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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, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ____ to ____
Commission file number 1-4717
KANSAS CITY SOUTHERN INDUSTRIES, INC.
(Exact name of Company as specified in its charter)
Delaware 44-0663509
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
114 West 11th 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:
Name of each exchange on
Title of each class which registered
Preferred Stock, Par Value $25 Per New York Stock Exchange
Share, 4%, Noncumulative
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]
Company Stock. The Company's common stock is listed on the New York Stock
Exchange under the symbol "KSU." As of March 8, 1999, 109,694,604 shares of
common stock and 242,710 shares of voting preferred stock were outstanding. On
such date, the aggregate market value of the voting and non-voting common and
preferred stock was $5,159,408,393 (amount computed based on closing prices of
preferred and common stock on New York Stock Exchange).
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 Parts I, III
for the 1999 Annual Meeting of
Stockholders, which will be filed no
later than 120 days after December 31, 1998
KANSAS CITY SOUTHERN INDUSTRIES, INC.
1998 FORM 10-K ANNUAL REPORT
Table of Contents
Page
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 5
Item 3. Legal Proceedings........................................... 9
Item 4. Submission of Matters to a Vote of Security Holders......... 9
Executive Officers of the Company........................... 9
PART II
Item 5. Market for the Company's Common Stock and
Related Stockholder Matters............................... 11
Item 6. Selected Financial Data..................................... 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................... 13
Item 7(A) Quantitative and Qualitative Disclosures About Market Risk.. 56
Item 8. Financial Statements and Supplementary Data................. 60
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure....................... 104
PART III
Item 10. Directors and Executive Officers of the Company............. 105
Item 11. Executive Compensation...................................... 105
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 105
Item 13. Certain Relationships and Related Transactions.............. 105
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K............................................... 106
Signatures.................................................. 111
ii
1
Part I
Item 1. Business
(a) GENERAL DEVELOPMENT OF COMPANY BUSINESS
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.
(b) INDUSTRY SEGMENT FINANCIAL INFORMATION
Kansas City Southern Industries, Inc. ("Company" or "KCSI") reports its
financial information in two business segments: Transportation and Financial
Services.
Kansas City Southern Lines, Inc. ("KCSL") is the holding company for
Transportation segment subsidiaries and affiliates. This segment includes, among
others, The Kansas City Southern Railway Company ("KCSR"), Gateway Western
Railway Company ("Gateway Western"), and strategic joint venture interests in
Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V.("Grupo TFM"), which owns
80% of the common stock of TFM, S.A. de C.V. ("TFM"), Mexrail, Inc. ("Mexrail"),
which wholly owns the Texas Mexican Railway Company ("Tex Mex"), and Southern
Capital Corporation, LLC ("Southern Capital"), a 50% owned joint venture.
FAM Holdings, Inc. ("FAM HC") has been formed for the purpose of becoming the
holding company for the subsidiaries and affiliates comprising the Financial
Services segment. The primary entities included in this segment are Janus
Capital Corporation ("Janus" - 82% owned, diluted), Berger Associates, Inc.
("Berger" - 100% owned) and Nelson Money Managers plc ("Nelson" - 80% owned).
Additionally, the Company owns an approximate 32% equity interest in DST
Systems, Inc. ("DST," formerly a 41% owned investment prior to the merger
transaction in December 1998 as discussed below).
The information set forth in response to Item 101 of Regulation S-K relative to
financial information by industry segment for the three years ended December 31,
1998 under Part II Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, of this Form 10-K, and Item 8, Financial
Statements and Supplementary Data, at Note 13 - Industry Segments of this Form
10-K, is incorporated by reference in partial response to this Item 1.
(c) NARRATIVE DESCRIPTION OF THE BUSINESS
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.
Transportation
KCSL, along with its principal subsidiaries and joint ventures, owns and
operates a rail network of approximately 6,000 miles of main and branch lines
that links key commercial and industrial markets in the United States and
Mexico. Together with its strategic alliance with the Canadian National Railway
Company/Illinois Central Corporation ("CN/IC") and other marketing agreements,
KCSL's reach has been expanded to comprise a contiguous rail network of
approximately 25,000 miles of main and branch lines connecting Canada, the
United States and Mexico. The Company believes that the economic growth within
the United States, Mexico and Canada is developing along a north/south axis and
becoming more interconnected and interdependent as a result of the
implementation of the North American Free Trade
2
Agreement ("NAFTA"). In order to capitalize on the growing trade resulting from
NAFTA, KCSL has transformed itself from a regional rail carrier into an
extensive North American transportation network. During the mid-1990's, while
other railroad competitors concentrated on enlarging their share of the
east/west transcontinental traffic in the United States, KCSL aggressively
pursued acquisitions, joint ventures, strategic alliances and marketing
partnerships with other railroads to achieve its goal of creating the "NAFTA
Railway."
KCSL's rail network connects midwestern, eastern and Canadian shippers,
including shippers utilizing Chicago and Kansas City -- 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. KCSL's
principal subsidiary, KCSR, which traces its origins to 1887, offers the
shortest route between Kansas City and major port cities along the Gulf of
Mexico in Louisiana, Mississippi and Texas. KCSR, in conjunction with the
Norfolk Southern Railway Co. ("Norfolk Southern"), operates the most direct rail
route, referred to as the "Meridian Speedway," linking the Atlanta and Dallas
gateways for traffic moving between the rapidly-growing 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.
In addition to KCSR, KCSL's railroad system includes Gateway Western, which
links Kansas City with East St. Louis and Springfield, Illinois and provides key
interchanges with the majority of other Class I railroads, as well as its
strategic joint venture interests in Grupo TFM and Mexrail, which provide direct
access to Mexico.
Through its joint ventures in Grupo TFM and Mexrail, operated in partnership
with Transportacion Maritima Mexicana, S.A. de C.V. ("TMM"), KCSL has
established a prominent position in the growing Mexican market. TFM's route
network provides the shortest connection to the major industrial and population
areas of Mexico from midwestern and eastern points in the United States. TFM,
which was privatized by the Mexican government in June 1997, passes through
Mexican states comprising approximately 69% of Mexico's population and
accounting for approximately 70% of Mexico's estimated gross domestic product.
Tex Mex connects with TFM at Laredo, Texas, (the single largest rail freight
transfer point between the United States and Mexico), other U.S. Class I
railroads, as well as with KCSR at Beaumont, Texas.
As a result of the KCSR/CN/IC strategic alliance to promote NAFTA traffic, the
Company has gained access to customers in Detroit, Michigan and Canada as well
as more direct access to Chicago. Separate marketing agreements with the Norfolk
Southern and I&M Rail Link, LLC provide KCSL with access to additional rail
traffic to and from the eastern and upper midwestern markets of the United
States. KCSL's system, through its core network, strategic alliances and
marketing partnerships, interconnects with all Class I railroads in North
America.
Financial Services
The Financial Services segment includes Janus, Berger, Nelson and a 32% interest
in DST. Janus and Berger, each headquartered in Denver, Colorado, are United
States investment advisors registered with the Securities and Exchange
Commission ("SEC"). Janus serves as an investment advisor to the Janus
Investment Funds ("Janus Funds") and Janus Aspen Series ("Janus Aspen"), as well
as to institutional and individual private accounts (including pension,
profit-sharing and other employee benefit plans, trusts, estates, charitable
organizations, endowments and foundations) and other investment companies.
Berger is also engaged in the business of providing financial asset management
services and products, principally through sponsorship of a family of mutual
funds (the "Berger Complex"). Nelson, a United Kingdom company, provides
investment planning and investment management services to individuals that are
retired or contemplating retirement. DST, together with its subsidiaries and
joint ventures, provides sophisticated information processing and computer
software services and products to the financial services industry (primarily to
mutual funds and investment managers), communications industries and
3
other service industries. DST is organized into three operating segments:
financial services, customer management and output solutions.
Janus derives its revenues and net income primarily from diversified advisory
services provided to the Janus Funds, Janus Aspen, other financial services
firms and private accounts. In order to perform its investment advisory
functions, Janus conducts fundamental investment research and valuation
analysis. In general, Janus' approach tends to focus on companies that are
experiencing or expected to experience above average growth relative to their
peers or the economy, or that are realizing or expected to realize positive
change due to new product development, new management, changing demographics or
regulatory developments. This approach utilizes research provided by outside
parties, as well as in-house research.
Janus has three wholly-owned subsidiaries: Janus Service Corporation ("Janus
Service"), Janus Capital International, Ltd. ("Janus International") and Janus
Distributors, Inc. ("Janus Distributors").
o Pursuant to transfer agency agreements, which are subject to renewal
annually, Janus Service provides full service accounting, recordkeeping,
administration and shareowner services to the Janus Funds and Janus Aspen
and their shareholders. To provide the consistent and reliable level of
service required to compete effectively in the direct distribution channel,
Janus Service maintains a highly trained group of telephone representatives
and utilizes leading edge technology to provide immediate data to support
call center and shareholder processing operations. This approach includes
the utilization of automated phone lines and an interactive Internet web
site ("Virtual Janus") both of which are integrated into the shareholder
services system. These customer service related enhancements provide Janus
Service with additional capacity to handle the high shareholder volume that
can be experienced during market volatility.
o Janus International is an investment advisor registered with the SEC that
executes securities trades from London, England. Beginning in fourth
quarter 1998, Janus launched a series of funds domiciled in Ireland, the
Janus World Funds PLC ("Janus World").
o Pursuant to a distribution agreement, Janus Distributors serves as the
distributor of the Janus Funds, Janus World and certain classes of Janus
Aspen and is a registered broker-dealer.
Berger is an investment advisor to the Berger Complex, which includes a series
of Berger mutual funds, as well as sub-advised mutual funds and pooled asset
trusts. Berger derives its revenues and net income from these advisory services.
Additionally, Berger is a 50% owner in a joint venture with the Bank of Ireland
Asset Management (U.S.) Limited ("BIAM"). The joint venture, BBOI Worldwide LLC,
serves as the investment advisor to the Berger/BIAM Funds and Berger acts as the
sub-administrator.
Nelson provides two distinct, but interrelated services to individuals that
generally are retired or contemplating retirement: investment advice and
investment management. Clients are assigned a specific investment advisor, who
meets with each client individually and conducts an analysis of the client's
investment objectives and then recommends the construction of a portfolio to
meet those objectives. The design and ongoing maintenance of the portfolio
structure is the responsibility of the investment advisor. The selection and
management of the instruments/securities which constitute the portfolio is the
responsibility of Nelson's investment management team. Revenues are earned based
on a percentage of the initial client investment as well as from a monthly fee
based on the level of assets under management.
