the United States, and has as its core route a key portion of the shortest, most direct rail passageway between Mexico City and Laredo, Texas. TFM serves most of Mexico’s principal industrial cities and three of its major shipping ports. TFM’s rail lines are the only ones which serve Nuevo Laredo, the largest rail freight exchange point between the United States and Mexico.

TFM wholly-owns Mexrail, Inc. (“Mexrail”). Mexrail owns 100% of The Texas-Mexican Railway Company (“Tex-Mex”). Tex-Mex operates a 157-mile rail line extending from Laredo to the port city of Corpus Christi, Texas and connects the operations of KCSR with TFM. Tex-Mex connects with TFM at Laredo and connects to KCSR through trackage rights at Beaumont, Texas. TFM, through its concession with the Mexican government, has the right to control and operate the southern half of the rail-bridge at Laredo and, indirectly through its ownership of Mexrail, owns the northern half of the rail-bridge at Laredo, which spans the Rio Grande River between the United States and Mexico. Laredo is a principal international gateway through which more than 50% of all rail and truck traffic between the United States and Mexico crosses the border.

Together, the Company’s rail network (KCSR, and equitable interests in TFM and Tex-Mex) comprises approximately 6,000 miles of main and branch lines extending from the midwest portions of the United States south into Mexico. Additionally, through a strategic alliance with Canadian National Railway Company (“CN”) and Illinois Central Corporation (“IC” and together with CN, “CN/IC”), the Company has access to a contiguous rail network of approximately 25,000 miles of main and branch lines connecting Canada, the United States and Mexico. The CN/IC alliance connects Canadian markets with major midwestern and southern markets in the United States as well as with major markets in Mexico through KCSR’s connections with Tex-Mex and TFM. Management believes that, as a result of the strategic position of our rail network, the Company is poised to continue to benefit from the growing north/south trade between the United States, Mexico and Canada promoted by the North American Free Trade Agreement (“NAFTA”).

KCS’s rail network is further expanded through marketing agreements with Norfolk Southern Railway Company (“Norfolk Southern”), The Burlington Northern and Santa Fe Railway Company (“BNSF”) and the Iowa, Chicago & Eastern Railroad Corporation (“IC&E” – formerly I&M Rail Link, LLC). Marketing agreements with Norfolk Southern allow the Company to capitalize on its east/west route from Meridian, Mississippi to Dallas, Texas (“Meridian Speedway”) to gain incremental traffic volume between the southeast and the southwest. The marketing alliance with BNSF was developed to promote cooperation, revenue growth and extend market reach for both railroads in the United States and Canada. It is also designed to improve

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operating efficiencies for both KCSR and BNSF in key market areas, as well as provide customers with expanded service options. KCSR’s marketing agreement with IC&E provides access to Minneapolis, Minnesota and Chicago, Illinois and to the origination of corn and other grain traffic in Iowa, Minnesota and Illinois.

The Company’s rail network interconnects with all other Class I railroads and provides shippers with an effective alternative to other railroad routes, giving direct access to Mexico and the southeastern and southwestern United States through less congested interchange hubs.

The Company also owns 50% of the common stock (or a 42% equity interest) of the Panama Canal Railway Company (“PCRC”), which holds the concession to operate a 47-mile coast-to-coast railroad located adjacent to the Panama Canal. The railroad handles containers in freight service across the isthmus. Panarail Tourism Company (“Panarail”), a wholly owned subsidiary of PCRC, operates a commuter and tourist railway service over the lines of the Panama Canal Railway. Passenger and freight service commenced during 2001.

Other subsidiaries and affiliates of KCS include the following:

• Southern Capital Corporation, LLC (“Southern Capital”), a 50% owned unconsolidated affiliate that leases locomotive and rail equipment to KCSR;

• Trans-Serve, Inc., (d/b/a Superior Tie and Timber—“ST&T”), an owner/operator of a railroad wood tie treating facility;

• PABTEX GP, LLC (“Pabtex”) located in Port Arthur, Texas. Pabtex is an owner of a bulk materials handling facility with deep-water access to the Gulf of Mexico that stores and transfers petroleum coke and soda ash from trucks and rail cars to ships, primarily for export; and

• Transfin Insurance, Ltd., a single-parent captive insurance company, providing property, general liability and certain other insurance coverage to KCS and its subsidiaries and affiliates.

KCS was organized in 1962 as Kansas City Southern Industries, Inc. and in 2002 formally changed its name to Kansas City Southern. KCS, as the holding company, supplies its various subsidiaries with managerial, legal, tax, financial and accounting services, in addition to managing other minor “non-operating” investments.

The information set forth in response to Item 101 of Regulation S-K under Part II Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Form 10-K is incorporated by reference in partial response to this Item 1.

RAIL NETWORK

Owned Network

KCSR owns and operates approximately 3,100 miles of main and branch lines and 1,250 miles of other tracks in a ten-state region that includes Missouri, Kansas, Arkansas, Oklahoma, Mississippi, Alabama, Tennessee, Louisiana, Texas and Illinois. KCSR has the shortest north/south rail route between Kansas City and several key ports along the Gulf of Mexico in Louisiana, Mississippi and Texas. KCSR’s rail route also serves the Meridian Speedway and the east/west route linking Kansas City with East St. Louis, Illinois and Springfield, Illinois. In addition, KCSR has limited haulage rights between Springfield and Chicago that allow for originating or terminating shipments on the rail lines of the former Gateway Western Railway Company (“Gateway Western”). These lines also provide access to East St. Louis and allow rail traffic to avoid the St. Louis, Missouri terminal. The geographic reach of KCSR enables service to a customer base that includes electric generating utilities, which use coal, and a wide range of companies in the chemical and petroleum, agricultural and mineral, paper and forest products, and automotive and intermodal markets.

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Eastern railroads and their customers can use the Company’s rail network to bypass the gateways at Chicago; St. Louis; Memphis, Tennessee and New Orleans by interchanging with KCSR at Springfield and East St. Louis and at Meridian and Jackson, Mississippi. Other railroads can also interconnect with the Company’s rail network via other gateways at Kansas City; Birmingham, Alabama; Shreveport and New Orleans, Louisiana; and Dallas, Beaumont and Laredo, Texas.

KCSR revenues and net income are dependent on providing reliable service to customers at competitive rates, the general economic conditions in the geographic region served and the ability to effectively compete against other rail carriers and alternative modes of surface transportation, such as over-the-road truck transportation. The ability of KCSR to construct and maintain the roadway in order to provide safe and efficient transportation service is important to its ongoing viability as a rail carrier. Additionally, cost containment is important in maintaining a competitive market position, particularly with respect to employee costs, as approximately 84% of KCSR employees are covered under various collective bargaining agreements.

Significant Investments

Grupo TFM

In December 1995, the Company entered into a joint venture agreement with Transportacion Maritima Mexicana, S.A. de C.V. (“TMM”) to, among other things, provide for participation in the privatization of the Mexican national railway system and to promote the movement of rail traffic over Tex-Mex, TFM and KCSR. Pursuant to written notice given by TMM’s successor, Grupo TMM, S.A., and in accordance with its terms, the joint venture agreement terminated on December 1, 2003. In 1997, the Company invested $298 million to obtain a 36.9% interest in Grupo TFM, the company formed by KCS and TMM under the joint venture agreement for the purpose of participating in the privatization of the Mexican national railway system. At the time Grupo TFM purchased 80% of the shares of TFM, TMM, the largest shareholder of Grupo TFM, owned 38.5% of Grupo TFM and the Mexican government owned the remaining 24.6%. In 2002, KCS and Grupo TMM exercised their call option on the Mexican government’s Grupo TFM shares and, on July 29, 2002, TFM completed the purchase of the Mexican government’s 24.6% ownership of Grupo TFM. The $256.1 million purchase price was funded utilizing a combination of proceeds from an offering of debt securities by TFM, a credit from the Mexican government for the reversion of certain rail facilities and other resources. This transaction increased the Company’s ownership percentage of Grupo TFM from 36.9% to approximately 46.6%. Grupo TFM owns 80% of the stock of TFM (all of which shares are entitled to full voting rights) while the remaining 20% of TFM (with limited voting rights) is owned by the Mexican government.

TFM holds the concession, which was awarded by the Mexican government in 1996, to operate Mexico’s Northeast Rail Lines (the “Concession”; the Northeast Rail Lines are now known as “TFM”) for 50 years ending in June 2047. Subject to certain conditions, TFM has an option to extend the Concession for an additional 50 years. The Concession is subject to certain mandatory trackage rights and is exclusive until 2027. The Mexican government, however, may revoke TFM’s exclusivity after 2017 if it determines that there is insufficient competition and may terminate the Concession as a result of certain conditions or events, including (1) TFM’s failure to meet its operating and financial obligations with regard to the Concession under applicable Mexican law, (2) a statutory appropriation by the Mexican government for reasons of public interest and (3) liquidation or bankruptcy of TFM. TFM’s assets and its rights under the Concession may, under certain circumstances such as natural disaster, war or other similar situations, also be seized temporarily by the Mexican government.

Under the Concession, TFM operates a strategically significant corridor between Mexico and the United States, and has as its core route a key portion of the shortest, most direct rail passageway between Mexico City and Laredo. TFM’s rail lines are the only ones which serve Nuevo Laredo, the largest rail freight exchange point between the United States and Mexico. TFM’s rail lines connect the most populated and industrialized regions of Mexico with Mexico’s principal U.S. border railway gateway at Laredo. In addition, TFM serves three of Mexico’s primary seaports at Veracruz and Tampico on the Gulf of Mexico and Lazaro Cardenas on the Pacific

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Ocean. TFM serves 15 Mexican states and Mexico City, which together represent a majority of the country’s population and account for a majority of its estimated gross domestic product. KCS management believes the Laredo gateway is the most important interchange point for rail freight between the United States and Mexico. As a result, KCS management believes that TFM’s routes are an integral part of Mexico’s foreign trade infrastructure.

This route structure enables the Company to benefit from growing trade resulting from the increasing integration of the North American economy through NAFTA. Through Tex-Mex and KCSR, as well as through interchanges with other major U.S. railroads, TFM provides its customers with access to an extensive rail network through which they may distribute their products throughout North America and overseas.

TFM operates approximately 2,650 miles of main and branch lines and certain additional sidings, spur tracks and main line tracks under trackage rights. TFM has the right to operate the rail lines through the Concession, but does not own the land, roadway or associated structures.

TFM, including its indirect ownership of Tex-Mex, is both a strategic and financial investment for KCS. Strategically, the Company’s investment in TFM promotes the NAFTA growth strategy, whereby KCS and its strategic partners can provide transportation services between the heart of Mexico’s industrial base, the United States and Canada. TFM seeks to establish its railroad as the primary inland freight transporter linking Mexico with the U.S. and Canadian markets along the NAFTA corridor. TFM’s strategy is to provide reliable customer service, capitalize on foreign trade growth and convert truck tonnage to rail.

KCS management believes TFM is an excellent long-term financial investment. TFM’s operating strategy has been to increase productivity and maximize operating efficiencies. With Mexico’s economic progress, growth of NAFTA trade between Mexico, the United States and Canada, and customer focused rail service, KCS management believes that the growth potential of TFM could be significant.

As further described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Developments—Proposed Acquisition of Grupo TFM from Grupo TMM”, on April 20, 2003, the Company entered into an agreement with Grupo TMM and other parties (“Acquisition Agreement”) under which KCS ultimately would acquire control of TFM through the purchase of shares of common stock of Grupo TFM (“Acquisition”). The obligations of KCS and Grupo TMM to complete the Acquisition are subject to a number of conditions. Grupo TMM and KCS are currently in dispute over Grupo TMM’s attempt to terminate the Acquisition Agreement. This dispute could adversely affect TFM’s operations and business.

On January 21, 2004, Moody’s Investors Service, or Moody’s, announced that it had placed the B1 senior unsecured debt rating of TFM under review for possible downgrade. Moody’s announced that, as part of the current review, it will consider the implications of these issues—the Grupo TMM/KCS dispute, the value and rights for the VAT reimbursement, and the obligations under the Mexican government’s put of TFM shares.

On February 26, 2004, Grupo TMM announced that during the fourth quarter of 2003, TFM failed to meet certain financial covenant ratios under its term loan facility and its commercial paper program. The press release stated that TFM was negotiating with its lenders on amendments to these credit agreements, which would retroactively amend the covenants and would effectively cure the defaults, and that TFM is also in the process of refinancing its commercial paper program to extend the maturity date to 2006. On March 11, 2004, Grupo TFM announced that effective March 10, 2004, it had received a waiver from the banks that participate in the term loan facility and commercial paper program and that it was waived from the financial covenants for the three months ended December 31, 2003 and for the period from January 1, 2004 through May 11, 2004.

The Mexican government has the right to compel the purchase of its 20% interest in TFM (referred to as the “Put”) by Grupo TFM following notification by the Mexican government in accordance with the terms of the

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applicable agreements. Upon exercise of the Put, Grupo TFM would be obligated to purchase the TFM capital stock at the initial share price paid by Grupo TFM adjusted for interest and inflation. Prior to October 30, 2003, Grupo TFM filed suit in the Federal District Court of Mexico City seeking, among other things, a declaratory judgment interpreting whether Grupo TFM was obligated to honor its obligation under the Put agreement, as the Mexican government had not made any effort to sell the TFM shares subject to the Put prior to October 31, 2003. In its suit, Grupo TFM named Grupo TMM and KCS as additional interested parties. The Mexican Court has admitted Grupo TFM’s complaint and issued an injunction that would, following the posting of a bond by Grupo TFM, block the Mexican government from exercising the Put. The Mexican government provided Grupo TFM with notice of its intention to sell its interest in TFM on October 30, 2003. Grupo TFM has responded to the Mexican government’s notice reaffirming its right and interest in purchasing the Mexican government’s remaining interest in TFM, but also advising the Mexican government that it would not take any action until its lawsuit seeking a declaratory judgment was resolved. In the event that Grupo TFM does not purchase the Mexican government’s 20% interest in TFM, Grupo TMM and KCS, or either of Grupo TMM or KCS alone, would, following notification by the Mexican government in accordance with the terms of the applicable agreements, be obligated to purchase the Mexican government’s remaining interest in TFM. As this matter is currently the subject of litigation in Mexico to which the Mexican government, Grupo TFM, Grupo TMM and KCS are parties, KCS management does not believe it is likely that the Mexican government will seek to exercise the Put until the litigation is resolved. Based upon public disclosures made by Grupo TMM, it is not in a position to make this purchase. Following the resolution of the lawsuit in Mexico, should Grupo TFM fail to purchase the Mexican government’s TFM shares in accordance with the terms of the Put, then the Mexican government has the right to put all the shares of TFM to KCS. In such an event, KCS would have the right, but not the obligation, to put 51% of the shares purchased by KCS to Grupo TMM. However, there can be no assurance that Grupo TMM would have the financial resources necessary to purchase those shares. If the Acquisition is completed, KCS will be solely responsible for purchasing the Mexican government’s 20% interest in TFM. If KCS had been required to purchase this interest as of December 31, 2003, the total purchase price would have been approximately $467.7 million.

The original term of the Grupo TFM joint venture agreement was renewed for a term of three years on December 1, 2000. Pursuant to written notice given by Grupo TMM, and in accordance with its terms, the joint venture agreement terminated on December 1, 2003. The joint venture did not have any material assets and management believes that the termination of the joint venture agreement will not have a material adverse effect on the Company or its interest in Grupo TFM.

The shareholders agreement dated May 1997 between KCS and Grupo TMM and certain affiliates, which governs the Company’s investment in Grupo TFM (1) restricts each of the parties to the shareholders agreement from directly or indirectly transferring any interest in Grupo TFM or TFM to a competitor of Grupo TFM, TFM or the parties without the prior written consent of each of the parties, and (2) provides that KCS and Grupo TMM may not transfer control of any subsidiary holding all or any portion of shares of Grupo TFM to a third party, other than an affiliate of the transferring party or another party to the shareholders agreement, without the consent of the other parties to the shareholders agreement. The Grupo TFM bylaws prohibit any transfer of shares of Grupo TFM to any person other than an affiliate of the existing shareholders without the prior consent of Grupo TFM’s board of directors. In addition, the Grupo TFM bylaws grant the shareholders of Grupo TFM a right of first refusal to acquire shares to be transferred by any other shareholder in proportion to the number of shares held by each non-transferring shareholder, although holders of preferred shares or shares with special or limited rights are only entitled to acquire those shares and not ordinary shares. The shareholders agreement requires that the boards of directors of Grupo TFM and TFM be constituted to reflect the parties’ relative ownership of the ordinary voting common stock of Grupo TFM.

Tex-Mex

On February 27, 2002, the Company, Grupo TMM, and certain of Grupo TMM’s affiliates entered into a stock purchase agreement with TFM to sell to TFM all of the common stock of Mexrail. The sale closed on March 27, 2002 and the Company received approximately $31.4 million for its 49% interest in Mexrail. The

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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 46.6% ownership of Grupo TFM. Under the stock purchase agreement, KCS retained rights to prevent further sale or transfer of the stock or significant assets of Mexrail and Tex-Mex and the right to continue to participate in the corporate governance of Mexrail and Tex-Mex, which will remain U.S. corporations and subject to the Company’s super majority rights contained in Grupo TFM’s bylaws.

Tex-Mex connects to KCSR through trackage rights over the rail lines of the Union Pacific Railroad Company (“UP”) between Robstown, Texas and Beaumont. These trackage rights were granted pursuant to a 1996 Surface Transportation Board (“STB”) decision and have an initial term of 99 years. Tex-Mex provides a vital link between the Company’s U.S. operations through KCSR and its Mexican operations through TFM.

On March 12, 2001, Tex-Mex purchased from UP a line of railroad right-of-way extending 84.5 miles between Rosenberg, Texas and Victoria, Texas, and granted Tex-Mex trackage rights sufficient to integrate the line into the existing trackage rights. The line is not in service and will require extensive reconstruction, which has not yet been scheduled. The purchase price for the line of $9.2 million was determined through arbitration and the acquisition also required the prior approval or exemption of the transaction by the STB. By its Order entered on December 8, 2000, the STB granted Tex-Mex’s Petition for Exemption and exempted the transaction from this prior approval requirement. Once reconstruction of the line is completed, Tex-Mex will be able to shorten its existing route between Corpus Christi and Houston, Texas by over 70 miles.

Panama Canal Railway Company

In January 1998, the Republic of Panama awarded PCRC, a joint venture company formed by KCSR and Mi-Jack Products, Inc. (“Mi-Jack”), the concession to reconstruct and operate the Panama Canal Railway, a 47-mile railroad located adjacent to the Panama Canal that provides international shippers with a railway transportation option to complement the Panama Canal. The Panama Canal Railway, which traces its origins back to the mid-1800’s, is a north-south railroad traversing the Panama isthmus between the Pacific and Atlantic Oceans. The railroad has been reconstructed and it resumed freight operations in December 2001. KCS management believes the prime potential and opportunity for this railroad to be in the movement of container traffic between the ports of Balboa and Colon for shipping customers repositioning such containers. The Panama Canal Railway has significant interest from both shipping companies and port terminal operators. In addition, there is demand for passenger traffic for both commuter and pleasure/tourist travel. Panarail operates and promotes commuter and tourist passenger service over the Panama Canal Railway. Passenger service started during July 2001. While only 47 miles long, KCS management believes the Panama Canal Railway provides the Company with a unique opportunity to participate in transoceanic shipments as a complement to the existing Panama Canal traffic.

As of December 31, 2003, the Company has invested approximately $21.0 million toward the reconstruction and operations of the Panama Canal Railway. This investment is comprised of $12.9 million of equity and $8.1 million of subordinated loans. These loans carry a 10% interest rate and are payable on demand, subject to certain restrictions.

In November 1999, PCRC completed the financing for the reconstruction project with the International Finance Corporation (“IFC”), a member of the World Bank Group. The financing was comprised of a $5 million investment by the IFC and senior loans through the IFC in an aggregate amount of up to $45 million. Additionally, PCRC has $3.4 million of equipment loans and other capital leases totaling $3.0 million. The IFC’s investment of $5 million in PCRC is comprised of non-voting preferred shares which pay a 10% cumulative dividend. As of December 31, 2003, PCRC has recorded a $2.0 million liability for these cumulative preferred dividends. The preferred shares may be redeemed at the IFC’s option any year after 2008 at the lower of (1) a net

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cumulative internal rate of return of 30% or (2) eight times earnings before interest, income taxes, depreciation and amortization for the two years preceding the redemption that is proportionate to the IFC’s percentage ownership in PCRC. Under the terms of the loan agreement with IFC, the Company is a guarantor for up to $5.6 million of the associated debt. Also if PCRC terminates the concession contract without the IFC’s consent, the Company is a guarantor for up to 50% of the outstanding senior loans. The Company is also a guarantor for up to $1.8 million of the equipment loans and approximately $100,000 relating to other capital leases. The cost of the reconstruction totaled approximately $80 million. The Company expects to loan an additional $3.5 million to PCRC during 2004 under the same terms as the existing $8.1 million subordinated loans.

Southern Capital

In 1996, KCSR and GATX Capital Corporation (“GATX”) formed a 50-50 joint venture—Southern Capital—to perform certain leasing and financing activities. Southern Capital’s operations are comprised of the acquisition of locomotives, rolling stock and other rail equipment and the leasing thereof to KCSR. Concurrent with the formation of this joint venture, KCSR entered into operating leases with Southern Capital for substantially all the locomotives and rolling stock that KCSR contributed or sold to Southern Capital at the time of formation of the joint venture. GATX contributed cash in the joint venture transaction formation.

The purpose for the formation of Southern Capital was to partner a Class I railroad in KCSR with an industry leader in the rail equipment financing in GATX. Southern Capital provides the Company with access to equipment financing alternatives.

Expanded Network

Through its strategic alliance with CN/IC and marketing agreements with Norfolk Southern, BNSF and the IC&E, the Company has expanded the domestic geographic reach beyond that covered by its owned network.

Strategic Alliance with Canadian National and Illinois Central.

In 1998, KCSR, CN and IC entered into a 15-year strategic alliance to coordinate the marketing, operations and investment elements of north-south rail freight transportation. The strategic alliance did not require STB approval and was effective immediately. This alliance connects Canadian markets, the major Midwest U.S. markets of Detroit, Michigan; Chicago, Kansas City and St. Louis and the key southern markets of Memphis, Dallas and Houston. It also provides U.S. and Canadian shippers with access to Mexico’s rail system through connections with Tex-Mex and TFM.

In addition to providing access to key north-south international and domestic U.S. traffic corridors, the alliance with CN/IC is intended to increase business primarily in the automotive and intermodal markets, the grain market, the chemical and petroleum market and the paper and forest products markets. This alliance has provided opportunities for revenue growth and positioned the Company as a key provider of rail service for NAFTA trade.

KCSR and CN formed a management group made up of senior management representatives from both railroads to, among other things, guide the realization of the alliance goals, and to develop plans for the construction of new facilities to support business development, including investments in automotive, intermodal and transload facilities at Memphis, Dallas, Kansas City and Chicago.

Under a separate agreement, KCSR was granted certain trackage and haulage rights and CN and IC were granted certain haulage rights. Under the terms of this agreement, and through action taken by the STB, in 2000 KCSR gained access to six additional chemical customers in the Geismar, Louisiana industrial area through haulage rights.

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Marketing Agreements with Norfolk Southern.

In December 1997, KCSR entered into a three-year marketing agreement with Norfolk Southern and Tex-Mex that allows KCSR to increase its traffic volume along the east-west corridor between Meridian and Dallas by using interchange points with Norfolk Southern. This agreement provides Norfolk Southern run-through service with access to Dallas and the Mexican border at Laredo while avoiding the rail gateways of Memphis and New Orleans. This agreement was renewed in December 2003 for a term of three years and will be automatically renewed for additional three-year terms unless written notice of termination is given at least 90 days prior to the expiration of the then-current term.

In May 2000, KCSR entered into an additional marketing agreement with Norfolk Southern under which KCSR provides haulage services for intermodal traffic between Meridian and Dallas in exchange for fees from Norfolk Southern. Under this agreement Norfolk Southern may quote rates and enter into transportation service contracts with shippers and receivers covering this haulage traffic. This agreement terminates on December 31, 2006 and provides KCSR with additional sources of intermodal business. Under the current arrangement, trains run between KCSR’s connection with Norfolk Southern at Meridian and the BNSF connection at Dallas. The structure of the agreement provides for lower gross revenue to KCSR, but improved operating income since, as a haulage arrangement, locomotives, locomotive fuel and car hire expenses are the responsibility of Norfolk Southern, not KCSR. Management believes this business has additional growth potential as Norfolk Southern may seek to shift its traffic to southern gateways to increase its length of haul.

Marketing Alliance with BNSF

In April 2002, KCSR and BNSF formed a comprehensive joint marketing alliance aimed at promoting cooperation, revenue growth and extending market reach for both railroads in the United States and Canada. The marketing alliance was also designed to improve operating efficiencies for both carriers in key market areas, as well as provide customers with expanded service options. KCSR and BNSF have agreed to coordinate marketing and operational initiatives in a number of target markets. The marketing alliance allows the two railroads to be more responsive to shippers’ requests for rates and service throughout the two rail networks. 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 marketing alliance provides important opportunities to grow KCSR’s revenue base, particularly in the chemical, grain and forest product markets, and provides participants with expanded access to important markets and shippers with enhanced options and competitive alternatives.

Marketing Agreement with IC&E.

In May 1997, KCSR entered into a marketing agreement with I&M Rail Link, now known as IC&E. This marketing agreement provides KCSR with access to Minneapolis and Chicago and to the origination of corn and other grain traffic in Iowa, Minnesota and Illinois. Through this marketing agreement, KCSR receives and originates shipments of grain products for delivery to poultry industry feed mills on its network. Grain is currently KCSR’s largest export into Mexico. This agreement is terminable upon 90 days notice. Management believes this agreement provides IC&E with an important channel of distribution over our rail network versus other railroads.

Haulage Rights.

As a result of the 1988 acquisition of the Missouri-Kansas-Texas Railroad by UP, KCSR was granted (1) haulage rights between Kansas City and each of Council Bluffs, Iowa, Omaha and Lincoln, Nebraska and Atchison and Topeka, Kansas, and (2) a joint rate agreement for our grain traffic between Beaumont and each of Houston and Galveston, Texas. KCSR has the right to convert these haulage rights to trackage rights. KCSR’s haulage rights require UP to move KCSR traffic in UP trains; trackage rights would allow KCSR to operate its trains over UP tracks. These rights have a term of 199 years. In addition, KCSR has limited haulage rights between Springfield and Chicago that allow for shipments that originate or terminate on the former Gateway Western’s rail lines.

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Markets Served

Chemical and Petroleum

Chemical and petroleum products accounted for approximately 21.5% of KCSR revenues in 2003. KCSR transports chemical and petroleum products via tank and hopper cars primarily to markets in the southeast and northeast United States through interchanges with other rail carriers. Primary traffic includes plastics, petroleum and oils, petroleum coke, rubber, and miscellaneous chemicals. KCSR’s access to six additional chemical customers in the Geismar, Louisiana industrial corridor has resulted in additional revenue for KCSR and management believes it could provide future competitive opportunities for revenue growth as existing contracts with other rail carriers expire for these customers.

Paper and Forest Products

Paper and forest products accounted for approximately 25.4% of 2003 KCSR revenues. The Company’s rail lines run through the heart of the southeastern U.S. timber-producing region. Management believes that forest products made from trees in this region are generally less expensive than those from other regions due to lower production costs. As a result, southern yellow pine products from the southeast are increasingly being used at the expense of western producers who have experienced capacity reductions because of public policy considerations. KCSR serves eleven paper mills directly and six others indirectly through short-line connections. Primary traffic includes pulp and paper, lumber, panel products (plywood and oriented strand board), engineered wood products, pulpwood, woodchips, raw fiber used in the production of paper, pulp and paperboard, as well as metal, scrap and slab steel, waste and military equipment. Slab steel products are used primarily in the manufacture of drill pipe for the oil industry, and military equipment is shipped to and from several military bases on the Company’s rail lines.

Agricultural and Mineral

Agricultural and mineral products accounted for approximately 18.9% of KCSR revenues in 2003. Agricultural products consist of domestic and export grain, food and related products. Shipper demand for agricultural products is affected by competition among sources of grain and grain products as well as price fluctuations in international markets for key commodities. In the domestic grain business, the Company’s rail lines receive and originate shipments of grain and grain products for delivery to feed mills serving the poultry industry. Through the marketing agreement with IC&E, the Company’s rail lines have access to sources of corn and other grain in Iowa and other Midwestern states. KCSR currently serves 35 feed mills along its rail lines throughout Arkansas, Oklahoma, Texas, Louisiana, Mississippi and Alabama. Export grain shipments include primarily wheat, soybeans and corn transported to the Gulf of Mexico for overseas destinations and to Mexico via Laredo. Over the long term, grain shipments are expected to increase as a result of the Company’s strategic investments in Tex-Mex and TFM, given Mexico’s reliance on grain imports. Food and related products consist mainly of soybean meal, grain meal, oils and canned goods, sugar and beer. Mineral shipments consist of a variety of products including ores, clay, stone and cement.

Intermodal and Automotive

Intermodal and automotive products accounted for approximately 10.3% of 2003 KCSR revenues. The intermodal freight business consists primarily of hauling freight containers or truck trailers by a combination of water, rail and motor carriers, with rail carriers serving as the link between the other modes of transportation. The Company’s intermodal business has grown significantly over the last ten years with intermodal units increasing from 61,748 in 1993 to 303,507 in 2003 and intermodal revenues increasing from $17 million to $53 million during the same period. Through our dedicated intermodal train service between Meridian and Dallas, the Company competes directly with truck carriers along the Interstate 20 corridor.

The intermodal business is highly price and service driven as the trucking industry maintains certain competitive advantages over the rail industry. Trucks are not obligated to provide or maintain rights of way and do not have to pay real estate taxes on their routes. In prior years, the trucking industry diverted a substantial

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amount of freight from railroads as truck operators’ efficiency over long distances increased. In response to these competitive pressures, railroad industry management sought avenues to improve the competitiveness of rail traffic and forged numerous alliances with truck companies in order to move more traffic by rail and provide faster, safer and more efficient service to their customers. KCSR has entered into agreements with several trucking companies for train service in several corridors, but those services are concentrated between Dallas and Meridian.

The strategic alliance with CN/IC and marketing agreements with Norfolk Southern provide the Company the opportunity to further capitalize on the growth potential of intermodal freight revenues, particularly for traffic moving between points in the upper Midwest and Canada to Kansas City, Dallas and Mexico. Furthermore, the Company is developing the former Richards-Gebaur Airbase in Kansas City as a U.S. customs pre-clearance processing facility, the Kansas City International Freight Gateway (“IFG”), which, when at full capacity, is expected to handle and process large volumes of domestic and international intermodal freight. Through an agreement with Mazda through the Ford Motor Company’s Claycomo manufacturing facility located in Kansas City, KCSR has developed an automotive loading and distribution facility at IFG. This loading and distribution facility became operational in April 2000 for the movement of Mazda vehicles. During 2003, the IFG served Ford through the loading and delivery of its new F-150 truck. Management believes that, as additional opportunities arise, the IFG facility will be expanded to include additional automotive and intermodal operations.

The Company’s automotive traffic consists primarily of vehicle parts moving into Mexico from the northern sections of the United States and finished vehicles moving from Mexico into the United States. CN/IC, Norfolk Southern and TFM have a number of automotive production facilities on their rail lines. The Company’s rail network essentially serves as the connecting bridge carrier for these movements of automotive parts and finished vehicles.

Coal

Coal historically has been one of the most stable sources of revenues and is the largest single commodity handled by KCSR. In 2003, coal revenues represented 16.1% of total KCSR revenues. Substantially all coal customers are under long term contracts, which typically have an average contract term of approximately five years. KCSR’s most significant customer is Southwestern Electric Power Company (“SWEPCO”- a subsidiary of American Electric Power, Inc.), which is under contract through 2006. The Company, directly or indirectly, delivers coal to eight electric generating plants, including the Flint Creek, Arkansas and Welsh, Texas facilities of SWEPCO, Kansas City Power and Light plants in Kansas City and Amsterdam, Missouri, an Empire District Electric Company plant near Joplin, Missouri and an Entergy Gulf States plant in Mossville, Louisiana. KCSR transports coal that originates in the Powder River Basin in Wyoming and is transferred to KCSR’s rail lines at Kansas City. KCSR serves as a bridge carrier for coal deliveries to a Texas Utilities electric generating plant in Martin Lake, Texas. In addition, KCSR delivers lignite to an electric generating plant at Monticello, Texas. SWEPCO comprised approximately 61.7% of KCSR total coal revenues and 9.8% of KCS consolidated revenues in 2003.

Other

Other rail-related revenues include a variety of miscellaneous services provided to customers and interconnecting carriers and accounted for approximately 7.8% of total KCSR revenues in 2003. Major items in this category include railcar switching services, demurrage (car retention penalties) and drayage (local truck transportation services). This category also includes haulage services performed for the benefit of BNSF under an agreement that continues through 2004 and includes minimum volume commitments.

Railroad Industry

Overview

U.S. railroad companies are categorized by the STB into three types: Class I, Class II (Regional) and Class III (Local). Currently, there are seven Class I railroads in the United States, which can be further divided

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geographically by eastern or western classification. The eastern railroads are CSX Corporation (“CSX”), Grand Trunk Corporation (which is owned by CN and includes IC and Wisconsin Central Transportation Corporation – “Wisconsin Central”) and Norfolk Southern. The western railroads include BNSF, KCSR, Soo Line Railroad Company (owned by Canadian Pacific Railway Company (“CP”)) and UP.

The STB and Regulation

The STB, an independent body administratively housed within the Department of Transportation, is responsible for the economic regulation of railroads within the United States. The STB’s mission is to ensure that competitive, efficient and safe transportation services are provided to meet the needs of shippers, receivers and consumers. The STB was created by an Act of Congress known as the ICC Termination Act of 1995 (“ICCTA”). Passage of the ICCTA represented a further step in the process of streamlining and reforming the Federal economic regulatory oversight of the railroad, trucking and bus industries that was initiated in the late 1970’s and early 1980’s. The STB is authorized to have three members, each with a five-year term of office. The STB Chairman is designated by the President of the United States from among the STB’s members. The STB adjudicates disputes and regulates interstate surface transportation. Railway transportation matters under the STB’s jurisdiction in general include railroad rate and service issues, rail restructuring transactions (mergers, line sales, line construction and line abandonment) and railroad labor matters.

The U.S. railroad industry was significantly deregulated with the passage of The Staggers Rail Act of 1980 (the “Staggers Act”). In enacting the Staggers Act, Congress recognized that railroads faced intense competition from trucks and other modes of transportation for most freight traffic and that prevailing regulation prevented them from earning adequate revenues and competing effectively. Through the Staggers Act, a new regulatory scheme allowing railroads to establish their own routes, tailor their rates to market conditions and differentiate rates on the basis of demand was put in place. The basic principle of the Staggers Act was that reasonable rail rates should be a function of supply and demand. The Staggers Act, among others things:

• allows railroads to price competing routes and services differently to reflect relative demand;

• allows railroads to enter into confidential rate and service contracts with shippers; and

• abolishes collective rate making except among railroads participating in a joint-line movement.

If it is determined that a railroad is not facing enough competition to hold down prices, the STB has the authority to investigate the actions of the railroad.

The Staggers Act has had a positive effect on the U.S. rail industry, competition, and savings to consumers. Lower rail rates brought about by the Staggers Act have resulted in significant cost savings for shippers and their customers. After decades of steady decline, the rail market share of inter-city freight ton-miles bottomed out at 35.2% in 1978 and has trended slowly upward since then, reaching 41.7% in 2001.

Railroad Consolidation

On June 11, 2001, the STB issued new rules governing major railroad mergers and consolidations involving two or more “Class I” railroads. These rules substantially increase the burden on rail merger applicants to demonstrate that a proposed transaction would be in the public interest. The rules require applicants to demonstrate that, among other things, a proposed transaction would enhance competition where necessary to offset negative effects of the transaction, such as competitive harm, and to address fully the impact of the transaction on transportation service.

The STB recognized, however, that a merger between KCSR and another Class I carrier would not necessarily raise the same concerns and risks as potential mergers between larger Class I railroads. Accordingly, the STB decided that for a merger proposal involving KCSR and another Class I railroad, the STB will waive the application of the new rules and apply the rules previously in effect unless it is persuaded that the new rules should apply.

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Competition

The Company’s rail operations compete against other railroads, many of which are much larger and have significantly greater financial and other resources. Since 1994, there has been significant consolidation among major North American rail carriers, including the 1995 merger of Burlington Northern, Inc. and Santa Fe Pacific Corporation (“BN/SF”, collectively “BNSF”), the 1995 merger of the UP and the Chicago and North Western Transportation Company (“UP/CNW”) and the 1996 merger of UP with Southern Pacific Corporation (“UP/SP”). Further, Norfolk Southern and CSX purchased the assets of Consolidated Rail Corporation (“Conrail”) in 1998 and the CN acquired the IC in June 1999. Most recently, in October 2001 CN completed its acquisition of Wisconsin Central. As a result of this consolidation, the railroad industry is now dominated by a few “mega-carriers.” KCS management believes that its revenues were negatively affected by the UP/CNW, UP/SP and BN/SF mergers, which led to diversions of rail traffic away from KCSR’s rail lines. Management regards the larger western railroads (BNSF and UP), in particular, as significant competitors to the Company’s operations and prospects because of their substantial resources. The ongoing impact of these mergers is uncertain. KCS management believes, however, that because of the Company’s investments and strategic alliances, it is positioned to attract additional rail traffic through our NAFTA rail network.

The Company is subject to competition from motor carriers, barge lines, and other maritime shipping, which compete across certain routes in its operating area. Truck carriers have eroded the railroad industry’s share of total transportation revenues. Changing regulations, subsidized highway improvement programs and favorable labor regulations have improved the competitive position of trucks in the United States as an alternative mode of surface transportation for many commodities. In the United States, the trucking industry generally is more cost and transit-time competitive than railroads for short-haul distances. In addition, Mississippi and Missouri River barge traffic, among others, compete with KCSR and its rail connections in the transportation of bulk commodities such as grains, steel and petroleum products. Intermodal traffic and certain other traffic face highly price sensitive competition, particularly from motor carriers. However, rail carriers, including KCSR, have placed an emphasis on competing in the intermodal marketplace and working together with motor carriers and each other to provide end-to-end transportation of products.

While deregulation of freight rates has enhanced the ability of railroads to compete with each other and with alternative modes of transportation, this increased competition has resulted in downward pressure on freight rates. Competition with other railroads and other modes of transportation is generally based on the rates charged, the quality and reliability of the service provided and the quality of the carrier’s equipment for certain commodities.

Employees and Labor Relations

As of December 31, 2003, KCS and its subsidiaries had approximately 2,670 employees.

Labor relations in the U.S. railroad industry are subject to extensive governmental regulation under the Railway Labor Act (“RLA”). Under the RLA, national labor agreements are renegotiated when they become open for modification, but their terms remain in effect until new agreements are reached. Typically, neither management nor labor employees are permitted to take economic action until extended procedures are exhausted.

Approximately 84% of KCSR employees are covered under various collective bargaining agreements. In 1996, national labor contracts governing KCSR were negotiated with all major railroad unions, including the United Transportation Union (“UTU”), the Brotherhood of Locomotive Engineers (“BLE”), the Transportation Communications International Union (“TCU”), the Brotherhood of Maintenance of Way Employees (“BMWE”), and the International Association of Machinists and Aerospace Workers. Existing national union contracts with the railroads became amendable at the end of 1999. In August 2002, a new labor contract was reached with the UTU. The provisions of this agreement include the use of remote control locomotives in and around terminals and retroactive application of wage increases back to July 1, 2002. Also, a new labor contract was reached with

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the TCU in 2002 and signed during 2003. A new labor contract was reached with the BMWE effective May 2001 and a formal agreement with the BLE was reached during 2003. In some cases, the wage increase elements of these new agreements have retroactive application. The provisions of the various labor agreements generally include periodic general wage increases, lump-sum payments to workers and greater work rule flexibility, among other provisions. Additionally, these agreements include provisions that employees under these contracts make contributions to cover a portion of the health and welfare costs. Currently, approximately 90% of all KCS unionized employees are governed under current contracts. Formal negotiations to enter into agreements are in progress with the remaining unions and the existing labor contracts will remain in effect until new agreements are reached. Management does not expect that the negotiations or the resulting labor agreements will have a material impact on our consolidated results of operations, financial condition or cash flows.

Railroad Retirement Act and Railroad Retirement Improvement Act

Railroad industry personnel are covered by the Railroad Retirement Act (“RRA”) instead of the Social Security Act. Employer contributions under the RRA are currently substantially higher than those under the Social Security Act and may rise further because of the increasing proportion of retired employees receiving benefits relative to the number of working employees. The RRA currently requires up to a 20.75% contribution by railroad employers on eligible wages while the Social Security and Medicare Acts only require a 7.65% employer contribution on similar wage bases. Railroad industry personnel are also covered by the Federal Employers’ Liability Act (“FELA”) rather than state workers’ compensation systems. FELA is a fault-based system with compensation for injuries settled by negotiation and litigation, which can be expensive and time-consuming. By contrast, most other industries are covered by state administered no-fault plans with standard compensation schedules. The difference in the labor regulations for the rail industry compared to the non-rail industries illustrates the competitive disadvantage placed upon the rail industry by federal labor regulations.

On December 21, 2001, the Railroad Retirement and Survivors’ Improvement Act of 2001 (“RRIA”) was signed into law. This legislation liberalizes early retirement benefits for employees with 30 years of service by reducing the full benefit age from 62 to 60, eliminates a cap on monthly retirement and disability benefits, lowers the minimum service requirement from 10 years to 5 years of service, and provides for increased benefits for surviving spouses. It also provides for the investment of railroad retirement funds in non-governmental assets, adjustments in the payroll tax rates paid by employees and employers, and the repeal of a supplemental annuity work-hour tax. The law also reduced the employer contribution for payroll taxes by 0.5% in 2002 and by an additional 1.4% in 2003. Beginning in 2004, the employer contribution will be based on a formula and could range between 8.2% and 22.1%. These reductions in the employer contributions under the RRA had a favorable impact on fringe benefits expenses during 2003. Additionally, the reduction in the retirement age from 62 to 60 is expected to result in increased employee attrition, leading to additional potential cost savings since it is not anticipated that all employees selecting early retirement will be replaced.

Insurance

KCS maintains multiple insurance programs for its various subsidiaries including rail liability and property, general liability, directors and officers’ coverage, workers compensation coverage and various specialized coverage for specific entities as needed. Coverage for KCSR is by far the most significant part of the KCS program. It includes liability coverage up to $250 million, subject to a $10 million deductible and certain aggregate limitations, and property coverage up to $200 million subject to a $5 million deductible ($10 million deductible in the event of flood or earthquake) and certain aggregate limitations. KCS management believes that the Company’s insurance program is in line with industry norms given its size and provides adequate coverage for potential losses.

Available Information

The Company’s Internet address is www.kcsi.com. Through this website, KCS makes available, free of charge, its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K,

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and amendments to those reports, as soon as reasonably practicable after electronic filing or furnishing of these reports with the Securities and Exchange Commission. In addition, the Company’s corporate governance guidelines, ethics and legal compliance policy, and the charters of the Audit Committee, the Nominating and Corporate Governance Committee and the Compensation and Organization Committee of the Company’s Board of Directors are available on the Company’s Internet website. These guidelines and charters are available in print to any stockholder who requests them. Written requests may be made to the Corporate Secretary of KCS, P.O. Box 219335, Kansas City, Missouri 64121 (or if by federal express or other form of express delivery to 427 West 12th Street, Kansas City, Missouri 64105).

Item 2. Properties

KCSR — Certain KCSR property statistics follow:

	2003		2002		2001
Route miles—main and branch line	3,108		3,109		3,103
Total track miles	4,351		4,359		4,444
Miles of welded rail in service	2,309		2,261		2,197
Main line welded rail (%)	61	%	61	%	59	%
Cross ties replaced	280,226		232,993		233,489
Average Age (in years):	2003		2002		2001
Wood ties in service	16.7		16.0		16.0
Rail in main and branch line	31.0		29.9		28.9
Road locomotives	25.5		24.6		23.6
All locomotives	26.5		25.6		24.5

KCSR’s fleet of locomotives and rolling stock consisted of the following at December 31:

	2003		2002		2001
	Leased	Owned	Leased	Owned	Leased	Owned
Locomotives:
Road Units	302	121	302	122	304	122
Switch Units	52	4	52	4	52	4
Other	—	8	—	8	—	8
Total	354	133	354	134	356	134
Rolling Stock:
Box Cars	5,252	1,354	5,358	1,366	6,164	1,420
Gondolas	761	61	760	74	780	88
Hopper Cars	2,746	805	2,614	966	2,002	1,179
Flat Cars (Intermodal
and Other)	1,366	552	1,599	541	1,585	601
Tank Cars	41	40	42	40	44	43
Auto Rack	200	—	201	—	201	—
Total	10,366	2,812	10,574	2,987	10,776	3,331

As of December 31, 2003, KCSR’s fleet consisted of 487 diesel locomotives, of which 133 were owned, 333 leased from Southern Capital and 21 leased from non-affiliates. KCSR’s fleet of rolling stock consisted of 13,178 freight cars, of which 2,812 were owned, 3,384 leased from Southern Capital and 6,982 leased from non-affiliates. The locomotives and freight cars leased from Southern Capital secure pass through certificates issued by Southern Capital during 2002.

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The owned equipment is subject to liens created under senior secured credit facilities, as well as liens created under certain capital leases and equipment trust certificates. KCSR indebtedness with respect to equipment trust certificates and capital leases totaled approximately $19.1 million at December 31, 2003.

KCSR, in support of its transportation operations, owns and operates repair shops, depots and office buildings along its right-of-way. A major facility, the Deramus Yard, is located in Shreveport, Louisiana and includes a general office building, locomotive repair shop, car repair shops, customer service center, material warehouses and fueling facilities totaling approximately 227,000 square feet. KCSR owns a 107,800 square foot facility in Pittsburg, Kansas that previously was used as a diesel locomotive repair facility. This facility was closed during 1999 and is now being leased to an engineering and manufacturing company. KCSR also owns freight warehousing and office facilities in Dallas, Texas totaling approximately 150,000 square feet. Other facilities owned by KCSR include a 21,000 square foot freight car repair shop in Kansas City, Missouri and approximately 15,000 square feet of office space in Baton Rouge, Louisiana. KCSR also has the support of a locomotive repair facility in Kansas City. This facility is owned and operated by General Electric Company (“GE”) and is used to maintain and repair AC 4400 locomotives that were manufactured by GE and are leased by KCSR.

In June 2001, the Company entered into a 17-year lease agreement for a new corporate headquarters building in downtown Kansas City, Missouri. In April 2002, the Company moved its corporate offices into this building. The Company’s corporate offices had previously been located in another building in downtown Kansas City, which was leased from a subsidiary of the Company until the building was sold in June 2001.

KCSR owns six intermodal facilities and has contracted with third parties to operate these facilities. These facilities are located in Dallas; Kansas City; Shreveport and New Orleans, Louisiana; Jackson, Mississippi; and Salisaw, Oklahoma. During 2003, the Company expanded the capacity of its Dallas and Shreveport facilities through capital improvements. The Company has constructed an automobile facility and has plans to construct an intermodal facility at the former Richards-Gebaur Airbase in Kansas City, Missouri. A portion of the automotive facility became operational in April 2000 for the storage and movement of automobiles. Intermodal and automotive operations at the facility may be further expanded in the future as business opportunities arise. The various intermodal facilities include strip tracks, cranes and other equipment used in facilitating the transfer and movement of trailers and containers.

KCSR also has ten bulk transload facilities, including facilities in Kansas City; Spiro, Oklahoma; Jackson; Dallas; Sauget, Illinois; Lake Charles and Baton Rouge, Louisiana; Vicksburg, Mississippi; and Pittsburg and Port Arthur, Texas. Due to growth in transload traffic, KCSR expanded its Jackson facility in 2003. In 2003, KCSR opened the transload facility in Pittsburg and returned to service a 70-acre bulk commodity handling facility in Port Arthur. Transload operations consist of rail/truck shipments whereby the products shipped are unloaded from the trailer, container or rail car and reloaded onto the other mode of transportation. Transload is similar to intermodal, except that intermodal shipments transfer the entire container or trailer and transload shipments transfer only the product being shipped.

KCSR owns 16.6% of the Kansas City Terminal Railway Company, which owns and operates approximately 80 miles of track, and operates an additional eight miles of track under trackage rights in greater Kansas City, Missouri. KCSR also leases for operating purposes certain short sections of trackage owned by various other railroad companies and jointly owns certain other facilities with these railroads.

Grupo TFM

TFM operates approximately 2,650 miles of main and branch lines and certain additional sidings, spur tracks and main line under trackage rights. TFM has the right to operate the rail lines, but does not own the land, roadway or associated structures. Approximately 81% of the main line operated by TFM consists of continuously

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welded rail. As of December 31, 2003, TFM owned 467 locomotives, owned or leased from affiliates 4,293 freight cars and leased from non-affiliates 150 locomotives and 7,683 freight cars. Grupo TFM (through TFM) has office space at which various operational, administrative, managerial and other activities are performed. The primary facilities are located in Mexico City and Monterrey, Mexico. TFM leases 94,915 square feet of office space in Mexico City and holds, under the Concession, a 115,157 square foot facility in Monterrey.

Panama Canal Railway Company

PCRC leases four locomotives and owns two locomotives. PCRC also owns 12 double stack cars, 6 passenger cars and various other infrastructure improvements and equipment. Under the concession, PCRC constructed and operates intermodal terminal facilities at each end of its railroad and an approximate 15,000 square foot equipment maintenance facility. All of this property and equipment is subject to liens securing PCRC debt as further described in Item 1, “Business—Rail Network—Significant Investments—Panama Canal Railway Company.”

Other

The Company owns 1,025 acres of property located on the waterfront in the Port Arthur, Texas area, which includes 22,000 linear feet of deep-water frontage and three docks. Port Arthur is an uncongested port with direct access to the Gulf of Mexico. Approximately 75% of this property is available for development.

Trans-Serve, Inc. operates a railroad wood tie treating plant in Vivian, Louisiana under an industrial revenue bond lease arrangement with an option to purchase. This facility includes buildings totaling approximately 12,000 square feet.

Pabtex GP LLP owns a 70-acre bulk commodity handling facility in Port Arthur, Texas.

KCSR owns a microwave system formerly owned and operated by Mid-South Microwave, Inc. prior to its merger into KCSR effective December 31, 2002. This system extends essentially along the right-of-way of KCSR from Kansas City to Dallas, Beaumont and Port Arthur and New Orleans.

Other subsidiaries of the Company own approximately 5,500 acres of land at various points adjacent to the KCSR right-of-way. Other properties owned include a 354,000 square foot warehouse at Shreveport and several former railway buildings now being rented to non-affiliated companies, primarily as warehouse space.

In the opinion of management, the various facilities, office space and other properties owned and/or leased by the Company and its subsidiaries are adequate for current operating needs.

The information set forth in response to Item 102 of Regulation S-K under Item 1, “Business”, of this Form 10-K and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” is incorporated by reference in partial response to this Item 2.

Item 3. Legal Proceedings

The information set forth in response to Item 103 of Regulation S-K under Part II Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Other—Litigation—Other— Environmental Matters and—Recent Developments—Dispute over Acquisition Agreement” of this Form 10-K is incorporated by reference in response to this Item 3. In addition, see the discussion in Part II Item 8, “Financial Statements and Supplementary Data—Note 9—Commitments and Contingencies” of this Form 10-K.

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Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the three-month period ended December 31, 2003.

Executive Officers of the Company

All executive officers are elected annually and serve at the discretion of the Board of Directors. All of the executive officers have employment agreements with the Company.

Name	Age	Position(s)
Michael R. Haverty	59	Chairman of the Board, President and Chief Executive Officer
Gerald K. Davies	59	Executive Vice President and Chief Operating Officer
Ronald G. Russ	49	Executive Vice President and Chief Financial Officer
Jerry W. Heavin	52	Senior Vice President—Operations of KCSR
Larry O. Stevenson	40	Senior Vice President—Sales and Marketing of KCSR
Warren K. Erdman	45	Vice President—Corporate Affairs
Paul J. Weyandt	51	Vice President and Treasurer
Mark W. Osterberg	53	Vice President and Comptroller
Jay M. Nadlman	43	Associate General Counsel and Corporate Secretary

The information set forth in the Company’s Definitive Proxy Statement in the description of The Board of Directors—Directors Serving Until the Annual Meeting of Stockholders in 2006 with respect to Mr. Haverty is incorporated herein by reference.

Gerald K. Davies has served as Executive Vice President and Chief Operating Officer of KCS since July 18, 2000. Mr. Davies joined KCSR in January 1999 as the Executive Vice President and Chief Operating Officer. Mr. Davies has served as a director of KCSR since November 1999. Prior to joining KCSR, Mr. Davies served as the Executive Vice President of Marketing with Canadian National Railway from 1993 through 1998. Mr. Davies held senior management positions with Burlington Northern Railway from 1976 to 1984 and 1991 to 1993, respectively, and with CSX Transportation from 1984 to 1991.

Ronald G. Russ has served as Executive Vice President and Chief Financial Officer since January 16, 2003. Mr. Russ served as Senior Vice President and Chief Financial Officer from July 1, 2002 to January 15, 2003. Mr. Russ served as Executive Vice President and Chief Financial Officer of Wisconsin Central from 1999 to 2002. He served as Treasurer of Wisconsin Central from 1987 to 1993. From 1993 to 1999 he was Executive Manager and Chief Financial Officer for Tranz Rail Holdings Limited, an affiliate of Wisconsin Central in Wellington, New Zealand. He also served in various capacities with Soo Line Railroad and The Chicago, Milwaukee, St. Paul and Pacific Railroad Company, spanning a 26-year career in the railroad industry.

Jerry W. Heavin has served as Senior Vice President of Operations and a director of KCSR since July 9, 2002. Mr. Heavin joined KCSR on September 1, 2001 and served as Vice President of Engineering of KCSR until July 8, 2002. Prior to joining KCSR, Mr. Heavin served as an independent engineering consultant from 1997 through August 2001. Mr. Heavin began his railroad career in 1970 with UP, serving in various capacities, including general superintendent transportation and chief engineer of facilities.

Larry O. Stevenson has served as Senior Vice President of Marketing and Sales of KCSR since January 1, 2003. Mr. Stevenson served as Vice President—Paper and Forest Products of KCSR from September 1, 2000 to December 31, 2002 and General Director Customer Service of KCSR from February 14, 2000 to August 31, 2000. Prior to joining KCSR, Mr. Stevenson served in various capacities at Canadian National Railway from June 1983 to December 1999, most recently as Assistant Vice President of Sales.

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Warren K. Erdman has served as Vice President—Corporate Affairs of KCS since April 15, 1997 and as Vice President—Corporate Affairs of KCSR since May 1997. Prior to joining KCS, Mr. Erdman served as Chief of Staff to United States Senator Kit Bond of Missouri from 1987 to 1997.

Paul J. Weyandt has served as Vice President and Treasurer of KCS and of KCSR since September 2001. Before joining KCS, Mr. Weyandt was a consultant to the Structured Finance Group of GE Capital Corporation from May 2001 to September 2001. Prior to consulting, Mr. Weyandt spent 23 years with BNSF, most recently as Assistant Vice President—Finance and Assistant Treasurer.

Mark W. Osterberg has served as Vice President and Comptroller of KCS and KCSR since February 2004. Mr. Osterberg was a financial and business process consultant in 2002 and 2003. He was the Chief Financial Officer of Sun Country Airlines, Inc. from April 2000 to December 2001. Sun Country entered US bankruptcy proceeding in January 2002 and its trade name and selected assets were sold to a third party in 2002. Mr. Osterberg served as Chief Financial Officer of Norton Motorcycles Inc., a development stage enterprise, and its predecessor from December 1998 to February 2000. Prior to that he served as the Vice President—Chief Accounting Officer for Northwest Airlines Corporation for seven years. Mr. Osterberg was also employed by the Deloitte Haskins & Sells (now Deloitte) auditing firm for nine years.

Jay M. Nadlman has served as Associate General Counsel and Corporate Secretary of KCS since April 1, 2001. Mr. Nadlman joined KCS in December 1991 as a General Attorney, and was promoted to Assistant General Counsel in 1997, serving in that capacity until April 1, 2001. Mr. Nadlman has served as Associate General Counsel and Secretary of KCSR since May 3, 2001 and as Assistant General Counsel and Assistant Secretary from August 1997 to May 3, 2001. Prior to joining KCS, Mr. Nadlman served as an attorney with the Union Pacific Railroad Company from 1985 to 1991.

There are no arrangements or understandings between the executive officers and any other person pursuant to which the executive officer was or is to be selected as an officer of KCS, except with respect to the executive officers who have entered into employment agreements. These employment agreements designate the position(s) to be held by the executive officer.

None of the above officers are related to one another by family.

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Part II

Item 5. Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The information set forth in response to Item 201 of Regulation S-K on the cover (page i) under the heading “Company Stock,” and in Part II Item 8, “Financial Statements and Supplementary Data, at Note 11—Quarterly Financial Data (Unaudited)” of this Form 10-K is incorporated by reference in partial response to this Item 5.

The Company has not declared any cash dividends on its common stock during the last two fiscal years and does not anticipate making any cash dividend payments to common stockholders in the foreseeable future. Pursuant to the Company’s amended and restated credit agreement, the Company is prohibited from the payment of cash dividends on the Company’s common stock.

On May 5, 2003, the Company completed the sale of $200 million (400,000 shares) of 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C (“Convertible Preferred Stock”), with a liquidation preference of $500 per share in a private offering under Rule 144A to qualified institutional buyers. Net proceeds to the Company were $193 million after fees to the initial purchasers of $7 million and other expenses of the offering. Dividends on the Convertible Preferred Stock will be cumulative and will be payable quarterly at an annual rate of 4.25% of the liquidation preference, when, as and if declared by the Company’s Board of Directors. Accumulated unpaid dividends will cumulate dividends at the same rate as dividends cumulate on the Convertible Preferred Stock. Each share of the Convertible Preferred Stock will be convertible, under certain conditions, and subject to adjustment under certain conditions, into 33.4728 shares of the Company’s common stock. Conversion rights arise only upon the occurrence of the following: (i) the closing sale price of the Company’s common stock exceeds a specified level for a specified period; (ii) upon certain credit rating downgrades; (iii) upon the convertible preferred stock trading below a certain level for a specified period; (iv) upon notice of redemption; and (v) upon the occurrence of certain corporate transactions. On or after May 20, 2008, the Company will have the option to redeem any or all of the Convertible Preferred Stock, subject to certain conditions. Under certain circumstances, at the option of the holders of the Convertible Preferred Stock, the Company may be required to purchase shares of the Convertible Preferred Stock from the holders. A portion of the proceeds from the sale of the Convertible Preferred Stock has been used to reduce debt. The remainder of the net proceeds from the sale of the Convertible Preferred Stock are expected to be used to pay a portion of the purchase price for the proposed acquisition of a controlling interest of Grupo TFM (See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Developments—Proposed Acquisition of Grupo TFM”) or to further reduce debt.

On August, 1, 2003, KCS filed a Form S-3 Registration Statement with the SEC to register, for resale by the holders, the Convertible Preferred Stock and the common stock into which such preferred stock may be converted. On October 24, 2003, this Registration Statement, as amended, was declared effective by the SEC. KCS has filed, and will continue to file, post-effective amendments to this Registration Statement as required by applicable rules and regulations. KCS will not receive any proceeds from the sale of the securities under this Registration Statement, as amended.

As of February 27, 2004, there were 5,316 record holders of the Company’s common stock.

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Item 6. Selected Financial Data

The selected financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included under Item 7 of this Form 10-K and the consolidated financial statements and the related notes thereto, and the Reports of Independent Accountants thereon, included under Item 8, “Financial Statements and Supplementary Data” of this Form 10-K and such data is qualified by reference thereto. All years reflect the 1-for-2 reverse common stock split to shareholders of record on June 28, 2000 paid July 12, 2000.

	2003			2002		2001		2000		1999
	(in millions, except per share and ratio amounts)
Revenues	$	581.3		$	566.2	$	583.2	$	578.7	$	609.0
Equity in net earnings from unconsolidated affiliates—continuing operations	$	11.0		$	43.4	$	27.1	$	22.1	$	5.2
Income from continuing operations before cumulative effect of accounting change (a)	$	3.3		$	57.2	$	31.1	$	16.7	$	10.2
Earnings per common share—Income (loss) from continuing operations before cumulative effect of accounting change (a)
Basic	$	(0.04	)	$	0.94	$	0.53	$	0.29	$	0.18
Diluted		(0.04	)		0.91		0.51		0.28		0.17
Total assets ( b)	$	2,152.9		$	2,008.8	$	2,010.9	$	1,944.5	$	2,672.0
Long-term obligations	$	523.4		$	582.6	$	658.4	$	674.6	$	760.9
Cash dividends per common share	$	—		$	—	$	—	$	—	$	0.32
Ratio of earnings to fixed charges (c)		—	(d)		1.3x		1.1x		1.0x		1.2x

(a) Income from continuing operations before cumulative effect of accounting change for the years ended December 31, 2003, 2002 and 2001 include certain unusual operating expenses and other income as further described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—“Results of Operations.” These costs include charges for casualty claims, cost related to the implementation of the Management Control System (“MCS”), benefits received from the settlement of certain legal and insurance claims, severance costs and expenses associated with legal verdicts against the Company, gains recorded on the sale of operating property, among others. Other non-operating income includes gains recorded on sale of non-operating properties and investments. For the year ended December 31, 1999, income from continuing operations includes unusual costs and expenses related to facility and project closures, employee separations and related costs, labor and personal injury related issues.

(b) The total assets presented herein as of December 31, 1999 include the net assets of Stilwell Financial Inc. (“Stilwell”, now Janus Capital Group Inc.) of $814.6 million. Due to the Spin-off on July 12, 2000, the total assets for the other periods presented do not include the net assets of Stilwell.

(c) The ratio of earnings to fixed charges is computed by dividing earnings by fixed charges. For this purpose “earnings” represent the sum of (i) pretax income from continuing operations adjusted for income (loss) from unconsolidated affiliates, (ii) fixed charges, (iii) distributed income from unconsolidated affiliates and (iv) amortization of capitalized interest, less capitalized interest. “Fixed charges” represent the sum of (i) interest expensed, (ii) capitalized interest, (iii) amortization of deferred debt issuance costs and (iv) one-third of our annual rental expense, which management believes is representative of the interest component of rental expense.

(d) For the year ended December 31, 2003, the ratio of earnings to fixed charges was less than 1:1. The ratio of earnings to fixed charges would have been 1:1 if a deficiency of $18.2 million was eliminated.

The information set forth in response to Item 301 of Regulation S-K under Part II Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Form 10-K is incorporated by reference in partial response to this Item 6.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion 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 8 of this Form 10-K. This discussion should be read in conjunction with these consolidated financial statements, the related notes and the Report of Independent Accountants thereon, and other information included in this report.

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CORPORATE OVERVIEW

KCS, a Delaware corporation, is a holding company with principal operations in rail transportation and its principal subsidiaries and affiliates include the following:

• The Kansas City Southern Railway Company (“KCSR”), a wholly-owned subsidiary;

• Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”), a 46.6% owned unconsolidated affiliate, which owns 80% of the 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”);

• Southern Capital Corporation, LLC (“Southern Capital”), a 50% owned unconsolidated affiliate that leases locomotive and rail equipment to KCSR;

• 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 was organized in 1962 as Kansas City Southern Industries, Inc. and in 2002 formally changed its name to Kansas City Southern. KCS, as the holding company, supplies its various subsidiaries with managerial, legal, tax, financial and accounting services, in addition to managing other minor “non-operating” investments.

EXECUTIVE SUMMARY

Overview

KCS operates under one reportable business segment in the rail transportation industry and KCSR, the Company’s principal subsidiary, is the smallest of the Class I railroads. The Company generates its revenues and cash flows by providing its customers with freight delivery services in both our regional area and throughout the United States, Mexico and Canada through connections with our affiliates and other Class I rail carriers. Our customers conduct business in a number of different industries, including electric-generating utilities, chemical and petroleum products, paper and forest products, agriculture and mineral products, automotive products and intermodal traffic. The Company uses its cash flows to support its operations and to invest in its infrastructure. The rail industry is a capital-intensive industry and the Company’s capital expenditures are a significant use of cash each year. In 2003, the Company’s capital expenditures were approximately $79 million and are projected to be $108 million in 2004. A more detailed discussion of capital expenditures is found in the “Liquidity and Capital Resources” section below.

Grupo TFM is an unconsolidated affiliate and the Company uses the equity accounting method to recognize its proportionate share of Grupo TFM’s earnings. TFM operates a strategically significant rail corridor between Mexico and the United States. KCS management believes that its investment in Grupo TFM is a strategic asset with substantial economic potential.

