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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2011 |
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to |
Commission File Number 333-08322
KANSAS CITY SOUTHERN DE MÉXICO, S.A. DE C.V.
(Exact name of Company as specified in its charter)
Kansas City Southern of Mexico
(Translation of Registrants name into English)
Mexico | 98-0519243 | |||
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |||
Montes Urales 625 Lomas de Chapultepec 11000 Mexico, D.F. Mexico (Address of Principal Executive Offices) |
(5255) 9178-5686
(Companys telephone number, including area code)
No Changes
(Former name, former address and former fiscal year, if changed since last report.)
Indicate by check mark whether the Company (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x Smaller reporting company ¨
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of June 30, 2011: 4,785,510,235
Kansas City Southern de México, S.A. de C.V. meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form with the reduced disclosure format.
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Kansas City Southern de México, S.A. de C.V. and Subsidiaries
Form 10-Q
June 30, 2011
Index
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Kansas City Southern de México, S.A. de C.V. and Subsidiaries
Form 10-Q
June 30, 2011
Item 1. | Financial Statements |
The unaudited Consolidated Financial Statements included herein have been prepared by Kansas City Southern de México, S.A. de C.V. (KCSM or the Company) pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). For the purposes of this report, unless the context otherwise requires, all references herein to KCSM and the Company shall mean Kansas City Southern de México, S.A. de C.V. and its subsidiaries. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations. The Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented. The Consolidated Financial Statements and Managements Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-Q should be read in conjunction with the consolidated financial statements and the related notes, as well as Managements Discussion and Analysis of Financial Condition and Results of Operations, included in the Companys Annual Report on Form 10-K for the year ended December 31, 2010. Results for the three and six months ended June 30, 2011 are not necessarily indicative of the results expected for the full year ending December 31, 2011.
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Kansas City Southern de México, S.A. de C.V. and Subsidiaries
Consolidated Statements of Income
Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(In millions) (Unaudited) |
||||||||||||||||
Revenues |
$ | 246.7 | $ | 206.8 | $ | 464.9 | $ | 397.6 | ||||||||
Operating expenses: |
||||||||||||||||
Compensation and benefits |
32.8 | 25.2 | 63.5 | 47.7 | ||||||||||||
Purchased services |
34.8 | 31.7 | 65.9 | 63.7 | ||||||||||||
Fuel |
40.8 | 32.4 | 74.6 | 58.8 | ||||||||||||
Equipment costs |
22.0 | 19.9 | 42.5 | 38.4 | ||||||||||||
Depreciation and amortization |
20.9 | 24.4 | 42.1 | 48.3 | ||||||||||||
Materials and other |
16.3 | 14.9 | 29.0 | 26.1 | ||||||||||||
Total operating expenses |
167.6 | 148.5 | 317.6 | 283.0 | ||||||||||||
Operating income |
79.1 | 58.3 | 147.3 | 114.6 | ||||||||||||
Equity in net earnings of unconsolidated affiliates |
0.7 | 2.9 | 1.5 | 4.4 | ||||||||||||
Interest expense |
(19.6 | ) | (25.7 | ) | (39.5 | ) | (53.2 | ) | ||||||||
Debt retirement costs |
(10.3 | ) | (16.7 | ) | (10.3 | ) | (31.6 | ) | ||||||||
Foreign exchange gain (loss) |
0.4 | (1.5 | ) | 0.4 | 1.3 | |||||||||||
Other income, net |
0.3 | 1.0 | 2.1 | 1.5 | ||||||||||||
Income before income taxes |
50.6 | 18.3 | 101.5 | 37.0 | ||||||||||||
Income tax expense |
18.4 | 3.2 | 35.8 | 10.8 | ||||||||||||
Net income |
$ | 32.2 | $ | 15.1 | $ | 65.7 | $ | 26.2 | ||||||||
See accompanying notes to consolidated financial statements.