DST operates throughout the United States, with operations in Kansas City,
Northern California and various locations on the East Coast, as well as
internationally in Canada, Europe, Africa and the Pacific Rim. DST has a single
class of stock, its common stock, which is publicly traded on the New York Stock
Exchange and the Chicago Stock Exchange. Prior to November 1995, KCSI owned all
of the stock of DST. In November 1995, a public offering reduced KCSI's
ownership interest in DST to approximately 41%. In December 1998, a wholly-owned
subsidiary of DST merged with USCS International, Inc. The merger resulted in a
reduction of KCSI's ownership of DST to approximately 32%. KCSI reports DST as
an equity investment in the consolidated financial statements.
4
Employees. As of December 31, 1998, the approximate number of employees of KCSI
and its majority owned subsidiaries was as follows:
Transportation:
KCSR 2,665
Gateway Western 235
Other 90
-----
Total 2,990
-----
Financial Services:
Janus 1,300
Berger 80
Nelson 145
Other 20
-----
Total 1,545
-----
Total KCSI 4,535
=====
5
Item 2. Properties
In the opinion of management, the various facilities, office space and other
properties owned and/or leased by the Company (and its subsidiaries and
affiliates) are adequate for existing operating needs.
TRANSPORTATION (KCSL)
KCSR
KCSR owns and operates approximately 2,756 miles of main and branch lines, and
approximately 1,175 miles of other tracks, in a nine state region, including
Missouri, Kansas, Arkansas, Oklahoma, Mississippi, Alabama, Tennessee,
Louisiana, and Texas. Approximately 215 miles of main and branch lines and 85
miles of other tracks are operated by KCSR under trackage rights and leases.
Kansas City Terminal Railway Company (of which KCSR is a partial owner with
other railroads) 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 such railroads.
KCSR and the Union Pacific Railroad ("UP") have a haulage and trackage rights
agreement, which gives KCSR access to Nebraska and Iowa, and additional routes
in Kansas, Missouri and Texas for movements of certain limited types of traffic.
The haulage rights require the UP to move KCSR traffic in UP trains; the
trackage rights allow KCSR to operate its trains over UP tracks.
KCSR, in support of its transportation operations, owns and operates repair
shops, depots and office buildings along its right-of-way. A major facility,
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 major diesel locomotive repair facility in
Pittsburg, Kansas and freight and truck maintenance buildings in Dallas, Texas
totaling approximately 125,200 square feet. KCSR and KCSI executive offices are
located in an eight story office building in Kansas City, Missouri and are
leased from a subsidiary of the Company. Other facilities owned by KCSR include
a 21,000 square foot car repair shop in Kansas City, Missouri and approximately
15,000 square feet of office space in Baton Rouge, Louisiana.
KCSR owns and operates seven intermodal facilities. These facilities are located
in Dallas and Port Arthur, Texas; Kansas City, Missouri; Sallisaw, Oklahoma;
Shreveport and New Orleans, Louisiana; and Jackson, Mississippi. The facility in
Port Arthur is owned and operated jointly with the Norfolk Southern. The
facility in Jackson was completed in December 1996. The various locations
include strip tracks, cranes and other equipment used in facilitating the
transfer and movement of trailers and containers.
6
KCSR's fleet of rolling stock at December 31 consisted of:
1998 1997 1996
Leased Owned Leased Owned Leased Owned
------- ------- ------- ------ ------ ------
Locomotives:
Road Units 258 108 238 113 213 160
Switch Units 52 - 52 - 52 -
Other 8 - 9 - 10 -
------- ------- ------- ------ ------ ------
Total 318 108 299 113 275 160
======= ======= ======= ====== ====== ======
Rolling Stock:
Box Cars 6,634 2,023 7,168 2,027 6,366 1,558
Gondolas 748 56 819 61 819 65
Hopper Cars 2,660 1,185 2,680 1,198 2,588 1,213
Flat Cars (Intermodal
and Other) 1,617 676 1,249 554 1,249 551
Tank Cars 34 58 35 59 40 60
Other Freight Cars - - 547 123 554 164
------- ------- ------- ------ ------ ------
Total 11,693 3,998 12,498 4,022 11,616 3,611
======= ======= ======= ====== ====== ======
As of December 31, 1998, KCSR's fleet of locomotives and rolling stock consisted
of 426 diesel locomotives, of which 108 were owned, 298 leased from affiliates
and 20 leased from non-affiliates, as well as 15,691 freight cars, of which
3,998 were owned, 3,113 leased from affiliates and 8,580 leased from
non-affiliates. A significant portion of the locomotives and rolling stock
leased from affiliates include equipment leased through Southern Capital, a
joint venture with GATX Capital Corporation formed in October 1996.
Some of the owned equipment is subject to liens created under conditional sales
agreements, equipment trust certificates and leases in connection with the
original purchase or lease of such equipment. KCSR indebtedness with respect to
equipment trust certificates, conditional sales agreements and capital leases
totaled approximately $78.8 million at December 31, 1998.
Certain KCSR property statistics follow:
1998 1997 1996
Route miles - main and branch line 2,756 2,845 2,954
Total track miles 3,931 4,036 4,147
Miles of welded rail in service 2,031 2,030 1,981
Main line welded rail (% of total) 65% 63% 58%
Cross ties replaced 255,591 332,440 438,170
Average Age (in years):
Wood ties in service 15.8 15.1 15.5
Rail in main and branch line 25.5 26.0 27.0
Road locomotives 23.3 22.1 21.9
All locomotives 23.9 22.8 22.5
Maintenance expenses for Way and Structure and Equipment (pursuant to regulatory
accounting rules, which include depreciation) for the three years ended December
31, 1998 and as a percent of KCSR revenues are as follows (dollars in millions):
7
KCSR Maintenance
Way and Structure Equipment
Percent of Percent of
Amount Revenue Amount Revenue
1998 $ 82.4 14.9% $ 118.3 21.4%
1997 122.2* 23.6 112.3 21.7
1996 92.6 18.8 99.8 20.3
* Way and structure expenses include $33.5 million related to asset
impairments. See Part II Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations, of this Form 10-K for further
discussion.
Gateway Western
Gateway Western operates a 402 mile rail line extending from Kansas City,
Missouri to East St. Louis and Springfield, Illinois. Additionally, Gateway
Western has restricted haulage rights extending to Chicago, Illinois. The
Gateway Western acquisition provides interchanges with various eastern rail
carriers and gave the Company access to the St. Louis rail gateway. The Surface
Transportation Board approved the Company's acquisition of Gateway Western in
May 1997.
Certain Gateway Western property statistics follow:
1998 1997 1996
Route miles - main and branch line 402 402 402
Total track miles 564 564 564
Miles of welded rail in service 121 109 109
Main line welded rail (% of total) 40% 39% 39%
Mexrail
Mexrail, a 49% owned KCSI affiliate, owns 100% of the Tex Mex and certain other
assets, including the northern U.S. half of a rail traffic bridge at Laredo,
Texas spanning the Rio Grande river. Grupo TFM operates the southern half of the
bridge. This bridge is a significant entry point for rail traffic between Mexico
and the U.S. The Tex Mex operates a 157 mile rail line extending from Corpus
Christi to Laredo, Texas, and also has trackage rights (from Union Pacific
Railroad) totaling approximately 360 miles between Corpus Christi and Beaumont,
Texas.
The Tex Mex is currently in the process of constructing a new rail yard in
Laredo, Texas. Phase I of the project was completed in December 1998 and
includes four tracks comprising approximately 6.5 miles. Phase II of the
project, which consists of two new intermodal tracks totaling approximately 2.8
miles, is expected to be completed in March 1999. Ground work for an additional
ten tracks has been completed; however, construction on the tracks has not yet
begun. Current capacity of the yard is approximately 800 freight cars. Upon
completion of all tracks, expected capacity will be 2,000 freight cars.
Certain Tex Mex property statistics follow:
1998 1997 1996
Route miles - main and branch line 157 157 157
Total track miles 530 521 521
Miles of welded rail in service 5 5 5
Main line welded rail (% of total) 3% 3% 3%
Locomotives (average years) 25 25 24
Grupo TFM Grupo TFM owns 80% of the common stock of TFM. TFM holds the
concession to operate Mexico's "Northeast Rail Lines" for 50 years, with the
option of a 50 year extension (subject to certain conditions). TFM operates
approximately 2,661 miles of main line and an additional 838 miles of sidings
and spur tracks, and main line under trackage rights. Approximately 80% of TFM's
main line consists of welded rail. TFM has the right to operate the rail, but
does not own the land, roadway or associated structures. 331 locomotives are
owned by TFM and approximately 4,034 freight cars are either owned by TFM or
8
leased from affiliates. 89 locomotives and 2,846 freight cars are leased
from non-affiliates. Grupo TFM (through TFM) also has office space at which
various operational, accounting, managerial and other activities are performed.
The primary facilities are located in Mexico City and Monterrey, Mexico. TFM
leases 140,354 square feet of office space in Mexico City and owns an 115,157
square foot facility in Monterrey. Grupo TFM was a 37% owned KCSI affiliate at
December 31, 1998.
Other Transportation
Southern Group, Inc. leases approximately 4,150 square feet of office space in
downtown Kansas City, Missouri from an affiliate of DST.
The Company is an 80% owner of Wyandotte Garage Corporation, which owns a
parking facility in downtown Kansas City, Missouri. The facility is located
adjacent to the Company's and KCSR's executive offices, and consists of 1,147
parking spaces utilized by the employees of the Company and its affiliates, as
well as the general public.
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, Inc. owns a 70 acre coal and petroleum coke bulk handling facility in
Port Arthur, Texas.
Mid-South Microwave, Inc. owns and operates a microwave system, which extends
essentially along the right-of-way of KCSR from Kansas City, Missouri to Dallas,
Beaumont and Port Arthur, Texas and New Orleans, Louisiana. This system is
leased to KCSR.
Other subsidiaries of the Company own approximately 8,000 acres of land at
various points adjacent to the KCSR right-of-way. Other properties also include
a 354,000 square foot warehouse at Shreveport, Louisiana, a bulk handling
facility at Port Arthur, Texas, and several former railway buildings now being
rented to non-affiliated companies, primarily as warehouse space.
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.
FINANCIAL SERVICES (FAM HC)
Janus
Janus leases from non-affiliates 340,000 square feet of office space in three
facilities for investment, administrative, marketing, information technology,
and shareowner processing operations, and approximately 33,500 square feet for
mail processing and storage requirements. These corporate offices and mail
processing facilities are located in Denver, Colorado. In September 1998, Janus
opened a 51,500 square foot investor service and data center in Austin, Texas.
Janus also leases 2,200 square feet of office space in Westport, Connecticut for
development of the Janus World Funds PLC and 2,500 square feet of office space
in London, England for securities research and trading. In December 1998, Janus
closed its investor service center in Kansas City, Missouri to focus efforts on
providing quality service through various electronic communication avenues.
Berger
Berger leases approximately 29,800 square feet of office space in Denver,
Colorado from a non-affiliate for its administrative and corporate functions.