As further described below in “Recent Developments,” on April 20, 2003, the Company reached an agreement (the “Acquisition Agreement”) with its partner, Grupo TMM, S.A. (“Grupo TMM”) and other parties to ultimately acquire control of TFM through the purchase of Grupo TMM’s shares of Grupo TFM (the “Acquisition”). However, Grupo TMM has advised the Company that it is unwilling to proceed with the Acquisition. The dispute over Grupo TMM’s unwillingness to proceed with the Acquisition is currently the subject of binding arbitration and the Company’s management cannot predict whether or not KCS will be able to complete the Acquisition. Additionally, there are several other uncertainties with respect to the Company’s investment in Grupo TFM as described further in “Recent Developments.” The Company is spending substantial time and financial resources to address these uncertainties as well as the disputed Acquisition and the ultimate resolution of these items could have a material affect on the Company’s results of operations, financial condition and cash flows.

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2003 Analysis

In 2003, the Company experienced consolidated revenue growth of approximately 3% compared to 2002 resulting from volume growth, targeted rate increases and improved operating performance at KCSR due to the efficiencies gained as a result of the implementation of a new transportation operating platform, Management Control System (“MCS”), in July 2002. Revenue increases were notable in paper and forest products, agriculture and minerals, intermodal traffic and certain chemical products as KCSR began to realize the benefit of a slight economic recovery during the latter part of 2003. KCSR also improved its operating performance during 2003, which was evident in key performance measurements such as reduced terminal dwell time, higher train speeds and lower average daily crew starts. Even with the increased traffic volumes and revenue growth, compensation and benefits expense was unchanged in 2003 compared to 2002 and car hire expense declined 49% year over year, both resulting from improvements in operating performance and demonstrating the impact of efficiencies gained from a more fully functional MCS. The contribution of these operating improvements to operating expenses, however, was offset by higher personal injury costs, which resulted in a $31.2 million increase in casualties and insurance expense, as well as higher fuel prices throughout 2003, which led to a $9.0 million increase in fuel costs year over year. Depreciation expense also increased $2.9 million in 2003 due to a full year of depreciation on MCS versus only a half year in 2002. These factors were the primary contributors to a $34.0 million increase in operating expenses in 2003 compared to 2002 and an $18.9 million decline in operating income.

The Company’s equity in earnings of unconsolidated affiliates decreased in 2003 compared to 2002, as a result of a $33.5 million reduction in equity in earnings from Grupo TFM. The Company’s equity in earnings from Grupo TFM were adversely affected by lower operating income, higher interest expense and a decline in the deferred tax benefit at Grupo TFM. In 2003, Grupo TFM’s overall freight volumes increased 3.3% compared to 2002. Freight revenues, however declined $13.6 million year over year, driven by the devaluation of the peso, which reduced revenues by approximately $34 million. In 2003, approximately 59.7% of Grupo TFM’s revenues were denominated in United States dollars. Additionally, for the year ended December 31, 2003, Grupo TFM’s results include a deferred tax benefit of $51.5 million (calculated under U.S. GAAP) compared to a deferred tax benefit of $91.5 million for the year ended December 31, 2002, resulting in an approximate $15.2 million reduction in the equity in net earnings recorded by the Company related to its proportionate ownership of Grupo TFM. For the year ended December 31, 2003, the Company’s equity in earnings from Grupo TFM were favorably impacted by the increase in ownership percentage arising from the purchase, by TFM, of the Mexican government’s 24.6% ownership of Grupo TFM during the second quarter of 2002.

2004 Outlook

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Information” for cautionary statements concerning forward-looking comments.

During 2004, KCSR expects to continue to take advantage of the economic recovery and focus on improving the Company’s domestic operations. Management expects overall KCSR revenues to increase in 2004 compared to 2003 as certain commodity segments are expected to experience growth based on higher demand. Except as discussed herein, assuming normalized rail operations, management expects KCSR’s variable operating expenses to be proportionate with revenue activity with cost efficiencies expected as a result of the continued improvements realized from the utilization of MCS. Fuel prices will fluctuate subject to market conditions, which, in 2003, were substantially higher than in 2002. Management is concerned about the trend of fuel prices due to uncertainty in the foreign markets and, as a result, the Company participates in derivative contracts to mitigate these market risks. KCSR currently has approximately 13% of its budgeted fuel usage for 2004 hedged through purchase commitments and fuel swaps, both of which reduce the risk of the adverse impact of volatile fuel prices. Additionally, in 2004, KCSR will begin purchasing a significant portion of its fuel through a pipeline system. The use of this pipeline is expected to result in fuel cost savings during 2004. Insurance costs are expected to rise commensurate with market conditions.

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During 2003, KCS retained the services of an international consulting engineering firm to undertake a depreciation study of the Company’s property, plant and equipment. This study, the results of which have been approved by the STB, indicates that, beginning in 2004, annual depreciation expense for KCSR will be reduced by approximately $13 million.

The Company is currently in the process of refinancing its existing senior secured credit facility as further described in “Recent Developments—Refinancing of Senior Secured Credit Facility.” KCS has received firm commitment letters from various banks and institutional investors committing to fully fund the new facility and KCS management expects to close this refinancing transaction prior to March 31, 2004. If, however, this transaction is not consummated on or prior to March 31, 2004, the Company may be in technical default of certain of its financial covenants under its existing credit facility.

The Company expects 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 Mexican peso or a change in Mexican inflation will have on the results of Grupo TFM. In addition, if a resolution is reached regarding the dispute over the agreement to acquire Grupo TMM’s interest in Grupo TFM and the transaction to place KCSR, TFM and Tex-Mex under common control is consummated, then the Company would report the results of operations of TFM and Tex-Mex as consolidated subsidiaries (See “Recent Developments—Proposed Acquisition of Grupo TFM from Grupo TMM”).

RISK FACTORS

The Company Faces Competition from Other Railroads and Other Transportation Providers. The Company is subject to competition from other railroads, many of which are much larger and have significantly greater financial and other resources. In addition, the Company is subject to competition from truck carriers and from barge lines and other maritime shipping. Increased competition has resulted in downward pressure on freight rates. Competition with other railroads and other modes of transportation is generally based on the rates charged, the quality and reliability of the service provided and the quality of the carrier’s equipment for certain commodities. While the Company must build or acquire and maintain its infrastructure, truck carriers and maritime shippers and barges are able to use public rights-of-way. Continuing competitive pressures and declining margins, future improvements that increase the quality of alternative modes of transportation in the locations in which the Company operates, or legislation that provides motor carriers with additional advantages, such as increased size of vehicles and less weight restrictions, could have a material adverse effect on the Company’s results of operations, financial condition and liquidity.

The Company may be required to make additional investments in TFM. The Mexican government has put rights with respect to the shares of TFM it holds to compel the purchase of those shares by Grupo TFM. The Mexican government provided Grupo TFM with notice of its intention to sell its interest in TFM. Grupo TFM has responded to the Mexican government’s notice reaffirming its right and interest in purchasing the Mexican government’s remaining interest in TFM, but also advising the Mexican government that it would not take any action until its lawsuit seeking a declaratory judgment was resolved. Grupo TFM filed a lawsuit seeking a declaratory judgment concerning its interpretation of its obligation to purchase the Mexican government’s shares of TFM, and that lawsuit is ongoing. KCS and Grupo TMM have been made parties to the lawsuit. In the event that Grupo TFM does not purchase the Mexican government’s 20% interest in TFM and Grupo TFM’s lawsuit is resolved in favor of Mexican government, then Grupo TMM and KCS, or either of Grupo TMM or KCS alone, would, following notification by the Mexican government in accordance with the terms of the applicable agreements, be obligated to purchase the Mexican government’s remaining interest in TFM. If the Acquisition is completed prior to the purchase of the Mexican government’s interest in TFM, KCS will be solely responsible for purchasing the Mexican government’s 20% interest in TFM. If KCS had been required to purchase this interest as of December 31, 2003, the total purchase price would have been approximately $467.7 million. Based upon public disclosures made by Grupo TMM, it is not in a position to make this purchase.

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The Company may be unable to complete the Acquisition. KCS and Grupo TMM are currently in a dispute over the Acquisition Agreement. KCS has initiated binding arbitration with respect to the dispute and has filed pleadings and obtained rulings from the Delaware Court of Chancery to preserve the parties’ positions pending resolution of the dispute. However, there can be no assurance that the parties will resolve their disputes relating to the Acquisition Agreement, or that the arbitrators or the courts will resolve the disputes, in favor of KCS. The American Arbitration Association International Center for Dispute Resolution hearing the dispute between the Company and Grupo TMM issued its interim award on March 19, 2004 finding that the Acquisition Agreement remains in force and is binding on KCS and Grupo TMM in accordance with its terms. KCS and Grupo TMM will now move on to the second phase of the arbitration, which will decide the remaining issues, including remedies and damages. Even if disputes relating to the Acquisition Agreement are resolved in favor of KCS, the consummation of the Acquisition is subject to a number of conditions. There can be no assurance that all of the conditions to the Acquisition will be satisfied. If the Acquisition is not consummated, the value of the Company’s investment in Grupo TFM may become impaired.

If the Mexican government’s preliminary findings and conclusions arising from its tax audit of TFM’s 1997 tax returns are sustained, it could have a material adverse effect on the financial condition, results of operations and business of TFM. As a result, the value of the Company’s investment in Grupo TFM could be materially adversely affected. On January 19, 2004, TFM received a Special Certificate from the Mexican Federal Treasury in the amount of 2.1 billion pesos (the same amount as the value added tax (“VAT”) refund claimed by TFM in 1997). On January 20, 2004, TFM was served with an official letter notifying TFM of the Mexican government’s preliminary findings and conclusions arising from its tax audit of TFM’s 1997 tax returns (the “Tax Audit Summary”). In the Tax Audit Summary, the Mexican government notified TFM of its preliminary conclusion that the documentation provided by TFM in support of the VAT refund credit shown on the 1997 tax return and TFM’s basis in the Concession title, locomotives and rail equipment, and capital leases purchased by TFM’s predecessor in interest prior to Grupo TFM’s purchase of 80% of the shares of TFM, do not comply with the formalities required by the applicable tax legislation. If sustained, the conclusions of the Tax Audit Summary would prevent TFM from depreciating the Concession title, locomotives and rail equipment, and capital leases that represent the majority of the value of the assets owned by TFM. The Tax Audit Summary also attached the Special Certificate pending resolution of the audit, as a potential asset to be used to satisfy any tax obligations owed by TFM as a result of the audit. If TFM is unable to depreciate the Concession title and the other assets reported on its 1997 tax return, this could have a material adverse effect on the financial condition, results of operations and business of TFM. As a result, the value of the Company’s investment in Grupo TFM could be materially adversely affected. See “Recent Developments—Value Added Tax (“VAT”) Lawsuit and VAT Contingency Payment under the Acquisition Agreement” below.

The Company’s business strategy, operations and growth rely significantly on joint ventures and other strategic alliances. Operation of the Company’s integrated rail network and the Company’s plans for growth and expansion rely significantly on joint ventures and other strategic alliances. Unless the Acquisition is consummated, the Company will continue to hold an indirect minority interest in Tex-Mex and TFM. As a minority shareholder, the Company is not in a position to control operations, strategies or financial decisions without the concurrence of Grupo TMM, the largest shareholder in Grupo TFM. In addition, conflicts currently exist and may arise in the future between the Company’s business objectives and those of Grupo TMM. The Company is currently in a dispute with Grupo TMM over Grupo TMM’s attempt to terminate the Acquisition Agreement. The Company cannot assure that this dispute will be resolved in the Company’s favor. If the Acquisition is not consummated, resolution of any future conflicts in the Company’s favor may be difficult or impossible given the Company’s minority ownership position. In addition, the Company’s operations are dependent on interchange, trackage rights, haulage rights and marketing agreements with other railroads and third parties that enable it to exchange traffic and utilize trackage the Company does not own. The Company’s ability to provide comprehensive rail service to the Company’s customers depends in large part upon the Company’s ability to maintain these agreements with other railroads and third parties. The termination of, or the failure to renew, these agreements could adversely affect the Company’s business, financial condition and results of operations. The Company is also dependent in part upon the financial health and efficient performance of

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other railroads. There can be no assurance that the Company will not be materially affected adversely by operational or financial difficulties of other railroads.

The Company’s Mexican and Panamanian Investments subject the Company to political and economic risks. The Company’s investment in Grupo TFM involves a number of risks. The Mexican government exercises significant influence over the Mexican economy and its actions could have a significant impact on TFM. The Company’s Mexican investment may also be adversely affected by currency fluctuations, price instability, inflation, interest rates, regulations, taxation, cultural differences, social instability, labor disputes and other political, social and economic developments in or affecting Mexico. Moreover, TFM’s commercial success is heavily dependent on expected increases in U.S.-Mexico trade and will be strongly influenced by the effect of NAFTA on such trade. Downturns in either of the U.S. or Mexican economies or in trade between the United States and Mexico would be likely to adversely impact TFM’s business, financial condition and results of operations. Additionally, the Mexican government may revoke the exclusivity of TFM’s Concession after 20 years if it determines that there is insufficient competition and may terminate the Concession as a result of certain conditions or events. TFM’s assets and its rights under the Concession may also be seized temporarily by the Mexican government. Revocation or termination of the Concession would materially adversely affect TFM’s operations and its ability to make payments on its debt. The Company’s investment in PCRC has risks associated with operating in Panama, including, among others, cultural differences, varying labor and operating practices, political risk and differences between the U.S. and Panamanian economies. There can be no assurances that the various risks associated with operating in Mexico can be effectively and economically mitigated by TFM or that the risks associated with operating in Panama can be effectively and economically mitigated by PCRC.

The Company’s leverage could adversely affect its ability to fulfill obligations under various debt instruments and operate its business. The Company is leveraged and will have significant debt service obligations. In addition, Grupo TFM is also leveraged and the acquisition of a controlling interest in Grupo TFM would increase the Company’s consolidated indebtedness and leverage. The Company’s level of debt could make it more difficult for it to borrow money in the future, will reduce the amount of money available to finance the Company’s operations and other business activities, exposes it to the risk of increased interest rates, makes it more vulnerable to general economic downturns and adverse industry conditions, could reduce the Company’s flexibility in planning for, or responding to, changing business and economic conditions, and may prevent it from raising the funds necessary to repurchase all of certain senior notes that could be tendered upon the occurrence of a change of control, which would constitute an event of default, or all of the Convertible Preferred Stock that could be put to the Company under certain circumstances. The Company’s failure to comply with the financial and other restrictive covenants in the Company’s debt instruments, which, among other things, require it to maintain specified financial ratios and limit the Company’s ability to incur debt and sell assets, could result in an event of default that, if not cured or waived, could have a material adverse effect on the Company’s business or prospects. The Company is currently exploring alternatives to refinance its existing credit facility, including its revolving credit facility. The Company has received firm commitment letters from various banks and institutional investors committing to fully fund the new facility and management expects to close this refinancing transaction prior to March 31, 2004. If, however, this transaction is not consummated on or prior to March 31, 2004, management believes that the Company may be in violation of certain of the financial covenants of its credit facility. If the Company does not have enough cash to service its debt, meet other obligations and fund other liquidity needs, the Company may be required to take actions such as reducing or delaying capital expenditures, selling assets, restructuring or refinancing all or part of its existing debt or seeking additional equity capital. The Company cannot assure that any of these remedies can be effected on commercially reasonable terms or at all. In addition, the terms of existing or future debt agreements may restrict the Company from adopting any of these alternatives.

The Company may be adversely affected by changes in general economic, weather or other conditions. The Company’s operations may be adversely affected by changes in the economic conditions of the industries and geographic areas that produce and consume the freight that the Company transports. The relative strength or

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weakness of the United States economy as well as various international and regional economies also affects the businesses served. Grupo TFM, PCRC and Panarail are more directly affected by their respective local economy. Historically, a stronger economy has resulted in improved results for rail transportation operations. Conversely, when the economy has slowed, results have been less favorable. The Company’s revenues may be affected by prevailing economic conditions and, if an economic slowdown or recession occurs in the Company’s key markets, the volume of rail shipments is likely to be reduced. Additionally, the Company’s operations may be affected by adverse weather conditions. A weak harvest in the Midwest, for example, may substantially reduce the volume of business handled for agricultural products customers. Additionally, many of the goods and commodities the Company transports experience cyclical demand. The Company’s results of operations can be expected to reflect this cyclical demand because of the significant fixed costs inherent in railroad operations. The Company’s operations may also be affected by natural disasters or terrorist acts. Significant reductions in the Company’s volume of rail shipments due to economic, weather or other conditions could have a material adverse effect on the Company’s business, financial condition, results of operations and cash flows.

The Company Is Subject to Governmental Regulation. The Company is subject to governmental regulation by federal, state and local regulatory agencies with respect to its railroad operations, as well as a variety of health, safety, labor, environmental, and other matters. Government regulation of the railroad industry is a significant determinant of the competitiveness and profitability of railroads. The Company’s failure to comply with applicable laws and regulations could have a material adverse effect on its operations, including limitations on the Company’s operating activities until compliance with applicable requirements is completed. These government agencies may change the legislative or regulatory framework within which the Company operates without providing any recourse for any adverse effects on the Company’s business that occurs as a result of this change. Additionally, some of the regulations require the Company to obtain and maintain various licenses, permits and other authorizations, and the Company cannot assure that it will continue to be able to do so.

The Company Is Subject to Environmental Laws and Regulations. The Company’s operations are subject to extensive federal, state and local environmental laws and regulations concerning, among other things, emissions to the air, discharges to waters, the handling, storage, transportation and disposal of waste and other materials and cleanup of hazardous material or petroleum releases, decommissioning of underground storage tanks and soil and groundwater contamination. The Company incurs, and expects to continue to incur, environmental compliance costs, including, in particular, costs necessary to maintain compliance with requirements governing chemical and hazardous material shipping operations, refueling operations and repair facilities. New laws and regulations, stricter enforcement of existing requirements, new spills, releases or violations or the discovery of previously unknown contamination could require the Company to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on the Company’s business, results of operations, financial condition and cash flows.

The Company is Vulnerable to Rising Fuel Costs or Disruptions in Fuel Supplies. The Company incurs substantial fuel costs in its operations and these costs represent a significant portion of the Company’s transportation expenses. Fuel costs are affected by traffic levels, efficiency of operations and equipment, and petroleum market conditions. The supply and cost of fuel is subject to market conditions and is influenced by numerous factors beyond the Company’s control, including general economic conditions, world markets, government programs and regulations and competition. Significant price increases may have a material adverse effect on the Company’s operating results. Additionally, fuel prices and supplies could also be affected by any limitation in the fuel supply or by any imposition of mandatory allocation or rationing regulations. In the event of a severe disruption of fuel supplies resulting from supply shortages, political unrest, a disruption of oil imports, war or otherwise, the resulting impact on fuel prices and subsequent price increases could materially adversely affect the Company’s operating results, financial condition and cash flows.

A Majority of the Company’s Employees Belong to Labor Unions, and Strikes or Work Stoppages Could Adversely Affect the Company’s Operations. The Company is a party to collective bargaining agreements with various labor unions in the United States. Approximately 84% of KCSR employees are covered under these

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agreements. The Company may be subject to, among other things, strikes, work stoppages or work slowdowns as a result of disputes with regard to the terms of these collective bargaining agreements or the Company’s potential inability to negotiate acceptable contracts with these unions. Moreover, because such agreements are generally negotiated on an industry-wide basis, determination of the terms and conditions of future labor agreements could be beyond our control and, as a result, the Company may be subject to terms and conditions in amended or future labor agreements that could have a material adverse affect on our results of operations, financial position and cash flows. If the unionized workers were to engage in a strike, work stoppage or other slowdown, or other employees were to become unionized or the terms and conditions in future labor agreements were renegotiated, the Company could experience a significant disruption of its operations and higher ongoing labor costs.

One of the Company’s coal customers accounts for approximately 10% of KCS’s total revenues. The Company’s largest coal customer, Southwestern Electric Power Company (“SWEPCO”), a subsidiary of American Electric Power Company, Inc., accounted for approximately 61.7% of the Company’s coal revenues and approximately 9.8% of KCS’s total revenues for the year ended December 31, 2003. The loss of all or a significant part of SWEPCO’s business, or a service outage at one or both of SWEPCO’s facilities that KCSR serves, could materially adversely affect the Company’s financial condition, results of operations and cash flows.

The Company May Be Subject to Various Claims and Lawsuits. The nature of the railroad business exposes the Company to the potential for various claims and litigation related to labor and employment, personal injury and property damage, environmental and other matters. The Company maintains insurance (including self-insurance) consistent with the industry practice against accident-related risks involved in the operation of the railroad. However, there can be no assurance that such insurance would be sufficient to cover the cost of damages suffered or that such insurance will continue to be available at commercially reasonable rates. Any material changes to current litigation trends could have a material adverse effect on the Company’s results of operations, financial condition and cash flows.

The Company May Be Affected by Future Acts of Terrorism or War. Terrorist attacks, such as those that occurred on September 11, 2001, any government response thereto and war or risk of war may adversely affect the Company’s results of operations, financial condition, and cash flows. These acts may also impact the Company’s ability to raise capital or the Company’s future business opportunities. The Company’s rail lines and facilities could be direct targets or indirect casualties of an act or acts of terror, which could cause significant business interruption and result in increased costs and liabilities and decreased revenues. These acts could have a material adverse effect on the Company’s results of operations, financial condition, and cash flows. In addition, insurance premiums charged for some or all of the coverage currently maintained by the Company could increase dramatically or certain coverage may not be available in the future.

RECENT DEVELOPMENTS

Refinancing of Senior Secured Credit Facility. On March 1, 2004, the Company repaid approximately $38.5 million of term debt (“Term B Loan”) under its senior secured credit facility (“Amended KCS Credit Facility”) using cash on-hand. After consideration of this repayment, the outstanding balance under the Term B Loan was $60 million. The Amended KCS Credit Facility also includes a revolving credit facility with a maximum borrowing amount of $100 million (“Revolving Credit Facility”). As of December 31, 2003, no amounts had been borrowed under the Revolving Credit Facility. Further, no amounts have been borrowed under the Revolving Credit Facility during 2004.

The Company is currently in the process of refinancing the Amended KCS Credit Facility, including the Revolving Credit Facility. Under the proposed terms of the new senior secured credit facility (“2004 KCS Credit Facility”), the Company expects to borrow $150 million under a new term loan due March 2008 (“2004 Term B Loan”). Additionally, the 2004 KCS Credit Facility provides for a new revolving credit facility, which expires in March 2007, with a maximum borrowing amount of $100 million (“2004 Revolving Credit Facility”). The Company does not anticipate any borrowing under the 2004 Revolving Credit Facility as of March 31, 2004. The

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Company has received firm commitment letters from various banks and institutional investors committing to fully fund the new loans and agreeing to the term sheet of the 2004 KCS Credit Facility. The commitments are subject only to proper documentation of the new facility. KCS management expects to close this refinancing transaction prior to March 31, 2004. If, however, the 2004 KCS Credit Facility is not consummated on or prior to March 31, 2004, the Company may be in technical default of certain of its existing financial covenants under the Amended KCS Credit Facility.

Prior to or at the same time as the completion of the refinancing transaction, management expects to use $60 million of cash on-hand to repay the existing Term B Loan. The $150 million of proceeds from the 2004 Term B Loan is expected to be used for general corporate purposes, including financing a portion of the Acquisition, if it occurs. The remaining costs of the Acquisition are expected to be financed using a combination of cash on-hand, available liquidity under the 2004 Revolving Credit Facility or other capital market transactions. As further described below in “Recent Developments—Proposed Acquisition of Grupo TFM from Grupo TMM,” the Company has not yet determined whether it would exercise its right to pay up to $80 million of the cash portion of the Acquisition purchase price by delivering up to 6,400,000 common shares. Also see “Recent Developments—Dispute over Acquisition Agreement.” As a result of the refinancing transaction described above, the Company expects to report a charge to earnings in the first quarter of 2004 of approximately $4 million related to the write-off of existing deferred financing costs.

Proposed Acquisition of Grupo TFM from Grupo TMM. On April 20, 2003, the Company entered into the Acquisition Agreement with Grupo TMM and other parties under which KCS ultimately would acquire control of TFM through the purchase of shares of common stock of Grupo TFM. Grupo TFM holds an 80% economic interest in TFM and all of the shares of stock with full voting rights of TFM. The remaining 20% economic interest in TFM is owned by the Mexican government in the form of shares with limited voting rights. The Mexican government has put rights with respect to its TFM shares as discussed below. The obligations of KCS and Grupo TMM to complete the Acquisition are subject to a number of conditions. For additional discussion of the terms of the Acquisition Agreement, see Note 3 in the Notes to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K.

The purpose of the Acquisition is to place TFM, and if STB approval is obtained, Tex-Mex, under the control of KCS, which will also control KCSR and Gateway Eastern. KCS management believes that common control of these railroads, which are already physically linked in an end-to-end configuration, will enhance competition and give shippers in the NAFTA trade corridor a strong transportation alternative as they make their decisions to move goods between the United States, Mexico and Canada. In addition, KCS management believes that this common control offers stockholders greater value through the operating efficiencies expected to come from common ownership and control. As part of this transaction, subject to KCS shareholder approval, KCS is expected to change its name to NAFTA Rail.

Under the terms of the Acquisition Agreement, KCS would acquire all of the interest of Grupo TMM in Grupo TFM for $200 million in cash and 18,000,000 shares of a new class of common securities of KCS, to be designated Class A Convertible Common Stock. KCS has the right to elect to pay up to $80 million of the cash portion of the purchase price by delivering up to 6,400,000 shares of KCS Class A Convertible Common Stock or KCS common stock. KCS has not yet determined whether it would exercise its right to pay up to $80 million of the cash portion of the purchase price by delivering up to 6,400,000 common shares. In addition, upon the satisfaction of certain conditions, KCS would make an additional payment to Grupo TMM ranging between $100 million and $180 million. See “Value Added Tax (“VAT”) Lawsuit and VAT Contingency Payment under the Acquisition Agreement” below. KCS anticipates that it would pay the cash portion of the purchase price, which would range between $120 million and $200 million, using a combination of existing cash assets and proceeds from the 2004 KCS Credit Facility as further described above in “Refinancing of Senior Secured Credit Facility.”

In connection with the Acquisition, KCS would enter into a consulting agreement with a consulting company organized by Jose Serrano, Chairman of the Board of Grupo TMM, Grupo TFM and TFM, pursuant to

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which it would provide consulting services to KCS in connection with the portion of the business of KCS in Mexico for a period of three years. As consideration for these services, the consulting company would receive an annual fee of $600,000 per year and a grant of 2,100,000 shares of restricted stock of KCS. The restricted stock would vest over a period of time subject to certain conditions. The consulting agreement may be extended for an additional year at the option of KCS, upon delivery of an additional 525,000 shares of common stock. The consulting agreement also provides for up to an additional 1,350,000 common shares to be issued contingent upon the achievement of certain objectives. The restricted stock issued and the cash fee would likely be accounted for as compensation expense in the consolidated financial statements of KCS.

KCS and Grupo TMM are in dispute over Grupo TMM’s attempt to terminate the Acquisition Agreement as discussed below.

Dispute over Acquisition Agreement. In August 2003, Grupo TMM shareholders voted not to approve the sale of Grupo TMM’s interests in Grupo TFM to KCS. Grupo TMM subsequently sent a notice to KCS claiming to terminate the Acquisition Agreement, because the Grupo TMM shareholders had failed to approve the Acquisition Agreement. KCS’s position has been and remains that the Acquisition Agreement does not provide that a negative shareholder vote by Grupo TMM shareholders is a basis for termination. KCS maintains that the Acquisition Agreement is still valid and remains in effect until at least December 31, 2004 (unless otherwise validly terminated in accordance with its terms).

KCS has taken actions to resolve this dispute and to preserve the parties’ positions while it seeks to resolve the dispute. In August 2003, KCS initiated the dispute resolution process, which included an informal 60-day negotiation period between the parties. The parties were unable to resolve the dispute within that period of time. KCS filed a complaint in the Delaware Chancery Court alleging that Grupo TMM had breached the Acquisition Agreement and seeking a preliminary injunction requiring Grupo TMM not to take any action in violation of the terms of the Acquisition Agreement. KCS also filed in the Delaware Court of Chancery a motion for a preliminary injunction, which was granted, to preserve the parties’ positions while KCS seeks to resolve its dispute over Grupo TMM’s attempt to terminate the Acquisition Agreement.

On October 31, 2003, KCS initiated binding arbitration in accordance with the terms of the Acquisition Agreement. In its Arbitration Demand, KCS seeks a determination that the Acquisition Agreement is in full force and effect, specific performance of the Acquisition Agreement, and damages for Grupo TMM’s breach of the terms of the Acquisition Agreement and failure to negotiate in good faith during the 60-day negotiation period. By the agreement of the parties, the arbitration has been bifurcated. The first stage of the arbitration only addressed the question of whether Grupo TMM’s purported negative shareholder vote gave Grupo TMM the right to terminate the Acquisition Agreement. On March 22, 2004, the Company announced that the panel of the American Arbitration Association International Center for Dispute Resolution hearing the dispute between the Company and Grupo TMM issued its interim award on March 19, 2004 finding that the Acquisition Agreement remains in force and is binding on KCS and Grupo TMM in accordance with its terms. The arbitration panel concluded that the rejection of the Acquisition Agreement by Grupo TMM’s shareholders did not authorize Grupo TMM’s purported termination of the Acquisition Agreement. The Company and Grupo TMM will now move on to the second phase of the arbitration, which will decide the remaining issues, including remedies and damages.

In connection with certain actions taken by Grupo TMM, KCS filed a motion to enforce injunction and hold Grupo TMM in contempt in the dispute between KCS and Grupo TMM over the Acquisition Agreement. In January 2004, the Delaware Court of Chancery issued a ruling, which held Grupo TMM in contempt of court for taking action inconsistent with the court’s previous order granting KCS’s motion for preliminary injunction. The court held that by Grupo TMM causing its subsidiary Grupo TFM to revoke powers of attorney requiring the signature of a KCS representative for transactions in excess of $2.5 million and in granting new powers of attorney to Grupo TMM directors, Jose Serrano and Mario Mohar to act on behalf of the company, Grupo TMM

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violated provisions of the Acquisition Agreement. The previous order of the court required Grupo TMM to cause Grupo TFM to conduct its business in accordance with past practices and not to directly or indirectly amend its organizational documents. The court ordered Grupo TMM to take the actions necessary to revoke the new powers of attorney, to re-enact the original powers of attorney, and to pay KCS its costs and attorneys fees for bringing the motion for contempt.

As of December 31, 2003, the Company has deferred approximately $9.3 million of costs related to the Acquisition. If the acquisition ultimately does not occur, these costs will be charged to expense. See Note 3 in the Notes to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K for a more detailed discussion of the actions taken by KCS in connection with this dispute.

Mexican Government’s Put Rights With Respect to TFM Stock. The Mexican government has the right to compel the purchase of its 20% interest in TFM (referred to as the “Put”) by Grupo TFM following notification by the Mexican government in accordance with the terms of the applicable agreements. Upon exercise of the Put, Grupo TFM would be obligated to purchase the TFM capital stock at the initial share price paid by Grupo TFM adjusted for interest and inflation. Prior to October 30, 2003, Grupo TFM filed suit in the Federal District Court of Mexico City seeking, among other things, a declaratory judgment interpreting whether Grupo TFM was obligated to honor its obligation under the Put Agreement, as the Mexican government had not made any effort to sell the TFM shares subject to the Put prior to October 31, 2003. In its suit, Grupo TFM named Grupo TMM and KCS as additional interested parties. The Mexican government has provided Grupo TFM with notice of its intention to sell its interest in TFM. Grupo TFM has responded to the Mexican government’s notice reaffirming its right and interest in purchasing the Mexican government’s remaining interest in TFM, but also advising the Mexican government that it would not take any action until its lawsuit seeking a declaratory judgment was resolved. Grupo TFM has received an injunction, which blocks the Mexican government from exercising the Put. Following the resolution of the lawsuit in Mexico or the lifting of this injunction, in the event that Grupo TFM does not purchase the Mexican government’s 20% interest in TFM, Grupo TMM and KCS, or either of Grupo TMM or KCS alone, would, following notification by the Mexican government in accordance with the terms of the applicable agreements, be obligated to purchase the Mexican government’s remaining interest in TFM. Based upon public disclosures made by Grupo TMM, it is not in a position to make this purchase. If the Acquisition is completed prior to the purchase of the Mexican government’s interest in TFM, KCS will be solely responsible for purchasing the Mexican government’s 20% interest in TFM. If KCS had been required to purchase this interest as of December 31, 2003, the total purchase price would have been approximately $467.7 million.

Value Added Tax (“VAT”) Lawsuit and VAT Contingency Payment under the Acquisition Agreement. The VAT lawsuit (“VAT Claim”), which has been pending in the Mexican courts since 1997, arose out of the Mexican Treasury’s delivery of a VAT credit certificate to a Mexican governmental agency rather than to TFM. The face value of the VAT credit at issue is 2,111,111,790 pesos or approximately $192 million in U.S. dollars, based on current exchange rates. The amount of any recovery would, in accordance with Mexican law, reflect the face value of the VAT credit adjusted for inflation and interest accruals from 1997, with certain limitations.

After several Mexican Fiscal Court and Mexican appellate court rulings during 2002 and 2003, on January 19, 2004, TFM received a Special Certificate from the Mexican Federal Treasury in the amount of $2.1 billion pesos discussed above. The Special Certificate represents the refund of the value added tax paid, and may be used by TFM to satisfy any tax liabilities due. The Special Certificate delivered to TFM on January 19, 2004 has the same face amount as the VAT refund claimed by TFM. TFM was served on January 20, 2004 with an official letter notifying TFM of the Mexican government’s preliminary findings and conclusions arising from its tax audit of TFM’s 1997 tax returns (“Tax Audit Summary”). In the Tax Audit Summary, the Mexican government notified TFM of its preliminary conclusion that the documentation provided by TFM in support of the VAT refund claim and depreciation of the TFM Concession title and the assets reported on TFM’s 1997 tax return do

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not comply with the formalities required by the applicable tax legislation. The Tax Audit Summary also attached the Special Certificate pending resolution of the audit. TFM has advised that it has, within the time allowed by the Tax Audit Summary, contested the conclusions of the Mexican tax authorities, and it has filed a constitutional appeal against the Tax Audit Summary, alleging the process followed by the Mexican government violated TFM’s constitutional rights. TFM has also filed a complaint against the Mexican government, seeking to have the amount of the Special Certificate adjusted to reflect interest and penalties in accordance with Mexican law.

In addition, provided the Acquisition has occurred and neither KCS nor any of its subsidiaries has purchased the Mexican government’s TFM shares upon exercise of the Put, KCS will be obligated to pay to Grupo TMM an additional amount (referred to as the “VAT Contingency Payment”) of up to $180 million in cash in the event that the VAT Claim is successfully resolved and the amount received is greater than the purchase price of the Put. If the Acquisition is completed, KCS will assume Grupo TMM’s obligations to make any payment upon the exercise by the Mexican government of the Put and will indemnify Grupo TMM and its affiliates, and their respective officers, directors, employees and shareholders, against obligations or liabilities relating thereto.

Because TFM has not recognized its claim as an asset for financial accounting purposes, any recovery by TFM would likely be recognized by TFM as income thereby favorably impacting the Company’s recognition of its equity in earnings in Grupo TFM. The Company is presently unable to predict the amount or timing of any VAT refund recovery. For further information with respect to the VAT refund claim, see Note 3 in the Notes to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K.

Mexrail Transactions. On May 9, 2003, pursuant to the terms of a stock purchase agreement for KCS to acquire control of Mexrail (the “Stock Purchase Agreement”), KCS acquired from Grupo TMM (through its subsidiary TFM) 51% of the shares of Mexrail for approximately $32.7 million. KCS deposited the Mexrail shares into a voting trust pending resolution of KCS’s application to the STB seeking authority to exercise common control over Tex-Mex, KCSR and Gateway Eastern. The Stock Purchase Agreement provided TFM the right to repurchase all of the Mexrail stock acquired by the Company at any time for the purchase price paid by the Company, subject to any STB orders or directions. In August 2003, KCS received a demand from TFM to repurchase those Mexrail shares. In September 2003, the STB issued a decision finding no need to rule on the transfer back to TFM of the 51% interest in Mexrail that KCS acquired. The repurchase of Mexrail by TFM closed on September 30, 2003 returning 100% ownership of Mexrail to TFM and the Stock Purchase Agreement automatically terminated. The repurchase price was $32.7 million; the same price KCS paid TFM in May 2003. The Stock Purchase Agreement, however, provided that in the event TFM reacquired the Mexrail shares from KCS, the parties to the Stock Purchase Agreement intended the terms and conditions of a February 27, 2002 stock purchase agreement under which TFM acquired the Mexrail shares, the Grupo TFM bylaws and the shareholders agreement dated May 1997 to become again valid and fully enforceable against the parties to such agreements.

Under the February 27, 2002 stock purchase agreement, KCS retained rights to prevent further sale or transfer of the stock or significant assets of Mexrail and Tex-Mex and the right to continue to participate in the corporate governance of Mexrail and Tex-Mex, which will remain U.S. corporations and subject to KCS’s super majority rights contained in Grupo TFM’s bylaws.

STB Review Status. KCS filed with the STB a Railroad Control Application, seeking permission to exercise common control over KCSR, Gateway Eastern and Tex-Mex. The STB issued its decision, effective June 13, 2003, finding that the transaction proposed in KCS’s application is a “minor transaction” under 49 CFR 1180.2(c), although KCS was required to supplement its application as discussed in the decision, to address some of the implications of KCS’s acquisition of control of TFM. The STB also outlined a procedural schedule for consideration of KCS’s application to exercise common control over KCSR, Gateway Eastern and Tex-Mex. The STB has issued an order suspending the procedural schedule pending a resolution of the uncertainties that now surround KCS’s efforts to acquire control of Tex-Mex, and requiring KCS to file status reports regarding developments in its efforts to acquire control of TFM and Tex-Mex.

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Notice of Termination of Joint Venture Agreement. KCS acknowledged receipt from Grupo TMM of a notice to terminate the joint venture agreement between the parties entered into in 1995. Pursuant to such notice, the joint venture agreement terminated on December 1, 2003. The joint venture agreement between the parties provided that upon its termination, the joint venture would be liquidated and any assets held in the name of the joint venture would be distributed proportionally to KCS and Grupo TMM. There are no significant assets held by the joint venture and its termination has not had a material adverse effect on KCS.

Redeemable Cumulative Convertible Perpetual Preferred Stock. On May 5, 2003, the Company completed the sale of $200 million of Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C (“Convertible Preferred Stock”) with a liquidation preference of $500 per share in a private offering. The Convertible Preferred Stock offering was made only by means of an offering memorandum pursuant to Rule 144A. Dividends on the Convertible Preferred Stock are cumulative and are payable quarterly at an annual rate of 4.25% of the liquidation preference, when, as and if declared by the Company’s Board of Directors. Accumulated unpaid dividends will cumulate dividends at the same rate as dividends cumulate on the Convertible Preferred Stock. Each share of the Convertible Preferred Stock will be convertible, under certain conditions, and subject to adjustment under certain conditions, into 33.4728 shares of the Company’s common stock. On or after May 20, 2008, the Company will have the option to redeem any or all of the Convertible Preferred Stock, subject to certain conditions. Under certain circumstances, at the option of the holders of the Convertible Preferred Stock, the Company may be required to purchase shares of the Convertible Preferred Stock from the holders. The Convertible Preferred Stock is redeemable at the option of a holder only in the event of a “fundamental change,” which is defined as “any transaction or event (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) in connection with which all or substantially all of the Company’s common stock is exchanged for, converted into, acquired for or constitutes solely the right to receive common stock that is not listed on a United States national securities exchange or approved for quotation on the Nasdaq National Market or similar system. The practical effect of this provision is to limit the Company’s ability to eliminate a holder’s ability to convert the Convertible Preferred Stock into common shares of a publicly traded security through a merger or consolidation transaction. In no other circumstances is the Company potentially obligated to redeem the Convertible Preferred Stock for cash. Accordingly, since the Company is in a position to control whether the Company experiences a “fundamental change,” the Convertible Preferred Stock is classified as permanent equity capital.

A portion of the proceeds from the sale of the Convertible Preferred Stock has been used to repay debt. The remainder of the net proceeds from the offering of the Convertible Preferred Stock are expected to be used to pay a portion of the Acquisition or further reduce debt. If the Acquisition were not to be completed, the Company would explore alternative uses for the remainder of the net proceeds realized from the issuance of the Convertible Preferred Stock.

On August, 1, 2003, KCS filed a Form S-3 Registration Statement with the SEC to register for resale by the holders the Convertible Preferred Stock and the common stock into which such preferred stock may be converted. On October 24, 2003, this Registration Statement, as amended, was declared effective by the SEC. KCS has filed, and will continue to file, post-effective amendments to this Registration Statement as required by applicable rules and regulations. KCS will not receive any proceeds from the sale of the securities under this Registration Statement, as amended.

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RESULTS OF OPERATIONS

The following table sets forth certain income statement components of the Company for the years ended December 31, 2003, 2002, and 2001, respectively, for use in the discussion below. See the consolidated financial statements in Item 8 of this Form 10-K for other captions not presented within this table.

	2003			2002			2001
	(dollars in millions)
Revenues	$	581.3		$	566.2		$	583.2
Operating expenses		552.2			518.2			527.8
Operating income		29.1			48.0			55.4
Equity in net earnings of unconsolidated affiliates		11.0			43.4			27.1
Gain on sale of Mexrail		—			4.4			—
Interest expense		(46.4	)		(45.0	)		(52.8	)
Debt retirement costs		—			(4.3	)		—
Other income		6.8			17.6			4.2
Income before income taxes		0.5			64.1			33.9
Income tax provision (benefit)		(2.8	)		6.9			2.8
Income before cumulative effect of accounting change		3.3			57.2			31.1
Cumulative effect of accounting change, net of income taxes		8.9			—			(0.4	)
Net income	$	12.2		$	57.2		$	30.7

The following table summarizes consolidated KCS revenues, including the revenues and carload statistics of KCSR for the years ended December 31, 2003, 2002, 2001, respectively. Certain prior year amounts have been reclassified to reflect changes in the business groups and to conform to the current year presentation.

	Revenues						Carloads and Intermodal Units
	2003		2002		2001		2003	2002	2001
	(dollars in millions)						(in thousands)
General commodities:
Chemical and petroleum	$	123.8	$	130.7	$	124.8	140.0	145.4	147.8
Paper and forest		146.1		134.8		129.1	186.2	178.2	182.2
Agricultural and mineral		108.5		97.2		93.8	140.6	126.5	125.7
Total general commodities		378.4		362.7		347.7	466.8	450.1	455.7
Intermodal and automotive		59.1		59.9		69.1	310.5	287.4	299.8
Coal		92.7		101.2		118.7	191.4	210.0	202.3
Carload revenues and carload
and intermodal units		530.2		523.8		535.5	968.7	947.5	957.8
Other rail-related revenues		45.1		37.9		39.4
Total KCSR revenues		575.3		561.7		574.9
Other subsidiary revenues		6.0		4.5		8.3
Total consolidated revenues	$	581.3	$	566.2	$	583.2

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The following table summarizes consolidated KCS operating expenses for the years ended December 31, 2003, 2002, and 2001, respectively.

	2003		2002		2001
	(dollars in millions)
Compensation and benefits	$	197.8	$	197.8	$	192.9
Depreciation and amortization		64.3		61.4		58.0
Purchased services		63.5		59.6		57.0
Operating leases		57.2		55.0		56.8
Casualties and insurance		56.4		25.2		42.1
Fuel		47.4		38.4		43.9
Car hire		10.0		19.7		19.8
Other		55.6		61.1		57.3
Total operating expenses	$	552.2	$	518.2	$	527.8

YEAR ENDED DECEMBER 31, 2003 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2002

Net Income. For the year ended December 31, 2003, net income declined $45.0 million to $12.2 million (10¢ per diluted share) from $57.2 million (91¢ per diluted share) for the year ended December 31, 2002. This year over year decline in net income resulted from a $33.5 million decrease in equity in earnings of Grupo TFM, a $34.0 million increase in operating expenses (mostly related to increases in casualty and fuel expenses as discussed further below), a $10.8 million decline in other income and a $1.4 million increase in interest expense. Also contributing to the comparably lower 2003 net income was the impact of a $4.4 million gain on the sale of Mexrail recorded in 2002. These factors, which led to a decline in net income, were partially offset by a $15.1 million increase in revenue, a $9.7 million decrease in the provision for income taxes, a benefit of $8.9 million (net of income taxes of $5.6 million) reported during 2003 relating to the cumulative effect of an accounting change, the effect of $4.3 million in debt retirement costs reported in 2002 and a $1.1 million improvement in the equity in net losses of other unconsolidated affiliates (PCRC and Southern Capital).

Net income available to common shareholders declined $50.7 million to $6.3 million in 2003 compared to $57.0 million in 2002, due to the $45.0 million reduction in net income and a $5.7 million increase in preferred stock dividends. The increase in preferred stock dividends resulted from dividends earned related to the issuance of $200 million of Convertible Preferred Stock during 2003 (see “Recent Developments—Redeemable Cumulative Convertible Perpetual Preferred Stock” for further information). The Convertible Preferred Stock accumulates dividends at an annual rate of 4.25%, which equates to a total of $8.5 million in annual dividend payments. During 2003, approximately $5.7 million of dividends relating to the Convertible Preferred Stock were earned, thereby reducing the net income available to the common shareholders. The assumed conversion of the Convertible Preferred Stock would have had an anti-dilutive effect on the diluted earnings per share calculation, and thus, were excluded from the weighted average common shares used to calculate diluted earnings per share.

Revenues. Consolidated revenues for the year ended December 31, 2003 increased $15.1 million to $581.3 million compared to $566.2 million for the year ended December 31, 2002. In 2003, KCSR revenues increased $13.6 million compared to 2002, primarily as a result of higher revenues for the paper and forest, agriculture and mineral and intermodal commodity groups as well as higher revenues for extra services (haulage, switching, demurrage). These revenue increases were partially offset by revenue declines in coal, chemical and petroleum products and automotive traffic. A portion of the revenue increases can be attributed to operational improvements realized in 2003 as a result of the increased effectiveness of MCS. During the second half of 2002, operations were slowed by the implementation of MCS, contributing to a decline in 2002 revenues. Extra service revenues increased during 2003 as a result of better information on train movements derived through MCS. Revenue for the year ended December 31, 2003 included approximately $3.6 million related to reductions of certain allowances and reserves based upon revised estimates. Revenue from other subsidiaries increased approximately

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$1.5 million year over year primarily due to volume increases at the Company’s bulk petroleum coke facility and higher sales to third parties at the Company’s wood tie treating facility. These increases were partially offset by a reduction of other revenues due to the sale of the Wyandotte Garage Corporation (“WGC”) during August 2002. The following discussion provides an analysis of KCSR revenues by commodity group.

Chemical and Petroleum. For the year ended December 31, 2003, chemical and petroleum product revenues declined $6.9 million (5.3%) to $123.8 million compared to $130.7 million for the year ended December 31, 2002, primarily as a result of lower revenues for plastic product shipments in large part due to the loss of a customer and lower production. Also contributing to lower revenues for the year ended December 31, 2003 compared to 2002 were declines in petroleum and agri-chemical product revenues. Petroleum revenues for 2003 dropped as a result of the adverse impact of high natural gas prices on petroleum production. Natural gas serves as both a feedstock and a source of energy for producers. Lower agri-chemical revenues resulted from changes in traffic mix. These declines in agri-chemical, petroleum and plastic product revenues were partially offset by higher revenues for gases, organic and inorganic products. Higher revenues for gases and organic products were primarily the result of production increases by certain customers, as well as targeted rate increases and longer hauls due to gateway changes. Higher revenues for inorganic products were primarily the result of increased access to production facilities in Geismar, Louisiana as well as new business previously shipped by other rail carriers, which resulted in higher traffic volume. Chemical and petroleum product revenue accounted for 21.5% and 23.3% of KCSR revenues for the years ended December 31, 2003 and 2002, respectively.

Paper and Forest. For the year ended December 31, 2003, paper and forest product revenue increased $11.3 million (8.4%) to $146.1 million versus $134.8 million for the year ended December 31, 2002, driven by higher revenues for pulp and paper, scrap paper, pulpwood/logs/chips and lumber/plywood products. Revenues for pulp and paper products as well as scrap paper increased primarily from higher production at KCSR’s paper mill customers and increased exports to Mexico. The increase in lumber and plywood product revenues resulted from continued strength in the housing and homebuilding industry due to sustained levels of housing starts. Increases in revenues for pulpwood/logs/chips resulted from higher production by certain customers and targeted rate increases. Partially offsetting these increases in paper and forest product revenues were lower military/other revenues as a result of the reduction of certain military training exercises, for which KCSR handles equipment transportation, due to the associated deployment of troops to the Middle East. Paper and forest product revenue accounted for 25.4% and 24.0% of KCSR revenues for the years ended December 31, 2003 and 2002, respectively.

Agricultural and Mineral. For the year ended December 31, 2003, agricultural and mineral product revenue increased $11.3 million (11.6%) to $108.5 million compared to $97.2 million for the year ended December 31, 2002. This increase resulted primarily from higher revenues for export grain, food products, ore and mineral products as well as stone, clay and glass products. These revenue increases were partially offset by a slight decline in domestic grain revenues for 2003 compared to 2002. This decline was primarily due to the effects of a relative decline in poultry production, reducing the demand for grain shipments to the Company’s poultry producing customers. The impact on domestic grain revenues of reduced poultry production was mostly offset by higher revenues associated with longer hauls gained as a result of a new contract with an existing customer. Increases in revenues for export grain reflected higher volumes of grain exports to Mexico. Food product revenues rose as a result of a new contract with an existing customer yielding increased carloads as well as longer hauls. Food product revenues also increased due to more beer shipments from Mexico into the United States and Canada. Ore and mineral product revenues increased due to higher demand from producers. Agricultural and mineral product revenues accounted for 18.9% and 17.3% of KCSR revenues for the years ended December 31, 2003 and 2002, respectively.

Intermodal and Automotive. For the year ended December 31, 2003, combined intermodal and automotive revenues declined $0.8 million (1.3%) to $59.1 million compared to $59.9 million for the year ended December 31, 2002, as a result of lower automotive revenues, which declined $3.7 million year over year. Automotive revenues declined as a result of the loss of certain automotive traffic in the third quarter of 2002 as well as the

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negative effects of the sluggish economy on the automotive industry as a whole. These automotive revenue declines were partially offset by the favorable impact on revenues of new automotive parts traffic obtained in the first quarter of 2003. Intermodal revenues for the year ended December 31, 2003 increased $2.9 million as a result of higher intermodal traffic with other connecting railroads. Intermodal and automotive revenues accounted for 10.3% and 10.7% of KCSR revenues for the years ended December 31, 2003 and 2002, respectively.

Coal. For the year ended December 31, 2003, coal revenues declined $8.5 million (8.4%) to $92.7 million compared to $101.2 million for the year ended December 31, 2002, primarily due to a decline in tons shipped resulting from lower overall customer demand. A portion of the coal revenue decline related to the loss of a coal customer in April 2002, as well as to the impact of scheduled maintenance shutdowns in 2003, which where longer in duration compared to 2002. These factors, which led to a reduction in coal revenues, were partially offset by the impact of higher per-carload revenues as a result of the use of aluminum cars, which are capable of greater hauling capacity. Coal revenue accounted for 16.1% and 18.0% of KCSR revenues for the years ended December 31, 2003 and 2002, respectively.

Other. For the year ended December 31, 2003 other rail-related revenues increased $7.2 million (19.0%) to $45.1 million compared to $37.9 million for the year ended December 31, 2002. This increase was primarily the result of higher revenues for demurrage and other rail-related extra services, which resulted from improved operating efficiencies associated with the implementation of MCS in third quarter 2002. Haulage revenue also increased slightly for the year ended December 31, 2003 compared to 2002. Other rail-related revenues accounted for 7.8% and 6.7% of KCSR revenues for the years ended December 31, 2003 and 2002, respectively.

Operating Expenses. For the year ended December 31, 2003, consolidated operating expenses increased $34.0 million to $552.2 million compared to $518.2 million for the year ended December 31, 2002. As described further below, this increase resulted primarily from higher costs for casualties and insurance and for fuel, which increased $31.2 million and $9.0 million, respectively, year over year. These costs were partially offset by lower expenses related to car hire and certain other expenses arising from operating efficiencies realized through improved employee knowledge and effectiveness in using MCS. In 2002, certain costs and expenses were higher than normal due to the impact of the implementation of MCS and the related congestion. The expenses most affected by the MCS implementation were compensation and benefits, depreciation, purchased services and car hire. See further discussion below.

Compensation and Benefits. For the year ended December 31, 2003, consolidated compensation and benefits expense was unchanged at $197.8 million compared to $197.8 million for the year ended December 31, 2002. During 2003, KCSR experienced a reduction in the number of crew starts and lower overtime pay in its transportation operations, even though carload volumes increased more than 2% in 2003 compared to 2002. Management believes these improvements are partially a result of the increased efficiency of train operations as KCSR operating personnel gained a better understanding of the data demands of MCS and have become more proficient at using this technology tool to enhance efficiencies. Furthermore, 2002 compensation and benefits costs were higher due to operating inefficiencies that occurred as a result of the implementation of MCS. The efficiency gains realized during 2003 have been offset by an increase in certain union wage rates and related back pay for prior service time as a result of the settlement of certain union contracts and higher overall health insurance related costs. In 2002, operating expenses were also affected by a $1.3 million increase in expenses for the estimate of post employment benefits arising from the Company’s third party actuarial study and the impact of a favorable adjustment related to the accrual for retroactive wage increases to union employees.

Depreciation and Amortization. For the year ended December 31, 2003, consolidated depreciation expense increased $2.9 million to $64.3 million compared to $61.4 million for the year ended December 31, 2002. This increase was primarily the result of the implementation of MCS in July of 2002, which was only depreciated for six months in 2002 compared to a full year in 2003. The remainder of the increase resulted from a net increase in the property, plant and equipment asset base.

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Purchased Services. For the year ended December 31, 2003, purchased services expense increased $3.9 million to $63.5 million compared to $59.6 million for the year ended December 31, 2002. The year over year increase primarily resulted from increased legal expenses, an increase in track, bridge, locomotive and car repairs performed by third parties and a reduction in intermodal lift fee credits received from other railroads. These cost increases were partially offset by higher car repairs billed to others by KCSR and lower training expenses in 2003. Training costs in 2002 were higher than normal due to the training associated with the implementation of MCS. Legal fees in 2003 were higher than 2002 due to the impact of a $1.0 million legal settlement received in 2002 and insurance recovery credits of $4.0 million realized in 2002.

Operating Leases. Consolidated operating lease expense for the year ended December 31, 2003 was $57.2 million compared to $55.0 million for the year ended December 31, 2002. This $2.2 million increase in lease expense was partially related to a new lease for maintenance vehicles and work equipment, which in prior periods were owned by KCSR and partially as a result of a full year of lease payments in 2003 for the Company’s new corporate headquarters building. The Company began leasing this facility in the second quarter of 2002. These increases were partially offset by lower freight car equipment costs as a result of the expiration of leases that have not been renewed due to the continued improvements in fleet utilization.

Casualties and Insurance. For the year ended December 31, 2003, consolidated casualties and insurance expense increased $31.2 million to $56.4 million compared to $25.2 million for the year ended December 31, 2002. The year over year increase was primarily due to additional costs recorded during the fourth quarter of 2003 related to personal injury liability reserves. The Company’s process of establishing liability reserves for personal injury incidents is based upon an actuarial study by an independent outside actuary, a process followed by most large railroads. This adjustment to the personal injury liability reserves was based on this actuarial study and was required due to adverse development of prior year claims and the continuing tort litigious environment surrounding the railroad industry, particularly for occupational injury claims. Also contributing to the increase in 2003 was higher property and liability related insurance costs, as well as the receipt of $8.5 million in legal and insurance settlements in 2002, which reduced the comparable 2002 expense.

Fuel. Locomotive fuel costs for the year ended December 31, 2003 increased $9.0 million to $47.4 million compared to $38.4 million for the year ended December 31, 2002, due to an approximate 23% increase in the average cost per gallon of fuel. KCSR’s average fuel price was approximately $0.86 per gallon in 2003 compared to approximately $0.69 per gallon in 2002. Fuel consumption remained relatively unchanged year over year as a result of fuel conservation measures offsetting higher consumption due to increased carload volumes.

Car Hire. Car hire expense for the year ended December 31, 2003 decreased $9.7 million to $10.0 million compared to $19.7 million for the year ended December 31, 2002. This decline resulted from improved fleet utilization associated with the implementation of MCS as KCSR was operating more efficiently during 2003 than in 2002. The improvement in fleet utilization has led to an increase in the number of KCSR freight cars being used by other railroads as well as a reduction in the number of freight cars owned by other railroads on the Company’s rail line. In the last half of 2002, the congestion-related issues associated with the implementation of MCS substantially impacted 2002 car hire expense.

Other Expense. Consolidated other expense decreased $5.5 million to $55.6 million for the year ended December 31, 2003 compared to $61.1 million for the year ended December 31, 2002, primarily as a result of higher gains recorded on the sale of operating properties. For 2003, gains from operating property sales were $5.9 million compared to $3.2 million for 2002, an increase of $2.7 million. Also impacting the comparison was a decline in costs for materials and supplies, employee expenses and a reduction in miscellaneous taxes.

Operating Income and KCSR Operating Ratio. For the year ended December 31, 2003, consolidated operating income decreased $18.9 million to $29.1 million compared to $48.0 million for the year ended December 31, 2002. This decrease was the result of a $15.1 million increase in revenues offset by a $34.0 million increase in operating expenses (mostly casualty and fuel related as discussed above). The operating ratios (ratio of railway operating expenses to railway operating revenues) for KCSR were 89.7% and 89.2% for the years ended December 31, 2003 and 2002, respectively.

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Equity in Net Earnings (Losses) of Unconsolidated Affiliates. For the year ended December 31, 2003, the Company recorded equity in net earnings of unconsolidated affiliates of $11.0 million, a $32.4 million decline compared to $43.4 million for the year ended December 31, 2002. This decrease was driven by lower equity in net earnings from Grupo TFM, which declined $33.5 million year over year, partially offset by a $1.1 million improvement in equity in net earnings (losses) from other unconsolidated affiliates.

Equity in earnings related to Grupo TFM decreased to $12.3 million for the year ended December 31, 2003 compared to $45.8 million for 2002. Revenues for Grupo TFM for the year ended December 31, 2003 decreased $13.6 million compared to the year ended December 31, 2002 while operating expenses (under accounting principles generally accepted in the United States of America—“U.S. GAAP”) were $17.2 million higher. Revenues for Grupo TFM were adversely affected by an 8% decline in automotive shipments year over year and the devaluation of the Mexican peso against the United States dollar on a year over year basis, which resulted in a reduction of revenues of approximately $34 million during 2003 versus 2002. Similar to KCSR, the increase in operating expenses at Grupo TFM was driven by higher fuel costs, which rose $13.8 million in 2003 versus 2002. Grupo TFM’s interest expense under U.S. GAAP in 2003 increased approximately $15.3 million compared to 2002 primarily as a result of increased debt costs related to the acquisition of the Mexican government’s ownership of Grupo TFM. Also contributing to the lower earnings of Grupo TFM was a $20.8 million increase in other expenses due to certain expenses associated with the VAT Claim. Additionally, for the year ended December 31, 2003, Grupo TFM’s results include a deferred tax benefit of $51.5 million (calculated under U.S. GAAP) compared to a deferred tax benefit of $91.5 million for the year ended December 31, 2002, resulting in an approximate $15.2 million reduction in the equity in net earnings recorded by the Company related to its proportionate ownership of Grupo TFM. This fluctuation was the result of numerous factors, including fluctuations in the foreign exchange rate of the Mexican peso and the United States dollar during 2003, as well as lower future Mexican corporate tax rates. These rate changes had the effect of reducing Grupo TFM’s deferred tax asset, thus reducing Grupo TFM’s deferred tax benefit. Grupo TFM’s deferred tax assets are the result of prior year net operating losses for income tax purposes. For the year ended December 31, 2003, fluctuations in the Mexican peso exchange rate also contributed to a $13.7 million exchange loss compared to an exchange loss of $17.4 million for the year ended December 31, 2002. The Company’s equity in net earnings of Grupo TFM was also impacted by the Company’s increased ownership of Grupo TFM to 46.6% from 36.9%, which the Company obtained indirectly in July 2002 as a result of the purchase by TFM of the Mexican government’s 24.6% ownership of Grupo TFM.

Results of the Company’s investment in Grupo TFM are reported under U.S. GAAP while Grupo TFM reports its financial results under International Financial Reporting Standards (“IFRS”). Because the Company is required to report its equity in net earnings in Grupo TFM under U.S. GAAP and Grupo TFM reports under IFRS, differences in deferred income tax calculations and the classification of certain operating expense categories occur. The deferred income tax calculations are significantly impacted by fluctuations in the relative value of the Mexican peso versus the U.S. dollar and the rate of Mexican inflation, and can result in significant variability in the amount of equity earnings reported by the Company.

Equity in net losses of the Company’s other unconsolidated affiliates for the year ended December 31, 2003 was $1.3 million compared to equity in net losses of $2.4 million for the year ended December 31, 2002. In 2003, losses associated with PCRC were $3.1 million compared to $3.8 million in 2002. PCRC is not operating at full capacity as initially planned due to the delay in completion of the port expansion at Balboa. These losses were offset by equity in net earnings from Southern Capital of $1.8 million and $1.4 million for the years ended December 31, 2003 and 2002, respectively.

Gain on Sale of Mexrail, Inc. Net income for the year ended December 31, 2002 includes a gain on the sale of the Company’s investment in Mexrail of $4.4 million (See “Recent Developments—Mexrail Transactions”).

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Interest Expense. Consolidated interest expense increased $1.4 million to $46.4 million for the year ended December 31, 2003 compared to $45.0 million for the year ended December 31, 2002. Interest expense rose due to higher interest rates arising from a shift to more fixed rate debt in June 2002, partially offset by the impact of a lower debt balance. The Company’s debt balance declined $59.2 million during 2003 to $523.4 million at December 31, 2003 from $582.6 million at December 31, 2002.

Debt Retirement Costs. Net income for the year ended December 31, 2002 includes debt retirement costs of $4.3 million related to the debt refinancing during the second quarter of 2002.

Other Income. Other income for the year ended December 31, 2003 declined $10.8 million compared to 2002, primarily due to substantially lower gains on the sale of non-operating property compared to 2002 as well as the impact of the sale of WGC in 2002. Gains recorded on the sale of non-operating property were $0.3 million and $7.4 million for the years ended December 31, 2003 and 2002, respectively.

Income Tax Provision (Benefit). For the year ended December 31, 2003, the Company’s income tax provision (benefit) decreased $9.7 million to a $2.8 million benefit compared to a $6.9 million provision for the year ended December 31, 2002 due to a $63.6 million decline in income (loss) before income taxes. This resulted in an effective income tax rate of (600.7)% and 11.3% for the years ended December 31, 2003 and 2002, respectively. Exclusive of equity earnings in Grupo TFM, the Company realized a pre-tax loss of $11.8 million in 2003 compared to pre-tax income of $18.3 million in 2002, resulting in a consolidated effective income tax rate of 23.8% for 2003 compared to 37.7% for 2002. This variance in the effective tax rate was primarily the result of changes in associated book/tax temporary differences, the level of pre-tax income, and the impact of permanent book/tax differences on the effective rate computation. The Company intends to indefinitely reinvest the equity earnings from Grupo TFM and accordingly, the Company does not provide deferred income tax expense for the excess of its book basis over the tax basis of its investment in Grupo TFM.

Cumulative Effect of Accounting Change. The Company adopted the provisions of Statement of Financial Accounting Standards No. 143 “Accounting for Asset Retirement Obligations” (“SFAS 143”) effective January 1, 2003. As a result, the Company changed its method of accounting for removal costs of certain track structure assets and recorded a benefit of $8.9 million (net of income taxes of $5.6 million) during the first quarter of 2003.

YEAR ENDED DECEMBER 31, 2002 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2001

Net Income. For the year ended December 31, 2002, net income increased $26.5 million to $57.2 million (91¢ per diluted share) from $30.7 million (50¢ per diluted share) for the year ended December 31, 2001. This increase was primarily the result of a $17.3 million increase in equity in earnings of Grupo TFM, a $13.4 million increase in other income, a $7.8 million decrease in interest expense, and a $4.4 million gain realized on the sale of Mexrail to TFM. This increase in net income was partially offset by a $7.4 million decline in operating income, a $4.1 million increase in the provision for income taxes, and a $1.0 million decline in equity in net earnings (losses) of other unconsolidated affiliates. Additionally, net income for the year ended December 31, 2002 includes debt retirement costs of $4.3 million related to the early retirement of term debt in June 2002. Net income for the year ended December 31, 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 year ended December 31, 2002 declined $17.0 million to $566.2 million compared to $583.2 million for the year ended December 31, 2001. In 2002, KCSR revenues declined $13.2 million compared to 2001, primarily as a result of lower coal and automotive revenues partially offset by higher revenues for all other major commodity groups. The increase in revenues for certain commodity groups, including chemical and petroleum products, agricultural and mineral products, paper and forest products and intermodal traffic, was driven by a combination of volume gains in certain commodities, increased length of haul

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and price improvements in key traffic lanes. These revenue gains were partially offset by volume losses in certain commodities within these groups. KCS management believes that revenues for these commodity groups would have improved even further during 2002, but were adversely affected by lower carloadings arising from congestion related to the implementation of MCS. Revenue from other subsidiaries decreased approximately $3.8 million year over year primarily due to demand driven volume declines related to the Company’s petroleum coke bulk handling facility. The following discussion provides an analysis of KCSR revenues by commodity group.