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Kansas City Southern de México, S.A. de C.V. and Subsidiaries
Consolidated Balance Sheets
June 30, 2011 |
December 31, 2010 |
|||||||
(In millions, except share amounts) |
||||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 100.7 | $ | 37.0 | ||||
Accounts receivable, net |
117.3 | 83.7 | ||||||
Related company receivables |
33.3 | 18.8 | ||||||
Materials and supplies |
35.2 | 35.1 | ||||||
Deferred income taxes |
98.2 | 109.2 | ||||||
Other current assets |
60.9 | 93.4 | ||||||
Total current assets |
445.6 | 377.2 | ||||||
Investments |
12.0 | 12.1 | ||||||
Property and equipment (including concession assets), net |
2,287.5 | 2,276.2 | ||||||
Other assets |
34.1 | 33.5 | ||||||
Total assets |
$ | 2,779.2 | $ | 2,699.0 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Debt due within one year |
$ | 11.0 | $ | 11.2 | ||||
Accounts payable and accrued liabilities |
140.7 | 152.0 | ||||||
Related company payables |
2.4 | 2.4 | ||||||
Total current liabilities |
154.1 | 165.6 | ||||||
Long-term debt |
869.1 | 874.4 | ||||||
Related company debt |
39.0 | 39.0 | ||||||
Deferred income taxes |
67.5 | 42.6 | ||||||
Other noncurrent liabilities and deferred credits |
93.6 | 87.7 | ||||||
Total liabilities |
1,223.3 | 1,209.3 | ||||||
Commitments and contingencies |
| | ||||||
Stockholders equity: |
||||||||
Common stock, 4,785,510,235 shares authorized, issued without par value |
602.3 | 602.3 | ||||||
Additional paid-in capital |
243.6 | 243.6 | ||||||
Retained earnings |
712.3 | 646.6 | ||||||
Accumulated other comprehensive loss |
(2.3 | ) | (2.8 | ) | ||||
Total stockholders equity |
1,555.9 | 1,489.7 | ||||||
Total liabilities and stockholders equity |
$ | 2,779.2 | $ | 2,699.0 | ||||
See accompanying notes to consolidated financial statements.
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Consolidated Statements of Cash Flows
Six Months Ended June 30, |
||||||||
2011 | 2010 | |||||||
(In millions) | ||||||||
(Unaudited) | ||||||||
Operating activities: |
||||||||
Net income |
$ | 65.7 | $ | 26.2 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
42.1 | 48.3 | ||||||
Deferred income taxes |
35.8 | 10.8 | ||||||
Equity in undistributed earnings of unconsolidated affiliates |
(1.5 | ) | (4.4 | ) | ||||
Deferred compensation |
11.0 | 3.2 | ||||||
Distributions from unconsolidated affiliates |
2.3 | 1.5 | ||||||
Cash payments related to hurricane damage |
(1.1 | ) | | |||||
Insurance proceeds related to hurricane damage |
21.7 | | ||||||
Gain on sale of Mexrail, Inc. |
| (0.7 | ) | |||||
Debt retirement costs |
10.3 | 31.6 | ||||||
Changes in working capital items: |
||||||||
Accounts receivable |
(33.6 | ) | (27.6 | ) | ||||
Related companies |
(16.5 | ) | (17.3 | ) | ||||
Materials and supplies |
0.2 | (1.2 | ) | |||||
Other current assets |
10.5 | (1.3 | ) | |||||
Accounts payable and accrued liabilities |
(6.5 | ) | 13.8 | |||||
Other, net |
(0.4 | ) | 1.3 | |||||
Net cash provided by operating activities |
140.0 | 84.2 | ||||||
Investing activities: |
||||||||
Capital expenditures |
(68.8 | ) | (45.4 | ) | ||||
Acquisition of an intermodal facility, net of cash acquired |
| (25.0 | ) | |||||
Insurance proceeds related to hurricane damage |
8.3 | | ||||||
Proceeds from disposal of property |
3.1 | 2.0 | ||||||
Repayments of loan from a related company |
| 31.4 | ||||||
Proceeds from sale of Mexrail, Inc. |
| 41.0 | ||||||
Other, net |
| (0.2 | ) | |||||
Net cash provided by (used for) investing activities |
(57.4 | ) | 3.8 | |||||
Financing activities: |
||||||||
Proceeds from issuance of long-term debt |
200.0 | 295.7 | ||||||
Repayment of long-term debt |
(206.0 | ) | (471.9 | ) | ||||
Debt costs |
(12.9 | ) | (30.1 | ) | ||||
Pro-rata contribution on common stock |
| 95.0 | ||||||
Net cash used for financing activities |
(18.9 | ) | (111.3 | ) | ||||
Cash and cash equivalents: |
||||||||
Net increase (decrease) during each period |
63.7 | (23.3 | ) | |||||
At beginning of year |
37.0 | 92.6 | ||||||
At end of period |
$ | 100.7 | $ | 69.3 | ||||
See accompanying notes to consolidated financial statements.