9
Nelson
Nelson leases 8,000 square feet of office space in Chester, England, the
location of its corporate headquarters, investment operations and one of its
marketing offices. During 1998, Nelson acquired additional office space adjacent
to its Chester location to accommodate expansion efforts. Also, Nelson leases
five branch marketing offices totaling approximately 8,500 square feet in the
following locations in England: London, Lichfield, Bath, Durham and Edinburgh.
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 and Environmental Matters" of this
Form 10-K is incorporated by reference in response to this Item 3. In addition,
see discussion in Part II Item 8, Financial Statements and Supplementary Data,
at Note 11 - Commitments and Contingencies of this Form 10-K.
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, 1998.
Executive Officers of the Company
Pursuant to General Instruction G(3) of Form 10-K and instruction 3 to paragraph
(b) of Item 401 of Regulation S-K, the following list is included as an
unnumbered Item in Part I of this Form 10-K in lieu of being included in KCSI's
Definitive Proxy Statement which will be filed no later than 120 days after
December 31, 1998. All executive officers are elected annually and serve at the
discretion of the Board of Directors (or in the case of Mr. T. H. Bailey, the
Janus Board of Directors). Certain of the executive officers have employment
agreements with the Company.
Name Age Position(s)
L.H. Rowland 61 Chairman, President and
Chief Executive Officer of the Company
M.R. Haverty 54 Executive Vice President, Director
T.H. Bailey 61 Chairman, President and
Chief Executive Officer of
Janus Capital Corporation
P.S. Brown 62 Vice President, Associate General
Counsel and Assistant Secretary
R.P. Bruening 60 Vice President, General Counsel and
Corporate Secretary
D.R. Carpenter 52 Vice President - Finance
W.K. Erdman 40 Vice President - Corporate Affairs
A.P. McCarthy 52 Vice President and Treasurer
J.D. Monello 54 Vice President and Chief Financial Officer
L.G. Van Horn 40 Vice President and Comptroller
The information set forth in the Company's Definitive Proxy Statement in the
description of the Board of Directors with respect to Mr. Rowland and Mr.
Haverty is incorporated herein by reference.
Mr. Bailey has continuously served as Chairman, President and Chief Executive
Officer of Janus Capital Corporation since 1978.
10
Mr. Brown has continuously served as Vice President, Associate General Counsel
and Assistant Secretary since July 1992.
Mr. Bruening has continuously served as Vice President, General Counsel and
Corporate Secretary since July 1995. From May 1982 to July 1995, he served as
Vice President and General Counsel. He also serves as Senior Vice President and
General Counsel of KCSR.
Mr. Carpenter has continuously served as Vice President - Finance since November
1996. He was Vice President - Finance and Tax from May 1995 to November 1996. He
was Vice President - Tax from June 1993 to May 1995. Prior to June 1993, he was
a member in the law firm of Watson & Marshall L.C., Kansas City, Missouri.
Mr. Erdman has continuously served as Vice President - Corporate Affairs since
April 1997. From January 1997 to April 1997 he served as Director - Corporate
Affairs. From 1987 to January 1997 he served as Chief of Staff for United States
Senator from Missouri, Christopher ("Kit") Bond.
Mr. McCarthy has continuously served as Vice President and Treasurer since May
1996. He was Treasurer from December 1989 to May 1996.
Mr. Monello has continuously served as Vice President and Chief Financial
Officer since March 1994. From October 1992 to March 1994, he served as Vice
President - Finance.
Mr. Van Horn has continuously served as Vice President and Comptroller since May
1996. He was Comptroller from October 1992 to May 1996.
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, except with respect to the executive officers who have
entered into employment agreements, which agreements designate the position(s)
to be held by the executive officer.
None of the above officers are related to one another by family.
11
Part II
Item 5. Market for the Company's Common Stock and Related Stockholder Matters
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 14 - Quarterly Financial Data
(Unaudited) of this Form 10-K is incorporated by reference in partial response
to this Item 5.
The payment and amount of dividends will be reviewed periodically and
adjustments considered that are consistent with growth in real earnings and
prevailing business conditions. In July 1997, the Board authorized a 3-for-1
split in the Company's common stock.
Unrestricted retained earnings of the Company at December 31, 1998 were $480.9
million.
As of March 8, 1999, there were 5,709 holders of the Company's common stock
based upon an accumulation of the registered stockholder listing.
Item 6. Selected Financial Data
(in millions, except per share and ratio data)
The selected financial data below should be read in conjunction with the
consolidated financial statements and the related notes thereto, and the Report
of Independent Accountants thereon, included under Item 8 of this Form 10-K, and
such data is qualified by reference thereto.
1998 (i) 1997 (ii) 1996 (iii) 1995 (iv) 1994 (v)
Revenues $ 1,284.3 $ 1,058.3 $ 847.3 $ 775.2 $ 1,088.4
Income (loss) from continuing
operations $ 190.2 $ (14.1) $ 150.9 $ 236.7 $ 104.9
Income (loss) from continuing
operations per common share:
Basic $ 1.74 $ (0.13) $ 1.33 $ 1.86 $ 0.80
Diluted 1.66 (0.13) 1.31 1.80 0.77
Total assets $ 2,619.7 $ 2,434.2 $ 2,084.1 $ 2,039.6 $ 2,230.8
Long-term obligations $ 825.6 $ 805.9 $ 637.5 $ 633.8 $ 928.8
Cash dividends per
common share $ .16 $ .15 $ .13 $ .10 $ .10
Ratio of earnings to
fixed charges 4.44 (vi) 1.60 (vii) 3.30 6.14 (viii) 3.28
(i) Includes a one-time non-cash charge of $36.0 million ($23.2 million
after-tax, or $0.21 per basic and diluted share) resulting from the merger
of a wholly-owned subsidiary of DST with USCS International, Inc. ("USCS").
The merger was accounted for by DST under the pooling of interests method.
The charge reflects the Company's reduced ownership of DST (from 41% to
approximately 32%), together with the Company's proportionate share of DST
and USCS fourth quarter merger-related charges. See note 2 to the
consolidated financial statements in this Form 10-K.
(ii) Includes $196.4 million ($158.1 million after-tax, or $1.47 per basic and
diluted share) of restructuring, asset impairment and other charges
recorded during fourth quarter 1997. The charges reflect: a $91.3 million
impairment of goodwill associated with KCSR's acquisition of MidSouth
Corporation in 1993; $38.5 million of long-lived assets held for disposal;
$9.2 million of
12
impaired long-lived assets; approximately $27.1 million in reserves related
to termination of a union productivity fund and employee separations; a
$12.7 million impairment of goodwill associated with the Company's
investment in Berger; and $17.6 million of other reserves for leases,
contracts and other reorganization costs. See Notes 1 and 3 to the
consolidated financial statements in this Form 10-K.
(iii)Includes a one-time after-tax gain of $47.7 million (or $0.42 per basic
share, $0.41 per diluted share), representing the Company's proportionate
share of the one-time gain recognized by DST in connection with the merger
of The Continuum Company, Inc., formerly a DST unconsolidated equity
affiliate, with Computer Sciences Corporation in a tax-free share exchange
(see Note 2 to the consolidated financial statements in this Form 10-K).
(iv) Reflects DST as an unconsolidated affiliate as of January 1, 1995 due to
the DST public offering and associated transactions completed in November
1995, which reduced the Company's ownership of DST to approximately 41% and
resulted in deconsolidation of DST from the Company's consolidated
financial statements. The public offering and associated transactions
resulted in a $144.6 million after-tax gain (or $1.14 per basic share,
$1.10 per diluted share) to the Company.
(v) Reflects DST as a consolidated subsidiary. See (iv) above for discussion of
DST public offering in 1995.
(vi) Financial information from which the ratio of earnings to fixed charges was
computed for the year ended December 31, 1998 includes the one-time
non-cash charge resulting from the DST and USCS merger discussed in (i)
above. If the ratio was computed to exclude this charge, the 1998 ratio of
earnings to fixed charges would have been 4.75.
(vii)Financial information from which the ratio of earnings to fixed charges
was computed for the year ended December 31, 1997 includes the
restructuring, asset impairment and other charges discussed in (ii) above.
If the ratio was computed to exclude these charges, the 1997 ratio of
earnings to fixed charges would have been 3.60.
(viii) Financial information from which the ratio of earnings to fixed charges
was computed for the year ended December 31, 1995 reflects DST as a
majority owned unconsolidated subsidiary through October 31, 1995, and an
unconsolidated 41% owned affiliate thereafter, in accordance with
applicable U.S. Securities and Exchange Commission rules and regulations.
If the ratio was computed to exclude the one-time pretax gain of $296.3
million associated with the November 1995 public offering and associated
transactions, the 1995 ratio of earnings to fixed charges would have been
3.04.
All years reflect the 3-for-1 common stock split to shareholders of record on
August 25, 1997, paid September 16, 1997.
Certain prior year information has been restated to conform to the current year
presentation. All years reflect the reclassification of certain income/expense
items from "Revenues" and "Costs and Expenses" to a separate "Other, net" line
item in the Consolidated Statements of Operations.
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.
13
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
The discussion set forth below, as well as other portions of this Form 10-K,
contains comments not based upon historical fact. Such forward-looking comments
are based upon information currently available to management and management's
perception thereof as of the date of this Form 10-K. Readers can identify these
forward-looking comments by the use of such verbs as expects, anticipates,
believes or similar verbs or conjugations of such verbs. The actual results of
operations of Kansas City Southern Industries, Inc. ("KCSI" or the " Company")
could materially differ from those indicated in forward-looking comments. The
differences could be caused by a number of factors or combination of factors
including, but not limited to, those factors identified in the Company's Current
Report on Form 8-K dated November 12, 1996 and its Amendment, Form 8-K/A dated
June 3, 1997, which have been filed with the U.S. Securities and Exchange
Commission (Files No. 1-4717) and are hereby incorporated by reference herein.
Readers are strongly encouraged to consider these factors when evaluating any
forward-looking comments. The Company will not update any forward-looking
comments set forth in this Form 10-K.
The discussion herein is intended to clarify and focus on the Company's results
of operations, certain changes in its financial position, liquidity, capital
structure and business developments for the periods covered by the consolidated
financial statements included under Item 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 is
qualified by reference thereto.
KCSI, a Delaware corporation organized in 1962, is a diversified holding company
with principal operations in rail transportation and financial services. The
Company supplies its various subsidiaries with managerial, legal, tax, financial
and accounting services, in addition to managing other "non-operating" and more
passive investments.
The Company's business activities by industry segment and principal subsidiary
companies are:
Transportation. The Transportation segment consists of all
Transportation-related subsidiaries and investments, including:
* The Kansas City Southern Railway Company ("KCSR"), a wholly-owned
subsidiary of the Company, operating a Class I Common Carrier railroad
system;
* Gateway Western Railway Company ("Gateway Western"), a wholly-owned
subsidiary of KCS Transportation Company ("KCSTC," a wholly-owned
subsidiary of the Company), operating a regional railroad system;
* Southern Group, Inc. ("SGI"), a wholly-owned subsidiary of KCSR, owning
100% of Carland, Inc. and managing the loan portfolio for Southern Capital
Corporation, LLC ("Southern Capital," a 50% owned joint venture);
* Equity investments in Southern Capital, Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. ("Grupo TFM" ), a 37% owned affiliate, Mexrail, Inc.