Chemical and Petroleum. For the year ended December 31, 2002, chemical and petroleum product revenues increased $5.9 million (4.7%) to $130.7 million compared to $124.8 million for the year ended December 31, 2001. These revenue increases were the result of a combination of higher traffic volumes for certain commodities within this business group as well as targeted rate increases and longer hauls due to gateway changes. Higher revenues for gases and organic products were primarily the result of production increases by certain customers, as well as changes in traffic patterns and targeted rate increases. Higher revenues for inorganic products were primarily the result of increased access to production facilities in Geismar, Louisiana, as well as new business previously shipped by other rail carriers, which resulted in higher traffic volume. Increases in the production of PVC and plastic pellet products led to an increase in carloadings and higher revenues for plastic products. These increases were partially offset by volume related declines in agri-chemical and petroleum product revenues due to lower industrial production related to the continued slowdown in the U.S. economy. Chemical and petroleum products revenue accounted for 23.3% and 21.7% of KCSR revenues for the years ended December 31, 2002 and 2001, respectively.

Paper and Forest. For the year ended December 31, 2002, paper and forest product revenue increased $5.7 million (4.4%) to $134.8 million versus $129.1 million for the year ended December 31, 2001. Increases in revenues for pulp and paper, scrap paper and lumber/plywood were partially offset by lower revenues for pulpwood/logs/chips, scrap metal and military/other traffic. Increase in pulp and paper revenues resulted from higher traffic volumes as a result of production growth in the paper industry, while continued strength in the home building market and housing starts led to increases in lumber and plywood product revenues. These revenues were also higher due to certain rate increases and changes in traffic mix and length of haul. Declines in industrial production as a result of the slowdown in the U.S. economy led to lower carloadings and revenues for pulpwood, logs, and chip products as well as metal products. The decline in military and other carload revenues is a reflection of the effect of a significant one-time military movement in 2001. Targeted rate increases and changes in traffic patterns for metal products and pulpwood, logs and chips partially offset the related revenue decline resulting from lower traffic volumes for these commodities. Paper and forest products revenue accounted for 24.0% and 22.5% of KCSR revenues for the years ended December 31, 2002 and 2001, respectively.

Agricultural and Mineral. For the year ended December 31, 2002, revenues for agricultural and mineral products increased $3.4 million (3.6%) to $97.2 million compared to $93.8 million for the year ended December 31, 2001, as a result of higher revenues across all major products in the agricultural and mineral commodity group. Domestic grain revenues increased as a result of certain rate increases and longer hauls partially offset by lower domestic demand. Export grain revenue increased slightly during 2002 versus 2001 on the strength of higher demand from Mexico and other export markets during the first half of 2002. This demand eased somewhat during the last half of 2002. Increases in revenue for stone, clay and glass product were primarily the result of higher production by two customers, targeted rate increases and longer hauls. Agricultural and mineral products revenue accounted for 17.3% and 16.3% of KCSR revenues for the years ended December 31, 2002 and 2001, respectively.

Intermodal and Automotive. For the year ended December 31, 2002, combined intermodal and automotive revenues decreased $9.2 million (13.3%) to $59.9 million compared to $69.1 million for the year ended December 31, 2001, primarily as a result of lower automotive revenues, which declined $12.3 million (57.0%) year over year. This decline in automotive revenues resulted from the loss of certain business in the third quarter of 2001 and the loss of a significant movement effective May 2002. Also contributing was the general decline in the domestic automobile industry as a result of weakness in the U.S. economy. These factors contributed to a 62.8% year over year decline in carload volumes for automotive traffic. For the year ended December 31, 2002,

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intermodal revenues increased $3.1 million (6.6%) compared to 2001, as a result of increases in domestic carload traffic as well as international traffic moving to Mexico. Intermodal and automotive revenues accounted for 10.7% and 12.0% of KCSR revenues for the years ended December 31, 2002 and 2001, respectively.

Coal. For the year ended December 31, 2002, coal revenues declined $17.5 million (14.7%) to $101.2 million compared to $118.7 million for the year ended December 31, 2001. Coal revenues were significantly impacted by a rate reduction at the Company’s largest utility customer as well as the loss of a coal customer in April 2002 due to the expiration of a contract. These revenue declines were partially offset by a near 7% increase in net tons delivered in 2002 compared to 2001, resulting from higher demand at certain utility customers and the reopening of a utility plant in Kansas City, Missouri in the second quarter of 2001 that had been out of service since July of 1999. Coal revenue accounted for 18.0% and 20.6% of KCSR revenues for the years ended December 31, 2002 and 2001, respectively.

Other. For the year ended December 31, 2002, other rail-related revenues declined $1.5 million (3.8%) to $37.9 million compared to $39.4 million for the year ended December 31, 2001. This decline was primarily the result of declines in switching and demurrage revenues partially offset by increases in other revenues. Haulage revenues remained relatively unchanged in 2002 compared to 2001. Other rail-related revenues accounted for 6.7% and 6.9% of KCSR revenues for the years ended December 31, 2002 and 2001, respectively.

Operating Expenses. For the year ended December 31, 2002, consolidated operating expenses decreased $9.6 million to $518.2 million compared to $527.8 million for the year ended December 31, 2001, resulting from a $6.0 million decline in KCSR expenses coupled with a $3.6 million decline in expenses from other subsidiaries. This decrease was partially offset by the impact of higher costs associated with the implementation of MCS. The expenses most affected by the MCS implementation were compensation and benefits, depreciation, purchased services and car hire. See further discussion below.

Compensation and Benefits. For the year ended December 31, 2002, consolidated compensation and benefits expense increased $4.9 million to $197.8 million compared to $192.9 million for the year ended December 31, 2001. This increase was primarily the result of higher overtime and crew costs during the second half of 2002 related to the traffic congestion resulting from the third quarter 2002 implementation of MCS. Compensation and benefits expense in 2002 was also impacted by the implementation of an increase in certain union wages effective July 1, 2002, higher health insurance costs and a $1.3 million increase in expenses for the estimate of post employment benefits arising from the Company’s third party actuarial study. Additionally, the increase in compensation and benefits was affected by the impact of a $2.0 million reduction in retirement-based costs for certain union employees recorded in 2001, which reduced comparable 2001 expense. These factors were partially offset by lower employee headcount, the automation of certain switch locomotive crew functions, a favorable adjustment related to the accrual for retroactive wage increases to union employees, which was not provided for in the national labor union contract and lower railroad retirement taxes as a result of the reduction in employer contributions under the Railroad Retirement Act. The increase in compensation and benefits expense was also impacted by the effect of workforce reduction costs of $1.3 million recorded in the first quarter of 2001.

Depreciation and Amortization. For the year ended December 31, 2002, consolidated depreciation expense increased $3.4 million to $61.4 million compared to $58.0 million for the year ended December 31, 2001. This increase was primarily the result of the implementation of MCS in July of 2002, which increased depreciation expense by $2.4 million in 2002. The remainder of the increase resulted from a net increase in the property, plant and equipment asset base.

Purchased Services. For the year ended December 31, 2002, purchased services expense increased $2.6 million to $59.6 million compared to $57.0 million for the year ended December 31, 2001. This increase was the result of higher environmental compliance costs and legal costs, higher locomotive and car repair costs contracted to third parties as well as an increase in other general purchased services. Also contributing to the increase in purchased services expense were higher employee training costs associated with the implementation

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of MCS and an increase to the reserve for environmental remediation related to a specific site. This increase in costs was partially mitigated by insurance and legal settlements totaling approximately $5.0 million.

Operating Leases. Consolidated operating lease expense for the year ended December 31, 2002 decreased $1.8 million to $55.0 million compared to $56.8 million for the year ended December 31, 2001. This decrease was primarily the result of the expiration of leases that were not been renewed due to continued changes in fleet utilization. This decrease in lease expense was partially offset by increases in lease costs of approximately $1.9 million in 2002 associated with the lease for the Company’s new corporate headquarters building.

Casualties and Insurance. For the year ended December 31, 2002, consolidated casualties and insurance expense decreased $16.9 million to $25.2 million compared to $42.1 million for the year ended December 31, 2001 due primarily to lower derailment costs, and the receipt of insurance settlements in 2002, partially offset by higher insurance costs. In the first quarter of 2001, the Company incurred $8.5 million in costs related to several significant derailments as well as the settlement of a personal injury claim. Derailment costs for the year ended December 31, 2002 were more normalized compared to 2001. Also impacting the decrease in casualties and insurance expense was the receipt of $8.5 million in legal and insurance settlements during 2002. Expenses in 2002 for personal injury claims were slightly higher compared to 2001. The Company’s process of establishing liability reserves for these types of incidents is based upon an actuarial study by an independent outside actuary, a process followed by most large railroads.

Fuel. Locomotive fuel costs for the year ended December 31, 2002 decreased $5.5 million to $38.4 million compared to $43.9 million for the year ended December 31, 2001. This decrease was the combined result of an 8.8% decrease in the average cost per gallon of fuel and a 4.0% decline in fuel consumption due primarily to aggressive fuel conservation measures.

Car Hire. Car hire expense for the year ended December 31, 2002 was relatively unchanged, decreasing only $0.1 million to $19.7 million compared to $19.8 million for the year ended December 31, 2001. For the first half of 2002, car hire expense decreased approximately $2.9 million compared to the same period in 2001 as KCSR was operating a more efficient and well-controlled railroad. In early 2001, an unusual number of significant derailments (as discussed in casualties and insurance), as well as the effects of line washouts and flooding had a significant adverse impact on the efficiency of KCSR’s operations in the first half of 2001. The resulting inefficiency led to congestion on KCSR’s rail lines during the first half of 2001, which contributed to an increase in the number of freight cars from other railroads on the Company’s rail line. For the second half of 2002, car hire expense increased $2.8 million compared to the second half of 2001. This increase was due to a higher number of freight cars from other railroads on the Company’s rail line as well as fewer KCSR freight cars on other railroads as a result of increased congestion resulting from the implementation of MCS in the third quarter of 2002.

Other Expense. Consolidated other expense increased $3.8 million to $61.1 million for the year ended December 31, 2002 compared to $57.3 million for the year ended December 31, 2001. Factors contributing to this increase included an increase in material and supply costs related to maintenance of way and equipment of $2.5 million, as well as a $2.6 million decline in gains recorded on the sale of operating assets by KCSR. The effect of these increases was partially offset by a decline in the cost of sales and other expenses incurred by certain subsidiaries.

Operating Income and KCSR Operating Ratio. For the year ended December 31, 2002, consolidated operating income decreased $7.4 million to $48.0 million compared to $55.4 million for the year ended December 31, 2001. This decrease was primarily the result of a $17.0 million decline in revenues partially offset by a $9.6 million decline in operating expenses. The operating ratio for KCSR was 89.2% and 88.2% for the years ended December 31, 2002 and 2001, respectively.

Equity in Net Earnings (Losses) of Unconsolidated Affiliates. For the year ended December 31, 2002, the Company recorded equity in earnings of unconsolidated affiliates of $43.4 million reflecting an increase of $16.3

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million compared to $27.1 million for the year ended December 31, 2001. This increase was driven by an increase in equity in earnings from Grupo TFM of $17.3 million partially offset by a $1.0 million decline in equity in earnings from other unconsolidated affiliates.

Equity in earnings related to Grupo TFM increased to $45.8 million for the year ended December 31, 2002 compared to $28.5 million for 2001. For the year ended December 31, 2001, the Company’s equity in the earnings of Grupo TFM included 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 reversion income, equity in earnings of Grupo TFM for the year ended December 31, 2002 increased $26.4 million compared to the year ended December 31, 2001. Revenues for Grupo TFM for the year ended December 31, 2002 decreased $7.5 million compared to the year ended December 31, 2001 (exclusive of Mexrail’s results) while operating expenses (under U.S.GAAP) were $29.5 million lower (exclusive of the 2001 reversion income and Mexrail’s results). For the year ended December 31, 2002, Grupo TFM’s results include a deferred tax benefit of $91.5 million (calculated under U.S. GAAP) compared to a deferred tax expense of $10.9 million for the year ended December 31, 2001. This increase was the result of numerous factors, including a deferred tax expense recorded in 2001 related to the line reversion income, the weakening of the Mexican peso exchange rate and tax benefits derived from the impact of Mexican inflation in 2002. For the year ended December 31, 2002, fluctuations in the Mexican peso exchange rate also contributed to a $17.4 million exchange loss compared to an exchange gain of $2.8 million for the year ended December 31, 2001.

Equity in losses of the Company’s other unconsolidated affiliates for the year ended December 31, 2002 were $2.4 million compared to equity in losses of $1.4 million for the year ended December 31, 2001. In 2002, losses associated with PCRC were $3.8 million compared to $1.6 million in 2001. 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 $2.1 million in 2001 compared to essentially a break-even amount for 2002 prior to its sale to TFM. These losses were mitigated by equity earnings from Southern Capital of $1.4 million and $2.4 million for the years ended December 31, 2002 and 2001, respectively.

Gain on Sale of Mexrail, Inc. Net income for the year ended December 31, 2002 includes a gain on the sale of the Company’s investment in Mexrail, Inc. of $4.4 million.

Interest Expense. Consolidated interest expense declined $7.8 million to $45.0 million for the year ended December 31, 2002 compared to $52.8 million for the year ended December 31, 2001. This decrease was the result of lower effective interest rates for the first six months of 2002 as well as lower debt balances. The Company’s debt balance declined $75.8 million during 2002 from $658.4 million at December 31, 2001 to $582.6 million at December 31, 2002.

Debt Retirement Costs. Net income for the year ended December 31, 2002 includes debt retirement costs of $4.3 million related to the debt refinancing during the second quarter of 2002.

Other Income. Other items affecting net income for the year ended December 31, 2002 were gains totaling approximately $7.4 million related to the sale of certain non-operating properties at a subsidiary of the Company and a $4.9 million gain on the sale of WGC. These items account for the majority of the increase reported in other income for 2002 compared to 2001.

Income Tax Expense. For the year ended December 31, 2002, the Company’s income tax provision increased $4.1 million to $6.9 million compared to $2.8 million for the year ended December 31, 2001. This increase was primarily the result of gains on the sale of the Company’s investments in WGC and Mexrail, as well as gains realized on the sale of other non-operating assets. Lower interest costs for the year ended December 31, 2002 also contributed to the increase in the income tax provision. These factors, which led to an increase in the income tax provision, were partially offset by lower domestic operating income and resulted in an effective income tax rate of 11.3% and 8.3% for the years ended December 31, 2002 and 2001, respectively. Exclusive of

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equity earnings in Grupo TFM, the consolidated effective income tax rate for the year ended December 31, 2002 was 37.7% compared to 51.8% for the year ended December 31, 2001. This variance in the effective tax rate was primarily the result of changes in associated book/tax temporary differences and certain non-taxable items. The Company intends to indefinitely reinvest the equity earnings from Grupo TFM and accordingly, the Company does not provide deferred income tax expense for the excess of its book basis over the tax basis of its investment in Grupo TFM.

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.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow Information and Contractual Obligations

Summary cash flow data follows for the years ended December 31, 2003, 2002 and 2001, respectively:

	2003			2002			2001
	(dollars in millions)
Cash flows provided by (used for):
Operating activities	$	67.3		$	95.7		$	68.7
Investing activities		(83.6	)		(34.9	)		(55.7	)
Financing activities		132.7			(66.5	)		(9.8	)
Net increase (decrease) in cash and cash equivalents		116.4			(5.7	)		3.2
Cash and cash equivalents at beginning of year		19.0			24.7			21.5
Cash and cash equivalents at end of year	$	135.4		$	19.0		$	24.7

During the year ended December 31, 2003, the Company’s consolidated cash position increased by $116.4 million from December 31, 2002. The primary sources of cash were as follows: the issuance of Convertible Preferred Stock; cash inflows from operating activities; proceeds from the disposal of property; and the proceeds from employee stock plans. The primary users of cash were as follows: investments in and loans to affiliates; repayment of debt; costs related to the Acquisition; cash dividends paid; and property acquisitions.

Operating Cash Flows. The Company’s cash flow from operations has historically been positive and sufficient to fund operations, as well as fund KCSR roadway capital improvements, other capital improvements and debt service. External sources of cash (principally bank debt and public debt) have been used to refinance existing indebtedness and to fund acquisitions, new investments, equipment additions and repurchases of Company common stock. The following table summarizes consolidated operating cash flow information for the years ended December 31, respectively:

	2003			2002			2001
	(dollars in millions)
Net income	$	12.2		$	57.2		$	30.7
Depreciation and amortization		64.3			61.4			58.0
Equity in undistributed earnings of unconsolidated affiliates		(11.0	)		(43.4	)		(27.1	)
Distributions from unconsolidated affiliates		—			—			3.0
Deferred income taxes		(3.1	)		21.8			30.4
Gains on sales of properties and investments		(6.2	)		(20.1	)		(5.8	)
Tax benefit realized upon exercise of stock options		2.5			4.5			5.6
Change in working capital items		1.3			10.4			(41.2	)
Other		7.3			3.9			15.1
Net cash flow from operating activities	$	67.3		$	95.7		$	68.7

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Net operating cash flows for 2003 declined $28.4 million to $67.3 million compared to $95.7 million in 2002. This decrease in operating cash flows was primarily attributable to a reduction of net income and changes in working capital balances, resulting mainly from the timing of payments and receipts and the receipt of income tax refunds.

Net operating cash flows for 2002 were $95.7 million compared to $68.7 million in 2001, an increase of $27.0 million. This increase was primarily attributable to higher net income as well as changes in working capital items related to collections on receivables partially offset by reductions in accounts payable and accrued liabilities.

Investing Cash Flows. Net investing cash outflows were $83.6 million and $34.9 million during the years ended December 31, 2003 and 2002, respectively. This $48.7 million increase in investing cash outflows was primarily related to the sale of Mexrail to TFM for $31.4 million in 2002. During 2003, in contemplation of the Acquisition, KCS repurchased a 51% interest in Mexrail for $32.7 million. As discussed in “Recent Developments—Mexrail Transactions,” in accordance with a demand from TFM, KCS sold its interest in Mexrail back to TFM on September 30, 2003 for $32.7 million. As a result of these two Mexrail transactions in 2003 offsetting each other, there was no net impact to net investing cash outflows during 2003. Therefore, the impact of the cash received in 2002 from the sale of Mexrail resulted in higher comparable investing cash outflows during 2003. Also impacting net investing cash outflows for 2003 was approximately $9.3 million of costs associated with the Acquisition that have been deferred and included in other investing activities. Additionally, proceeds from the sale of property for 2003 were $5.7 million less than 2002.

Net investing cash outflows were $34.9 million and $55.7 million during the years ended December 31, 2002 and 2001, respectively. This variance of $20.8 million was primarily caused by an increase of $31.1 million of proceeds received from the sale of investments and a $3.8 million decrease in investment in and loans to affiliates. In the first quarter of 2002, the Company sold its 49% interest in Mexrail to TFM for approximately $31.4 million. The proceeds from the sale exceeded the Company’s carrying value of Mexrail by $11.2 million. The Company recognized a gain of $4.4 million on the sale while the remaining $6.8 million in excess proceeds was deferred. The Company used the proceeds from the sale of Mexrail to reduce debt. These cash inflows were partially offset by a $13.8 million increase in capital expenditures compared to 2001.

Generally, operating cash flows and borrowings under lines of credit have been used to finance property acquisitions and investments in and loans to affiliates.

Financing Cash Flows. Financing cash outflows are used primarily for the repayment of debt while financing cash inflows are generated from proceeds from the issuance of long-term debt and proceeds from the issuance of common stock under employee stock plans. During 2003, financing cash flows were also generated through the issuance of the Convertible Preferred Stock with net proceeds of $193.0 million. Financing cash flows for 2003, 2002, and 2001 were as follows:

• Borrowings of $200 million and $35.0 million in 2002 and 2001, respectively. There were no borrowings during 2003. Proceeds from the issuance of debt in June 2002 were used to refinance term debt. In 2001, borrowings under the Company’s revolving credit facility were used to fund payments on term debt.

• Repayment of indebtedness in the amounts of $59.2 million, $270.9 million and $51.3 million in 2003, 2002 and 2001, respectively. Repayment of indebtedness is generally funded through operating cash flows and proceeds from the disposals of property. In 2003, the repayment of debt was funded through operating cash flows, proceeds from the disposal of property and the proceeds received from the Convertible Preferred Stock. In 2002, the repayment of indebtedness was funded from the proceeds from the issuance of debt, as well as operating cash flows and proceeds from the disposals of certain assets. In 2001, the repayment of indebtedness was funded through borrowings under the Company’s revolving credit facility, as well as operating cash flows and proceeds from the disposals of property.

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• Payment of debt issuance costs $5.7 million and $0.4 million in 2002 and 2001, respectively. In 2002, the Company paid $5.7 million of debt issuance costs related to the $200 million offering in June 2002 of 7½% senior notes due June 15, 2009 (“7½% Notes”). There were no debt issuance costs in 2003.

• Proceeds from the sale of KCS common stock pursuant to employee stock plans of $5.3 million, $10.3 million and $8.9 million in 2003, 2002 and 2001, respectively.

• Payment of cash dividends of $4.7 million, $0.2 million and $0.2 million in 2003, 2002 and 2001, respectively. Approximately $4.5 million of dividends were paid in 2003 relating to the Convertible Preferred Stock.

Contractual Obligations

The following table outlines the Company’s material obligations under long-term debt and other contractual commitments at December 31, 2003. Typically, payments for these obligations are funded through operating cash flows. If operating cash flows are not sufficient, funds received from other sources, including borrowings under credit facilities and proceeds from property and other asset dispositions, might also be available. These obligations are customary transactions similar to those entered into by others in the transportation industry. The Company anticipates refinancing certain of its long-term debt prior to maturity.

	Payments Due by Period
Contractual Obligations	Total		Less than 1 Year		2-3 Years		4-5 Years		After 5 Years
	(dollars in millions)
Long-term debt (including capital lease obligations)	$	523.4	$	9.9	$	17.0	$	295.5	$	201.0
Operating leases		402.8		56.2		91.5		71.5		183.6
Other contractual obligations(a)		86.8		5.5		18.9		11.0		51.4
Total contractual obligations	$	1,013.0	$	71.6	$	127.4	$	378.0	$	436.0

(a) Other contractual obligations includes purchase commitments and certain maintenance agreements.

Off-Balance Sheet Arrangements

As further described in Note 3 to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K, the Company holds a 50% interest in Southern Capital, a joint venture that provides the Company with access to equipment financing alternatives. Southern Capital’s principal operations are the acquisition of locomotives, rolling stock and other railroad equipment and the leasing thereof to the Company. On June 25, 2002, Southern Capital refinanced the outstanding balance of certain debt through the issuance of 5.7% pass through trust certificates and proceeds from the sale of 50 locomotives. These pass through trust certificates are secured by all of the locomotives and rolling stock owned by Southern Capital and rental payments payable by KCSR under the operating and financing leases of the equipment owned by Southern Capital. As Southern Capital is a 50% owned unconsolidated joint venture, this debt is not reflected in KCS’s Consolidated Balance Sheets, which are included in Item 8 of this Form 10-K.

Also, as described in Note 3 to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K, under the terms of the loan agreement with IFC, the Company is a guarantor for up to $5.6 million of associated debt. Also, if PCRC terminates the concession contract without the IFC’s consent, the Company is a guarantor for up to 50% of the outstanding senior loans. The Company is also a guarantor for up to $1.8 million of the equipment loans and approximately $100,000 relating to the other capital leases.

Capital Expenditures

Capital improvements for KCSR roadway track structures have historically been funded with cash flows from operations and external debt. The Company has historically used equipment trust certificates for major

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purchases of locomotives and rolling stock, while using internally generated cash flows or leasing for other equipment. Through its Southern Capital joint venture, the Company has the ability to finance railroad equipment, and therefore, has increasingly used lease-financing alternatives for its locomotives and rolling stock.

The following table summarizes the cash capital expenditures by type for 2003, 2002 and 2001, respectively.

Capital Expenditure Category	2003		2002		2001
	(dollars in millions)
Track infrastructure	$	50.5	$	40.2	$	38.0
Locomotives, freight cars and other equipment		14.0		14.9		14.2
Information technology		3.1		5.8		10.0
Facilities and improvements		4.7		14.8		1.5
Other		6.7		4.1		2.3
Total capital expenditures	$	79.0	$	79.8	$	66.0

Internally generated cash flows and borrowings under the Company’s lines of credit were used to finance capital expenditures. Internally generated cash flows and borrowings are expected to be used to fund capital programs for 2004, currently estimated at approximately $108 million.

KCSR Maintenance

KCSR, like all railroads, is required to maintain its own property infrastructure. Portions of roadway and equipment maintenance costs are capitalized and other portions are expensed (as components of material and supplies, purchased services and others), as appropriate. Maintenance and capital improvement programs are in conformity with the Federal Railroad Administration’s track standards and are accounted for in accordance with applicable regulatory accounting rules. Management expects to continue to fund roadway and equipment maintenance expenditures with internally generated cash flows. Maintenance expenses (exclusive of amounts capitalized) for way and structure (roadbed, rail, ties, bridges, etc.) and equipment (locomotives and rail cars) for the three years ended December 31, 2003, 2002 and 2001 respectively, as a percentage of KCSR revenues were as follows:

	KCSR Maintenance
	Way and Structure				Equipment
	Amount		Percent of Revenue		Amount		Percent of Revenue
	(dollars in millions)
2003	$	41.1	7.1	%	$	42.5	7.3	%
2002		43.6	7.7			48.2	8.5
2001		43.9	7.5			44.8	7.7

Capital Structure

Components of the Company’s capital structure are as follows.

	2003			2002
	(dollars in millions)
Debt due within one year	$	9.9		$	10.0
Long-term debt		513.5			572.6
Total debt		523.4			582.6
Stockholders’ equity		963.7			752.9
Total debt plus equity	$	1,487.1		$	1,335.5
Total debt as a percent of total debt plus equity (“debt ratio”)		35.2	%		43.6	%

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The Company’s consolidated debt ratio as of December 31, 2003 decreased 8.4 percentage points compared to December 31, 2002 as a result of an increase in stockholders’ equity and a decrease in debt. Total consolidated debt decreased $59.2 million as a result of net repayments of long-term debt. Stockholders’ equity increased $210.8 million primarily as a result of net proceeds received from the issuance of Convertible Preferred Stock of $193.0 million in 2003. In addition, stockholders’ equity increased as a result of 2003 net income of $12.2 million and the issuance of common stock under employee stock plans partially offset by dividends on preferred stock.

Shelf Registration Statements and Public Securities Offerings. The Company currently has two shelf registration statements on file with the SEC (“Initial Shelf”—Registration No. 33-69648; “Second Shelf”—Registration No. 333-61006). 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.

Amendment of Credit Agreement. During 2003, the Company received approval from its lenders for two separate amendments to certain provision of the Amended KCS Credit Facility dated June 12, 2002. The Company requested the first amendment in order to provide flexibility in structuring the funding for the transaction to acquire the Mexican government’s interest in TFM as further discussed in “Recent Developments—Mexican Government’s Put Rights with Respect to TFM Stock.” The Company entered into a second amendment in which the lenders of the Amended KCS Credit Facility specifically approved (i) the Company’s investment in further equity interests of Grupo TFM and in equity interests representing 51% of Mexrail’s issued and outstanding capital stock and (ii) the use of the Company’s cash to acquire Mexrail in connection with the proposed Acquisition.

Overall Liquidity

As part of the Amended KCS Credit Facility, the Company has financing available under the Revolving Credit Facility, which has a maximum borrowing amount of $100 million and matures on January 11, 2006. As of December 31, 2003, no amounts had been borrowed under the Revolving Credit Facility. Further, no amounts have been borrowed under the Revolving Credit Facility during 2004. The Amended KCS Credit Facility contains, among other provisions, various financial covenants. The Company was in compliance with these provisions, including the financial covenants as of December 31, 2003. As a result of these financial covenants, the Company’s borrowings under the Revolving Credit Facility may be restricted.

On March 1, 2004, the Company repaid approximately $38.5 million of term debt (“Term B Loan”) under the Amended KCS Credit Facility using cash on-hand. After consideration of this repayment, the outstanding balance under the Term B Loan was $60 million. The Company is currently in the process of refinancing the Amended KCS Credit Facility, including the Revolving Credit Facility. Under the proposed terms of the new senior secured credit facility (“2004 KCS Credit Facility”), the Company expects to borrow $150 million under a new term loan due March 2008 (“2004 Term B Loan”). Additionally, the 2004 KCS Credit Facility provides for a new revolving credit facility, which expires in March 2007, with a maximum borrowing amount of $100 million (“2004 Revolving Credit Facility”). The Company does not anticipate any borrowing under the 2004 Revolving Credit Facility as of March 31, 2004. The Company has received firm commitment letters from various banks and institutional investors committing to fully fund the new loans and agreeing to the term sheet of the 2004 KCS Credit Facility. The commitments are subject only to proper documentation of the new facility. KCS management expects to close this refinancing transaction prior to March 31, 2004. If, however, the 2004 KCS Credit Facility is not consummated on or prior to March 31, 2004, the Company may be in technical default of certain of its existing financial covenants under the Amended KCS Credit Facility.

Prior to or at the same time as the completion of the refinancing transaction, management expects to use $60 million of cash on-hand to repay the existing Term B Loan. The $150 million of proceeds from the 2004 Term B Loan is expected to be used for general corporate purposes, including financing a portion of the Acquisition, if it

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occurs. The remaining costs of the Acquisition are expected to be financed using a combination of cash on-hand, available liquidity under the 2004 Revolving Credit Facility or other capital market transactions. As further described below in “Recent Developments—Proposed Acquisition of Grupo TFM from Grupo TMM,” the Company has not yet determined whether it would exercise its right to pay up to $80 million of the cash portion of the Acquisition purchase price by delivering up to 6,400,000 common shares. Also see “Recent Developments—Dispute over Acquisition Agreement.” As a result of the refinancing transaction described above, the Company expects to report a charge to earnings in the first quarter of 2004 of approximately $4 million related to the write-off of existing deferred financing costs.

As discussed in “Recent Developments—Mexican Government’s Put Rights with Respect to TFM Stock,” Grupo TMM and KCS, or either Grupo TMM or KCS, could be required to purchase the Mexican government’s interest in TFM. If KCS and Grupo TMM, or either KCS or Grupo TMM individually had been required to purchase the Mexican government’s 20% interest in TFM, the total purchase price would have been approximately $467.7 million as of December 31, 2003. The Company is exploring various alternatives for financing this transaction. It is anticipated that this financing, if necessary, can be accomplished using the Company’s ability to access the capital markets. No commitments for such financing have been obtained at this time.

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 2004. Also, if necessary, management believes it will be able to obtain the necessary financing to fund the Acquisition and the purchase of the Mexican government’s 20% interest in TFM. The Company’s operating cash flows and financing alternatives, however, 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 can be impacted by independent rating agencies, which assign debt ratings based on certain credit measurements such as interest coverage and leverage ratios. During 2003, both Standard Poor’s Rating Services and Moody’s Investors Service (“Moody’s”) downgraded the debt ratings of KCS. Moody’s also downgraded the Company’s debt ratings in 2004. These reductions in the Company’s debt ratings did not have any impact on the Company’s interest rates or financial covenant ratios, but could adversely impact borrowing costs in the future.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The accounting and financial reporting policies of the Company are in conformity with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Management believes that the following accounting policies and estimates are critical to an understanding of the Company’s historical and future performance. Management has discussed the development and selection of the following critical accounting estimates related with the Audit Committee of the Company’s Board of Directors and the Audit Committee has reviewed the Company’s related disclosures.

Depreciation of Property, Plant and Equipment

The railroad industry is extremely capital intensive. Plant maintenance and the depreciation of operating assets constitutes a substantial operating expense for the Company, as well as the railroad industry as a whole. The Company capitalizes costs relating to additions and replacements of property, plant and equipment and depreciates it consistent with industry standards and rules established by the STB. The cost of property, plant and equipment normally retired, less salvage value, is charged to depreciation expense over the estimated life of the

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operating assets using composite straight-line rates for financial statement purposes. The STB approves the depreciation rates used by KCSR (excluding the amortization of computer software). KCSR periodically conducts studies of depreciation rates for properties and equipment and implements approved changes, as necessary, to depreciation rates. These studies take into consideration the historical retirement experience of similar assets, the current condition of the assets, current operations and potential changes in technology, estimated salvage value of the assets, and industry regulations. For all other consolidated subsidiaries, depreciation is derived based upon the asset value in excess of estimated salvage value using the straight-line method over the estimated useful lives of the assets for financial reporting purposes. Depreciation is based upon estimates of the useful lives of assets as well as their net salvage value at the end of their useful lives. Estimation of the useful lives of assets that are long-lived as well as their salvage value requires significant management judgement. Accordingly, management believes that accounting estimates related to depreciation expense are critical.

For the years ended December 31, 2003, 2002, and 2001, no significant changes were made to the depreciation rates applied to operating assets, the underlying assumptions related to estimates of depreciation, or the methodology applied. Currently, the Company depreciates its operating assets, including road and structures, rolling stock and equipment, and capitalized leases over a range of 3 to 120 years depending upon the estimated life of the particular asset. The Company amortizes computer software over a range of 3 to 12 years depending upon the estimated useful life of the software. In addition to the adjustment to rates as a result of the depreciation studies, certain other events could occur that would materially effect the Company’s estimates and assumptions related to depreciation. Unforeseen changes in operations or technology could substantially alter management’s assumptions regarding the Company’s ability to realize the return of its investment in operating assets and, therefore, affect the amount of depreciation expense to charge against both current and future revenues. Because depreciation expense is a function of analytical studies made of property, plant and equipment, subsequent studies could result in different estimates of useful lives and net salvage values. If future depreciation studies yield results indicating that the Company’s assets have shorter lives as a result of obsolescence, physical condition, changes in technology or changes in net salvage values, the estimate of depreciation expense could increase. Likewise, if future studies indicate that assets have longer lives, the estimate of depreciation expense could decrease. For the year ended December 31, 2003, consolidated depreciation expense was $64.3 million, representing 11.6% of consolidated operating expenses. If the estimated lives of all assets being depreciated were increased by one year, the consolidated depreciation expense would have decreased by approximately $2.5 million or 3.8%. If the estimated lives of all assets being depreciated were decreased by one year, the consolidated depreciation expense would have increased by approximately $2.8 million or 4.4%.

Provision for Environmental Remediation

The Company’s operations are subject to extensive federal, state and local environmental laws and regulations. The major environmental laws to which the Company is subject, include, among others, the Federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA,” also known as the Superfund law), the Toxic Substances Control Act, the Federal Water Pollution Control Act, and the Hazardous Materials Transportation Act. CERCLA can impose joint and several liability for cleanup and investigation costs, without regard to fault or legality of the original conduct, on current and predecessor owners and operators of a site, as well as those who generate, or arrange for the disposal of, hazardous substances. The risk of incurring environmental liability is inherent in the railroad industry. The Company owns property that is, or has been, used for industrial purposes. Use of these properties may subject the Company to potentially material liabilities relating to the investigation and cleanup of contaminants, claims alleging personal injury, or property damage as the result of exposures to, or release of, hazardous substances.

The Company conducts studies, as well as site surveys, to determine the extent of environmental damage and the necessary requirements to remediate this damage. These studies incorporate the analysis of our internal environmental engineering staff and consultation with legal counsel. From these studies and surveys, a range of estimates of the costs involved is derived and a liability and related expense for environmental remediation is

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recorded within this range. The Company’s recorded liabilities for these issues represent its best estimates (on an undiscounted basis) of remediation and restoration costs that may be required to comply with present laws and regulations. These estimates are based on forecasts of the total future direct costs related to environmental remediation. These estimates change periodically as additional or better information becomes available as to the extent of site remediation required, if any. In addition, advanced technologies related to the detection, appropriate remedial course of action and anticipated cost can influence these estimates. Certain changes could occur that would materially affect the Company’s estimates and assumptions related to costs for environmental remediation. If the Company becomes subject to more stringent environmental remediation costs at known sites, if the Company discovers additional contamination, discovers previously unknown sites, or becomes subject to related personal or property damage, the Company could incur material costs in connection with its environmental remediation. Accordingly, management believes that estimates related to the accrual of environmental remediation liabilities are critical to the Company’s results of operations.

For the year ended December 31, 2003, the expense related to environmental remediation was $0.5 million and is included as purchased services expense on the consolidated statements of income. Additionally, as of December 31, 2003, the Company has a total liability recorded for environmental remediation of $4.2 million. This amount was derived from a range of reasonable estimates based upon the Company’s studies and site surveys described above and in accordance with Statement of Financial Accounting Standards No. 5 “Accounting for Contingencies” (“SFAS 5”). For environmental remediation sites known as of December 31, 2003, if the highest estimate from the range (based upon information presently available) were recorded, the total estimated liability would have increased $4.4 million in 2003.

Provision for Casualty Claims

Due to the nature of railroad operations, claims related to personal injuries and third party liabilities resulting from crossing collisions, as well as claims related to personal property damage and other casualties, is a substantial expense to the Company. Employees are compensated for work related personal injury claims according to provisions contained within the Federal Employers’ Liability Act (“FELA”). Claims are estimated and recorded for known reported occurrences as well as for incurred but not reported (“IBNR”) occurrences. Consistent with the general practice within the railroad industry, the Company’s estimated liability for these casualty expenses is actuarially determined on an undiscounted basis. In estimating the liability for casualty claims, the Company obtains an estimate from an independent third party actuarial firm, which calculates an estimate using historical experience and estimates of claim costs as well as numerous assumptions regarding factors relevant to the derivation of an estimate of future claim costs. For other occupational injury claims, an assessment is made on a case-by-case basis in accordance with SFAS 5.

Personal injury and casualty claims are subject to a significant degree of uncertainty, especially estimates related to IBNR personal injuries for which a party has yet to assert a claim and, therefore, the degree to which injuries have been incurred and the related costs have not yet been determined. Additionally, in estimating costs related to casualty claims, management must make assumptions regarding future costs. The cost of casualty claims is significantly related to numerous factors, including the severity of the injury, the age of the claimant, and the legal jurisdiction. In deriving an estimate of the provision for casualty claims, management must make assumptions related to substantially uncertain matters. Additionally, changes in the assumptions made in actuarial studies could potentially have a material effect on the estimate of the provision for casualty claims. Accordingly, management believes that the accounting estimate related to the liability for personal injuries and other casualty claims is critical to the Company’s results of operations.

For the year ended December 31, 2003, the provision for casualty events was approximately $35.4 million and was included in casualties and insurance expense in the consolidated statements of income. Additionally, as of December 31, 2003, the Company had a total liability recorded for casualty claims of approximately $49.5 million. For the year ended December 31, 2003, the provision for casualty expense represented 6.4% of consolidated operating expenses. For purposes of earnings sensitivity analysis, if the December 31, 2003 reserve were adjusted (increased or decreased) 10%, casualty expense would have changed $5.0 million.

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Provision for Income Taxes

Deferred income taxes represent a substantial liability of the Company. For financial reporting purposes, management determines the Company’s current tax liability, as well as deferred tax assets and liabilities. In accordance with the liability method of accounting for income taxes as specified in Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes,” the provision for income taxes is the sum of income taxes both currently payable and deferred into the future. Currently payable income taxes represent the liability related to the Company’s income tax return for the current year while the net deferred tax expense or benefit represents the change in the balance of deferred tax assets or liabilities as reported on the balance sheet. The changes in deferred tax assets and liabilities are determined based upon the changes in differences between the basis of assets and liabilities for financial reporting purposes and the basis of assets and liabilities for tax purposes as measured by the enacted tax rates that management estimates will be in effect when these differences reverse. In addition to estimating the future tax rates applicable to the reversal of tax differences, management must also make certain assumptions regarding whether tax differences are permanent or temporary. If the differences are temporary, management must estimate the timing of their reversal, and whether taxable operating income in future periods will be sufficient to fully recognize any gross deferred tax assets of the Company. Accordingly, management believes that the estimate related to the provision for income taxes is critical to the Company’s results of operations.

For the years ended December 31, 2003, 2002, and 2001, management made no material changes in its assumptions regarding the determination of the provision for income taxes. However, certain events could occur that would materially affect the Company’s estimates and assumptions regarding deferred taxes. Changes in current tax laws and applicable enacted tax rates could affect the valuation of deferred tax assets and liabilities, thereby impacting the Company’s income tax provision. Additionally, significant declines in taxable operating income could materially impact the realizable value of deferred tax assets.

As of December 31, 2003, the Company’s financial reporting basis exceeded the tax basis of its investment in Grupo TFM by $92.1 million. Management has not provided a deferred income tax liability for the income taxes, if any, that would become payable upon the realization of this basis difference because the Company considers Grupo TFM to be a foreign corporate joint venture and anticipates that Grupo TFM’s earnings will be permanently invested in Grupo TFM. Likewise the Company has no plans to realize this basis differential by a sale of its investment in Grupo TFM. If management were to change this assumption in determining its provision for deferred taxes, the impact on earnings could be significant. If the Company were to realize this basis difference in the future by a receipt of dividends or the sale of its investment in Grupo TFM, as of December 31, 2003, the Company could incur additional gross federal income taxes of approximately $32.2 million, which may be partially or fully offset by Mexican income taxes and could be available to reduce U.S. federal income taxes at such time.

For the year ended December 31, 2003, the Company’s income tax benefit was $2.8 million consisting of $0.3 million for the current tax provision and $3.1 million for the deferred tax benefit. Changes in management’s estimates and assumptions regarding the enacted tax rate applied to deferred tax assets and liabilities, the ability to realize the value of deferred tax assets, or the timing of the reversal of tax basis differences could potentially impact the provision for income taxes. Changes in these assumptions could potentially change the effective tax rate. A 10% change in the effective tax rate from 23.7% (exclusive of the equity in earnings of Grupo TFM—see “Results of Operations—Income Tax Provision (Benefit)”) to 33.7% would increase the current year income tax benefit approximately $1 million.

Equity in Net Earnings of Grupo TFM

Equity in the earnings of unconsolidated affiliates is a significant component of the Company’s net income. For financial reporting purposes, the Company records equity in the net earnings of its unconsolidated affiliates in accordance with the provisions of Accounting Principles Board Opinion No. 18 “The Equity Method of

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Accounting for Investments in Common Stock.” For the Company’s investment in Grupo TFM, the equity in net earnings recorded by the Company is materially impacted by estimates included in Grupo TFM’s tax computation. These estimates are dependent to a certain extent on changes in Mexican tax rates, fluctuations in the Mexican rate of inflation and changes in the exchange rate between the U.S. dollar and the Mexican peso. To determine the income tax provision (benefit) and the value of deferred tax assets and liabilities, Grupo TFM and KCS management must make assumptions and estimates related to material amounts into the future. Accordingly, management of the Company believes that the accounting estimate made by Grupo TFM and KCS management related to Grupo TFM’s provision for income taxes is a “critical accounting estimate” due to its significant impact on the Company’s results of operations.

For the year ended December 31, 2001, there were no material changes in the assumptions regarding the determination of the provision for income taxes for Grupo TFM. Effective January 1, 2002, Mexico implemented changes in its income tax laws that had an impact on the Company’s equity in Grupo TFM’s earnings reported under the equity method of accounting. Beginning in 2003, the Mexican corporate income tax rate is being reduced from 35% to 32% in one-percent increments. As a result of this change in tax rates, management’s assumptions and estimates related to the value of Grupo TFM’s net tax asset changed, and the value of Grupo TFM’s tax asset was reduced by approximately $7.6 million in the year ended December 31, 2002, resulting in an impact of approximately $2.8 million to the Company. The provision for income taxes and the value of Grupo TFM’s net deferred tax assets could be further impacted by changes in the rate of inflation in Mexico, provisions within Mexican tax law that provide for inflation indexation for tax purposes, as well as changes in the exchange rate between the U.S. dollar and the Mexican peso. Changes in these estimates could have a material impact on the Company’s equity in earnings of Grupo TFM.

OTHER

Significant Customer. Southwestern Electric Power Company (“SWEPCO”), a subsidiary of American Electric Power, Inc., is the Company’s only customer that accounted for more than 10% of revenues during the years ended December 31, 2002 and 2001, respectively. Revenues related to SWEPCO during these periods were $64.7 million and $75.9 million, respectively. During 2003, revenues related to SWEPCO were $57.2 million, representing approximately 9.8% of the Company’s revenues. KCSR coal revenues declined in 2002 as a result of a contractual rate reduction for SWEPCO, which became effective on January 1, 2002.

Management Control System. On July 14, 2002, the Company initiated the transition from its legacy operating system to a platform called 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, delivers work orders to yard and train crews to ensure that the service being provided reflects what was sold to the customer. The system also tracks individual shipments as they move across the rail system, compares that movement to the service sold to the customer and automatically reports the shipment’s status to the customer and to operations management. If a shipment falls behind schedule, MCS automatically generates alerts and action recommendations so that corrective action promptly can be initiated.

During the second half of 2002, the Company’s operating 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. The initial difficulties experienced by office and field personnel in transitioning to this new platform led to the congestion issues and operating inefficiencies, which contributed to a decline in 2002 consolidated operating income. By mid-November 2002, however, the Company’s operations began to experience improved transit times and terminal activities as MCS capabilities began to be fully integrated into KCS management processes, and operations were virtually recovered by the end of 2002. Operating statistics, such as terminal dwell time, train velocity and cars on-line, significantly improved during 2003, confirming this recovery. See “Results of Operations” for further information.

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Derivative Instruments. The Company does not engage in the trading of derivatives. The Company’s objective for using derivative instruments is to manage its fuel and interest rate risk and mitigate the impact of fluctuations in fuel prices and interest rates. The Company accounts for derivative transactions under SFAS 133 as amended, as set forth in Note 2 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

In general, the Company enters into derivative transactions in limited situations based on management’s assessment of current market conditions and perceived risks. Management intends to respond to evolving business and market conditions in order to manage risks and exposures associated with the Company’s various operations, and in doing so, may enter into such transactions more frequently as deemed appropriate.

Fuel Derivative Transactions

Fuel expense is a significant component of the Company’s operating expenses. Fuel costs are affected by (i) traffic levels, (ii) efficiency of operations and equipment, and (iii) fuel market conditions. To lock-in the price for future fuel purchases to protect the Company’s operating results against adverse fuel price fluctuations, from time to time, KCSR enters into transactions, such as forward purchase commitments and commodity swap transactions. These derivative instruments hedge against fluctuations in the price of No. 2 Gulf Coast Heating Oil, the commodity on which the Company’s diesel fuel prices are determined. Using these risk management strategies, the Company is able to limit its risk to rising diesel fuel prices. These derivative transactions are correlated to market benchmarks and positions are monitored to ensure that they will not exceed actual fuel requirements in any period. See Note 10 in the Notes to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K.

Interest Rate Derivative Transactions

The Company did not participate in any interest rate derivative transactions during 2003 and had no interest rate hedge transactions outstanding as of December 31, 2003 and 2002. At December 31, 2001 the Company had five separate interest rate cap agreements for an aggregate notional amount of $200 million. These agreements expired during 2002.

Foreign Exchange Matters. In connection with the Company’s investment in Grupo TFM, matters arise with respect to financial accounting and reporting for foreign currency transactions and for translating foreign currency transactions into U.S. dollars. The Company follows the requirements outlined in Statement of Financial Accounting Standards No. 52 “Foreign Currency Translation” (“SFAS 52”), and related authoritative guidance. Grupo TFM uses the U.S. dollar as its functional currency. Equity earnings (losses) from Grupo TFM included in the Company’s results of operations reflect the Company’s share of any such translation gains and losses that Grupo TFM records in the process of translating certain transactions from Mexican pesos to U.S. dollars. Results of the Company’s investment in Grupo TFM are reported under U.S. GAAP while Grupo TFM reports its financial results under IFRS. Because the Company is required to report its equity earnings (losses) in Grupo TFM under U.S. GAAP and Grupo TFM reports under IFRS, differences in deferred income tax calculations and the classification of certain operating expense categories occur.

The Company continues to evaluate existing alternatives with respect to utilizing foreign currency instruments to hedge its U.S. dollar investment in Grupo TFM as market conditions change or exchange rates fluctuate. At December 31, 2003, 2002 and 2001, the Company had no outstanding foreign currency hedging instruments.

Litigation. The Company and its subsidiaries are involved as plaintiff or defendant in various legal actions arising in the normal course of business. While the ultimate outcome of the various legal proceedings involving the Company and its subsidiaries cannot be predicted with certainty, it is management’s opinion (after consultation with legal counsel) that the Company’s litigation accrued liabilities are adequate. The Company also is a defendant in various matters brought primarily by current and former employees and third parties for job

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related injury incidents or crossing accidents. The Company is aggressively defending these matters and has established liability reserves which management believes are adequate to cover expected costs. Nevertheless, due to the inherent unpredictability of these matters, the Company could incur substantial costs above reserved amounts. The following provides an update on certain more significant cases. See “Recent Developments— Dispute over Acquisition Agreement” for discussion of dispute with TMM over the Acquisition.

Stilwell Tax Dispute. On November 19, 2002, Stilwell, now Janus Capital Group Inc., filed a Statement of Claim against KCS with the American Arbitration Association. This claim involves the entitlement to compensation expense deductions for federal income tax purposes, which are associated with the exercise of certain stock options issued by Stilwell (the “Substituted Options”) in connection with the Spin-off of Stilwell from KCS on July 12, 2000. Stilwell alleges that upon exercise of a Substituted Option, Stilwell is entitled to the associated compensation expense deductions. Stilwell bases its claim on a letter, dated August 17, 1999, addressed to Landon H. Rowland, Chairman, President and Chief Executive Officer of Kansas City Southern Industries, Inc. (the “Letter”), purporting to allow Stilwell to claim such deductions. The Letter was signed by the Vice President and Tax Counsel of Stilwell, who was also at the time the Senior Assistant Vice President and Tax Counsel of KCS, and by Landon H. Rowland, currently a director of KCS and the former non-executive Chairman of Janus Capital Group Inc., who was at that time a director and officer of both Stilwell and KCS.

Stilwell seeks a declaratory award and/or injunction ordering KCS to file and amend its tax returns for the tax year 2000 and subsequent years to reflect that KCS does not claim the associated compensation expense deductions and to indemnify Stilwell against any related taxes imposed upon Stilwell, which allegedly has taken, and plans to take, such deductions. On December 20, 2002, KCS filed an Objection to Stilwell’s Demand for Arbitration and Motion to Dismiss. KCS disputes the validity and enforceability of the Letter. KCS asserts, among other things, that a Private Letter Ruling issued by the Internal Revenue Service on July 9, 1999 provides that KCS subsidiaries are entitled to compensation expense deductions upon exercise of Substituted Options by their employees.

KCS has answered that the claims of Stilwell are without merit and intends to vigorously defend against them. Given the stage of the proceeding, KCS is unable to predict the outcome, but does not expect this matter to result in an adverse financial consequences that would be material to KCS’s net income in the event, which it regards as unlikely, that it would not prevail.

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. A Master Global Settlement Agreement (“MGSA”) was signed in early 2002. During 2002, KCSR made all payments under the MGSA and collected $19.3 million from its excess insurance carriers. Court approval of the MGSA is expected in 2004 from the 22^nd Judicial District Court of Washington Parish, Louisiana. KCSR also expects to receive releases from about 4,000 Mississippi plaintiffs in numerous cases pending in the First Judicial District Circuit Court of Hinds County, Mississippi.

Houston Cases. In August 2000, KCSR and certain of its affiliates were added as defendants in lawsuits pending in Jefferson and Harris Counties, Texas. These lawsuits allege damage to approximately 3,000 plaintiffs as a result of an alleged toxic chemical release from a tank car in Houston, Texas on August 21, 1998. Litigation involving the shipper and the delivering carrier had been pending for some time, but KCSR, which handled the car during the course of its transport, had not previously been named a defendant. On June 28, 2001, KCSR reached a final settlement with the 1,664 plaintiffs in the lawsuit filed in Jefferson County, Texas. In 2002, KCSR settled with virtually all of the plaintiffs in the lawsuit filed in the 164^th Judicial District Court of Harris

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County, Texas, for approximately $0.3 million. The remaining plaintiffs have indicated that they intend to retain new counsel, yet to date, KCS has not received any notice of new counsel entering the case.

Environmental Matters. As discussed above in “Critical Accounting Policies and Estimates,” the Company’s operations, as well as those of its competitors, are subject to extensive federal, state and local environmental laws and regulations. Certain laws and regulations can impose joint and several liability for cleanup and investigation costs, without regard to fault or legality of the original conduct, on current and predecessor owners and operators of a site, as well as those who generate, or arrange for the disposal of, hazardous substances. The Company does not foresee that compliance with the requirements imposed by the current environmental legislation will impair its competitive capability or result in any material additional capital expenditures, operating or maintenance costs. However, stricter environmental requirements relating to our business, which may be imposed in the future, could result in significant additional costs.

The risk of incurring environmental liability is inherent in the railroad industry. The Company’s operations involve the use and, as part of serving the petroleum and chemicals industry, transportation of hazardous materials. The Company has a professional team available to respond and handle environmental issues that might occur in the transport of such materials. The Company also is a partner in the Responsible Care^® program and, as a result, has initiated certain additional environmental, health and safety practices. KCSR performs ongoing review and evaluation of the various environmental programs and issues within the Company’s operations, and, as necessary, takes actions to limit the Company’s exposure to environmental liabilities.

Although the Company is responsible for investigating and remediating contamination at several locations, based on currently available information, the Company does not expect any related liabilities, individually or collectively, to have a material impact on its results of operations, financial position or cash flows. In the event that the Company becomes subject to more stringent cleanup requirements at these sites, discovers additional contamination, or becomes subject to related personal or property damage claims, the Company could incur material costs in connection with these sites.

KCSR has been named a Potential Responsible Party (PRP) in connection with a former foundry site in Alexandria, Louisiana. A small portion of this property was owned through a former subsidiary during the years 1924 to 1974 and leased to a small foundry operator. The foundry operator, Ruston Foundry, ceased operations in early 1990. The site is on the CERCLA National Priorities List of contaminated sites. The United States Environmental Protection Agency has completed a Record of Decision of the site. Management is in the process of negotiating a settlement with respect to this site and continues to evaluate its potential financial statement impact. Management’s has recorded its best estimate of potential liability of $1.9 million as of December 31, 2003 related to potential remediation costs at this site. Further evaluation is ongoing and any remaining exposure is not expected to have a material effect on the Company’s results of operations, financial condition, or cash flows.

In 1996, the Louisiana Department of Transportation (“LDOT”) sued KCSR and a number of other defendants in Louisiana state court to recover cleanup costs incurred by LDOT while constructing Interstate Highway 49 at Shreveport, Louisiana (Louisiana Department of Transportation v. The Kansas City Southern Railway Company, et al., Case No. 417190-B in the First Judicial District Court, Caddo Parish, Louisiana). The cleanup was associated with contamination in the area of a former oil refinery site, operated by Crystal Refinery. KCSR’s main line was adjacent to that site. LDOT claims that a 1966 derailment contributed to contamination at the site. However, KCSR management believes that KCSR’s liability exposure with respect to this site is remote.

The Company records liabilities for remediation and restoration costs related to past activities when the Company’s obligation is probable and the costs can be reasonably estimated. Costs of ongoing compliance activities to current operations are expensed as incurred. The Company’s recorded liabilities with respect to these various environmental issues represent its best estimates of remediation and restoration costs that may be required to comply with present laws and regulations. Although these costs cannot be predicted with certainty,

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management believes that the ultimate outcome of identified matters will not have a material adverse effect on the Company’s consolidated results of operations, financial condition or cash flows.

Recent Accounting Pronouncements. See Note 2 in the Notes to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K for information relative to recent accounting pronouncements.

Regulatory Influence. In addition to the environmental agencies mentioned above, KCSR’s operations are regulated by the STB, various state regulatory agencies, and the Occupational Safety and Health Administration (“OSHA”). State agencies regulate some aspects of rail operations with respect to health and safety and in some instances, intrastate freight rates. OSHA has jurisdiction over certain health and safety features of railroad operations. The Company does not foresee that regulatory compliance under present statutes will impair its competitive capability or result in any material effect on its results of operations, financial condition or cash flows.

Inflation. Inflation has not had a significant impact on the Company’s operations in the past three years. U.S. GAAP requires the use of historical costs. Replacement cost and related depreciation expense of the Company’s property would be substantially higher than the historical costs reported. Any increase in expenses from these fixed costs, coupled with variable cost increases due to significant inflation, would be difficult to recover through price increases given the competitive environments of the Company’s principal subsidiaries. Higher fuel prices have impacted KCSR’s operating results in 2003, 2002 and 2001. During the two-year period ended December 31, 1999, locomotive fuel expenses represented an average of 6.9% of KCSR’s total costs and expenses compared to 9.2% in 2003, 7.7% in 2002 and 8.8% in 2001. See “Foreign Exchange Matters” above with respect to inflation in Mexico.

CAUTIONARY INFORMATION

The discussions set forth in this Annual Report on Form 10-K contain statements concerning potential future events. Such forward-looking statements are based upon assumptions by the Company’s management, as of the date of this Annual Report, including assumptions about risks and uncertainties faced by the Company. In addition, management may make forward-looking statements orally or in other writings, including, but not limited to, in press releases, in the annual report to shareholders and in the Company’s other filings with the Securities and Exchange Commission. Readers can identify these forward-looking statements by the use of such verbs as expects, anticipates, believes or similar verbs or conjugations of such verbs. These forward-looking statements include, without limitation, statements regarding: expectations as to operational improvements; expectations as to cost savings, revenue growth and earnings; the time by which certain objectives will be achieved; estimates of costs relating to environmental remediation and restoration; proposed new products and services; expectations that claims, lawsuits, environmental costs, commitments, contingent liabilities, labor negotiations or agreements, or other matters will not have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity; and statements concerning projections, predictions, expectations, estimates or forecasts as to the Company’s business, financial and operational results, and future economic performance, statements of management’s goals and objectives and other similar expressions concerning matters that are not historical facts. If any of management’s assumptions prove incorrect or should unanticipated circumstances arise, the Company’s actual results could materially differ from those anticipated by such forward-looking statements. The differences could be caused by a number of factors or combination of factors including, but not limited to, the factors identified below and the factors discussed above under the heading “Risk Factors.” Readers are strongly encouraged to consider these factors when evaluating any forward-looking statements concerning the Company.

• whether the Company is fully successful in executing the Company’s business strategy, including capitalizing on NAFTA trade to generate traffic and increase revenues, exploiting the Company’s

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domestic opportunities, establishing new and expanding existing strategic alliances and marketing agreements and providing superior customer service;

• whether the Company is successful in retaining and attracting qualified management personnel;

• whether the Company is able to generate cash that will be sufficient to allow it to pay principal and interest on the Company’s debt and meet the Company’s obligations and to fund the Company’s other liquidity needs;

• whether the Company is able to complete the Acquisition;

• the Company’s ability to satisfy its contingent obligation to purchase shares of TFM, owned by the government of Mexico;

• Material adverse changes in economic and industry conditions, both within the United States and globally;

• the effects of adverse general economic conditions affecting customer demand and the industries and geographic areas that produce and consume commodities carried;

• the effect of NAFTA on the level of U.S.-Mexico trade;

• industry competition, conditions, performance and consolidation;

• general legislative and regulatory developments, including possible enactment of initiatives to re-regulate the rail industry;

• legislative, regulatory, or legal developments involving taxation, including enactment of new federal or state income tax rates, revisions of controlling authority, and the outcome of tax claims and litigation;

• changes in securities and capital markets;

• natural events such as severe weather, fire, floods, earthquakes or other disruptions of the Company’s operating systems, structures and equipment;

• any adverse economic or operational repercussions from terrorist activities and any governmental response thereto;

• war or risk of war;

• changes in fuel prices;

• changes in labor costs and labor difficulties, including stoppages affecting either the Company’s operations or the Company’s customers’ abilities to deliver goods to it for shipment; and

• the outcome of claims and litigation, including those related to environmental contamination, personal injuries and occupational illnesses arising from hearing loss, repetitive motion and exposure to asbestos and diesel fumes.

The Company will not update any forward-looking statements in this Annual Report to reflect future events or developments. If the Company does update one or more forward-looking statements, no inference should be drawn that the Company will make additional updates with respect thereto or with respect to other forward-looking statements.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The Company utilizes various financial instruments that have certain inherent market risks. Generally, these instruments have not been entered into for trading purposes. The following information, together with information included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K and Note 10 to the Consolidated Financial Statements in Item 8 of this Form 10-K, which are hereby incorporated by reference, describe the key aspects of certain financial instruments that have market risk to the Company.

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Interest Rate Sensitivity

The Company’s floating-rate indebtedness totaled $98.5 million and $149.3 million at December 31, 2003 and 2002, respectively. The Company’s variable rate debt, comprised of a revolving credit facility and a term loan, accrues interest based on target interest indexes (e.g., London Interbank Offered Rate—“LIBOR,” federal funds rate, etc.) plus an applicable spread, as set forth in the credit agreement. As a result of the 2002 refinancing of $200 million of variable rate debt with the 7½% Notes, the Company has been able to reduce its sensitivity to fluctuations in interest rates compared to previous years. However, given the balance of $98.5 million variable rate debt at December 31, 2003, the Company is still sensitive to fluctuations in interest rates. For example, a hypothetical 100 basis points increase in each of the respective target interest indexes would result in additional interest expense of approximately $1.0 million on an annualized basis for the floating-rate instruments held by the Company as of December 31, 2003.

Based upon the borrowing rates available to KCS and its subsidiaries for indebtedness with similar terms and average maturities, the fair value of the Company’s long-term debt was approximately $558 million at December 31, 2003 and $617 million at December 31, 2002.

Commodity Price Sensitivity

As described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Other—Derivative Instruments” of this Form 10-K, the Company participates in diesel fuel purchase commitment and swap transactions. At December 31, 2003, the Company was a party to seven fuel swap agreements. Based on market prices at December 31, 2003, the Company would receive payments from the third party counterparty of approximately $0.9 million on the settlement date of the agreement, representing the excess of the current market price over the agreed upon swap price. If market prices of fuel dropped below the swap price, then KCS would be obligated to pay an amount equal to the difference between the market price and the swap price for each gallon of fuel hedged. At December 31, 2002, the excess of payments to be received or savings to be realized over the market price related to diesel fuel purchase commitments and fuel swap transactions approximated $1.8 million and $0.6 million, respectively. A hypothetical 10% increase in the price of diesel fuel would have resulted in additional fuel expense of approximately $4.7 million for the year ended December 31, 2003.

At December 31, 2003, the Company held fuel inventories for use in normal operations. These inventories were not material to the Company’s overall financial position. With the exception of the 13% of fuel currently hedged under fuel swap transactions for 2004, fuel costs are expected to mirror market conditions in 2003.

Foreign Exchange Sensitivity

The Company owns a 46.6% interest in Grupo TFM, incorporated in Mexico. In connection with the Company’s investment in Grupo TFM, matters arise with respect to financial accounting and reporting for foreign currency transactions and for translating foreign currency transactions into U.S. dollars. Grupo TFM uses the U.S. dollar as its functional currency. Equity earnings (losses) from Grupo TFM included in the Company’s results of operations reflect the Company’s share of any such translation gains and losses that Grupo TFM records in the process of translating certain transactions from Mexican pesos to U.S. dollars. Therefore, the Company has exposure to fluctuations in the value of the Mexican peso. While not currently utilizing foreign currency instruments to hedge the Company’s U.S. dollar investment in Grupo TFM, the Company continues to evaluate existing alternatives as market conditions and exchange rates fluctuate.

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Item 8. Financial Statements and Supplementary Data

Index to Financial Statements

	Page
Management Report on Responsibility for Financial Reporting	61
Financial Statements:
Report of Independent Accountants	62
Consolidated Statements of Income for the three years ended December 31, 2003	63
Consolidated Balance Sheets at December 31, 2003 and 2002	64
Consolidated Statements of Cash Flows for the three years ended December 31, 2003	65
Consolidated Statements of Changes in Stockholders’ Equity for the three years ended December 31, 2003	66
Notes to Consolidated Financial Statements	67

Financial Statement Schedules:

All schedules are omitted because they are not applicable, are insignificant or the required information is shown in the consolidated financial statements or notes thereto.

The combined and consolidated financial statements of Grupo TFM as of December 31, 2003 and for each of the three years in the period ended December 31, 2003 are attached to this Form 10-K as Exhibit 99.1.