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Kansas City Southern de México, S.A. de C.V. and Subsidiaries
Notes to Consolidated Financial Statements
1. Accounting Policies, Interim Financial Statements and Basis of Presentation
In the opinion of the management of KCSM, the accompanying unaudited consolidated financial statements contain all adjustments necessary for a fair presentation of the results for interim periods. All adjustments made were of a normal and recurring nature. Certain information and footnote disclosure normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Companys Annual Report on Form 10-K for the year ended December 31, 2010. The results of operations for the three and six months ended June 30, 2011, are not necessarily indicative of the results to be expected for the full year ending December 31, 2011. Certain prior year amounts have been reclassified to conform to the current year presentation.
2. Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (the FASB) issued new guidance on the presentation of comprehensive income, which eliminates the option for entities to present components of other comprehensive income (OCI) as a part of the statement of changes in stockholders equity and requires that all non-owner changes in stockholders equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. This standard is effective for the Company beginning the first quarter of 2012.
3. Hurricane Alex
Hurricane Alex made landfall on June 30, 2010, causing widespread damage and flooding in central and northeastern Mexico. The hurricane resulted in extensive damage to KCSMs track and bridge infrastructures, and also caused multiple track-related incidents and significantly disrupted the Companys rail service.
The Company maintains a comprehensive insurance program intended to cover such events. The property and casualty insurance program covers loss or damage to Company property and third party property over which the Company has custody and control and covers losses associated with business interruption. This program has combined coverage for both property damage and business interruption and has a self-insured retention amount of $10.0 million for flood related losses. In addition, the Company also maintains a general liability insurance program. This program had a self-insured retention of $1.0 million in Mexico at the time of Hurricane Alex. The Companys policy limits are in excess of the hurricane losses incurred.
Hurricane Alex affected revenues as customers were required to use alternate carriers or modes of transportation until rail service was restored. The Company estimated that resulting lost revenues in the third quarter of 2010 were approximately $28.0 million before related avoided costs. In addition, the Company incurred losses related to property damage and incremental expenses of $34.9 million. The $34.9 million of incurred losses related to property damage and incremental expense was offset by a receivable for probable insurance recoveries. Effective July 7, 2011, the Company settled the portion of the insurance claim related to the property and casualty program, including business interruption for $66.0 million before the related self-insured retention of $10.0 million. Through June 30, 2011, the Company has received $40.0 million of insurance proceeds related to the property and casualty claim (see table below) and expects to receive final settlement proceeds of $16.0 million in the third quarter of 2011. KCSM will allocate $12.1 million of the total insurance proceeds received to the Companys affiliate, The Kansas City Southern Railway Company (KCSR), for KCSRs portion of property damage, incremental expense and business interruption. The $9.0 million of the proceeds retained by the Company that are in excess of the receivable will be recognized by KCSM as a gain on insurance recovery within operating expenses in the third quarter of 2011.