("Mexrail") a 49% owned affiliate along with its wholly owned subsidiary,
The Texas Mexican Railway Company ("Tex Mex"), and Panama Canal Railway
Company ("PCRC"), a 50% owned joint venture;
* Various other consolidated subsidiaries;
* Kansas City Southern Lines, Inc. ("KCSL"), a wholly-owned subsidiary of the
Company, serving as a holding company for Transportation-related entities;
14
Financial Services. The Financial Services segment consists of all subsidiaries
engaged in the management of investments for mutual funds, private and other
accounts, as well as any Financial Services-related investments. Included are:
* Janus Capital Corporation ("Janus"), an 82% owned subsidiary, diluted;
* Berger Associates, Inc. ("Berger"), a wholly-owned subsidiary;
* Nelson Money Managers plc ("Nelson"), an 80% owned subsidiary
* DST Systems, Inc. ("DST"), an approximate 32% owned equity investment (see
ownership interest discussion below);
* FAM Holdings, Inc. ("FAM HC"), a wholly-owned subsidiary of the Company
formed for the purpose of becoming a holding company for Financial
Services-related subsidiaries and affiliates.
Upon the completion of a public offering of DST common stock and associated
transactions in November 1995, the Company's ownership of DST was reduced from
100% to approximately 41%. As discussed below, the fourth quarter 1998 merger
between a wholly-owned subsidiary of DST and USCS International, Inc. ("USCS")
reduced KCSI's ownership of DST to approximately 32% and resulted in a one-time
pretax non-cash charge of approximately $36.0 million.
All per share information included in this Item 7 is presented on a diluted
basis, unless specifically identified otherwise.
RECENT DEVELOPMENTS
DST Merger. On December 21, 1998, DST and USCS announced the completion of the
merger of USCS with a wholly-owned DST subsidiary. The merger, accounted for as
a pooling of interests by DST, expands DST's presence in the output solutions
and customer management software and services industries. USCS is a leading
provider of customer management software to the cable television and convergence
industries. Under the terms of the merger, USCS became a wholly-owned subsidiary
of DST. DST issued approximately 13.8 million shares of its common stock in the
transaction.
The issuance of additional DST common shares reduced KCSI's ownership interest
from 41% to approximately 32%. Additionally, the Company recorded a one-time
pretax non-cash charge of approximately $36.0 million ($23.2 million after-tax,
or $0.21 per share), reflecting the Company's reduced ownership of DST and the
Company's proportionate share of DST and USCS fourth quarter merger-related
costs. KCSI accounts for its investment in DST under the equity method.
Option to Purchase Mexican Government's Ownership Interest in TFM, S.A. de
C.V. ("TFM"). On January 28, 1999, the Company, along with other direct and
indirect owners of TFM, entered into a preliminary agreement with the Mexican
Government ("Government"). As part of that agreement, an option was granted to
the Company, Transportacion Maritima Mexicana, S.A. de C.V. ("TMM") and Grupo
Servia, S.A. de C.V. ("Grupo Servia") to purchase all or a portion of the
Government's 20% ownership interest in TFM at a discount. The option to purchase
all or a portion of the Government's interest expires on November 30, 1999. If
the purchase of at least 35% of the Government's stock is not completed by May
31, 1999, the entire option will expire on that date. If the option is fully
exercised, the Company's additional cash investment is not expected to exceed
$88 million. As part of this agreement and as a condition to exercise this
option, the parties have agreed to settle the outstanding claims against the
Government regarding a refund of Mexican Value Added Tax (VAT) payments. TFM has
also agreed to sell to the Government a small section of redundant trackage for
inclusion in another railroad concession. In addition, under the terms of the
agreement, the Government would be released from its capital call obligations
(as described below in "Results of Operations") at the moment that the option is
exercised in whole or in part. Furthermore, TFM, TMM, Grupo Servia and the
Company have agreed to sell, in a public offering, a direct or indirect
participation in at least the same percentage currently represented by the
shares exercised in this option, by October 31, 2003, at the latest, subject to
market conditions. The
15
option and the other described agreements are conditioned on the parties
entering into a final written agreement and obtaining all necessary consents and
authorizations.
Planned Separation of the Company Business Segments. As previously disclosed,
the Company announced its intention to separate the Transportation and Financial
Services segments through a proposed dividend of the stock of a new holding
company for its Financial Services businesses (the "Separation"). On February
27, 1998, a filing was made with the Internal Revenue Service ("IRS") requesting
a favorable tax ruling on the proposed Separation. On October 20, 1998, the
Company announced that a favorable ruling on the initial structure proposed to
the IRS was not expected and, accordingly, KCSI withdrew its request for a tax
ruling. As a result, the Separation did not occur during 1998 as previously
contemplated. The Company resubmitted a request for a tax ruling in January
1999. Subject to receipt of a favorable ruling from the IRS and consideration of
other relevant factors, the Separation is expected to occur before the end of
1999.
Additionally, in contemplation of the Separation, the Company's stockholders
approved a reverse stock split at a special stockholders' meeting held on July
15, 1998. The Company will not effect the reverse stock split until the
Separation is completed.
Houston Emergency Service Order. On October 31, 1997 the Surface Transportation
Board ("STB") issued an emergency service order which took effect on November 5,
1997 and extended through August 2, 1998. On July 31, 1998, the STB announced
that it would not extend the emergency service order. This decision provided for
a "45-day wind down" period until September 17, 1998, during which the Tex Mex
continued to provide service under the terms of the emergency service order. As
a result of this emergency service order, Tex Mex revenues increased during
fourth quarter 1997 and through the first three quarters of 1998. However,
expenses associated with accommodating the increase in traffic and
congestion-related problems of the UP system offset this revenue increase.
As previously disclosed, the KCSR and Tex Mex, along with the Texas Railroad
Commission and several shipper advocate groups, filed the Houston Area Consensus
Plan ("Consensus Plan") with the STB during second quarter 1998. The Consensus
Plan sought to provide the Tex Mex with permanent access to the Houston/Gulf
Coast markets and to expand neutral switching to hundreds of shippers. On
December 21, 1998, the STB announced its ruling against the Consensus Plan,
denying the Tex Mex permanent access to the Houston area.
RESULTS OF OPERATIONS
In addition to the developments mentioned above, consolidated operating results
from 1996 to 1998 were affected by the following significant developments.
Acquisition of Nelson. On April 20, 1998, the Company completed its acquisition
of 80% of Nelson, an investment advisor and manager based in the United Kingdom
("UK"). Nelson has six offices throughout the UK and offers planning based asset
management services directly to private clients. Nelson managed approximately
$1.2 billion of assets as of December 31, 1998. The acquisition, accounted for
as a purchase, was completed using a combination of cash, KCSI common stock and
notes payable. The total purchase price was approximately $33 million. The
purchase price is in excess of the fair market value of the net tangible and
identifiable intangible assets received and this excess was recorded as goodwill
to be amortized over a period of 20 years. Assuming the transaction had been
completed January 1, 1998, inclusion of Nelson's results on a pro forma basis,
as of and for the year ended December 31, 1998, would not have been material to
the Company's consolidated results of operations.
16
Marketing Alliance with Canadian National Railway Company ("CN")/Illinois
Central Corporation ("IC"). On April 16, 1998, KCSR, CN and IC announced a
15-year marketing alliance that offers shippers new competitive options in a
rail freight transportation network that links key north-south continental
freight markets. The marketing alliance did not require approval from the STB
and was effective immediately. This alliance connects points in Canada with the
major U.S. Midwest markets of Detroit, Chicago, Kansas City and St. Louis, as
well as key Southern markets of Memphis, Dallas and Houston. It also provide
shippers with access to Mexico's rail system through Grupo TFM.
In addition to providing access to key north-south international and domestic
U.S. traffic corridors, the railways' seek to increase business in existing
markets, primarily automotive and intermodal, but also in other key carload
markets, including those for chemical and forest products. Traffic increases,
although not significant in 1998, have already been evident and Transportation
management expects this alliance to provide opportunities for revenue growth and
position the railway as a key provider of rail service to the North American
Free Trade Agreement ("NAFTA") corridor.
Under a separate access agreement, subject to STB approval of the proposed CN-IC
merger, CN and KCSR plan investments in automotive, intermodal and transload
facilities at Memphis, Dallas, Kansas City and Chicago to capitalize on the
growth potential represented by the marketing alliance. Access to proposed
terminals would be assured for the 25-year life span of the facilities,
regardless of any change in corporate control. Under the terms of this access
agreement, KCSR would extend its rail system in the Gulf area and, in the year
2000, gain access to three additional chemical customers in the Geismar,
Louisiana industrial area, one of the largest chemical production areas in the
world, through a haulage agreement. Management expects this access to provide
additional revenue opportunities for the Company. Prior to this access
agreement, the Company received preliminary STB approval for construction of a
nine-mile rail line from KCSR's main line into the Geismar industrial area,
which the chemical manufacturers requested be built to provide them with
competitive rail service. The Company will continue to hold the option of the
Geismar build-in provided that it is able to obtain the requisite approvals.
Voluntary Coordination Agreement with the Norfolk Southern Railway Company
("Norfolk Southern"). The Company entered into a Voluntary Coordination
marketing agreement with the Norfolk Southern that allows the Company to
capitalize on the east-west corridor between Meridian, Mississippi and Dallas,
Texas through incremental traffic volume gained through interchange with the
Norfolk Southern. This agreement provides the Norfolk Southern run-through
service with access to Dallas and Mexico while avoiding the congested rail
gateways of Memphis, Tennessee and New Orleans, Louisiana. In addition, KCSR and
Norfolk Southern have a new joint intermodal operation at Port Arthur, Texas,
which provides an alternative route for traffic from the Houston market by
utilizing KCSR's rail network.
Termination of the Kansas City Southern Industries, Inc. Employee Plan Funding
Trust ("EPFT" or "Trust"). Effective September 30, 1998, the Company terminated
the EPFT, which was established as a grantor trust for the purpose of holding
shares of KCSI Series B Convertible Preferred Stock ("Series B Preferred Stock")
for the benefit of various KCSI employee benefit plans, including the Employee
Stock Ownership Plan, Stock Option Plans and Employee Stock Purchase Plan
(collectively, "Benefit Plans"). The EPFT was administered by an independent
bank trustee ("Trustee") and included in the Company's consolidated financial
statements.