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Management Report on Responsibility for Financial Reporting

The accompanying consolidated financial statements and related notes of Kansas City Southern and its subsidiaries were prepared by management in conformity with generally accepted accounting principles appropriate in the circumstances. In preparing the financial statements, management has made judgments and estimates based on currently available information. Management is responsible for not only the financial information, but also all other information in this Annual Report on Form 10-K. Representations contained elsewhere in this Annual Report on Form 10-K are consistent with the consolidated financial statements and related notes thereto.

The Company’s financial statements as of and for the years ended December 31, 2003, 2002 and 2001 have been audited by its independent accountants, KPMG LLP. Management has made available to the independent accountants all of the Company’s financial records and related data, as well as the minutes of shareholders’ and directors’ meetings. Furthermore, management believes that all representations made to the Company’s independent accountants during their audits were valid and appropriate.

The Company has a formalized system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that its financial records are reliable. Management monitors the system for compliance, and the Company’s internal auditors review and evaluate both internal accounting and operating controls and recommend possible improvements thereto. In addition, as part of their audit of the consolidated financial statements, the independent accountants, review and test the internal accounting controls on a selective basis to establish the extent of their reliance thereon in determining the nature, extent and timing of audit tests to be applied. The internal audit staff coordinates with the independent accountants during the annual audit of the Company’s financial statements.

The Board of Directors pursues its oversight role in the area of financial reporting and internal accounting control through its Audit Committee. This committee, composed solely of qualified non-management directors, meets regularly with the respective independent accountants, management and internal auditors to monitor the proper discharge of responsibilities relative to internal accounting controls and to evaluate the quality of external financial reporting. Both the independent accountants and internal auditors have full and free access to this committee.

Michael R. Haverty

Chairman, President & Chief Executive Officer

Ronald G. Russ

Executive Vice President & Chief Financial Officer

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Report of Independent Accountants

To the Board of Directors and Stockholders of

Kansas City Southern

We have audited the accompanying consolidated balance sheets of Kansas City Southern and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the financial statements of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (Grupo TFM), a 46.6% owned investee company, as of December 31, 2003 or for the years ended December 31, 2003 and December 31, 2001. The Company’s investment in Grupo TFM at December 31, 2003 was $392.1 million and its equity in earnings of Grupo TFM was $12.3 million and $28.5 million for the years ended December 31, 2003 and 2001, respectively. The financial statements of Grupo TFM as of and for the year ended December 31, 2003 and for the year ended December 31, 2001 were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Grupo TFM as of and for the year ended December 31, 2003 and for the year ended December 31, 2001, is based solely on the reports of the other auditors.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors for 2003 and 2001 provide a reasonable basis for our opinion.

In our opinion, based on our audits, and the reports of other auditors for 2003 and 2001, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kansas City Southern and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 2 to the consolidated financial statements, effective January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations.”

KPMG LLP

Kansas City, Missouri

March 19, 2004

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KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31

Dollars in Millions, Except Share and per Share Amounts

	2003			2002			2001
Revenues	$	581.3		$	566.2		$	583.2
Operating expenses
Compensation and benefits		197.8			197.8			192.9
Depreciation and amortization		64.3			61.4			58.0
Purchased services		63.5			59.6			57.0
Operating leases		57.2			55.0			56.8
Casualties and insurance		56.4			25.2			42.1
Fuel		47.4			38.4			43.9
Car hire		10.0			19.7			19.8
Other		55.6			61.1			57.3
Total operating expenses		552.2			518.2			527.8
Operating income		29.1			48.0			55.4
Equity in net earnings (losses) of unconsolidated affiliates:
Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V.		12.3			45.8			28.5
Other		(1.3	)		(2.4	)		(1.4	)
Gain on sale of Mexrail, Inc.		—			4.4			—
Interest expense		(46.4	)		(45.0	)		(52.8	)
Debt retirement costs		—			(4.3	)		—
Other income		6.8			17.6			4.2
Income before income taxes and cumulative effect of accounting change		0.5			64.1			33.9
Income tax provision (benefit) (Note 6)		(2.8	)		6.9			2.8
Income before cumulative effect of accounting change		3.3			57.2			31.1
Cumulative effect of accounting change, net of income taxes		8.9			—			(0.4	)
Net income	$	12.2		$	57.2		$	30.7
Preferred stock dividends		5.9			0.2			0.2
Net income available to common shareholders	$	6.3		$	57.0		$	30.5
Per Share Data
Basic earnings (loss) per common share
Basic earnings (loss) per share before cumulative effect of accounting change	$	(0.04	)	$	0.94		$	0.53
Cumulative effect of accounting change, net of income taxes		0.14			—			(0.01	)
Total basic earnings per common share	$	0.10		$	0.94		$	0.52
Diluted earnings (loss) per common share
Diluted earnings (loss) per share before cumulative effect of accounting change	$	(0.04	)	$	0.91		$	0.51
Cumulative effect of accounting change, net of income taxes		0.14			—			(0.01	)
Total diluted earnings per common share	$	0.10		$	0.91		$	0.50
Weighted average common shares outstanding (in thousands)
Basic		61,725			60,336			58,598
Potential dilutive common shares		—			1,982			2,386
Diluted		61,725			62,318			60,984

See accompanying notes to consolidated financial statements

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KANSAS CITY SOUTHERN

CONSOLIDATED BALANCE SHEETS

at December 31

Dollars in Millions, Except Share and per Share Amounts

	2003			2002
ASSETS
Current Assets:
Cash and cash equivalents	$	135.4		$	19.0
Accounts receivable, net (Note 4)		108.2			114.9
Accounts receivable from related parties		6.4			3.6
Inventories		36.8			34.2
Other current assets (Note 4)		21.3			44.5
Total current assets		308.1			216.2
Investments (Note 3)		442.7			423.1
Properties, net (Note 4)		1,362.5			1,337.4
Goodwill		10.6			10.6
Other assets		29.0			21.5
Total assets	$	2,152.9		$	2,008.8
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Debt due within one year (Note 5)	$	9.9		$	10.0
Accounts and wages payable		45.5			47.7
Accrued liabilities (Note 4)		119.4			128.6
Total current liabilities		174.8			186.3
Other Liabilities:
Long-term debt (Note 5)		513.5			572.6
Deferred income taxes (Note 6)		391.5			392.8
Other noncurrent liabilities and deferred credits (Note 4)		109.4			104.2
Commitments and contingencies (Notes 3,5,6,7,8,9,10)
Total other liabilities		1,014.4			1,069.6
Stockholders’ Equity (Notes 2,7):
$25 par, 4% noncumulative, Preferred stock, 840,000 shares authorized, 649,736 shares issued, 242,170 shares outstanding		6.1			6.1
$1 par, Cumulative Preferred stock, 400,000 shares authorized, issued and outstanding at December 31, 2003; 0 shares authorized, issued and outstanding at December 31, 2002		0.4			—
$.01 par, Common stock, 400,000,000 shares authorized; 73,369,116 shares issued; 62,175,621 and 61,103,015 shares outstanding at December 31, 2003 and 2002, respectively		0.6			0.6
Paid in capital		110.9			—
Retained earnings		846.2			748.5
Accumulated other comprehensive loss		(0.5	)		(2.3	)
Total stockholders’ equity		963.7			752.9
Total liabilities and stockholders’ equity	$	2,152.9		$	2,008.8

See accompanying notes to consolidated financial statements

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KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31

Dollars in Millions

	2003			2002			2001
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income	$	12.2		$	57.2		$	30.7
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		64.3			61.4			58.0
Deferred income taxes		(3.1	)		21.8			30.4
Equity in undistributed earnings of unconsolidated affiliates		(11.0	)		(43.4	)		(27.1	)
Distributions from unconsolidated affiliates		—			—			3.0
Gain on sale of assets		(6.2	)		(20.1	)		(5.8	)
Cumulative effect of accounting change		(8.9	)		—			0.4
Tax benefit realized upon exercise of stock options		2.5			4.5			5.6
Changes in working capital items
Accounts receivable		4.0			12.4			4.0
Inventories		(2.5	)		(8.8	)		6.1
Other current assets		15.3			29.8			(19.3	)
Accounts and wages payable		(2.8	)		(2.4	)		(5.1	)
Accrued liabilities		(12.7	)		(20.6	)		(26.9	)
Other, net		16.2			3.9			14.7
Net		67.3			95.7			68.7
INVESTING ACTIVITIES:
Property acquisitions		(79.0	)		(79.8	)		(66.0	)
Proceeds from disposal of property		12.4			18.1			18.1
Investment in and loans to affiliates		(40.4	)		(4.4	)		(8.2	)
Proceeds from sale of investments, net		32.7			31.7			0.6
Deferred costs related to acquisition of Grupo TFM		(9.3	)		—			—
Other, net		—			(0.5	)		(0.2	)
Net		(83.6	)		(34.9	)		(55.7	)
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt		—			200.0			35.0
Repayment of long-term debt		(59.2	)		(270.9	)		(51.3	)
Net proceeds from issuance of preferred stock		193.0			—			—
Debt issuance costs		—			(5.7	)		(0.4	)
Proceeds from stock plans		5.3			10.3			8.9
Cash dividends paid		(4.7	)		(0.2	)		(0.2	)
Other, net		(1.7	)		—			(1.8	)
Net		132.7			(66.5	)		(9.8	)
CASH AND CASH EQUIVALENTS:
Net increase (decrease) in cash and cash equivalents		116.4			(5.7	)		3.2
At beginning of year		19.0			24.7			21.5
At end of period	$	135.4		$	19.0		$	24.7
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash payments (refunds)
Interest	$	42.4		$	45.5		$	49.1
Income tax payments (refunds)	$	(23.6	)	$	(29.6	)	$	(25.0	)

See accompanying notes to consolidated financial statements.

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KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Dollars in Millions, Except per Share Amounts

	$25 Par Preferred Stock		$1 Par Cumulative Preferred Stock		$.01 Par Common Stock		Paid In Capital		Retained Earnings			Accumulated Other Comprehensive Income (loss)			Total
Balance at December 31, 2000	$	6.1	$	—	$	0.6	$	—	$	636.7		$	—		$	643.4
Comprehensive income:
Net income										30.7
Cumulative effect of accounting change													(0.9	)
Change in fair market value of cash flow hedge of unconsolidated affiliate													(2.0	)
Comprehensive income																27.8
Dividends on $25 Par Preferred Stock ($1.00/share)										(0.2	)					(0.2	)
Options exercised and stock subscribed										9.3						9.3
Balance at December 31, 2001		6.1		—		0.6		—		676.5			(2.9	)		680.3
Comprehensive income:
Net income										57.2
Change in fair value of cash flow hedges													(0.1	)
Amortization of accumulated other comprehensive income (loss) related to interest rate swaps													0.7
Comprehensive income																57.8
Dividends on $25 Par Preferred Stock ($1.00/share)										(0.2	)					(0.2	)
Options exercised and stock subscribed										15.0						15.0
Balance at December 31, 2002		6.1		—		0.6		—		748.5			(2.3	)		752.9
Comprehensive income:
Net income										12.2
Change in fair value of cash flow hedges													0.6
Amortization of accumulated other comprehensive income (loss) related to interest rate swaps													1.2
Comprehensive income																14.0
Issuance of preferred stock				0.4				110.9		81.7						193.0
Dividends on $25 Par Preferred Stock ($1.00/share)										(0.2	)					(0.2	)
Dividends on $1 Par Cumulative Preferred Stock ($11.22/share)										(4.5	)					(4.5	)
Options exercised and stock subscribed										5.2						5.2
Stock plan shares issued from treasury										3.3						3.3
Balance at December 31, 2003	$	6.1	$	0.4	$	0.6	$	110.9	$	846.2		$	(0.5	)	$	963.7

See accompanying notes to consolidated financial statements.

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KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Description of the Business

Kansas City Southern (“KCS” or the “Company”) is a Delaware corporation that was initially organized in 1962 as Kansas City Southern Industries, Inc. In 2002, the Company formally changed its name to Kansas City Southern. KCS is a holding company with principal operations in rail transportation. KCS’s principal subsidiaries and affiliates, which are reported under one business segment, include the following:

• The Kansas City Southern Railway Company (“KCSR”), a wholly-owned subsidiary of KCS;

• Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”), a 46.6% owned unconsolidated affiliate of KCSR. Grupo TFM owns 80% of the stock of TFM, S.A. de C.V. (“TFM”). TFM wholly-owns Mexrail, Inc. (“Mexrail”). Mexrail wholly-owns The Texas-Mexican Railway Company (“Tex-Mex”);

• Southern Capital Corporation, LLC (“Southern Capital”), a 50% owned unconsolidated affiliate of KCSR that leases locomotive and rail equipment to KCSR;

• Panama Canal Railway Company (“PCRC”), an unconsolidated affiliate of which KCSR indirectly owns 50% of the common stock. PCRC owns all of the common stock of Panarail Tourism Company (“Panarail”).

KCS, along with its principal subsidiaries and joint ventures, owns and operates a rail network that links key commercial and industrial markets in the United States and Mexico. The Company also has a strategic alliance with the Canadian National Railway Company (“CN”) and Illinois Central Corporation (“IC”) (collectively “CN/IC”) and other marketing agreements, which provide the ability for the Company to expand its geographic reach.

KCS’s rail network, including its joint ventures, strategic alliances and marketing agreements, connects shippers in the midwestern and eastern regions of the United States, including shippers utilizing Chicago, Illinois and Kansas City, Missouri—the two largest rail centers in the United States—with the largest industrial centers of Canada and Mexico, including Toronto, Edmonton, Mexico City and Monterrey. KCS’s rail system, through its core network, strategic alliances and marketing agreements, interconnects with all Class I railroads in North America.

KCSR, which owns and operates one of seven Class I railroads (railroads with annual revenues of at least $272.0 million) in the United States, is comprised of approximately 3,100 miles of main and branch lines and approximately 1,250 miles of other tracks in a ten-state region that includes Missouri, Kansas, Arkansas, Oklahoma, Mississippi, Alabama, Tennessee, Louisiana, Texas and Illinois. KCSR, which traces its origins to 1887, offers the shortest north/south rail route between Kansas City and several key ports along the Gulf of Mexico in Louisiana, Mississippi and Texas. Additionally, KCSR, in conjunction with the Norfolk Southern Railway Company (“Norfolk Southern”), operates the most direct rail route (referred to as the “Meridian Speedway”), between the Atlanta, Georgia and Dallas, Texas rail gateways, for rail traffic moving between the southeast and southwest regions of the United States. The Meridian Speedway also provides eastern shippers and other U.S. and Canadian railroads with an efficient connection to Mexican markets. KCSR’s rail route also serves the east/west route linking Kansas City with East St. Louis and Springfield, Illinois. Further, KCSR has limited haulage rights between Springfield and Chicago that allow for shipments that originate or terminate on the former Gateway Western’s rail lines. These lines also provide access to East St. Louis and allow rail traffic to avoid the St. Louis, Missouri terminal. KCSR’s geographic reach enables service to a customer base that includes, among others, electric generating utilities, which use coal, and a wide range of companies in the chemical and petroleum, agricultural and mineral, paper and forest, and automotive and intermodal markets.

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The Company’s rail network links directly to major trading centers in Mexico through TFM and Tex-Mex. TFM operates a railroad of approximately 2,650 miles of main and branch lines running from the U.S./Mexican border at Laredo, Texas to Mexico City and serves most of Mexico’s principal industrial cities and three of its major shipping ports. TFM also owns all of Mexrail, which in turn wholly-owns Tex-Mex. Tex-Mex operates approximately 160 miles of main and branch lines between Laredo and the port city of Corpus Christi, Texas. TFM, through its concession with the Mexican government, has the right to control and operate the southern half of the rail-bridge at Laredo and, indirectly through its ownership of Mexrail, owns the northern half of the rail-bridge at Laredo, which spans the Rio Grande River between the United States and Mexico. Laredo is the principal international gateway where more than 50% of all rail and truck traffic between the United States and Mexico crosses the border.

Note 2. Significant Accounting Policies

Principles of Consolidation. The accompanying consolidated financial statements are presented using the accrual basis of accounting and include the Company and its majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year presentation.

The equity method of accounting is used for all entities in which the Company or its subsidiaries have significant influence, but not more than 50% voting interest; the cost method of accounting is generally used for investments of less than 20% voting interest.

Use of Estimates. The accounting and financial reporting policies of the Company conform with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Management reviews its estimates, including those related to the recoverability and useful lives of assets, as well as liabilities for litigation, environmental remediation, casualty claims, and income taxes. Changes in facts and circumstances may result in revised estimates. Actual results could differ from those estimates.

Revenue Recognition. The Company recognizes freight revenue based upon the percentage of completion of a commodity movement. Other revenues, in general, are recognized when the product is shipped, as services are performed or contractual obligations fulfilled.

Cash Equivalents. Short-term liquid investments with an initial maturity of generally three months or less are considered cash equivalents.

Inventories. Materials and supplies inventories are valued at the lower of average cost or market.

Properties and Depreciation. Properties are stated at cost. Additions and renewals, including those on leased assets that increase the life or utility of the asset are capitalized and all properties are depreciated over the estimated remaining life or lease term of such assets, whichever is shorter. Depreciation for railway operating assets is derived using the group-life method. This method classifies similar assets by equipment or road type and depreciates these assets as a whole. Ordinary maintenance and repairs are charged to expense as incurred.

The cost of transportation equipment and road property normally retired, less salvage value, is charged to accumulated depreciation. The cost of industrial and other property retired, and the cost of transportation property abnormally retired, together with accumulated depreciation thereon, are eliminated from the property accounts and the related gains or losses are reflected in net income. Gains recognized on the sale or disposal of operating properties that were reflected in operating income were $5.9 million, $3.1 million and $5.8 million in 2003, 2002 and 2001, respectively. Gains or losses recognized on the sale of non-operating properties reflected in

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other income were $0.3 million and $7.4 million in 2003 and 2002, respectively. Gains or losses recognized on the sale of non-operating properties reflected in other income were not significant in 2001.

Depreciation is computed using group straight-line rates for financial statement purposes. The Surface Transportation Board (“STB”) approves the depreciation rates used by KCSR. KCSR periodically evaluates depreciation rates for properties and equipment and implements approved rates. Depreciation for other consolidated subsidiaries is computed based on the asset value in excess of estimated salvage value using the straight-line method over the estimated useful lives of the assets.

Accelerated depreciation is used for income tax purposes. The weighted-average annual depreciation rates for financial statement purposes are:

Road and structures	3%
Rolling stock and equipment	3%
Other equipment	2%
Computer software	9%
Capitalized leases	6%

Long-lived assets. The Company evaluates the recoverability of its operating properties when there is an indication that an asset value has been impaired. The measurement of possible impairment is based primarily on the ability to recover the carrying value of the asset from expected future operating cash flows related to the assets on an undiscounted basis.

Casualty Claims. Casualty claims in excess of self-insurance levels are insured up to certain coverage amounts, depending on the type of claim. The Company’s casualty liability reserve is based on a study by an independent third party actuarial firm performed on an undiscounted basis. The reserve is based on claims filed and an estimate of claims incurred but not yet reported. While the ultimate amount of claims incurred is dependent on various factors, it is management’s opinion that the recorded liability is a reasonable estimate of aggregate future claims. Adjustments to the liability will be reflected as operating expenses in the period in which the adjustments are known. For other occupational injury claims, an assessment is made on a case-by-case basis and a liability is established when management determines that it is probable and reasonably estimable.

Computer Software Costs. Costs incurred in conjunction with the purchase or development of computer software for internal use are capitalized. Costs incurred in the preliminary project stage, as well as training and maintenance costs, are expensed as incurred. Direct and indirect costs associated with the application development stage of internal use software are capitalized until such time that the software is substantially complete and ready for its intended use. Capitalized costs are amortized on a straight-line basis over the useful life of the software. As of December 31, 2003 and 2002, a total of approximately $59.7 million and $58.0 million, respectively, was capitalized (including a total of approximately $5.9 million of capitalized interest costs for each of 2003 and 2002, respectively) for the transportation operating system, management control system (“MCS”), which was implemented in July, 2002.

Goodwill and other intangible assets. 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. The transitional disclosures are presented in the table below. During the year ended December 31, 2002, the Company’s goodwill decreased primarily due to the sale of Mexrail to TFM.

69

	Year Ended December 31,
	2003		2002		2001
Reported net income	$	12.2	$	57.2	$	30.7
Add back: Goodwill amortization		—		—		0.6
Adjusted net income	$	12.2	$	57.2	$	31.3
Reported diluted earnings per share—net income	$	0.10	$	0.91	$	0.50
Add back: Goodwill amortization		—		—		0.01
Adjusted diluted earnings per share—net income	$	0.10	$	0.91	$	0.51

Fair Value of Financial Instruments. The Company’s financial instruments include cash and cash equivalents, accounts receivable, lease and contract receivables, accounts payable and long-term debt.

The financial statement carrying value of the Company’s cash equivalents approximates fair value due to their short-term nature. Carrying value approximates fair value for all financial instruments with six months or less to re-pricing or maturity and for financial instruments with variable interest rates. The Company estimates the fair value of long-term debt based upon borrowing rates available at the reporting date for indebtedness with similar terms and average maturities. Based upon the borrowing rates currently available to the Company and its subsidiaries for indebtedness with similar terms and average maturities, the fair value of long-term debt was approximately $558 million and $617 million at December 31, 2003 and 2002, respectively. The financial statement carrying value was $523 million and $583 million at December 31, 2003 and 2002, respectively.

Derivative Instruments. Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended, requires that derivatives be recorded on the balance sheet as either assets or liabilities measured at fair value. Changes in the fair value of derivatives are recorded either through current earnings or as other comprehensive income, depending on the type of hedge transaction. Gains and losses on the derivative instrument reported in other comprehensive income are reclassified into earnings in the periods in which earnings are impacted by the variability of the cash flow of the hedged item. The ineffective portion of all hedge transactions is recognized in current period earnings.

KCS adopted the provisions of SFAS 133, as amended, effective January 1, 2001. As a result of the change in the method of accounting for derivative 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 financial statements and represents the ineffective portion of certain interest rate cap agreements. In 2002, these interest rate cap agreements expired with no significant effect on earnings.

Income Taxes. Deferred income tax effects of transactions reported in different periods for financial reporting and income tax return purposes are recorded under the liability method of accounting for income taxes. This method gives consideration to the future tax consequences of the deferred income tax items and immediately recognizes changes in income tax laws upon enactment.

Grupo TFM provides deferred income taxes for the difference between the financial reporting and income tax bases of its assets and liabilities. The Company records its proportionate share of these income taxes through its equity in Grupo TFM’s earnings. As of December 31, 2003, the Company had not provided deferred income taxes for the temporary difference between the financial reporting basis and income tax basis of its investment in Grupo TFM because Grupo TFM is a foreign corporate joint venture that is considered permanent in duration, and the Company does not expect the reversal of the temporary difference to occur in the foreseeable future.

Changes of Interest in Subsidiaries and Equity Investees. A change of the Company’s interest in a subsidiary or equity investee resulting from the sale of the subsidiary’s or equity investee’s stock is generally recorded as a gain or loss in the Company’s net income in the period that the change of interest occurs. If an

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issuance of stock by the subsidiary or affiliate is from treasury shares on which gains have been previously recognized, however, KCS will record the gain directly to its equity and not include the gain in net income. A change of interest in a subsidiary or equity investee resulting from a subsidiary’s or equity investee’s purchase of its stock increases the Company’s ownership percentage of the subsidiary or equity investee. The Company records this type of transaction under the purchase method of accounting, whereby any excess of fair market value over the net tangible and identifiable intangible assets is recorded as goodwill.

Treasury Stock. The excess of par over cost of the preferred shares held in Treasury is credited to paid in capital. Common shares held in Treasury are accounted for as if they were retired and the excess of cost over par value of such shares is charged to paid in capital.

Stock Plans. Proceeds received from the exercise of stock options or subscriptions are credited to the appropriate stockholders’ equity accounts in the year exercised.

Pursuant to Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), compensation expense is recognized ratably over the option vesting period to the extent that an option exercise price is less than the market price of the stock at the date of grant. Because KCS’s practice is to set the option exercise price equal to the market price of the stock at date of grant, no compensation expense is recognized for financial reporting purposes.

The FASB issued Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”) in October 1995. This statement allows companies to continue under the approach set forth in APB 25 for recognizing stock-based compensation expense in the financial statements, but encourages companies to adopt the fair value method of accounting for employee stock options. Under SFAS 123, companies must either record compensation expense based on the estimated grant date fair value of stock options granted or disclose the impact on net income as if they had adopted the fair value method (for grants subsequent to December 31, 1994). If KCS had measured compensation cost for the KCS stock options granted to its employees and shares subscribed by its employees under the KCS employee stock purchase plan, under the fair value based method prescribed by SFAS 123, net income and earnings per share would have been as follows:

	2003			2002			2001
Net income (in millions):
As reported	$	12.2		$	57.2		$	30.7
Total stock-based compensation expense determined under fair value method, net of income taxes		(1.8	)		(1.7	)		(4.0	)
Pro forma		10.4			55.5			26.7
Earnings per Basic share:
As reported	$	0.10		$	0.94		$	0.52
Pro forma		0.07			0.92			0.45
Earnings per Diluted share:
As reported	$	0.10		$	0.91		$	0.50
Pro forma		0.07			0.88			0.43

All shares held in the Employee Stock Ownership Plan (“ESOP”) are treated as outstanding for purposes of computing the Company’s earnings per share. See additional information on the ESOP in Note 8.

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Earnings Per Share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if convertible securities and stock options were converted into common stock or exercised. The following is a reconciliation from the weighted average shares used for the basic earnings per share computation to the diluted earnings per share computation for the three years ended December 31, 2003 (in thousands):

	2003	2002	2001
Basic shares	61,725	60,336	58,598
Dilutive effect of stock options	—	1,982	2,386
Dilutive effect of convertible preferred stock	—	—	—
Diluted shares	61,725	62,318	60,984
Shares excluded from diluted computation	261	321	97

For the year ended December 31, 2003, 8,926,080 potential dilutive shares related to the $1 par, 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C (“Convertible Preferred Stock”) and 1,356,879 potential dilutive shares related to stock options were excluded from the computation of diluted earnings per share because the inclusion of these shares would have been anti-dilutive to earnings per share. For the years ended December 31, 2003, 2002 and 2001, 261,093, 320,687 and 97,357 shares, respectively, related to stock options were excluded from the calculation of diluted earnings per share because the exercise prices were greater than the average market price of the common shares.

The only adjustment that currently affects the numerator of the Company’s diluted earnings per share computation is preferred dividends. During 2003, preferred dividends of $5.9 million were deducted from net income to calculate basic earnings per share. Additionally, because the potentially dilutive shares relating to the Convertible Preferred Stock were anti-dilutive, these convertible preferred dividends ($5.7 million earned during 2003) were also deducted from net income to calculate diluted earnings per share. Preferred dividends deducted from net income in each of 2002 and 2001 were $0.2 million related to the $25 par, 4% noncumulative preferred stock.

Postretirement benefits. The Company provides certain medical, life and other postretirement benefits to certain retirees. The costs of such benefits are expensed over the estimated period of employment.

Environmental liabilities. The Company records liabilities for remediation and restoration costs related to past activities when the Company’s obligation is probable and the costs can be reasonably estimated. Costs of ongoing compliance activities related to current operations are expensed as incurred.

New Accounting Pronouncements.

SFAS 143

KCS adopted Statement of Financial Accounting Standard No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”). Under SFAS 143, the fair value of a liability for an asset retirement obligation must be recognized in the period in which it is incurred if a reasonable estimate of the fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. KCSR, along with other Class I railroads, depreciates track structure (rail, ties, and other track material) in accordance with regulations promulgated by the STB. These regulations require KCSR to depreciate track structure to a net salvage value (gross estimated salvage value less estimated costs to remove the track structure at the end of its useful life). For certain track structure such as ties, with little or no gross salvage value, this practice ultimately results in depreciating an asset below a value of zero, and thus, in effect, results in recording a liability. Under the requirements of SFAS 143, in the absence of a legal obligation to remove the track structure, such accounting

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practice is prohibited. The Company adopted the provisions of SFAS 143 in the first quarter of 2003, and, as a result, reviewed its depreciation of track structures to determine instances where the depreciation of removal costs has resulted or would be expected (based on the current depreciation rate) to result in the depreciation of an asset below zero when considering net salvage value. As a result of this review, the Company estimated the excess depreciation recorded on such assets and recorded this amount as a reduction in accumulated depreciation of $14.5 million and as a cumulative effect of an accounting change of $8.9 million (net of taxes of $5.6 million) as required by SFAS 143 in the first quarter of 2003. Additionally, depreciation rates applied to certain track structure elements that were previously yielding a negative salvage value have been modified to comply with the provisions of SFAS 143. For the year ended December 31, 2003, this resulted in a reduction in depreciation expense of approximately $1.4 million.

A summary of the pro forma net income and earnings per share had SFAS 143 been applied retroactively is as follows:

	2003			2002		2001
Net income (in millions)
As reported	$	12.2		$	57.2	$	30.7
Pro forma	$	3.3		$	58.6	$	32.0
Earnings per Basic share:
As reported	$	0.10		$	0.94	$	0.52
Pro forma	$	(0.04	)	$	0.97	$	0.54
Earnings per Diluted share:
As reported	$	0.10		$	0.91	$	0.50
Pro forma	$	(0.04	)	$	0.94	$	0.52

FIN 45

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 provides guidance on the accounting and disclosure requirements relating to the issuance of certain types of guarantees and requires the guarantor to recognize at the inception of a guarantee a liability for the fair value of the potential obligation. The provisions for the initial recognition and measurement of guarantees are effective prospectively for all guarantees issued or modified after December 31, 2002. See Note 3 and Note 9 for disclosures of guarantees.

FIN 46 (revised)

In December 2003, the FASB issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”). FIN 46R, clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements” to certain variable interest entities by providing guidance on how a business entity should evaluate whether it has controlling financial interest in an entity through means other than voting rights and how the entity should be consolidated. FIN 46R replaces Interpretation No. 46 “Consolidation of Variable Interest Entities,” which was issued in January 2003. The Company adopted FIN 46R effective for the year ended December 31, 2003. The Company performed an assessment of its equity method investments in Southern Capital and PCRC for any potential impact this interpretation may have on its accounting for these entities as equity investments. The adoption of FIN 46R had no material impact on the Company’s accounting for its investment in Southern Capital or PCRC since, at inception, these entities had sufficient funding and capital.

Significant Customer. Southwestern Electric Power Company (“SWEPCO”), a subsidiary of American Electric Power, Inc., is the Company’s only customer that accounted for more than 10% of revenues during the years ended December 31, 2002 and 2001, respectively. Revenues related to SWEPCO during these periods were $64.7 million and $75.9 million, respectively. During 2003, revenues related to SWEPCO were $57.2 million, representing approximately 9.8% of the Company’s revenues.

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Note 3. Investments

Investments, including investments in unconsolidated affiliates, are as follows (in millions):

Company Name	Percentage Ownership as of December 31, 2003		Carrying Value
			2003		2002
Grupo TFM	46.6	%	$	392.1	$	380.1
Southern Capital	50	%		28.0		24.9
PCRC	50	%(a)		4.5		7.5
Other				18.1		10.6
			$	442.7	$	423.1

(a) The Company owns 50% of the outstanding voting common stock of PCRC.

GRUPO TFM

In June 1996, the Company and Transportacion Maritima Mexicana, S.A. de C.V. (“TMM”—now Grupo TMM ) formed Grupo TFM to participate in the privatization of the Mexican railroad system. In December 1996, the Mexican government awarded Grupo TFM the right to acquire an 80% interest (representing 100% of the shares with unrestricted voting rights) in TFM for approximately 11.072 billion Mexican pesos (approximately $1.4 billion based on the U.S. dollar/Mexican peso exchange rate on the award date). TFM holds a 50-year concession (with the option of a 50-year extension subject to certain conditions) to operate approximately 2,650 miles of track that directly links Mexico City and Monterrey (as well as Guadalajara through trackage rights) with the ports of Lazaro Cardenas, Veracruz and Tampico and the Mexican/United States border crossings of Nuevo Laredo-Laredo, Texas and Matamoros-Brownsville, Texas. TFM’s route network provides a connection to the major industrial and population areas of Mexico from the United States. TFM interchanges traffic with Tex-Mex and the Union Pacific Railroad Company (“UP”) at Laredo, Texas.

The Company 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%. The purchase price was calculated by accreting the Mexican government’s initial investment of approximately $199 million from the date of the Mexican government’s investment through the date of the purchase, using the interest rate on one-year U.S. Treasury securities.

At December 31, 2003, the Company’s investment in Grupo TFM was approximately $392.1 million. The Company’s interest in Grupo TFM is approximately 46.6%, with Grupo TMM owning approximately 48.5% and the remaining 4.9% is owned indirectly by the Mexican government through its 20% ownership of TFM. The Company has a management services agreement with Grupo TFM to provide certain consulting and management services. As of December 31, 2003 and 2002, $1.3 million and $2.4 million, respectively, is reflected as an account receivable in the Company’s consolidated balance sheet related to this management service agreement. Total management fees billed to Grupo TFM were $1.3 million, $1.2 million and $1.2 million for the years ended December 31, 2003, 2002 and 2001, respectively. The Company accounts for its investment in Grupo TFM under the equity method. Additionally, the Company has an account receivable of $4.9 million and $0.8 million as of December 31, 2003 and 2002, respectively, from Tex-Mex related to certain materials and services provided in the normal course of operations. Total amounts billed to Tex-Mex were $4.7 million, $1.9 million and $1.4 million for the years ended December 31, 2003, 2002 and 2001, respectively.

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The Company is party to certain agreements with Grupo TMM covering Grupo TFM, which contains “change of control” provisions, provisions intended to preserve the Company’s and Grupo TMM’s proportionate ownership of the 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. Under certain circumstances, such agreements could affect the Company’s ownership percentage and rights in these equity affiliates.

The May 1997 shareholders agreement between KCS and Grupo TMM and certain affiliates (1) restricted each of the parties to the shareholders agreement from directly or indirectly transferring any interest in Grupo TFM or TFM to a competitor of Grupo TFM or TFM without the prior written consent of each of the parties, and (2) provided that KCS and Grupo TMM may not transfer control of any subsidiary holding all or any portion of shares of Grupo TFM to a third party, other than an affiliate of the transferring party or another party to the shareholders agreement, without the consent of the other parties to the shareholders agreement. The shareholders agreement required that the boards of directors of Grupo TFM and TFM be constituted to reflect the parties’ relative ownership of the ordinary voting common stock of Grupo TFM.

Proposed Acquisition of Grupo TFM from Grupo TMM. On April 20, 2003, the Company entered into an agreement with Grupo TMM and other parties (the “Acquisition Agreement”), under which KCS ultimately would acquire control of TFM through the purchase of shares of common stock of Grupo TFM (the “Acquisition”). Grupo TFM holds an 80% economic interest in TFM and all of the shares of stock with full voting rights of TFM. The remaining 20% economic interest in TFM is owned by the Mexican government in the form of shares with limited voting rights. KCS currently owns a 46.6% economic interest in Grupo TFM and 49.0% of the shares of common stock of Grupo TFM entitled to full voting rights. The Acquisition Agreement and other related agreements were designed to, following KCS shareholder approval and regulatory approval, place KCSR, Tex-Mex, Gateway Eastern Railway Company (“Gateway Eastern”) and TFM, under the common control of a single transportation holding company, NAFTA Rail, to be headquartered in Kansas City, Missouri. As part of the Acquisition, subject to KCS shareholder approval, KCS is expected to change its name to NAFTA Rail. See “Dispute over Acquisition Agreement” below.

Upon the terms and subject to the conditions of the Acquisition Agreement, TMM Multimodal, S.A. de C.V., a subsidiary of Grupo TMM, would receive 18 million shares of Class A Convertible Common Stock of the Company, representing, at the time of the Acquisition Agreement, approximately 22% (20% voting, 2% subject to voting restrictions) of the Company, $200 million in cash (with the option to pay up to $80 million of the $200 million cash component due at closing to Grupo TMM with up to 6.4 million additional shares of Company stock) and a potential incentive payment of between $100 million and $180 million based on the resolution of certain future contingencies related to the value added tax lawsuit and the purchase of the Mexican government’s interest in TFM. See “Value Added Tax (“VAT”) Lawsuit and VAT Contingency Payment under the Acquisition Agreement” below.

In connection with the Acquisition, KCS would enter into a consulting agreement with a consulting company organized by Jose Serrano, Chairman of the Board of Grupo TMM, Grupo TFM and TFM, pursuant to which it would provide consulting services to KCS in connection with the portion of the business of KCS in Mexico for a period of three years. As consideration for these services, the consulting company would receive an annual fee of $600,000 per year and a grant of 2,100,000 shares of restricted stock of KCS. The restricted stock would vest over a period of time subject to certain conditions. The consulting agreement may be extended for an additional year at the option of KCS, upon delivery of an additional 525,000 shares of common stock. The consulting agreement also provides for up to an additional 1,350,000 common shares to be issued contingent upon the achievement of certain objectives. The restricted stock issued and the cash fee would likely be accounted for as compensation expense in the consolidated financial statements of KCS.

The common control of KCSR and Tex-Mex under NAFTA Rail requires approval of the United States Department of Justice (“Department of Justice”) and the Surface Transportation Board (“STB”) in the

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United States. Additionally, the acquisition of Grupo TFM shares by NAFTA Rail requires the approval of Mexico’s Competition Commission and the Mexican National Foreign Investments Commission in Mexico.

KCS’s solicitation for permission as a foreign investor to control TFM, through Grupo TFM, was filed with the Mexican National Foreign Investments Commission on April 25, 2003. On August 27, 2003, KCS announced that it received notice from the Mexican National Foreign Investments Commission of that Commission’s decision to close the proceeding with respect to KCS’s application to acquire control of Grupo TFM and, through Grupo TFM, of TFM, without prejudice to refile in the event the dispute is resolved between KCS and Grupo TMM over whether the Acquisition Agreement remains in effect.

KCS’s Notification with respect to the acquisition of the Grupo TFM shares was filed with the Mexican Competition Commission on April 21, 2003. KCS has received formal written notice that the Mexican Competition Commission has approved the proposed consolidation, without conditions. On September 26, 2003, KCS announced this approval was extended for an additional 180 days. As a procedural matter, the Executive Secretary of the Mexican Competition Commission declined to provide an additional extension, consistent with past practice. KCS intends to seek renewed authority at the appropriate time.

On August 1, 2003, the Company announced that the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“HSR”) for the proposed Acquisition had expired without a formal request from the Department of Justice for additional information of documentary material, allowing KCS and Grupo TMM to consummate the transaction without any further delays that could have resulted from requests for additional information by the Department of Justice under U.S. antitrust laws. Under the HSR process, the Department of Justice had thirty days after notice was filed to issue a “second request” asking for various documents and information from the HSR parties. The waiting period officially expired on July 31, 2003, without action by the Department of Justice.

As of December 31, 2003, costs of approximately $9.3 million related to the Acquisition have been deferred and are reported as “other assets” in the accompanying consolidated balance sheets.

KCS and Grupo TMM are in dispute over Grupo TMM’s attempt to terminate the Acquisition Agreement as discussed below.

Dispute over Acquisition Agreement. On August 18, 2003, Grupo TMM shareholders voted not to approve the sale of Grupo TMM’s interests in Grupo TFM to KCS. On August 23, 2003, Grupo TMM sent a notice to KCS claiming to terminate the Acquisition Agreement because the Grupo TMM shareholders had failed to approve the Acquisition Agreement.

On August 29, 2003, KCS delivered to Grupo TMM a formal Notice of Dispute, pursuant to the Acquisition Agreement. This initiated an informal 60-day negotiation period between the parties. The parties were unable to resolve the dispute within that period of time. On August 29, 2003, KCS filed a complaint in the Delaware Chancery Court alleging that Grupo TMM had breached the Acquisition Agreement and seeking a preliminary injunction requiring Grupo TMM not to take any action in violation of the terms of the Acquisition Agreement. KCS’s position has been and remains that the Acquisition Agreement does not provide that a negative shareholder vote by Grupo TMM shareholders is a basis for termination. KCS maintains that the Acquisition Agreement is still valid and remains in effect until at least December 31, 2004 (unless otherwise validly terminated in accordance with its terms).

On September 2, 2003, the Company filed in the Delaware Court of Chancery a motion for a preliminary injunction to preserve the parties’ positions while KCS seeks to resolve its dispute over Grupo TMM’s attempt to terminate the Acquisition Agreement. On October 28, 2003, Chancellor William B. Chandler III of the Delaware Court of Chancery entered a written order granting KCS’s motion seeking a preliminary injunction to preserve the parties’ positions pending resolution of KCS’s dispute with Grupo TMM.

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On October 31, 2003, KCS initiated binding arbitration in accordance with the terms of the Acquisition Agreement by serving an Arbitration Demand on Grupo TMM and the American Arbitration Association. In its Arbitration Demand, KCS seeks a determination that the Acquisition Agreement is in full force and effect, specific performance of the Acquisition Agreement, and damages for Grupo TMM’s breach of the terms of the Acquisition Agreement and failure to negotiate in good faith during the 60-day negotiation period. By the agreement of the parties, the arbitration has been bifurcated. The first stage of the arbitration only addressed the question of whether Grupo TMM’s purported negative shareholder vote gave Grupo TMM the right to terminate the Acquisition Agreement. On March 22, 2004, the Company announced that the panel of the American Arbitration Association International Center for Dispute Resolution hearing the dispute between the Company and Grupo TMM issued its interim award on March 19, 2004 finding that the Acquisition Agreement remains in force and is binding on KCS and Grupo TMM in accordance with its terms. The arbitration panel concluded that the rejection of the Acquisition Agreement by Grupo TMM’s shareholders did not authorize Grupo TMM’s purported termination of the Acquisition Agreement. The Company and Grupo TMM will now move on to the second phase of the arbitration, which will decide the remaining issues, including remedies and damages.

On January 6, 2004, KCS announced that in a ruling by the Delaware Court of Chancery regarding a motion to enforce injunction and hold Grupo TMM in contempt in the dispute between KCS and Grupo TMM over the Acquisition Agreement, the court held Grupo TMM in contempt of court for taking actions inconsistent with the court’s October 28, 2003 order discussed above. The court held that by Grupo TMM causing its subsidiary Grupo TFM to revoke powers of attorney requiring the signature of a KCS representative for transactions in excess of $2.5 million and in granting new powers of attorney to Grupo TMM directors, Jose Serrano and Mario Mohar to act on behalf of the company, Grupo TMM violated provisions of the Acquisition Agreement. The previous order of the court required Grupo TMM to cause Grupo TFM to conduct its business in accordance with past practices and not to directly or indirectly amend its organizational documents. The court ordered Grupo TMM to take the actions necessary to revoke the new powers of attorney, to re-enact the original powers of attorney, and to pay KCS its costs and attorneys fees for bringing the motion for contempt.

Mexican Government’s Put Rights With Respect to TFM Stock. The Mexican government has the right to compel the purchase of its 20% interest in TFM (referred to as the “Put”) by Grupo TFM following notification by the Mexican government in accordance with the terms of the applicable agreements. Upon exercise of the Put, Grupo TFM would be obligated to purchase the TFM capital stock at the initial share price paid by Grupo TFM adjusted for interest and inflation. Prior to October 30, 2003, Grupo TFM filed suit in the Federal District Court of Mexico City seeking, among other things, a declaratory judgment interpreting whether Grupo TFM was obligated to honor its obligation under the Put Agreement, as the Mexican government had not made any effort to sell the TFM shares subject to the Put prior to October 31, 2003. In its suit, Grupo TFM named Grupo TMM and KCS as additional interested parties. The Mexican government has provided Grupo TFM with notice of its intention to sell its interest in TFM. Grupo TFM has responded to the Mexican government’s notice reaffirming its right and interest in purchasing the Mexican government’s remaining interest in TFM, but also advising the Mexican government that it would not take any action until its lawsuit seeking a declaratory judgment was resolved. Grupo TFM has received an injunction, which blocks the Mexican government from exercising the Put. Following the resolution of the lawsuit in Mexico or the lifting of this injunction, in the event that Grupo TFM does not purchase the Mexican government’s 20% interest in TFM, Grupo TMM and KCS, or either of Grupo TMM or KCS alone, would, following notification by the Mexican government in accordance with the terms of the applicable agreements, be obligated to purchase the Mexican government’s remaining interest in TFM. Based upon public disclosures made by Grupo TMM, it is not in a position to make this purchase. If the Acquisition is completed prior to the purchase of the Mexican government’s interest in TFM, KCS will be solely responsible for purchasing the Mexican government’s 20% interest in TFM. If KCS had been required to purchase this interest as of December 31, 2003, the total purchase price would have been approximately $467.7 million.

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Value Added Tax (“VAT”) Lawsuit and VAT Contingency Payment under the Acquisition Agreement. The VAT lawsuit (“VAT Claim”), which has been pending in the Mexican courts since 1997, arose out of the Mexican Treasury’s delivery of a VAT credit certificate to a Mexican governmental agency rather than to TFM. The face value of the VAT credit at issue is 2,111,111,790 pesos or approximately $192 million in U.S. dollars, based on current exchange rates. The amount of any recovery would, in accordance with Mexican law, reflect the face value of the VAT credit adjusted for inflation and interest accruals from 1997, with certain limitations.

In September 2002, the Mexican appellate court issued a judgment in favor of TFM on the VAT Claim, vacating a prior judgment of the Mexican Fiscal Court and remanding the case to the Fiscal Court with specific instructions to enter a new decision consistent with the guidance provided by the Mexican appellate court’s ruling. The Mexican appellate court’s ruling required the fiscal authorities to issue the VAT credit certificate only in the name of TFM. On December 6, 2002, the upper chamber of the Fiscal Court issued a ruling denying TFM’s right to receive a VAT refund from the Mexican Federal Government. In June 2003, the Mexican appellate court issued a judgment in favor of TFM against the ruling of the Fiscal Court. The judgment granted TFM constitutional protection against the ruling of the Fiscal Court issued on December 6, 2002 denying TFM’s right to receive the VAT refund. The judgment ordered the Fiscal Court to vacate its December 6, 2002 resolution and to issue a new resolution following the guidelines of the Mexican appellate court’s judgment. The Mexican appellate court found that the VAT refund certificate had not been delivered to TFM, and confirmed the Fiscal Court’s determination that TFM has the right to receive the VAT refund certificate. The Mexican appellate court’s ruling states that the Treasury’s decision denying delivery of the VAT refund certificate to TFM violated the law, and it instructs that the VAT reimbursement certificate be issued to TFM on the terms established by Article 22 of the Federal Fiscal Code in effect at that time. As a result of the Mexican appellate court’s ruling, the case was remanded to the Mexican Fiscal Court. On August 14, 2003, Grupo TMM announced that in a public session held August 13, the Mexican Fiscal Court issued a resolution regarding TFM’s VAT Claim vacating its previous resolution of December 6, 2002, and, in strict compliance with the ruling issued on June 11, 2003 by the Mexican appellate court, resolved that TFM has proved its case, and that a “ficta denial” occurred, declaring such denial null and void as ordered by the Mexican appellate court. On October 3, 2003, Grupo TMM announced that the Tax Attorney of the Mexican government had filed for a review of the ruling.

TFM received, on January 19, 2004, a Special Certificate from the Mexican Federal Treasury in the amount of 2.1 billion pesos as discussed above. The Special Certificate represents the refund of the value added tax paid and may be used by TFM to satisfy any tax liabilities due. The Special Certificate has the same face amount as the VAT refund claimed by TFM. TFM was served on January 20, 2004 with an official letter notifying TFM of the Mexican Government’s findings and conclusions arising from its tax audit of TFM’s 1997 tax returns (“Tax Audit Summary”). In the Tax Audit Summary, the Mexican government notified TFM of its preliminary conclusion that the documentation provided by TFM in support of the VAT refund and TFM’s basis in the concession title, locomotives and rail equipment, and capital leases purchased by TFM’s predecessor in interest, Ferrocarril del Noreste, S.A. de C.V., prior to Grupo TFM’s purchase of 80% of the shares of TFM, do not comply with the formalities required by the applicable tax legislation. If sustained, the conclusions of the Tax Audit Summary would prevent TFM from depreciating the concession title, locomotives and rail equipment, and capital leases that represent the majority of the value of the assets owned by TFM. The Tax Audit Summary also seized the Special Certificate received by TFM on January 19, 2004 from the Mexican Federal Treasury in the amount of 2,111,111,790 pesos, pending resolution of the audit, as a potential asset to be used to satisfy any tax obligations owed by TFM as a result of the audit. TFM has advised that it has, within the time allowed by the Tax Audit Summary, contested the conclusions of the Mexican tax authorities, and it has filed a constitutional appeal against the Tax Audit Summary, alleging that the process followed by the Mexican government violated TFM’s constitutional rights. TFM has also filed a complaint seeking an order that would require the Mexican government to issue a new Special Certificate in the amount of the original VAT refunded, adjusted to reflect interest and penalties from 1997 in accordance with applicable Mexican law and regulations.

In addition, provided the Acquisition has occurred and neither KCS nor any of its subsidiaries has purchased the Mexican government’s TFM shares upon exercise of the Put, KCS will be obligated to pay to Grupo TMM an

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additional amount (referred to as the “VAT Contingency Payment”) of up to $180 million in cash in the event that the VAT Claim is successfully resolved and the amount received is greater than the purchase price of the Put. If the Acquisition is completed, KCS will assume Grupo TMM’s obligations to make any payment upon the exercise by the Mexican government of the Put and will indemnify Grupo TMM and its affiliates, and their respective officers, directors, employees and shareholders, against obligations or liabilities relating thereto.

Because TFM has not recognized its claim as an asset for financial accounting purposes, any recovery by TFM would likely be recognized by TFM as income thereby favorably impacting the Company’s recognition of its equity in earnings in Grupo TFM. The Company is presently unable to predict the amount or timing of any VAT refund recovery.

Mexrail Transactions. On May 9, 2003, pursuant to the terms of a stock purchase agreement for KCS to acquire control of Mexrail (the “Stock Purchase Agreement”), KCS acquired from Grupo TMM (through its subsidiary TFM) 51% of the shares of Mexrail for approximately $32.7 million. KCS deposited the Mexrail shares into a voting trust pending resolution of KCS’s application to the STB seeking authority to exercise common control over Tex-Mex, KCSR and Gateway Eastern. The Stock Purchase Agreement provided TFM the right to repurchase all of the Mexrail stock acquired by the Company at any time for the purchase price paid by the Company, subject to any STB orders or directions. In August 2003, KCS received a demand from TFM to repurchase those Mexrail shares. In September 2003, the STB issued a decision finding no need to rule on the transfer back to TFM of the 51% interest in Mexrail that KCS acquired. The repurchase of Mexrail by TFM closed on September 30, 2003 returning 100% ownership of Mexrail to TFM and the Stock Purchase Agreement automatically terminated. The repurchase price was $32.7 million; the same price KCS paid TFM in May 2003. The Stock Purchase Agreement, however, provided that in the event TFM reacquired the Mexrail shares from KCS, the parties to the Stock Purchase Agreement intended the terms and conditions of a February 27, 2002 stock purchase agreement under which TFM acquired the Mexrail shares, the Grupo TFM bylaws and the shareholders agreement dated May 1997 to become again valid and fully enforceable against the parties to such agreements.

On February 27, 2002, KCS, Grupo TMM, and certain of Grupo TMM’s affiliates entered into a stock purchase agreement with TFM to sell to TFM all of the common stock of Mexrail. Under the February 27, 2002 stock purchase agreement, KCS retained rights to prevent further sale or transfer of the stock or significant assets of Mexrail and Tex-Mex and the right to continue to participate in the corporate governance of Mexrail and Tex-Mex, which will remain U.S. corporations and subject to KCS’s super majority rights contained in Grupo TFM’s bylaws.

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 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 million of excess proceeds was deferred and is being amortized over 20 years.

STB Review Status. KCS filed with the STB on May 13, 2003 a Railroad Control Application, seeking permission to exercise common control over KCSR, Gateway Eastern and Tex-Mex. On June 9, 2003, the STB issued its decision, effective June 13, 2003, finding that the transaction proposed in KCS’s application is a “minor transaction” under 49 CFR 1180.2(c), although KCS was required to supplement its application as discussed in the decision, to address some of the implications of KCS’s acquisition of control of TFM. KCS filed the supplement on June 23, 2003, as required by the decision. The STB also outlined a procedural schedule for consideration of KCS’s application to exercise common control over KCSR, Gateway Eastern and Tex-Mex. The STB decision set October 17, 2003 as the date by which it would issue its final decision on the merits of the application. On September 23, 2003, the STB entered an order asking all interested parties to file comments by

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September 30, 2003 addressing whether “in light of recent developments” the STB should continue with the procedural schedule, which called for a decision on the merits to be issued by October 17, 2003. On September 30, 2003, KCS filed comments with the STB suggesting that STB precedent establishes that the STB has sufficient jurisdiction to rule on control applications even where closing on the underlying transaction has been put in doubt. In the alternative, KCS argued that the matter should be held in abeyance, rather than dismissed, until the arbitration is completed. On October 8, 2003, the STB issued an order suspending the procedural schedule pending a resolution of the uncertainties that surround KCS’s efforts to acquire control of Tex-Mex, and requiring KCS to file status reports regarding developments in its efforts to acquire control of TFM and Tex-Mex. In accordance with the STB’s order, KCS filed its first status report on November 3, 2003, and a follow-up status report was filed on February 2, 2004.

SOUTHERN CAPITAL

In 1996, the Company and GATX Capital Corporation (“GATX”) completed a transaction for the formation and financing of a joint venture, Southern Capital, to perform certain leasing and financing activities. Southern Capital’s principal operations are the acquisition of locomotives, rolling stock and other railroad equipment and the leasing thereof to the Company. The Company holds a 50% interest in Southern Capital, which it accounts for using the equity method of accounting.

Concurrent with the formation of this joint venture, the Company entered into operating leases with Southern Capital for substantially all the locomotives and rolling stock contributed or sold to Southern Capital at rental rates which management believes reflected market conditions at that time. KCSR paid Southern Capital $35.3 million, $28.7 million and $28.8 million under these operating leases in 2003, 2002 and 2001, respectively. In connection with the formation of Southern Capital, the Company received cash that exceeded the net book value of assets contributed to the joint venture by approximately $44.1 million. Accordingly, this excess fair value over book value is being recognized as a reduction in lease rental expense over the terms of the leases (approximately $4.5 million, $4.5 million and $4.4 million in 2003, 2002 and 2001, respectively). During 2001, the Company received dividends of $3.0 million from Southern Capital. No dividends were received from Southern Capital during 2003 or 2002.

During 2001, Southern Capital refinanced its five-year credit facility, which was scheduled to mature on October 19, 2001, with a one-year bridge loan for $201 million. On June 25, 2002, Southern Capital refinanced the outstanding balance of this bridge loan through the issuance of approximately $167.6 million of 5.7% pass through trust certificates and proceeds from the sale of 50 locomotives. Of this amount, $104.0 million is secured by all of the locomotives and rolling stock owned by Southern Capital (other than the 50 locomotives, which were sold, as discussed below) and rental payments payable by KCSR under the operating and financing 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 certificates.

The remaining amount of Certificates, $63.6 million, was assigned to General Electric Corporation (“GE”), the buyer of the 50 locomotives, and is secured by the sold locomotives. Southern Capital does not have the option, nor is it obligated to repurchase or redeem the lease receivable or related equipment on or prior to the expiration of the lease agreement entered into with KCSR at the time of the sale. Southern Capital does not guarantee the lease payments of KCSR and has no obligation to make such payments if KCSR should fail to do so. In the event of a default by KCSR, a third party insurance company, MBIA, guarantees the outstanding debt and may seize the collateralized assets, or find a third party lessee to continue making the rental payments to satisfy the debt requirements.

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PANAMA CANAL RAILWAY COMPANY

In January 1998, the Republic of Panama awarded PCRC, a joint venture between KCSR and Mi-Jack Products, Inc. (“Mi-Jack”), the concession to reconstruct and operate the Panama Canal Railway, a 47-mile railroad located adjacent to the Panama Canal, that provides international shippers with a railway transportation option to complement the Panama Canal. The Panama Canal Railway, which traces its origins back to the late 1800’s, is a north-south railroad traversing the Panama isthmus between the Pacific and Atlantic Oceans. The railroad has been reconstructed and it resumed freight operations on December 1, 2001. Panarail operates and promotes commuter and tourist passenger service over the Panama Canal Railway. Passenger service started during July 2001.

As of December 31, 2003, the Company has invested approximately $21.0 million toward the reconstruction and operations of the Panama Canal Railway. This investment is comprised of $12.9 million of equity and $8.1 million of subordinated loans. These loans carry a 10% interest rate and are payable on demand, subject to certain restrictions.

In November 1999, PCRC completed the financing arrangements for this project with the International Finance Corporation (“IFC”), a member of the World Bank Group. The financing is comprised of a $5 million investment by the IFC and senior loans through the IFC in an aggregate amount of up to $45 million. Additionally, PCRC has $3.5 million of equipment loans and other capital leases totaling $3.0 million. The IFC’s investment of $5 million in PCRC is comprised of non-voting preferred shares which pay a 10% cumulative dividend. Under the terms of the loan agreement with IFC, the Company is a guarantor for up to $5.6 million of the associated debt. Also if PCRC terminates the concession contract without the IFC’s consent, the Company is a guarantor for up to 50% of the outstanding senior loans. The Company is also a guarantor for up to $1.8 million of the equipment loans and approximately $100,000 relating to the other capital leases. The cost of the reconstruction totaled approximately $80 million.

Financial Information. Financial information of unconsolidated affiliates that the Company and its subsidiaries accounted for under the equity method follows. Amounts, including those for Grupo TFM, are presented under U.S. GAAP. Certain prior year amounts have been reclassified to reflect amounts from applicable audited financial statements (in millions).

	December 31, 2003
	Grupo TFM		Southern Capital		PCRC
Investment in unconsolidated affiliates	$	392.1	$	28.0	$	4.5
Equity in net assets of unconsolidated affiliates		378.9		28.0		4.5
Financial Condition:
Current assets	$	225.7	$	5.0	$	3.6
Non-current assets		2,111.8		127.3		84.2
Assets	$	2,337.5	$	132.3	$	87.8
Current liabilities	$	362.7	$	1.2	$	9.9
Non-current liabilities		806.7		75.0		68.9
Minority interest		354.9		—		—
Equity of stockholders and partners		813.2		56.1		9.0
Liabilities and equity	$	2,337.5	$	132.3	$	87.8
Operating results:
Revenues	$	698.5	$	31.3	$	7.7
Costs and expenses	$	591.0	$	27.6	$	13.8
Net income (loss)	$	27.3	$	3.6	$	(6.1	)

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	December 31, 2002
	Grupo TFM		Southern Capital		PCRC
Investment in unconsolidated affiliates	$	380.1	$	24.9	$	7.5
Equity in net assets of unconsolidated affiliates		366.0		24.9		7.5
Financial Condition:
Current assets	$	265.2	$	5.5	$	8.8
Non-current assets		2,061.3		139.4		83.3
Assets	$	2,326.5	$	144.9	$	92.1
Current liabilities	$	147.3	$	—	$	4.0
Non-current liabilities		1,045.3		95.1		73.1
Minority interest		348.0		—		—
Equity of stockholders and partners		785.9		49.8		15.0
Liabilities and equity	$	2,326.5	$	144.9	$	92.1
Operating results:
Revenues	$	712.1	$	31.0	$	5.0
Costs and expenses	$	553.0	$	26.4	$	12.9
Net income (loss)	$	110.2	$	2.7	$	(7.9	)

	December 31, 2001
	Grupo TFM		Southern Capital		Mexrail			PCRC
Operating results:
Revenues	$	667.8	$	30.2	$	55.0		$	1.8
Costs and expenses	$	457.7	$	25.5	$	58.2		$	3.2
Net income	$	76.7	$	4.8	$	(2.0	)	$	(2.0	)

The Company, Grupo TFM, and certain of their affiliates entered into an agreement on February 27, 2002 with TFM to sell to TFM all of the common stock of Mexrail. The sale closed on March 27, 2002. Accordingly for 2003 and 2002, the results of Mexrail have been consolidated into the results of Grupo TFM.

The effects of foreign currency transactions and capitalized interest prior to June 23, 1997, which are not recorded on Grupo TFM’s books, result in the difference between the carrying amount of the Company’s investment in Grupo TFM and the underlying equity in net assets. Additionally, the purchase by TFM of the Mexican government’s former 24.6% interest in Grupo TFM resulted in a reduction of Grupo TFM’s stockholder’s equity as the purchased shares from the Mexican government were recorded as treasury shares at Grupo TFM. The Company invested no funds in this transaction, however, and, therefore, it did not have an impact on the Company’s investment in Grupo TFM. As a result, the difference between the Company’s equity in net assets of Grupo TFM and its underlying investment arising as a result of this transaction is being amortized against the Company’s equity in earnings from Grupo TFM over a 33 year period, which was the estimate of the average remaining useful life of Grupo TFM’s concession assets.

The deferred income tax calculations for Grupo TFM are significantly impacted by fluctuations in the relative value of the Mexican peso versus the U.S. dollar and the rate of Mexican inflation, and can result in significant variability in the amount of equity earnings (losses) reported by the Company.

Foreign Exchange Matters. In connection with the Company’s investment in Grupo TFM, matters arise with respect to financial accounting and reporting for foreign currency transactions and for translating foreign currency financial statements into U.S. dollars. The Company follows the requirements outlined in Statement of Financial Accounting Standards No. 52 “Foreign Currency Translation” (“SFAS 52”), and related authoritative

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guidance. Grupo TFM uses the U.S. dollar as its functional currency. Equity earnings (losses) from Grupo TFM included in the Company’s results of operations reflect the Company’s share of any such translation gains and losses that Grupo TFM records in the process of translating certain transactions from Mexican pesos to U.S. dollars.

The Company continues to evaluate existing alternatives with respect to utilizing foreign currency instruments to hedge its U.S. dollar investment in Grupo TFM as market conditions change or exchange rates fluctuate. At December 31, 2003, 2002 and 2001, the Company had no outstanding foreign currency hedging instruments.

Results of the Company’s investment in Grupo TFM are reported under U.S. GAAP while Grupo TFM reports its financial results under International Financial Reporting Standards (“IFRS”). Because the Company is required to report its equity earnings (losses) in Grupo TFM under U.S. GAAP and Grupo TFM reports under IFRS, differences in deferred income tax calculations and the classification of certain operating expense categories occur. The deferred income tax calculations are significantly impacted by fluctuations in the relative value of the Mexican peso versus the U.S. dollar and the rate of Mexican inflation, and can result in significant variability in the amount of equity earnings (losses) reported by the Company.

Note 4. Other Balance Sheet Captions

Accounts Receivable. Accounts receivable include the following items (in millions):

	2003			2002
Accounts receivable	$	125.0		$	127.5
Allowance for doubtful accounts		(10.4	)		(9.0	)
Accounts receivable, net	$	114.6		$	118.5
Bad debt expense	$	1.9		$	0.5

Other Current Assets. Other current assets include the following items (in millions):

	2003		2002
Deferred income taxes	$	10.3	$	18.7
Federal income taxes receivable		—		16.6
Prepaid expenses		2.9		3.8
Other		8.1		5.4
Total	$	21.3	$	44.5

Properties. Properties and related accumulated depreciation and amortization are summarized below (in millions):

	2003		2002
Properties, at cost
Road properties	$	1,663.3	$	1,606.4
Equipment		275.1		280.5
Computer software		64.6		62.4
Equipment under capital leases		6.6		6.6
Other		8.7		8.4
Total		2,018.3		1,964.3
Accumulated depreciation and amortization		734.3		702.3
Total		1,284.0		1,262.0
Construction in progress		78.5		75.4
Net Properties	$	1,362.5	$	1,337.4

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For the years ended December 31, 2003 and 2002, the Company capitalized approximately $7.0 and $2.0 million, respectively, of costs related to capital projects for which no cash outlay had yet occurred. These costs were included in accounts payable and accrued liabilities at December 31, 2003 and 2002, respectively.

