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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, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ____ to ____
Commission file number 1-4717
KANSAS CITY SOUTHERN
(Exact name of Company as specified in its charter)
Delaware 44-0663509
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
427 West 12th Street, Kansas City, Missouri 64105
(Address of principal executive offices) (Zip Code)
Company's telephone number, including area code (816) 983-1303
Securities registered pursuant to Section 12 (b) of the Act:
Name of each exchange on
Title of each class which registered
- ----------------------------------------- ------------------------
Preferred Stock, Par Value $25 Per Share, New York Stock Exchange
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]
Indicate by check mark whether the Company is an accelerated filer (as defined
in Exchange Act Rule 12b-2)
YES [X] NO [ ]
Company Stock. The Company's common stock is listed on the New York Stock
Exchange under the symbol "KSU." As of June 30, 2002, the aggregate market value
of the voting and non-voting common and preferred stock held by non-affiliates
of the Company was approximately $1,027 million (amount computed based on
closing prices of preferred and common stock on New York Stock Exchange). As of
February 28, 2003, 61,495,992 shares of common stock and 242,170 shares of
voting preferred stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the following documents are incorporated herein by reference into
Part of the Form 10-K as indicated:
Document Part of Form 10-K into which incorporated
- ------------------------------------ -----------------------------------------
Company's Definitive Proxy Statement Parts I, III
for the 2003 Annual Meeting of
Stockholders, which will be filed no
later than 120 days after
December 31, 2002
KANSAS CITY SOUTHERN
2002 FORM 10-K ANNUAL REPORT
Table of Contents
Page
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PART I
Item 1. Business............................................................ 1
Item 2. Properties.......................................................... 14
Item 3. Legal Proceedings................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders................. 18
Executive Officers of the Company................................... 18
PART II
Item 5. Market for the Company's Common Stock and
Related Stockholder Matters....................................... 19
Item 6. Selected Financial Data............................................. 20
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations .............................. 21
Item 7A Quantitative and Qualitative Disclosures About Market Risk.......... 55
Item 8. Financial Statements and Supplementary Data......................... 58
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................... 102
PART III
Item 10. Directors and Executive Officers of the Company..................... 102
Item 11. Executive Compensation.............................................. 103
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters........................ 103
Item 13. Certain Relationships and Related Transactions...................... 103
Item 14. Controls and Procedures............................................. 103
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K........................................................ 104
Signatures.......................................................... 111
ii
Part I
Item 1. Business
(a) GENERAL DEVELOPMENT OF COMPANY BUSINESS
Kansas City Southern ("KCS" or the "Company"), a Delaware corporation, is a
holding company with principal operations in rail transportation that was
initially organized in 1962 as Kansas City Southern Industries, Inc. In 2002,
the Company formally changed its name to Kansas City Southern.
On June 14, 2000, KCS's Board of Directors approved the spin-off of Stilwell
Financial Inc. ("Stilwell"), the Company's then wholly-owned financial services
subsidiary. On July 12, 2000, KCS completed the spin-off of Stilwell through a
special dividend of Stilwell common stock distributed to KCS common stockholders
of record on June 28, 2000 ("Spin-off"). Each KCS stockholder received two
shares of the common stock of Stilwell for every one share of KCS common stock
owned on the record date. The total number of Stilwell shares distributed was
222,999,786. Under tax rulings received from the Internal Revenue Service
("IRS"), the Spin-off qualifies as a tax-free distribution under Section 355 of
the Internal Revenue Code of 1986, as amended. Also on July 12, 2000, KCS
completed a reverse stock split whereby every two shares of KCS common stock
were converted into one share of KCS common stock.
Other 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
response to this Item 1.
(b) INDUSTRY SEGMENT FINANCIAL INFORMATION
KCS, as the holding company, supplies its various subsidiaries with managerial,
legal, tax, financial and accounting services, in addition to managing other
minor "non-operating" investments. KCS's principal subsidiaries and affiliates,
which are reported under one business segment, include the following:
o The Kansas City Southern Railway Company ("KCSR"), a wholly-owned
subsidiary;
o Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), a
46.6% owned unconsolidated affiliate, which owns 80% of the common stock of
TFM, S.A. de C.V. ("TFM"). TFM wholly-owns Mexrail, Inc. ("Mexrail").
Mexrail owns 100% of The Texas-Mexican Railway Company ("Tex Mex");
o Southern Capital Corporation, LLC ("Southern Capital"), a 50% owned
unconsolidated affiliate that leases locomotive and rail equipment to KCSR;
o Panama Canal Railway Company ("PCRC"), an unconsolidated affiliate of which
KCSR owns 50% of the common stock. PCRC owns all of the common stock of
Panarail Tourism Company ("Panarail").
Other subsidiaries of the Company include:
o Trans-Serve, Inc., (d/b/a Superior Tie and Timber - "ST&T"), an
owner/operator of a railroad wood tie treating facility;
o PABTEX GP, LLC ("Pabtex") located in Port Arthur, Texas with deep-water
access to the Gulf of Mexico. Pabtex is an owner of a bulk materials
handling facility that stores and transfers petroleum coke from trucks and
rail cars to ships primarily for export; and
o Transfin Insurance, Ltd., a single-parent captive insurance company,
providing property, general liability and certain other insurance coverage
to KCS and its subsidiaries and affiliates.
Effective December 31, 2002, the Company merged Mid-South Microwave, Inc.
("Mid-South Microwave") and Rice-Carden Corporation ("Rice-Carden), two
wholly-owned subsidiaries, into KCSR. Prior to the merger, Mid-South Microwave
owned and operated a 1,600-mile industrial frequency microwave transmission
system. This system is now
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owned and operated by KCSR and serves as its primary communications facility.
Prior to the merger, Rice-Carden owned and operated various industrial real
estate and spur rail tracks. This real estate, which is primarily contiguous to
the KCSR right-of-way, is now owned and operated by KCSR.
During 2002, due to the relocation of the Company's headquarters to a new
building in downtown Kansas City, Missouri, the Company sold its interests in
Wyandotte Garage Corporation, which owns and operates a parking facility located
adjacent to the Company's former headquarters building in downtown Kansas City,
Missouri.
Other 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 and under Item 8, "Financial Statements
and Supplementary Data" of this Form 10-K, is incorporated by reference in
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
response to this Item 1.
OVERVIEW
The Company, along with its subsidiaries and affiliates, owns and operates a
uniquely positioned North American rail network strategically focused on the
growing north/south freight corridor that connects key commercial and industrial
markets in the central United States with major industrial cities in Mexico. The
Company's principal subsidiary, KCSR, which was founded in 1887, is one of seven
Class I railroads in the United States. The Company's rail network (KCSR, TFM
and Tex Mex) is comprised of approximately 6,000 miles of main and branch lines.
Through a strategic alliance with Canadian National Railway Company ("CN") and
Illinois Central Corporation ("IC") (together "CN/IC"), the Company has access
to a contiguous rail network of approximately 25,000 miles of main and branch
lines connecting Canada, the United States and Mexico. Management believes that,
as a result of the strategic position of our rail network, the Company is poised
to continue to benefit from the growing north/south trade between the United
States, Mexico and Canada promoted by the North American Free Trade Agreement
("NAFTA").
The Company's rail network interconnects with all other Class I railroads and
provides shippers with an effective alternative to other railroad routes, giving
direct access to Mexico and the southeastern and southwestern United States
through less congested interchange hubs.
The Company's rail network links directly to major trading centers in Mexico
through Tex Mex and TFM. TFM operates a railroad that runs from the U.S./Mexico
border at Laredo, Texas to Mexico City and serves most of Mexico's principal
industrial cities and three of its major shipping ports. TFM also owns Mexrail,
which wholly owns Tex Mex. Tex Mex operates between Laredo and the port city of
Corpus Christi, Texas and with trackage rights connects to KCSR at Beaumont,
Texas. TFM, through its concession with the Mexican government, has the right to
control and operate the southern half of the rail-bridge at Laredo and,
indirectly through its ownership of Mexrail, owns the northern half of the
rail-bridge at Laredo, which spans the Rio Grande River between the United
States and Mexico. Our principal international gateway is at Laredo, where more
than 50% of all rail and truck traffic between the United States and Mexico
crosses the border.
KCS's rail network is further expanded through its strategic alliance with CN/IC
and marketing agreements with Norfolk Southern Railway Company ("Norfolk
Southern"), The Burlington Northern and Santa Fe Railway Company ("BNSF") and
the Iowa, Chicago & Eastern Railroad Corporation ("IC&E" - formerly I&M Rail
Link, LLC). The CN/IC alliance connects Canadian markets with major midwestern
and southern markets in the United States as well as with major markets in
Mexico through KCRS's connections with Tex Mex and TFM. Marketing agreements
with Norfolk Southern allow the Company to capitalize on its east/west route
from Meridian, Mississippi to Dallas, Texas ("Meridian
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Speedway") to gain incremental traffic volume between the southeast and the
southwest. The marketing alliance with BNSF was developed to promote
cooperation, revenue growth and extend market reach for both railroads in the
United States and Canada. It is also designed to improve operating efficiencies
for both KCSR and BNSF in key market areas, as well as provide customers with
expanded service options. KCSR's marketing agreement with IC&E provides access
to Minneapolis, Minnesota and Chicago and to originations of corn and other
grain in Iowa, Minnesota and Illinois.
The Company also owns 50% of the common stock (or a 42% equity interest) of
PCRC, which holds the concession to operate a 47-mile coast-to-coast railroad
located adjacent to the Panama Canal. The railroad handles containers in freight
service across the isthmus. Panarail, a wholly owned subsidiary of PCRC,
operates a commuter and tourist railway service over the lines of the Panama
Canal Railway. Passenger service commenced during the third quarter of 2001 and
freight service started during the fourth quarter of 2001.
RAIL NETWORK
Owned Network
KCSR owns and operates approximately 3,100 miles of main and branch lines and
1,250 miles of other tracks in a ten-state region that includes Missouri,
Kansas, Arkansas, Oklahoma, Mississippi, Alabama, Tennessee, Louisiana, Texas
and Illinois. KCSR has the shortest north/south rail route between Kansas City
and several key ports along the Gulf of Mexico in Louisiana, Mississippi and
Texas. KCSR's rail route also serves the Meridian Speedway and the east/west
route linking Kansas City with East St. Louis, Illinois and Springfield,
Illinois. In addition, KCSR has limited haulage rights between Springfield and
Chicago that allow for shipments that originate or terminate on the rail lines
of the former Gateway Western Railway Company ("Gateway Western"). These lines
also provide access to East St. Louis and allow rail traffic to avoid the St.
Louis terminal. This geographic reach enables service to a customer base that
includes electric generating utilities, which use coal, and a wide range of
companies in the chemical and petroleum, agricultural and mineral, paper and
forest, and automotive and intermodal markets.
Eastern railroads and their customers can bypass the gateways at Chicago,
Illinois; St. Louis, Missouri; Memphis, Tennessee and New Orleans, Louisiana by
interchanging with KCSR at Springfield, Illinois and East St. Louis and at
Meridian and Jackson, Mississippi. Other railroads can also interconnect with
the Company's rail network via other gateways at Kansas City, Missouri;
Birmingham, Alabama; Shreveport and New Orleans, Louisiana; and Dallas, Beaumont
and Laredo, Texas.