In 1993, KCSI transferred one million shares of Series B Preferred Stock to the
EPFT for a purchase price of $200 million (based on an independent valuation),
which the Trust financed through KCSI. The indebtedness of the EPFT to KCSI was
repayable over 27 years with interest at 6% per annum, with no principal
payments for the first three years. Principal payments from the EPFT to the
Company of $21.3 million since the date of inception decreased the indebtedness
to $178.7 million, plus accrued interest, on the date of termination. As a
result of these principal payments, 127,638 shares of Series B Preferred
17
Stock were released from the Trust's suspense account and available for
distribution to the Benefit Plans. None of these shares, however, were
distributed prior to termination of the EPFT.
In accordance with the agreement to terminate the EPFT, the Company received
872,362 shares of Series B Preferred Stock in full repayment of the indebtedness
from the Trust. In addition, the remaining 127,638 shares of Series B Preferred
Stock were converted by the Trustee into KCSI Common Stock, at the rate of 12 to
1, resulting in the issuance to the EPFT of 1,531,656 shares of such Common
Stock. This Common Stock was then transferred by the Trustee to KCSI and the
Company has set these shares aside for use in connection with the KCSI 1991
Stock Option and Performance Award Plan, as amended and restated effective July
15, 1998. Following the foregoing transactions, the EPFT was terminated.
The impact of the EPFT termination on the Company's consolidated financial
statements was a reclassification among the components of the stockholders'
equity accounts, with no change in the consolidated assets and liabilities of
the Company.
Restructuring, Asset Impairment and Other Charges. In connection with the
Company's review of its accounts for the year ended December 31, 1997 in
accordance with its established accounting policies, as well as a change in the
Company's methodology for evaluating the recoverability of goodwill during 1997
(as set forth in Note 1 to the consolidated financial statements), $196.4
million of restructuring, asset impairment and other charges were recorded
during fourth quarter 1997. After consideration of related tax effects, these
charges reduced consolidated earnings by $158.1 million, or $1.47 per share. The
charges included:
o A $91.3 million impairment of goodwill associated with KCSR's 1993
acquisition of MidSouth Corporation ("MidSouth"). In response to the
changing competitive and business environment in the rail industry, in 1997
the Company revised its accounting methodology for evaluating the
recoverability of intangibles from a business unit approach to analyzing
each of the Company's significant investment components. Based on this
analysis, the remaining purchase price in excess of fair value of the
MidSouth assets acquired was not recoverable.
o A $38.5 million charge representing long-lived assets held for disposal.
Certain branch lines on the MidSouth route and certain non-operating real
estate were designated for sale. During 1998, one of the branch lines was
sold for a pretax gain of approximately $2.9 million. Efforts are ongoing
to procure bids on the other branch line and non-operating real estate.
o Approximately $27.1 million in reserves related to termination of a union
productivity fund and employee separations. The union productivity fund was
established in connection with prior collective bargaining agreements and
required KCSR to pay employees when reduced crew levels were used. The
termination of this fund has resulted in a reduction of salaries and wages
expense for the year ended December 31, 1998 of approximately $4.8 million.
During 1998, approximately $23.1 million in cash payments reduced these
reserves and approximately $2.5 million of the reserves were reduced based
primarily on changes in the estimate of claims made relating to the union
productivity fund. Approximately $1.5 million of accruals related to the
union productivity fund and employee separations remain at December 31,
1998.
o A $12.7 million impairment of goodwill associated with the Company's
investment in Berger. In connection with the Company's review of the
carrying value of its various assets, management determined that a portion
of the intangibles recorded in connection with the Berger investment were
not recoverable, primarily due to below-peer performance and growth of the
core Berger funds.
o A $9.2 million impairment of assets at Pabtex, Inc. (a subsidiary of the
Company) as a result of continued operating losses and a decline in its
customer base.
o Approximately $17.6 million of other charges and reserves related to
leases, contracts, impaired investments and other reorganization costs.
Based on the Company's review of its assets and liabilities, certain
charges were recorded to reflect recoverability and/or obligation as of
December 31, 1997. During 1998, approximately $8.0 million in cash payments
were made leaving approximately $5.0 million accrued at December 31, 1998.
18
Operating Difficulties of the Union Pacific Railroad. As reported in the press,
the Union Pacific Railroad ("UP") experienced difficulties with its railroad
operations, reportedly linked to its acquisition of the Southern Pacific
Railroad ("SP"). UP is one of KCSR's largest interchange partners. The UP's
difficulties resulted in overall traffic congestion of the U.S. railroad system
and impacted KCSR's ability to interchange traffic with UP, both for domestic
and international traffic (i.e., to and from Mexico). This system congestion
resulted in certain equipment shortages due to KCSR's rolling stock being
retained within the UP system for unusually extended periods of time, for which
UP remits car hire amounts. During the fourth quarter of 1997, KCSR agreed to
accept certain UP trains in diverted traffic to assist in the easing of the UP's
system congestion, resulting in revenues of approximately $3.9 million.
Grupo TFM. As disclosed previously, Grupo TFM, a joint venture of the Company
and TMM, was awarded the right to purchase 80% of the common stock of TFM for
approximately 11.072 billion Mexican pesos (approximately $1.4 billion based on
the U.S. dollar/Mexican peso exchange rate on December 5, 1996). TFM holds the
concession to operate over Mexico's Northeast Rail Lines for 50 years, with the
option of a 50 year extension (subject to certain conditions).
The remaining 20% of TFM was retained by the Government, which has the option of
selling its 20% interest through a public offering, or selling it to Grupo TFM
after October 31, 2003 at the initial share price paid by Grupo TFM plus
interest computed at the Mexican Base Rate (the Unidad de Inversiones (UDI)
published by Banco de Mexico). In the event that Grupo TFM does not purchase the
Government's 20% interest in TFM, the Government may require TMM and KCSI to
purchase the Government's holdings in proportion to each partner's respective
ownership interest in Grupo TFM (without regard to the Government's interest in
Grupo TFM - see below).
On January 31, 1997, Grupo TFM paid the first installment of the purchase price
(approximately $565 million based on the U.S. dollar/Mexican peso exchange rate)
to the Government, representing approximately 40% of the purchase price. This
initial installment of the TFM purchase price was funded by Grupo TFM through
capital contributions from TMM and the Company. The Company contributed
approximately $298 million to Grupo TFM, of which approximately $277 million was
used by Grupo TFM as part of the initial installment payment. The Company
financed this contribution using borrowings under existing lines of credit.
On June 23, 1997, Grupo TFM completed the purchase of 80% of TFM through the
payment of the remaining $835 million to the Government. This payment was funded
by Grupo TFM using a significant portion of the funds obtained from: (i) senior
secured term credit facilities ($325 million); (ii) senior notes and senior
discount debentures ($400 million); (iii) proceeds from the sale of 24.6% of
Grupo TFM to the Government (approximately $199 million based on the U.S.
dollar/Mexican peso exchange rate on June 23, 1997); and (iv) additional capital
contributions from TMM and the Company (approximately $1.4 million from each
partner). Additionally, Grupo TFM entered into a $150 million revolving credit
facility for general working capital purposes. The Government's interest in
Grupo TFM is in the form of limited voting right shares, and the purchase
agreement includes a call option for TMM and the Company, which is exercisable
at the original amount (in U.S. dollars) paid by the Government plus interest
based on one-year U.S. Treasury securities.
In February and March 1997, the Company entered into two separate forward
contracts - $98 million in February 1997 and $100 million in March 1997 - to
purchase Mexican pesos in order to hedge against a portion of the Company's
exposure to fluctuations in the value of the Mexican peso versus the U.S.
dollar. In April 1997, the Company realized a $3.8 million pretax gain in
connection with these contracts. This gain was deferred, and has been accounted
for as a component of the Company's investment in Grupo TFM. These contracts
were intended to hedge only a portion of the Company's exposure related to the
final installment of the purchase price and not any other transactions or
balances.
19
Concurrent with the financing transactions, Grupo TFM, TMM and the Company
entered into a Capital Contribution Agreement ("Contribution Agreement") with
TFM, which includes a possible capital call of $150 million from TMM and the
Company if certain performance benchmarks, outlined in the agreement, are not
met. The Company would be responsible for approximately $74 million of the
capital call. The term of the Contribution Agreement is three years. In a
related agreement between Grupo TFM, TFM and the Government, among others, the
Government agreed to contribute up to $37.5 million of equity capital to Grupo
TFM if TMM and the Company were required to contribute under the capital call
provisions of the Contribution Agreement prior to July 16, 1998. As of July 16,
1998, no additional contributions from the Company were requested or made and,
therefore, the Government did not contribute additional equity capital to Grupo
TFM. The Government also committed that if it had not made any contributions by
July 16, 1998, it would, up to July 31, 1999, make additional capital
contributions to Grupo TFM (of up to an aggregate amount of $37.5 million) on a
proportionate basis with TMM and the Company if capital contributions are
required. Any capital contributions to Grupo TFM from the Government would be
used to reduce the contribution amounts required to be paid by TMM and the
Company pursuant to the Contribution Agreement. As of December 31, 1998 no
additional contributions from the Company have been requested or made.
At December 31, 1998, the Company's investment in Grupo TFM was approximately
$285.1 million. The Company's interest in Grupo TFM is approximately 37% (with
TMM and a TMM affiliate owning the remaining 38.4%). The Company accounts for
its investment in Grupo TFM under the equity method.
See "Recent Developments" above for discussion of the Company's option to
purchase a portion of the Government's interest in TFM.
I&M Rail Link. During 1997, KCSR entered into a marketing agreement with I&M
Rail Link, LLC, which provides KCSR with access to customers (primarily new
grain origins) in the upper Midwest, as well as Chicago and Minneapolis. This
agreement is similar to a haulage rights agreement, but without the restrictions
on traffic. The Company believes this agreement provides KCSR with the ability
to increase its traffic, particularly with respect to agricultural and mineral
products.
Berger Ownership Interest. As a result of certain transactions during 1997, the
Company increased its ownership in Berger to 100% from approximately 80% at
December 31, 1996. In January and December 1997, Berger purchased, for treasury,
the common stock of minority shareholders. Also in December 1997, the Company
acquired additional Berger shares from a minority shareholder through the
issuance of KCSI common stock. In connection with these transactions, Berger
granted options to acquire shares of Berger stock to certain of its employees.
At December 31, 1998, the Company's ownership would have been diluted to
approximately 91% if all of the outstanding options had been exercised. These
transactions resulted in approximately $17.8 million of goodwill, which is being
amortized over 15 years. However, see discussion of impairment of a portion of
this goodwill in "Restructuring, Asset Impairment and Other Charges" above.
The Company's 1994 acquisition of a controlling interest in Berger was completed
under a Stock Purchase Agreement ("Agreement") covering a five-year period
ending in October 1999. Pursuant to the Agreement, the Company may be required
to make additional purchase price payments (up to $36.6 million) based upon
Berger attaining certain incremental levels of assets under management up to $10
billion by October 1999. The Company made no payments under the Agreement during
1998. In 1997 and 1996, the Company made additional payments of $3.1 and $23.9
million, respectively, resulting in adjustments to the purchase price. The
goodwill amounts are amortized over 15 years.