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Notes to Consolidated Financial Statements(Continued)
As of June 30, 2011, $40.0 million of insurance proceeds were collected in the following periods (in millions):
Period Received |
Amount Collected | |||
Fourth quarter 2010 |
$ | 10.0 | ||
First quarter 2011 |
15.0 | |||
Second quarter 2011 |
15.0 | |||
Total proceeds collected |
$ | 40.0 | ||
On July 5, 2011, the Company received $3.0 million of insurance proceeds for the portion of the insurance claim related to general liability. The Company expects to settle the general liability insurance claim during the third quarter of 2011, and related proceeds will be recognized as a gain on insurance recovery within operating expenses when all contingencies have been resolved, which generally occurs at the time of final settlement.
4. Property and Equipment (including Concession Assets)
Property and equipment, including concession assets, and related accumulated depreciation and amortization are summarized below (in millions):
June 30, 2011 |
December 31, 2010 |
|||||||
Land |
$ | 76.2 | $ | 76.2 | ||||
Concession land rights |
141.2 | 141.2 | ||||||
Road property |
2,042.8 | 1,998.0 | ||||||
Equipment |
389.9 | 393.0 | ||||||
Technology and other |
20.1 | 20.3 | ||||||
Construction in progress |
72.0 | 73.1 | ||||||
Total property |
2,742.2 | 2,701.8 | ||||||
Accumulated depreciation and amortization |
454.7 | 425.6 | ||||||
Property and equipment (including concession assets), net |
$ | 2,287.5 | $ | 2,276.2 | ||||
Concession assets, net of accumulated amortization of $323.2 million and $305.3 million, totaled $1,826.5 million and $1,800.1 million at June 30, 2011 and December 31, 2010, respectively.
5. Fair Value Measurements
The Companys short-term financial instruments include cash and cash equivalents, accounts receivable, and accounts payable. The carrying value of the short term financial instruments approximates their fair value.
The fair value of the Companys debt is estimated using quoted market prices when available. When quoted market prices are not available, fair value is estimated based on current market interest rates for debt with similar maturities and credit quality. The fair value of the Companys debt was $969.2 million and $981.2 million at June 30, 2011 and December 31, 2010, respectively. The carrying value was $919.1 million and $924.6 million at June 30, 2011 and December 31, 2010, respectively.
6. Long Term Debt
On May 6, 2011, pursuant to an offer to purchase, KCSM commenced a cash tender offer for all of its 7 5/8% Senior Notes due December 1, 2013 (the 7 5/8% Senior Notes) and, pursuant to a separate offer to purchase, KCSM commenced a cash tender offer for all of its 7 3/8% Senior Notes due June 1, 2014 (the 7 3/8% Senior Notes). Through June 7, 2011, the Company purchased and redeemed the remaining $32.4 million of the 7 5/8% Senior Notes and all of the outstanding $165.0 million of the 7 3/8% Senior Notes using the proceeds received from the issuance of $200.0 million principal amount of 6 1/8% senior unsecured notes due June 15, 2021 (the 6 1/8% Senior Notes) and cash on hand. KCSM recorded debt retirement costs of $10.3 million in the second quarter of 2011.
On May 20, 2011, KCSM issued $200.0 million principal amount of 6 1/8% Senior Notes, at par, bearing interest semiannually at a fixed annual rate of 6 1/8%. The Company used proceeds from the issuance of the 6 1/8% Senior Notes and cash on hand to purchase
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Notes to Consolidated Financial Statements(Continued)
and redeem the 7 5/8% Senior Notes and 7 3/8% Senior Notes as discussed above, and pay all fees and expenses incurred in connection with the 6 1/8% Senior Notes offering and the tender offers. The 6 1/8% Senior Notes are redeemable at KCSMs option, in whole or in part, on and after June 15, 2016, at the following redemption prices (expressed as percentages of principal amount) if redeemed during the 12-month period commencing on June 15 of the following years, plus any accrued and unpaid interest to the date of redemption: 2016 103.063%, 2017 102.042%, 2018 101.021% and 2019 100.000%. In addition, the Company may redeem up to 35% of the 6 1/8% Senior Notes at a redemption price equal to 106.125% any time prior to June 15, 2014 from the proceeds of the sale of KCSMs capital stock or the capital stock of KCS and the notes are redeemable, in whole but not in part, at KCSMs option at their principal amount, plus any accrued unpaid interest in the event of certain changes in the Mexican withholding tax rate.