KCSR revenues and net income are dependent on providing reliable service to
customers at competitive rates, the general economic conditions in the
geographic region served and the ability to effectively compete against other
rail carriers and alternative modes of surface transportation, such as
over-the-road truck transportation. The ability of KCSR to construct and
maintain the roadway in order to provide safe and efficient transportation
service is important to its ongoing viability as a rail carrier. Additionally,
cost containment is important in maintaining a competitive market position,
particularly with respect to employee costs, as approximately 84% of KCSR
employees are covered under various collective bargaining agreements.
Significant Investments
Grupo TFM
In December 1995, the Company entered into a joint venture agreement with
Transportacion Maritima Mexicana, S.A. de C.V. ("TMM") to provide for
participation in the privatization of the Mexican national railway system
through Grupo TFM, and to promote the movement of rail traffic over Tex Mex, TFM
and KCSR. In 1997, the Company invested $298 million to obtain a 36.9% interest
in Grupo TFM. At the time of purchase, TMM, the largest shareholder of Grupo
TFM, owned 38.5% of Grupo TFM and the Mexican government owned the remaining
24.6%. In 2001, TMM and Grupo TMM, S.A. ("Grupo TMM" - formerly Grupo Servia
S.A. de C.V) merged with the surviving entity being Grupo TMM. In 2002, KCS and
Grupo TMM exercised their call option and, on July 29, 2002, TFM completed the
purchase of the
Page 3
Mexican government's 24.6% ownership of Grupo TFM. The $256.1 million purchase
price was funded utilizing a combination of proceeds from an offering of debt
securities by TFM, a credit from the Mexican government for the reversion of
certain rail facilities and other resources. This transaction resulted in an
increase in the Company's ownership percentage of Grupo TFM from 36.9% to
approximately 46.6%. Grupo TFM owns 80% of the common stock of TFM and all of
the shares entitled to full voting rights, while the remaining 20% of TFM is
owned by the Mexican government.
TFM holds the concession, which was awarded by the Mexican Government in 1996,
to operate Mexico's Northeast Rail Lines (the "Concession"; the "Northeast Rail
Lines are now known as "TFM") for the 50 years ending in June 2047 and, subject
to certain conditions, has an option to extend the Concession for an additional
50 years. The Concession is subject to certain mandatory trackage rights and is
exclusive until 2027. However, the Mexican government may revoke TFM's
exclusivity after 2017 if it determines that there is insufficient competition
and may terminate the Concession as a result of certain conditions or events,
including (1) TFM's failure to meet its operating and financial obligations with
regard to the Concession under applicable Mexican law, (2) a statutory
appropriation by the Mexican government for reasons of public interest and (3)
liquidation or bankruptcy of TFM. TFM's assets and its rights under the
Concession may, under certain circumstances such as natural disaster, war or
other similar situations, also be seized temporarily by the Mexican government.
Under the Concession, TFM operates a strategically significant corridor between
Mexico and the United States, and has as its core route a key portion of the
shortest, most direct rail passageways between Mexico City and Laredo, Texas.
TFM's rail lines are the only ones which serve Nuevo Laredo, the largest rail
freight exchange point between the United States and Mexico. TFM's rail lines
connect the most populated and industrialized regions of Mexico with Mexico's
principal U.S. border railway gateway at Laredo. In addition, TFM serves three
of Mexico's primary seaports at Veracruz and Tampico on the Gulf of Mexico and
Lazaro Cardenas on the Pacific Ocean. TFM serves 15 Mexican states and Mexico
City, which together represent a majority of the country's population and
account for a majority of its estimated gross domestic product. KCS management
believes the Laredo gateway is the most important interchange point for rail
freight between the United States and Mexico. As a result, TFM's routes are an
integral part of Mexico's foreign trade.
This route structure enables the Company to benefit from growing trade resulting
from the increasing integration of the North American economy through NAFTA.
Trade between Mexico and the United States has grown from 1993 through 2002.
Through Tex Mex and KCSR, as well as through interchanges with other major U.S.
railroads, TFM provides its customers with access to an extensive rail network
through which they may distribute their products throughout North America and
overseas.
TFM operates approximately 2,650 miles of main and branch lines and certain
additional sidings, spur tracks and main line tracks under trackage rights. TFM
has the right to operate the rail lines, but does not own the land, roadway or
associated structures. Approximately 81% of the main line operated by TFM
consists of continuously welded rail. As of December 31, 2002, TFM owned 468
locomotives, owned or leased from affiliates 4,558 freight cars and leased from
non-affiliates 150 locomotives and 6,800 freight cars.
On February 27, 2002, the Company, Grupo TMM, and certain of Grupo TMM's
affiliates entered into a stock purchase agreement with TFM to sell to TFM all
of the common stock of Mexrail. Mexrail owns the northern half of the
international railway bridge at Laredo, Texas and all of the common stock of the
Tex Mex. The sale closed on March 27, 2002 and the Company received
approximately $31.4 million for its 49% interest in Mexrail. The Company used
the proceeds from the sale of Mexrail to reduce debt. Although the Company no
longer directly owns 49% of Mexrail, it retains an indirect ownership through
its 46.6% ownership of Grupo TFM. Under the stock purchase agreement, KCS
retained rights to prevent further sale or transfer of the stock or significant
assets of Mexrail and Tex Mex and the right to continue to participate in the
corporate governance of Mexrail and Tex Mex, which will remain U.S. corporations
and subject to the Company's super majority rights contained in Grupo TFM's
bylaws.
Tex Mex operates a 160-mile rail line extending from Laredo to Corpus Christi.
Tex Mex connects to KCSR through trackage rights over The Union Pacific Railroad
Company ("UP") between Robbstown, Texas and Beaumont. These
Page 4
trackage rights were granted pursuant to a 1996 Surface Transportation Board
("STB") decision and have an initial term of 99 years. Tex Mex provides a vital
link between the Company's U.S. operations through KCSR and its Mexican
operations through TFM.
On March 12, 2001, Tex Mex purchased from UP a line of railroad right-of-way
extending 84.5 miles between Rosenberg, Texas and Victoria, Texas, and granted
Tex Mex trackage rights sufficient to integrate the line into the existing
trackage rights. The line is not in service and will require extensive
reconstruction, which has not yet been scheduled. The purchase price for the
line of $9.2 million was determined through arbitration and the acquisition also
required the prior approval or exemption of the transaction by the STB. By its
Order entered on December 8, 2000, the STB granted Tex Mex's Petition for
Exemption and exempted the transaction from this prior approval requirement.
Once reconstruction of the line is completed, Tex Mex will be able to shorten
its existing route between Corpus Christi and Houston, Texas by over 70 miles.
TFM, including its indirect ownership of Tex Mex, is both a strategic and
financial investment for KCS. Strategically KCSR's investment in TFM promotes
the NAFTA growth strategy whereby the Company and its strategic partners can
provide transportation services between the heart of Mexico's industrial base,
the United States and Canada. TFM seeks to establish its railroad as the primary
inland freight transporter linking Mexico with the U.S. and Canadian markets
along the NAFTA corridor. TFM's strategy is to provide reliable customer
service, capitalize on foreign trade growth and convert truck tonnage to rail.
KCS management believes TFM is an excellent long-term financial investment.
TFM's operating strategy has been to increase productivity and maximize
operating efficiencies. With Mexico's economic progress, growth of NAFTA trade
between Mexico, the United States and Canada, and customer focused rail service,
KCS management believes that the growth potential of TFM could be significant.
The term of the Grupo TFM joint venture agreement was renewed for a term of
three years on December 1, 2000 and will automatically renew for additional
terms of three years each unless either Grupo TMM or the Company gives notice of
termination at least 90 days prior to the end of the then-current term. The
joint venture agreement may also terminate under certain circumstances prior to
the end of a term, including upon a change of control or bankruptcy of either
Grupo TMM or the Company or a material default by Grupo TMM or the Company. Upon
termination of the agreement, any joint venture assets that are not held in the
name of KCS or Grupo TMM will be distributed proportionally to Grupo TMM and
KCS. The joint venture does not have any material assets and management believes
that a termination of the joint venture agreement would not have a material
adverse effect on the Company or its interest in Grupo TFM.
The shareholders agreement dated May 1997 between KCS and Grupo TMM and certain
affiliates, which governs the Company's investment in Grupo TFM (1) restricts
each of the parties to the shareholders agreement from directly or indirectly
transferring any interest in Grupo TFM or TFM to a competitor of Grupo TFM or
TFM without the prior written consent of each of the parties, and (2) provides
that KCS and Grupo TMM may not transfer control of any subsidiary holding all or
any portion of shares of Grupo TFM to a third party, other than an affiliate of
the transferring party or another party to the shareholders agreement, without
the consent of the other parties to the shareholders agreement. The Grupo TFM
bylaws prohibit any transfer of shares of Grupo TFM to any person other than an
affiliate of the existing shareholders without the prior consent of Grupo TFM's
board of directors. In addition, the Grupo TFM bylaws grant the shareholders of
Grupo TFM a right of first refusal to acquire shares to be transferred by any
other shareholder in proportion to the number of shares held by each
non-transferring shareholder, although holders of preferred shares or shares
with special or limited rights are only entitled to acquire those shares and not
ordinary shares. The shareholders agreement requires that the boards of
directors of Grupo TFM and TFM be constituted to reflect the parties' relative
ownership of the ordinary voting common stock of Grupo TFM.
On or prior to October 31, 2003 the Mexican government may sell its 20% interest
in TFM through a public offering (with the consent of Grupo TFM if prior to
October 31, 2003). If, on October 31, 2003, the Mexican government has not sold
all of its capital stock in TFM, Grupo TFM is obligated to purchase the capital
stock at the initial share price paid by Grupo TFM, adjusted for Mexican
inflation and changes in the U.S. Dollar/Mexican Peso exchange rate. In the
event that Grupo TFM does not purchase the Mexican government's remaining
interest in TFM, Grupo TMM and KCS, or
Page 5
either Grupo TMM or KCS, are obligated to purchase the Mexican government's
interest. KCS and Grupo TMM have cross indemnities in the event the Mexican
government requires only one of them to purchase its interest. The cross
indemnities allow the party required to purchase the Mexican government's
interest to require the other party to purchase its pro rata portion of such
interest. However, if KCS were required to purchase the Mexican government's
interest in TFM and Grupo TMM could not meet its obligations under the
cross-indemnity, then KCS would be obligated to pay the total purchase price for
the Mexican government's interest. If KCS and Grupo TMM, or either KCS or Grupo
TMM alone had been required to purchase the Mexican government's 20% interest in
TFM as of December 31, 2002, the total purchase price would have been
approximately $485.0 million.
Panama Canal Railway Company
In January 1998, the Republic of Panama awarded PCRC, a joint venture between
KCSR and Mi-Jack Products, Inc. ("Mi-Jack"), the concession to reconstruct and
operate the Panama Canal Railway, a 47-mile railroad located adjacent to the
Panama Canal, that provides international shippers with a railway transportation
option to complement the Panama Canal. The Panama Canal Railway, which traces
its origins back to the mid-1800's, is a north-south railroad traversing the
Panama isthmus between the Pacific and Atlantic Oceans. The railroad has been
reconstructed and it resumed freight operations on December 1, 2001. KCS
management believes the prime potential and opportunity for this railroad to be
in the movement of container traffic between the ports of Balboa and Colon for
shipping customers repositioning of such containers. The Panama Canal Railway
has significant interest from both shipping companies and port terminal
operators. In addition, there is demand for passenger traffic for both commuter
and pleasure/tourist travel. Panarail operates and promotes commuter and tourist
passenger service over the Panama Canal Railway. Passenger service started
during July 2001. While only 47 miles long, KCS management believes the Panama
Canal Railway provides the Company with a unique opportunity to participate in
transoceanic shipments as a complement to the existing Panama Canal traffic.