Accrued Liabilities. Accrued liabilities include the following items (in millions):

	2003		2002
Claims reserves	$	34.4	$	35.3
Prepaid freight charges due other railroads		19.7		24.5
Car hire per diem		9.0		11.5
Vacation accrual		7.8		7.8
Property and other taxes		5.2		4.4
Interest payable		6.6		6.4
Other		36.7		38.7
Total	$	119.4	$	128.6

Other Noncurrent Liabilities and Deferred Credits. Other noncurrent liabilities and deferred credits include the following items (in millions):

	2003		2002
Claims reserves	$	36.6	$	25.1
Accrued employee benefits		9.0		8.8
Deferred gain on sale of equipment to Southern Capital		13.7		18.7
Deferred gain on sale of Mexrail		6.1		6.5
Other		44.0		45.1
Total	$	109.4	$	104.2

Note 5. Long-Term Debt

Indebtedness Outstanding. Long-term debt and pertinent provisions follow (in millions):

	2003		2002
KCS	$	1.3	$	1.3
KCSR
Borrowings pursuant to Amended KCS Credit Facility
Revolving Credit Facility, variable interest rate at December 31, 2003— 4.03%, due January 2006		—		—
Term Loans, variable interest rate at December 31, 2003 — 3.67%, due June 2008		98.5		149.2
7½% Senior Notes, due June 15, 2009		200.0		200.0
9½% Senior Notes, due October 1, 2008		200.0		200.0
Equipment Trust Certificates, 8.56% to 9.23%, due serially to December 15, 2006		17.1		23.5
Capital Lease Obligations, 7.15% to 9.00%, due serially to September 30, 2009		1.9		2.5
Term Loans with State of Illinois, 3% to 5%, due serially to 2009		2.8		3.3
OTHER		1.8		2.8
Total		523.4		582.6
Less: debt due within one year		9.9		10.0
Long-term debt	$	513.5	$	572.6

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Amended KCS Credit Facility. In June 2002, in conjunction with the repayment of certain of the term loans under the Company’s former senior secured credit facility (“KCS Credit Facility”) using the net proceeds received from the offering of 7½% Senior Notes (see below), the Company amended and restated the KCS Credit Facility (“Amended KCS Credit Facility”). The Amended KCS Credit Facility 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 (“Revolving Credit Facility”), which matures on January 11, 2006. Letters of credit are also available under the Revolving Credit Facility up to a limit of $15 million. The proceeds from future borrowings under the Revolving Credit Facility 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 Amended KCS Credit Facility 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 Revolving Credit Facility 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 Revolving Credit Facility 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 December 31, 2003, the applicable margin was 2.25% per annum for LIBOR borrowings and 1.25% per annum for alternate base rate borrowings.

The Amended KCS Credit Facility also requires the payment to the lenders of a commitment fee of 0.50% per annum on the average daily, unused amount of the Revolving Credit Facility. Additionally, a fee equal to a per annum rate of 0.25% plus the applicable margin for LIBOR priced borrowings under the Revolving Credit Facility will be paid on any letter of credit issued under the Revolving Credit Facility.

The Amended KCS Credit Facility 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 Amended KCS Credit Facility also contains certain customary events of default. These covenants, along with other provisions, could restrict maximum utilization of the Revolving Credit Facility.

Refinancing of Amended KCS Credit Facility. On March 1, 2004, the Company repaid approximately $38.5 million of term debt (“Term B Loan”) under the Amended KCS Credit Facility using cash on-hand. After consideration of this repayment, the outstanding balance under the Term B Loan was $60 million.

The Company is currently in the process of refinancing the Amended KCS Credit Facility, including the Revolving Credit Facility. Under the proposed terms of the new senior secured credit facility (“2004 KCS Credit Facility”), the Company expects to borrow $150 million under a new term loan due March 2008 (“2004 Term B Loan”). Additionally, the 2004 KCS Credit Facility provides for a new revolving credit facility, which expires in March 2007, with a maximum borrowing amount of $100 million (“2004 Revolving Credit Facility”). The Company does not anticipate any borrowing under the 2004 Revolving Credit Facility as of March 31, 2004. The Company has received firm commitment letters from various banks and institutional investors committing to fully fund the new loans and agreeing to the term sheet of the 2004 KCS Credit Facility. The commitments are subject only to proper documentation of the new facility. KCS management expects to close this refinancing transaction prior to March 31, 2004. If, however, the 2004 KCS Credit Facility is not consummated on or prior to March 31, 2004, the Company may be in technical default of certain of its existing financial covenants under the Amended KCS Credit Facility.

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As a result of the refinancing transaction described above, the Company expects to report a charge to earnings in the first quarter of 2004 of approximately $4 million related to the write-off of existing deferred costs.

7½% Senior Notes. In June 2002, KCSR issued $200 million of 7½% senior notes due June 15, 2009 (“7½% Notes”). Net proceeds from the offering of $195.8 million, together with cash, were used to repay term debt under the KCS Credit Facility and certain other secured indebtedness of the Company. These 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. These registered 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.

9½% Senior Notes. During the third quarter of 2000, KCSR completed a $200 million offering of 8-year senior unsecured notes (“9½% Notes”). Net proceeds from this offering of $196.5 million were used to refinance term debt and reduce commitments under the KCS Credit Facility. The refinanced debt was scheduled to mature on January 11, 2001. These registered notes bear a fixed annual interest rate and are due on October 1, 2008. These registered 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.

Debt issuance costs related to indebtedness have been deferred and are being amortized over the respective term of the loans.

Leases and Debt Maturities. The Company and its subsidiaries lease transportation equipment, as well as office and other operating facilities under various capital and operating leases. Rental expenses under operating leases were $57.2 million, $55.0 million and $56.8 million for the years 2003, 2002 and 2001, respectively. Minimum annual payments and present value thereof under existing capital leases, other debt maturities, and minimum annual rental commitments under noncancellable operating leases are as follows (dollars in millions):

			Capital Leases								Operating Leases
	Long- Term Debt		Minimum Lease Payments		Less Interest		Net Present Value		Total Debt		Southern Capital		Third Party		Total
2004	$	9.5	$	0.6	$	0.2	$	0.4	$	9.9	$	29.2	$	27.0	$	56.2
2005		8.7		0.5		0.1		0.4		9.1		25.5		22.4		47.9
2006		7.6		0.4		0.1		0.3		7.9		22.3		21.3		43.6
2007		48.0		0.3		—		0.3		48.3		18.5		19.1		37.6
2008		246.9		0.3		—		0.3		247.2		18.5		15.4		33.9
Later years		200.8		0.2		—		0.2		201.0		138.0		45.6		183.6
Total	$	521.5	$	2.3	$	0.4	$	1.9	$	523.4	$	252.0	$	150.8	$	402.8

KCSR Indebtedness. KCSR has purchased locomotives and rolling stock under equipment trust certificates and capitalized lease obligations. The equipment, which has been pledged as collateral for the related indebtedness, has an original cost of $134.7 million and a net book value of $65.9 million.

Other Agreements, Guarantees, Provisions and Restrictions. The Company has debt agreements containing restrictions on subsidiary indebtedness, advances and transfers of assets, and sale and leaseback transactions, as well as requiring compliance with various financial covenants. At December 31, 2003, the Company was in compliance with the provisions and restrictions of these agreements. Because of certain financial covenants contained in the debt agreements, however, maximum utilization of the Company’s available line of credit may be restricted.

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Change in Control Provisions. Certain loan agreements and debt instruments entered into or guaranteed by the Company and its subsidiaries provide for default in the event of a specified change in control of the Company or particular subsidiaries of the Company.

Note 6. Income Taxes

Current income tax expense represents the amounts expected to be reported on the Company’s income tax return, and deferred tax expense or benefit represents the change in net deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse.

Tax Expense. Income tax provision (benefit) consists of the following components (in millions):

	2003			2002			2001
Current
Federal	$	—		$	(15.3	)	$	(26.6	)
State and local		0.3			0.4			(1.1	)
Foreign withholding taxes		—			—			0.1
Total current		0.3			(14.9	)		(27.6	)
Deferred
Federal		(4.1	)		20.8			29.5
State and local		1.0			1.0			0.9
Total deferred		(3.1	)		21.8			30.4
Total income tax provision (benefit)	$	(2.8	)	$	6.9		$	2.8

The federal and state deferred tax liabilities (assets) at December 31 are as follows (in millions):

	2003			2002
Liabilities:
Depreciation	$	449.2		$	415.4
Other, net		2.6			—
Gross deferred tax liabilities		451.8			415.4
Assets:
NOL carryovers		(23.9	)		(8.8	)
Book reserves not currently deductible for tax		(26.8	)		(27.2	)
Vacation accrual		(2.7	)		(2.8	)
Investments		(12.6	)		(1.2	)
Other, net		(4.6	)		(1.3	)
Gross deferred tax assets		(70.6	)		(41.3	)
Net deferred tax liability	$	381.2		$	374.1

Based upon the Company’s history of operating income and its expectations for the future, management has determined that operating income of the Company will, more likely than not, be sufficient to realize fully the gross deferred tax assets set forth above.

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Tax Rates. Differences between the Company’s effective income tax rates and the U.S. federal income tax statutory rates of 35% are as follows (in millions):

	2003			2002			2001
Income tax provision using the Statutory rate in effect	$	0.2		$	21.4		$	11.9
Tax effect of
Earnings of equity investees		(4.3	)		(15.0	)		(9.4	)
Other, net		0.5			(0.9	)		0.4
Federal income tax provision (benefit)		(3.6	)		5.5			2.9
State and local income tax provision (benefit)		0.8			1.4			(0.2	)
Foreign withholding taxes		—			—			0.1
Total tax expense (benefit)	$	(2.8	)	$	6.9		$	2.8
Effective tax rate		(600.7	)%		11.3	%		8.3	%

Difference Attributable to Grupo TFM Investment. At December 31, 2003, the Company’s book basis exceeded the tax basis of its investment in Grupo TFM by $92.1 million. The Company has not provided a deferred income tax liability for the income taxes, if any, which might become payable on the realization of this basis difference because the Company intends to indefinitely reinvest in Grupo TFM the financial accounting earnings which gave rise to the basis differential. Moreover, the Company has no other plans to realize this basis differential by a sale of its investment in Grupo TFM. If the Company were to realize this basis difference in the future by a receipt of dividends or the sale of its interest in Grupo TFM, as of December 31, 2003 the Company would incur gross federal income taxes of $32.2 million, which might be partially or fully offset by Mexican income taxes and could be available to reduce federal income taxes at such time.

Tax Carryovers. The remaining amount of federal net operating loss (NOL) carryover generated by MidSouth and Gateway Western prior to acquisition by the Company is approximately $8.7 million at December 31, 2003 with expiration dates beginning in 2008. The use of preacquisition net operating losses and tax credit carryovers is subject to limitations imposed by the Internal Revenue Code. The Company does not anticipate that these limitations will affect utilization of the carryover prior to its expiration.

Additionally, in 2003, 2002 and 2001, the Company generated both federal and state NOL’s. The 2002 and 2001 federal NOL’s were carried back to 2000 and 1999 respectively, whereas the state NOL’s have been carried forward. The federal and state NOL’s created in 2003 will be carried forward up to 20 years. Both the federal and state NOL’s are analyzed each year to determine the likelihood of realization. The Company believes the amount recognized is more likely than not to be realized.

Tax Examinations. The IRS is currently in the process of examining the consolidated federal income tax returns for the years 1997 through 1999. The IRS has recently concluded its examination of the 1993 to 1996 tax years and the Company expects to receive a refund related to this examination in late 2004 or early 2005. The Company also has a refund request for the 1990-1992 tax years related to a single issue and expects to receive a refund in 2004. The statute of limitations has closed for years prior to 1993. In addition, other taxing authorities are currently examining the years 1998 through 2002. The Company believes it has recorded adequate estimated liabilities for any likely additional taxes. Since most of these asserted tax deficiencies represent temporary differences, subsequent payments of taxes will not require additional charges to income tax expense. Accruals have been made for interest (net of tax benefit) for estimated settlement of the proposed tax assessments. Management believes that final settlement of these matters will not have a material adverse effect on the Company’s consolidated results of operations, financial condition, or cash flows.

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Note 7. Stockholders’ Equity

Stockholders’ Equity. Information regarding the Company’s capital stock at December 31, 2003 and 2002 follows:

	Shares Authorized	Shares Issued
$25 Par, 4% noncumulative, Preferred stock	840,000	649,736
$1 Par, Preferred stock	2,000,000	None
$1 Par, Series A, Preferred stock	150,000	None
$1 Par, Series B convertible, Preferred stock	1,000,000	None
$1 Par, Redeemable Cumulative Convertible Perpetual Preferred Stock	400,000	400,000
$.01 Par, Common stock	400,000,000	73,369,116

Shares outstanding at December 31:

	2003	2002
$25 Par, 4% noncumulative, Preferred stock	242,170	242,170
$1 Par, Redeemable Cumulative Convertible Perpetual Preferred Stock	400,000	—
$.01 Par, Common stock	62,175,621	61,103,015

Stock Option Plans. The Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan (as amended and restated effective November 7, 2002) provides for the granting of options to purchase up to 16.0 million shares of the Company’s common stock by officers and other designated employees. Options have been granted under this plan at 100% of the average market price of the Company’s stock on the date of grant and generally may not be exercised sooner than one year or longer than ten years following the date of the grant, except that options outstanding with limited rights (“LRs”) or limited stock appreciation rights (“LSARs”), become immediately exercisable upon certain defined circumstances constituting a change in control of the Company. The plan includes provisions for stock appreciation rights, LRs and LSARs. All outstanding options include LSARs, except for options granted to non-employee Directors prior to 1999.

For purposes of computing the pro forma effects of option grants under the fair value accounting method prescribed by SFAS 123, the fair value of each option grant is estimated on the date of grant using a version of the Black-Scholes option pricing model. The following assumptions were used for the various grants depending on the date of grant, nature of vesting and term of option:

	2003	2002	2001
Dividend Yield	0%	0%	0%
Expected Volatility	35% to 41%	35% to 38%	35% to 40%
Risk-free Interest Rate	1.68% to 2.30%	2.16% to 3.88%	2.98% to 4.84%
Expected Life	3 years	3 years	3 years

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Summary of Company’s Stock Option Plans. A summary of the status of the Company’s stock option plans as of December 31, 2003, 2002 and 2001 and changes during the years then ended is presented below.

	2003				2002				2001
	Shares		Weighted- Average Exercise Price		Shares		Weighted- Average Exercise Price		Shares		Weighted- Average Exercise Price
Outstanding at January 1	4,845,226		$	6.35	5,821,315		$	5.44	6,862,036		$	4.92
Exercised	(769,782	)		4.60	(1,265,418	)		4.87	(1,128,838	)		3.71
Canceled/Expired	(114,582	)		10.67	(144,388	)		6.15	(105,537	)		4.79
Granted	652,001			12.15	433,717			14.25	193,654			13.37
Outstanding at December 31	4,612,863		$	7.36	4,845,226		$	6.35	5,821,315		$	5.44
Exercisable at December 31	3,807,886		$	6.30	3,784,417		$	5.63	4,803,942		$	5.13
Weighted-average fair value of options granted during the period			$	4.86			$	3.97			$	4.18

The following table summarizes information about stock options outstanding at December 31, 2003:

	OUTSTANDING					EXERCISABLE
Range of Exercise Prices	Shares Outstanding	Weighted- Average Remaining Contractual Life		Weighted- Average Exercise Price		Shares Exercisable	Weighted- Average Exercise Price
$.20 –1	122,752	1.6	years	$	0.88	122,752	$	0.88
1 – 2	127,255	3.4			1.34	127,255		1.34
2 – 4	89,799	4.9			2.75	89,799		2.75
4 – 7	3,000,785	6.5			5.77	3,000,785		5.77
7 – 10	95,072	6.7			8.23	95,072		8.23
10 – 13	85,000	7.5			12.62	85,000		12.62
13 – 17	1,092,200	8.8			13.07	287,223		15.02
.20 –17	4,612,863	6.8		$	7.36	3,807,886	$	6.30

At December 31, 2003, shares available for future grants under the stock option plan were 1,261,987.

Stock Purchase Plan. The Employee Stock Purchase Plan (“ESPP”), established in 1977, provides substantially all full-time employees of the Company, certain subsidiaries and certain other affiliated entities, with the right to subscribe to an aggregate of 11.4 million shares of common stock. The purchase price for shares under any stock offering is to be 85% of the average market price on either the exercise date or the offering date, whichever is lower, but in no event less than the par value of the shares.

The following table summarizes activity related to the various ESPP offerings:

	Date Initiated	Shares Subscribed	Price	Shares Issued	Date Issued	Received from Employees*
						(in millions)
Fifteenth Offering	2003	242,589	$11.28	—	—	$	—
Fourteenth Offering	2002	248,379	$9.27–$12.29	197,734	2003/2004		2.4
Thirteenth Offering	2001	402,902	$10.24–$10.57	338,004	2002/2003		3.5

* Represents amounts received from employees through payroll deductions for share purchases under applicable offering.

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At December 31, 2003, there were approximately 4.3 million shares available for future ESPP offerings.

For purposes of computing the pro forma effects of employees’ purchase rights under the fair value accounting method prescribed by SFAS 123, the fair value of the offerings under the ESPP is estimated on the date of grant using a version of the Black-Scholes option pricing model. The following weighted-average assumptions were used for the Fifteenth, Fourteenth, and Thirteenth Offerings, respectively: i) dividend yield of 0.00%, 0.00% and 0.00%; ii) expected volatility of 35%, 36%, and 38%, iii) risk-free interest rate of 1.26%, 2.22%, and 2.98% ; and iv) expected life of one year. The weighted-average fair value of purchase rights granted under the Fifteenth, Fourteenth and Thirteenth Offerings of the ESPP were $2.95, $3.00, and $3.00, respectively.

Treasury Stock. Shares of common stock in Treasury at December 31, 2003 totaled 11,193,495 compared with 12,266,101 at December 31, 2002 and 14,125,949 at December 31, 2001. The Company issued shares of common stock from Treasury—1,072,606 in 2003, 1,859,848 in 2002, and 1,095,895 in 2001—to fund the exercise of options and subscriptions under various employee stock option and purchase plans. Shares repurchased during 2003, 2002 and 2001 were not material.

Redeemable Cumulative Convertible Perpetual Preferred Stock. On May 5, 2003, the Company completed the sale of $200 million of Redeemable Cumulative Convertible Perpetual Preferred Stock (“Convertible Preferred Stock”) with a liquidation preference of $500 per share in a private offering. The Convertible Preferred Stock offering was made only by means of an offering memorandum pursuant to Rule 144A. Dividends on the Convertible Preferred Stock are cumulative and are payable quarterly at an annual rate of 4.25% of the liquidation preference, when, as and if declared by the Company’s board of directors. Accumulated unpaid dividends will cumulate dividends at the same rate as dividends cumulate on the Convertible Preferred Stock. Each share of the Convertible Preferred Stock will be convertible, under certain conditions, and subject to adjustment under certain conditions, into 33.4728 shares of the Company’s common stock. On or after May 20, 2008, the Company will have the option to redeem any or all of the Convertible Preferred Stock, subject to certain conditions. Under certain circumstances, at the option of the holders of the Convertible Preferred Stock, the Company may be required to purchase shares of the Convertible Preferred Stock from the holders. The Convertible Preferred Stock is redeemable at the option of a holder only in the event of a “fundamental change,” which is defined as “any transaction or event (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) in connection with which all or substantially all of the Company’s common stock is exchanged for, converted into, acquired for or constitutes solely the right to receive common stock that is not listed on a United States national securities exchange or approved for quotation on the Nasdaq National Market or similar system. The practical effect of this provision is to limit the Company’s ability to eliminate a holder’s ability to convert the Convertible Preferred Stock into common shares of a publicly traded security through a merger or consolidation transaction. In no other circumstances is the Company potentially obligated to redeem the Convertible Preferred Stock for cash. Accordingly, since the Company is in a position to control whether the Company experiences a “fundamental change,” the Convertible Preferred Stock is classified as permanent equity capital.

A portion of the net proceeds from the Convertible Preferred Stock has been used to reduce debt. The remainder of the net proceeds are expected to be used to pay a portion of the purchase price for the proposed acquisition of a controlling interest of Grupo TFM or to further reduce debt. If the acquisition of the controlling interest of Grupo TFM were not to be completed, the Company would explore alternative uses of the remaining net proceeds realized from the issuance of the Convertible Preferred Stock.

On August, 1, 2003, KCS filed a Form S-3 Registration Statement with the SEC to register for resale by the holders the Convertible Preferred Stock and the common stock into which such preferred stock may be converted. On October 24, 2003, this Registration Statement, as amended, was declared effective by the SEC. KCS has filed, and will continue to file, post effective amendments to this Registration Statement as required by applicable rules and regulations. KCS will not receive any proceeds from the sale of the securities under this Registration Statement, as amended.

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Stockholder Rights Plan. On September 19, 1995, the Board of Directors of the Company declared a dividend distribution of one Right for each outstanding share of the Company’s common stock, to the stockholders of record on October 12, 1995. Each Right entitles the registered holder to purchase from the Company 1/1,000th of a share of Series A Preferred Stock or in some circumstances, common stock, other securities, cash or other assets as the case may be, at a price of $210 per share, subject to adjustment.

The Rights, which are automatically attached to the common stock, are not exercisable or transferable apart from the common stock until the tenth calendar day following the earlier to occur of (unless extended by the Board of Directors and subject to the earlier redemption or expiration of the Rights): (i) the date of a public announcement that an acquiring person acquired, or obtained the right to acquire, beneficial ownership of 20 percent or more of the outstanding shares of the common stock of the Company (or 15 percent in the case that such person is considered an “adverse person”), or (ii) the commencement or announcement of an intention to make a tender offer or exchange offer that would result in an acquiring person beneficially owning 20 percent or more of such outstanding shares of common stock of the Company (or 15 percent in the case that such person is considered an “adverse person”). Until exercised, the Rights will have no rights as a stockholder of the Company, including, without limitation, the right to vote or to receive dividends. In connection with certain business combinations resulting in the acquisition of the Company or dispositions of more than 50% of Company assets or earnings power, each Right shall thereafter have the right to receive, upon the exercise thereof at the then current exercise price of the Right, that number of shares of the highest priority voting securities of the acquiring company (or certain of its affiliates) that at the time of such transaction would have a market value of two times the exercise price of the Right. The Rights expire on October 12, 2005, unless earlier redeemed by the Company as described below.

At any time prior to the tenth calendar day after the first date after the public announcement that an acquiring person has acquired beneficial ownership of 20 percent (or 15 percent in some instances) or more of the outstanding shares of the common stock of the Company, the Company may redeem the Rights in whole, but not in part, at a price of $0.005 per Right. In addition, the Company’s right of redemption may be reinstated following an inadvertent trigger of the Rights (as determined by the Board) if an acquiring person reduces its beneficial ownership to 10 percent or less of the outstanding shares of common stock of the Company in a transaction or series of transactions not involving the Company.

The Series A Preferred shares purchasable upon exercise of the Rights will have a cumulative quarterly dividend rate set by the Board of Directors or equal to 1,000 times the dividend declared on the common stock for such quarter. Each share will have the voting rights of one vote on all matters voted at a meeting of the stockholders for each 1/1,000th share of preferred stock held by such stockholder. In the event of any merger, consolidation or other transaction in which the common shares are exchanged, each Series A Preferred share will be entitled to receive an amount equal to 1,000 times the amount to be received per common share. In the event of a liquidation, the holders of Series A Preferred shares will be entitled to receive $1,000 per share or an amount per share equal to 1,000 times the aggregate amount to be distributed per share to holders of common stock. The shares will not be redeemable. The vote of holders of a majority of the Series A Preferred shares, voting together as a class, will be required for any amendment to the Company’s Certificate of Incorporation that would materially and adversely alter or change the powers, preferences or special rights of such shares.

Change In Control Provisions. The Company and certain of its subsidiaries have entered into agreements with employees whereby, upon defined circumstances constituting a change in control of the Company or subsidiary, certain stock options become exercisable, certain benefit entitlements are automatically funded and such employees are entitled to specified cash payments upon termination of employment.

The Company and certain of its subsidiaries have established trusts to provide for the funding of corporate commitments and entitlements of officers, directors, employees and others in the event of a specified change in control of the Company or subsidiary. Assets held in such trusts at December 31, 2003 were not material. Depending upon the circumstances at the time of any such change in control, the most significant factor of which

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would be the highest price paid for KCS common stock by a party seeking to control the Company, funding of the Company’s trusts could be substantial.

Note 8. Profit Sharing and Other Postretirement Benefits

The Company maintains various plans for the benefit of its employees as described below. For the years ended December 31, 2003, 2002 and 2001, the Company expensed $0.9 million, $0.4 million and $0.9 million, respectively, related to the 401(k) and Profit Sharing Plan. During 2003, 2002 and 2001, the Company did not recognize any expenses relative to profit sharing or the ESOP.

401(k) and Profit Sharing Plan. During 2000, the Company combined the Profit Sharing Plan and the 401(k) Plan into the KCS 401(k) and Profit Sharing Plan (the “401(k) Plan”). The 401(k) Plan permits participants to make contributions by salary reduction pursuant to section 401(k) of the Internal Revenue Code and also allows employees to direct their profit sharing accounts into selected investments. The Company matched employee 401(k) contributions up to a maximum of 5% of compensation in 2003 and 3% of compensation during 2002 and 2001. Qualified profit sharing plans are maintained for most employees not included in collective bargaining agreements. Contributions for the Company and its subsidiaries are made at the discretion of the Board of Directors of KCS in amounts not to exceed the maximum allowable for federal income tax purposes.

Employee Stock Ownership Plan. KCS established the ESOP for employees not covered by collective bargaining agreements. KCS contributions to the ESOP are based on a percentage of wages earned by eligible employees. Contributions and percentages are determined by the Compensation and Organization Committee of the Board of Directors.

Other Postretirement Benefits. The Company provides certain medical, life and other postretirement benefits other than pensions to its retirees. The medical and life plans are available to employees not covered under collective bargaining arrangements, who have attained age 60 and rendered ten years of service. Individuals employed as of December 31, 1992 were excluded from a specific service requirement. The medical plan is contributory and provides benefits for retirees, their covered dependents and beneficiaries. The medical plan provides for an annual adjustment of retiree contributions, and also contains, depending on the plan coverage selected, certain deductibles, co-payments, coinsurance and coordination with Medicare. The life insurance plan is non-contributory and covers retirees only. The Company’s policy, in most cases, is to fund benefits payable under these plans as the obligations become due. However, certain plan assets (money market funds held in a life insurance company) exist with respect to life insurance benefits. A life insurance company holds these assets and the Company receives an investment return on these assets based on the six-month Treasury Bill rate plus 25 basis points.

The following assumptions were used to determine postretirement obligations/costs for the years ended December 31:

	2003		2002
Annual increase in CPI	2.25	%	2.50	%
Expected rate of return on life insurance plan assets	6.50		6.50
Discount rate	6.00		6.50
Salary increase	3.00		3.00

The Company’s health care costs, excluding former Gateway Western employees and certain former employees of the MidSouth, are limited to the increase in the Consumer Price Index (“CPI”) with a maximum annual increase of 5%. Accordingly, health care costs in excess of the CPI limit will be borne by the plan participants, and therefore assumptions regarding health care cost trend rates are not applicable.

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During 2001, the Company reduced its liability and recorded a reduction of operating expenses by approximately $2.0 million in connection with the transfer of union employees formerly covered by the Gateway Western plan to a multi-employer sponsored union plan, which effectively eliminated the Company’s postretirement liability for this group of employees. This reduced the number of former Gateway Western employees or retirees covered under Gateway Western’s benefit plan. The Gateway Western benefit plans are slightly different from those of the Company and other subsidiaries. Gateway Western provides contributory health, dental and life insurance benefits to these remaining employees and retirees. In 2001, the assumed annual rate of increase in health care costs for Gateway Western employees and retirees under this plan was 10%, decreasing over six years to 5.5% in 2008 and thereafter. An increase or decrease in the assumed health care cost trend rates by one percent in 2003, 2002 and 2001 would not have a significant impact on the accumulated postretirement benefit obligation. The effect of this change on the aggregate of the service and interest cost components of the net periodic postretirement benefit is not significant.

A reconciliation of the accumulated postretirement benefit obligation, change in plan assets and funded status, respectively, at December 31 follows (in millions):

	2003			2002
Accumulated postretirement benefit obligation at beginning of year	$	10.0		$	9.1
Service cost		0.2			0.2
Interest cost		0.6			0.6
Actuarial and other (gain) loss		(2.3	)		1.0
Benefits paid (i)		(0.9	)		(0.9	)
Accumulated postretirement benefit obligation at end of year		7.6			10.0
Fair value of plan assets at beginning of year		1.0			1.0
Actual return on plan assets		0.1			0.1
Benefits paid (i)		(0.1	)		(0.1	)
Fair value of plan assets at end of year		1.0			1.0
Funded status and accrued benefit cost	$	(6.6	)	$	(9.0	)

(i) Benefits paid for the reconciliation of accumulated postretirement benefit obligation include both medical and life insurance benefits, whereas benefits paid for the fair value of plan assets reconciliation include only life insurance benefits. Plan assets relate only to the life insurance benefits. Medical benefits are funded as obligations become due.

Net periodic postretirement benefit cost included the following components (in millions):

	2003		2002			2001
Service cost	$	0.2	$	0.2		$	0.2
Interest cost		0.6		0.6			0.8
Expected return on plan assets		—		(0.1	)		(0.1	)
Net periodic postretirement benefit cost	$	0.8	$	0.7		$	0.9

During 2001 a post-retirement benefit for directors was eliminated, resulting in a reduction of the related liability of approximately $1.4 million.

Under collective bargaining agreements, KCSR participates in a multi-employer benefit plan, which provides certain post-retirement health care and life insurance benefits to eligible union employees and certain retirees. Premiums under this plan are expensed as incurred and were $1.7 million, $1.0 million and $0.8 million for 2003, 2002 and 2001, respectively. Based on existing rates, premium amounts are not expected to change substantially in 2004 compared to 2003.

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Note 9. Commitments and Contingencies

Litigation. The Company and its subsidiaries are involved as plaintiff or defendant in various legal actions arising in the normal course of business. While the ultimate outcome of the various legal proceedings involving the Company and its subsidiaries cannot be predicted with certainty, it is management’s opinion that the estimated liabilities related to the Company’s litigation are adequate.

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. A Master Global Settlement Agreement (“MGSA”) was signed in early 2002. During 2002, KCSR made all payments under this agreement and collected $19.3 million from its excess insurance carriers. Court approval of the MGSA is expected in 2004 from the 22^nd Judicial District Court of Washington Parish, Louisiana. KCSR also expects to receive releases from about 4,000 Mississippi plaintiffs in numerous cases pending in the First Judicial District Circuit Court of Hinds County, Mississippi.

Houston Cases

In August 2000, KCSR and certain of its affiliates were added as defendants in lawsuits pending in Jefferson and Harris Counties, Texas. These lawsuits allege damage to approximately 3,000 plaintiffs as a result of an alleged toxic chemical release from a tank car in Houston, Texas on August 21, 1998. Litigation involving the shipper and the delivering carrier had been pending for some time, but KCSR, which handled the car during the course of its transport, had not previously been named a defendant. On June 28, 2001, KCSR reached a final settlement with the 1,664 plaintiffs in the lawsuit filed in Jefferson County, Texas. In 2002, KCSR settled with virtually all of the plaintiffs in the lawsuit filed in the 164^th Judicial District Court of Harris County, Texas, for approximately $0.3 million. The remaining plaintiffs have indicated that they intend to retain new counsel, yet to date, KCS has not received any notice of new counsel entering the case.

Stilwell Tax Dispute

On November 19, 2002, Stilwell Financial, Inc. (“Stilwell”), now Janus Capital Group Inc., filed a Statement of Claim against KCS with the American Arbitration Association. This claim involves the entitlement to compensation expense deductions for federal income tax purposes which are associated with the exercise of certain stock options issued by Stilwell (the “Substituted Options”) in connection with the Spin-off of Stilwell from KCS on July 12, 2000. Stilwell alleges that upon exercise of a Substituted Option, Stilwell is entitled to the associated compensation expense deductions. Stilwell bases its claim on a letter, dated August 17, 1999, addressed to Landon H. Rowland, Chairman, President and Chief Executive Officer of Kansas City Southern Industries, Inc. (the “Letter”), purporting to allow Stilwell to claim such deductions. The Letter was signed by the Vice President and Tax Counsel of Stilwell, who was also at the time the Senior Assistant Vice President and Tax Counsel of KCS, and by Landon H. Rowland, currently a director of KCS and the former non-executive Chairman of Janus Capital Group Inc., who was at that time a director and officer of both Stilwell and KCS.

Stilwell seeks a declaratory award and/or injunction ordering KCS to file and amend its tax returns for the tax year 2000 and subsequent years to reflect that KCS does not claim the associated compensation expense deductions and to indemnify Stilwell against any related taxes imposed upon Stilwell, which allegedly has taken, and plans to take, such deductions. On December 20, 2002, KCS filed an Objection to Stilwell’s Demand for

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Arbitration and Motion to Dismiss. KCS disputes the validity and enforceability of the Letter. KCS asserts, among other things, that a Private Letter Ruling issued by the Internal Revenue Service on July 9, 1999 provides that KCS subsidiaries are entitled to compensation expense deductions upon exercise of Substituted Options by their employees.

KCS has answered that the claims of Stilwell are without merit and intends to vigorously defend against them. Given the stage of the proceeding, KCS is unable to predict the outcome, but does not expect this matter to result in any material adverse financial consequences to KCS’s net income in the event, which it regards as unlikely, that it would not prevail.

Environmental Liabilities. The Company’s operations are subject to extensive federal, state and local environmental laws and regulations. The major environmental laws to which the Company is subject, include, among others, the Federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA,” also known as the Superfund law), the Toxic Substances Control Act, the Federal Water Pollution Control Act, and the Hazardous Materials Transportation Act. CERCLA can impose joint and several liability for cleanup and investigation costs, without regard to fault or legality of the original conduct, on current and predecessor owners and operators of a site, as well as those who generate, or arrange for the disposal of, hazardous substances. The Company does not foresee that compliance with the requirements imposed by the environmental legislation will impair its competitive capability or result in any material additional capital expenditures, operating or maintenance costs.

The risk of incurring environmental liability is inherent in the railroad industry. As part of serving the petroleum and chemicals industry, KCSR transports hazardous materials and has a professional team available to respond and handle environmental issues that might occur in the transport of such materials. Additionally, the Company is a partner in the Responsible Care^® program and, as a result, has initiated certain additional environmental, health and safety programs. KCSR performs ongoing reviews and evaluations of the various environmental programs and issues within the Company’s operations, and, as necessary, takes actions to limit the Company’s exposure to potential liability.

The Company owns property that is, or has been, used for industrial purposes. Use of these properties may subject the Company to potentially material liabilities relating to the investigation and cleanup of contaminants, claims alleging personal injury, or property damage as the result of exposures to, or release of, hazardous substances. Although the Company is responsible for investigating and remediating contamination at several locations, based on currently available information, the Company does not expect any related liabilities, individually or collectively, to have a material impact on its results of operations, financial position or cash flows. In the event that the Company becomes subject to more stringent cleanup requirements at these sites, discovers additional contamination, or becomes subject to related personal or property damage claims, the Company could incur material costs in connection with these sites.

The Company records liabilities for remediation and restoration costs related to past activities when the Company’s obligation is probable and the costs can be reasonably estimated. Costs of ongoing compliance activities to current operations are expensed as incurred. The Company’s recorded liabilities for these issues represent its best estimates (on an undiscounted basis) of remediation and restoration costs that may be required to comply with present laws and regulations. Although these costs cannot be predicted with certainty, management believes that the ultimate outcome of identified matters will not have a material adverse effect on the Company’s consolidated results of operations, financial condition or cash flows.

Panama Canal Railway Company. Under certain limited conditions, the Company is a guarantor for up to $5.6 million of cash deficiencies associated with the operations of PCRC. In addition, the Company is a guarantor for up to $1.9 million of equipment loans. Further, if the Company or its partner terminate the concession contract without the consent of the IFC, the Company is a guarantor for up to 50% of the outstanding senior loans. See Note 3.

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Note 10. Derivative Instruments and Purchase Commitments

Derivative Instruments. The Company does not engage in the trading of derivatives. The Company’s objective for using derivative instruments is to manage its fuel and interest rate risk and mitigate the impact of fluctuations in fuel prices and interest rates. In general, the Company enters into derivative transactions in limited situations based on management’s assessment of current market conditions and perceived risks. Management intends to respond to evolving business and market conditions in order to manage risks and exposures associated with the Company’s various operations, and in doing so, may enter into such transactions more frequently as deemed appropriate.

Fuel Derivative Transactions

At December 31, 2003 the Company was a party to seven fuel swap agreements for a notional amount of approximately 9.8 million gallons of fuel. Under the terms of these swaps, the Company receives a variable price based upon an average of the spot prices calculated on a monthly basis as reported through a petroleum price reporting service and pays a fixed price determined at the time the Company enters into the swap transaction. The variable price the Company is receiving is approximately equal to the price the Company is paying in the market for locomotive fuel. By entering into these swap transactions, the Company is able to fix the cost of fuel for the notional amount of gallons hedged.

A summary of the swap agreements to which KCSR was a party as of December 31, 2003 follows:

Trade Dates	Notional Amount	Fixed pay per gallon	Expiration Date
November 14, 2002 through October 31, 2003	9.8 million gallons	62.5¢–69.0¢	December 31, 2003 through December 31, 2005

Cash settlements of these swaps occur on a monthly basis on the fifth business day of the month following the month in which the settlement is calculated. As of December 31, 2003, the fair market value of the benefit of the swaps was $0.9 million. For the years ended December 31, 2003, 2002 and 2001, KCSR consumed 55.4 million, 55.3 million and 57.6 million gallons of fuel, respectively.

Fuel hedging transactions, including fuel swaps as well as forward purchase commitments resulted in a decrease in fuel expense of $1.1 million, and $0.4 million in 2003 and 2002, respectively. Fuel purchase commitments resulted in an increase in fuel expense of $0.4 million in 2001.

Interest Rate Derivative Transactions

The Company did not participate in any interest rate derivative transactions during 2003 and had no interest rate hedge transactions outstanding as of December 31, 2003 and 2002. At December 31, 2001, the Company had five separate interest rate cap agreements for an aggregate notional amount of $200 million. These agreements expired during 2002.

Southern Capital

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 derivative transactions to which Southern Capital was a participant. The Company also adjusts its investment in Southern Capital by the change in the fair value of these derivative instruments. For the years ended December 31, 2002 and 2001, the Company recorded a reduction to its stockholders equity (accumulated other comprehensive loss) of approximately $0.3 million and $2.9 million, respectively, for its portion of the amount recorded by Southern Capital for the adjustment to the fair value of its interest rate swap transactions. The Company also reduced its investment in Southern Capital by the same amount.

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During 2002, in conjunction with the refinancing of its debt, Southern Capital terminated these interest rate swap transactions. As a result, Southern Capital is amortizing the balance of accumulated other comprehensive income (loss) into interest expense over the former remaining life of the interest rate swap transactions. The Company is recording the impact of this charge through a related reduction in equity earnings from Southern Capital and is amortizing the related accumulated other comprehensive income (loss) balance to its investment in Southern Capital. During the years ended December 31, 2003 and 2002, the Company recorded related amortization of $1.2 million and $0.7 million, respectively.

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Note 11. Quarterly Financial Data (Unaudited)

(in millions, except per share amounts):

	2003
	Fourth Quarter			Third Quarter			Second Quarter			First Quarter
Revenues	$	148.5		$	146.3		$	146.3		$	140.2
Operating expenses		139.1			115.2			116.1			117.5
Depreciation and amortization		16.2			16.2			16.0			15.9
Operating income (loss)		(6.8	)		14.9			14.2			6.8
Equity in net earnings (losses) of unconsolidated affiliates
Grupo TFM		6.1			1.6			(2.3	)		6.9
Other		(0.3	)		(0.9	)		(0.2	)		0.1
Interest expense		(11.6	)		(11.6	)		(11.7	)		(11.5	)
Other income		2.0			2.0			1.5			1.3
Income (loss) before income taxes and cumulative effect of accounting change		(10.6	)		6.0			1.5			3.6
Income taxes provision (benefit)		(5.4	)		1.7			2.0			(1.1	)
Income (loss) before cumulative effect of accounting change		(5.2	)		4.3			(0.5	)		4.7
Cumulative effect of accounting change		—			—			—			8.9
Net income (loss)	$	(5.2	)	$	4.3		$	(0.5	)	$	13.6
Per Share Data (i)
Total basic earnings (loss) per common share	$	(0.10	)	$	0.02		$	(0.03	)	$	0.22
Total diluted earnings (loss) per common share	$	(0.10	)	$	0.02		$	(0.03	)	$	0.22
Dividends per share: $25 par preferred stock	$	0.25		$	0.25		$	0.25		$	0.25
Dividends per share: $1 Par Convertible Preferred Stock	$	5.32		$	5.90		$	—		$	—
Stock Price Ranges:
Preferred—High	$	20.00		$	20.25		$	20.00		$	20.50
—Low	$	18.50		$	18.75		$	16.90		$	17.25
Common—High	$	14.97		$	13.37		$	12.78		$	13.02
—Low	$	10.95		$	10.60		$	10.70		$	10.65

(i) The accumulation of 2003’s four quarters for basic and diluted earnings (loss) per share data does not total the respective earnings per share for the year ended December 31, 2003 due to rounding.

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	2002
	Fourth Quarter			Third Quarter			Second Quarter			First Quarter
Revenues	$	144.2		$	138.9		$	139.2		$	143.9
Operating expenses		114.2			116.9			110.1			115.6
Depreciation and amortization		16.1			15.8			14.6			14.9
Operating income		13.9			6.2			14.5			13.4
Equity in net earnings (losses) of unconsolidated affiliates Grupo TFM		18.2			9.8			13.0			4.8
Other		(0.5	)		(0.7	)		(1.3	)		0.1
Gain on sale of Mexrail, Inc.		—			—			—			4.4
Interest expense		(11.7	)		(11.5	)		(10.5	)		(11.3	)
Debt retirement costs		—			—			(4.3	)		—
Other income		2.3			6.5			4.4			4.4
Income from operations before income taxes		22.2			10.3			15.8			15.8
Income taxes provision (benefit)		1.8			(0.3	)		1.3			4.1
Net income	$	20.4		$	10.6		$	14.5		$	11.7
Per Share Data
Total basic earnings per common share	$	0.33		$	0.17		$	0.24		$	0.20
Total diluted earnings per common share	$	0.32		$	0.17		$	0.23		$	0.19
Dividends per share: $25 par preferred stock	$	0.25		$	0.25		$	0.25		$	0.25
Stock Price Ranges:
Preferred—High	$	20.00		$	19.85		$	20.75		$	19.50
—Low	$	18.00		$	16.25		$	19.45		$	17.95
Common—High	$	15.00		$	17.35		$	17.00		$	15.99
—Low	$	12.00		$	12.75		$	14.96		$	12.75

101

Note 12. Condensed Consolidating Financial Information

As discussed in Note 5, KCSR has outstanding $200 million of 9½% Notes due 2008 and $200 million of 7½% Notes due 2009. Both of these note issues are unsecured obligations of KCSR, however, they are also jointly and severally and fully and unconditionally guaranteed on an unsecured senior basis by KCS and certain of its subsidiaries (all of which are wholly-owned) within the KCS consolidated group. For each of these note issues, KCSR 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 affiliates whose securities collateralize an issue 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

	December 31, 2003
	Parent			KCSR			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Consolidating Adjustments			Consolidated KCS
	(dollars in millions)
Revenues	$	—		$	575.0		$	21.5		$	15.4		$	(30.6	)	$	581.3
Operating expenses		13.5			517.7			20.9			30.7			(30.6	)		552.2
Operating income (loss)		(13.5	)		57.3			0.6			(15.3	)		—			29.1
Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries		12.5			11.7			—			11.1			(24.3	)		11.0
Interest expense		(0.6	)		(45.8	)		(0.5	)		—			0.5			(46.4	)
Other income		0.1			5.9			0.1			1.2			(0.5	)		6.8
Income (loss) before income taxes		(1.5	)		29.1			0.2			(3.0	)		(24.3	)		0.5
Income tax provision (benefit)		(4.8	)		7.2			0.1			(5.3	)		—			(2.8	)
Income before cumulative effect of accounting change		3.3			21.9			0.1			2.3			(24.3	)		3.3
Cumulative effect of accounting change, net of income taxes		8.9			8.9			—			—			(8.9	)		8.9
Net income	$	12.2		$	30.8		$	0.1		$	2.3		$	(33.2	)	$	12.2

	December 31, 2002
	Parent			KCSR			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Consolidating Adjustments			Consolidated KCS
	(dollars in millions)
Revenues	$	—		$	567.4		$	18.1		$	38.3		$	(57.6	)	$	566.2
Operating expenses		10.8			506.4			19.5			39.1			(57.6	)		518.2
Operating income (loss)		(10.8	)		61.0			(1.4	)		(0.8	)		—			48.0
Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries		61.5			45.6			—			43.6			(107.3	)		43.4
Gain on sale of Mexrail		—			4.4			—			—			—			4.4
Interest expense		(0.4	)		(44.1	)		(0.4	)		(0.1	)		—			(45.0	)
Debt retirement costs		—			(4.3	)		—			—			—			(4.3	)
Other income		3.9			11.0			2.0			0.7			—			17.6
Income (loss) before income taxes		54.2			73.6			0.2			43.4			(107.3	)		64.1
Income tax provision (benefit)		(3.0	)		10.6			0.1			(0.8	)		—			6.9
Net income	$	57.2		$	63.0		$	0.1		$	44.2		$	(107.3	)	$	57.2

102

	December 31, 2001
	Parent			KCSR			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Consolidating Adjustments			Consolidated KCS
	(dollars in millions)
Revenues	$	—		$	580.3		$	12.3		$	20.1		$	(29.5	)	$	583.2
Operating expenses		13.6			511.4			13.1			19.2			(29.5	)		527.8
Operating income (loss)		(13.6	)		68.9			(0.8	)		0.9			—			55.4
Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries		39.2			26.8			—			29.4			(68.3	)		27.1
Interest expense		1.3			(55.2	)		(0.5	)		(0.4	)		2.0			(52.8	)
Other income		0.2			6.0			—			—			(2.0	)		4.2
Income (loss) before income taxes		27.1			46.5			(1.3	)		29.9			(68.3	)		33.9
Income tax provision (benefit)		(4.0	)		6.7			(0.5	)		0.6			—			2.8
Income (loss) before cumulative effect of accounting change		31.1			39.8			(0.8	)		29.3			(68.3	)		31.1
Cumulative effect of accounting change, net of income taxes		(0.4	)		(0.4	)		—			—			0.4			(0.4	)
Net income	$	30.7		$	39.4		$	(0.8	)	$	29.3		$	(67.9	)	$	30.7

Condensed Consolidating Balance Sheets

	As of December 31, 2003
	Parent		KCSR		Guarantor Subsidiaries		Non- Guarantor Subsidiaries		Consolidating Adjustments			Consolidated KCS
	(dollars in millions)
ASSETS
Current assets	$	221.9	$	285.3	$	11.7	$	15.1	$	(225.9	)	$	308.1
Investments held for operating purposes and investments in subsidiaries		801.4		431.1		—		452.4		(1,242.2	)		442.7
Properties, net		0.2		1,358.5		3.8		—		—			1,362.5
Goodwill and other assets		11.0		28.6		1.7		11.3		(13.0	)		39.6
Total assets	$	1,034.5	$	2,103.5	$	17.2	$	478.8	$	(1,481.1	)	$	2,152.9
LIABILITIES AND EQUITY
Current liabilities	$	14.8	$	346.7	$	3.8	$	35.4	$	(225.9	)	$	174.8
Long-term debt		1.3		511.5		0.7		—		—			513.5
Payable to affiliates		19.5		—		0.7		—		(20.2	)		—
Deferred income taxes		3.3		398.5		0.2		2.5		(13.0	)		391.5
Other liabilities		31.9		54.4		4.3		18.8		—			109.4
Stockholders’ equity		963.7		792.4		7.5		422.1		(1,222.0	)		963.7
Total liabilities and equity	$	1,034.5	$	2,103.5	$	17.2	$	478.8	$	(1,481.1	)	$	2,152.9

103

	As of December 31, 2002
	Parent		KCSR		Guarantor Subsidiaries		Non- Guarantor Subsidiaries		Consolidating Adjustments			Consolidated KCS
	(dollars in millions)
ASSETS
Current assets	$	43.3	$	234.7	$	17.6	$	13.0	$	(92.4	)	$	216.2
Investments held for operating purposes and investments in subsidiaries		769.1		412.1		—		432.5		(1,190.6	)		423.1
Properties, net		0.2		1,333.2		3.9		0.1		—			1,337.4
Goodwill and other assets		1.6		30.5		1.7		8.1		(9.8	)		32.1
Total assets	$	814.2	$	2,010.5	$	23.2	$	453.7	$	(1,292.8	)	$	2,008.8
LIABILITIES AND EQUITY
Current liabilities	$	7.2	$	245.3	$	9.1	$	16.2	$	(91.5	)	$	186.3
Long-term debt		1.2		569.6		1.8		—		—			572.6
Payable to affiliates		12.8		—		0.6		—		(13.4	)		—
Deferred income taxes		8.6		391.1		0.3		2.6		(9.8	)		392.8
Other liabilities		31.5		44.7		4.0		25.1		(1.1	)		104.2
Stockholders’ equity		752.9		759.8		7.4		409.8		(1,177.0	)		752.9
Total liabilities and equity	$	814.2	$	2,010.5	$	23.2	$	453.7	$	(1,292.8	)	$	2,008.8

Condensed Consolidating Statements of Cash Flows

	December 31, 2003
	Parent			KCSR			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Consolidating Adjustments			Consolidated KCS
	(dollars in millions)
Net cash flows provided by (used for) operating activities:	$	(130.9	)	$	210.3		$	(10.3	)	$	3.2		$	(5.0	)	$	67.3
Investing activities:
Property acquisitions		—			(78.6	)		(0.4	)		—			—			(79.0	)
Proceeds from disposal of property		—			12.4			—			—			—			12.4
Investments in and loans to affiliates		(41.8	)		(6.1	)		—			(28.6	)		36.1			(40.4	)
Proceeds from sale of investments		32.7			—			—			—			—			32.7
Repayment of loans to affiliates		—			—			—			20.7			(20.7	)		—
Other, net		(9.3	)		(1.8	)		(0.1	)		(3.2	)		5.1			(9.3	)
Net		(18.4	)		(74.1	)		(0.5	)		(11.1	)		20.5			(83.6	)
Financing activities:
Proceeds from issuance of long-term debt		—			—			—			—			—			—
Repayment of long-term debt		—			(58.2	)		(1.0	)		—			—			(59.2	)
Proceeds of loans from affiliates		27.4			—			—			—			(27.4	)		—
Repayment of loans from affiliates		(20.7	)		—			—			—			20.7			—
Issuance of preferred stock, net		193.0			—			—			—			—			193.0
Proceeds from stock plans		5.1			0.2			—			—			—			5.3
Cash dividends paid		(4.7	)		—			—			—			—			(4.7	)
Other, net		—			(1.7	)		—			8.8			(8.8	)		(1.7	)
Net		200.1			(59.7	)		(1.0	)		8.8			(15.5	)		132.7
Cash and cash equivalents:
Net increase (decrease)		50.8			76.5			(11.8	)		0.9			—			116.4
At beginning of period		(10.8	)		17.5			11.8			0.5			—			19.0
At end of period	$	40.0		$	94.0		$	—		$	1.4		$	—		$	135.4

104

	December 31, 2002
	Parent			KCSR			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Consolidating Adjustments			Consolidated KCS
	(dollars in millions)
Net cash flows provided by (used for) operating activities	$	(27.9	)	$	99.6		$	13.3		$	18.7		$	(8.0	)	$	95.7
Investing activities:
Property acquisitions		—			(79.1	)		(0.7	)		—			—			(79.8	)
Proceeds from disposal of property		—			18.1			—			—			—			18.1
Investments in and loans to affiliates		(3.0	)		—			—			(13.0	)		11.6			(4.4	)
Proceeds from sale of investments		1.4			31.3			—			—			(1.0	)		31.7
Other, net		—			(1.0	)		—			(8.1	)		8.6			(0.5	)
Net		(1.6	)		(30.7	)		(0.7	)		(21.1	)		19.2			(34.9	)
Financing activities:
Proceeds from issuance of long-term debt		—			200.0			—			—			—			200.0
Repayment of long-term debt		(0.4	)		(269.3	)		(1.0	)		(0.2	)		—			(270.9	)
Proceeds of loans from affiliates		8.0			—			0.2			—			(8.2	)		—
Debt issuance costs		—			(5.7	)		—			—			—			(5.7	)
Proceeds from stock plans		10.0			0.3			—			—			—			10.3
Cash dividends paid		(0.2	)		—			—			—			—			(0.2	)
Other, net		—			—			—			3.0			(3.0	)		—
Net		17.4			(74.7	)		(0.8	)		2.8			(11.2	)		(66.5	)
Cash and cash equivalents:
Net increase (decrease)		(12.1	)		(5.8	)		11.8			0.4			—			(5.7	)
At beginning of period		1.3			23.2			—			0.2			—			24.7
At end of period	$	(10.8	)	$	17.4		$	11.8		$	0.6		$	—		$	19.0

105

	December 31, 2001
	Parent			KCSR			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Consolidating Adjustments			Consolidated KCS
	(dollars in millions)
Net cash flows provided by (used for) operating activities	$	(10.0	)	$	74.2		$	(3.9	)	$	7.1		$	1.3		$	68.7
Investing activities:
Property acquisitions		—			(65.7	)		(0.2	)		(0.1	)		—			(66.0	)
Proceeds from disposal of property		—			14.8			3.3			—			—			18.1
Investments in and loans to affiliates		—			(2.6	)		—			(9.0	)		3.4			(8.2	)
Proceeds from sale of investments		—			—			0.6			—			—			0.6
Other, net		—			—			0.5			—			(0.7	)		(0.2	)
Net		—			(53.5	)		4.2			(9.1	)		2.7			(55.7	)
Financing activities:
Proceeds from issuance of long- term debt		—			35.0			—			—			—			35.0
Repayment of long-term debt		—			(50.0	)		(1.0	)		(0.3	)		—			(51.3	)
Proceeds of loans from affiliates		1.4			—			0.6			—			(2.0	)		—
Debt issuance costs		—			(0.4	)		—			—			—			(0.4	)
Proceeds from stock plans		8.9			—			—			—			—			8.9
Cash dividends paid		(0.2	)		—			—			—			—			(0.2	)
Other, net		(0.3	)		(1.5	)		—			2.0			(2.0	)		(1.8	)
Net		9.8			(16.9	)		(0.4	)		1.7			(4.0	)		(9.8	)
Cash and cash equivalents:
Net increase (decrease)		(0.2	)		3.8			(0.1	)		(0.3	)		—			3.2
At beginning of period		1.5			19.4			0.1			0.5			—			21.5
At end of period	$	1.3		$	23.2		$	—		$	0.2		$	—		$	24.7

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

There were no disagreements with accountants on accounting and financial disclosure matters during 2003 or 2002.

Item 9(a). Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the fiscal year for which this annual report on Form 10-K is filed. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There have not been any significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. There were no significant deficiencies or material weakness in the internal controls, and therefore no corrective actions were taken.

106

Part III

The Company has incorporated by reference certain responses to the Items of this Part III pursuant to Rule 12b-23 under the Exchange Act and General Instruction G(3) to Form 10-K. The Company’s definitive proxy statement for the annual meeting of stockholders scheduled for May 6, 2004 (“Proxy Statement”) will be filed no later than 120 days after December 31, 2003.

Item 10. Directors and Executive Officers of the Company

(a) Directors of the Company

The information set forth in response to Item 401 of Regulation S-K under the heading “Proposal 1—Election of Three Directors” and “The Board of Directors” in the Company’s Proxy Statement is incorporated herein by reference in partial response to this Item 10.

(b) Executive Officers of the Company

The information set forth in response to Item 401 of Regulation S-K under “Executive Officers of the Company,” an unnumbered Item in Part I (immediately following Item 4, Submission of Matters to a Vote of Security Holders), of this Form 10-K, is incorporated herein by reference in partial response to this Item 10.

(c) Compliance with Section 16(a) of the Exchange Act

The information set forth in response to Item 405 of Regulation S-K under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Proxy Statement is incorporated herein by reference in partial response to this Item 10.

(d) Code of Ethics

The Company has adopted a Code of Business Conduct and Ethics (the “Code of Ethics”) that applies to directors, officers (including, among others, the Company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions) and employees. The Company has posted its Code of Ethics on its Internet website at www.kcsi.com. The Company will also post on this Internet website any amendments to, or waivers from, a provision of its Code of Ethics that applies to the Company’s principal executive officer, principal financial officer, principal accounting officer, or persons performing similar functions as required by applicable rules and regulations.

Item 11. Executive Compensation

The information set forth in response to Item 402 of Regulation S-K under “Management Compensation” and “The Board of Directors—Compensation of Directors” in the Company’s Proxy Statement, (other than the Compensation and Organization Committee Report on Executive Compensation and the Stock Performance Graph), is incorporated herein by reference in response to this Item 11.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information set forth in response to Item 403 of Regulation S-K under the heading “Principal Stockholders and Stock Owned Beneficially by Directors and Certain Executive Officers” in the Company’s Proxy Statement is incorporated herein by reference in partial response to this Item 12.

107

Equity Compensation Plan Information

The following table provides information as of December 31, 2003 about our common stock that may be issued upon the exercise of options, warrants and rights, as well as shares remaining available for future issuance under our existing equity compensation plans.

	(a)	(b)		(c)
Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)(1)
Equity compensation plans approved by security holders	4,612,863	$	7.36	6,092,779
Equity compensation plans not approved by security holders	0		0	0
Total	4,612,863	$	7.36	6,092,779

(1) Includes 4,830,792 shares available for issuance under the Employee Stock Purchase Plan. In addition, includes 1,261,987 shares available for issuance under the 1991 Plan as awards in the form of Restricted Shares, Bonus Shares, Performance Units or Performance Shares or issued upon the exercise of Options (including ISOs), stock appreciation rights or limited stock appreciation rights awarded under the 1991 Plan.

The Company has no knowledge of any arrangement the operation of which may at a subsequent date result in a change of control of the Company.

Item 13. Certain Relationships and Related Transactions

The information set forth in response to Item 404 of Regulation S-K under the heading “Compensation Committee Interlocks and Insider Participation; Certain Relationships and Related Transactions” in the Company’s Proxy Statement is incorporated herein by reference in response to this Item 13.

Item 14. Principal Accountant Fees and Services

Information concerning principal accounting fees and services under the heading “Audit Matters—Principal Accounting Firm Fees” and “The Board of Directors—The Audit Committee” in the Company’s Proxy Statement is hereby incorporated by reference in response to this Item 14.

108

Part IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) List of Documents filed as part of this Report

(1) Financial Statements

The financial statements and related notes, together with the report of KPMG LLP appear in Part II Item 8, Financial Statements and Supplementary Data, of this Form 10-K.

(2) Financial Statement Schedules

The schedules and exhibits for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission appear in Part II Item 8, “Financial Statements and Supplementary Data”, under the “Index to Financial Statements” of this Form 10-K.

(3) List of Exhibits

(a) Exhibits

The Company has incorporated by reference herein certain exhibits as specified below pursuant to Rule 12b-32 under the Exchange Act.

(2) Plan of acquisition, reorganization, arrangement, liquidation or succession

2.1	Acquisition Agreement, dated as of April 20, 2003, by and among KCS, KARA Sub, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V. and TMM Multimodal, S.A. de C.V. which is filed as Exhibit 10.1 to KCS’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 (Commission File No. 1-4717) is incorporated herein by reference as Exhibit 2.1
2.2	Stock Purchase Agreement, dated as of April 20, 2003 by and among KCS, Grupo TMM, S.A. and TFM, S.A. de C.V., which is filed as Exhibit 10.2 to KCS’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 (Commission File No. 1-4717) is incorporated herein by reference as Exhibit 2.2
2.3	Form of Amended and Restated Certificate of Incorporation of KCS**
2.4	Form of First Amendment to Rights Agreement**
2.5	Form of Stockholders’ Agreement to be entered into by and among KCS, Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and certain stockholders of Grupo TMM, S.A.**
2.6	Form of Registration Rights Agreement to be entered into by and among KCS, Grupo TMM, S.A., TMM Holdings, S.A. de C.V. and TMM Multimodal, S.A. de C.V.**
2.7	Form of Consulting Agreement to be entered into by and between KCS and a consulting firm to be established by José Serrano Segovia**
2.8	Marketing and Services Agreement to be entered into by and among KCS, Grupo TMM, S.A. and TFM, S.A. de C.V.**

** Incorporated herein by reference to Appendices A, and C through G, respectively, to KCS’s Special Meeting Preliminary Proxy Statement filed June 26, 2003 (Commission File No. 1-4717), as Exhibits 2.3 through 2.8, respectively.

109

(3) Articles of Incorporation and Bylaws

Articles of Incorporation

3.1 Exhibit 3.1 to the Company’s Registration Statement on Form S-4 originally filed July 12, 2002 (Registration No. 333-92360), as amended and declared effective on July 30, 2002 (the “ 2002 S-4 Registration Statement”), Restated Certificate of Incorporation, is hereby incorporated by reference as Exhibit 3.1

Bylaws

3.2 The By-Laws of Kansas City Southern, as amended and restated to March 8, 2004, is attached hereto as Exhibit 3.2

(4) Instruments Defining the Right of Security Holders, Including Indentures

4.1	The Fourth, Seventh, Eighth, Eleventh, Twelfth, Thirteenth, Fourteenth, Fifteenth and Sixteenth paragraphs of Exhibit 3.1 hereto are incorporated by reference as Exhibit 4.1
4.2	Article I, Sections 1, 3 and 11 of Article II, Article V and Article VIII of Exhibit 3.2 hereto are incorporated by reference as Exhibit 4.2
4.3	The Indenture, dated July 1, 1992 between the Company and The Chase Manhattan Bank (the “1992 Indenture”) which is attached as Exhibit 4 to the Company’s Shelf Registration of $300 million of Debt Securities on Form S-3 filed June 19, 1992 (Registration No. 33-47198) and as Exhibit 4(a) to the Company’s Form S-3 filed March 29, 1993 (Registration No. 33-60192) registering $200 million of Debt Securities, is hereby incorporated by reference as Exhibit 4.3
4.3.1	Exhibit 4.5.2 to the Company’s Form 10-K for the fiscal year ended December 31, 1999 (Commission File No. 1-4717), Supplemental Indenture dated December 17, 1999 to the 1992 Indenture with respect to the 6.625% Notes Due March 1, 2005 issued pursuant to the 1992 Indenture, is hereby incorporated by reference as Exhibit 4.3.1
4.3.2	Exhibit 4.5.4 to the Company’s Form 10-K for the fiscal year ended December 31, 1999 (Commission File No. 1-4717), Supplemental Indenture dated December 17, 1999 to the 1992 Indenture with respect to the 7% Debentures Due December 15, 2025 issued pursuant to the 1992 Indenture, is hereby incorporated by reference as Exhibit 4.3.2
4.4	Exhibit 99 to the Company’s Form 8-A dated October 24, 1995 (Commission File No. 1-4717), which is the Stockholder Rights Agreement by and between the Company and Harris Trust and Savings Bank dated as of September 19, 1995, is hereby incorporated by reference as Exhibit 4.4
4.5	Exhibit 4.1 to the Company’s S-4 Registration Statement on Form S-4 originally filed on January 25, 2001 (Registration No. 333-54262), as amended and declared effective on March 15, 2001 (the “2001 S-4 Registration Statement”), the Indenture, dated as of September 27, 2000, among the Company, The Kansas City Southern Railway Company (“KCSR”), certain other subsidiaries of the Company and The Bank of New York, as trustee (the “2000 Indenture”), is hereby incorporated by reference as Exhibit 4.5
4.5.1	Exhibit 4.1.1 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Supplemental Indenture, dated as of January 29, 2001, to the 2000 Indenture, among the Company, KCSR, certain other subsidiaries of the Company and The Bank of New York, as trustee, is hereby incorporated by reference as Exhibit 4.5.1
4.6	Form of Exchange Note (included as Exhibit B to Exhibit 4.5.1 hereto)
4.7	Exhibit 4.3 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), the Exchange and Registration Rights Agreement, dated as of September 27, 2000, among the Company, KCSR, certain other subsidiaries of the Company, is hereby incorporated by reference as Exhibit 4.7

110

4.8	The Indenture, dated June 12, 2002, among KCSR, the Company and certain subsidiaries of the Company, and U.S. Bank National Association, as Trustee (the “2002 Indenture”), which is attached as Exhibit 4.1 to the 2002 S-4 Registration Statement (Registration No. 333-92360) is hereby incorporated by reference as Exhibit 4.8
4.8.1	Form of Face of Exchange Note, included as Exhibit B to Exhibit 4.8 and filed as Exhibit 4.2 to the 2002 S-4 Registration Statement (Registration No. 333-92360) is hereby incorporated by reference as Exhibit 4.8.1
4.9	Certificate of Designations, which is filed as Exhibit 3.1(b) to KCS’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 4.1
4.10	Exhibit 4.5 to the Company’s Registration Statement on Form S-3 originally filed on August 1, 2003 (Registration No. 333-107573), as amended and declared effective on October 24, 2003 (the “2003 S-3 Registration Statement”), Registration Rights Agreement dated May 5, 2003 among KCS, Morgan Stanley & Co. Incorporated and Deutsche Bank Securities Inc., is hereby incorporated by reference as Exhibit 4.10.