The 6 1/8% Senior Notes are denominated in dollars and are unsecured, unsubordinated obligations, rank pari passu in right of payment with the Companys existing and future unsecured, unsubordinated obligations, and are senior in right of payment to KCSMs future subordinated indebtedness. In addition, the 6 1/8% Senior Notes include certain covenants which are customary for these types of debt instruments and borrowers with similar credit ratings. The 6 1/8% Senior Notes contain certain covenants that, among other things, prohibit or restrict KCSM from taking certain actions, including the ability to incur debt, pay dividends or make other distributions in respect of KCSMs stock, issue guarantees, enter into certain transactions with affiliates, make restricted payments, sell certain assets, create liens, engage in sale-leaseback transactions and engage in mergers, divestitures and consolidations. However, these limitations are subject to a number of important qualifications and exceptions.
7. Comprehensive Income
Other comprehensive income refers to revenues, expenses, gains and losses that under U.S. GAAP are included in comprehensive income, a component of stockholders equity within the consolidated balance sheets, rather than net income. Under existing accounting standards, other comprehensive income for KCSM reflects the cumulative translation adjustment on Ferrocarril y Terminal del Valle de México, S.A. de C.V. (FTVM).
KCSMs total comprehensive income is as follows (in millions):
Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net income |
$ | 32.2 | $ | 15.1 | $ | 65.7 | $ | 26.2 | ||||||||
Other comprehensive income: |
||||||||||||||||
Cumulative translation adjustment FTVM |
0.1 | (0.2 | ) | 0.5 | 0.3 | |||||||||||
Total comprehensive income |
$ | 32.3 | $ | 14.9 | $ | 66.2 | $ | 26.5 | ||||||||
8. Commitments and Contingencies
Concession Duty. Under KCSMs 50-year railroad concession from the Mexican government (the Concession), the Mexican government has the right to receive a payment from the Company equivalent to 0.5% of the gross revenue during the first 15 years of the Concession period and, beginning on June 24, 2012, 1.25% of the gross revenue for the remaining years of the Concession period. For the three and six months ended June 30, 2011, the concession duty expense, which is recorded within operating expenses, was $1.3 million and $2.4 million, respectively, compared to $1.1 million and $2.1 million for the same periods in 2010.
Litigation. The Company is a party to various legal proceedings and administrative actions, all of which, except as set forth below, are of an ordinary, routine nature and incidental to its operations. KCSM aggressively defends these matters and has established liability provisions, which management believes are adequate to cover expected costs. Although it is not possible to predict the outcome of any legal proceeding, in the opinion of management, other than those proceedings described in detail below, such proceedings and actions should not, individually, or in the aggregate, have a material adverse effect on the Companys financial condition and liquidity. However, a material adverse outcome in one or more of these proceedings could have a material adverse impact on the results of operations in a particular quarter or fiscal year.
Environmental Liabilities. The Companys operations are subject to Mexican federal and state laws and regulations relating to the protection of the environment through the establishment of standards for water discharge, water supply, emissions, noise pollution, hazardous substances and transportation and handling of hazardous and solid waste. The Mexican government may bring administrative and criminal proceedings and impose economic sanctions against companies that violate environmental laws, and temporarily or even permanently close non-complying facilities.
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Notes to Consolidated Financial Statements(Continued)
The risk of incurring environmental liability is inherent in the railroad industry. As part of serving the petroleum and chemicals industry, the Company transports hazardous materials and has a professional team available to respond and handle environmental issues that might occur in the transport of such materials. Additionally, the Company has initiated environmental, health and safety management system programs to reduce the Companys potential liability. The Company performs ongoing reviews and evaluations of the various environmental programs and issues within the Companys operations, and, as necessary, takes actions intended to limit the Companys exposure to potential liability. Although these costs cannot be predicted with certainty, management believes that the ultimate outcome of identified matters will not have a material adverse effect on the Companys consolidated financial position or cash flows.