As of December 31, 2002, the Company has invested approximately $19.9 million
toward the reconstruction and operations of the Panama Canal Railway. This
investment is comprised of $12.9 million of equity and $7.0 million of
subordinated loans. These loans carry a 10% interest rate and are payable on
demand, subject to certain restrictions.
In November 1999, PCRC completed the financing arrangements for this project
with the International Finance Corporation ("IFC"), a member of the World Bank
Group. The financing is comprised of a $5 million investment by the IFC and
senior loans through the IFC in an aggregate amount of up to $45 million.
Additionally, PCRC has $4.2 million of equipment loans from Transamerica
Corporation and other capital leases totaling $3.8 million. The IFC's investment
of $5 million in PCRC is comprised of non-voting preferred shares which pay a
10% cumulative dividend. As of December 31, 2002, PCRC has recorded a $1.5
million liability for these cumulative preferred dividends. The preferred shares
may be redeemed at the IFC's option any year after 2008 at the lower of (1) a
net cumulative internal rate of return of 30% or (2) eight times earnings before
interest, income taxes, depreciation and amortization for the two years
preceding the redemption that is proportionate to the IFC's percentage ownership
in PCRC. Under the terms of the loan agreement with IFC, the Company is a
guarantor for up to $5.6 million of the associated debt. Also if PCRC terminates
the concession contract without the IFC's consent, the Company is a guarantor
for up to 50% of the outstanding senior loans. The Company is also a guarantor
for up to $2.1 million of the equipment loans from Transamerica Corporation and
approximately $50,000 relating to the other capital leases. The cost of the
reconstruction totaled approximately $80 million. The Company expects to loan an
additional $2 million to PCRC during 2003 under the same terms as the existing
$7.0 million subordinated loans.
Southern Capital
In 1996, KCSR and GATX Capital Corporation ("GATX") formed a 50-50 joint
venture--Southern Capital--to perform certain leasing and financing activities.
Southern Capital's operations are comprised of the acquisition of locomotives
and rolling stock and the leasing thereof to KCSR. Concurrent with the formation
of this joint venture, KCSR entered into operating leases with Southern Capital
for substantially all the locomotives and rolling stock that KCSR contributed or
sold to Southern Capital at the time of formation of the joint venture. GATX
contributed cash in the joint venture transaction formation. Southern Capital
formerly managed a portfolio of non-rail loan assets primarily in the amusement
entertainment, construction and trucking industries which it sold in April 1999
to Textron Financial Corporation, thereby leaving only the rail equipment
related assets that are leased to KCSR.
Page 6
The purpose for the formation of Southern Capital was to partner a Class I
railroad in KCSR with an industry leader in the rail equipment financing in
GATX. Southern Capital provides the Company with access to equipment financing
alternatives.
Expanded Network
Through our strategic alliance with CN/IC and marketing agreements with Norfolk
Southern, BNSF and the IC&E, the Company has expanded the domestic geographic
reach beyond that covered by its owned network.
Strategic Alliance with Canadian National and Illinois Central.
In 1998, KCSR, CN and IC announced a 15-year strategic alliance aimed at
coordinating the marketing, operations and investment elements of north-south
rail freight transportation. The strategic alliance did not require STB approval
and was effective immediately. This alliance connects Canadian markets, the
major midwest U.S. markets of Detroit, Michigan, Chicago, Kansas City and St.
Louis and the key southern markets of Memphis, Dallas and Houston. It also
provides U.S. and Canadian shippers with access to Mexico's rail system through
connections with Tex Mex and TFM.
In addition to providing access to key north-south international and domestic
U.S. traffic corridors, the alliance with CN/IC is intended to increase business
primarily in the automotive and intermodal markets, the grain market, the
chemical and petroleum market and the paper and forest products markets. This
alliance has provided opportunities for revenue growth and positioned the
Company as a key provider of rail service for NAFTA trade.
KCSR and CN formed a management group made up of senior management
representatives from both railroads to, among other things, guide the
realization of the alliance goals, and to develop plans for the construction of
new facilities to support business development, including investments in
automotive, intermodal and transload facilities at Memphis, Dallas, Kansas City
and Chicago.
Under a separate agreement, KCSR was granted certain trackage and haulage rights
and CN and IC were granted certain haulage rights. Under the terms of this
agreement, and through action taken by the STB, in October 2000 KCSR gained
access to six additional chemical customers in the Geismar, Louisiana industrial
area through haulage rights.
Marketing Agreements with Norfolk Southern.
In December 1997, KCSR entered into a three-year marketing agreement with
Norfolk Southern and Tex Mex that allows KCSR to increase its traffic volume
along the east-west corridor between Meridian and Dallas by using interchange
points with Norfolk Southern. This agreement provides Norfolk Southern
run-through service with access to Dallas and the Mexican border at Laredo while
avoiding the rail gateways of Memphis and New Orleans. This agreement was
renewed in December 2000 for a term of three years and will be automatically
renewed for additional three-year terms unless written notice of termination is
given at least 90 days prior to the expiration of the then-current term.
In May 2000, KCSR entered into an additional marketing agreement with Norfolk
Southern under which KCSR provides haulage services for intermodal traffic
between Meridian and Dallas in exchange for fees from Norfolk Southern. Under
this agreement Norfolk Southern may quote rates and enter into transportation
service contracts with shippers and receivers covering this haulage traffic.
This agreement terminates on December 31, 2006.
The May 2000 marketing agreement with Norfolk Southern provides KCSR with
additional sources of intermodal business. Under the current arrangement, trains
run between the Company's connection with Norfolk Southern at Meridian and the
BNSF connection at Dallas. The structure of the agreement provides for lower
gross revenue to KCSR, but improved operating income since, as a haulage
arrangement, locomotives, locomotive fuel and car hire expenses are the
responsibility of Norfolk Southern, not KCSR. Management believes this business
has additional growth potential as Norfolk Southern seeks to shift its traffic
to southern gateways to increase its length of haul.
Page 7
Marketing Alliance with BNSF
In April 2002, KCSR and BNSF formed a comprehensive joint marketing alliance
aimed at promoting cooperation, revenue growth and extending market reach for
both railroads in the United States and Canada. The marketing alliance is also
expected to improve operating efficiencies for both carriers in key market
areas, as well as provide customers with expanded service options. KCSR and BNSF
have agreed to coordinate marketing and operational initiatives in a number of
target markets. The marketing alliance is expected to allow the two railroads to
be more responsive to shippers' requests for rates and service throughout the
two rail networks. Coal and unit train operations are excluded from the
marketing alliance, as well as any points where KCSR and BNSF are the only
direct rail competitors. Movements to and from Mexico by either party are also
excluded. Management believes this marketing alliance will afford important
opportunities to grow KCSR's revenue base, particularly in the chemical, grain
and forest product markets, providing both participants with expanded access to
important markets and providing shippers with enhanced options and competitive
alternatives.
Marketing Agreement with IC&E.
In May 1997, KCSR entered into a marketing agreement with I&M Rail Link, now
known as IC&E. This marketing agreement provides KCSR with access to Minneapolis
and Chicago and to originations of corn and other grain in Iowa, Minnesota and
Illinois. Through this marketing agreement, KCSR receives and originates
shipments of grain products for delivery to poultry industry feed mills on its
network. Grain is currently KCSR's largest export into Mexico. This agreement is
terminable upon 90 days notice. Management believes this agreement provides IC&E
with an important channel of distribution over our rail network versus other
railroads.
Haulage Rights.
As a result of the 1988 acquisition of the Missouri-Kansas-Texas Railroad by UP,
KCSR was granted (1) haulage rights between Kansas City and each of Council
Bluffs, Iowa, Omaha and Lincoln, Nebraska and Atchison and Topeka, Kansas, and
(2) a joint rate agreement for our grain traffic between Beaumont and each of
Houston and Galveston, Texas. KCSR has the right to convert these haulage rights
to trackage rights. KCSR's haulage rights require UP to move KCSR traffic in UP
trains; trackage rights would allow KCSR to operate its trains over UP tracks.
These rights have a term of 199 years. In addition, KCSR has limited haulage
rights between Springfield and Chicago that allow for shipments that originate
or terminate on the former Gateway Western's rail lines.
Markets Served
The following table summarizes KCSR revenue and carload statistics by commodity
category. Certain prior year amounts have been reclassified to reflect changes
in the business groups and to conform to the current year presentation.
Carloads and
Revenues Intermodal Units
--------------------------------- ---------------------------------
(dollars in millions) (in thousands)
2002 2001 2000 2002 2001 2000
--------- --------- --------- --------- --------- ---------
General commodities:
Chemical and petroleum $ 130.7 $ 124.8 $ 127.1 145.4 147.8 155.9
Paper and forest 134.8 129.1 130.8 178.2 182.2 190.6
Agricultural and mineral 97.2 93.8 100.1 126.5 125.7 132.0
--------- --------- --------- --------- --------- ---------
Total general commodities 362.7 347.7 358.0 450.1 455.7 478.5
Intermodal and automotive 59.9 69.1 64.2 287.4 299.8 274.1
Coal 101.2 118.7 105.0 210.0 202.3 184.2
--------- --------- --------- --------- --------- ---------
Carload revenues and carload
and intermodal units 523.8 535.5 527.2 947.5 957.8 936.8
========= ========= =========
Other rail-related revenues 35.8 36.8 42.4
--------- --------- ---------
Total KCSR revenues $ 559.6 $ 572.3 $ 569.6
========= ========= =========
Page 8
Chemical and Petroleum
Chemical and petroleum products accounted for approximately 23.4% of KCSR
revenues in 2002. KCSR transports chemical and petroleum products via tank and
hopper cars primarily to markets in the southeast and northeast United States
through interchanges with other rail carriers. Primary traffic includes
plastics, petroleum and oils, petroleum coke, rubber, and miscellaneous
chemicals. Under the terms of the CN/IC strategic alliance, and through certain
actions taken by the STB, KCSR obtained access to six additional chemical
customers in the Geismar, Louisiana industrial corridor (one of the largest
concentrations of chemical suppliers in the world) effective October 1, 2000.
This access has resulted in additional revenue for KCSR and management believes
it could provide future competitive opportunities for revenue growth as existing
contracts with other rail carriers expire for these customers.
Paper and Forest
Paper and forest products accounted for approximately 24.1% of 2002 KCSR
revenues. The Company's rail lines run through the heart of the southeastern
U.S. timber-producing region. Management believes that forest products made from
trees in this region are generally less expensive than those from other regions
due to lower production costs. As a result, southern yellow pine products from
the southeast are increasingly being used at the expense of western producers
who have experienced capacity reductions because of public policy
considerations. KCSR serves eleven paper mills directly and six others
indirectly through short-line connections. Primary traffic includes pulp and
paper, lumber, panel products (plywood and oriented strand board), engineered
wood products, pulpwood, woodchips, raw fiber used in the production of paper,
pulp and paperboard, as well as metal, scrap and slab steel, waste and military
equipment. Slab steel products are used primarily in the manufacture of drill
pipe for the oil industry, and military equipment is shipped to and from several
military bases on the Company's rail lines.