(9) Voting Trust Agreement

(Inapplicable)

(10) Material Contracts

10.1	Form of Officer Indemnification Agreement which is attached as Exhibit 10.1 to the Company’s Form 10-K for the year ended December 31, 2001 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.1
10.2	Form of Director Indemnification Agreement which is attached as Exhibit 10.2 to the Company’s Form 10-K for the year ended December 31, 2001 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.2
10.3	The 1992 Indenture (See Exhibit 4.3)
10.4.1	Supplemental Indenture dated December 17, 1999 to the 1992 Indenture with respect to the 6.625% Notes Due March 1, 2005 issued pursuant to the 1992 Indenture (See Exhibit 4.3.1)
10.4.2	Supplemental Indenture dated December 17, 1999 to the 1992 Indenture with respect to the 7% Debentures Due December 15, 2025 issued pursuant to the 1992 Indenture (See Exhibit 4.3.2)
10.5	Exhibit 10.1 to the Company’s Form 10-Q for the period ended March 31, 1997 (Commission File No. 1-4717), The Kansas City Southern Railway Company Directors’ Deferred Fee Plan as adopted August 20, 1982 and the amendment thereto effective March 19, 1997 to such plan, is hereby incorporated by reference as Exhibit 10.5
10.6	Exhibit 10.4 to the Company’s Form 10-K for the fiscal year ended December 31, 1990 (Commission File No. 1-4717), Description of the Company’s 1991 incentive compensation plan, is hereby incorporated by reference as Exhibit 10.6
10.7	Exhibit 10.10 to the Company’s 2002 S-4 Registration Statement (Registration No. 333-92360), Directors Deferred Fee Plan, adopted August 20, 1982, amended and restated June 1, 2002, is hereby incorporated by reference as Exhibit 10.7
10.8	Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan, as amended and restated effective as of November 7, 2002 which is attached as Exhibit 10.8 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.8
10.9	Exhibit 10.8 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Tax Disaffiliation Agreement, dated October 23, 1995, by and between the Company and DST Systems, Inc., is hereby incorporated by reference as Exhibit 10.9

111

10.10.1	Kansas City Southern 401(k) and Profit Sharing Plan (Amended and Restated Effective April 1, 2002), which is attached as Exhibit 10.10.1 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.10.1
10.10.2	First Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), effective January 1, 2003, which is attached as Exhibit 10.10.2 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.10.2
10.10.3	Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), dated June 30, 2003 and effective as of January 1, 2001, is attached hereto as Exhibit 10.10.3
10.10.4	Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), dated December 3, 2003 and effective as of January 1, 2003, is attached hereto as Exhibit 10.10.4
10.11	Exhibit 10.10 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), the Assignment, Consent and Acceptance Agreement, dated August 10, 1999, by and among the Company, DST Systems, Inc. and Stilwell Financial Inc., is hereby incorporated by reference as Exhibit 10.11
10.12	Employment Agreement, as amended and restated January 1, 2001, by and among the Company, KCSR and Michael R. Haverty, which is attached as Exhibit 10.12 to the Company’s Form 10-K for the year ended December 31, 2001 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.12
10.13	Exhibit 10.14 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Employment Agreement, dated January 1, 1999, by and among the Company, KCSR and Gerald K. Davies, is hereby incorporated by reference as Exhibit 10.13
10.13.1	Amendment to Employment Agreement, dated as of January 1, 2001, by and among the Company, KCSR and Gerald K. Davies which is attached as Exhibit 10.13.1 to the Company’s Form 10-K for the year ended December 31, 2001 (Commission File No. 1-4717) is hereby incorporated by reference as Exhibit 10.13.1
10.14	Employment Agreement, dated June 1, 2002 by and among the Company, KCSR and Ronald G. Russ, which is attached as Exhibit 10.17 to the Company’s 2002 S-4 Registration Statement (Registration No. 333-92360) is hereby incorporated by reference as Exhibit 10.14
10.14.1	First Amendment to Employment Agreement, dated March 14, 2003, by and among the Company, KCSR, and Ronald G. Russ, which is attached as Exhibit 10.14.1 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.14.1
10.15	Employment Agreement, dated September 1, 2001, by and between the Company, KCSR and Jerry W. Heavin, which is attached as Exhibit 10.15 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.15
10.15.1	First Amendment to Employment Agreement, dated March 14, 2003, by and among the Company, KCSR and Jerry W. Heavin, which is attached as Exhibit 10.15.1 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.l5.1
10.16	Employment Agreement, dated August 14, 2000, by and between the Company, KCSR and Larry O. Stevenson, which is attached as Exhibit 10.16 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.16

112

10.16.1	Amendment to Employment Agreement dated January 1, 2002, by and among the Company, KCSR and Larry O. Stevenson, which is attached as Exhibit 10.16.1 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.16.1
10.16.2	Amendment to Employment Agreement, dated March 14, 2003, by and among the Company, KCSR and Larry O. Stevenson, which is attached as Exhibit 10.16.2 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.16.2
10.17	Employment Agreement (Amended and Restated January 1, 2001) by and between the Company and Louis G. Van Horn, which is attached as Exhibit 10.17 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.17
10.18	Employment Agreement dated as of February 9, 2004, by and among the Company, KCSR and Mark W. Osterberg is attached hereto as Exhibit 10.18
10.19	Exhibit 10.18 to the Company’s Form 10-K for the year ended December 31, 1998 (Commission File No. 1-4717), Kansas City Southern Industries, Inc. Executive Plan, as amended and restated effective November 17, 1998, is hereby incorporated by reference as Exhibit 10.19
10.20	The Kansas City Southern Annual Incentive Plan, which is attached as Exhibit 10.20 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.20
10.21	Amendment and Restatement Agreement dated June 12, 2002, among the Company, KCSR and the lenders named therein, together with the Amended and Restated Credit Agreement dated June 12, 2002 among the Company, KCSR and the lenders named therein attached thereto as Exhibit A, which is attached as Exhibit 10.6 to the Company’s 2002 S-4 Registration Statement (Registration No. 333-92360), is hereby incorporated by reference as Exhibit 10.21
10.21.1	Reaffirmation Agreement, dated June 12, 2002, among the Company, KCSR and JP Morgan Chase Bank, which is attached as Exhibit 10.6.1 to the Company’s 2002 S-4 Registration Statement (Registration No. 333-92360), is hereby incorporated by reference as Exhibit 10.21.1
10.21.2	Master Assignment and Acceptance, dated June 12, 2002, among the Company, KCSR and the lenders named therein, which is attached as Exhibit 10.6.2 to the Company’s 2002 S-4 Registration Statement (Registration No. 333-92360), is hereby incorporated by reference as Exhibit 10.21.2
10.21.3	The First Amendment, dated as of April 3, 2003, to the Amended and Restated Credit Agreement (as amended, supplemented or otherwise modified from time to time, the “Credit Agreement”) dated as of June 12, 2002 among the Company, KCSR, the Lenders party thereto and JP Morgan Chase Bank, which is attached as Exhibit 10.3 to the Company’s Form 10-Q for the quarter ended March 31, 2003 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.21.3
10.21.4	The Second Amendment, dated as of April 28, 2003, to the Credit Agreement, which is attached as Exhibit 10.4 to the Company’s Form 10-Q for the quarter ended March 31, 2003 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.21.3
10.22	The 2000 Indenture (See Exhibit 4.5)
10.23	Supplemental Indenture, dated as of January 29, 2001, to the 2000 Indenture (See Exhibit 4.5.1)
10.24	Exhibit 10.23 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Intercompany Agreement, dated as of August 16, 1999, between the Company and Stilwell Financial Inc., is hereby incorporated by reference as Exhibit 10.24

113

10.25	Exhibit 10.24 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Tax Disaffiliation Agreement, dated as of August 16, 1999, between the Company and Stilwell Financial Inc., is hereby incorporated by reference as Exhibit 10.25
10.26	Exhibit 10.25 to the Company’s 2001 S-4 Registration Statement (Registration No. 333- 54262), Pledge Agreement, dated as of January 11, 2000, among the Company, KCSR, the subsidiary pledgors party thereto and The Chase Manhattan Bank, as Collateral Agent (the “Pledge Agreement”), is hereby incorporated by reference as Exhibit 10.26
10.27	Exhibit 10.26 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Guarantee Agreement, dated as of January 11, 2000, among the Company, the subsidiary guarantors party thereto and The Chase Manhattan Bank, as Collateral Agent (the “Guarantee Agreement”), is hereby incorporated by reference as Exhibit 10.27
10.28	Exhibit 10.27 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Security Agreement, dated as of January 11, 2000, among the Company, KCSR, the subsidiary guarantors party thereto and The Chase Manhattan Bank, as Collateral Agent (the “Security Agreement”), is hereby incorporated by reference as Exhibit 10.28
10.29	Exhibit 10.28 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Indemnity, Subrogation and Contribution Agreement, dated as of January 11, 2000, among the Company, KCSR, the subsidiary guarantors party thereto and The Chase Manhattan Bank, as Collateral Agent (the “Indemnity, Subrogation and Contribution Agreement”), is hereby incorporated by reference as Exhibit 10.29
10.30	Exhibit 10.29 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Supplement No. 1, dated as of January 29, 2001, to the Pledge Agreement, among PABTEX GP, LLC, SIS Bulk Holding, Inc. and The Chase Manhattan Bank, as Collateral Agent, is hereby incorporated by reference as Exhibit 10.30
10.31	Exhibit 10.30 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Supplement No. 1, dated as of January 29, 2001, to the Guarantee Agreement, among PABTEX GP, LLC, SIS Bulk Holding, Inc. and The Chase Manhattan Bank, as Collateral Agent, is hereby incorporated by reference as Exhibit 10.31
10.32	Exhibit 10.31 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Supplement No. 1, dated as of January 29, 2001, to the Security Agreement, among PABTEX GP, LLC, SIS Bulk Holding, Inc. and The Chase Manhattan Bank, as Collateral Agent, is hereby incorporated by reference as Exhibit 10.32
10.33	Exhibit 10.32 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Supplement No. 1, dated as of January 29, 2001, to the Indemnity, Subrogation and Contribution Agreement, among PABTEX GP, LLC, SIS Bulk Holding, Inc. and The Chase Manhattan Bank, as Collateral Agent, is hereby incorporated by reference as Exhibit 10.33
10.34	Lease Agreement, as amended, between The Kansas City Southern Railway Company and Broadway Square Partners LLP dated June 26, 2001, which is attached as Exhibit 10.34 to the Company’s Form 10-K for the year ended December 31, 2001 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.34
10.35	The 2002 Indenture (See Exhibit 4.8)
10.36	Agreement to Forego Compensation between A. Edward Allinson and the Company, fully executed on March 30, 2001; Loan Agreement between A. Edward Allinson and the Company fully executed on September 18, 2001; and the Promissory Note executed by the Trustees of The A. Edward Allinson Irrevocable Trust Agreement dated, June 4, 2001, Courtney Ann Arnot, A. Edward Allinson III and Bradford J. Allinson, Trustees, as Maker, and the Company, as Holder, which are attached as Exhibit 10.36 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), are hereby incorporated by reference as Exhibit 10.36

114

10.37	Agreement to Forego Compensation between Michael G. Fitt and the Company, fully executed on March 30, 2001; Loan Agreement between Michael G. Fitt and the Company, fully executed on September 7, 2001; and the Promissory Note executed by the Trustees of The Michael G. and Doreen E. Fitt Irrevocable Insurance Trust, Anne E. Skyes, Colin M-D. Fitt and Ian D.G. Fitt, Trustees, as Maker, and the Company, as Holder, which are attached as Exhibit 10.37 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), are hereby incorporated by reference as Exhibit 10.37
10.38.1	Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), which is attached as Exhibit 10.38 to the Company’s Form 10-K for the year ended December 31, 2002 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.38
10.38.2	Amendment to the Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), dated June 30, 2003 and effective as of January 1, 2001, is attached hereto as Exhibit 10.38.2
10.38.3	Amendment to the Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), dated December 3, 2003 and effective as of January 1, 2003, is attached hereto as Exhibit 10.38.3
10.39	Placement Agreement dated April 29, 2003 by and among the Company, Morgan Stanley & Co. Incorporated and Deutsche Bank Securities Inc., which is attached as Exhibit 10 to the Company’s Form 10-Q for the quarter ended June 30, 2003, is hereby incorporated by reference as Exhibit 10.39

(11) Statement Re Computation of Per Share Earnings

(Inapplicable)

(12) Statements Re Computation of Ratios

12.1 The Computation of Ratio of Earnings to Fixed Charges prepared pursuant to Item 601(b)(12) of Regulation S-K is attached to this Form 10-K as Exhibit 12.1

(13) Annual Report to Security Holders, Form 10-Q or Quarterly Report to Security Holders

(Inapplicable)

(16) Letter Re Change in Certifying Accountant

(Inapplicable)

(18) Letter Re: Change in Accounting Principles

(Inapplicable)

(21) Subsidiaries of the Company

21.1 The list of the Subsidiaries of the Company prepared pursuant to Item 601(b)(21) of Regulation S-K is attached to this Form 10-K as Exhibit 21.1

(22) Published Report Regarding Matters Submitted to Vote of Security Holders

(Inapplicable)

115

(23) Consents of Experts and Counsel

23.1 The Consents of Independent Accountants prepared pursuant to Item 601(b)(23) of Regulation S-K are attached to this Form 10-K as Exhibit 23.1

(24) Power of Attorney

(Inapplicable)

(31) Rule 13a-14(a)/15d-14(a) Certifications

31.1	Certification of Michael R. Haverty, Chief Executive Officer of the Company, is attached hereto as Exhibit 31.1
31.2	Certification of Ronald G. Russ, Chief Financial Officer of the Company, is attached hereto as Exhibit 31.2

(32) Section 1350 Certifications

32.1 Certification Pursuant to 18 U.S.C. Section 1350 of Michael R. Haverty, Chief Executive Officer of the Company, and Ronald G. Russ, Chief Financial Officer of the Company, is attached hereto as Exhibit 32

(99) Additional Exhibits

99.1 The combined and consolidated financial statements of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (including the notes thereto and the Report of Independent Accountants thereon) as of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003 as listed under Item 15(a)(2) herein, are hereby included in this Form 10-K as Exhibit 99.1

(b) Reports on Form 8-K

The Company furnished a Current Report on Form 8-K, dated October 8, 2003, under Items 7 and 9 of such form, reporting the announcement of the date, time and other relevant information regarding the Company’s third quarter presentation and conference call of its financial results for the three and nine months ended September 30, 2003.

The Company furnished a Current Report on Form 8-K, dated October 9, 2003, under Items 7 and 9 of such form, reporting the announcement that it accepted the decision of the Surface Transportation Board to suspend the procedural schedule involving KCS’s request to gain regulatory approval of the control of The Texas-Mexican Railway Company, a wholly owned subsidiary of Mexrail, Inc.

The Company filed a Current Report on Form 8-K, dated October 23, 2003, under Items 5 and 7 of such form, reporting the announcement that Chancellor William B. Chandler III of the Court of Chancery of the State of Delaware had, in a ruling from the bench, stated his intention to grant KCS’s motion seeking a preliminary injunction to preserve the status quo pending resolution of KCS’s dispute with Grupo TMM, S.A., and its subsidiaries TMM Holdings, S.A. de C.V. and TMM Multimodal, S.A. de C.V.

The Company furnished a Current Report on Form 8-K, dated October 27, 2003, under Items 7 and 9 of such form, reporting the announcement that its registration statement on Form S-3 relating to the resale of its 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C, and the underlying common stock, by the selling security holders of these securities had been declared effective by the Securities and Exchange Commission.

The Company furnished a Current Report on Form 8-K, dated November 3, 2003, under Items 7 and 12 of such form, reporting the announcement of KCS’s third quarter and year to date 2003 earnings and operating results.

116

The Company furnished a Current Report on Form 8-K, dated December 16, 2003, under Items 7 and 9 of such form, reporting pro forma financial information of the Company that was included in the Post-Effective Amendment No. 3 to the Company’s registration statement on Form S-3 filed December 16, 2003 (“Post-Effective Amendment No. 3”) and included Pro Forma Condensed Consolidated Balance Sheet As of September 30, 2003, Pro Forma Condensed Consolidated Income Statement for the Six Months Ended June 30, 2003 and Pro Forma Condensed Consolidated Income Statement for the Year Ended December 31, 2002. The Company also furnished information included in the Post-Effective Amendment No. 3 relating to the Company’s Computation of Ratio of Earnings to Fixed Charges.

The Company furnished a Current Report on Form 8-K/A dated December 19, 2003, under Items 7 and 9 of such form, to amend the Company’s Current Report on Form 8-K filed on December 17, 2003, and Exhibit 99.1 thereto, which contained a clerical error in labeling the Pro Forma Condensed Consolidated Income Statement for the Six Months Ended June 30, 2003 (rather than the Nine Months Ended September 30, 2003).

117

SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) 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.

KANSAS CITY SOUTHERN
By:	/s/    M.R. HAVERTY
	M.R. Haverty Chairman, President, Chief Executive Officer and Director

March 29, 2004

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated on March 29, 2004.

Signature	Capacity
/S/    M.R. HAVERTY         M.R. Haverty	Chairman, President, Chief Executive Officer and Director
/S/    G.K. DAVIES         G.K. Davies	Executive Vice President and Chief Operating Officer
/S/    R.G. RUSS         R.G. Russ	Executive Vice President and Chief Financial Officer (Principal Financial Officer)
/S/    M.W. OSTERBERG         M.W. Osterberg	Vice President and Comptroller (Principal Accounting Officer)
/S/    A.E. ALLINSON         A.E. Allinson	Director
/S/    M.G. FITT         M.G. Fitt	Director
/S/    J.R. JONES         J.R. Jones	Director
/S/    T.A. MCDONNELL         T.A. McDonnell	Director
/S/    K.L. PLETZ         K.L. Pletz	Director
L.H. Rowland	Director
/S/    R.E. SLATER         R.E. Slater	Director
/S/    B.G. THOMPSON         B.G. Thompson	Director

118

KANSAS CITY SOUTHERN

2003 FORM 10-K ANNUAL REPORT

INDEX TO EXHIBITS

Exhibit No.	Document	Regulation S-K Item 601(b) Exhibit No.
3.2	The By-Laws of Kansas City Southern, as amended and restated to March 8, 2004	3
10.10.3	Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), dated June 30, 2003 and effective as of January 1, 2001	10
10.10.4	Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), dated December 3, 2003 and effective as of January 1, 2001	10
10.18	Employment Agreement dated as of February 9, 2004 by and among the Company, KCSR and Mark W. Osterberg	10
10.38.2	Amendment to the Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), dated June 30, 2003 and effective as of January 1, 2001	10
10.38.3	Amendment to the Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), dated December 3, 2003 and effective as of January 1, 2003	10
12.1	Computation of Ratio of Earnings to Fixed Charges	12
21.1	Subsidiaries of the Company	21
23.1	Consents of Independent Accountants	23
31.1	Certification Pursuant to 18 U.S.C. Section 1350, As Adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002—Michael R. Haverty	31
31.2	Certification Pursuant to 18 U.S.C. Section 1350, As Adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002—Ronald G. Russ	31
32.1	Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002—Michael R. Haverty and Ronald G. Russ	32
99.1	Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. combined and consolidated financial statements as of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003	99

119

EX-3.2

Exhibit 3.2

BY-LAWS

OF

KANSAS CITY SOUTHERN

INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE

As amended and restated to March 8, 2004

ARTICLE I

MEETINGS OF STOCKHOLDERS

Section 1. Place of Meetings. Meetings of stockholders for any purpose may be held at such time and place, within or without the State of Delaware, as shall be designated by the Board of Directors and stated in the notice of the meeting.

Section 2. Annual Meetings. The annual meeting of the stockholders, at which they shall elect directors and transact such other business as may properly be brought before the meeting, shall be held on the first Thursday of May in each year unless the Board of Directors shall designate some other date therefor in April through September.

To be properly brought before the meeting, business must be either (i) specified in the notice of the meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (ii) otherwise properly brought before the meeting by or at the direction of the Board of Directors, or (iii) otherwise properly brought before the meeting by a stockholder. In addition to any other applicable requirements, for business to be properly brought before the meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, such a stockholder’s notice must be delivered to or mailed and received at the principal executive offices of the Corporation, not less than 45 days nor more than 90 days prior to the meeting; provided, however, that in the event that the meeting is designated by the Board of Directors to be held at a date other than the first Thursday in May and less than 60 days’ notice or prior public disclosure of the date of the meeting is given or made to stockholders, to be timely, the notice by the stockholder must be so received not later than the close of business on the 15th day following the day on which such notice of the date of the meeting was mailed or such public disclosure was made, whichever first occurs. A stockholder’s notice to the Secretary shall set forth as to each matter the stockholder proposes to bring before the meeting (i) a brief description of the business desired to be brought before the meeting and the reasons for conducting such business at the meeting, (ii) the name and address of the stockholder proposing such business, (iii) the class and number of shares of capital stock of the Corporation which are beneficially owned by the stockholder and the name and address of record under which such stock is held and (iv) any material interest of the stockholder in such business.

Notwithstanding anything in these By-Laws to the contrary, no business shall be conducted at the annual meeting except in accordance with the procedures set forth in this Section 2 of Article I; provided, however, that nothing in this Section 2 of Article I shall be deemed to preclude discussion by any stockholder of any business properly brought before the annual meeting.

The Chairman of the annual meeting shall have the power to determine whether or not business was properly brought before the meeting in accordance with the provisions of this Section 2 of Article I, and, if the Chairman should determine that any such business was not properly brought before the meeting, the Chairman shall so declare to the meeting and any such business shall not be transacted.

Section 3. Notice of Annual Meetings. Written notice of each annual meeting of the stockholders stating the place, day and hour of the meeting, shall be given to each stockholder entitled to vote thereat, at least ten (10) days before the date of the meeting.

Section 4. Quorum. Except as otherwise required by statute, by the Certificate of Incorporation or by these By-Laws, the presence, in person or by proxy, of stockholders holding a majority in number of shares of the stock issued and outstanding and entitled to vote, shall constitute a quorum at all meetings of the stockholders. If, at any such meeting, such quorum shall not be present or represented, the stockholders present in person or by proxy shall have power to adjourn the meeting from time to time without notice other than announcement at the meeting until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present in person or by proxy, any business may be transacted which might have been transacted at the meeting as originally noticed.

Section 5. Voting. Each holder of shares of common stock and preferred stock shall be entitled to vote on the basis of one vote for each voting share held by him, except as provided in the Certificate of Incorporation and except that in elections for directors when the holders of the preferred stock do not have the right, voting as a class, to elect two directors, each holder of voting shares shall be entitled to as many votes as shall equal the number of shares which he is entitled to vote, multiplied by the number of directors to be elected and he may cast all of such votes for a single director or may distribute them among the number to be voted for, or any two or more of them, as he may see fit.

Section 6. List of Stockholders Entitled to Vote. The Board of Directors shall cause the officer who has charge of the stock ledger of the corporation to prepare and make, at least ten (10) days before every election of directors, a complete list of the stockholders entitled to vote at said election, arranged in alphabetical order, showing the address of and the number of shares of common stock and preferred stock registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the election, either at a place within the city where the election is to be held, and which place be specified, at the place where said meeting, or, if not specified, at the place where said meeting is to be held, and the list shall be produced and kept at the time and place of election during the whole time thereof, and subject to the inspection of any stockholder who may be present.

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Section 7. Inspectors. For each meeting of stockholders there may be appointed by the Board of Directors or by the Chairman of the meeting three (3) inspectors of election. If any inspector shall fail or be unable to serve as inspector or for any reason be unable to complete his duties, an alternate inspector shall be appointed by the Board of Directors or the Chairman of the meeting. The inspectors of election shall examine and canvass the proxies and ballots, and make and submit a signed report of the votes cast at the meeting, which shall be entered at large upon the records.

Section 8. Inspectors’ Oath. An inspector, before he enters on the duties of his office, shall take and subscribe an oath substantially in the following form before any officer authorized by law to administer oaths:

“I do solemnly swear that I will execute the duties of an inspector of the election now to be held with strict impartiality and according to the best of my ability.”

Section 9. Special Meeting. Special meetings of the stockholders for any purpose or purposes may be called at any time by the Chairman of the Board of Directors, the Chief Executive Officer or the President, or at the request in writing of a majority of the Board of Directors, by giving ten (10) days written notice thereof to the stockholders. Business transacted at any special meeting of the stockholders shall be limited to the purpose stated in the notice.

Section 10. Organization. The Chairman of the Board of Directors, and in his absence the Chief Executive Officer, the President or one of the Vice Presidents, shall call meetings of the stockholders to order and act as Chairman of such meeting. In the absence of all these officers, the Board of Directors may appoint a Chairman of the meeting. The Secretary of the Corporation shall act as secretary at all meetings of the shareholders; but the Board of Directors may designate an Assistant Secretary for that purpose before the meeting and, if no such designation shall have been made, then such designation may be made by the Chairman of the meeting. The conduct of any meeting of the stockholders shall be governed by such rules, regulations and procedures as the Chairman of the meeting, in his sole and exclusive discretion shall determine.

Section 11. Stockholder Nomination of Directors.

(a) Any stockholder who meets the requirements of this section may submit a director candidate nomination for consideration by the Nominating and Corporate Governance Committee by complying with the requirements of this section, including: (i) the nomination must be made for an election to be held at a meeting of stockholders at which directors are otherwise to be elected; (ii) the stockholder must be a record owner on the record date for that meeting, and at the meeting, of securities representing at least two percent (2%) of the securities entitled to be voted at the meeting for election of directors; (iii) the stockholder must deliver a timely written nomination notice to the office of the Corporate Secretary, providing the information required by this section; and (iv) the nominee must meet the minimum qualifications for Directors established by the Board.

(b) To be timely for an annual meeting, a stockholder’s nomination notice must be received by the Corporate Secretary’s office not later than the 90^th day, nor earlier than

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the 150^th day prior to the first anniversary of the preceding year’s annual meeting; provided, however, that if the date of the annual meeting is to be more than 30 days before, or more than 60 days after, such anniversary date, notice by the stockholder to be timely must be delivered not earlier than the 150^th day prior to such annual meeting and not later than the 15^th day following the day on which public announcement of the date of such annual meeting was first made by the Corporation.

(c) To be timely for a special stockholders’ meeting at which directors will be elected, a stockholder’s nomination notice must be received by the Corporate Secretary’s office not later than the close of business on the 15^th day following the day on which the Corporation shall first publicly announce the date of the special meeting.

(d) For purposes of these Bylaws, “public announcement” shall mean disclosure (i) in any press release distributed by the Corporation, (ii) published by the Corporation on its website or (iii) included in a document publicly filed by the Corporation with the Securities and Exchange Commission.

(e) The stockholder’s nomination notice shall include as to each person whom the stockholder proposes to nominate (i) all information relating to such person as shall be required to be disclosed in solicitations of proxies for election of directors, or as otherwise required, pursuant to applicable rules of the Securities and Exchange Commission or the New York Stock Exchange; (ii) the nominee’s written consent to be named in the proxy statement, to serve as a director and to comply with the Corporation’s rules, guidelines and policies applicable to Directors; (iii) the name and address of the stockholder and the telephone number(s) at which the Corporation will be able to reach the stockholder and the nominee during normal business hours; (iv) the class and number of shares of the Corporation which are owned beneficially and of record by the stockholder; (v) a fully completed Director’s Questionnaire on the form supplied by the Corporation, executed by the nominee; and (vi) such other information as the Nominating and Corporate Governance Committee shall reasonably deem relevant, to be provided within such time limits as shall reasonably be imposed by the Nominating and Corporate Governance Committee.

(f) Notwithstanding the foregoing, or anything else in these Bylaws to the contrary no nominee from a stockholder will be considered who was previously submitted for election to the Board of Directors and failed to receive at least 25% of the votes cast at such election, until a period of three years has passed from the date of such election.

ARTICLE II

BOARD OF DIRECTORS

Section 1. General Powers. The general management of the business and affairs and all the corporate powers of the Corporation shall be vested in and exercised by its Board of Directors which shall exercise all of the powers of the Corporation except such as are by statute, or by the Certificate of Incorporation or by these By-Laws, conferred upon or reserved to the stockholders. The directors shall act only as a Board and the individual directors shall have no power as such.

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Section 2. Number, Term and Qualifications. The number of directors shall not be less than three nor more than eighteen, the exact number of directors to be determined from time to time by resolution adopted by a majority of the whole Board, and such exact number shall be eighteen until otherwise determined by resolution adopted by a majority of the whole Board. Directors need not be stockholders.

The Board of Directors shall be divided into three classes as nearly equal in number as possible. At each annual meeting of stockholders, successors to directors of the class whose terms then expire shall be elected to hold office for a term expiring at the third succeeding annual meeting of stockholders. When the number of directors is changed, any newly created directorships or any decrease in directorships shall be so apportioned among the classes as to make all classes as nearly equal in number as possible. Notwithstanding the foregoing, whenever the holders of the preferred stock shall have the right, voting as a class, to elect two directors at the next annual meeting of stockholders, the terms of all directors shall expire at the next annual meeting of stockholders, and then and thereafter all directors shall be elected for a term of one year expiring at the succeeding annual meeting.

From and after January 19, 1990, no person who has attained the age of 72 shall be eligible to be nominated or to serve as a member of the Board of Directors, but any person who shall attain the age of 72 during the term of directorship to which he was elected shall be eligible to serve the remainder of such term; provided, however, that any person, regardless of age, who, on January 19, 1990, is an incumbent director, shall be eligible to be nominated for election and to serve one (1) additional term.

Section 3. Election of Directors. Directors shall be elected at the annual meetings of stockholders by ballot in the manner provided in these By-Laws and the Certificate of Incorporation.

Section 4. Newly Created Directorships and Vacancies. Newly created directorships and vacancies which shall occur in the Board of Directors because of death, resignation, disqualification or any other cause, may be filled by a majority of the directors then in office, though less than a quorum, pursuant to Section 223 of the General Corporation Law of Delaware. Such directors may, by resolution, eliminate any vacant directorship thereby reducing the size of the whole Board of Directors but in no event shall the size of the Board of Directors be reduced to less than three directors. No decrease in the Board of Directors shall shorten the term of any incumbent directors.

Section 5. Resignations. Any director of the Corporation may resign at any time by giving written notice to the President or to the Secretary of the Corporation. Such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein. Unless otherwise provided therein, the acceptance of such resignation shall not be necessary to make it effective.

Section 6. Organization. The Board of Directors shall hold its organizational meeting as soon as practicable after the Annual Meeting of Stockholders. The Chairman of the Board of Directors, or in his absence the President, shall preside at all meetings of the Board of Directors.

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Section 7. Place of Meetings. The Board of Directors may hold its meetings, both regular and special, at such place or places, within or without the State of Delaware as determined by the Board of Directors.

Section 8. Regular Meetings. Regular meetings of the Board of Directors may be held without notice at such times and at such places as shall from time to time be determined by the Board of Directors.

Section 9. Special Meetings. Special meetings of the Board of Directors may be called at the request of the Chairman of the Board of Directors, the Executive Committee, or of the President, or of any three members of the Board of Directors. Notice of the time and place of such meeting shall be given either by mail to each director at least three (3) days before such meeting or personally, by telephone, or by telegram to each director at least twelve (12) hours before such meeting.

Section 10. Quorum. A majority of the Board of Directors at a meeting duly assembled shall be necessary to constitute a quorum for the transaction of business except as otherwise provided by statute, by the Certificate of Incorporation or by these By-Laws. The act of a majority of the directors present at a meeting at which a quorum is present shall be the act of the Board of Directors. In the absence of a quorum, a majority of the directors present may adjourn the meeting from time to time until a quorum be present, without notice other than by announcement at the meeting.

Section 11. Report to Stockholders. The President and Board of Directors shall make a report or statement of the affairs of the Corporation at each regular annual meeting of the stockholders subsequent to the first annual meeting.

Section 12. Compensation. The directors may receive reasonable fees to be determined from time to time by the Board of Directors for services actually performed in attending meetings and for other services actually performed and the expenses of attendance, if any, may be allowed for attendance at each regular or special meeting of the Board of Directors. A director who is, at the same time, an officer or employee of the Corporation or of any subsidiary or affiliate, shall not be entitled to receive any compensation or fee for service as a director or as a member of any committee of the Board of Directors.

Section 13. Consent of Directors in Lieu of Meeting. Unless otherwise restricted by the Certificate of Incorporation or By-Laws, any action required or permitted to be taken at any meeting of the Board of Directors, or of any committee thereof, may be taken without a meeting if all members of the Board or Directors or Committee, as the case may be, consent thereto in writing and the writing or writings are filed with the minutes of proceedings of the Board of Directors or Committee.

ARTICLE III

COMMITTEES

Section 1. Executive Committee: Organization and Powers. There shall be an Executive Committee to consist of the Chairman of the Board of Directors, the Chief Executive

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Officer and two (2) or more non-officer directors, the number of which being fixed from time to time by resolution adopted by a majority vote of the whole Board of Directors. The Board of Directors shall elect the members of the Executive Committee by vote of a majority of the whole Board of Directors and one member of the Executive Committee shall be elected as Chairman by the vote of a majority of the whole Board of Directors. The members of the Executive Committee shall be elected annually at the Board’s organizational meeting or as soon as thereafter as possible.

When the Board of Directors is not in session, the Executive Committee shall have and may exercise all the powers of the Board of Directors in the management of the business and affairs of the Corporation in all cases in which specific directions shall not have been given by the Board of Directors including, but not limited to, the power to declare dividends on the common and preferred stock of the Corporation, and to authorize the seal of the Corporation to be affixed to all papers which may require it. The members of the Executive Committee shall act only as a committee and individual members shall have no power as such.

Section 2. Compensation and Organization Committee: Organization and Powers. There shall be a Compensation and Organization Committee to consist of three (3) or more non-employee directors, the number of which being fixed from time to time by resolution adopted by a majority vote of the whole Board of Directors, a majority of whom shall be a “disinterested person” within the meaning ascribed thereto under Rule 16b-3 promulgated under the Securities Exchange Act of 1934 as amended from time to time and interpreted by the Securities and Exchange Commission. The Board of Directors shall elect the members of the Compensation and Organization Committee by vote of a majority of the whole Board of Directors, and one member of the Compensation and Organization Committee shall be elected its Chairman by the vote of a majority of the whole Board of Directors. The members of the Compensation and Organization committee shall be elected annually at the Board’s organizational meeting or as soon thereafter as possible.

The Compensation and Organization Committee shall have the power: to authorize and determine all salaries for the officers and supervisory employees of the Corporation and subsidiary companies as may be prescribed from time to time by resolution adopted by the Board of Directors; to administer the incentive compensation plans of the Corporation, The Kansas City Southern Railway Company and the other subsidiaries of the Corporation in accordance with the powers and authority granted in such plans; and to determine any incentive allowances to be made to officers and staff of the Corporation and its subsidiaries. The Compensation and Organization Committee shall have the power to administer the Employee Stock Purchase Plan of the Corporation under which eligible employees of the Corporation and its subsidiaries and affiliates are permitted to subscribe to and to purchase shares of the Corporation common stock through payroll deductions.

The Compensation and Organization Committee shall have full power: to act as the Stock Option Plan Committee to construe and interpret any stock option plan or similar plan of the Corporation and all options, stock appreciation rights and limited rights granted under this plan or any other plan; to determine the terms and provisions of the respective option agreements, including such terms and provisions as, in the judgement of the Committee, are necessary or desirable to qualify any of the options as “incentive stock options”; to establish and amend rules for its administration; to grant options, stock appreciation rights and limited rights under any stock option plan of the Corporation; to determine and designate the

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recipients of options, stock appreciation rights and limited rights; to determine and designate the dates that options, stock appreciation rights and limited rights are granted; to determine and designate the number of shares subject to options, stock appreciation rights and limited rights; to determine and designate the option prices and option periods; and to correct any defect or supply any omission or reconcile any inconsistency in any stock option plan of the Corporation or in any option, stock appreciation right or limited right to the extent the Committee deems desirable to carry any stock option plan or any option, stock appreciation right or limited right into effect.

The Compensation and Organization Committee shall also have the power: to review the consolidated earnings of the Corporation and to make recommendations to the Board of Directors with respect to the allocation of funds to the Corporation’s Profit Sharing Plan; and to review the results of the investment program of the Profit Sharing Plan and make reports thereof to the Board of Directors.

The Compensation and Organization Committee shall also have the power and duty to initiate, review and approve succession plans and major organizational plans and changes within the Corporation and its subsidiaries.

Section 3. Audit Committee: Organization and Powers. There shall be an Audit Committee to consist of three (3) or more non-officer directors, the number of which being fixed from time to time by resolution adopted by a majority vote of the whole Board of Directors. The Board of Directors shall elect the members of the Audit Committee by vote of a majority of the whole Board of Directors and one member of the Audit Committee shall be elected as Chairman by a vote of a majority of the whole Board of Directors. The members of the Audit Committee shall be appointed by the Board of Directors to serve staggered three-year terms.

The Audit Committee shall have the power and the duty to meet with and consider suggestions from members of management and of the Corporation’s internal audit staff, as well as with the Corporation’s independent accountants, concerning the financial operations of the Corporation. The Audit Committee shall additionally have the power to review audited financial statements of the Corporation and consider and recommend the employment of, and approve the fee arrangement with, independent accountants for both audit functions and for advisory and other consulting services.

Section 4. Nominating and Corporate Governance Committee: Organization and Powers. There shall be a Nominating and Corporate Governance Committee consisting of three (3) or more directors, the number of which being fixed from time to time by resolution adopted by a majority vote of the whole Board of Directors. Each member of this Committee shall be affirmatively determined by a majority vote of the whole Board of Directors to qualify as independent under the New York Stock Exchange listing standards then in effect. The members of the Nominating and Corporate Governance Committee shall be elected and vacancies filled by the vote of a majority of the whole Board of Directors, and one member of the Nominating and Corporate Governance Committee shall be elected its Chairman by the vote of a majority of the whole Board of Directors. The members of the Nominating and Corporate Governance Committee shall be elected by the Board of Directors to serve staggered three-year terms.

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The primary purposes of this Committee shall be to (i) identify and recommend to the Board of Directors qualified nominees for election to the Board of Directors (whether for election by the stockholders or by the Board of Directors) and (ii) to advise the Board of Directors with respect to the establishment, implementation and evaluation of corporate governance guidelines applicable to the Company. The Committee shall prepare and present to the Board of Directors for approval a written charter setting forth in more detail the duties and responsibilities of the Committee.

Section 5. Rules, Records and Reports. The Committees may make and adopt such rules and regulations governing their proceedings as they may deem proper and which are consistent with the statutes of the State of Delaware, the Certificate of Incorporation and By-Laws. The committees shall keep a full and accurate record of all their acts and proceedings and report the same from time to time to the Board of Directors.

Section 6. Meetings. Regular meetings of the committees shall be held at such times and at such places as from time to time may be fixed by the committees. Special meetings of the committees may be held at such other times as may in the judgement of the Chairman or, he being absent, in the judgement of a member, be necessary. Notice of regular meetings need not be given. Notice of special meetings shall be given to each member by mail not less than three (3) days before the meeting or personally, by telephone or telegram to each member not less than twelve (12) hours before the meeting, unless the Chairman of the committee, or a member acting in that capacity in his absence, shall deem a shorter notice expedient.

Section 7. Quorum. A majority of members of a committee shall constitute a quorum for the transaction of business and the act of a majority of those present shall be the act of the committee (except with respect to the Compensation and Organization Committee, in which any act of the Compensation and Organization Committee when acting as the Stock Option Plan Committee under any stock option plan, must be authorized and approved by at least (3) members).

Section 8. Subcommittees. A committee may appoint such subcommittees as it shall deem necessary.

Section 9. Vacancies. Any vacancy in a committee shall be filled by a majority of the whole Board of Directors.

Section 10. Substitute Members. Whenever at any time a member of any committee shall be absent from a meeting of that committee and it shall be necessary in order to constitute a quorum or, for other reason, it may be deemed expedient or desirable, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously designate a director (subject to the eligibility requirements set forth in Sections 2, 3, and 4 above) to serve and act in his stead; and in the event that the absence of a committee member shall be prolonged, such substitute member may, subject to the approval of the committee, continue to act for the term of its duration. A director so designated shall rank as a duly qualified member of the committee during incumbency, and shall be entitled to participate in its deliberations with the same force and effect as if elected in the manner herein elsewhere provided.

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Section 11. Compensation. Subject to the provisions of Section 12 of Article II of these By-Laws, each member of any committee may receive a reasonable fee to be fixed by the Board of Directors for services actually performed in attending meetings, and for other services actually performed, and shall receive expenses of attendance, if any actually incurred by him for attendance at any meeting of the committee.

ARTICLE IV

OFFICERS, AGENTS AND EMPLOYEES

Section 1. Election of Officers. The Board of Directors at its annual organizational meeting, shall elect a Chairman of the Board of Directors and President of the Corporation, who shall be a member of the Board of Directors. The Board of Directors may elect a Chief Executive Officer and a Chief Operating Officer, and the Chief Executive Officer shall be a member of the Board of Directors.

Section 2. Vice Presidents. The Board of Directors may, in its discretion, appoint an Executive Vice President and one or more additional Vice Presidents.

Section 3. Other Officers. The Board of Directors shall appoint a Secretary, a Treasurer, a General Counsel and Comptroller. The Board of Directors may also appoint one or more Assistant Secretaries, and one or more Assistant Treasurers.

Section 4. Powers, Duties and Responsibilities. The powers, duties and responsibilities of the officers and employees of the Corporation, which are not prescribed by statute, by the Certificate of Incorporation or by these By-Laws, shall be defined in rules or regulations which may be adopted and from time to time modified or changed by the Board of Directors.

Section 5. Vacancies. The Board of Directors shall, as soon as practicable, fill any vacancy in the office of Chairman of the Board of Directors or President. Any vacancy in any other office may be filled temporarily by the Chairman of the Board of Directors or the President. In case of temporary incapacity or absence of any of the officers, the Chairman of the Board of Directors, or the President, may make an appointment pro tem and confer on such appointee full power and authority to act in place of any of said officers or appointees so temporarily incapacitated or absent; but such appointment shall be subject to change by the Board of Directors or by the Executive Committee at any regular or special meeting.

Section 6. Absence from Duty. No officer or employee of the Corporation shall be absent from duty without the consent of the President or the head of the department in which he is employed.

Section 7. Resignations. Any officer may resign at any time giving written notice to the President or to the Secretary of the Corporation. Such resignation shall take effect at the date of the receipt of such notice, or at any later time specified therein and, unless otherwise provided therein, the acceptance of such resignation shall not be necessary to make it effective.

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Section 8. Removals. All officers and agents of the Corporation shall be subject to removal at any time by the affirmative vote of a majority of the members of the Board of Directors present at any meeting. All officers and employees not appointed by the Board of Directors shall hold their offices at the discretion of the Executive Committee or of the officer appointing them.

Section 9. Term of Office. The officers of the Corporation shall hold office for one year and until their successors shall have been duly elected or appointed and qualified, or until they shall die, resign or be removed.

Section 10. Salaries. The salaries of officers elected or appointed by the Board of Directors or by the Executive Committee, shall be fixed by the Compensation and Organization Committee. The salaries of all other officers and employees shall be fixed by the President, or by the heads of departments subject to the approval of the President; and the compensation of all officers and employees shall be subject to the control of the Board of Directors or of the Compensation and Organization Committee.

No special compensation shall be paid to any officer or employee unless authorized by the Board of Directors, the Executive Committee or the Compensation and Organization Committee.

CHAIRMAN OF THE BOARD OF DIRECTORS

Section 11. Duties. The Chairman of the Board of Directors shall preside at all meetings of the Stockholders and the Board of Directors at which he is present and perform such other duties as the Board of Directors may prescribe. In his absence, the President shall discharge the duties of the Chairman of the Board of Directors.

CHAIRMAN OF THE EXECUTIVE COMMITTEE

Section 12. Duties. The Chairman of the Executive Committee shall preside at all meetings of the Executive Committee. In the absence of the Chairman of the Executive Committee, his duties shall be discharged by the President.

PRESIDENT

Section 13. General Powers and Duties. The President shall have the general care, supervision and control of the Corporation’s business and operation in all departments under control of the Board of Directors. The President shall have such other powers and perform such other duties as the Board of Directors may from time to time prescribe and shall perform such other duties as are incidental to the office of President. In the absence or incapacity of the Chairman of the Board of Directors, he shall preside at all meetings of the Board of Directors and stockholders.

Section 14. Appointments. Except as otherwise provided by statute, the Certificate of Incorporation, or these By-Laws, the President may appoint such additional officers and may employ such persons as he shall deem necessary for the proper management of the business and property of the Corporation.

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VICE PRESIDENTS

Section 15. Powers and Duties. The Vice Presidents shall have such powers and perform such duties as shall from time to time be conferred and prescribed by the Board of Directors or by the Executive Committee. The Executive Vice President shall, however, be the ranking officer in the affairs of the Corporation next below the President.

SECRETARY

Section 16. Duties. The Secretary, or, in his absence, an Assistant Secretary, shall attend all meetings of the stockholders, of the Board of Directors and of the Executive Committee, and shall record their proceedings. He shall report to the Board of Directors and the Executive Committee and through the respective Chairman.

Section 17. Notice of Meetings. The Secretary shall give due notice of all meetings of the stockholders and of the Board of Directors and of the Executive Committee, where such notice is required by law, by the Certificate of Incorporation, by these By-Laws, by the Board of Directors or by the Executive Committee.

Section 18. Custody of Seal, Etc. The Secretary shall be custodian of the seal of the Corporation and of its records, and of such papers and documents as may be committed to his care by the Board of Directors or of the Executive Committee. He shall have power to affix the seal of the Corporation to instruments to which the same is authorized to be affixed by the Board of Directors or by the Executive Committee, and shall have power to attest the same. He shall perform such other duties as may be assigned to him by the Chairman of the Board of Directors, the President, the Board of Directors or the Executive Committee, or as may be prescribed in the rules or regulations to be adopted by the Board of Directors.

Section 19. Duties of Assistant Secretaries. The Assistant Secretary or Secretaries shall perform such duties as may be assigned to him or them by the Board of Directors or by the Executive Committee or the President, or as may be prescribed in the rules or regulations, if any, to be adopted by the Board of Directors or the Executive Committee; and, when authorized by the Board of Directors or by the Executive Committee, he or they shall have the power to affix the corporate seal to instruments and to attest the same, and to sign the certificates of stock of the Corporation.

TREASURER

Section 20. Duties. The Treasurer, either in person or through competent and faithful assistants, shall receive, keep and disburse all moneys, belonging or coming to the Corporation; he shall keep regular, true and full accounts of all receipts and disbursements, and make detailed reports of the same to the President, to the Board of Directors or to the Executive Committee, through the Chairman of said Board of Directors or Committee, as and when required.

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Section 21. Other Duties. The Treasurer shall perform such other duties in connection with the administration of the financial affairs of the Corporation as the Board of Directors or the Executive Committee shall assign to him or as may be prescribed in the rules or regulations to be adopted by the Board of Directors or the Executive Committee. The Treasurer shall give bond in such amount as shall be required by the Board of Directors or by the Executive Committee. Any Assistant Treasurer appointed pursuant to the provisions of these By-Laws shall also give bond in such amount as shall be required by the Board of Directors or by the Executive Committee.

GENERAL COUNSEL

Section 22. Duties. The General Counsel shall render such legal services and perform such duties as the Board of Directors, Executive Committee, Chairman of the Board of Directors, President or other elected or appointed officer may request from time to time.

COMPTROLLER

Section 23. Duties. The Comptroller shall have charge of the Accounting Department. He shall have the supervision and management of all accounts of the Corporation, and shall prescribe, enforce and maintain the system of bookkeeping, and the books, blanks, etc., for keeping the accounts of the Corporation. He shall have the cooperation of all departments. He shall keep regular sets of books, showing a complete record of the general business transactions of the Corporation, and for that purpose shall receive from the Treasurer, Assistant Treasurers and agents of the Corporation such daily or other reports of receipts and disbursements as he may require.

Section 24. Custody of Contracts. The Comptroller shall have the custody of all written contracts and other similar written instruments to which the Corporation is a party.

Section 25. Statements by Comptroller. The Comptroller shall render such statements of the affairs of the Corporation, shown by his books and records, as may be required for the information of the Board of Directors or of the Executive Committee, and shall by proper distribution and classification of the accounts under his charge, be prepared to furnish such reports as may be required by the Chairman of the Board of Directors, the President, the Board of Directors, and the Executive Committee, or any state or federal official.

ARTICLE V

CERTIFICATE OF STOCK

Section 1. Provision for Issue, Transfer and Registration. The Board of Directors shall provide for the issue, transfer and registration of the capital stock of the Corporation in the City of New York or elsewhere, and for that purpose may appoint the necessary officers, transfer agents and registrars of transfers.

Section 2. Certificates of Stock. Every holder of stock in the Corporation shall be entitled to have a certificate, signed by, or in the name of the Corporation by, the President or a Vice President and the Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary of the Corporation, certifying the number of shares owned.

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Section 3. Facsimile Signatures of Certificates. The signature of any officer, transfer agent, or registrar on a certificate for shares of the Corporation may be facsimile. In case any officer, transfer agent or registrar who has signed, or whose facsimile signature has been used on, any such certificate or certificates shall cease to be such officer, transfer agent or registrar of the Corporation, whether because of death, resignation or otherwise, before such certificate or certificates have been delivered by the Corporation, such certificate or certificates may nevertheless be adopted by the Corporation and be issued and delivered as though the person or persons who signed such certificate or certificates or whose facsimile signature or signatures have been used thereon had not ceased to be such officer, transfer agent or registrar of the Corporation. Record shall be kept by the Transfer Agent of the number of each certificate, the date thereof, the name of the person owning the shares represented thereby, and the number of shares. Every certificate surrendered to the Corporation for transfer or otherwise in exchange for a new certificate shall be canceled by perforation or otherwise with the date of cancellation indicated thereon.

Section 4. Transfer of Stock. Transfer of stock of the capital stock of the Corporation shall be made only on the books of the Corporation by the holder thereof, or by his attorney thereunto authorized by a power of attorney duly executed and filed with the Transfer Agent of the Corporation, and on surrender for cancellation of the certificate or certificates for such shares. A person in whose name shares of stock stand on the books of the Corporation and no one else shall be deemed the owner thereof as regards the Corporation.

Section 5. Registrar and Transfer Agent. The Corporation shall at all times maintain a registrar, which shall in every case be a bank or trust company, and a transfer agent, to be appointed by the Board of Directors, in accordance with the requirements of the New York Stock Exchange, and registration and transfer of the Corporation’s stock certificates shall be in accordance with the rules and regulations of said stock exchange. The Board of Directors may also make such additional rules and regulations as it may deem expedient concerning the issue, transfer and registration of certificates for shares of the capital stock of the Corporation.

Section 6. Closing of Transfer Books; Record Date. The Board of Directors may close the stock transfer books of the Corporation for a period not more than sixty (60) days nor less than ten (10) days preceding the date of any meeting of stockholders or the date for payment of any dividend or the date for the allotment of rights or the date when any change or conversion or exchange of capital stock shall go into effect. In lieu of closing the stock transfer books as aforesaid, the Board of Directors may fix in advance a date, not more than sixty (60) days nor less than ten (10) days preceding the date of any meeting of stockholders, or the date for the payment of any dividend, or the date for the allotment of rights, or the date when any change or conversion or exchange of capital stock shall go into effect, as a record date for the determination of the stockholders entitled to notice of, and to vote at, any such meeting, and any adjournment thereof, or entitled to receive payment of any such dividend, or to any such allotment of rights, or to exercise the rights in respect of any such change, conversion or exchange of capital stock and, in such case, such stockholders and only such stockholders as shall be stockholders of record on the date so fixed shall be entitled to such notice of, and to vote at, such meeting and any adjournment thereof, or to receive payment of such dividend, or to receive such allotment of rights, or to exercise such rights, as the case may be notwithstanding any transfer of any stock on the books of the Corporation after any such record date fixed as aforesaid.

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ARTICLE VI

SEAL

Section 1. The authorized seal shall have inscribed thereon the name of the Corporation, the year of incorporation and the name of the state of incorporation. The seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise applied.

ARTICLE VII

FISCAL YEAR

Section 1. The fiscal year of the Corporation shall commence on the first day of January of each year.

ARTICLE VIII

NOTICES

Section 1. Form of Notice. Where notice, other than by publication, is required to be given by Delaware law, the Certificate of Incorporation or By-Laws, notice to directors and stockholders shall not be construed to mean personal notice, but such notice may be given in writing, by mail, addressed to such directors or stockholders at such address as appears on the books of the Corporation. Notice by mail shall be deemed to be given at the time when the same shall be mailed. Notice to directors may also be given personally, by telephone, by telegram or in such other manner as may be provided in these By-Laws.

Section 2. Waiver of Notice. Whenever any notice is required to be given under the provisions of the statutes or of the Certificate of Incorporation or of these By-Laws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated herein, shall be deemed equivalent thereto.

ARTICLE IX

INDEMNIFICATION, AMENDMENTS AND MISCELLANEOUS

Section 1. Indemnification. Each person who, at any time is, or shall have been, a director, officer, employee or agent of the Corporation, and is threatened to be or is made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that he is, or was, a director, officer, employee or agent of the Corporation, or served at the request of the Corporation as a director, officer, employee, trustee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall be indemnified against expense (including attorneys’ fees), judgment, fines and amounts paid in settlement actually and reasonably incurred by him in

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connection with any such action, suit or proceeding to the full extent provided under Section 145 of the General Corporation Law of the State of Delaware. The foregoing right of indemnification shall in no way be exclusive of any other rights of indemnification to which any such director, officer, employee or agent may be entitled, under any By-Law, agreement, vote of stockholders or disinterested directors or otherwise.

Section 2. Amendments. These By-Laws may be altered, amended or repealed by a vote of a majority of the whole Board of Directors at any meeting of the Board of Directors. The Board of Directors in its discretion may, but need not, submit any proposed alteration, amendment or repeal of the By-Laws to the stockholders at any regular or special meeting of the stockholders for their adoption or rejection; provided notice of the proposed alteration, amendment or repeal be contained in the notice of such stockholders’ meeting.

Section 3. Proxies. Unless otherwise provided by resolution of the Board of Directors, the President or, in his absence or disability, a Vice President, from time to time in the name and on behalf of the Corporation: may appoint an attorney or attorneys, agent or agents of the Corporation (who may be or include himself), in the name and on behalf of the Corporation to cast the votes which the Corporation may be entitled to cast as a stockholder or otherwise in any other corporation any of whose stock or other securities may be held by the Corporation, at meetings of the holders of the stock or other securities of such other corporations or to consent in writing to any action by such other corporation; may instruct the person or persons so appointed as to the manner of casting such votes or giving such consent; and may execute or cause to be executed in the name and on behalf of the Corporation and under its corporate seal all such written proxies or other instruments as may be necessary or proper to evidence the appointment of such attorneys and agents.

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EX-10.10.3

Exhibit 10.10.3

AMENDMENT

TO THE

KANSAS CITY SOUTHERN

401(k) AND PROFIT SHARING PLAN

(As Amended and Restated Effective April 1, 2002)

The Kansas City Southern 401(k) and Profit Sharing Plan, as amended and restated effective April 1, 2002, (the “Plan”), is hereby further amended as follows effective January 1, 2001:

I.

The following sentence is added to the end of the first paragraph of Section 1.10 of the Plan:

Compensation (including Compensation under Section 3.08 of the Plan) also includes any “qualified transportation fringe” within the meaning of Code § 132(f) if such amount is excludable from the Participant’s taxable income by reason of Code § 132(f)(4).

IN WITNESS WHEREOF, Kansas City Southern has executed this Amendment.

Dated: June 30, 2003

KANSAS CITY SOUTHERN
By:	/s/ Eric B. Freestone

EX-10.10.4

Exhibit 10.10.4

AMENDMENT

TO THE

KANSAS CITY SOUTHERN

401(k) AND PROFIT SHARING PLAN

(As Amended and Restated Effective April 1, 2002)

The Kansas City Southern 401(k) and Profit Sharing Plan, as amended and restated effective April 1, 2002, (the “Plan”), and as subsequently amended, is hereby further amended by adding the following Article VI-A to the Plan in order to comply with the Final and Temporary Regulations under Code Section 401(a)(9) as required by Internal Revenue Service Revenue Procedure 2002-29.

ARTICLE VI-A.

MINIMUM DISTRIBUTION REQUIREMENTS

6A.1 GENERAL RULES.

(a) Effective Date. The provisions of this Article VI-A apply to the determination of required minimum distributions made in calendar years beginning on and after January 1, 2003.

(b) Precedence. The requirements of this Article will take precedence over any inconsistent provisions of the Plan; provided, however, this Article shall not be construed to permit distribution commencing later or over a time period longer than otherwise permitted under the Plan.

(c) Treasury Regulations Incorporated. All distributions required under this Article will be determined and made in accordance with the Treasury Regulations under Code Section 401(a)(9).

(d) TEFRA Section 242(b)(2) Elections. Notwithstanding the other provisions of this Article VI-A, distributions may be made under a designation made before January 1, 1984, in accordance with Section 242(b)(2) of the Tax Equity and Fiscal Responsibility Act (TEFRA) and the provisions of the Plan that relate to Section 242(b)(2) of TEFRA.

6A.2 TIME AND MANNER OF DISTRIBUTION.

(a) Required Beginning Date. The Participant’s Nonforfeitable Accrued Benefit will be distributed, or begin to be distributed, to the Participant no later than the Participant’s Required Beginning Date.

(b) Death of Participant Before Distributions Begin. If the Participant dies before distributions begin, the Participant’s Nonforfeitable Accrued Benefit will be distributed, or begin to be distributed, no later than as follows:

(1) If the Participant’s surviving spouse is the Participant’s sole designated Beneficiary, then distributions to the spouse will begin by December 31

of the calendar year immediately following the calendar year in which the Participant died, or by December 31 of the calendar year in which the Participant would have attained age 70 ¹/2, if later.

(2) If the Participant’s surviving spouse is not the Participant’s sole designated Beneficiary, then either distributions to the designated Beneficiary will begin by December 31 of the calendar year immediately following the calendar year in which the Participant died or the Participant’s entire Nonforfeitable Accrued Benefit will be distributed to the designated Beneficiary by December 31 of the calendar year containing the fifth anniversary of the Participant’s death.

(3) If there is no designated Beneficiary as of September 30 of the year following the year of the Participant’s death, the Participant’s entire Nonforfeitable Accrued Benefit will be distributed by December 31 of the calendar year containing the fifth anniversary of the Participant’s death.

(4) If the Participant’s surviving spouse is the Participant’s sole designated Beneficiary and the spouse dies after the Participant but before distributions to the spouse begin, this Section 6A.2(b), other than Section 6A.2(b)(1), will apply as if the spouse were the Participant.

For purposes of this Section 6A.2(b), and Section 6A.4, unless Section 6A.2(b)(4) applies, distributions are considered to begin on the Participant’s Required Beginning Date. If Section 6A.2(b)(4) applies, distributions are considered to begin on the date distributions are required to begin to the spouse under Section 6A.2(b)(1).

(c) Forms of Distribution. Unless the Participant’s Nonforfeitable Accrued Benefit is distributed in a single sum on or before the Required Beginning Date, as of the first distribution calendar year distributions will be made in accordance with Sections 6A.3 and 6A.4.

6A.3 REQUIRED MINIMUM DISTRIBUTIONS DURING PARTICIPANT’S LIFETIME.

(a) Amount of Required Minimum Distribution For Each Distribution Calendar Year. During the Participant’s lifetime, the minimum amount that will be distributed for each distribution calendar year is the lesser of

(1) the quotient obtained by dividing the Participant’s account balance by the distribution period in the Uniform Lifetime Table set forth in Section 1.401(a)(9)-9 of the Treasury Regulations, using the Participant’s age as of the Participant’s birthday in the distribution calendar year; or

(2) If the Participant’s sole designated beneficiary for the distribution calendar year is the Participant’s spouse, the quotient obtained by dividing the Participant’s account balance by the number in the Joint and Last Survivor Table set forth in Section 1.401(a)(9)-9 of the Treasury Regulations, using the Participant’s and spouse’s attained ages as of the Participant’s and spouse’s birthdays in the distribution calendar year.

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(b) Lifetime Required Minimum Distributions Continue Through Year of Participant’s Death. Required minimum distributions will be determined under this Section 6A.3 beginning with the first distribution calendar year and up to and including the distribution calendar year that includes the Participant’s date of death.

6A.4 REQUIRED MINIMUM DISTRIBUTIONS AFTER PARTICIPANT’S DEATH.

(a) Death On or After Date Distributions Begin.

(1) Participant Survived by Designated Beneficiary. If the Participant dies on or after the date distributions begin and there is a designated Beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the Participant’s death is the quotient obtained by dividing the Participant’s account balance by the longer of the remaining life expectancy of the Participant or the remaining life expectancy of the Participant’s designated Beneficiary, determined as follows:

A. The Participant’s remaining life expectancy is calculated using the age of the Participant in the year of death, reduced by one for each subsequent year.

B. If the Participant’s spouse is the Participant’s sole designated Beneficiary, the remaining life expectancy of the spouse is calculated for each distribution calendar year after the year of the Participant’s death using the spouse’s age as of the spouse’s birthday in that year. For distribution calendar years after the year of the spouse’s death, the remaining life expectancy of the spouse is calculated using the age of the spouse as of the spouse’s birthday in the calendar year of the spouse’s death, reduced by one for each subsequent calendar year.

C. If the Participant’s spouse is not the Participant’s sole designated beneficiary, the designated beneficiary’s remaining life expectancy is calculated using the age of the beneficiary in the year following the year of the Participant’s death, reduced by one for each subsequent year.

(2) No Designated Beneficiary. If the Participant dies on or after the date distributions begin and there is no designated beneficiary as of September 30 of the year after the year of the Participant’s death, the minimum amount that will be distributed for each distribution calendar year after the year of the Participant’s death is the quotient obtained by dividing the Participant’s account balance by the Participant’s remaining life expectancy calculated using the age of the Participant in the year of death, reduced by one for each subsequent year.

(b) Death Before Date Distributions Begin.

(1) Participant Survived by Designated Beneficiary. If the Participant dies before the date distributions begin and there is a designated Beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the Participant’s death is the quotient obtained by dividing the Participant’s account balance by the remaining life expectancy of the Participant’s

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designated Beneficiary, determined as provided in Section 6A.4, unless the Participant’s entire interest is distributed to the designated Beneficiary by December 31 of the calendar year containing the fifth anniversary of the Participant’s death.

(2) No Designated Beneficiary. If the Participant dies before the date distributions begin and there is no designated Beneficiary as of September 30 of the year following the year of the Participant’s death, distribution of the Participant’s entire interest will be completed by December 31 of the calendar year containing the fifth anniversary of the Participant’s death.

(3) Death of Spouse Before Distributions to Spouse Are Required to Begin. If the Participant dies before the date distributions begin, the Participant’s spouse is the Participant’s sole designated Beneficiary, and the spouse dies before distributions are required to begin to the spouse under Section 6A.2, this Section 6A.4(b) will apply as if the spouse were the Participant.

6A.5 DEFINITIONS.

(a) Designated Beneficiary. The designated Beneficiary under the provisions of the Plan who is also the designated beneficiary under Code Section 401(a)(9) and Section 1.401(a)(9)-l, Q&A-4, of the Treasury Regulations.

(b) Distribution calendar year. A calendar year for which a minimum distribution is required. For distributions beginning before the Participant’s death, the first distribution calendar year is the calendar year immediately preceding the calendar year which contains the Participant’s Required Beginning date. For distributions beginning after the Participant’s death, the first distribution calendar year is the calendar year in which distributions are required to begin under Section 6A.2(b). The required minimum distribution for the Participant’s first distribution calendar year will be made on or before the Participant’s Required Beginning Date. The required minimum distribution for other distribution calendar years, including the required minimum distribution for the distribution calendar year in which the Participant’s Required Beginning Date occurs, will be made on or before December 31 of that distribution calendar year.

(c) Life expectancy. Life expectancy as computed by use of the Single Life Table in Section 1.401(a)(9)-9 of the Treasury Regulations.

(d) Participant’s account balance. The vested balance of the Participant’s Accounts as of the last valuation date in the calendar year immediately preceding the distribution calendar year (valuation calendar year) increased by the amount of any vested contributions made and allocated or vested forfeitures allocated to the account balance as of dates in the valuation calendar year after the valuation date and decreased by distributions made in the valuation calendar year after the valuation date. The account balance for the valuation calendar year includes any amounts rolled over or transferred to the Plan either in the valuation calendar year or in the distribution calendar year if distributed or transferred in the valuation calendar year.

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(e) Required Beginning Date. The Required Beginning Date as defined in Section 6.01(B).

IN WITNESS WHEREOF, Kansas City Southern has executed this Amendment.

Dated: December 3, 2003

KANSAS CITY SOUTHERN
By:	/s/ Eric B. Freestone

EX-10.18

Exhibit 10.18

EMPLOYMENT AGREEMENT

THIS AGREEMENT, made and entered into as of this 9th day of February, 2004, by and between The Kansas City Southern Railway Company, a Missouri corporation (“Railway”), Kansas City Southern, a Delaware corporation (“KCS”) and Mark W. Osterberg, an individual (“Executive”).

WHEREAS, Executive has been offered employment by Railway, and Railway, KCS and Executive desire for Railway to continue to employ Executive on the terms and conditions set forth in this Agreement and to provide an incentive to Executive to remain in the employ of Railway hereafter, particularly in the event of any change in control (as herein defined) of KCS, or Railway, thereby establishing and preserving continuity of management of Railway.