Stock Split and 20% Increase in Quarterly Common Stock Dividend. On July 29,
1997, the Company's Board of Directors ("Board") authorized a 3-for-1 split in
the Company's common stock effected in the form of a stock dividend. The Board
also voted to increase the quarterly dividend 20% to
20
$0.04 per share (post-split). Both dividends were paid on September 16, 1997 to
stockholders of record as of August 25, 1997. Amounts reported in this Form 10-K
reflect this stock split.
Common Stock Repurchases. The Company's Board has authorized management to
repurchase a total of 33 million shares of KCSI common stock under two programs
- - the 1995 program for 24 million shares and the 1996 program for nine million
shares. During 1998, there were no repurchases under these programs. During
1997, the Company purchased approximately 2.9 million shares (post-split) at an
aggregate cost of approximately $50 million. With these transactions, the
Company has repurchased approximately 27.6 million shares of its common shares,
completing the 1995 program and part of the 1996 program. In connection with
these programs, the Company entered into a forward stock purchase contract in
1995 for the repurchase of shares, which was completed during 1997. See
discussion in "Financial Instruments and Purchase Commitments" below.
Gateway Western. KCSTC acquired beneficial ownership of the outstanding stock of
Gateway Western in December 1996. The stock acquired by KCSTC was held in an
independent voting trust until the Company received approval from the STB on the
acquisition effective May 5, 1997. The consideration paid for Gateway Western
(including various acquisition costs and liabilities) was approximately $12.2
million, which exceeded the fair value of the underlying net assets by
approximately $12.1 million. The resulting intangible is being amortized over a
period of 40 years.
Because the Gateway Western stock was held in trust during first quarter 1997,
the Company accounted for Gateway Western under the equity method as a
wholly-owned unconsolidated subsidiary. Upon STB approval of the acquisition,
the Company consolidated Gateway Western in the Transportation segment.
Additionally, the Company restated first quarter 1997 to include Gateway Western
as a consolidated subsidiary as of January 1, 1997, and results of operations
for the year ended December 31, 1997 reflect this restatement.
Under a prior agreement with The Atchison, Topeka & Santa Fe Railway Company,
Burlington Northern Santa Fe Corporation has the option of purchasing the assets
of Gateway Western (based on a fixed formula in the agreement) through the year
2004.
Southern Capital Joint Venture. In October 1996, the Company and GATX Capital
Corporation ("GATX") completed the formation and financing of a joint venture to
perform certain leasing and financing activities. The venture, Southern Capital,
was formed through a GATX contribution of $25 million in cash and a Company
contribution (through KCSR and Carland) of $25 million in net assets, comprising
a negotiated fair value of locomotives and rolling stock and long-term
indebtedness owed to KCSI and its subsidiaries. In an associated transaction,
Southern Leasing Corporation (an indirect wholly-owned subsidiary of the Company
prior to dissolution in October 1996) sold to Southern Capital approximately $75
million of loan portfolio assets and rail equipment.
As a result of these transactions and subsequent repayment by Southern Capital
of indebtedness owed to KCSI and its subsidiaries, the Company received cash
which exceeded the net book value of its assets by approximately $44.1 million.
Concurrent with the formation of the joint venture, KCSR entered into operating
leases with Southern Capital for the majority of the rail equipment acquired by
or contributed to Southern Capital. Accordingly, this excess fair value over
book value is being recognized over the terms of the leases (approximately $4.4
million in 1998 and $4.9 million in 1997).
The cash received by the Company was used to reduce outstanding indebtedness by
approximately $217 million, after consideration of applicable income taxes,
through repayments on various lines of credit and subsidiary indebtedness. The
Company reports its 50% ownership interest in Southern Capital under the equity
method of accounting.
21
1998 and 1997 net income was positively impacted as a result of the Southern
Capital transaction. Reduced depreciation and interest expense, together with
equity earnings from Southern Capital, has more than offset the increase in
fixed lease expense related to the transaction.
Under a prior agreement, GATX had an option to notify the Company of its intent
to cause disposal of the loan portfolio assets of Southern Capital. GATX
exercised its option with regard to this agreement and the Company and GATX are
jointly reviewing options for disposition of these loan portfolio assets. The
portfolio of rail assets would remain with Southern Capital. The disposal of the
loan portfolio assets is not expected to have a material impact on the Company's
results of operations, financial position or cash flows.
DST's Investment in Continuum. On August 1, 1996, The Continuum Company, Inc.
("Continuum"), formerly an approximate 23% owned DST equity affiliate, merged
with Computer Sciences Corporation ("CSC," a publicly traded company) in a
tax-free share exchange. In exchange for its ownership interest in Continuum,
DST received CSC common stock, which DST accounts for as available for sale
securities as defined in Statement of Financial Accounting Standards No. 115
"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115").
As a result of the transaction, the Company's 1996 earnings included
approximately $47.7 million (after-tax), or $0.41 per share, representing the
Company's proportionate share of the one-time gain recognized by DST in
connection with the merger. Continuum ceased to be an equity affiliate of DST,
thereby eliminating any future Continuum equity earnings or losses. DST
recognized equity losses in Continuum of $4.9 million for the first six months
of 1996.
Railroad Industry Trends and Competition. During the period from 1996 to 1998,
the railroad industry has continued to experience ongoing consolidation.
Following the 1995 mergers involving the Burlington Northern, Inc. and Santa Fe
Pacific Corporation ("BN/SF") and the UP and the Chicago and North Western
Transportation Company ("UP/CNW"), in 1996, the UP merged with SP ("UP/SP"). In
1997, CSX Corporation ("CSX") and Norfolk Southern completed negotiations to
purchase parts of Conrail, Inc. ("Conrail"). The STB has approved this
transaction. Finally, in February 1998, the CN announced its intention to
acquire the IC, which is still awaiting STB approval.
The Company believes that KCSR revenues were negatively affected (primarily in
1996 and early 1997) by the UP/SP and BN/SF mergers as a result of the increased
competition which led to diversions of rail traffic away from KCSR lines. The
ongoing impact to KCSR of these mergers, as well as the merger of the CN/IC and
the CSX/Norfolk Southern/Conrail transaction is uncertain. Management believes,
however, that because of its investments and strategic alliances, it is well
positioned to attract additional rail traffic through its "NAFTA Railway."
In addition to competition within the railroad industry, highway carriers
compete with KCSR throughout its operating area. Since deregulation of the
railroad industry, competition has resulted in extensive downward pressure on
freight rates. Truck carriers have eroded the railroad industry's share of total
transportation revenues. However, rail carriers, including KCSR, have placed an
emphasis on competing in the intermodal marketplace, working together to provide
end-to-end transportation of products.
Mississippi and Missouri River barge traffic, among others, also competes with
KCSR in the transportation of bulk commodities such as grains, steel and
petroleum products.
In response to the changing competitive and business environment in the rail
industry, in 1997 the Company revised its accounting methodology for evaluating
the recoverability of intangibles from a business unit approach to analyzing
each of the Company's significant investment components. Based on this analysis,
$91.3 million of the remaining purchase price in excess of fair value of the
MidSouth assets acquired was not recoverable. This charge was recorded as of
December 31, 1997.
22
See "Union Labor Negotiations" below for a discussion of the impact of labor
issues and regulations on competition in the transportation industry.
Berger Joint Venture. During 1996, Berger entered into a joint venture agreement
with Bank of Ireland Asset Management (U.S.) Limited, a subsidiary of Bank of
Ireland, to develop and market a series of international and global mutual
funds. The new venture, named BBOI Worldwide LLC ("BBOI"), is headquartered in
Denver, Colorado. Regulatory approvals were received in October 1996, and the
first no-load mutual fund product - the Berger/BIAM International Fund - was
introduced in fourth quarter 1996. Currently, BBOI manages five funds and assets
under management for these funds totaled $522 million at December 31, 1998
compared with $161 million at December 31, 1997. Berger accounts for its 50%
investment in BBOI under the equity method.
Union Labor Negotiations. Approximately 84% of KCSR employees and 88% of Gateway
Western employees are covered under various collective bargaining agreements.
In 1996, national labor contracts governing the KCSR were negotiated with all
major railroad unions, including the United Transportation Union, the
Brotherhood of Locomotive Engineers, the Transportation Communications
International Union, the Brotherhood of Maintenance of Way Employees, and the
International Association of Machinists and Aerospace Workers. The provisions of
the various labor agreements, which extend to December 31, 1999, generally
include periodic general wage increases, lump-sum payments to workers, and
greater work rule flexibility, among other provisions. These agreements did not
have a material effect on the Company's consolidated results of operations,
financial position or cash flows. As a result of the operating efficiencies
gained by the existing agreements, management believes the Company is better
positioned to compete effectively with alternative forms of transportation.
Railroads continue, however, to be restricted by certain remaining restrictive
work rules and are thus prevented from achieving optimum productivity with
existing technology and systems. Currently, informal discussions are being held
with certain national labor unions with regard to the next labor contract. These
discussions are preliminary and formal negotiations will not begin until
November 1999. Management does not expect that this process or the resulting
labor agreements will have a material impact on its consolidated results of
operations, financial condition or cash flows.
Labor agreements related to former MidSouth employees covered by collective
bargaining agreements reopened for negotiations in 1996. These agreements entail
eighteen separate groups of employees and are not included in the national labor
contracts. KCSR management is currently in the process of meeting with these
unions representing its employees. While these discussions are ongoing, the
Company does not anticipate that this process or the resulting labor agreements
will have a material impact on its consolidated results of operations, financial
condition or cash flows.
The majority of employees of the Gateway Western are covered by collective
bargaining agreements which extend through December 1999. Unions representing
machinists and electrical workers, however, are operating under 1994 contracts
and are currently in negotiations to extend these contracts. Negotiations on the
agreements which extend through December 1999 are expected to begin in late
1999. The Company does not anticipate that this process or the resulting labor
agreements will have a material impact on its consolidated results of
operations, financial condition or cash flows.
KCSR, Gateway and other railroads continue to be affected by labor regulations
which are more burdensome than those governing non-rail industries, such as
trucking competitors. The Railroad Retirement Act requires up to a 23.75%
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. Other programs, such as The Federal Employees Liability Act (FELA), when
compared to worker's compensation laws, vividly illustrate the competitive
disadvantage placed upon the rail industry by federal labor regulations.
23
During 1998, the Brotherhood of Locomotive Engineers and the United
Transportation Union, the two unions representing a majority of the Company's
employees, have agreed to merge. Currently, details of the merged union are
being discussed and determined by the involved parties. The merger of these two
unions is not expected to have a material impact on the Company's results of
operations, financial position or cash flows.