Agricultural and Mineral
Agricultural and mineral products accounted for approximately 17.4% of KCSR
revenues in 2002. Agricultural products consist of domestic and export grain,
food and related products. Shipper demand for agricultural products is affected
by competition among sources of grain and grain products as well as price
fluctuations in international markets for key commodities. In the domestic grain
business, the Company's rail lines receive and originate shipments of grain and
grain products for delivery to feed mills serving the poultry industry. Through
the marketing agreement with IC&E, the Company's rail lines have access to
sources of corn and other grain in Iowa and other Midwestern states. KCSR
currently serves 35 feed mills along its rail lines throughout Arkansas,
Oklahoma, Texas, Louisiana, Mississippi and Alabama. Export grain shipments
include primarily wheat, soybean and corn transported to the Gulf of Mexico for
overseas destinations and to Mexico via Laredo. Over the long term, grain
shipments are expected to increase as a result of the Company's strategic
investments in Tex Mex and TFM, given Mexico's reliance on grain imports. Food
and related products consist mainly of soybean meal, grain meal, oils and canned
goods, sugar and beer. Mineral shipments consist of a variety of products
including ores, clay, stone and cement.
Intermodal and Automotive
Intermodal and automotive products accounted for approximately 10.7% of 2002
KCSR revenues. The intermodal freight business consists primarily of hauling
freight containers or truck trailers by a combination of water, rail and motor
carriers, with rail carriers serving as the link between the other modes of
transportation. The Company's intermodal business has grown significantly over
the last eight years with intermodal units increasing from 61,748 in 1993 to
274,473 in 2002 and intermodal revenues increasing from $17 million to $51
million during the same period. Through our dedicated intermodal train service
between Meridian and Dallas, the Company competes directly with truck carriers
along the Interstate 20 corridor.
The intermodal business is highly price and service driven as the trucking
industry maintains certain competitive advantages over the rail industry. Trucks
are not obligated to provide or maintain rights of way and do not have to pay
real estate taxes on their routes. In prior years, the trucking industry
diverted a substantial amount of freight from railroads as truck operators'
efficiency over long distances increased. In response to these competitive
pressures, railroad industry management sought avenues to improve the
competitiveness of rail traffic and forged numerous alliances with truck
companies in order to move more traffic by rail and provide faster, safer and
more efficient service to their customers. KCSR has entered into agreements with
several trucking companies for train service in several corridors, but those
services are concentrated between Dallas and Meridian.
Page 9
The strategic alliance with CN/IC and marketing agreements with Norfolk Southern
provide the Company the potential to further capitalize on the growth potential
of intermodal freight revenues, particularly for traffic moving between points
in the upper midwest and Canada to Kansas City, Dallas and Mexico. Furthermore,
the Company is developing the former Richards-Gebaur Airbase in Kansas City as a
U.S. customs pre-clearance processing facility, the Kansas City International
Freight Gateway ("IFG"), which, when at full capacity, is expected to handle and
process large volumes of domestic and international intermodal freight. Through
an agreement with Mazda through the Ford Motor Company Claycomo manufacturing
facility located in Kansas City, KCSR has developed an automotive loading and
distribution facility at IFG. This loading and distribution facility became
operational in April 2000 for the movement of Mazda vehicles. Management
believes that, as additional opportunities arise, the IFG facility will be
expanded to include additional automotive and intermodal operations.
The Company's automotive traffic consists primarily of vehicle parts moving into
Mexico from the northern sections of the United States and finished vehicles
moving from Mexico into the United States. CN/IC, Norfolk Southern and TFM have
a significant number of automotive production facilities on their rail lines.
The Company's rail network essentially serves as the connecting bridge carrier
for these movements of automotive parts and finished vehicles.
Coal
Coal historically has been one of the most stable sources of revenues and is the
largest single commodity handled by KCSR. In 2002, coal revenues represented
18.1% of total KCSR revenues. Substantially all coal customers are under long
term contracts, which typically have an average contract term of approximately
five years. KCSR's most significant customer is Southwestern Electric Power
Company ("SWEPCO"- a subsidiary of American Electric Power, Inc.), which is
under contract through 2006. The Company, directly or indirectly, delivers coal
to eight electric generating plants, including the Flint Creek, Arkansas and
Welsh, Texas facilities of SWEPCO, Kansas City Power and Light plants in Kansas
City and Amsterdam, Missouri, an Empire District Electric Company plant near
Joplin, Missouri and an Entergy Gulf States plant in Mossville, Louisiana. The
coal KCSR transports originates in the Powder River Basin in Wyoming and is
transferred to KCSR's rail lines at Kansas City. KCSR serves as a bridge carrier
for coal deliveries to a Texas Utilities electric generating plant in Martin
Lake, Texas. In addition, KCSR delivers lignite to an electric generating plant
at Monticello, Texas. SWEPCO comprised approximately 63.9% of KCSR total coal
revenues and 11.4% of KCS consolidated revenues in 2002. Coal revenue declined
approximately 15% in 2002 compared to 2001 as a result of a contractual rate
reduction, which took effect on January 1, 2002, as well as the expiration in
April 2002 of a contract that was not renewed for another coal customer.
Other
Other rail-related revenues include a variety of miscellaneous services provided
to customers and interconnecting carriers and accounted for approximately 6.4%
of total KCSR revenues in 2002. Major items in this category include railcar
switching services, demurrage (car retention penalties) and drayage (local truck
transportation services). This category also includes haulage services performed
for the benefit of BNSF under an agreement that continues through 2004 and
includes minimum volume commitments.
Railroad Industry
Overview
U.S. railroad companies are categorized by the STB into three types: Class I,
(railroads with annual revenues of at least $250 million, as indexed for
inflation) Class II (Regional) and Class III (Local). There currently are seven
Class I railroads in the United States, which can be further divided
geographically by eastern or western classification. The eastern railroads are
CSX Corporation ("CSX"), Grand Trunk Corporation (which is owned by CN and
includes IC and Wisconsin Central Transportation Corporation - "Wisconsin
Central")) and Norfolk Southern. The western railroads include BNSF, KCSR, Soo
Line Railroad Company (owned by Canadian Pacific Railway Company ("CP")) and UP.
The STB and Regulation
The STB, an independent body administratively housed within the Department of
Transportation, is responsible for the economic regulation of railroads within
the United States. The STB's mission is to ensure that competitive, efficient
and
Page 10
safe transportation services are provided to meet the needs of shippers,
receivers and consumers. The STB was created by an Act of Congress known as the
ICC Termination Act of 1995 ("ICCTA"). Passage of the ICCTA represented a
further step in the process of streamlining and reforming the Federal economic
regulatory oversight of the railroad, trucking and bus industries that was
initiated in the late 1970's and early 1980's. The STB is authorized to have
three members, each with a five-year term of office. The STB Chairman is
designated by the President of the United States from among the STB's members.
The STB adjudicates disputes and regulates interstate surface transportation.
Railway transportation matters under the STB's jurisdiction in general include
railroad rate and service issues, rail restructuring transactions (mergers, line
sales, line construction and line abandonment) and railroad labor matters.
The U.S. railroad industry was significantly deregulated with the passage of The
Staggers Rail Act of 1980 (the "Staggers Act"). In enacting the Staggers Act,
Congress recognized that railroads faced intense competition from trucks and
other modes of transportation for most freight traffic and that prevailing
regulation prevented them from earning adequate revenues and competing
effectively. Through the Staggers Act, a new regulatory scheme allowing
railroads to establish their own routes, tailor their rates to market conditions
and differentiate rates on the basis of demand was put in place. The basic
principle of the Staggers Act was that reasonable rail rates should be a
function of supply and demand. The Staggers Act, among others things:
o allows railroads to price competing routes and services differently to
reflect relative demand;
o allows railroads to enter into confidential rate and service contracts
with shippers; and
o abolishes collective rate making except among railroads participating
in a joint-line movement.
If it is determined that a railroad is not facing enough competition to hold
down prices, then the STB has the authority to investigate the actions of the
railroad.
The Staggers Act has had a positive effect on the U.S. rail industry,
competition, and savings to consumers. Lower rail rates brought about by the
Staggers Act have resulted in significant cost savings for shippers and their
customers. After decades of steady decline, the rail market share of inter-city
freight ton-miles bottomed out at 35.2% in 1978 and has trended slowly upward
since then, reaching 41.0% in 2000 and 41.7% in 2001.
Recent Events in Railroad Consolidation
On June 11, 2001, the STB issued new rules governing major railroad mergers and
consolidations involving two or more "Class I" railroads. These rules
substantially increase the burden on rail merger applicants to demonstrate that
a proposed transaction would be in the public interest. The rules require
applicants to demonstrate that, among other things, a proposed transaction would
enhance competition where necessary to offset negative effects of the
transaction, such as competitive harm, and to address fully the impact of the
transaction on transportation service.
The STB recognized, however, that a merger between KCSR and another Class I
carrier would not necessarily raise the same concerns and risks as potential
mergers between larger Class I railroads. Accordingly, the STB decided that for
a merger proposal involving KCSR and another Class I railroad, the STB will
waive the application of the new rules and apply the rules previously in effect
unless it is persuaded that the new rules should apply.
Competition
The Company's rail operations compete against other railroads, many of which are
much larger and have significantly greater financial and other resources. Since
1994, there has been significant consolidation among major North American rail
carriers, including the 1995 merger of Burlington Northern, Inc. and Santa Fe
Pacific Corporation ("BN/SF", collectively "BNSF"), the 1995 merger of the UP
and the Chicago and North Western Transportation Company ("UP/CNW") and the 1996
merger of UP with Southern Pacific Corporation ("SP"). Further, Norfolk Southern
and CSX purchased the assets of Conrail in 1998 and the CN acquired the IC in
June 1999. In October 2001, CN completed its acquisition of Wisconsin Central
Transportation Corporation. As a result of this consolidation, the railroad
industry is now dominated by a few "mega-carriers." KCS management believes that
revenues were negatively affected by the UP/CNW, UP/SP and BN/SF mergers, which
led to diversions of rail traffic away from KCSR's rail lines. Management
Page 11
regards the larger western railroads (BNSF and UP), in particular, as
significant competitors to the Company's operations and prospects because of
their substantial resources. The ongoing impact of these mergers is uncertain.
KCS management believes, however, that because of the Company's investments and
strategic alliances, it is positioned to attract additional rail traffic through
our NAFTA rail network.
The Company is subject to competition from motor carriers, barge lines, and
other maritime shipping, which compete across certain routes in our operating
area. Truck carriers have eroded the railroad industry's share of total
transportation revenues. Changing regulations, subsidized highway improvement
programs and favorable labor regulations have improved the competitive position
of trucks in the United States as an alternative mode of surface transportation
for many commodities. In the United States, the trucking industry generally is
more cost and transit-time competitive than railroads for short-haul distances.
In addition, Mississippi and Missouri River barge traffic, among others, compete
with KCSR and its rail connections in the transportation of bulk commodities
such as grains, steel and petroleum products. Intermodal traffic and certain
other traffic face highly price sensitive competition, particularly from motor
carriers. However, rail carriers, including KCSR, have placed an emphasis on
competing in the intermodal marketplace and working together with motor carriers
and each other to provide end-to-end transportation of products.
While deregulation of freight rates has enhanced the ability of railroads to
compete with each other and with alternative modes of transportation, this
increased competition has resulted in downward pressure on freight rates.
Competition with other railroads and other modes of transportation is generally
based on the rates charged, the quality and reliability of the service provided
and the quality of the carrier's equipment for certain commodities.
Employees and Labor Relations
Labor relations in the U.S. railroad industry are subject to extensive
governmental regulation under the Railway Labor Act ("RLA"). Under the RLA,
national labor agreements are renegotiated when they become open for
modification, but their terms remain in effect until new agreements are reached.