NOW, THEREFORE, in consideration of the mutual covenants and agreements herein contained, it is agreed by and between Railway, KCS and Executive as follows:

1.    Employment. Railway hereby employs Executive as its Vice President & Comptroller to serve at the pleasure of the Board of Directors of Railway (the “Railway Board”) and to have such duties, powers and responsibilities as may be prescribed or delegated from time to time by the President or other officer to whom Executive reports, subject to the powers vested in the Railway Board and in the stockholders of Railway. Executive shall faithfully perform his duties under this Agreement to the best of his ability and shall devote substantially all of his working time and efforts to the business and affairs of Railway and its affiliates.

2.    Compensation.

(a)    Base Compensation. Railway shall pay Executive as compensation for his services hereunder an annual base salary at the rate approved by the Railway’s Compensation Committee. Such rate shall not be reduced except as agreed by the parties or except as part of a general salary reduction program imposed by Railway for non-union employees and applicable to all officers of Railway, not related to a Change of Control.

3.    Benefits. During the period of his employment hereunder, Railway shall provide Executive with coverage under such benefit plans and programs as are made generally available to similarly situated employees of Railway, provided (a) Railway shall have no obligation with respect to any plan or program if Executive is not eligible for coverage thereunder, and (b) Executive acknowledges that stock options and other stock and equity participation awards are granted in the discretion of the Railway Board or the Compensation Committee of the Railway Board and that Executive has no right to receive stock options or other equity participation awards or any particular number or level of stock options or other awards. In determining contributions, coverage and benefits under any disability insurance policy and under any cash compensation-based plan provided to Executive by Railway, it shall be assumed that the value of Executive’s annual compensation, pursuant to this Agreement, is 145% of Executive’s annual base salary. Executive acknowledges that all rights and benefits under benefit plans and programs shall be governed by the official text of each plan or program and not by any summary or description thereof or any provision of this Agreement (except to the extent that this Agreement expressly modifies such benefit plans or programs) and that neither KCS, nor Railway is under any obligation to continue in effect or to fund any such plan or program, except as provided in Paragraph 7 hereof.

4.    Term and Termination.

The “Term” of this Agreement shall begin on the date first written above and continue until terminated as provided in (a) through (d) of this Section 4.

(a)    Termination by Executive. Executive may terminate this Agreement and his employment hereunder by providing at least thirty (30) days advance written notice to Railway, except that in the event of any material breach of this Agreement by Railway, Executive may terminate this Agreement and his employment hereunder immediately upon notice to Railway.

(b)    Death or Disability. This Agreement and Executive’s employment hereunder shall terminate automatically on the death or disability of Executive, except to the extent employment is continued under Railway’s disability plan. For purposes of this

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Agreement, Executive shall be deemed to be disabled if he qualifies for disability benefits under Railway’s long-term disability plan.

(c)    Termination by Railway For Cause. Railway may terminate this Agreement and Executive’s employment “for cause” immediately upon notice to Executive. For purposes of this Agreement (except for Paragraph 7), termination “for cause” shall mean termination based upon any one or more of the following:

(i)    Any material breach of this Agreement by Executive;

(ii)    Executive’s dishonesty involving Railway, KCS, or any subsidiary of Railway or KCS;

(iii)    Gross negligence or willful misconduct in the performance of Executive’s duties as determined in good faith by the Railway Board;

(iv)    Executive’s failure to substantially perform his duties and responsibilities hereunder, including without limitation Executive’s willful failure to follow reasonable instructions of the President or other officer to whom Executive reports;

(v)    Executive’s breach of an express employment policy of Railway or its affiliates;

(vi)    Executive’s fraud or criminal activity;

(vii)    Embezzlement or misappropriation by Executive; or

(viii)    Executive’s breach of his fiduciary duty to Railway, or KCS, or their affiliates.

(d)    Termination by Railway Other Than For Cause.

(i)    Railway may terminate this Agreement and Executive’s employment other than for cause immediately upon notice to Executive, and in such event, Railway shall provide severance benefits to Executive in accordance with Paragraph 4(d)(ii) below. Executive acknowledges and agrees that such severance benefits constitute the exclusive remedy of Executive upon termination of employment other than for cause. Notwithstanding any other provision of this Agreement, as a condition to receiving such severance benefits, Executive shall execute a full release of claims in favor of Railway and KCS and their affiliates in the form Attached hereto as Appendix A.

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(ii) Unless the provisions of Paragraph 7 of this Agreement are applicable, if Executive’s employment is terminated under Paragraph 4(d)(i), Railway shall continue, for a period of one (1) year following such termination, (a) to pay to Executive as severance pay a monthly amount equal to one-twelfth (1/12th) of the annual base salary referenced in Paragraph 2(a) above, at the rate in effect immediately prior to termination, and, (b) to reimburse Executive for the cost (including state and federal income taxes payable with respect to this reimbursement) of continuing the health insurance coverage provided pursuant to this Agreement or obtaining health insurance coverage comparable to the health insurance provided pursuant to this Agreement, and obtaining coverage comparable to the life insurance provided pursuant to this Agreement, unless Executive is provided comparable health or life insurance coverage in connection with other employment. The foregoing obligations of Railway shall continue until the end of such one (1) year period notwithstanding the death or disability of Executive during said period (except, in the event of death, the obligation to reimburse Executive for the cost of life insurance shall not continue). In the year in which termination of employment occurs, Executive shall be eligible to receive benefits under the Railway Incentive Compensation Plan and any Executive Plan in which Executive participates (the “Executive Plan”) (if such Plans then are in existence and Executive was entitled to participate immediately prior to termination) in accordance with the provisions of such plans then applicable, and severance pay received in such year shall be taken into account for the purpose of determining benefits, if any, under the Railway Incentive Compensation Plan but not under the Executive Plan. After the year in which termination occurs, Executive shall not be entitled to accrue or receive benefits under the Railway Incentive Compensation Plan or the Executive Plan with respect to the severance pay provided herein, notwithstanding that benefits under such plan there are still generally available to executive employees of Railway. After termination of employment, Executive shall not be entitled to accrue or receive benefits under any other employee benefit plan or program, except that Executive shall be entitled to participate in the KCS Section 401(k) and Profit Sharing Plan and the KCS Employee Stock Ownership Plan (if Railway employees then still participate in such plans) in the year of

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termination of employment only if Executive meets all requirements of such plans for participation in such year.

5.    Confidentiality and Non-Disclosure.

(a)    Executive understands and agrees that he will be given Confidential Information (as defined below) during his employment with Railway relating to the business of Railway, KCS and/or their affiliates, in exchange for his agreement herein. Executive hereby expressly agrees to maintain in strictest confidence and not to use in any way (including without limitation in any future business relationship of Executive), publish, disclose or authorize anyone else to use, publish or disclose in any way, any Confidential Information relating in any manner to the business or affairs of Railway, KCS and/or their affiliates. Executive agrees further not to remove or retain any figures, calculations, letters, documents, lists, papers, or copies thereof, which embody Confidential Information of Railway, KCS and/or their affiliates, and to return, prior to Executive’s termination of employment for any reason, any such information in Executive’s possession. If Executive discovers, or comes into possession of, any such information after his termination he shall promptly return it to Railway. Executive acknowledges that the provisions of this paragraph are consistent with Railway’s policies and procedures to which Executive, as an employee of Railway, is bound.

(b)    For purposes of this Agreement, “Confidential Information” includes, but is not limited to, information in the possession of, prepared by, obtained by, compiled by, or that is used by Railway, KCS or their affiliates or customers, and: (i) is proprietary to, about, or created by Railway, KCS or their affiliates or customers; (ii) gives Railway, KCS or their affiliates or customers some competitive business advantage, the opportunity of obtaining such advantage, or disclosure of which might be detrimental to the interest of Railway, KCS or their affiliates or customers; and (iii) is not typically disclosed by Railway, KCS or their affiliates or customers, or known by persons who are not employed by Railway, KCS or their affiliates or customers. Without in any way limiting the foregoing and by way of example, Confidential Information shall include: information pertaining to Railway’s, KCS’s or their affiliates’ business operations such as financial and operational information and data, operational plans and strategies, business and marketing strategies, pricing information, plans for various products and services, and acquisition and divestiture planning.

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(c)    In the event of any breach of this Paragraph 5 by Executive, Railway shall be entitled to terminate any and all remaining severance benefits under Paragraph 4(d)(ii) and shall be entitled to pursue such other legal and equitable remedies as may be available. Executive acknowledges, understands and agrees that Railway, KCS and/or their affiliates will suffer immediate and irreparable harm if Executive fails to comply with any of his obligations under Paragraph 5 of this Agreement, and that monetary damages alone will be inadequate to compensate Railway, KCS or their affiliates for such breach. Accordingly, Executive agrees that Railway, KCS and/or their affiliates shall, in addition to any other remedies available to it at law or in equity, be entitled to temporary, preliminary, and permanent injunctive relief and specific performance to enforce the terms of Paragraph 5 without the necessity of proving inadequacy of legal remedies or irreparable harm or posting bond.

6.    Duties Upon Termination; Survival.

(a)    Duties. Upon termination of this Agreement by Railway or Executive for any reason, Executive shall immediately sign such written resignations from all positions as an officer, director or member of any committee or board of Railway and all direct and indirect subsidiaries and affiliates of Railway as may be requested by Railway and shall sign such other documents and papers relating to Executive’s employment, benefits and benefit plans as Railway may reasonably request.

(b)    Survival. The provisions of Paragraphs 5, 6(a) and 7 of this Agreement shall survive any termination of this Agreement by Railway or Executive, and the provisions of Paragraph 4(d)(ii) shall survive any termination of this Agreement by Railway under Paragraph 4(d)(i).

7.    Continuation of Employment Upon Change in Control.

(a)    Continuation of Employment. Subject to the terms and conditions of this Paragraph 7, in the event of a Change in Control (as defined in Paragraph 7(d)) at any time during the term of this Agreement, Executive agrees to remain in the employ of Railway for a period of three years (the “Three Year Period”) from the date of such Change in Control (the “Control Change Date”). Railway agrees to continue to employ Executive for the Three Year Period. During the Three Year Period, (i) the Executive’s position (including offices, titles,

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reporting requirements and responsibilities), authority and duties shall be at least commensurate in all material respects with the most significant of those held, exercised and assigned at any time during the 12 month period immediately before the Control Change Date and (ii) the Executive’s services shall be performed at the location where Executive was employed immediately before the Control Change Date or at any other location less than 40 miles from such former location. During the Three Year Period, Railway shall continue to pay to Executive an annual base salary on the same basis and at the same intervals as in effect prior to the Control Change Date at a rate not less than 12 times the highest monthly base salary paid or payable to the Executive by Railway in respect of the 12-month period immediately before the Control Change Date.

(b)    Benefits. During the Three-Year Period, Executive shall be entitled to participate, on the basis of his executive position, in each of the following KCS, or Railway plans (together, the “Specified Benefits”) in existence, and in accordance with the terms thereof, at the Control Change Date:

(i)    any benefit plan, and trust fund associated therewith, related to: (A) life, health, dental, disability, accidental death and dismemberment insurance or accrued but unpaid vacation time; (B) profit sharing, thrift or deferred savings (including deferred compensation, such as under Sec. 401(k) plans); (C) retirement or pension benefits; (D) ERISA excess benefits and similar plans and (E) tax favored employee stock ownership (such as under ESOP, and Employee Stock Purchase programs); and

(ii)    any other benefit plans hereafter made generally available to executives of Executive’s level or to the employees of Railway generally.

In addition, Railway and KCS shall use their best efforts to cause all outstanding options held by Executive under any stock option plan of KCS or its affiliates to become immediately exercisable on the Control Change Date and to the extent that such options are not vested and are subsequently forfeited, the Executive shall receive a lump-sum cash payment within 5 days after the options are forfeited equal to the difference between the fair market value of the shares of stock subject to the non-vested, forfeited options determined as of the date such options are forfeited and the exercise price for such options. During the Three-Year Period Executive shall be entitled to participate, on the basis of his executive position, in any incentive compensation plan of KCS, or Railway in accordance with the terms thereof at the Control Change Date; provided that if under KCS, or Railway programs or Executive’s Employment Agreement in

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existence immediately prior to the Control Change Date, there are written limitations on participation for a designated time period in any incentive compensation plan, such limitations shall continue after the Control Change Date to the extent so provided for prior to the Control Change Date.

If the amount of contributions or benefits with respect to the Specified Benefits or any incentive compensation is determined on a discretionary basis under the terms of the Specified Benefits or any incentive compensation plan immediately prior to the Control Change Date, the amount of such contributions or benefits during the Three Year Period for each of the Specified Benefits shall not be less than the average annual contributions or benefits for each Specified Benefit for the three plan years ending prior to the Control Change Date and, in the case of any incentive compensation plan, the amount of the incentive compensation during the Three Year Period shall not be less than 75% of the maximum that could have been paid to the Executive under the terms of the incentive compensation plan.

(c)    Payment. With respect to any plan or agreement under which Executive would be entitled at the Control Change Date to receive Specified Benefits or incentive compensation as a general obligation of Railway which has not been separately funded (including specifically, but not limited to, those referred to under Paragraph 7(b)(i)(D) above), Executive shall receive within five (5) days after such date full payment in cash (discounted to the then present value on the basis of a rate of seven percent (7%) per annum) of all amounts to which he is then entitled thereunder.

(d)    Change in Control. For purposes of this Agreement, a “Change in Control” shall be deemed to have occurred if:

(i)    for any reason at any time less than seventy-five percent (75%) of the members of the KCS Board shall be individuals who fall into any of the following categories: (A) individuals who were members of the KCS Board on the date of the Agreement; or (B) individuals whose election, or nomination for election by KCS’s stockholders, was approved by a vote of at least seventy-five percent (75%) of the members of the KCS Board then still in office who were members of the KCS Board on the date of the Agreement; or (C) individuals whose election, or nomination for election, by KCS’s stockholders, was approved by a vote of at least seventy-five percent (75%) of

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the members of the KCS Board then still in office who were elected in the manner described in (A) or (B) above, or

(ii)    any “person” (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934 (the “Exchange Act”)) other than KCS shall have become after September 18, 1997, according to a public announcement or filing, the “beneficial owner” (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of Railway or KCS representing thirty percent (30%) (or, with respect to Paragraph 7(c) hereof, 40%) or more (calculated in accordance with Rule 13d-3) of the combined voting power of Railway’s or KCS’s then outstanding voting securities; or

(iii)    the stockholders of Railway or KCS shall have approved a merger, consolidation or dissolution of Railway or KCS or a sale, lease, exchange or disposition of all or substantially all of Railway’s or KCS’s assets, if persons who were the beneficial owners of the combined voting power of Railway’s or KCS’s voting securities immediately before any such merger, consolidation, dissolution, sale, lease, exchange or disposition do not immediately thereafter, beneficially own, directly or indirectly, in substantially the same proportions, more than 60% of the combined voting power of any corporation or other entity resulting from any such transaction.

(e)    Termination After Control Change Date. Notwithstanding any other provision of this Paragraph 7, at any time after the Control Change Date, Railway may terminate the employment of Executive (the “Termination”), but unless such Termination is for Cause as defined in subparagraph (g) or for disability, within five (5) days of the Termination Railway shall pay to Executive his full base salary through the Termination, to the extent not theretofore paid, plus a lump sum amount (the “Special Severance Payment”) equal to the product (discounted to the then present value on the basis of a rate of seven percent (7%) per annum) of (i) 160% of his annual base salary specified in Paragraph 7(a) multiplied by (ii) Two; and Specified Benefits (excluding any incentive compensation) to which Executive was entitled immediately prior to Termination shall continue until the end of the 3-year period (“Benefits Period”) beginning on the date of Termination. If any plan pursuant to which Specified Benefits are provided immediately prior to Termination would not permit continued participation by Executive after Termination, then Railway shall pay to Executive within five (5) days after

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Termination a lump sum payment equal to the amount of Specified Benefits Executive would have received under such plan if Executive had been fully vested in the average annual contributions or benefits in effect for the three plan years ending prior to the Control Change Date (regardless of any limitations based on the earnings or performance of KCS, or Railway) and a continuing participant in such plan to the end of the Benefits Period. Following the end of the Benefits Period, Railway shall continue to provide to the Executive and the Executive’s family the following benefits (“Post-Period Benefits”): (1) prior to the Executive’s attainment of age sixty (60), health, prescription and dental benefits equivalent to those then applicable to active peer executives of Railway) and their families, as the same may be modified from time to time, and (2) following the Executive’s attainment of age sixty (60) (and without regard to the Executive’s period of service with Railway) health and prescription benefits equivalent to those then applicable to retired peer executives of Railway and their families immediately prior to the Change of Control. The cost to the Executive of such Post-Period Benefits shall not exceed the cost of such benefits to active or retired (as applicable) peer executives immediately prior to the Change of Control. Notwithstanding the preceding two sentences of this Paragraph 7(e), if the Executive is covered under any health, prescription or dental plan provided by a subsequent employer, then the corresponding type of plan coverage (i.e., health, prescription or dental), required to be provided as Post-Period Benefits under this Paragraph 7(e) shall cease. The Executive’s rights under this Paragraph 7(e) shall be in addition to, and not in lieu of, any post-termination continuation coverage or conversion rights the Executive may have pursuant to applicable law, including without limitation continuation coverage required by Section 4980 of the Code. Nothing in this Paragraph 7(e) shall be deemed to limit in any manner the reserved right of Railway, in its sole and absolute discretion, to at any time amend, modify or terminate health, prescription or dental benefits for active or retired employees generally.

(f)    Resignation After Control Change Date. In the event of a Change in Control as defined in Paragraph 7(d), thereafter, upon good reason (as defined below), Executive may, at any time during the three-year period following the Change in Control, in his sole discretion, on not less than thirty (30) days’ written notice (the “Notice of Resignation”) to the Secretary of Railway and effective at the end of such notice period, resign his employment with Railway (the “Resignation”). Within five (5) days of such a Resignation, Railway shall pay to Executive his full base salary through the effective date of such Resignation, to the extent not

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theretofore paid, plus a lump sum amount equal to the Special Severance Payment (computed as provided in the first sentence of Paragraph 7(e), except that for purposes of such computation all references to “Termination” shall be deemed to be references to “Resignation”). Upon Resignation of Executive, Specified Benefits to which Executive was entitled immediately prior to Resignation shall continue on the same terms and conditions as provided in Paragraph 7(e) in the case of Termination (including equivalent payments provided for therein), and Post-Period Benefits shall be provided on the same terms and conditions as provided in Paragraph 7(e) in the case of Termination. For purposes of this Agreement, “good reason” means any of the following:

(i) the assignment of the Executive of any duties inconsistent in any respect with the Executive’s position (including offices, titles, reporting requirements or responsibilities), authority or duties as contemplated by Section 7(a)(i), or any other action by Railway which results in a diminution or other material adverse change in such position, authority or duties;

(ii) any failure by Railway to comply with any of the provisions of Paragraph 7;

(iii) Railway’s requiring the Executive to be based at any office or location other than the location described in Section 7(a)(ii);

(iv) any other material adverse change to the terms and conditions of the Executive’s employment; or

(v) any purported termination by Railway of the Executive’s employment other than as expressly permitted by this Agreement (any such purported termination shall not be effective for any other purpose under this Agreement).

A passage of time prior to delivery of the Notice of Resignation or a failure by the Executive to include in the Notice of Resignation any fact or circumstance which contributes to a showing of Good Reason shall not waive any right of the Executive under this Agreement or preclude the Executive from asserting such fact or circumstance in enforcing rights under this Agreement.

(g) Termination for Cause After Control Change Date. Notwithstanding any other provision of this Paragraph 7, at any time after the Control Change Date, Executive may be terminated by Railway “for cause.” Cause means commission by the Executive of any felony or

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willful breach of duty by the Executive in the course of the Executive’s employment; except that Cause shall not mean:

(i) bad judgment or negligence;

(ii) any act or omission believed by the Executive in good faith to have been in or not opposed to the interest of Railway (without intent of the Executive to gain, directly or indirectly, a profit to which the Executive was not legally entitled);

(iii) any act or omission with respect to which a determination could properly have been made by the Railway Board that the Executive met the applicable standard of conduct for indemnification or reimbursement under Railway’s by-laws, any applicable indemnification agreement, or applicable law, in each case in effect at the time of such act or omission; or

(iv) any act or omission with respect to which Notice of Termination of the Executive is given, more than 12 months after the earliest date on which any member of the Railway Board, not a party to the act or omission, knew or should have known of such act or omission.

Any Termination of the Executive’s employment by Railway for Cause shall be communicated to the Executive by Notice of Termination.

(h) Gross-up for Certain Taxes. If it is determined (by the reasonable computation of Railway’s independent auditors, which determinations shall be certified to by such auditors and set forth in a written certificate (“Certificate”) delivered to the Executive) that any benefit received or deemed received by the Executive from Railway, or KCS pursuant to this Agreement or otherwise (collectively, the “Payments”) is or will become subject to any excise tax under Section 4999 of the Code or any similar tax payable under any United States federal, state, local or other law (such excise tax and all such similar taxes collectively, “Excise Taxes”), then Railway shall, immediately after such determination, pay the Executive an amount (the “Gross-up Payment”) equal to the product of:

(i) the amount of such Excise Taxes; multiplied by

(ii) the Gross-up Multiple (as defined in Paragraph 7(k)).

The Gross-up Payment is intended to compensate the Executive for the Excise Taxes and any federal, state, local or other income or excise taxes or other taxes payable by the Executive with respect to the Gross-up Payment.

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Railway shall cause the preparation and delivery to the Executive of a Certificate upon request at any time. Railway shall, in addition to complying with this Paragraph 7(h), cause all determinations and certifications under Paragraphs 7(h)-(o) to be made as soon as reasonably possible and in adequate time to permit the Executive to prepare and file the Executive’s individual tax returns on a timely basis.

(i) Determination by the Executive.

(i) If Railway shall fail to: (A) deliver a Certificate to the Executive or (B) pay to the Executive the amount of the Gross-up Payment, if any, within 14 days after receipt from the Executive of a written request for a Certificate, or if at any time following receipt of a Certificate the Executive disputes the amount of the Gross-up Payment set forth therein, the Executive may elect to demand the payment of the amount which the Executive, in accordance with an opinion of counsel to the Executive (“Executive Counsel Opinion”), determines to be the Gross-up Payment. Any such demand by the Executive shall be made by delivery to Railway of a written notice which specifies the Gross-up Payment determined by the Executive and an Executive Counsel Opinion regarding such Gross-up Payment (such written notice and opinion collectively, the “Executive’s Determination”). Within 14 days after delivery of the Executive’s Determination to Railway, Railway shall either: (A) pay the Executive the Gross-up Payment set forth in the Executive’s Determination (less the portion of such amount, if any, previously paid to the Executive by Railway) or (B) deliver to the Executive a Certificate specifying the Gross-up Payment determined by Railway’s independent auditors, together with an opinion of Railway’s counsel (“Railway Counsel Opinion”), and pay the Executive the Gross-up Payment specified in such Certificate. If for any reason Railway fails to comply with clause (B) of the preceding sentence, the Gross-up Payment specified in the Executive’s Determination shall be controlling for all purposes.

(ii) If the Executive does not make a request for, and Railway does not deliver to the Executive, a Certificate, Railway shall, for purposes of Paragraph 7(j), be deemed to have determined that no Gross-up Payment is due.

(j) Additional Gross-up Amounts. If, despite the initial conclusion of Railway and/or the Executive that certain Payments are neither subject to Excise Taxes nor to be counted in determining whether other Payments are subject to Excise Taxes (any such item, a

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“Non-Parachute Item”), it is later determined (pursuant to subsequently-enacted provisions of the Code, final regulations or published rulings of the IRS, final IRS determination or judgment of a court of competent jurisdiction or Railway’s independent auditors) that any of the Non-Parachute Items are subject to Excise Taxes, or are to be counted in determining whether any Payments are subject to Excise Taxes, with the result that the amount of Excise Taxes payable by the Executive is greater than the amount determined by Railway or the Executive pursuant to Paragraph 7(h) or Paragraph 7(i), as applicable, then Railway shall pay the Executive an amount (which shall also be deemed a Gross-up Payment) equal to the product of:

(i)    the sum of (A) such additional Excise Taxes and (B) any interest, fines, penalties, expenses or other costs incurred by the Executive as a result of having taken a position in accordance with a determination made pursuant to Paragraph 7(h); multiplied by

(ii)    the Gross-up Multiple.

(k)    Gross-up Multiple. The Gross-up Multiple shall equal a fraction, the numerator of which is one (1.0), and the denominator of which is one (1.0) minus the sum, expressed as a decimal fraction, of the rates of all federal, state, local and other income and other taxes and any Excise Taxes applicable to the Gross-up Payment; provided that, if such sum exceeds 0.8, it shall be deemed equal to 0.8 for purposes of this computation. (If different rates of tax are applicable to various portions of a Gross-up Payment, the weighted average of such rates shall be used.)

(l)    Opinion of Counsel. “Executive Counsel Opinion” means a legal opinion of nationally recognized executive compensation counsel that there is a reasonable basis to support a conclusion that the Gross-up Payment determined by the Executive has been calculated in accord with this Paragraph 7 and applicable law. “Company Counsel Opinion” means a legal opinion of nationally recognized executive compensation counsel that (i) there is a reasonable basis to support a conclusion that the Gross-up Payment set forth in the Certificate of Railway’s independent auditors has been calculated in accord with this Paragraph 7 and applicable law, and (ii) there is no reasonable basis for the calculation of the Gross-up Payment determined by the Executive.

(m)    Amount Increased or Contested. The Executive shall notify Railway in writing of any claim by the IRS or other taxing authority that, if successful, would require the

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payment by Railway of a Gross-up Payment. Such notice shall include the nature of such claim and the date on which such claim is due to be paid. The Executive shall give such notice as soon as practicable, but no later than 10 business days, after the Executive first obtains actual knowledge of such claim; provided, however, that any failure to give or delay in giving such notice shall affect Railway’s obligations under this Paragraph 7 only if and to the extent that such failure results in actual prejudice to Railway. The Executive shall not pay such claim less than 30 days after the Executive gives such notice to Railway (or, if sooner, the date on which payment of such claim is due). If Railway notifies the Executive in writing before the expiration of such period that it desires to contest such claim, the Executive shall:

(i)    give Railway any information that it reasonably requests relating to such claim;

(ii)    take such action in connection with contesting such claim as Railway reasonably requests in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by Railway;

(iii)    cooperate with Railway in good faith to contest such claim; and

(iv)    permit Railway to participate in any proceedings relating to such claim; provided, however, that Railway shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including related interest and penalties, imposed as a result of such representation and payment of costs and expenses. Without limiting the foregoing, Railway shall control all proceedings in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner. The Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as Railway shall determine; provided, however, that if Railway directs the Executive to pay such claim and sue for a refund, Railway shall advance the amount of such payment to the Executive, on are interest-free basis and shall

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indemnify the Executive, on an after-tax basis, for any Excise Tax or income tax, including related interest or penalties, imposed with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. The Railway’s control of the contest shall be limited to issues with respect to which a Gross-up Payment would be payable. The Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the IRS or other taxing authority.

(n)    Refunds. If, after the receipt by the Executive of an amount advanced by Railway pursuant to Paragraph 7(m), the Executive receives any refund with respect to such claim, the Executive shall (subject to Railway’s complying with the requirements of Paragraph 7(m)) promptly pay Railway the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by Railway pursuant to Paragraph 7(m), a determination is made that the Executive shall not be entitled to a full refund with respect to such claim and Railway does not notify the Executive in writing of its intent to contest such determination before the expiration of 30 days after such determination, then the applicable part of such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-up Payment required to be paid. Any contest of a denial of refund shall be controlled by Paragraph 7(m).

(o)    Expenses. If any dispute should arise under this Agreement after the Control Change Date involving an effort by Executive to protect, enforce or secure rights or benefits claimed by Executive hereunder, Railway shall pay (promptly upon demand by Executive accompanied by reasonable evidence of incurrence) all reasonable expenses (including attorneys’ fees) incurred by Executive in connection with such dispute, without regard to whether Executive prevails in such dispute except that Executive shall repay Railway any amounts so received if a court having jurisdiction shall make a final, nonappealable determination that Executive acted frivolously or in bad faith by such dispute. To assure Executive that adequate funds will be made available to discharge Railway’s obligations set forth in the preceding sentence, Railway has established a trust and upon the occurrence of a Change in Control shall promptly deliver to the trustee of such trust to hold in accordance with the terms

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and conditions thereof that sum which the Railway Board shall have determined is reasonably sufficient for such purpose.

(p)    Prevailing Provisions. On and after the Control Change Date, the provisions of this Paragraph 7 shall control and take precedence over any other provisions of this Agreement which are in conflict with or address the same or a similar subject matter as the provisions of this Paragraph 7.

8.    Mitigation and Other Employment. After a termination of Executive’s employment pursuant to Paragraph 4(d)(i) or a Change in Control as defined in Paragraph 7(d), Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise, and except as otherwise specifically provided in Paragraph 4(d)(ii) with respect to health and life insurance and in Paragraph 7(e) with respect to health, prescription and dental benefits, no such other employment, if obtained, or compensation or benefits payable in connection therewith shall reduce any amounts or benefits to which Executive is entitled hereunder. Such amounts or benefits payable to Executive under this Agreement shall not be treated as damages but as severance compensation to which Executive is entitled because Executive’s employment has been terminated.

9.    KCS Not An Obligor. Notwithstanding that KCS has executed this Agreement, it shall have no obligation for the payment of salary, benefits, or other compensation hereunder, and all such obligations shall be the sole responsibility of Railway.

10.    Notice. Notices and all other communications to either party pursuant to this Agreement shall be in writing and shall be deemed to have been given when personally delivered, delivered by facsimile or deposited in the United States mail by certified or registered mail, postage prepaid, addressed, in the case of Railway or KCS, to Railway or KCS at 427 West 12th Street, Kansas City, Missouri 64105, Attention: Secretary, or, in the case of the Executive, to him at 427 West 12^th Street, Kansas Cty, Missouri, 64105, or to such other address as a party shall designate by notice to the other party.

11.    Amendment. No provision of this Agreement may be amended, modified, waived or discharged unless such amendment, waiver, modification or discharge is agreed to in writing signed by Executive, the President of Railway and the President of KCS. No waiver by

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any party hereto at any time of any breach by another party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the time or at any prior or subsequent time.

12.    Successors in Interest. The rights and obligations of KCS and Railway under this Agreement shall inure to the benefit of and be binding in each and every respect upon the direct and indirect successors and assigns of KCS and Railway, regardless of the manner in which such successors or assigns shall succeed to the interest of KCS or Railway hereunder, and this Agreement shall not be terminated by the voluntary or involuntary dissolution of KCS or Railway or by any merger or consolidation or acquisition involving KCS or Railway, or upon any transfer of all or substantially all of KCS’s or Railway’s assets, or terminated otherwise than in accordance with its terms. In the event of any such merger or consolidation or transfer of assets, the provisions of this Agreement shall be binding upon and shall inure to the benefit of the surviving corporation or the corporation or other person to which such assets shall be transferred. Neither this Agreement nor any of the payments or benefits hereunder may be pledged, assigned or transferred by Executive either in whole or in part in any manner, without the prior written consent of Railway.

13.    Severability. The invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions hereof, and this Agreement shall be construed in all respects as if such invalid or unenforceable provisions were omitted.

14.    Controlling Law and Jurisdiction. The validity, interpretation and performance of this Agreement shall be subject to and construed under the laws of the State of Missouri, without regard to principles of conflicts of law.

15.    Entire Agreement. This Agreement constitutes the entire agreement among the parties with respect to the subject matter hereof and terminates and supersedes all other prior agreements and understandings, both written and oral, between the parties with respect to the terms of Executive’s employment or severance arrangements.

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IN WITNESS WHEREOF, the parties hereto have executed this Amended and Restated Agreement as of the 9th day of February 2004.

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
By:	/s/ Michael R. Haverty
	Michael R. Haverty, Chairman, President, & CEO
KANSAS CITY SOUTHERN
By:	/s/ Michael R. Haverty
	Michael R. Haverty, Chairman, President, & CEO
EXECUTIVE
By:	/s/    Mark W. Osterberg
	Mark W. Osterberg

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Appendix A

WAIVER AND RELEASE

In consideration of the benefits described in the Employment Agreement, I do hereby fully waive all claims and release The Kansas City Southern Railway Company (KCSR), and its affiliates, parents, subsidiaries, successors, assigns, directors and officers, fiduciaries, employees and agents, as well as any employee benefit plans from liability and damages related in any way to any claim I may have against or KCSR. This waiver and release includes, but is not limited to all claims, causes of action and rights under Title VII of the Civil Rights Act of 1964, as amended; the Civil Rights Act of 1991; the Age Discrimination in Employment Act of 1967, as amended; the Civil Rights Act of 1866; the American with Disabilities Act of 1990; the Rehabilitation Act of 1973; the Older Workers Benefit Protection Act of 1990; the Employee Retirement Income Security Act of 1974, as amended; the Worker Adjustment and Retraining Notification Act; the Family and Medical Leave Act; the Federal Employers Liability Act; the Railway Labor Act, including bumping rights, rights to file a grievance, rights to a hearing (whether before any company official, any system, group, regional or special adjustment board, the National Railroad Adjustment Board, or any other entity), and any rights to arbitration thereunder; the Missouri Human Rights Act, the Kansas Act Against Discrimination, the Kansas and Missouri Workers’ Compensation acts, and all local state and federal statutes and regulations; all claims arising from labor protective conditions imposed by the Interstate Commerce Commission or the Surface Transportation Board; all any KCSR incentive or benefit plan or program, and any rights under any collective bargaining agreement, including seniority rights, bumping rights and reinstatement rights, rights to file or assert a grievance or other complaint, rights to a hearing, or rights to arbitration under such agreement; and all rights under common law such as breach of contract, tort or personal injury of any sort.

I understand that this Agreement and Release also precludes me from recovering any relief as a result of any lawsuit, grievance or claims brought on my behalf and arising out of my employment or resignation of, or separation from employment, provided that nothing in this Agreement and this Release may affect my entitlement, if any, to workers’ compensation or unemployment compensation. Additionally, nothing in this Agreement and Release prohibits me from communications with, filing a complaint with, or full cooperation in the

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investigations of, any governmental agency on matters within their jurisdictions. However, as stated above, this Agreement and Release does prohibit me from recovering any relief, including monetary relief, as a result of such activities.

If any term, provision, covenant, or restriction of this Agreement and Release is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of this Agreement and Release and the other terms, provisions, covenants and restrictions hereof shall remain in full force and effect and shall in no way be affected, impaired or invalidated. I understand and agree that, in the event of breach by me of any of the terms and conditions of this Agreement and Release, the Railway will be entitled to recover all costs and expenses as a result of my breach, including but not limited to, reasonable attorneys’ fees and costs.

I have read this Agreement and Release and I understand all of its terms. I enter into and sign this Agreement and Release knowingly and voluntarily, with full knowledge of what it means.

/s/    Mark W. Osterberg
Employee Signature	Date
Mark W. Osterberg
Employee Name (Please Print)	Social Security Number

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EX-10.38.2

Exhibit 10.38.2

AMENDMENT

TO THE

KANSAS CITY SOUTHERN

EMPLOYEE STOCK OWNERSHIP PLAN

(As Amended and Restated Effective April 1, 2002)

The Kansas City Southern Employee Stock Ownership Plan, as amended and restated effective April 1, 2002, (the “Plan”), is hereby further amended as follows effective January 1, 2001:

I.

The following sentence is added to the end of the first paragraph of Section 1.10 of the Plan:

Compensation (including Compensation under Section 3.04 of the Plan) also includes any “qualified transportation fringe” within the meaning of Code § 132(f) if such amount is excludable from the Participant’s taxable income by reason of Code § 132(f)(4).

IN WITNESS WHEREOF, Kansas City Southern has executed this Amendment.

Dated: June 30, 2003

KANSAS CITY SOUTHERN
By:	/s/ Eric B. Freestone

EX-10.38.3

Exhibit 10.38.3

SECOND AMENDMENT

TO THE

KANSAS CITY SOUTHERN

EMPLOYEE STOCK OWNERSHIP PLAN

(As Amended and Restated Effective April 1, 2002)

The Kansas City Southern Employee Stock Ownership Plan, as amended and restated effective April 1, 2002, (the “Plan”), and as subsequently amended, is hereby further amended by adding the following Article VI-A to the Plan in order to comply with the Final and Temporary Regulations under Code Section 401(a)(9) as required by Internal Revenue Service Revenue Procedure 2002-29.

ARTICLE VI-A.

MINIMUM DISTRIBUTION REQUIREMENTS

6A.1 GENERAL RULES.

(a) Effective Date. The provisions of this Article VI-A apply to the determination of required minimum distributions made in calendar years beginning on and after January 1, 2003.

(b) Precedence. The requirements of this Article will take precedence over any inconsistent provisions of the Plan; provided, however, this Article shall not be construed to permit distribution commencing later or over a time period longer than otherwise permitted under the Plan.

(c) Treasury Regulations Incorporated. All distributions required under this Article will be determined and made in accordance with the Treasury Regulations under Code Section 401(a)(9).

(d) TEFRA Section 242(b)(2) Elections. Notwithstanding the other provisions of this Article VI-A, distributions may be made under a designation made before January 1, 1984, in accordance with Section 242(b)(2) of the Tax Equity and Fiscal Responsibility Act (TEFRA) and the provisions of the Plan that relate to Section 242(b)(2) of TEFRA.

6A.2 TIME AND MANNER OF DISTRIBUTION.

(a) Required Beginning Date. The Participant’s Nonforfeitable Accrued Benefit will be distributed, or begin to be distributed, to the Participant no later than the Participant’s Required Beginning Date.

(b) Death of Participant Before Distributions Begin. If the Participant dies before distributions begin, the Participant’s Nonforfeitable Accrued Benefit will be distributed, or begin to be distributed, no later than as follows:

(1) If the Participant’s surviving spouse is the Participant’s sole designated Beneficiary, then distributions to the spouse will begin by December 31 of the calendar year immediately following the calendar year in which the Participant died, or by December 31 of the calendar year in which the Participant would have attained age 70 ¹/2, if later.

(2) If the Participant’s surviving spouse is not the Participant’s sole designated Beneficiary, then either distributions to the designated Beneficiary will begin by December 31 of the calendar year immediately following the calendar year in which the Participant died or the Participant’s entire Nonforfeitable Accrued Benefit will be distributed to the designated Beneficiary by December 31 of the calendar year containing the fifth anniversary of the Participant’s death.

(3) If there is no designated Beneficiary as of September 30 of the year following the year of the Participant’s death, the Participant’s entire Nonforfeitable Accrued Benefit will be distributed by December 31 of the calendar year containing the fifth anniversary of the Participant’s death.

(4) If the Participant’s surviving spouse is the Participant’s sole designated Beneficiary and the spouse dies after the Participant but before distributions to the spouse begin, this Section 6A.2(b), other than Section 6A.2(b)(1), will apply as if the spouse were the Participant.

For purposes of this Section 6A.2(b), and Section 6A.4, unless Section 6A.2(b)(4) applies, distributions are considered to begin on the Participant’s Required Beginning Date. If Section 6A.2(b)(4) applies, distributions are considered to begin on the date distributions are required to begin to the spouse under Section 6A.2(b)(1).

(c) Forms of Distribution. Unless the Participant’s Nonforfeitable Accrued Benefit is distributed in a single sum on or before the Required Beginning Date, as of the first distribution calendar year distributions will be made in accordance with Sections 6A.3 and 6A.4.

6A.3 REQUIRED MINIMUM DISTRIBUTIONS DURING PARTICIPANT’S LIFETIME.

(a) Amount of Required Minimum Distribution For Each Distribution Calendar Year. During the Participant’s lifetime, the minimum amount that will be distributed for each distribution calendar year is the lesser of

(1) the quotient obtained by dividing the Participant’s account balance by the distribution period in the Uniform Lifetime Table set forth in Section 1.401(a)(9)-9 of the Treasury Regulations, using the Participant’s age as of the Participant’s birthday in the distribution calendar year; or

(2) If the Participant’s sole designated beneficiary for the distribution calendar year is the Participant’s spouse, the quotient obtained by dividing the Participant’s account balance by the number in the Joint and Last Survivor Table set forth in Section 1.401(a)(9)-9 of the Treasury Regulations, using the Participant’s and spouse’s attained ages as of the Participant’s and spouse’s birthdays in the distribution calendar year.

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(b) Lifetime Required Minimum Distributions Continue Through Year of Participant’s Death. Required minimum distributions will be determined under this Section 6A.3 beginning with the first distribution calendar year and up to and including the distribution calendar year that includes the Participant’s date of death.

6A.4 REQUIRED MINIMUM DISTRIBUTIONS AFTER PARTICIPANT’S DEATH.

(a) Death On or After Date Distributions Begin.

(1) Participant Survived by Designated Beneficiary. If the Participant dies on or after the date distributions begin and there is a designated Beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the Participant’s death is the quotient obtained by dividing the Participant’s account balance by the longer of the remaining life expectancy of the Participant or the remaining life expectancy of the Participant’s designated Beneficiary, determined as follows:

A. The Participant’s remaining life expectancy is calculated using the age of the Participant in the year of death, reduced by one for each subsequent year.

B. If the Participant’s spouse is the Participant’s sole designated Beneficiary, the remaining life expectancy of the spouse is calculated for each distribution calendar year after the year of the Participant’s death using the spouse’s age as of the spouse’s birthday in that year. For distribution calendar years after the year of the spouse’s death, the remaining life expectancy of the spouse is calculated using the age of the spouse as of the spouse’s birthday in the calendar year of the spouse’s death, reduced by one for each subsequent calendar year.

C. If the Participant’s spouse is not the Participant’s sole designated beneficiary, the designated beneficiary’s remaining life expectancy is calculated using the age of the beneficiary in the year following the year of the Participant’s death, reduced by one for each subsequent year.

(2) No Designated Beneficiary. If the Participant dies on or after the date distributions begin and there is no designated beneficiary as of September 30 of the year after the year of the Participant’s death, the minimum amount that will be distributed for each distribution calendar year after the year of the Participant’s death is the quotient obtained by dividing the Participant’s account balance by the Participant’s remaining life expectancy calculated using the age of the Participant in the year of death, reduced by one for each subsequent year.

(b) Death Before Date Distributions Begin.

(1) Participant Survived by Designated Beneficiary. If the Participant dies before the date distributions begin and there is a designated Beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the Participant’s death is the quotient obtained by dividing the

- 3 -

Participant’s account balance by the remaining life expectancy of the Participant’s designated Beneficiary, determined as provided in Section 6A.4, unless the Participant’s entire interest is distributed to the designated Beneficiary by December 31 of the calendar year containing the fifth anniversary of the Participant’s death.

(2) No Designated Beneficiary. If the Participant dies before the date distributions begin and there is no designated Beneficiary as of September 30 of the year following the year of the Participant’s death, distribution of the Participant’s entire interest will be completed by December 31 of the calendar year containing the fifth anniversary of the Participant’s death.

(3) Death of Spouse Before Distributions to Spouse Are Required to Begin. If the Participant dies before the date distributions begin, the Participant’s spouse is the Participant’s sole designated Beneficiary, and the spouse dies before distributions are required to begin to the spouse under Section 6A.2, this Section 6A.4(b) will apply as if the spouse were the Participant.

6A.5 DEFINITIONS.

(a) Designated Beneficiary. The designated Beneficiary under the provisions of the Plan who is also the designated beneficiary under Code Section 401(a)(9) and Section 1.401(a)(9)-l, Q&A-4, of the Treasury Regulations.

(b) Distribution calendar year. A calendar year for which a minimum distribution is required. For distributions beginning before the Participant’s death, the first distribution calendar year is the calendar year immediately preceding the calendar year which contains the Participant’s Required Beginning date. For distributions beginning after the Participant’s death, the first distribution calendar year is the calendar year in which distributions are required to begin under Section 6A.2(b). The required minimum distribution for the Participant’s first distribution calendar year will be made on or before the Participant’s Required Beginning Date. The required minimum distribution for other distribution calendar years, including the required minimum distribution for the distribution calendar year in which the Participant’s Required Beginning Date occurs, will be made on or before December 31 of that distribution calendar year.

(c) Life expectancy. Life expectancy as computed by use of the Single Life Table in Section 1.401(a)(9)-9 of the Treasury Regulations.

(d) Participant’s account balance. The vested balance of the Participant’s Accounts as of the last valuation date in the calendar year immediately preceding the distribution calendar year (valuation calendar year) increased by the amount of any vested contributions made and allocated or vested forfeitures allocated to the account balance as of dates in the valuation calendar year after the valuation date and decreased by distributions made in the valuation calendar year after the valuation date. The account balance for the valuation calendar year includes any amounts rolled over or transferred to the Plan either in the valuation calendar year or in the distribution calendar year if distributed or transferred in the valuation calendar year.

- 4 -

(e) Required Beginning Date. The Required Beginning Date as defined in Section 6.01(B).

IN WITNESS WHEREOF, Kansas City Southern has executed this Amendment.

Dated: December 3, 2003

KANSAS CITY SOUTHERN
By:	/s/ Eric B. Freestone

- 5 -

EX-12.1

Exhibit 12.1

KANSAS CITY SOUTHERN

AND SUBSIDIARY COMPANIES

COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES

	As of December 31st
	2003			2002		2001		2000			1999
Pretax income/(loss) from continuing operations, excluding equity in earnings of unconsolidated affilites	$	(10.5	)	$	20.7	$	6.8	$	(2.0	)	$	12.0
Interest Expense on Indebtedness		46.4			45.0		52.8		65.8			57.4
Portion of Rents Representative of an Appropriate Interest Factor		19.1			18.3		18.9		19.4			18.0
Distributed income of equity investments		—			—		3.0		5.0			—
Income (Loss) as Adjusted	$	55.0		$	84.0	$	81.5	$	88.2		$	87.4
Fixed Charges:
Interest Expense on Indebtedness	$	46.4		$	45.0	$	52.8	$	65.8		$	57.4
Capitalized Interest		—			1.7		4.2		—			—
Portion of Rents Representative of an Appropriate Interest Factor		19.1			18.3		18.9		19.4			18.0
Preferred Security Dividends as defined by Item 503(d)(B) of Regulation S-K		7.7			0.4		0.4		0.4			0.4
Total Fixed Charges	$	73.2		$	65.4	$	76.3	$	85.6		$	75.8
Ratio of Earnings to Fixed Charges		—	(a)		1.28		1.07		1.03			1.15

Note: Excludes amortization expense on debt discount due to immateriality

(a) For the year ended December 31, 2003, the ratio of earnings to fixed charges was less than 1:1. The ration of earnings to fixed charges would have been 1:1 if a deficiency of $18.2 million was eliminated.

EX-21.1

Exhibit 21.1

Subsidiaries of the Company

Kansas City Southern, a Delaware corporation, has no parent. All subsidiaries of the Company listed below are included in the consolidated financial statements unless otherwise indicated

	Percentage or Ownership	State or other Jurisdiction of Incorporation or Organization
Canama Transportation (7)	100	Cayman Islands
Caymex Transportation, Inc. (1)	100	Delaware
Gateway Eastern Railway Company (1)	100	Illinois
Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. *(6)	46.6	Mexico
Joplin Union Depot *	33	Missouri
KC Terminal Railway (10)	16	Missouri
Mexrail, Inc. *(13)	100	Delaware
NAFTA Rail, S.A. de C.V. (7)	100	Mexico
North American Freight Transportation
Alliance Rail Corporation	100	Delaware
PABTEX GP, LLC (2)	100	Texas
PABTEX L.P. (11)	100	Delaware
Panama Canal Railway Company *(8)	42	Cayman Islands
Panarail Tourism Company (9)	100	Cayman Islands
Port Arthur Bulk Marine Terminal Co. (1)	80	Partnership
SCC Holdings, LLC (1)	100	Delaware
SIS Bulk Holding, Inc. (2)	100	Delaware
Southern Capital Corporation, LLC *(12)	50	Colorado
Southern Development Company (1)	100	Missouri
Southern Industrial Services, Inc.	100	Delaware
The Kansas City Southern Railway Company	100	Missouri
The Texas Mexican Railway Company *(4)	100	Texas
TFM, S.A. de C.V. *(5)	80	Mexico
TransFin Insurance, Ltd.	100	Vermont
Trans-Serve, Inc. (2) (3)	100	Delaware
Veals, Inc.	100	Delaware

* Unconsolidated Affiliate, Accounted for Using the Equity Method

(1) Subsidiary of The Kansas City Southern Railway Company

(2) Subsidiary of Southern Industrial Services, Inc.

(3) Conducting business as Superior Tie & Timber

(4) Subsidiary of Mexrail, Inc.

(5) Subsidiary of Grupo Transportacion Ferroviaria, S.A. de C.V.

(6) Unconsolidated affiliate of NAFTA Rail, S.A. de C.V.

(7) Subsidiary of Caymex Transportation, Inc.

(8) Unconsolidated affiliate of Canama Transportation

(9) Subsidiary of Panama Canal Railway Company

(10) Unconsolidated affiliate of The Kansas City Southern Railway Company

(11) Subsidiary of SIS Bulk Holding, Inc.

(12) Unconsolidated affiliate of SCC Holdings, Inc.

(13) Subsidiary of TFM, S.A. de C.V.

EX-23.1

Exhibit 23.1

Independent Auditors’ Consent

The Board of Directors

Kansas City Southern:

We consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-50517, 33-50519, 33-64511, 333-91993, 333-73122, 333-58250, 333-51854, and 333-91478) and on Form S-3 (Nos. 33-69648, 333-61006 and 333-107573) of Kansas City Southern of our report dated March 19, 2004 with respect to the consolidated balance sheets of Kansas City Southern as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2003, which report appears in the December 31, 2003 annual report on Form 10-K of Kansas City Southern. The financial statements of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (Grupo TFM), a 46.6% owned investee company, as of and for the year ended December 31, 2003 and for the year ended December 31, 2001 were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Grupo TFM as of and for the year ended December 31, 2003 and the year ended December 31, 2001, is based solely on the reports of other auditors.

Our report refers to the adoption by the Company of Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, effective January 1, 2003.

/s/ KPMG LLP

Kansas City, Missouri

March 29, 2004

CONSENT OF PRICEWATERHOUSECOOPERS, S.C.

“ We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-50517, 33-50519, 33-64511, 333-91993, 333-73122, 333-58250, 333-51854, and 333-91478) and on Form S-3 (Nos. 33-69648, 333-61006 and 333-107573) of Kansas City Southern of our report dated March 19, 2004, relating to the combined and consolidated financial statements of Grupo Transportación Ferroviaria Mexicana, S.A. de C.V., which are included in this Annual Report on Form 10-K.”

Mexico City, March 30, 2004

/s/ PricewaterhouseCoopers, S.C.

/s/ Alberto Del Castillo V. V.

Audit Partner

EX-31.1

Exhibit 31.1

CERTIFICATIONS

I, Michael R. Haverty, certify that:

1. I have reviewed this annual report on Form 10-K of Kansas City Southern (the “registrant”);

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and;

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting, which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 29, 2004

/s/ Michael R. Haverty

Michael R. Haverty

Chairman, President and Chief Executive Officer

1

EX-31.2

Exhibit 31.2

CERTIFICATIONS

I, Ronald G. Russ, certify that:

1. I have reviewed this annual report on Form 10-K of Kansas City Southern (the “registrant”);

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and;

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting, which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 29, 2004

/s/ Ronald G. Russ

Ronald G. Russ

Executive Vice President and Chief Financial Officer

1

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Kansas City Southern (the “Company”) on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Michael R. Haverty, Chief Executive Officer of the Company, and Ronald G. Russ, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes –Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Michael R. Haverty

Michael R. Haverty

Chief Executive Officer

March 29, 2004

/s/ Ronald G. Russ

Ronald G. Russ

Chief Financial Officer

March 29, 2004

A signed original of this written statement required by Section 906 has been provided to Kansas City Southern and will be retained by Kansas City Southern and furnished to the Securities and Exchange Commission or its staff upon request.

EX-99.1

Exhibit 99.1

GRUPO TRANSPORTACIÓN FERROVIARIA

MEXICANA, S. A. DE C. V.

COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2001, 2002 AND 2003

GRUPO TRANSPORTACIÓN FERROVIARIA

MEXICANA, S. A. DE C. V.

COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2001, 2002 AND 2003

INDEX

Contents	Page
Report of Independent Auditors	1 and 2
Combined and Consolidated Balance Sheets	3
Combined and Consolidated Statements of Income	4
Combined and Consolidated Statements of Changes in Stockholders’ Equity	5
Combined and Consolidated Statements of Cash Flows	6
Notes to the Combined and Consolidated Financial Statements	7 to 44

REPORT OF INDEPENDENT AUDITORS

Mexico City, March 19, 2004

To the Board of Directors and Stockholders of

Grupo Transportación Ferroviaria Mexicana, S. A. de C. V.

We have audited the accompanying combined and consolidated balance sheets of Grupo Transportación Ferroviaria Mexicana, S. A. de C. V. and subsidiaries as of December 31, 2003 and 2002, and the related combined and consolidated statements of income, of changes in stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2003, all expressed in US dollars. These combined and consolidated financial statements are the responsibility of the Company’s Management. Our responsibility is to express an opinion on these combined and consolidated financial statements based on our audits.

We conducted our audits in accordance with International Auditing Standards and Auditing Standards Generally Accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and that they were prepared in accordance with International Financial Reporting Standards. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by Management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the aforementioned combined and consolidated financial statements present fairly, in all material respects, the combined and consolidated financial position of Grupo Transportación Ferroviaria Mexicana, S. A. de C. V. and subsidiaries as of December 31, 2003 and 2002, and the combined and consolidated results of their operations, the changes in their stockholders’ equity and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with International Financial Reporting Standards.

International Financial Reporting Standards vary in certain significant respects from Accounting Principles Generally Accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 12 to the combined and consolidated financial statements.

PricewaterhouseCoopers

/s/    ALBERTO DEL CASTILLO V. V.

Alberto Del Castillo V. Vilchis

Audit Partner

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

COMBINED AND CONSOLIDATED BALANCE SHEETS

(Note 1)

(amounts in thousands of US dollars)

	December 31,
	2002			2003
Assets
Current assets:
Cash and cash equivalents	$	30,249		$	3,597
Accounts receivable—Net		90,596			101,595
Amounts due from related parties (Note 7)		5,316			5,410
Taxes recoverable		78,808			51,244
Other accounts receivable—Net		27,820			34,046
Materials and supplies		20,261			16,693
Other current assets		12,200			13,157
Total current assets		265,250			225,742
Long-term account receivable		1,388			1,350
Concession rights and related assets—Net (Note 3)		1,215,487			1,174,217
Property, machinery and equipment—Net (Note 4)		609,367			632,431
Investment held in associate company (Note 2h.)		7,435			8,020
Other assets		524			1,507
Deferred income taxes (Note 10)		100,972			78,845
Total assets	$	2,200,423		$	2,122,112
Liabilities and stockholders’ equity
Short-term liabilities:
Current portion of long-term debt (Note 5)	$	18,286		$	192,740
Current portion of capital lease obligations (Note 11)		267			414
Amounts owed to related parties (Note 7)		9,175			10,010
Suppliers		57,236			65,522
Advance payments from customers		7,055			5,809
Accounts payable and accrued expenses		55,276			86,268
Total short-term liabilities		147,295			360,763
Long-term portion of capital lease obligations (Note 11)		1,875			1,556
Long-term debt (Note 5)		968,555			745,189
Other long-term liabilities		40,735			33,724
Total long-term liabilities		1,011,165			780,469
Total liabilities		1,158,460			1,141,232
Minority interest (Note 2o.)		329,619			317,475
Commitments and contingencies (Note 11)
Stockholders’ equity (Note 8):
Common stock, 10,063,570 shares authorized and issued without par value		807,008			807,008
Treasury shares		(204,904	)		(204,904	)
Effect on purchase of subsidiary shares		(33,562	)		(33,562	)
Retained earnings		143,802			94,863
Total stockholders’ equity		712,344			663,405
Total liabilities and stockholders’ equity	$	2,200,423		$	2,122,112

The accompanying notes are an integral part of these combined and consolidated financial statements.

(3)

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

COMBINED AND CONSOLIDATED STATEMENTS OF INCOME

(Notes 1 and 7)

(amounts in thousands of US dollars, except per share amounts)

	Year ended December 31,
	2001			2002			2003
Transportation revenues	$	720,627		$	712,140		$	698,528
Costs and expenses:
Salaries, wages and employee benefits		128,845			124,413			121,762
Purchased services		147,015			163,835			155,594
Fuel, material and supplies		68,717			58,594			71,843
Other costs		147,578			129,428			130,769
Depreciation and amortization		79,496			82,552			86,554
		571,651			558,822			566,522
Income on transportation		148,976			153,318			132,006
Other income (expenses)—Net (Note 9)		35,572			(19,255	)		(35,382	)
Operating income		184,548			134,063			96,624
Interest income		4,510			4,974			1,509
Interest expense		(87,009	)		(101,722	)		(112,641	)
Exchange gain (loss)—Net		2,783			(17,411	)		(13,695	)
Net financing cost		(79,716	)		(114,159	)		(124,827	)
Income (loss) before provision for deferred income taxes and minority interest		104,832			19,904			(28,203	)
Income tax and deferred income tax expense (Note 10)		(2,652	)		(30,233	)		(32,890	)
Income (loss) before minority interest		102,180			(10,329	)		(61,093	)
Minority interest		(20,431	)		2,341			12,154
Net income (loss) for the year	$	81,749		($	7,988	)	($	48,939	)
Net income (loss) for the year per share (Note 2p.)	$	8.12		($	.89	)	($	6.45	)

The accompanying notes are an integral part of these combined and consolidated financial statements.

(4)

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

COMBINED AND CONSOLIDATED STATEMENTS OF CHANGES

IN STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED

DECEMBER 31, 2001, 2002 AND 2003

(Notes 1 and 8)

(amounts in thousands of US dollars)

	Common stock		Effect on purchase of subsidiary shares			Treasury shares			Retained earnings			Total
Balance at December 31, 2000	$	807,008	$	17,912					$	69,763		$	894,683
Net income for the year										81,749			81,749
Balance at December 31, 2001		807,008		17,912						151,512			976,432
Effect on purchase of subsidiary shares				(51,474	)					278			(51,196	)
Treasury shares						($	204,904	)					(204,904	)
Net loss for the year										(7,988	)		(7,988	)
Balance at December 31, 2002		807,008		(33,562	)		(204,904	)		143,802			712,344
Net loss for the year										(48,939	)		(48,939	)
Balance at December 31, 2003	$	807,008	($	33,562	)	($	204,904	)	$	94,863		$	663,405

The accompanying notes are an integral part of these combined and consolidated financial statements.

(5)

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Note 1)

(amounts in thousands of US dollars)

	Year ended December 31,
Cash flows from operating activities:	2001			2002			2003
Net income (loss) for the year	$	81,749		($	7,988	)	($	48,939	)
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization		79,496			82,552			86,554
Amortization of discount on senior unsecured debentures
and commercial paper		49,408			23,158			370
Income tax and deferred income tax expense		2,652			30,233			32,890
Minority interest		20,431			(2,341	)		(12,154	)
Loss on sale of property, machinery and equipment—Net		7,585			6,897			2,909
Gain on transfer of concession rights—Net		(60,744	)
Changes in other assets and liabilities:
Accounts receivable		(17,697	)		12,966			(10,999	)
Other accounts receivable		(24,595	)		(36,915	)		21,338
Materials and supplies		1,269			3,068			3,568
Other current assets		(1,084	)		(2,170	)		(957	)
Amounts due to related parties		(21,289	)		(4,180	)		741
Accounts payable and accrued expenses		11,912			13,811			27,269
Other non-current assets and long-term liabilities		3,454			(6,345	)		(2,926	)
Total adjustments		50,798			120,734			148,603
Net cash provided by operating activities		132,547			112,746			99,664
Cash flows from investing activities:
Investment in Mexrail Inc.					(44,000	)
Sale of property, machinery and equipment		2,012			642			2,390
Acquisition of property, machinery and equipment		(85,245	)		(89,355	)		(73,121	)
Acquisition of treasury shares					(162,575	)
Net cash used in investing activities		(83,233	)		(295,288	)		(70,731	)
Cash flows from financing activities:
Payments under commercial paper		(25,156	)		(340,000	)		(37,001	)
Proceeds from commercial paper					196,738
Proceeds from senior notes					175,241
Proceeds from term loan facility					128,000
Principal payment of term loan facility								(18,286	)
Principal payments under capital lease obligations		(4,227	)		(298	)		(298	)
Net cash (used in) provided by financing activities		(29,383	)		159,681			(55,585	)
Increase (decrease) in cash and cash equivalents		19,931			(22,861	)		(26,652	)
Cash and cash equivalents:
Beginning of the year		33,179			53,110			30,249
End of the year	$	53,110		$	30,249		$	3,597
Supplemental information:
Cash paid during the year for interest	$	28,779		$	58,525		$	98,626
Non-cash transactions:
Due from Mexican Government	$	81,892		$	93,555
Due from related parties				$	20,000
Assets acquired through capital lease obligation	$	2,448					$	120

The accompanying notes are an integral part of these combined and consolidated financial statements.

(6)

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003

(amounts in thousands of US dollars ($) or thousands of Pesos (Ps),

except number of shares)

NOTE 1 - THE COMPANY:

Grupo Transportación Ferroviaria Mexicana, S. A. de C. V. (“Grupo TFM”) was incorporated on July 12, 1996. In December 1996, Grupo TFM was awarded the right to acquire (the “Acquisition”) an 80% interest in TFM, S. A. de C. V. (“TFM” or the “Company”), formerly Ferrocarril del Noreste, S. A. de C. V. pursuant to a stock purchase agreement.

Grupo TFM is a non-operating holding company with no material assets or operations other than its investment in the Company, which in turn is the holding company of Mexrail, Inc. (“Mexrail”) and Arrendadora TFM, S. A. de C. V. (“Arrendadora TFM”). The stockholders of Grupo TFM are TMM Multimodal, S. A. de C. V. (“TMM Multimodal”), an indirect subsidiary of Grupo TMM, S. A. de C. V. (“Grupo TMM”), Nafta Rail, S. A. de C. V. (“Nafta”), an indirectly wholly owned subsidiary of Kansas City Southern (“KCS”) and TFM. See Note 8.

TFM lines are comprised of approximately 2,641 (excluding the 20 miles of the Griega-Mariscala stretch, see Note 3) miles of track, which form a strategically important rail link within Mexico and to the North American Free Trade Agreement corridor. TFM lines directly link Mexico City and Monterrey (as well as Guadalajara through trackage rights) with the ports of Lázaro Cárdenas, Veracruz and Támpico and the Mexican/United States border crossings of Nuevo Laredo-Laredo, Texas and Matamoros-Brownsville, Texas.

Approximately 71% of the Company’s employees are covered under a collective bargaining agreement dated July 1, 2001. Under this labor agreement, the compensation terms of the collective bargaining agreement are subject to renegotiation on an annual basis, whereas all other terms are to be renegotiated every two years.

On February 27, 2002, Grupo TMM and KCS announced that they had agreed to sell Mexrail (a US company), and its wholly owned subsidiary, the Tex-Mex Railway, to TFM for an aggregate price of $64 million ($32.6 million to Grupo TMM and $31.4 million to KCS). The sale was completed on March 27, 2002 and the purchase price was paid by crediting an account receivable

(7)

amounting to $20,000 due from Grupo TMM, and the remaining balance of $44,000 was paid in cash. As a result, Mexrail, Inc., with its wholly owned subsidiary, the Tex-Mex Railway, became wholly owned subsidiaries of TFM. TFM now controls the operation and dispatching of the entire international rail bridge.

The purchase of Mexrail by TFM was accounted for at historical cost in a manner similar to a pooling of interests because it is considered a business reorganization among companies within the same control group. As a result, all the assets and liabilities acquired by TFM were recorded at their historical cost. The transaction resulted in a reduction of stockholders’ equity, at TFM level amounting to $41,952 representing the difference between the historical carrying value of the assets and liabilities acquired and the purchase price of $64,000. Thus, the transaction in Grupo TFM was accounted as a reduction of stockholders’ equity amounting to $33,562 and to minority interest amounting to $8,390.

Since the above sale of Mexrail to TFM was a transaction between entities under common control, the transaction, for financial reporting purposes, has been retroactively restructured for all the previous periods on a historical cost basis in a manner similar to a pooling of interest.

Arrendadora TFM was incorporated on September 27, 2002 under the Mexican Law regulations and its only operation is the leasing to TFM of the locomotives and cars acquired through the privatization previously transferred by TFM (locomotives in 2002 and cars in 2003). Arrendadora TFM is a subsidiary of TFM.