Safety and Quality Programs. During 1997, KCSR continued its implementation of
important safety and quality programs, including an extensive, cross-functional
"Pro-Formance" initiative focusing on continuous improvements in all aspects of
the organization. Because of the continued focus on safety and quality programs,
KCSR has experienced a decline in accident related statistics in recent years;
however reportable injuries increased slightly during 1998. Although total
derailments declined 18% from the period 1996-1998, two significant derailments
experienced during the latter half of 1998 led to an increase in derailment
costs during 1998. One of KCSR management's primary objectives is to operate in
the safest environment possible and efforts are ongoing to improve its safety
experience. "Safety" and "Quality" programs comprise two important ongoing
elements of KCSR management's goal of reducing employee injuries and related
benefits are expected to be recurring in nature and realizable over future
years. Program expenses are not anticipated to have a material impact on
operating results in future years.
INDUSTRY SEGMENT RESULTS
The Company's revenues, operating income and net income by industry segment are
as follows (in millions):
1998(i) 1997(ii) 1996(iii)
----------- ----------- -----------
Revenues
Transportation $ 613.5 $ 573.2 $ 517.7
Financial Services 670.8 485.1 329.6
----------- ----------- -----------
Total $ 1,284.3 $ 1,058.3 $ 847.3
=========== =========== ===========
Operating Income (Loss)
Transportation $ 113.9 $ (92.7) $ 72.1
Financial Services 280.6 199.2 131.8
----------- ----------- -----------
Total $ 394.5 $ 106.5 $ 203.9
=========== =========== ===========
Net Income (Loss)
Transportation $ 38.0 $ (132.1) $ 16.3
Financial Services 152.2 118.0 134.6
----------- ----------- -----------
Total $ 190.2 $ (14.1) $ 150.9
=========== =========== ===========
(i) Includes a one-time non-cash charge of $36.0 million ($23.2 million
after-tax) resulting from the merger of a wholly-owned subsidiary of DST
with USCS. The merger was accounted for by DST under the pooling of
interests method. The charge reflects the Company's reduced ownership of
DST (from 41% to approximately 32%), together with the Company's
proportionate share of DST and USCS fourth quarter merger-related charges.
See Note 2 to the consolidated financial statements in this Form 10-K.
(ii) Includes $196.4 million ($158.1 million after-tax, comprised of $141.9
million -Transportation segment and $16.2 million Financial Services
segment) of restructuring, asset impairment and other charges recorded
during fourth quarter 1997. The charges reflect impairment of goodwill
associated with KCSR's 1993 acquisition of the MidSouth and the Company's
investment in Berger, long-lived assets held for disposal, impaired
long-lived assets, reserves related to termination of a union productivity
fund and employee separations, and other reserves for leases, contracts and
reorganization costs. See Notes 1 and 3 to the consolidated financial
statements in this Form 10-K. Additionally, Transportation results for the
year ended 1997 include revenues and expenses from Gateway Western.
24
(iii)Includes a one-time after-tax gain of $47.7 million representing the
Company's proportionate share of the one-time gain recognized by DST in
connection with the merger of Continuum with CSC (see Note 2 to the
consolidated financial statements in this Form 10-K).
Consolidated net income for 1998 increased to $190.2 million from a consolidated
loss of $14.1 million in 1997. Exclusive of the 1998 and 1997 one-time charges,
consolidated net income grew $69.4 million, or 48%, to $213.4 million from
$144.0 million in 1997, reflecting earnings improvements in both the
Transportation and Financial Services segments. Consolidated revenues for the
year ended December 31, 1998 were $226 million (21%) higher than 1997 as a
result of increases in both segments. Operating income, exclusive of 1997
restructuring, asset impairment and other charges, increased $91.6 million (30%)
year to year, driven by higher revenues as well as improved consolidated
operating margins.
Consolidated 1997 revenues increased $211.0 million over 1996, reflecting
improvements in both the Transportation and Financial Services segments year to
year, as well as the inclusion of Gateway Western revenues. While 1997 total
operating income decreased from 1996 by 48%, operating income exclusive of the
restructuring, asset impairment and other charges increased nearly $100 million,
indicative of a higher rate of revenue growth compared to expenses. The
consolidated loss of $14.1 million for the year ended December 31, 1997 includes
$196.4 million ($158.1 million after-tax) in restructuring, asset impairment and
other charges, as previously discussed. Consolidated net income of $150.9
million for the year ended 1996 includes a one-time gain of $47.7 million
resulting from the Continuum transaction. Exclusive of these amounts,
consolidated net income in 1997 of $144.0 million was $40.8 million, or 40%,
higher than 1996. This increase reflects improvement in ongoing operations for
both the Transportation and the Financial Services segments, primarily from
higher revenues and improved operating margins.
A discussion of each business segment's results of operations follows.
TRANSPORTATION (KCSL)
The following summarizes the income statement components of the Transportation
segment and provides a reconciliation to ongoing domestic Transportation
earnings:
1998 1997 1996
---------- ---------- ----------
Revenues $ 613.5 $ 573.2 $ 517.7
Costs and expenses 442.9 426.1 382.7
Depreciation and amortization 56.7 61.8 62.9
Restructuring, asset impairment
and other charges - 178.0 -
---------- ---------- ----------
Operating income (loss) 113.9 (92.7) 72.1
Equity in net earnings (losses) of
unconsolidated affiliates (2.9) (9.7) 1.5
Interest expense (59.6) (53.3) (52.8)
Other, net 13.7 5.0 7.9
---------- ---------- ----------
Pretax income (loss) 65.1 (150.7) 28.7
Income tax expense (benefit) 27.1 (18.6) 12.4
---------- ---------- ----------
Transportation net income (loss) 38.0 (132.1) 16.3
Restructuring, asset impairment and
other charges, net of tax - 141.9 -
Grupo TFM losses and interest, net of tax 14.3 17.6 -
---------- ---------- ----------
Ongoing domestic Transportation
earnings $ 52.3 $ 27.4 $ 16.3
========== ========== ==========
25
Ongoing domestic Transportation segment earnings increased $24.9 million, or
90.9%, to $52.3 million for the year ended December 31, 1998. This increase
resulted from higher revenues, which grew $40.3 million, or 7.0% (primarily from
a 6.5% increase in revenues at KCSR) and lower operating costs as a percentage
of revenue. The Transportation segment's operating income, exclusive of 1997
restructuring, asset impairment and other charges, increased 33.5% to $113.9
million from $85.3 million in 1997. This increase was driven by improved
operating margins as a result of a slower rate of growth in operating expenses
compared to revenues. Exclusive of depreciation and amortization and 1997
restructuring, asset impairment and other charges, the Transportation segment's
operating costs as a percentage of revenues decreased by more than 2% as a
result of continuing cost containment efforts. The termination of the union
productivity fund resulted in a savings of approximately $4.8 million during
1998 and these savings are expected to continue in the future. Depreciation and
amortization expenses declined $5.1 million, or 8.3%, chiefly due to the
reduction of amortization and depreciation expense of approximately $5.6 million
arising from the impairment of goodwill and certain branch lines held for sale
recorded during December 1997, partially offset by increased depreciation from
property additions. See "Results of Operations" above for further discussion.
Ongoing domestic Transportation segment earnings of $27.4 million for the year
ended December 31, 1997 were compared to $16.3 million for the prior year, an
increase of $11.1 million or 68%. This increase was driven by revenue growth
from $517.7 million to $573.2 million, chiefly due to higher KCSR revenues and
the addition of the Gateway Western, partially offset by the loss of revenues
from Southern Leasing Corporation, which was dissolved in the fourth quarter of
1996. In addition, cost containment initiatives by management in the second half
of 1997 helped to increase operating margins and contributed to higher earnings.
Transportation expenses, exclusive of the restructuring, asset impairment and
other charges, increased $42.3 million, or 9.5% to $487.9 million for 1997
compared with $445.6 million for 1996. The increase was attributable to
operating lease expenses resulting from the Southern Capital transaction and the
inclusion of Gateway Western expenses in 1997 (variable operating expenses were
essentially unchanged year to year). Depreciation and amortization expenses in
1997 for the Transportation segment decreased $1.1 million (1.7%) from 1996 due
to the transfer of assets to Southern Capital during the fourth quarter of 1996,
offset by the inclusion of Gateway Western.
Interest Expense and Other, net
Interest expense for the year ended December 31, 1998 increased $6.3 million, or
11.8%, to $59.6 million as a result of the inclusion of a full year's interest
associated with the debt related to the Company's investment in Grupo TFM,
partially offset by a decrease in average debt balances due to net repayments
and a slight decrease in interest rates relating to the lines of credit.
Additionally during 1997, interest of $7.4 million was capitalized as part of
the investment in Grupo TFM until operations commenced (June 23, 1997). Other,
net increased $8.7 million to $13.7 million for the year ended December 31,
1998. Included in this increase is a one-time gain of $2.9 million (pretax) from
the sale of a branch line and $2.8 million of interest related to a tax refund
in 1998. Other non-operating real estate sales comprised the majority of the
remaining increase.
The 1% increase in 1997 Transportation interest expense (to $53.3 million) is
due to interest associated with the investment in Grupo TFM, together with
interest on Gateway Western indebtedness, offset by debt repayments made at the
end of 1996 associated with the Southern Capital transaction. Capitalized
interest related to the Company's Grupo TFM investment totaled $7.4 million for
the year ended December 31, 1997, which ceased upon gaining operational control
of TFM on June 23, 1997. Other, net decreased $2.9 million, or 36.7%, to $5.0
million for 1997 from $7.9 million in 1996, primarily attributable to the 1996
one-time gain of approximately $2.9 million recorded by KCSR in connection with
the sale of real estate.
Income Taxes
Income taxes increased $45.7 million from a 1997 benefit of $18.6 million to a
$27.1 million expense for the year ended December 31, 1998. This fluctuation
resulted primarily because of the restructuring, asset
26
impairment and other charges in 1997. Exclusive of these charges, income
tax expense from year to year increased by $9.6 million, or 54.8%, primarily due
to higher operating income in 1998.
Income taxes decreased $31.0 million from $12.4 million of expense in 1996 to
$18.6 million of benefit for 1997, primarily as a result of the impact of
restructuring, asset impairment and other charges on pretax income. Exclusive of
these charges, income tax expense for 1997 would have been approximately $17.5
million.
KCSL Subsidiaries
Following is a detailed discussion of the primary subsidiaries and
unconsolidated affiliates comprising the Transportation segment. Results of less
significant subsidiaries have been omitted.
The Kansas City Southern Railway Company
KCSR operates in a nine state region, including Missouri, Kansas, Arkansas,
Oklahoma, Mississippi, Alabama, Tennessee, Louisiana, and Texas. KCSR has the
shortest rail route between Kansas City and the Gulf of Mexico, serving the
ports of Beaumont and Port Arthur, Texas; and New Orleans, Baton Rouge, Reserve
and West Lake Charles, Louisiana. Through haulage rights, KCSR has access to the
states of Nebraska and Iowa and serves the ports of Houston and Galveston,
Texas. Kansas City, Missouri, as the second largest rail center in the United
States, represents an important interchange gateway for KCSR. KCSR also has
interchange gateways in New Orleans and Shreveport, Louisiana; Dallas and
Beaumont, Texas; and Jackson and Meridian, Mississippi.