Typically, neither management nor labor employees are permitted to take economic
action until extended procedures are exhausted. Existing national union
contracts with the railroads became amendable at the end of 1999. Included in
the contracts was a provision for wages to increase automatically in the year
following the contract term. These federal labor regulations are often more
burdensome and expensive than regulations governing other industries and may
place KCS at a competitive disadvantage relative to other non-rail industries,
such as trucking competitors, which are not subject to these regulations.
Railroad industry personnel are covered by the Railroad Retirement Act ("RRA")
instead of the Social Security Act. Employer contributions under the RRA are
currently substantially higher than those under the Social Security Act and may
rise further because of the increasing proportion of retired employees receiving
benefits relative to the number of working employees. The RRA currently requires
up to a 21.85% contribution by railroad employers on eligible wages while the
Social Security and Medicare Acts only require a 7.65% employer contribution on
similar wage bases. Railroad industry personnel are also covered by the Federal
Employers' Liability Act ("FELA") rather than state workers' compensation
systems. FELA is a fault-based system with compensation for injuries settled by
negotiation and litigation, which can be expensive and time-consuming. By
contrast, most other industries are covered by state administered no-fault plans
with standard compensation schedules. The difference in the labor regulations
for the rail industry compared to the non-rail industries illustrates the
competitive disadvantage placed upon the rail industry by federal labor
regulations.
Approximately 84% of KCSR employees are covered under various collective
bargaining agreements. Periodically, the collective bargaining agreements with
the various unions become eligible for re-negotiation. In 1996, national labor
contracts governing KCSR were negotiated with all major railroad unions,
including the United Transportation Union ("UTU"), the Brotherhood of Locomotive
Engineers ("BLE"), the Transportation Communications International Union
("TCU"), the Brotherhood of Maintenance of Way Employees ("BMWE"), and the
International Association of Machinists and Aerospace Workers. In August 2002, a
new labor contract was reached with the UTU. The provisions of this agreement
include the use of remote control locomotives in and around terminals and
retroactive application of wage increases back to July 1, 2002. Also, a new
labor contract has been reached with the TCU. It is anticipated that this
agreement will be signed during the first quarter of 2003. A new labor contract
was reached with the BMWE effective
Page 12
May 31, 2001. Formal negotiations to enter into new agreements are in progress
with the other unions and the 1996 labor contracts will remain in effect until
new agreements are reached. The wage increase elements of these new agreements
may have retroactive application. Management has reached new agreements with all
but one of the unions relating to the former Gateway Western. Gateway Western
was merged into KCSR on October 1, 2001. Similarly, management has reached new
agreements with all but one of the unions relating to the former MidSouth
Railroad ("MidSouth") employees (MidSouth was merged into KCSR on January 1,
1994). Discussions with these unions are ongoing. The provisions of the various
labor agreements generally include periodic general wage increases, lump-sum
payments to workers and greater work rule flexibility, among other provisions.
Management does not expect that the negotiations or the resulting labor
agreements will have a material impact on our consolidated results of
operations, financial condition or cash flows.
Railroad Retirement Improvement Act
On December 21, 2001, the Railroad Retirement and Survivors' Improvement Act of
2001 ("RRIA") was signed into law. This legislation liberalizes early retirement
benefits for employees with 30 years of service by reducing the full benefit age
from 62 to 60, eliminates a cap on monthly retirement and disability benefits,
lowers the minimum service requirement from 10 years to 5 years of service, and
provides for increased benefits for surviving spouses. It also provides for the
investment of railroad retirement funds in non-governmental assets, adjustments
in the payroll tax rates paid by employees and employers, and the repeal of a
supplemental annuity work-hour tax. The law also reduced the employer
contribution for payroll taxes by 0.5% in 2002 and by an additional 1.4% in
2003. Beginning in 2004, the employer contribution will be based on a formula
and could range between 8.2% and 22.1%. These reductions in the employer
contributions under the RRA are expected to have a favorable impact on fringe
benefits expenses in 2003. Additionally, the reduction in the retirement age
from 62 to 60 is expected to result in increased employee attrition, leading to
additional potential cost savings since it is not anticipated that all employees
selecting early retirement will be replaced.
Insurance
KCS maintains multiple insurance programs for its various subsidiaries including
rail liability and property, general liability, directors and officers'
coverage, workers compensation coverage and various specialized coverage for
specific entities as needed. Coverage for KCSR is by far the most significant
part of the KCS program. It includes liability coverage up to $250 million,
subject to a $3 million deductible ($10 million for incidents occurring on or
after July 1, 2002) and certain aggregate limitations, and property coverage up
to $200 million subject to a $2 million deductible and certain aggregate
limitations. We believe that our insurance program is in line with industry
norms given the size of the Company and provides adequate coverage for potential
losses.
Employees
As of December 31, 2002, the approximate number of employees of KCS and its
consolidated subsidiaries was as follows:
KCSR 2,653
All other combined 54
----------
Total 2,707
==========
Available Information
The Company's Internet address is www.kcsi.com. Through this website, KCS makes
available, free of charge, its Annual Reports on Form 10-K, Quarterly Reports on
Form 10-Q and Current Reports on Form 8-K, and amendments to those reports, as
soon as reasonably practicable after electronic filing or furnishing of these
reports with the Securities and Exchange Commission.
Page 13
Item 2. Properties
The information set forth in response to Item 102 of Regulation S-K under Item
1, "Business", of this Form 10-K and Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations", is incorporated by
reference in response to this Item 2.
In the opinion of management, the various facilities, office space and other
properties owned and/or leased by the Company and its subsidiaries are adequate
for current operating needs.
KCSR
Certain KCSR property statistics follow:
2002 2001 2000
--------- --------- ---------
Route miles - main and branch line 3,109 3,103 3,103
Total track miles 4,359 4,444 4,444
Miles of welded rail in service 2,261 2,197 2,157
Main line welded rail (%) 61% 59% 59%
Cross ties replaced 232,993 233,489 355,444
Average Age (in years): 2002 2001 2000
----------------------- --------- --------- ---------
Wood ties in service 16.0 16.0 15.2
Rail in main and branch line 29.9 28.9 29.5
Road locomotives 24.6 23.6 22.9
All locomotives 25.6 24.5 23.8
KCSR's fleet of locomotives and rolling stock consisted of the following at
December 31:
2002 2001 2000
Leased Owned Leased Owned Leased Owned
-------- -------- -------- -------- -------- --------
Locomotives:
Road Units 302 122 304 122 324 122
Switch Units 52 4 52 4 55 9
Other -- 8 -- 8 -- 8
-------- -------- -------- -------- -------- --------
Total 354 134 356 134 379 139
======== ======== ======== ======== ======== ========
Rolling Stock:
Box Cars 5,358 1,366 6,164 1,420 5,951 2,020
Gondolas 760 74 780 88 842 95
Hopper Cars 2,614 966 2,002 1,179 2,217 1,285
Flat Cars (Intermodal
And Other) 1,599 541 1,585 601 1,584 616
Tank Cars 42 40 44 43 46 55
Auto Rack 201 -- 201 -- 201 --
-------- -------- -------- -------- -------- --------
Total 10,574 2,987 10,776 3,331 10,841 4,071
======== ======== ======== ======== ======== ========
As of December 31, 2002, KCSR's fleet consisted of 488 diesel locomotives, of
which 134 were owned, 333 leased from Southern Capital and 21 leased from
non-affiliates. KCSR's fleet of rolling stock consisted of 13,561 freight cars,
of which 2,963 were owned, 3,387 leased from Southern Capital and 7,211 leased
from non-affiliates. The locomotives and freight cars leased from Southern
Capital secure pass through certificates issued by Southern Capital during 2002.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Recent Developments - Debt Refinancing - Southern
Capital."
Page 14
The owned equipment is subject to liens created under our senior secured credit
facilities, as well as liens created under certain conditional sales agreements,
capital leases, and equipment trust certificates. KCSR indebtedness with respect
to equipment trust certificates and capital leases totaled approximately $26.0
million at December 31, 2002.
KCSR, in support of its transportation operations, owns and operates repair
shops, depots and office buildings along its right-of-way. A major facility, the
Deramus Yard, is located in Shreveport, Louisiana and includes a general office
building, locomotive repair shop, car repair shops, customer service center,
material warehouses and fueling facilities totaling approximately 227,000 square
feet. KCSR owns a 107,800 square foot facility in Pittsburg, Kansas that
previously was used as a diesel locomotive repair facility. This facility was
closed during 1999 and is now being leased to an engineering and manufacturing
company. KCSR also owns freight warehousing and office facilities in Dallas,
Texas totaling approximately 150,000 square feet. Other facilities owned by KCSR
include a 21,000 square foot freight car repair shop in Kansas City, Missouri
and approximately 15,000 square feet of office space in Baton Rouge, Louisiana.
KCSR also has the support of a locomotive repair facility in Kansas City,
Missouri. This facility is owned and operated by General Electric Company ("GE")
to repair and maintain 50 AC 4400 locomotives manufactured by GE. These
locomotives are leased by KCSR from Southern Capital.
In June 2001, the Company entered into a 17-year lease agreement for a new
corporate headquarters building in downtown Kansas City, Missouri. In April
2002, the Company moved its corporate offices into this building. The Company's
corporate offices had previously been located in another building in downtown
Kansas City, Missouri, which was leased from a subsidiary of the Company until
the building was sold in June 2001.
KCSR owns six intermodal facilities and has contracted with third parties to
operate these facilities. These facilities are located in Dallas; Kansas City;
Shreveport and New Orleans, Louisiana; Jackson, Mississippi and Salisaw,
Oklahoma. The Company has constructed an automobile facility and has plans to
construct an intermodal facility at the former Richards-Gebaur Airbase in Kansas
City, Missouri. A portion of the automotive facility became operational in April
2000 for the storage and movement of automobiles. Intermodal and automotive
operations at the facility may be further expanded in the future as business
opportunities arise. The Company is also expanding the intermodal facilities in
Kansas City, Dallas and Shreveport. The various intermodal facilities include
strip tracks, cranes and other equipment used in facilitating the transfer and
movement of trailers and containers. KCSR also has six bulk transload facilities
located at Kansas City, Missouri; Spiro, Oklahoma; Jackson, Mississippi; Dallas
Texas; Sauget, Illinois and Baton Rouge, Louisiana. Due to growth in transload
traffic, KCSR expanded its facility in Spiro during the fourth quarter of 2002,
and plans to expand the facility in Jackson during the first half of 2003. The
sixth transload facility was opened in Baton Rouge, Louisiana in early 2003. A
second Dallas transload facility was expected to open during 2002, however, due
to lower than expected traffic as a result of the continued slowdown in the
North American economy, opening of this facility has been postponed pending
development of additional traffic. Transload operations consist of rail/truck
shipments whereby the products shipped are unloaded from the trailer, container
or rail car and reloaded onto the other mode of transportation. Transload is
similar to intermodal, except that intermodal shipments transfer the entire
container or trailer and transload shipments transfer only the product being
shipped.
KCSR owns 16.6% of the Kansas City Terminal Railway Company, which owns and
operates approximately 80 miles of track, and operates an additional eight miles
of track under trackage rights in greater Kansas City, Missouri. KCSR also
leases for operating purposes certain short sections of trackage owned by
various other railroad companies and jointly owns certain other facilities with
these railroads.