Settlement Agreement. On February 9, 2010, (i) KCSM and (ii) Ferrocarril Mexicano, S.A. de C.V. (Ferromex), Ferrosur, S.A. de C.V. (Ferrosur), Minera México, S.A. de C.V., Infraestructura y Transportes Ferroviarios, S.A. de C.V., Infraestructura y Transportes México, S.A. de C.V., Líneas Ferroviarias de México, S.A. de C.V., Grupo Ferroviario Mexicano, S.A. de C.V., and Grupo México, S.A.B. de C.V. (jointly, the Ferromex Parties) entered into a Settlement Agreement (the Settlement Agreement).
Pursuant to the Settlement Agreement, the parties agreed to completely, definitively and irrevocably terminate (i) certain disputes, procedures and controversies among KCSM and the Ferromex Parties, in connection with the merger between Ferromex and Ferrosur, including KCSMs involvement in such procedures as an interested party; and (ii) the lawsuit filed against KCSM and the Mexican Government in connection with several disputes, procedures and controversies before judicial authorities with respect to the acquisition of the shares of Ferrocarril del Noreste, S.A. de C.V. (now KCSM) by Grupo Transportación Ferroviaria Mexicana, S.A. de C.V., in 1997 (the Settlement Procedures). The parties waived their rights to any future actions derived from or related to the Settlement Procedures. Further, the parties did not settle or agree to settle any disputes, controversies or procedures other than the Settlement Procedures.
Under the Settlement Agreement, Ferrosur agreed to grant KCSM certain trackage and switching rights within Veracruz, México, and switching rights in the Puebla-Tlaxcala zone. In a related agreement, the parties further agreed to amend the FTVM by-laws to, among other changes, grant certain veto and voting rights to KCSM at the shareholders and the board of directors levels.
In November 2005, Ferromex acquired control of and merged with Ferrosur creating Mexicos largest railway, though such merger had been previously rejected by the Comisión Federal de Competencia (Mexican Antitrust Commission or COFECO). The Settlement Agreement provides that if COFECO does not authorize the merger of Ferromex and Ferrosur, the Settlement Agreement shall be terminated twelve months after the relevant resolution of the Governmental Authority is issued or when the unwinding is effective, whichever is later. On May 12, 2010, the Administrative and Fiscal Federal Court annulled the decision of COFECO and approved the merger between Ferromex and Ferrosur. On October 21, 2010, COFECO filed an appeal with the Collegiate Circuit Federal Court and on March 25, 2011, the Collegiate Circuit Federal Court dismissed the appeal and the merger between Ferromex and Ferrosur is considered final.
Certain Disputes with Ferromex. KCSM and Ferromex use certain trackage rights, haulage rights, and interline services (the Services) provided by each other. The rates to be charged after January 1, 2009, were agreed to pursuant to the Trackage Rights Agreement, dated February 9, 2010 (the Trackage Rights Agreement), between KCSM and Ferromex. The rates payable for these Services for the period beginning in 1998 through December 31, 2008 are still not resolved. If KCSM cannot reach an agreement with Ferromex for rates applicable for Services prior to January 1, 2009 which are not subject to the Trackage Rights Agreement, the Secretaría de Comunicaciones y Transportes (Secretary of Communications and Transportation) (SCT) is entitled to set the rates in accordance with Mexican law and regulations. KCSM and Ferromex both initiated administrative proceedings seeking a determination by the SCT of the rates that KCSM and Ferromex should pay each other in connection with the Services. The SCT issued rulings in 2002 and 2008 setting the rates for the Services and both KCSM and Ferromex challenged these rulings.