On May 9, 2003, TFM sold its 51% interest in Mexrail and its wholly owned subsidiary the Tex-Mex Railway, to KCS for 32.6 million. The Mexrail stock sold was to remain in an independent voting trust pending approval of the transaction by the U.S. Surface Transportation Board (“STB”). Within two years of the date of this agreement, TFM had the right to repurchase all of the shares from KCS at any time for an amount equal to the purchase price. Such right was unconditional and could be exercised in the sole discretion of TFM by written notice to KCS given by the chairman of TFM and without any other corporate approvals of TFM or Grupo TMM. Since the sale was conditional on obtaining approval of the transaction by the STB, TFM recognized a liability for the net present value of the purchase price. Proceeds from the sale were re-invested in TFM. In September 2003, TFM reacquired for $32.6 million the shares previously transferred to KCS, and the related liability was canceled.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Grupo TFM and subsidiaries prepare their financial statements in accordance with International Financial Reporting Standards (“IFRS”) expressed in U.S. dollars, which differ in certain material respects from those under United States of America Generally Accepted Accounting Principles (“U.S. GAAP”). See Note 12. The most significant accounting policies are described below.

a. Consolidation

The consolidated financial statements include the accounts of Grupo TFM and its subsidiaries. All intercompany balances and transactions have been eliminated.

b. Translation

Although Grupo TFM and subsidiaries are required to maintain for tax purposes their books and records in Mexican pesos (“Ps”), except Mexrail and its subsidiary, Grupo TFM and subsidiaries keep records and use the US dollar as their functional and reporting currency.

Monetary assets and liabilities denominated in Mexican pesos are translated into US dollars using current exchange rates. The difference between the exchange rate on the date of the transaction and the exchange rate on the settlement date, or balance sheet date if not settled, is included in the income statement as a foreign exchange gain/loss. Non monetary assets or liabilities originally denominated in Mexican pesos are translated into US dollars using the historical exchange rate at the date of the transaction. Capital stock transactions and minority interest are translated at historical rates. Results of operations are mainly translated at the monthly average exchange rates. Depreciation and amortization of non-monetary assets are translated at the historical exchange rate.

c. Cash and cash equivalents

Cash and cash equivalents represent highly liquid interest-bearing deposits and investments with an original maturity of less than three months.

d. Accounts receivable

Accounts receivable are carried at original invoice amount less provision made for impairment of these receivables. A provision for impairment of trade receivables is established when there is objective evidence that the Company will not be able to collect all amounts due according to the original terms of receivables.

e. Materials and supplies

Materials and supplies, consisting mainly of fuel and items for maintenance of property and equipment, are valued at the lower of the average cost and net realizable value.

f. Concession rights and related assets

Costs incurred by the Company to acquire the concession rights and related assets were capitalized and are amortized on a straight-line basis over the estimated useful lives of the related assets and rights acquired (see Notes 3 and 4). The purchase price to acquire the concession rights and related assets was allocated to the identifiable assets acquired and liabilities assumed in connection with the privatization process (see Note 3) based on their estimated fair value.

The assets acquired and liabilities assumed include:

(i) The tangible assets acquired pursuant to the asset purchase agreement, consisting of locomotives, rail cars and materials and supplies;

(ii) The rights to utilize the right of way, track structure, buildings and related maintenance facilities of the TFM lines;

(iii) The 25% equity interest in the company established to operate the Mexico City rail terminal facilities; and

(iv) Capital lease obligations assumed.

g. Property, machinery and equipment

Machinery and equipment acquired through the asset purchase agreement were initially recorded at their estimated fair value. Subsequent acquisitions are stated at cost. Depreciation is calculated by the straight-line method based on the estimated useful lives of the respective fixed assets (see Note 4).

Recurring maintenance and repair expenditures are charged to operating expenses as incurred. The cost of locomotives rebuilt is capitalized and is amortized over the period in which benefits are expected to be received (eight years).

h. Investment held in associate company

TFM’s 25% interest in the Mexico City rail terminal is accounted for using the equity method of accounting. For the years ended December 31, 2001, 2002 and 2003, the equity in the loss (income) of Mexico City rail terminal amounted $915, ($1,269) and ($282), respectively and is included in other income (expenses)-net in the combined and consolidated statements of income (see Note 9).

i. Deferred income tax

Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax basis of assets and liabilities and their carrying amounts in the financial statements. Currently enacted tax rates are used in the determination of deferred income tax.

Deferred tax assets are recognized to the extent that it is probable that future taxable profit against which the temporary differences can be utilized, will be available.

Deferred income tax is provided on temporary differences arising on investments in subsidiaries and associates, except where the timing of the reversal of the temporary difference can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future.

j. Borrowings

Borrowings are recognized initially as the proceeds received, net of transactions costs incurred. Borrowings are subsequently stated at amortized cost using the effective yield method; any difference between proceeds (net of transactions costs) and the redemption value is recognized in the income statements over the period of the borrowings.

k. Seniority premiums

Seniority premiums to which employees are entitled upon termination of employment after 15 years of service are expensed in the years in which the services are rendered. Starting in 2002, the Company recognized the seniority premiums based on actuarial computations. At December 31, 2002 and 2003, the Company had a provision of $778 and $847, respectively, which is included in other long-term liabilities in the combined and consolidated balance sheets.

Other compensations based on length of service to which employees may be entitled in the event of dismissal, in accordance with the Mexican Federal Law, are charged to the statement of income in the year in which they become payable.

l. Revenue recognition

Revenue is recognized proportionally as a shipment moves from origin to destination.

m. Intangible assets and long-lived assets

The carrying value of intangible assets and long-lived assets are periodically reviewed by the Company and impairments are recognized whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An impairment loss is recognized for the amount by which the carrying amount of the assets exceeds its recoverable amount, which is the higher of an asset’s net selling price and its value in use. For the purpose of assessing impairment, assets are grouped at the lowest level for which there are separately identifiable discounted cash flows.

n. Leases

Leases of property, machinery and equipment where the Company has substantially all the risks and rewards of ownership are classified as finance leases. Finance leases are capitalized at the inception of the lease at the lower of the fair value of the leased property and the present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges so as to achieve a constant rate on the finance balance outstanding. The interest element of the finance cost is charged to the income statement over the lease period so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period.

Leases where the lessor retains a significant portion of the risks and rewards of ownership are classified as operating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the period of the lease.

o. Minority interest

The minority interest reflects the 20% share of the Company held by the Government.

p. Net income (loss) per share

Net income (loss) per share is calculated based on the weighted average number of shares outstanding during the year. The weighted average number of shares outstanding for the years ended December 31, 2001, 2002 and 2003 was 10,063,570; 9,011,069 and 7,585,100, respectively.

q. Use of estimates

The preparation of the combined and consolidated financial statements requires Management to make estimates and assumptions that could affect the reported amounts of assets and liabilities at the date of the financial statements. Actual results could differ from these estimates.

r. Financial risk management

(i) Financial risk factors

The Company enters into financial and commodity derivative instruments as a part of its risk management program including currency exchange contracts, interest rate arrangements and U.S. based fuel futures. These contracts are mark to market and accordingly gains and losses related to such transactions are recognized in results of operations on a monthly basis. See Note 6.

(ii) Foreign exchange risk

TFM operates internationally and is exposed to foreign exchange risk arising from exposure primarily with respect to the Mexican peso.

At December 31, 2003 Grupo TFM had monetary assets and liabilities denominated in Mexican pesos of Ps1,325 million and Ps261 million (Ps1,292 million and Ps414 million, at December 31, 2002), respectively. At December 31, 2002 and 2003 the exchange rate was Ps10.45 and Ps11.23 per US dollar, respectively. At March 19, 2004, date of issuance of these consolidated financial statements, the exchange rate was Ps10.98 per US dollar.

(iii) Interest-rate risk

The Company’s income and operating cash flows are substantially independent of changes in market interest rates. The interest rates of the finance leases to which TFM is lessor are fixed at the inception of the lease. TFM’s policy is to maintain approximately 75% of its borrowings in fixed-rate instruments. At the year and December 31, 2002 and 2003 75% and 80% were at fixed rates.

(iv) Concentration of risk

Over 19.4% of the Company’s transportation revenues are generated by the automotive industry, which is made up of a relatively small number of customers. In addition, the Company’s largest customer accounted for approximately 10% of transportation revenues. The Company performs ongoing credit valuations of its customers’ financial conditions and maintains a provision for impairment of those receivables.

s. Reclassifications

Certain figures of the years 2001 and 2002 were reclassified according to 2003 figures.

t. New accounting pronouncements

The International Accounting Standards Board (“IASB”) on December 18, 2003 revised International Accounting Standards (“IAS”) 1, 2, 8, 10, 16, 17, 21, 24, 27, 28, 31, 33 and 40 and gave notice of the withdrawal of IAS 15. The revised standards mark the near-completion of the IASB’s improvement project.

The project addressed concerns, questions and criticism raised by securities regulators and other interested parties about the existing set of IASs. The project brings:

- Removal of some options (i. e. allowed alternatives)

- Better reporting through convergence

- New guidance and disclosures

Improved versions of two further standards (IAS 32 and IAS 39) were also revised by the Board as part of its improvements project and issued on December 17, 2003.

The effective date for the amended standards is for financial periods beginning on or after January 1, 2005. Earlier adoption is permitted.

On February 19, 2004, the IASB published IFRS 2, “Share-based Payment”. Effective date is for periods beginning on or after January 1, 2005. IFRS 2 replaces the IAS 19 disclosure requirements for equity compensation benefits. The IFRS 2 requires an entity to recognize share-based payment transactions in its financial statements, including transactions with employees or other parties to be settled in cash, other assets or equity instruments of the entity. The standard sets out measurement principles and specific requirements for three types of share-based payment transactions: equity-settled share-based payment transactions; cash-settled share-based transactions and with settlement alternatives.

Management is currently evaluating the impact, if any, of the adoption of the above-mentioned standards.

NOTE 3—CONCESSION RIGHTS AND RELATED ASSETS:

In December 1996, the Mexican Government (the “Government”) granted TFM the Concession (the “Concession”) to operate the northeast rail lines for an initial period of fifty years, exclusive for thirty years, renewable, subject to certain conditions, for a second period of equal length.

Under the terms of the Concession, the Company has the right to use and the obligation to maintain the right of way, track structure, buildings and related maintenance facilities. Ownership of such property and fixtures, however, has been retained by the Government.

Concession rights and related assets are summarized below:

	December 31,						Estimated useful lives (years)
	2002			2003
Land	$	132,878		$	132,878		50
Buildings		33,113			33,113		27-30
Bridges		75,350			75,350		41
Tunnels		94,043			94,043		40
Rail		317,268			317,268		29
Concrete and wood ties		137,351			137,351		27
Yards		106,174			106,174		35
Ballast		107,189			107,189		27
Grading		391,808			391,808		50
Culverts		14,942			14,942		21
Signals		1,418			1,418		26
Other		61,792			61,792		5-50
		1,473,326			1,473,326
Accumulated amortization		(257,839	)		(299,109	)
Concession rights and related assets—Net	$	1,215,487		$	1,174,217

Amortization of concession rights was $40.0 million, $40.2 million, and $41.0 for the years ended December 31, 2001, 2002 and 2003, respectively.

On February 9, 2001 the Ministry of Communications and Transport (“SCT”) issued statement 4.123. Under this statement, the SCT and TFM agreed to transfer a line of the two-way Griega-Mariscala stretch to the Government in order to be included in the North Pacific concession. In return for this stretch, TFM recorded a receivable from the Government in the amount of $85,226, which was applied against the purchase price of the 24.63% Grupo TFM’s capital stock owned indirectly by the Government through Ferrocarriles Nacionales de México (“FNM”) and Nacional Financiera, S. N. C. (“Nafin”) (see Note 8). During 2001, the Company recognized a net gain related with this transaction of approximately $60,744, which was credited to other income (expenses)-net in the combined and consolidated statement of income (see Note 9).

Government payment was restated in accordance with an appraisal performed by the “Comisión de Avalúos de Bienes Nacionales”, until the payment date.

On February 12, 2001, the SCT modified the Concession title granted to TFM (i) to transfer the Griega-Mariscala stretch described above, and (ii) authorized the dismantling of the catenary running over the route between Huehuetoca, State of Mexico and the City of Querétaro.

NOTE 4—PROPERTY, MACHINERY AND EQUIPMENT:

Pursuant to the asset purchase agreement, the Company obtained the right to acquire locomotives and rail cars and various materials and supplies, formerly owned by FNM. The Company also agreed to assume the outstanding indebtedness, as of the commencement of operations, relating to certain locomotives originally acquired by FNM under capital lease arrangements (see Note 11). Legal title to the purchased assets was transferred to TFM at that time.

	2003
	Balance at beginning of year - net of accumulated depreciation		Additions		Disposals		Transfer and others			Depreciation		Balance at end of year - net of accumulated depreciation		Estimated useful lives (years)
Locomotives	$	111,644								$	11,609	$	100,035	14
Freight cars		66,023	$	122	$	3,356					5,387		57,402	12 -16
Machinery of workshop		7,000		5			$	387			1,944		5,448	8
Machinery of road		21,712		310				78			1,910		20,190	14
Terminal and other equipment		35,528		1,212		177		17,951			5,153		49,361	1 - 15
Track improvement		234,769		27,391				22,939			9,096		276,003	15 - 48
Buildings		5,368		820		34					177		5,977	20
Overhaul		45,246		9,758							10,197		44,807	8
		527,290		39,618		3,567		41,355			45,473		559,223
Land		37,607		18		198							37,427
Construction in progress		44,470		33,485				(42,174	)				35,781
	$	609,367	$	73,121	$	3,765	($	819	)	$	45,473	$	632,431
	2002
	Balance at beginning of year - net of accumulated depreciation		Additions		Disposals		Transfer and others			Depreciation		Balance at end of year - net of accumulated depreciation		Estimated useful lives (years)
Locomotives	$	123,385			$	122				$	11,619	$	111,644	14
Freight cars		76,905				4,974					5,908		66,023	12 - 16
Machinery of workshop		8,499	$	70			$	337			1,906		7,000	8
Machinery of road		20,790		14		61		2,747			1,778		21,712	14
Terminal and other equipment		36,798		1,571		223		3,069			5,687		35,528	1 - 15
Track Improvement		195,136		5,518				40,885			6,770		234,769	15 - 48
Buildings		5,033		181				292			138		5,368	20
Overhaul		44,092		10,120							8,966		45,246	8
		510,638		17,474		5,380		47,330			42,772		527,290
Land		37,459				14		162					37,607
Construction in progress		20,624		71,881				(48,035	)				44,470
	$	568,721	$	89,355	$	5,394	($	543	)	$	42,772	$	609,367

Depreciation of property, machinery and equipment was $39.5 million in 2001, $42.8 million in 2002 and $45.5 in 2003.

(16)

NOTE 5—FINANCING:

Financing is summarized as follows:

	December 31,
	2002							2003
	Proceeds		Deferred financing costs/ discount			Borrowings		Proceeds		Deferred financing costs/ discount			Borrowings
Short-term debt:
Commercial paper (1)								$	85,000	($	593	)	$	84,407
Current portion of long-term debt:
Term loan facility (2)	$	18,286				$	18,286		109,713		(1,380	)		108,333
	$	18,286				$	18,286	$	194,713	($	1,973	)	$	192,740
	December 31,
	2002							2003
	Proceeds		Deferred financing costs/ discount			Borrowings		Proceeds		Deferred financing costs/ discount			Borrowings
Long-term debt:
Senior notes due 2007 (3)	$	150,000				$	150,000	$	150,000				$	150,000
Senior discount debentures (4)		443,501	($	7,592	)		435,909		443,501	($	6,247	)		437,254
Senior notes due 2012 (5)		180,000		(25,654	)		154,346		180,000		(22,065	)		157,935
Commercial paper (1)		122,000		(1,517	)		120,483
Term loan facility (2)		109,714		(1,897	)		107,817
	$	1,005,215	($	36,660	)	$	968,555	$	773,501	($	28,312	)	$	745,189

On September 17, 2002, the total amount of the initial commercial paper was due and the Company entered into two new bank facilities provided by a consortium of banks for an aggregate amount of $250 million in order to refinance the initial commercial paper program (the “Credit Agreement”). The Company repaid the remaining $60 million of indebtedness outstanding under the former commercial paper program.

According to the Credit Agreement, the Company entered into two new bank facilities as follows:

(1) New commercial paper

The second and new commercial paper program consists of a two-year facility in the amount of $122,000, which is supported by a letter of credit issued under the bank facility. The new commercial paper facility allows the Company to draw-down advances from time to time, subject to certain terms and conditions. The obligations of the new commercial paper facility rank at least pari passu with the other senior unsecured indebtedness.

The average interest rate for the year ended December 31, 2002 and 2003 was 1.87% and 1.28%, respectively.

(2) Term loan facility

The term loan facility is a four-year term loan in the amount of $128,000. The term loan is payable in semi-annual installments beginning in September 2003 and ending in September 2006 and bearing interest at Libor plus applicable margin. The obligations of the term loan facility rank at least pari passu with the other senior unsecured indebtedness. The average interest rate for the year ended December 31, 2002 and 2003 was 4.44% and 3.97%, respectively.

On October 22, 2003, the Company began discussions with the Syndicate Members towards the refinancing the outstanding balance of the existing $122,000 commercial paper program, including the reduction of such program to a maximum amount of $85,000 and the required changes to financial covenants to the above mentioned credit agreements.

As of March 19, 2004, date of issuance of these combined and consolidated financial statements the Company is still discussing the terms of the refinancing of its commercial paper program.

(3) Senior notes due 2007

In June 1997 the Company issued US dollar denominated securities bearing interest semiannually at a fixed rate of 10.25% and maturing on June 15, 2007.

Interest expense related with the senior notes amounted $16,167, for each one of the years ended December 31, 2001, 2002 and 2003.

(4) Senior discount debentures (“SDD”)

The US dollar denominated SDD were sold in June 1997, at a substantial discount from their principal amount of $443,501, and no interest was payable thereon prior to June 15, 2002. The SDD will mature on June 15, 2009. The SDD yield 11.75% fixed rate at semiannual specified date an accreted value, computed on the basis of semiannual compounding and maturing on June 15, 2002. Interest on the SDD is payable semiannually at a fixed rate of 11.75%, commencing on December 15, 2002. The SDD are redeemable at the option of the Company, in whole or in part, at any time on or after June 15, 2002, at a certain redemption price of 100% starting on June 15, 2004 from and thereafter (expressed in percentages of principal amount at maturity), plus accrued and unpaid interest, if any.

(18)

Interest expense related with the SDD amounted $47,763, $53,406 and $54,796 during 2001, 2002 and 2003, respectively.

(5) Senior notes due 2012

TFM completed a solicitation of consents of holders of 10.25% Senior Notes due 2007 and 11.75% SDD due 2009 senior notes and its debentures to an amendment providing for certain changes to the “Limitation on Restricted Payments”, “Limitation on Indebtedness”, and “Limitation on Liens” covenants in each of the indentures pursuant to which the securities were issued. TFM obtained the requisite consents and paid a fee of $16,972 to allow it to issue additional $180,000 in new debt and to purchase the call option shares in Grupo TFM held by the Government (see Note 8).

In June 2002, TFM issued senior notes for an aggregate principal amount of $180,000. The senior notes are denominated in dollars, bear interest semi-annually at a fixed rate of 12.50% and mature on June 15, 2012. The senior notes are redeemable at TFM’s option on or after June 15, 2007 and, subject to certain limitations. The senior notes were issued at a discount of $2.5 million, which is being amortized based on the interest method over its term.

The Company incurred and capitalized $25.1 million in consent and professional services fees in connection with the issuance of these notes and is being amortized based on the interest method over the term of the senior notes.

Interest expense related with the senior notes due 2012 amounted to $23,659, for the year ended December 31, 2003.

Covenants

The agreements related to the above-mentioned loans include certain affirmative and negative covenants and maintenance of certain financial conditions, including, among other things, dividend and other payment restrictions affecting restricted subsidiaries, limitation on affiliate transactions and restrictions and asset sales, with which Grupo TFM and subsidiaries were in compliance at December 31, 2002.

On May 2, 2003 the Credit Agreement was amended to restate some covenants for the term loan facility and the commercial paper program.

On October 24, 2003 and on March 10, 2004, TFM received a waiver from the banks which participate in the Credit Agreement of the term loan facility and the commercial paper program. TFM is now waived from the financial covenants under such agreement for the three months ended September 30, 2003 and for the three months ended December 31, 2003, respectively.

(19)

Considering that some financial covenants were breached in 2003, and it is probable that further breaches will occur within twelve months period of the balance sheet date, the outstanding long-term loan facility amounting to $71,762 has been reclassified to short-term debt as of December 31, 2003.

Maturity of long-term debt is as follows:

	December 31,
	2002							2003
	Proceeds		Deferred financing costs/ discount			Borrowings		Proceeds		Deferred financing costs/ discount			Borrowings
2004	$	158,570	($	2,034	)	$	156,536
2005		36,572		(517	)		36,055
2006		36,572		(863	)		35,709
2007		150,000					150,000	$	150,000				$	150,000
2008 and thereafter		623,501		(33,246	)		590,255
2009 and thereafter									623,501	($	28,312	)		595,189
	$	1,005,215	($	36,660	)	$	968,555	$	773,501	($	28,312	)	$	745,189

NOTE 6—FINANCIAL INSTRUMENTS:

Fuel swap contracts

The Company may seek to assure itself of more predictable fuel expenses through U.S. fuel swap contracts. TFM’s fuel hedging program covered approximately 25% of estimated fuel purchases. Hedge positions are also closely monitored to ensure that they will not exceed actual fuel requirements in any period.

As of December 31, 2002, the Company had ten swap contracts outstanding for 5,000,083 gallons of fuel which expired in January and February 2003. The realized gain was $1,548 and the Company has only recorded at December 31, 2002 a benefit of $1,009 and in 2003 the remaining $539 were recognized.

As a result of the fuel swaps contracts acquired during 2003, the realized gain was $849. As of December 31, 2003, the Company did not have any fuel future contracts.

Foreign exchange contracts

The purpose of the Company’s foreign exchange contracts is to limit the risks arising from its peso-denominated monetary assets and liabilities.

The nature and quantity of any hedging transactions will be determined by Management of the Company based upon net assets exposure and market conditions.

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As of December 31, 2002, the Company had one Mexican peso call option outstanding in the notional amount of $1.7 million, based on the average exchange rate of Ps11.0 per dollar. This option expired in May 29, 2003.

Additionally, as of December 31, 2002, the Company had one forward contract outstanding in the notional amount of $10 million, based on the exchange rate of Ps9.769 per dollar. This forward expired on February 13, 2003.

As of December 31, 2003, the Company had two Mexican peso call options outstanding in the notional amount of $11.8 million and $1.7 million, respectively, based on the exchange rate of Ps13.00 and Ps.12.50 each one per dollar. These options will expire on September 8, and May 29, 2004, respectively. The premium paid was $250 and $40, respectively.

Fair value of financial instruments

The fair values of cash and cash equivalents, accounts receivable, short-term debt and accounts payable approximate carrying values because of the short maturity of these financial instruments.

The related fair value based on the quoted market prices for the Senior notes due 2007 and SDD or similar issues at December 31, 2002 was $140,625 and $427,334, and at December 31, 2003 was $142,922 and $446,956, respectively. The related fair value based on the quoted market prices for the senior notes due 2012 at December 31, 2002 and 2003 was $179,325 and $205,200, respectively. The carrying amount of commercial paper and term loan facility approximates fair value due to their variable rates.

NOTE 7—BALANCES AND TRANSACTIONS WITH RELATED PARTIES:

	December 31,
	2002		2003
Accounts receivable:
Terminal Ferroviaria del Valle de México, S. A. de C. V.			$	1,550
Other Grupo TMM’s subsidiaries	$	5,316		3,860
	$	5,316	$	5,410
Accounts payable:
KCS	$	1,222	$	4,345
Terminal Ferroviaria del Valle de México, S. A. de C. V.		3,479
Other Grupo TMM’s subsidiaries		4,474		5,665
	$	9,175	$	10,010

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The most important transactions with related parties are summarized as follows:

	Year ended December 31,
	2001		2002		2003
Transportation revenues	$4,431		$10,375		$13,783
Management services	($2,500	)	($  2,500	)	($  2,500	)
Other expenses	($9,161	)	($  9,800	)	($  8,426	)

Grupo TMM management services agreement

The Company and Grupo TMM entered into a management services agreement pursuant to which Grupo TMM provides certain consulting and management services to the Company commencing May 1997 for a term of 12 months and which may be renewed for additional one-year periods by agreement of the parties. Under the terms of the agreement, Grupo TMM is to be reimbursed for its costs and expenses incurred in the performance of such services.

KCS Transportation Company (“KCSTC”) management services agreement

The Company and KCSTC, a wholly owned subsidiary of KCS, entered into a management services agreement pursuant to which KCSTC makes available to the Company certain railroad consulting and management services commencing May 1997 for a term of 12 months and which may be renewed for additional one-year periods by agreement of the parties. Under the terms of the agreement, KCSTC is to be reimbursed for its costs and expenses incurred in the performance of such services.

On April 30, 2002, TFM and KCS, as successor in interest through merger with KCSTC, as well as TFM and Grupo TMM, entered into amendments to the management services agreements that provides for automatic renewal of the agreements and compensates KCS and Grupo TMM for their services under the agreements. The amendments state that KCS and Grupo TMM are entitled to receive (1) $2,500,000 paid in nine equal monthly installments beginning in April 2002, as compensation for services rendered between January 1, 1999 and December 31, 2000; (2) and additional $2,500,000 in a lump sum payment on or before January 2, 2003 as compensation for services rendered from January 1, 2001 through December 31, 2002; and (3) quarterly service payments, payable in arrears, for the period beginning January 1, 2003 at an annual rate of $1,250,000. The management services agreements are terminable by either party upon 60 days written notice.

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NOTE 8—STOCKHOLDERS’ EQUITY:

Grupo TFM’s capital stock is variable with a fixed minimum of Ps50,000 and an unlimited maximum. The capital stock of Grupo TFM is divided into series without par value, whose principal differences relate to: a) Series “A” shares with voting rights, which can be held only by persons or companies of Mexican nationality and represent up to 51% of the capital stock of Grupo TFM; b) Series “B” shares with voting rights, which can be held by persons or companies of non-Mexican nationality and represent up to 49% of the capital stock of Grupo TFM, unless authorized by the National Commission of Foreign Investments, in which case the percentage can be higher, and c) Series “L” shares with restricted voting rights, which are not entitled to a dividend preference.

In connection with the original formation of Grupo TFM, the Government purchased a 24.63% non-voting interest in Grupo TFM for $198.8 million. The Government also granted the original shareholders of Grupo TFM an option (the “call option”) to purchase the Government’s equity interest in Grupo TFM. TFM has been appointed as the purchaser and, on July 29, 2002, purchased all of the call option shares for an aggregate purchase price of $256.1 million. The purchase price for the call option shares was financed through (1) a portion ($162,575) of the proceeds of the issuance of $180,000 of debt securities by TFM (see Note 5) and approximately $93,555 was applied against note receivables from the Government. Thus, the shares acquired by TFM are being considered as treasury shares.

At December 31, 2003 the capital stock of Grupo TFM is represented by 10,063,570 shares as follows:

Stockholders	Number of shares (fixed portion of capital stock)	Number of shares (variable portion of capital stock)
	Series “A”	Series “A”
TMM Multimodal	25,500	3,842,901
	Series “B”	Sub-series “B”
Nafta	24,500	3,692,199
		Sub-series “L-2”
TFM (treasury shares)		2,478,470
Total	50,000	10,013,570

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Pursuant to the new shares sub-series “L-2” granted to TFM, the voting rights attached to these shares are limited to the following matters: (i) extension of the duration of the Company; (ii) premature dissolution of the Company; (iii) change in the object of the Company; (iv) change of nationality of the Company; (v) transformation of the Company; (vi) merger with another company; (vii) the split-up of the Company and (viii) the cancellation of the registration of the shares with the Mexican Stock Exchange or any foreign stock exchange of the shares which might be registered. Except as described above, holders of Sub-series “L-2” shares have no voting rights. Grupo TFM Sub-series “L-2” shares do not confer upon the holders thereof any right to preference dividends.

The sub-series “L-1” shares that were previously held the by Government were cancelled as the call option was appointed by TFM.

At the General Ordinary Stockholders’ Meeting held on December 21, 2001, the stockholders of Grupo TFM agreed to pay dividends of $33,819, equivalent to $3.3605 per share.

At the Unanimous Resolutions Meeting held on December 21, 2001, the stockholders of TFM agreed to pay dividends of $33,165, equivalent to $0.0002396 per share.

On March 26, 2002, the Company received the ruling from Mexican Court annulling the Ordinary Stockholders’ Meeting mentioned above. As a consequence the Unanimous Resolutions Meeting mentioned above, was also annulled, thus the dividends, agreed in both Meetings, were cancelled in the consolidated financial statements as of December 31, 2001, giving retroactive effect to said annulment. Thus, the amounts paid in this regard were applied against the acquisition of Mexrail and the purchase price of the 24.63%. (See Note 1).

The Government retained a 20% interest in TFM’s shares and reserved the right to sell such shares by October 31, 2003 in a public offering. In the event that such public offering does not occur by October 31, 2003, Grupo TFM may purchase the Government’s equity interest in TFM at a purchase price equal to the per share price initially paid by Grupo TFM, indexed based on Mexican inflation. If Grupo TFM does not purchase the Government’s TFM interest, the Government may require Grupo TMM and KCS to purchase the TFM shares at the price discussed above. See actual events on Note 11.

Dividends paid are not subject to income tax if paid from the Net Tax Profit Account and will be taxed at a rate that fluctuates between 4.62% and 7.69% if they arise from the Reinvested Net Tax Profit Account. Any excess over this account is subject to a tax equivalent to 49.25% and 47.06% depending on whether paid in 2004 or 2005, respectively. The tax is payable by the Company and may be credited against its income tax in the same year or the following two years. Dividends paid are not subject to tax withholding.

In the event of a capital reduction, any excess of stockholders’ equity over capital contributions, the latter restated in accordance with the provisions of the Income Tax Law, is accorded the same treatment as dividends.

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NOTE 9—OTHER INCOME (EXPENSES):

	December 31,
	2001			2002			2003
Fees paid in VAT Lawsuit (1)				($	6,260	)	($	26,701	)
Sales of property and equipment—Net	($	7,585	)		(6,897	)		(2,909	)
Costs of locomotive sublease		(1,452	)		(1,256	)		(1,240	)
Electric locomotive maintenance		(2,469	)		(2,428	)		(2,428	)
Gain on sale of Hercules Mariscala Line		60,744			2,384
Equity in Terminal Ferroviaria del Valle de
México		(915	)		1,269			282
Recoverable income tax		2,861						1,222
Other—Net		(15,612	)		(6,067	)		(3,608	)
	$	35,572		($	19,255	)	($	35,382	)

(1) As a result of the resolution of the courts regarding the VAT claim, in which TFM won on August 13, 2003, TFM has paid to external lawyers handling the case on behalf of the Company, fees in accordance with the terms of the agreements. Notwithstanding, in accordance with IAS the VAT recovery is a contingency gain as of December, 31, 2003. (See Note 11)

NOTE 10—INCOME TAX, EMPLOYEES’ STATUTORY PROFIT SHARING, ASSET TAX AND TAX LOSS CARRYFORWARDS:

Income tax

Grupo TFM and its subsidiaries compute income tax on an individual basis. However, Grupo TFM and its subsidiaries (except Mexrail and its subsidiary) report tax results to Grupo TMM at the 60% from its holding interest in each subsidiary to determine Grupo TMM’s consolidated tax result. Thus, Arrendadora TFM owes income tax of $2,551 to Grupo TMM as of December 31, 2003.

Grupo TFM and its subsidiaries had historical combined losses for tax purposes of $51,680, $401,415 and $234,403 for the years ended December 31, 2001, 2002 and 2003, respectively. The difference between tax losses and book income (loss) is due principally to the inflation gain or loss recognized for tax purposes, the difference between book and tax depreciation and amortization, non-deductible expenses and temporary differences for certain items that are reported in different periods for financial reporting and income tax purposes.

(25)

The expense for income tax charged to income was as follows:

	Year ended December 31,
	2001		2002		2003
Current income tax expense	$	79	$	—	$	10,763
Deferred income tax expense		2,573		30,233		22,127
Net income tax expense	$	2,652	$	30,233	$	32,890

Reconciliation of the income tax expense based on the statutory income tax rate to recorded income tax expense was as follows:

	Year ended December 31,
	2001			2002			2003
Income (loss) before income tax	$	104,832		$	19,904		($	28,203	)
Income tax at 35% in 2001 and 2002 and 34% in 2003	$	36,691		$	6,967		($	9,589	)
(Decrease) increase resulting from:
Effects of inflationary and devaluation components		28,680			(42,251	)		(15,347	)
Indexation of depreciation and amortization		(39,648	)		48,117			30,154
Effects of inflation on tax loss carryforwards		(26,202	)		14,281			(9,222	)
Non-deductible expenses		911			2,128			578
Change in tax rate from 35% to 32%					(1,837	)		2,992
Other - Net		2,220			3,828			2,630
Net deferred income tax expense	$	2,652		$	30,233		$	32,890

According to the amendments to the Mexican Income Tax Law in 2002, the income tax rate will decrease one percent per year from 35% starting in 2003 up to 32% in 2005.

(26)

The components of deferred tax assets and (liabilities) are comprised of the following:

	December 31,
	2002			2003
Tax-loss carryforwards	$	381,954		$	478,947
Inventories and provisions - Net		31,255			20,597
Machinery and equipment		(42,951	)		(48,224	)
Concession rights		(264,046	)		(367,949	)
Other		(5,240	)		(4,526	)
Net deferred income tax asset	$	100,972		$	78,845

The Company has recognized deferred tax assets related to its tax loss carryforwards and other items after evaluating the reversal of existing taxable temporary differences. To the extent that the balance of the deferred tax assets exceeds the existing temporary differences. Management has evaluated the recoverability of such amounts by estimating future tax profits expected in the foreseeable future and the remaining tax loss carryforward periods which extend between 2012 through 2046. The tax profits include estimates of profitability and macroeconomic assumptions which are based on Management’s best estimate as of this date.

Employees’ statutory profit sharing

Employees’ statutory profit sharing is determined by the Company at the rate of 10% on taxable income, adjusted as prescribed by the Mexican Income Tax Law. For the years ended December 31, 2001, 2002 and 2003, there was no basis for employees’ statutory profit sharing.

Asset tax

The Asset Tax Law establishes a tax of 1.8% on the average of assets, less certain liabilities, which is payable when it exceeds the income tax due. For the year ended December 31, 2001 the Company was not subject to assets tax. There was no asset tax due in 2002 and 2003.

Tax loss carryforwards

At December 31, 2003 Grupo TFM and its subsidiaries had combined tax loss carryforwards, which under the Mexican Income Tax Law are inflation-indexed through the date of utilization as shown in next page.

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Year in which     loss arose	Inflation-indexed amounts as of December 31, 2003		Year of expiration
1996	$	14,130	2046
1997		228,092	2046
1998		339,384	2046
1999		9,049	2046
2000		160,049	2046
2001		68,743	2046
2002		398,791	2012
2003		274,817	2013
	$	1,493,055

NOTE 11 - COMMITMENTS AND CONTINGENCIES:

Commitments:

Concession duty

Under the Concession, the Government has the right to receive a payment from the Company equivalent to 0.5% of the gross revenue during the first 15 years of the Concession period and 1.25% during the remaining years of the Concession period. For the years ended December 31, 2001, 2002 and 2003 the concession duty expense amounted to $3,391, $3,267 and $3,599, respectively, which was recorded as operating expense.

Capital lease obligations

At December 31, 2002 and 2003, the outstanding indebtedness corresponds to two land capital leases for a period of ten years, in which TFM has the option to purchase them at the end of the agreement term.

Locomotives operating leases

In May 1998 and September 1999, the Company entered into operating lease agreements for 75 locomotives each, which expire over the next 17 and 18 years, respectively. At the end of the contracts the locomotives will be returned to the lessor. As of December 31, 2003, the Company had received 150 locomotives. Rents under these agreements amounted $28.8 million in 2001, $29.1 million in 2002 and $29.1 million in 2003.

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Future minimum payments, by year and in the aggregate, under the aforementioned leases are as follows:

	At December 31,
Year ending December 31,	2002		2003
2003	$	29,095
2004		29,135	$	29,135
2005		29,095		29,095
2006		29,095		29,095
2007		29,095		29,095
2008 and thereafter		344,173		29,135
2009 and thereafter				315,038
	$	489,688	$	460,593

Railcars operating leases

The Company leases certain railcars under agreements, which are classified as operating leases. The term of the contracts fluctuate between 3 and 15 years. Future minimum rental payments, under these agreements are shown as follows:

	At December 31,
Year ending December 31,	2002		2003
2003	$	32,830
2004		18,064	$	31,930
2005		12,504		15,592
2006		10,012		12,642
2007		9,084		10,433
2008 and thereafter		51,143		9,498
2009 and thereafter				40,942
	$	133,637	$	121,037

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Locomotives maintenance agreements

The Company has entered into two locomotives maintenance agreements, which expire in 2004 and 2018 with third-party contractors. Under current arrangements, the contractors provide both routine maintenance and major overhauls at an established rate in a range from four to five hundred dollars per locomotive per day.

Track maintenance and rehabilitation agreement

In May 2000, the Company entered into a track maintenance and rehabilitation agreement, which expires in 2012. Under this contract, the contractor provides both routine maintenance and major rehabilitation to the Celaya - Lazaro Cardenas stretch, which is comprised of approximately 350 miles. Maintenance and rehabilitation expense amounted to $30.2 million in 2001, $35.6 million in 2002 and $3.4 million in 2003. Under this agreement, the Company will pay approximately $30 million in the following 10 years.

Fuel purchase agreement

On December 19, 1997, the Company entered into a fuel purchase agreement with PEMEX Refinación, under which the Company has the obligation to purchase at market price a minimum of 15,000 cubic meters and a maximum of 20,000 cubic meters per month of PEMEX diesel. The term of the agreement is indefinite but can be terminated for justified cause by each party with a written notification upon three months notice.

Fuel freight service agreement

On October 30, 2002, the Company entered into a freight service agreement with PEMEX Refinación, which will expire until 2006. Under this agreement the Company has the obligation to provide services amounting in pesos by year as shown below:

	Minimum	Maximum
2003	Ps 126,264	Ps 315,659
2004	98,769	246,922
2005	98,769	246,922
2006	65,756	164,390
	Ps 389,558	Ps 973,893

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Contingencies:

A) Value Added Tax Lawsuit

The Company has filed a claim for the refund of approximately $262 million (Ps 2,111 million) of value added tax (“VAT”) paid in connection with the Acquisition (see Note 1).

On September 25, 2002 the Mexican Magistrates Court of the First District (the “Federal Court”) issued its judgment in favor of TFM on the VAT claim, which has been pending in the Mexican Courts since 1997. The claim arose out of the Mexican Treasury’s delivery of a VAT refund certificate to a Mexican governmental agency rather than to TFM. By a unanimous decision, a three-judge panel of the Federal Court vacated a prior judgment of the Mexican Fiscal Court (Tribunal Federal de Justicia Fiscal y Administrativa) and remanded the case to the Mexican Fiscal Court with specific instructions to enter a new decision consistent with the guidance provided by the Federal Court’s ruling. The Federal Court’s ruling required the fiscal authorities to issue the VAT refund certificate in the name of TFM. On December 6, 2002 the upper chamber of the Mexican Fiscal Court issued a ruling denying TFM’s right to receive a value added tax refund from the Government. On January 8, 2003, TFM was officially notified of the new judgment of the Fiscal Court and on January 29, 2003, filed the appropriate appeal.

On June 11, 2003 the Federal Court issued a judgment in favor of TFM against the ruling of the Fiscal Court. On July 9, 2003 TFM was formally notified by a three-judge panel of the Federal Court of its June 11, 2003 judgment, which granted TFM constitutional protection (“amparo”) against the ruling of the Fiscal Court issued on December 6, 2002, which had denied TFM the right to receive the VAT refund certificate. The Federal Court found that the VAT refund certificate had not been delivered to TFM, and confirmed the Fiscal Court’s determination that TFM had the right to receive the VAT refund certificate. The Federal Court’s ruling stated that the Treasury’s decision denying delivery of the VAT refund certificate to TFM violated the Mexican Law, and it instructed that the VAT refund certificate be issued to TFM on the terms established by Article 22 of the Mexican Fiscal Code in effect at that time.

In a public session held on August 13, 2003, the Fiscal Court issued a resolution regarding TFM’s VAT lawsuit vacating its previous resolution of December 6, 2002, and in strict compliance with the ruling issued on June 11, 2003, by the Fiscal Court, resolved that TFM had proved its case, and that a “ficta denial” occurred, declaring such denial null and void as ordered by the Fiscal Court. On August 25, 2003, TFM was formally notified by the Fiscal Court of its resolution regarding TFM’s VAT lawsuit. The resolution was the result of the unanimous vote of the nine magistrates present at the public session. The Fiscal Court ordered the issuance of the

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VAT refund certificate to TFM under the terms established by Article 22 of the Mexican Fiscal Code in effect in 1997. On October 13, 2003 the Mexican Tax Attorney of the Federal Government (Procuraduría Fiscal de la Federación) filed for a review of the Fiscal Court’s ruling issued on August 13, 2003. On November 5, 2003, the Federal Court found no merit to the requested review and as a result, the August 13, 2003 Fiscal Court’s ruling remains in place.

On January 19, 2004, the Mexican Treasury delivered to TFM, pursuant to the August 13, 2003 Fiscal Court ruling, a Special VAT Certificate representing the historical claim amount of Ps2,111 million, or approximately $188 million as of December 31, 2003. TFM will continue seeking for the additional amounts representing the effect of inflation and interest on the original claim amount.

Recent events

On January 20, 2004, the Mexican Fiscal Administration Service (“Servicio de Administración Tributaria” or “SAT”) issued a provisional attachment of the Special VAT Certificate, stating that the documents that support the value of the Special VAT Certificate do not comply with applicable tax requirements. TFM has publicly stated it will oppose the SAT’s action through all possible legal means.

In the preliminary summation finding, the SAT noted that the Company, “… wrongfully declared a VAT receivable for Ps2,111 million, which in the Company’s opinion refers to expenses that do not comply with fiscal requirements, and therefore, are not deductible. In our view, TFM did not prove its VAT claim with corresponding documentation, which incorporates fiscal requisites as to the identity of the taxpayer, its tax identification code, address of the seller and buyer of the assets in question, and the VAT shown as separate from the principal…” and as a result, the VAT cannot be credited. TFM has not made any reserve for this purported claim as it believes that it has not merits and as of today, no tax liability has been levied against TFM, as the final summary of the audit is still pending.

B) The Mexican Government Put

In October 2003, Grupo TFM requested that a federal judge in Mexico provide an appropriate interpretation of the Put Agreements. When the Government opened the Mexican railroad system to private investment, it retained a 20% equity interest in TFM. The intention was to sell these shares through a public offering, at such time as the Government considered it appropriate and with approval of the Comisión Nacional Bancaria y de Valores- “CNBV”, with the objective of strengthening the market for public investments in Mexico and encouraging additional investors to invest in the capital stock of TFM.

Additionally, TFM’s bid contained the following condition: “The franchise purchasers will be obligated to acquire the equity portion that cannot be placed in the Bolsa Mexicana de Valores- “BMV”, at the initial offering prices plus respective interest”.

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The Company believes that under the Put Agreements, the Government agreed to comply with the following process in order to sell the equity interest that the Government retains in TFM:

1. Register the TFM shares with the BMV;

2. Receive the approval of the CNBV to exercise the put;

3. Request that TFM provide all information necessary to place the Government’s equity stake in the equity markets; and

4. Place the number of TFM shares it is able to in the equity markets once all necessary approvals are granted.

When the above steps are completed, the Government is to notify Grupo TFM of the number of TFM shares that could not be placed in the equity markets and is to request that Grupo TFM acquire those shares at the minimum stipulated price. The Company does not believe that any of the steps described above have been carried out. As a result, the Company believes that the Government has not yet completed the steps required for it to request that Grupo TFM acquire the equity stake in TFM held by the Government.

The price of the Government’s interest, as indexed for Mexican inflation, as of December 31, 2003 was approximately 1,570.3 million UDIS (representing Ps5,264 million, or approximately $468.4 million). This amount may not be equal to the fair market value of the Mexican Government’s interest. Nevertheless, if the Government’s put rights were properly exercised and the transaction was consummated, purchase accounting would apply and goodwill may be recognized for the excess, if any, of the purchase price over the fair value of net assets acquired.

Nevertheless, and notwithstanding the judicial proceeding initiated by Grupo TFM in October 2003, on October 31, 2003, the SCT requested that Grupo TFM confirm whether it intends to purchase the TFM shares subject to the put rights of the Government. Grupo TFM responded that the purchase of the Government’s shares of TFM was the subject of an ongoing judicial proceeding that had yet to be resolved. On November 3, 2003, the SCT stated in a communication to Grupo TFM that it had complied with the requirements for the exercise of its put rights as set out in the Put Agreements and that all procedures required to execute the sale of the Government’s TFM shares would be made through the SAT.

(33)

Grupo TFM requested that a federal court review the SCT’s communications with respect to the Government’s put rights. On December 16, 2003, the Fourth Administrative District Court issued an injunction ordering the parties to maintain the status quo pending judicial resolution of the dispute. In order for the injunction to be effective, the Fourth Administrative District Court required that Grupo TFM post a bond for the equivalent of six months of interest on the exercise price of the Government’s put option to be calculated at an interest rate of 6% per annum (approximately Ps160 millions or approximately $14.3 million at December 31, 2003).

However, as no further action has been taken by the Government to enforce its rights in connection with the put shares, Grupo TFM’s obligation to post such a bond is considered discretionary under Mexican law. Consequently, Grupo TFM has elected, for the time being, not to post the bond so as not to incur unnecessary expense. Grupo TFM has the right to post the bond at any time while the amparo proceeding is pending. Grupo TFM will vigorously defend its view that the Government has not fulfilled the prescribed steps required to exercise its put rights. Although Grupo TFM believes that it will prevail in legal proceedings related to these matters, there can be no assurance that it will prevail.

In the event that Grupo TFM does not purchase the Government’s put, Grupo TMM and KCS, or either Grupo TMM or KCS, are obligated to purchase the Government’s interest. Grupo TMM and KCS have cross indemnities in the event the Government requires only one of them to purchase its interest. The cross indemnities allow the party required to purchase the Government’s interest to require the other party to purchase its pro rata portion of such interest.

C) Ferrocarril Mexicano, S. A. de C. V. (“Ferromex”) disputes

TFM and Ferromex have not been able to agree upon the rates each of them is required to pay to the other for interline services and haulage and trackage rights. Therefore, in accordance with TFM’s rights under the Mexican railroad services law and regulations, in February 2001, TFM initiated and administrative proceeding requesting a determination of such rates by the SCT.

In September 2001, Ferromex filed a legal claim against TFM relating to the payments that TFM and Ferromex are required to make to each other for interline services and trackage and haulage rights. TFM believes that this legal claim is without merit, and that the payments for interline services and trackage and haulage rights owed to TFM by Ferromex exceed the amount of payments that Ferromex claims TFM owes to Ferromex for such services and rights. Accordingly, TFM believes that the outcome of this legal claim will not have a material adverse effect on the financial condition of TFM. On September 25, 2002, the Third Civil Court of Mexico City rendered its judgment in favor of TFM. Ferromex appealed the judgment and TFM prevailed in such appeal. Ferromex went in last resource, to the “amparo” proceedings before Federal Courts, and obtained a resolution that orders the higher local court to review the case again exclusively for the interline services. The higher local issued a new ruling which both, Ferromex and TFM claimed in a new “amparo” proceeding at the Federal Court, and which is pending resolution. TFM cannot predict whether it will ultimately prevail.

(34)

In connection with the Ferromex claim, Ferromex temporarily prevented TFM from using certain short trackage rights which TFM has over a portion of its route running from Celaya to Silao, which is the site of a General Motors plant from where TFM transports finished vehicles to the border crossing at Nuevo Laredo. Ferromex was subsequently ordered by the court to resume giving us access, and in October 2001, TFM filed a counterclaim against Ferromex relating to these actions. TFM has also initiated several judicial and administrative proceedings at the SCT to seek the imposition sanctions on Ferromex for violations to the trackage rights in the route from Celaya to Silao, which as of to date have not been resolved.

TFM has also initiated several administrative and judicial proceedings (including criminal actions) against Ferromex at the SCT and the relevant Federal Courts, in connection with its trackage rights in Altamira, Topo Grande-Chipinque, Guadalajara, Arellano-Chicalote, Ramos Arizpe-Encantada, and Pedro C. Morales-Cerro de la Silla. TFM cannot predict whether it will ultimately prevail on such proceedings.

In March 2002, the SCT issued its ruling in response to TFM’s request, establishing a rate to be charged for trackage rights using the criteria set forth in the Mexican railroad services law and regulations. TFM is appealing the ruling and requesting a suspension of the effectiveness of the ruling pending resolution of its appeal. TFM cannot predict whether it will ultimately prevail. TFM believes that even if the rates established in the ruling goes into effect and TFM and Ferromex begin using the long-distance trackage rights over each other’s rail line, this will not have a material adverse effect on TFM’s results of operations. A separate ruling was issued confirming TFM’s right to use the Celaya-Silao stretch of Ferromex track, which was appealed by Ferromex before Federal Courts obtaining the suspension of such ruling. TFM requested and obtained an “amparo” proceeding against such suspension and Ferromex appealed the resolution granting the “amparo” to TFM. The final resolution on the appeal of Ferromex is pending. TFM cannot predict whether it will ultimately prevail in this “amparo” proceeding as well as on the main procedure regarding TFM’s right to use the Celaya-Silao stretch of Ferromex track.

Both Ferromex and TFM have suspended the reconciliation of their balances in 2003, and have initiated several judicial and administrative proceedings in connection with the amounts payable to each other for interline services, haulage and trackage rights. Those procedures continue under litigation and therefore are pending of final resolution.

D) Dispute between Grupo TMM and KCS

On April 20, 2003, Grupo TMM entered into the Acquisition Agreement with KCS, which owns a 49% voting interest in Grupo TFM, under the terms of which Grupo TMM was to sell its entire interest in Grupo TFM, which owns 80% of TFM and through which its railroad operations are conducted. Under the agreement, KCS was to acquire the Grupo TMM’s interest in Grupo TFM in exchange for $200 million in cash and 18,000,000 shares of common stock of KCS’s successor corporation. In addition, Grupo TMM was to have the right to receive an additional earnout of up to $175 million in cash ($180 million if KCS elected to defer a portion of the payment) in the event that the pending VAT claim against the Government by TFM was

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successfully resolved prior to the execution by the Government of its “put” rights in certain shares of TFM and the amount of VAT Proceeds received was greater than the purchase price of the “put” shares held by the Government. Completion of the TFM sale was subject to approval by (i) holders of Grupo TMM existing notes, (ii) the shareholders of KCS and (iii) the shareholders of Grupo TMM, receipt of certain governmental approvals in the United States and Mexico and other customary conditions. Subsequent to the execution of the Acquisition Agreement, KCS representatives undertook certain activities that Grupo TMM believes jeopardized the economic value to be realized by Grupo TMM and its shareholders form the sale of Grupo TFM. Grupo TMM believes these actions interfered with its ability to realize the earnout and also created the potential for serious detriment to the value of the KCS shares Grupo TMM was to receive in the transaction.

On August 18, 2003, Grupo TMM’s shareholders voted to reject the Acquisition Agreement. In addition, Grupo TMM’s Board of Directors met on August 22, 2003 and voted to terminate the Acquisition Agreement. Grupo TMM sent a notice of termination of the Acquisition Agreement to KCS that day.

KCS has disputed Grupo TMM rights to terminate the Acquisition Agreement and alleged certain breaches by Grupo TMM of the Acquisition Agreement. Under the terms of the Acquisition Agreement, the parties have submitted these disputes to binding arbitration. An arbitration panel has been chosen in accordance with the terms of the Acquisition Agreement. KCS has obtained a preliminary injunction for the Delaware Chancery Court enjoining Grupo TMM from violating the terms of the Acquisition Agreement pending a subsequent decision by a panel of arbitrators regarding whether the Acquisition Agreement was properly terminated.

On December 8, 2003, Grupo TMM and KCS participated in a preliminary hearing with the arbitrators during which the arbitrators deliberated whether the issued of the Acquisition Agreement’s continued effectiveness should be bifurcated from the other issues in the case. On December 22, 2003, the panel bifurcated the issue of whether Grupo TMM properly terminated the Acquisition Agreement for the other disputed issues between the parties. On February 2, 3 and 4, 2004 a hearing was held in New York on the issue of whether Grupo TMM’s termination was proper. Grupo TMM maintained that they properly terminated the Acquisition Agreement while KCS sought a declaration that the Acquisition Agreement was wrongfully terminated. On February 19, 2004, Grupo TMM and KCS filed post-hearing briefs with the panel. Grupo TMM is currently awaiting a ruling from the panel on the issue of whether Grupo TMM’s termination was proper, which ruling is expected from the panel in April 2004. Once the panel issues its ruling, the parties will agree to a schedule to resolve the other remaining issues.

In March 2003, Grupo TMM announced that the three-member panel in the arbitration proceeding between KCS and Grupo TMM concluded, in an interim award, that the rejection of the Acquisition Agreement by Grupo TMM’s shareholders in its vote on August 18, 2003, did not authorized Grupo TMM to terminate the Agreement. Accordingly, the three-member panel indicated the Agreement will remain in force and binding on the parties until otherwise terminated according to its terms or by law. In reaching the conclusion, the panel found it

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unnecessary to determine whether approval by Grupo TMM’s shareholders is a “condition” of the Agreement.

Grupo TMM continues to believe that any transaction cannot occur without approval of the Company’s shareholders, and the panel’s decision did not reach a conclusion on that issue. The arbitration process will continue, and Grupo TMM will review the interim reward with its counsel and analyze the alternatives available to it in this process.

E) Other Legal Disputes involving KCS

Several Grupo TFM and TFM board of directors meetings have taken place since August 25, 2003. KCS and certain of its representatives have initiated judicial proceedings in Mexico seeking the nullification of such board meetings. In addition, KCS has initiated another proceeding seeking the nullification of Grupo TFM’s November 24, 2003 shareholders’ meeting. The Company believes that KCS’s claims in this connection are without merit. At present, the Company has responded to all claims concerning which the Company has been served. Although the Company cannot assure the outcome of the proceedings resulting from these claims, the Company believes that none of the underlying claims initiated by KCS in Mexico, if ultimately determined in favor of KCS, will have a material adverse effect on Grupo TFM or TFM.

F) Other legal proceedings

- The Company is a party to various other legal proceedings and administrative actions, all of which are of an ordinary or routine nature and incidental to its operations. Although it is impossible to predict the outcome of any legal proceeding, in the opinion of the Company’s Management, such proceedings and actions should not, individually or in the aggregate, have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

- The Company has significant transactions and relationships with related parties. Because of these relationships, in accordance with the Mexican Income Tax Law, the Company must obtain a transfer pricing study that confirms that the terms of these transactions are the same as those that would result from transactions among wholly unrelated parties. The Company is in the process of completing this study.

- In January 2004, TFM and Arrendadora TFM assumed joint and several responsibility for the prepayment of federal taxes.

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- The SAT, which is empowered to verify tax results for the last five years, is performing a review of the TFM´s 2000 and 2001 tax results. At present no final conclusion has been reached from the tax authorities; however, the Company considers that no material adverse effect would result from these reviews.

NOTE 12—RECONCILIATION OF DIFFERENCES BETWEEN IFRS AND U.S. GAAP:

The Company’s combined and consolidated financial statements are prepared in accordance with IFRS which differ in certain material respects from U.S. GAAP. The main differences between IFRS and U.S. GAAP, as they relate to the Company, are summarized in the following pages. An explanation is provided when considered necessary of the effects on the consolidated net income and on stockholders’ equity.

a. Reconciliation of net income

	Reference to subnote d.	Year ended December 31,
		2001			2002			2003
Net income (loss) under IFRS		$	81,749		($	7,988	)	($	48,939	)
Deferred income tax (expense) benefit	i		(6,679	)		121,738			84,379
Deferred employees’ statutory profit sharing expense (benefit)	i		(2,623	)		25,792			11,528
Deferred charges	ii		(933	)		702
Amortization of deferred charges	ii								34
Depreciation	iii					(459	)		(612	)
Effect of U.S. GAAP adjustments on minority interest			2,047			(29,601	)		(19,076	)
Net income under U.S. GAAP		$	73,561		$	110,184		$	27,314

b. Reconciliation of stockholders’ equity

	Reference to subnote d.	December 31,
		2002			2003
Stockholders’ equity under IFRS		$	712,344		$	663,405
Deferred income tax	i		33,406			117,785
Deferred employees’ statutory profit sharing	i		38,693			50,221
Deferred charges	ii		(231	)		(197	)
Depreciation	iii		(459	)		(1,071	)
Effect on purchase of subsidiary shares	iii		16,447			16,447
Effect of U.S. GAAP adjustments on minority interest			(14,328	)		(33,404	)
Stockholders’ equity under U.S. GAAP		$	785,872		$	813,186

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c. Analysis of changes in stockholders’ equity under U.S. GAAP:

	Reference to subnote d.	December 31,
		2002			2003
Balance at beginning of the year		$	915,341		$	785,872
Effect on purchase of subsidiary shares	iii		(34,749	)
Treasury shares			(204,904	)
Net income			110,184			27,314
Balance at end of the year		$	785,872		$	813,186

d. Significant differences between IFRS and U.S. GAAP:

i. Deferred income tax and employees’ statutory profit sharing

The deferred income tax included in the consolidated financial statements was calculated in accordance with the IAS-12 (revised) which requires the recording of deferred taxes for fixed assets and concession, including the effects of indexing for tax purposes.

U.S. GAAP prohibits recognition of deferred tax assets or liabilities for differences related to assets and liabilities that are remeasured from the local currency into the functional currency using historical exchange rates and that result from changes in exchange rates or the indexation for tax purposes.

In Mexico, companies are obligated to pay their employees a portion of the net income as defined by specific regulations. For U.S. GAAP purposes, deferred profit sharing liabilities or assets would be recorded for temporary differences that may arise in the determination of the current liability based on the statutory rate of 10%. These temporary differences are similar to those that exist for deferred income tax purposes. IFRS do not require the establishment of assets or liabilities for these differences.

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The differences in the net deferred income tax and employees’ statutory profit sharing assets determined under U.S. GAAP and IFRS at December 31, 2002 and 2003 are summarized below:

	Deferred income tax assets						Deferred profit sharing assets
	2002			2003			2002			2003
Amounts recorded under IFRS	$	100,972		$	78,845		$	-		$
Amount determined under U.S. GAAP		134,378			196,630			38,693			50,221
Net difference	($	33,406	)	($	117,785	)	($	38,693	)	($	50,221	)

Under U.S. GAAP, employee profit sharing would be considered as operating expense.

ii. Deferred charges

During 2001, the Company incurred in certain financing costs paid to third parties which were capitalized under IFRS amounting to $933. Under U.S. GAAP, it is required that these costs are expensed as incurred.

Additionally during 2002, the Company incurred in certain expenses related with the $180,000 senior notes as mentioned in Note 5. Under U.S.GAAP the legal fees for the exchange of such senior notes amounting to $231 should be expensed as incurred. Nevertheless, under IFRS these expenses should be capitalized and amortized over the period of the senior notes. The amortization for the year ended December 31, 2003 was 34.

iii. Mexrail transaction

As more fully described in Note 1, on March 27,2002, Grupo TMM and KCS sold their respective interests in Mexrail to TFM for an aggregate purchase price of $64 million. Under U.S. GAAP, TFM has recorded this transaction pursuant to SFAS No. 141 “Business Combinations” with partial fair value step-up (49%), for KCS’s investment, being recognized for the assets and liabilities being acquired. Thus, the amount recorded was $20,557 and the corresponding deferred income tax (45%) for $9,249, both allocated in fixed assets. During the year ended December 31, 2003 the depreciation was $612 ($459 for 2002). The portion sold by Grupo TMM to TFM (51%) amounting to $21.4 million was accounted for on a historical carryover basis since both Mexrail and TFM are under the common control of Grupo TMM. Thus, the effect of the latter affected stockholders’ equity by $16.4 million (80%) and minority interest by $4.1 million.

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iv. Earnings per share

The weighted average number of shares outstanding for the years ended December 31, 2001, 2002 and 2003 was 10,063,570; 9,011,069 and 7,585,100, respectively. The net income per share (basic and diluted) under U.S. GAAP was $7.31 in 2001, $12.23 in 2002 and $3.60 in 2003.

v. Intangible assets and long-lived assets

In accordance with IFRS, impairments are recognized using discounted operating cash flows, while under U.S. GAAP the Company must use undiscounted cash flows. Under both methods, there is no impairment of intangible assets and long-lived assets.

vi. Deferred financing costs

For U.S. GAAP purposes costs of issuing debt should be deferred as an asset and amortized by periodic charges to the income statement using the interest method over the life of the debt. Under IFRS, those costs are presented net from the debt proceedings.

vii. Effect of recently issued accounting standards as they relate to the Company

In April 2003, SFAS No. 149 Amendments to SFAS No. 133 (“SFAS No. 133”) on “Derivative Instruments and Hedging Activities” was issued and is applicable for contracts entered into or modified after June 30, 2003. The requirements of SFAS No. 133, as amended by SFAS 149 requires all derivative instruments to be recognized as either assets or liabilities on the balance sheet, measured at fair values. The statement permits special hedge accounting for fair value, cash flow and foreign currency hedges providing specific criteria are met. Certain aspects of the required hedge criteria do not allow portfolio hedging.

In May 2003, Statement of Financial Accounting Standard No. 150 (“SFAS 150”) “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS 150 improves the accounting for certain free standing financial instruments that, under previous guidance, issuers could account for as equity. SFAS 150 requires that certain instruments be classified as liabilities in the statements of financial position. With the exception of the deferral of the provisions related to mandatorily redeemable non controlling interests, SFAS No. 150 is applicable for all financial instruments entered into or modified after May 31, 2003 and is otherwise applicable at the beginning of the first interim period after June 15, 2003.

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In January 2003, FIN 46 “Consolidations of Variable Interest Entities” (“FIN 46”), was issued and clarifies the application of Accounting Research Bulletin No. 51 “Consolidated Financial Statements”, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. These types of entities are referred to as VIEs. For all Special Purpose Entities (“SPEs”) created prior to February 1, 2003, public companies must apply either the provisions of FIN 46 or early adopt the provisions of FIN 46-R at the end of the first interim or annual reporting period ending after December 15, 2003 (i. e., as of December 31, 2003 for an entity with a calendar year-end). If a public company applies FIN 46 for such period, the provisions of FIN 46-R must be applied as of the end of the first interim or annual reporting period ending after March 15, 2004. For all non-SPEs created prior to February 1, 2003, public companies will be required to adopt FIN 46-R at the end of the first interim or annual reporting period ending after March 15, 2004. For all entities (regardless or whether the entity is an SPE) that were created subsequent to January 31, 2003, public companies were already required to apply the provisions of FIN 46, and should continue doing so unless they elect to early adopt the provisions of FIN 46-R as of the first interim or annual reporting period ending after December 15, 2003. If they do not elect to early adopt FIN 46-R, public companies would be required apply FIN 46-R to these post-January 31, 2003 entities as of the end of the first interim or annual reporting period ending after March 15, 2004.

The Company is currently evaluating the impact, if any, that the adoption of the above mentioned standards may have on the combined and consolidated financial statements.

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e. Condensed combined and consolidated balance sheets and income statements

The following condensed combined and consolidated balance sheets and income statements reflect the effects of the principal differences between IFRS and U.S. GAAP:

	Condensed combined and consolidated Balance Sheets
	December 31,
	2002			2003
Total current assets	$	265,250		$	225,742
Long-term account receivable		1,388			1,350
Concession rights and related assets - Net		1,215,487			1,174,217
Property, machinery and equipment - Net		638,716			660,294
Deferred income taxes and employees’ statutory profit sharing		163,822			238,474
Other non-current assets		41,850			37,447
Total assets	$	2,326,513		$	2,337,524
Total short-term liabilities	$	147,295		$	362,689
Total long-term liabilities		1,045,287			806,660
Total liabilities		1,192,582			1,169,349
Minority interest		348,059			354,989
Capital stock		807,008			807,008
Treasury Shares		(204,904	)		(204,904	)
Effect on purchase of subsidiary shares		(17,115	)		(17,115	)
Retained earnings		200,883			228,197
Total stockholders’ equity		785,872			813,186
Total liabilities and stockholders’ equity	$	2,326,513		$	2,337,524

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	Condensed combined and consolidated Statements of Income
	Years ended December 31,
	2001			2002			2003
Transportation revenues	$	720,627		$	712,140		$	698,528
Cost and expenses		521,115			541,254			558,481
Income on transportation		199,512			170,886			140,047
Other expenses - Net		(17,587	)		(11,721	)		(32,473	)
Operating income		181,925			159,165			107,574
Net financing cost		(80,649	)		(113,226	)		(124,827	)
Income (loss) before provision for deferred income taxes and minority interest		101,276			45,939			(17,253	)
Current income tax		(79	)					(10,763	)
Deferred income tax (expense) benefit		(9,252	)		91,505			62,252
Minority interest		(18,384	)		(27,260	)		(6,922	)
Net income for the year	$	73,561		$	110,184		$	27,314

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