Systems and Technology
Management Control System
On July 14, 2002, the Company initiated a conversion from its legacy system
operating platform to a Management Control System ("MCS") on KCSR. The Company
had previously implemented a pilot version of MCS on the former Gateway Western
(which was merged into KCSR effective October 1, 2001) in the first quarter of
2000. In anticipation of the conversion to MCS, significant resources were
committed to the planning and training of personnel. However, upon
implementation of MCS, personnel responsible for train operations experienced
initial difficulties implementing the
Page 15
new system as they learned to respond to the data discipline demanded by the new
system. As a result, KCSR experienced considerable congestion throughout its
U.S. rail network with escalated freight car volumes in its major terminals and
less efficient train movements. Although management believes that the issues
related to the implementation of MCS largely were resolved prior to the end of
2002, the initial difficulties experienced by operating personnel in converting
to the new platform led to the congestion issues and operating inefficiencies
during the second half of 2002, which contributed to a decline in consolidated
operating income. See Item 7, "Management's Discussion of Financial Condition
and Results of Operations - Results of Operations" for a discussion of the
impact on operations. MCS includes the following elements:
o a new waybill system;
o a new transportation system;
o a work queue management infrastructure;
o a service scheduling system; and
o EDI interfaces to the new systems.
MCS is designed to deliver work orders to yard and train crews to ensure that
the service being provided reflects what was sold to the customer. The system
also tracks individual shipments as they move across the rail system, compares
that movement to the service sold to the customer and automatically reports the
shipment's status to the customer and to operations management. If a shipment
falls behind schedule, MCS automatically generates alerts and action
recommendations so that corrective action promptly can be initiated.
MCS provides better analytical tools for management to use in its
decision-making process. MCS provides more accurate and timely information on,
among other things, terminal dwell time, car velocity through terminals and
priority of switching to meet schedules. A data warehouse provides an improved
decision support infrastructure. By making decisions based upon that
information, management is working to improve service quality and the
utilization of locomotives, rolling stock, crews, yards, and line of road and
thereby reduce cycle times and costs. With the implementation of MCS service
scheduling, personnel are striving to improve customer service through improved
advanced planning and real-time decision support. With the design of all new
business processes around workflow technology, management intends to more
effectively follow key operating statistics to measure productivity and improve
performance across the entire operation.
As KCSR continues to become more accustomed to using MCS, management expects
that clerical and information technology group efficiencies will also continue
to improve. Management believes that information technology and other support
groups will be able to reduce maintenance costs, increase their flexibility to
respond to new requests and improve productivity. By using a layered design
approach, MCS is expected to have the ability to extend to new technology as it
becomes available. MCS can be further modified to connect customers with
additional applications via the Internet and is intended to be constructed to
support multiple railroads, permit modifications to accommodate the local
language requirements of the area and operate across multiple time zones. A
later enhancement of MCS is expected to also include revenue and car accounting
systems. Additionally, MCS is expected to be implemented on Tex Mex later this
year and on TFM next year.
Train Dispatching System
KCSR is currently operating on two types of train dispatching systems, Direct
Train Control ("DTC") and Centralized Traffic Control ("CTC"). DTC uses direct
radio communication between dispatchers and engineers to coordinate train
movement. DTC is used on approximately 65% of KCSR's track, including the track
from Shreveport to Meridian and Shreveport to New Orleans. CTC controls switches
and signals in the field from the dispatcher's desk top via microwave link. CTC
is used on approximately 35% of KCSR's track, including the track from Kansas
City to Beaumont and Shreveport to Dallas. CTC is normally utilized on heavy
traffic areas. Each dispatcher has an assigned territory displayed on
high-resolution monitors driven by a mini-mainframe in Shreveport with a remote
station in Beaumont. KCSR implemented a new dispatching computer system in May
1999, which has enhanced the overall efficiency of train movements on the
railroad system.
Page 16
Grupo TFM
TFM operates approximately 2,650 miles of main and branch lines and certain
additional sidings, spur tracks and main line under trackage rights. TFM has the
right to operate the rail lines, but does not own the land, roadway or
associated structures. Approximately 81% of the main line operated by TFM
consists of continuously welded rail. As of December 31, 2002, TFM owned 468
locomotives, owned or leased from affiliates 4,558 freight cars and leased from
non-affiliates 150 locomotives and 6,800 freight cars. Grupo TFM (through TFM)
has office space at which various operational, administrative, managerial and
other activities are performed. The primary facilities are located in Mexico
City and Monterrey, Mexico. TFM leases 94,915 square feet of office space in
Mexico City and holds, under the Concession, a 115,157 square foot facility in
Monterrey. On February 27, 2002, the Company, Grupo TMM, and certain of Grupo
TMM's affiliates entered into an agreement with TFM to sell to TFM all of the
common stock of Mexrail. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Recent Developments - Sale of
Mexrail, Inc. to TFM" for further discussion.
Panama Canal Railway Company
PCRC, a joint venture in which the Company owns 50% of the common stock (or a
42% equity interest), holds the concession to operate a 47-mile railroad that
runs parallel to the Panama Canal. Reconstruction of the railroad was completed
during 2001 and both passenger and freight traffic commenced during 2001. PCRC
leases four locomotives and owns two locomotives. PCRC also owns 12 double stack
cars, 6 passenger cars and various other infrastructure improvements and
equipment. Under the concession, PCRC constructed and operates operating
intermodal terminal facilities at each end of its railroad and an approximate
15,000 square foot equipment maintenance facility. All of this property and
equipment is subject to liens securing PCRC debt as further described in Item 1,
"Narrative Description of the Business - Rail Network - Significant Investments
- - Panama Canal Railway Company."
Other
The Company owns 1,025 acres of property located on the waterfront in the Port
Arthur, Texas area, which includes 22,000 linear feet of deep-water frontage and
three docks. Port Arthur is an uncongested port with direct access to the Gulf
of Mexico. Approximately 75% of this property is available for development.
Trans-Serve, Inc. operates a railroad wood tie treating plant in Vivian,
Louisiana under an industrial revenue bond lease arrangement with an option to
purchase. This facility includes buildings totaling approximately 12,000 square
feet.
Pabtex GP LLP owns a 70-acre bulk commodity handling facility in Port Arthur,
Texas.
Mid-South Microwave was merged into KCSR effective December 31, 2002. Prior to
the merger, Mid-South Microwave, Inc. owned and operated a microwave system,
which extended essentially along the right-of-way of KCSR from Kansas City to
Dallas, Beaumont and Port Arthur, Texas and New Orleans, Louisiana. This system
is now owned by KCSR.
Other subsidiaries of the Company own approximately 5,500 acres of land at
various points adjacent to the KCSR right-of-way. Other properties owned include
a 354,000 square foot warehouse at Shreveport, Louisiana and several former
railway buildings now being rented to non-affiliated companies, primarily as
warehouse space.
Item 3. Legal Proceedings
The information set forth in response to Item 103 of Regulation S-K under Part
II Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Other - Litigation, - Other - Environmental Matters and
- -Significant Developments - Houston Cases" 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 - Note 11 - Commitments and
Contingencies" of this Form 10-K.
Page 17
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, 2002.
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 KCS's
Definitive Proxy Statement which will be filed no later than 120 days after
December 31, 2002. All executive officers are elected annually and serve at the
discretion of the Board of Directors. All of the executive officers have
employment agreements with the Company.
Name Age Position(s)
- ---- --- -----------
Michael R. Haverty 58 Chairman of the Board, President and Chief
Executive Officer
Gerald K. Davies 58 Executive Vice President and Chief Operating
Officer
Ronald G. Russ 48 Executive Vice President and Chief Financial
Officer
Jerry W. Heavin 51 Senior Vice President - Operations of KCSR
Larry O. Stevenson 39 Senior Vice President - Sales and Marketing of
KCSR
Warren K. Erdman 44 Vice President - Corporate Affairs
Paul J. Weyandt 50 Vice President and Treasurer
Louis G. Van Horn 44 Vice President and Comptroller
Jay M. Nadlman 42 Associate General Counsel and Corporate
Secretary
The information set forth in the Company's Definitive Proxy Statement in the
description of Nominees for Directors to Serve Until the Annual Meeting of
Stockholders in 2006 in Proposal 1 with respect to Mr. Haverty is incorporated
herein by reference.
Gerald K. Davies has served as Executive Vice President and Chief Operating
Officer of KCS since July 18, 2000. Mr. Davies joined KCSR in January 1999 as
the Executive Vice President and Chief Operating Officer. Mr. Davies has served
as a director of KCSR since November 1999. Prior to joining KCSR, Mr. Davies
served as the Executive Vice President of Marketing with Canadian National
Railway from 1993 through 1998. Mr. Davies held senior management positions with
Burlington Northern Railway from 1976 to 1984 and 1991 to 1993, respectively,
and with CSX Transportation from 1984 to 1991.
Ronald G. Russ has served as Executive Vice President and Chief Financial
Officer since January 16, 2003. Mr. Russ served as Senior Vice President and
Chief Financial Officer from July 1, 2002 to January 15, 2003. Mr. Russ served
as Executive Vice President and Chief Financial Officer of Wisconsin Central
from 1999 to 2002. He served as Treasurer of Wisconsin Central from 1987 to
1993. From 1993 to 1999 he was executive manager and chief financial officer for
Tranz Rail Holdings Limited, an affiliate of Wisconsin Central in Wellington,
New Zealand. He also served in various capacities with Soo Line Railroad and The
Chicago, Milwaukee, St. Paul and Pacific Railroad Company, spanning a 25-year
career in the railroad industry.
Jerry W. Heavin has served as Senior Vice President of Operations and a director
of KCSR since July 9, 2002. Mr. Heavin joined KCSR on September 1, 2001 and
served as Vice President of Engineering of KCSR until July 8, 2002. Prior to
joining KCSR, Mr. Heavin served as an independent engineering consultant from
1997 through August 2001. Mr. Heavin began his railroad career in 1970 with UP,
serving in various capacities, including general superintendent transportation
and chief engineer of facilities.
Larry O. Stevenson has served as Senior Vice President of Marketing and Sales of
KCSR since January 1, 2003. Mr. Stevenson served as Vice President - Paper and
Forest Products of KCSR from September 1, 2000 to December 31, 2002 and General
Director Customer Service of KCSR from February 14, 2000 to August 31, 2000.
Prior to joining
Page 18
KCSR, Mr. Stevenson served in various capacities at Canadian National Railway
from June 1983 to December 1999, most recently as Assistant Vice President of
Sales.
Warren K. Erdman has served as Vice President--Corporate Affairs of KCS since
April 15, 1997 and as Vice President--Corporate Affairs of KCSR since May 1997.
Prior to joining KCS, Mr. Erdman served as Chief of Staff to United States
Senator Kit Bond of Missouri from 1987 to 1997.
Paul J. Weyandt has served as Vice and President and Treasurer of KCS and of
KCSR since September 2001. Before joining KCS, Mr. Weyandt was a consultant to
the Structured Finance Group of GE Capital Corporation from May 2001 to
September 2001. Prior to consulting, Mr. Weyandt spent 23 years with BNSF, most
recently as Assistant Vice President - Finance and Assistant Treasurer.
Louis G. Van Horn has served as Vice President and Comptroller of KCS since May
1996. Mr. Van Horn has also served as Vice President and Comptroller of KCSR
since 1995. Mr. Van Horn was Comptroller of KCS from September 1992 to May 1996.
From January 1992 to September 1992, Mr. Van Horn served as Assistant
Comptroller of KCS. Mr. Van Horn is a Certified Public Accountant.