In addition, KCSM is currently involved in judicial, civil and administrative proceedings and negotiations with Ferromex regarding the rates payable to each other for the Services for the periods prior to January 1, 2009. Although KCSM and Ferromex have challenged these matters based on different grounds and these cases continue to evolve, management believes the amounts recorded related to these matters are adequate.
While the outcome of these matters cannot be predicted with certainty, the Company does not believe, when finally resolved, that these disputes will have a material effect on its results of operations or financial condition. However, an unexpected adverse resolution could have a material effect on the results of operations in a particular quarter or fiscal year.
SCT Sanction Proceedings. In April 2006, the SCT initiated proceedings against KCSM, claiming that KCSM had failed to make certain minimum capital investments projected for 2004 and 2005 under its five-year business plan filed with the SCT prior to its April 2005 acquisition by Kansas City Southern (KCS) (collectively, the Capital Investment Proceedings). KCSM responded to the SCT by providing evidence in support of its investments and explaining why it believes sanctions were not appropriate. On March 24, 2011, the Company received a favorable resolution from the Tax and Administration Court and the Company considers this matter resolved.
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Kansas City Southern de México, S.A. de C.V. and Subsidiaries
Notes to Consolidated Financial Statements(Continued)
On July 23, 2008, the SCT delivered notice to KCSM of proceedings against KCSM, claiming, among other things, that KCSM refused to grant Ferromex access to certain trackage over which Ferromex alleges it has trackage rights on six different occasions and, thus denied Ferromex the ability to provide service to a Mexican subsidiary of a large U.S. Auto Manufacturer at this location. On August 13, 2008, KCSM filed a response to the SCT. On July 15, 2010, the SCT resolved to consolidate these six sanction proceedings into a single proceeding, determining that the actions that motivated the underlying claims constitute a single occasion. On August 19, 2010, Ferromex filed an appeal which KCSM considers to be without merit. Management believes that even if KCSM were to be found liable, a single sanction would be imposed and could be challenged in the Administrative and Fiscal Federal Court. A single sanction makes it more likely that any unfavorable resolution will not have a material impact on KCSMs results of operations. However, if KCSM is ultimately sanctioned by the SCT for generic sanctions on five occasions over the term of the Concession, KCSM could be subject to possible future SCT action seeking revocation of the Concession.
Contractual Agreements. In the normal course of business, the Company enters into various contractual agreements related to commercial arrangements and the use of other railroads or governmental entities infrastructure needed for the operations of the business. The Company is involved or may become involved in certain disputes involving transportation rates, product loss or damage, charges, and interpretations related to these agreements. While the outcome of these matters cannot be predicted with certainty, the Company does not believe, when finally resolved, that these disputes will have a material effect on its results of operations or financial condition. However, an unexpected adverse resolution could have a material effect on the results of operations in a particular quarter or fiscal year.
Credit Risk. The Company continually monitors risks related to the economic changes and certain customer receivables concentrations. Significant changes in customer concentration or payment terms, deterioration of customer credit-worthiness or further weakening in economic trends could have a significant impact on the collectability of KCSMs receivables and operating results. If the financial condition of KCSMs customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company has recorded provisions for uncollectability based on its best estimate at June 30, 2011.
Income Tax. Tax returns filed by the Company from 2004 through the current year remain open to examination by the taxing authorities. The 2004 and 2005 tax returns are currently under examination. The Company believes that no provision is required as it expects to resolve these audits without a material adjustment. However, an unexpected adverse resolution could have a material effect on the results of operations in a particular quarter or fiscal year.