Major commodities moved by KCSR include coal, grain and farm products,
petroleum, chemicals, paper and forest products, intermodal, as well as other
general commodities. Management believes that KCSR, in conjunction with the
Norfolk Southern, operates the most direct rail route, referred to as the
"Meridian Speedway," linking the Atlanta and Dallas gateways for traffic moving
between the rapidly-growing 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 the Mexican markets and
has allowed KCSR to be more competitive in transcontinental intermodal
transportation.
For the year ended December 31, 1998, KCSR's contribution to the Company's
consolidated earnings increased $25.6 million to $53.0 million, compared to
$27.4 million (exclusive of restructuring, asset impairment and other charges)
in 1997. This increase was primarily due to a $33.8 million increase in
revenues, partially offset by a $4.0 million increase in variable and fixed
operating costs.
Exclusive of the restructuring, asset impairment and other charges recorded in
fourth quarter 1997, KCSR contributed $27.4 million to the Company's
consolidated earnings compared to $17.1 million in 1996. This increase is
primarily due to a $25.3 million increase in KCSR revenues offset by a lesser
increase in variable and fixed operating costs.
27
Revenues
The following summarizes revenues, carloads and net ton miles of KCSR by
commodity mix:
Carloads and
Revenues Intermodal Units Net Ton Miles
------------------------- ----------------------- -----------------------
(in millions) (in thousands) (in millions)
1998 1997 1996 1998 1997 1996 1998 1997 1996
-------- ------- ------- ----- ----- ----- ------ ------ ------
General commodities:
Chemical and petroleum $ 138.3 $ 133.1 $ 129.0 165.4 162.9 165.9 4,510 4,199 4,070
Paper and forest 108.8 106.4 103.5 172.5 175.8 177.3 3,121 3,072 2,910
Agricultural and mineral 94.7 85.0 75.0 130.8 119.6 113.2 4,574 4,002 3,306
Other 20.2 20.5 18.7 25.4 24.4 22.6 649 913 1,007
-------- ------- ------- ----- ----- ----- ------ ------ ------
Total general commodities 362.0 345.0 326.2 494.1 482.7 479.0 12,854 12,186 11,293
Intermodal 46.3 43.2 40.3 182.6 161.6 149.4 1,325 1,240 1,402
Coal 117.6 102.6 102.5 204.4 177.1 179.6 7,477 6,249 5,735
-------- ------- ------- ----- ----- ----- ------ ------ ------
Subtotal 525.9 490.8 469.0 881.1 821.4 808.0 21,656 19,675 18,430
Other 25.7 27.0 23.5 - - - - - -
-------- ------- ------- ----- ----- ----- ------ ------ ------
Total $ 551.6 $ 517.8 $ 492.5 881.1 821.4 808.0 21,656 19,675 18,430
======== ======= ======= ===== ===== ===== ====== ====== ======
KCSR revenues for 1998 were $551.6 million, a $33.8 million increase over 1997
as a result of higher revenues in all major commodity groups. 1998 coal revenues
increased $15.0 million, or 14.7%, compared to 1997 while intermodal revenues
were 7.3% higher. General commodities, led by an increase of 11.4% in
agricultural and mineral products revenues, improved $17.0 million, or nearly
5%. A portion of increased revenues relate to traffic with Mexico, which
increased approximately 118% during 1998, resulting in an additional $10 million
of revenue. Also, increased carloads resulting from the CN/IC alliance
contributed to the higher revenues.
1997 KCSR revenues were $25.3 million, or 5.1%, higher than 1996 due to a 5.8%
increase in general commodities and a 7.2% increase in intermodal revenues.
Agricultural and mineral products led general commodities with a 13.3% increase
over 1996 comprised primarily of domestic and export grain and food products.
The following is a discussion of KCSR's major commodity groups.
Coal
Coal continues to be the largest single commodity handled by KCSR, which
delivers coal to seven electric generating plants, located at Amsterdam,
Missouri; Flint Creek, Arkansas; Welsh, Texas; Mossville, Louisiana; Kansas
City, Missouri; Pittsburg, Kansas; and Hugo, Oklahoma. Two coal customers,
Southwestern Electric Power Company ("SWEPCO") and Entergy Gulf States (formerly
Gulf States Utility Company), comprised approximately 81%, 82% and 83% of total
coal revenues generated by KCSR in 1998, 1997and 1996, respectively. KCSR also
delivers lignite to an electric generating plant at Monticello, Texas ("TUMCO").
KCSR's contract with SWEPCO, its largest customer, extends through the year
2006. During 1998, coal revenues increased notably over prior years; however,
historically coal revenues have a tendency to equalize on an annual basis.
Coal movements generated $117.6 million of revenue during 1998, a 14.7% increase
over 1997. This 1998 increase resulted from higher unit coal traffic (increase
in carloads of nearly 16%) arising from several factors. 1) In 1998,
unseasonably warm weather resulted in a higher demand for electric power in
certain regions served by the KCSR and several utility customers requested more
coal to handle this increased demand. Additionally, in order to replenish
inventory levels depleted from this excess demand, several locations increased
their coal shipments. 2) During 1997, unit coal revenues were negatively
28
affected by unplanned outages (primarily during first and second quarters) at
several utilities served by KCSR, and first quarter weather problems which
affected carriers and the mines originating the coal. During 1998, the level of
unplanned outages declined and, thus, more unit coal trains were delivered to
customers. Additionally, although KCSR experienced certain weather related
slow-downs due to flooding during fourth quarter 1998, it did not significantly
impact coal revenues. 3) 1998 results reflect a full year of revenues for a
utility customer not served by KCSR until after the first quarter of 1997. Coal
accounted for 22.4% of carload revenues during 1998 compared with 20.9% for
1997.
Coal revenues during 1997 were $102.6 million, virtually unchanged from 1996.
Coal traffic comprised 20.9% of carload revenues and 21.6% of carloads in 1997
compared with 21.9% and 22.2%, respectively, in 1996 indicating the growth
realized in other commodities.
Chemicals and Petroleum
Chemical and petroleum products, serviced via tank and hopper cars primarily to
markets in the Southeast and Northeast through interchange with other rail
carriers, as a combined group represent the largest commodity to KCSR in terms
of revenue. Management expects that revenues in this commodity group could grow
in future years as a result of KCSR's marketing agreement with the CN/IC, which
is expected to provide KCSR access to the manufacturing facilities of BASF
Corporation, Shell Chemical Company and Borden Chemical and Plastics in Geismar,
Louisiana, a large industrial corridor.
Chemical and petroleum revenues increased $5.2 million to $138.3 million in 1998
compared to 1997. Increases in miscellaneous chemicals and soda ash carloads,
coupled with higher revenues per carload for plastic and petroleum products,
were offset by lower carloads for plastics, petroleum products and petroleum
coke. The higher revenues per carload for plastics and petroleum products
resulted from a combination of rate increases and length of hauls, while the
increased miscellaneous chemical and soda ash carloads arose from the continued
strength of these markets. Shipments of plastic products have decreased as a
result of a reduced emphasis on low margin business, while petroleum and
petroleum coke carload declines are a result of economic turmoil overseas
(primarily Asia) affecting the export market. Chemical and petroleum products
accounted for 26.3% of total 1998 carload revenues compared with 27.1% for 1997.
During 1997, chemical and petroleum revenues increased to $133.1 million from
$129.0 million. This $4.1 million increase, or 3.2%, resulted primarily from
increased revenues in plastics, miscellaneous chemical, soda ash and petroleum
shipments offset by reduced petroleum coke shipments. Chemical and petroleum
products accounted for 27.1% of total 1997 carload revenues compared with 27.5%
for 1996.
Paper and Forest
KCSR, whose rail line runs through the heart of the southeastern U.S. timber
producing region, serves eleven paper mills directly (including International
Paper Co. and Georgia Pacific, Riverwood International, among others) and six
others indirectly through short-line connections, and transports pulpwood,
woodchips and raw fiber used in the production of paper, pulp and paperboard.
Paper and forest product revenues increased $2.4 million to $108.8 million for
1998, primarily as a result of increased carloads and revenues per carload for
pulp, paper and lumber products, offset by a reduction in pulpwood chip
shipments. Improved lumber shipments have resulted from the strong home building
and remodeling market in 1998, while pulp/paper increases are primarily a result
of paper mill expansions for several customers served by KCSR. Although paper
and forest revenues increased for 1998, fourth quarter carloads and revenues
decreased compared with fourth quarter of 1997. Paper and forest product
revenues are expected to remain somewhat flat during 1999 due to a reduced
demand for these products and higher current inventories and stockpiles. Paper
and forest traffic comprised 20.7% of carload revenues during 1998 compared to
21.7% in 1997.
Paper and forest products revenues increased $2.9 million, or 2.8%, to $106.4
million for the year ended December 31, 1997 from $103.5 million from the year
ended December 31, 1996 as a result of increased carloads for lumber/plywood and
higher revenues per carload for pulpwood and woodchips offset by
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decreased pulpwood and woodchips carloads. Paper and forest traffic
comprised 21.7% of carload revenues in 1997 as compared to 22.1% in 1996.
Agricultural and Mineral
Agricultural and Mineral product revenues for the year ended December 31, 1998
were $94.7 million, an increase of $9.7 million, or 11.4%, compared to 1997.
Increased carloads for most agricultural and mineral products, including
domestic and export grain, food, nonmetallic ores, cement, glass and stone
contributed to the increase. Higher revenues per carload, most notably in export
grain and food products, were partially offset by a reduction in revenues per
carload from domestic grain movements. Changes in revenues per carload are
primarily due to mix in the length of haul. A portion of the volume increases
can be attributed to increased traffic flow with Mexico. Over the long-term, the
Company expects to continue to supply carloads of grain to Mexico through Grupo
TFM because of Mexico's reliance on imports of grain to meet its minimum needs.
Agricultural and mineral products comprised 18.0% of carload revenues in 1998
compared with 17.3% in 1997.
Agricultural and mineral products revenues for 1997 increased $10 million, or
13.3%, compared to 1996 primarily as a result of higher carloads of grain,
especially corn, due to a strong harvest. Additionally, carloads of nonmetallic
minerals increased approximately 18% over 1996 volume. Agricultural and mineral
products accounted for 17.3% of carload revenues in 1997 compared with 16% in
1996.
Intermodal
The intermodal freight business consists of hauling freight containers or truck
trailers by a combination of water, rail and motor carriers, with rail carriers
serving as the links between motor carriers and ports. KCSR increased its share
of the U.S. intermodal traffic primarily through the acquisition of the
MidSouth, which extended the Company's east/west line running from Dallas, Texas
to Shreveport, Louisiana to Meridian, Mississippi. During 1997, the Company
committed to a plan to pursue intermodal business based on operating margin
versus growth through carload volume. This strategy continues as the Company
increas