Jay M. Nadlman has served as Associate General Counsel and Corporate Secretary
of KCS since April 1, 2001. Mr. Nadlman joined KCS in December 1991 as a General
Attorney, and was promoted to Assistant General Counsel in 1997, serving in that
capacity until April 1, 2001. Mr. Nadlman has served as Associate General
Counsel and Secretary of KCSR since May 3, 2001 and as Assistant General Counsel
and Assistant Secretary from August 1997 to May 3, 2001. Prior to joining KCS,
Mr. Nadlman served as an attorney with Union Pacific Railroad Company from 1985
to 1991.
There are no arrangements or understandings between the executive officers and
any other person pursuant to which the executive officer was or is to be
selected as an officer of KCS, except with respect to the executive officers who
have entered into employment agreements, 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.
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 13 - Quarterly Financial Data
(Unaudited)" of this Form 10-K is incorporated by reference in response to this
Item 5.
On July 12, 2000, KCS completed its spin-off of Stilwell through a special
dividend of Stilwell common stock distributed to KCS common stockholders of
record on June 28, 2000 ("Spin-off"). The Spin-off occurred after the close of
business of the New York Stock Exchange on July 12, 2000, and each KCS
stockholder received two shares of the common stock of Stilwell for every one
share of KCS common stock owned on the record date. The total number of Stilwell
shares distributed was 222,999,786. Also on July 12, 2000, KCS completed a
reverse stock split whereby every two shares of KCS common stock were converted
into one share of KCS common stock. The Company's stockholders approved a
one-for-two reverse stock split in 1998 in contemplation of the Spin-off. The
total number of KCS shares outstanding immediately following this reverse split
was 55,749,947.
The Company has not declared any cash dividends on its common stock during the
last two fiscal years and does not anticipate making any cash dividend payments
to common stockholders in the foreseeable future. Pursuant to the Company's
amended and restated credit agreement as further described in Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Recent Developments - Debt Refinancing - New Credit Agreement," the
Company is restricted from the payment of cash dividends on the Company's common
stock.
Page 19
During 2002 and 2000, certain debt securities were issued by KCSR pursuant to
Rule 144A under the Securities Act of 1933 in the United States and Regulation S
outside of the United States. These notes are guaranteed by the Company and were
ultimately exchanged for registered notes. See Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Recent
Developments - Debt Refinancing - 7 1/2% Senior Notes and - Significant
Developments - 2000 Debt Refinancing and Re-capitalization of the Company's Debt
Structure - Registration of Senior Unsecured Notes" for further discussion.
As of February 28, 2003, there were 5,674 holders of the Company's common stock
based upon an accumulation of the registered stockholder listing.
Item 6. Selected Financial Data (dollars in millions, except per share
and ratio data)
The selected financial data below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included under Item 7 of this Form 10-K and the consolidated
financial statements and the related notes thereto, and the Reports of
Independent Accountants thereon, included under Item 8, "Financial Statements
and Supplementary Data" of this Form 10-K and such data is qualified by
reference thereto. All years reflect the 1-for-2 reverse common stock split to
shareholders of record on June 28, 2000 paid July 12, 2000.
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Revenues $ 566.2 $ 583.2 $ 578.7 $ 609.0 $ 620.0
Equity in net earnings (losses)
from unconsolidated affiliates -
continuing operations $ 43.4 $ 27.1 $ 22.1 $ 5.2 $ (2.9)
Income from continuing operations (i) $ 57.2 $ 31.1(ii) $ 16.7 $ 10.2 $ 38.0
Income from continuing
operations per common share:
Basic $ 0.94 $ 0.53 $ 0.29 $ 0.18 $ 0.69
Diluted 0.91 0.51 0.28 0.17 0.67
Total assets (iii) $ 2,008.8 $ 2,010.9 $ 1,944.5 $ 2,672.0 $ 2,337.0
Total debt $ 582.6 $ 658.4 $ 674.6 $ 760.9 $ 836.3
Cash dividends per
Common share $ -- $ -- $ -- $ 0.32 $ 0.32
Ratio of earnings to fixed charges (iv) 1.3x 1.1x 1.0x 1.2x 1.9x
(i) Income from continuing operations for the years ended December 31, 2002,
2001 and 2000 include certain unusual costs and expenses and other income
as further described in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - "Results of Operations."
These costs include MCS implementation related costs, benefits received
from the settlement of certain legal and insurance claims, severance
costs and expenses associated with legal verdicts against the Company,
gains recorded on the sale of operating property, among others. Other
non-operating income includes gains recorded on sale of non-operating
properties and investments. For the year ended December 31, 1999, income
from continuing operations includes unusual costs and expenses related to
facility and project closures, employee separations Separation related
costs, labor and personal injury related issues.
(ii) Income from continuing operations for the year ended December 31, 2001
excludes a charge for the cumulative effect of an accounting change of
$0.4 million (net of income taxes of $0.2 million). This charge reflects
the Company's adoption of Statement of Financial Accounting Standard No.
133, "Accounting for Derivative Instruments and Hedging Activities"
effective January 1, 2001.
(iii) The total assets presented herein as of December 31, 1999 and 1998
include the net assets of Stilwell of $814.6 million and $540.2 million
respectively. Due to the Spin-off on July 12, 2000, the total assets as
of December 31, 2002, 2001 and 2000 do not include the net assets of
Stilwell.
Page 20
(iv) The ratio of earnings to fixed charges is computed by dividing earnings
by fixed charges. For this purpose "earnings" represent the sum of (i)
pretax income from continuing operations adjusted for income (loss) from
unconsolidated affiliates, (ii) fixed charges, (iii) distributed income
from unconsolidated affiliated and (iv) amortization of capitalized
interest, less capitalized interest. "Fixed charges" represent the sum of
(i) interest expensed, (ii) capitalized interest, (iii) amortization of
deferred debt issuance costs and (iv) one-third of our annual rental
expense, which management believes is representative of the interest
component of rental expense.
The information set forth in response to Item 301 of Regulation S-K under Part
II Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations", of this Form 10-K is incorporated by reference in
partial response to this Item 6.
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
OVERVIEW
The discussion set forth below, as well as other portions of this Form 10-K,
contains forward-looking comments that are not based upon historical
information. Such forward-looking comments are based upon information currently
available to management and management's perception thereof as of the date of
this Form 10-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 ("KCS"
or the "Company") could materially differ from those indicated in
forward-looking comments. The differences could be caused by a number of factors
or combination of factors including, but not limited to, those factors
identified in the Company's Current Report on Form 8-K dated December 11, 2001,
which is on file with the U.S. Securities and Exchange Commission ("SEC") (File
No.1-4717) and is 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 Reports of Independent Accountants thereon, and is
qualified by reference thereto.
General
Kansas City Southern ("KCS" or the "Company") is a Delaware corporation. KCS,
formerly Kansas City Southern Industries, Inc., is a holding company and its
principal subsidiaries and affiliates include the following:
o The Kansas City Southern Railway Company ("KCSR"), a wholly-owned
subsidiary;
o Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. ("Grupo TFM"), a
46.6% owned unconsolidated affiliate, which owns 80% of the common stock of
TFM, S.A. de C.V. ("TFM"). TFM wholly owns Mexrail, Inc. ("Mexrail").
Mexrail owns 100% of The Texas-Mexican Railway Company ("Tex Mex");
o Southern Capital Corporation, LLC ("Southern Capital"), a 50% owned
unconsolidated affiliate that leases locomotive and rail equipment to KCSR;
o Panama Canal Railway Company ("PCRC"), an unconsolidated affiliate of which
KCSR owns 50% of the common stock. PCRC owns all of the common stock of
Panarail Tourism Company ("Panarail").
During 2002, due to the relocation of the Company's headquarters to a new
building in downtown Kansas City, Missouri, the Company sold its interest in
Wyandotte Garage Corporation ("WGC"), which owns and operates a parking facility
located adjacent to the Company's former headquarters building in downtown
Kansas City, Missouri.
KCS, as the holding company, supplies its various subsidiaries with managerial,
legal, tax, financial and accounting services, in addition to managing other
"non-operating" investments.
Page 21
Effective October 1, 2001, the Gateway Western Railway Company ("Gateway
Western") was merged into KCSR. Discussions of KCSR in this Form 10-K include
the operations and operating results of Gateway Western.
All per share information included in this Item 7 is presented on a diluted
basis unless specifically identified otherwise.
RECENT DEVELOPMENTS
The following items reflect significant developments, events or transactions
that have occurred during the year ended December 31, 2002 or in 2003 prior to
the Company's filing of this Form 10-K.
Value Added Tax ("VAT") Lawsuit. As previously announced in the Company's
Current Report on Form 8-K dated October 11, 2002, a three judge panel of the
Court of the First Circuit ("Appellate Court") in Mexico City unanimously ruled
in favor of TFM, finding that the decision issued by the Superior Court of the
Federal Tribunal of Fiscal and Administrative Justice ("Fiscal Court") denying
TFM's VAT claim had violated TFM's constitutional rights. The Appellate Court,
in its decision, remanded the case back to the Fiscal Court with specific
instructions to vacate its prior decision and enter a new decision consistent
with the guidance provided by the Appellate Court's ruling. The Appellate Court
ruling requires the fiscal authorities to issue the VAT credit certificate only
in the name of the interested party, to issue the VAT credit certificate only in
strict accordance with the terms of the fiscal code, and to deliver the VAT
credit certificate only to the beneficiary.
As previously announced in the Company's Current Report on Form 8-K dated
December 9, 2002, the Fiscal Court once again has issued a ruling denying TFM's
VAT claim. TFM has filed in 2003 a timely constitutional appeal from the Fiscal
Court's decision with the Appellate Court. Based on the advice of TFM's legal
counsel, the Company and Grupo TMM remain confident of TFM's right under Mexican
law to receive the VAT credit certificate. The face value of the VAT credit at
issue is approximately $206 million. TFM's VAT claim dates from 1997. The amount
of any recovery would, in accordance with Mexican law, reflect the face value of
the VAT credit adjusted for inflation and interest accruals from 1997, with
certain limitations.
Automobile Accident. On January 28, 2003, a passenger car carrying a driver and
four passengers near Batchelor, Louisiana struck a KCSR section truck carrying
two employees. All five occupants of the passenger car were pronounced dead at
the scene while the two KCSR employees suffered minor injuries. The driver of
the KCSR truck has been charged with five counts of negligent homicide.
Investigation of the incident is still in its early stages and KCSR has not been
served with any litigation regarding this incident. KCSR believes that it has
insurance coverage for all but its $100,000 deductible in potential damages
arising from this incident.
Purchase of Mexican government's ownership of Grupo TFM. KCS and Grupo TMM
exercised their call option and, on July 29, 2002, completed the purchase of the
Mexican government's 24.6% ownership of Grupo TFM. The Mexican government's
ownership interest of Grupo TFM was purchased by TFM for a purchase price of
$256.1 million, utilizing a combination of proceeds from an offering of debt
securities by TFM, a credit from the Mexican government for the reversion of
certain rail facilities and other resources. This transaction results in an
increase in the Company's ownership percentage of Grupo TFM from 36.9% to
approximately 46.6%.
Debt Refinancing. During 2002, the Company was party to several debt refinancing
transactions as described below.
7 1/2% Senior Notes
On June 12, 2002, KCSR issued $200 million of 7 1/2% senior notes due June 15,
2009 ("7 1/2% Notes") through a private offering pursuant to Rule 144A under the
Securities Act of 1933 in the United States and Regulation S outside the United
States ("Note Offering"). Net proceeds from the Note Offering of $195.8 million,
together with cash, were used to repay a portion of the term debt under the
Company's senior secured credit facility ("KCS Credit Facility") and certain
other secured indebtedness of the Company. Debt issuance costs related to the
Note Offering of approximately $4.6 million were deferred and are being
amortized over the seven-year term of the 7 1/2% Notes. The remaining balance of
deferred debt issuance costs associated with the Note Offering was approximately
$4.2 million at December 31, 2002. Debt retirement costs associated with the
prepayment of certain term loans under the KCS Credit Facility using proceeds
from
Page 22
the Note Offering were approximately $4.3 million. These debt retirement costs
were previously reported as an extraordinary item, but have been reclassified in
accordance with Statement of Financial Accounting Standards No. 145, "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" ("SFAS 145"), which the Company early adopted in the
fourth quarter of 2002.
KCS submitted a Form S-4 Registration Statement to the SEC on July 12, 2002, as
amended on July 24, 2002, relative to an Exchange Offer for the $200 million 7
1/2% Notes due 2009. On July 30, 2002, the SEC declared this Registration
Statement effective thereby providing the opportunity for holders of the initial
7 1/2% Notes to exchange them for registered notes with substantially identical
terms. All of the 7 1/2% Notes due 2009 were exchanged for $200 million of
registered notes due June 15, 2009. The registered notes bear a fixed annual
interest rate to be paid semi-annually on June 15 and December 15 and are due
June 15, 2009. The registered notes are general unsecured obligations of KCSR,
are guaranteed by the Company and certain of its subsidiaries, and contain
certain covenants and restrictions customary for this type of debt instrument
and for borrowers with similar credit ratings.
New Credit Agreement
On June 12, 2002, in conjunction with the repayment of certain of the term loans
under the KCS Credit Facility using the net proceeds received from the Note
Offering, the Company amended and restated the KCS Credit Facility (the amended
and restated credit agreement is referred to as the New Credit Agreement
herein). The New Credit Agreement provides KCSR with a $150 million term loan
("Tranche B term loan"), which matures on June 12, 2008, and a $100 million
revolving credit facility ("Revolver"), which matures on January 11, 2006.
Letters of credit are also available under the Revolver up to a limit of $15
million. The proceeds from future borrowings under the Revolver may be used for
working capital and for general corporate purposes. The letters of credit may be
used for general corporate purposes. Borrowings under the New Credit Agreement
are secured by substantially all of the Company's assets and are guaranteed by
the majority of its subsidiaries.
The Tranche B term loan and the Revolver bear interest at the London Interbank
Offered Rate ("LIBOR"), or an alternate base rate, as the Company shall select,
plus an applicable margin. The applicable margin for the Tranche B term loan is
2% for LIBOR borrowings and 1% for alternate base rate borrowings. The
applicable margin for the Revolver is based on the Company's leverage ratio
(defined as the ratio of the Company's total debt to consolidated EBITDA
(earnings before interest, taxes, depreciation and amortization, excluding the
undistributed earnings of unconsolidated affiliates) for the prior four fiscal
quarters). Based on the Company's leverage ratio as of December 31, 2002, the
applicable margin was 2.25% per annum for LIBOR borrowings and 1.25% per annum
for alternate base rate borrowings.
The New Credit Agreement also requires the payment to the lenders of a
commitment fee of 0.50% per annum on the average daily, unused amount of the
Revolver. Additionally, a fee equal to a per annum rate of 0.25% plus the
applicable margin for LIBOR priced borrowings under the Revolver will be paid on
any letter of credit issued under the Revolver.
The New Credit Agreement contains certain provisions, covenants and restrictions
customary for this type of debt and for borrowers with a similar credit rating.
These provisions include, among others, restrictions on the Company's ability
and its subsidiaries ability to 1) incur additional debt or liens; 2) enter into
sale and leaseback transactions; 3) merge or consolidate with another entity; 4)
sell assets; 5) enter into certain transactions with affiliates; 6) make
investments, loans, advances, guarantees or acquisitions; 7) make certain
restricted payments, including dividends, or make certain payments on other
indebtedness; and 8) make capital expenditures. In addition, the Company is
required to comply with certain financial ratios, including minimum interest
expense coverage and leverage ratios. The New Credit Agreement also contains
certain customary events of default. These covenants, along with other
provisions, could restrict maximum utilization of the Revolver.
Debt issuance costs related to the New Credit Agreement of approximately $1.1
million were deferred and are being amortized over the respective term of the
loans. The remaining balance of deferred debt issuance costs associated with the
New Credit Agreement was approximately $1.0 million at December 31, 2002.
Page 23
Southern Capital
On June 25, 2002, Southern Capital refinanced the outstanding balance of its
one-year bridge loan through the issuance of approximately $167.6 million of
pass through trust certificates and the sale of 50 locomotives. The pass through
trust certificates are secured by the sold locomotives, all of the remaining
locomotives and rolling stock owned by Southern Capital and rental payments
payable by KCSR under the sublease of the sold locomotives and its leases of the
equipment owned by Southern Capital. Payments of interest and principal of the
pass through trust certificates, which are due semi-annually on June 30 and
December 30 commencing on December 30, 2002 and ending on June 30, 2022, are
insured under a financial guarantee insurance policy by MBIA Insurance
Corporation. KCSR leases or subleases all of the equipment securing the pass
through trust certificates.
Implementation of New Management Control System. On July 14, 2002, the Company
initiated the transition from its legacy operating system to a new platform
called the Management Control System ("MCS") on KCSR. This state-of-the-art
system is designed to provide better analytical tools for management to use in
its decision-making processes. MCS, among other things, delivers work orders to
yard and train crews to ensure that the service being provided reflects what was
sold to the customer. The system also tracks individual shipments as they move
across the rail system, compares that movement to the service sold to the
customer and automatically reports the shipment's status to the customer and to
operations management. If a shipment falls behind schedule, MCS automatically
generates alerts and action recommendations so that corrective action promptly
can be initiated. The Company's depreciation expense is expected to increase by
approximately $4.8 million per annum ($2.4 million in 2002) as a result of the
implementation of MCS.
As previously announced, in the second half of 2002, the Company's operating
results were impacted by higher operating costs and some temporary traffic
diversions caused by congestion directly related to the implementation of MCS.
The MCS implementation slowed the railroad as employees learned to respond to
the data discipline demanded by this new system. The initial difficulties
experienced by office and field personnel in transitioning to this new platform
led to the congestion issues and operating inefficiencies, which contributed to
a decline in consolidated operating income. By mid-November 2002, however, the
Company's operations began to experience improved transit times and terminal
activities as MCS capabilities began to be fully integrated into KCS management
processes and operations were virtually recovered by year end. See Results of
Operations below for a discussion of the impact on 2002 results of operations.
Sale of Mexrail, Inc. to TFM. The Company, Grupo TMM, and certain of Grupo TMM's
affiliates entered into an agreement on February 27, 2002 with TFM to sell to
TFM all of the common stock of Mexrail. Mexrail owns the northern half of the
international railway bridge at Laredo, Texas and all of the common stock of the
Tex Mex. The sale closed on March 27, 2002 and the Company received
approximately $31.4 million for its 49% interest in Mexrail. The Company used
the proceeds from the sale of Mexrail to reduce debt. Although the Company no
longer directly owns 49% of Mexrail, it retains an indirect ownership through
its ownership of Grupo TFM. The proceeds from the sale of Mexrail to TFM
exceeded the carrying value of the Company's investment in Mexrail by $11.2
million. The Company recognized a $4.4 million gain on the sale of Mexrail to
TFM in the first quarter of 2002, while the remaining $6.8 of excess proceeds
was deferred and is being amortized over 20 years.
Company Changes Name to Kansas City Southern. On May 2, 2002, at the Annual
Meeting of Stockholders, the shareholders of the Company approved a proposal to
amend the Certificate of Incorporation to change the name of the Company from
"Kansas City Southern Industries, Inc." to "Kansas City Southern." The name
change became effective on May 2, 2002 following the filing of the amended
Certificate of Incorporation with the Secretary of State of the State of
Delaware. The name change reflects the change in the Company's business and
holdings following the spin-off of Stilwell Financial Inc. on July 12, 2000. By
dropping "Industries, Inc." from the name, KCS will maintain the identification
in the marketplace of the Company and KCSR, while emphasizing KCS's focus on
transportation rather than a variety of industries. The name change did not
require a change in the security ticker symbol of KSU on the New York Stock
Exchange.
Page 24
Changes to Mexican Tax Law. Effective January 1, 2002, Mexico implemented
changes in its income tax laws. One of these changes reduced the Mexican
corporate income tax rate from 35% to 32% in one-percent increments beginning in
2003, resulting in a 32% income tax rate in 2005. Accordingly, under accounting
principles generally accepted in the United States of America ("U.S. GAAP"),
Grupo TFM recorded the impact of this rate change during 2002. This rate change
had the effect of reducing Grupo TFM's deferred tax asset, thus reducing Grupo
TFM's deferred tax benefit for 2002. After consideration of minority interest,
the impact of this rate change resulted in an approximate $2.8 million decline
in the Company's equity in earnings of Grupo TFM for 2002.
KCSR and The Burlington Northern and Santa Fe Railway Company ("BNSF") Form
Marketing Alliance. In April 2002, KCSR and BNSF formed a comprehensive joint
marketing alliance aimed at promoting cooperation, revenue growth and extending
market reach for both railroads in the United States and Canada. The marketing
alliance is also expected to improve operating efficiencies for both carriers in
key market areas, as well as provide customers with expanded service options.
KCSR and BNSF have agreed to coordinate marketing and operational initiatives in
a number of target markets. The marketing alliance is expected to allow the two
railroads to be more responsive to shippers' requests for rates and service
throughout the two rail networks. Coal and unit train operations are excluded
from the marketing alliance, as well as any points where KCSR and BNSF are the
only direct rail competitors. Movements to and from Mexico by either party are
also excluded. Management believes this marketing alliance will provide
important opportunities to grow KCSR's revenue base, particularly in the
intermodal, chemical, grain and forest product markets, providing both
participants with expanded access to important markets and providing shippers
with enhanced options and competitive alternatives.
SIGNIFICANT DEVELOPMENTS
Bogalusa Cases.. In July 1996, KCSR was named as one of twenty-seven defendants
in various lawsuits in Louisiana and Mississippi arising from the explosion of a
rail car loaded with chemicals in Bogalusa, Louisiana on October 23, 1995. As a
result of the explosion, nitrogen dioxide and oxides of nitrogen were released
into the atmosphere over parts of that town and the surrounding area allegedly
causing evacuations and injuries. Approximately 25,000 residents of Louisiana
and Mississippi (plaintiffs) have asserted claims to recover damages allegedly
caused by exposure to the released chemicals. On October 29, 2001, KCSR and
representatives for its excess insurance carriers negotiated a settlement in
principle with the plaintiffs for $22.3 million. A Master Global Settlement
Agreement ("MGSA") was signed in early 2002. During 2002, KCSR made all payments
under the MGSA and collected $19.3 million from its excess insurance carriers.
Court approval of the MGSA is expected in 2003 from the 22nd Judicial District
Court of Washington Parish, Louisiana. KCSR also expects to receive releases
from about 4,000 Mississippi plaintiffs in numerous cases pending in the First
Judicial District Circuit Court of Hinds County, Mississippi.
Houston Cases. In August 2000, KCSR and certain of its affiliates were added as
defendants in