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Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
The discussion below, as well as other portions of this Form 10-Q, contain forward-looking statements that are not based upon historical information. Readers can identify these forward-looking statements by the use of such verbs as expects, anticipates, believes or similar verbs or conjugations of such verbs. Such forward-looking statements are based upon information currently available to management and managements perception thereof as of the date of this Form 10-Q. However, such statements are dependent on and, therefore, can be influenced by, a number of external variables over which management has little or no control, including: domestic and international economic conditions; interest rates; the business environment in industries that produce and consume rail freight; competition and consolidation within the transportation industry; fluctuation in prices or availability of key materials, in particular diesel fuel; labor difficulties, including strikes and work stoppages; credit risk of customers and counterparties and their failure to meet their financial obligations; the outcome of claims and litigation; legislative and regulatory developments; political and economic conditions in Mexico and the level of trade between the United States and Mexico; changes in securities and capital markets; disruptions to the Companys technology infrastructure, including its computer systems; natural events such as severe weather, hurricanes and floods; acts of terrorism or risk of terrorist activities; and war or risk of war. For more discussion about each risk factor, see Part I, Item 1A Risk Factors in the Companys Annual Report on Form 10-K for the year ended December 31, 2010, which is on file with the U.S. Securities and Exchange Commission (File No. 333-08322) and any updates contained herein. Readers are strongly encouraged to consider these factors when evaluating forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the timing when, or by which, such performance or results will be achieved. As a result, actual outcomes or results could materially differ from those indicated in forward-looking statements. Forward-looking statements contained in this Form 10-Q will not be updated.
This discussion is intended to clarify and focus on Kansas City Southern de México, S. A. de C.V.s (KCSM or the Company) results of operations, certain changes in its financial position, liquidity, capital structure and business developments for the periods covered by the consolidated financial statements included under Item 1 of this Form 10-Q, and has been abbreviated pursuant to General Instruction H(2)(a) of Form 10-Q. This discussion should be read in conjunction with those consolidated financial statements and the related notes, and is qualified by reference to them.
Critical Accounting Policies and Estimates
The Companys discussion and analysis of its financial position and results of operations is based upon its consolidated financial statements. The preparation of these consolidated financial statements requires estimation and judgment that affect the reported amounts of revenue, expenses, assets, and liabilities. The Company bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the accounting for assets and liabilities that are not readily apparent from other sources. If the estimates differ materially from actual results, the impact on the consolidated financial statements may be material. The Companys critical accounting policies are disclosed in the 2010 Annual Report on Form 10-K.
Second Quarter Analysis
The Company reported quarterly net income of $32.2 million for the three months ended June 30, 2011, compared to quarterly net income of $15.1 million for the same period in 2010. This net income increase reflects a 19% increase in revenues during the three months ended June 30, 2011, as compared to the same period in 2010, driven primarily by the overall increase in carload/unit volumes resulting from the continued improvement in the economy, positive pricing impacts and increased fuel surcharge. In addition, revenues increased due to the effects of fluctuations in the value of the U.S. dollar against the value of the Mexican peso.
Operating expenses increased 13% compared to the same period in 2010, primarily due to higher volumes, increases in fuel prices and compensation and benefits rates and the effect of fluctuations in the value of the U.S. dollar against the value of the Mexican peso.
KCSMs revenues and operating expenses affected by fluctuations in the value of the U.S. dollar against the value of the Mexican peso. Based on the volume of revenue and expense transactions denominated in Mexican pesos, revenue and expense fluctuations generally offset, with insignificant net impacts to operating income.
Operating expenses as a percentage of revenues declined to 67.9% for the three months ended June 30, 2011 as compared to 71.8% for the same period in 2010.
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Results of Operations
The following summarizes KCSMs consolidated income statement components (in millions):
Three Months Ended June 30, |
Change Dollars |
|||||||||||
2011 | 2010 | |||||||||||
Revenues |
$ | 246.7 | $ | 206.8 | $ | 39.9 | ||||||
Operating expenses |
167.6 | 148.5 | 19.1 | |||||||||
Operating income |
79.1 | 58.3 | 20.8 | |||||||||
Equity in net earnings of unconsolidated affiliates |
0.7 | 2.9 | (2.2 | ) | ||||||||
Interest expense |
(19.6 | ) | (25.7 | ) | 6.1 | |||||||
Debt retirement costs |
(10.3 | ) | (16.7 | ) | 6.4 | |||||||
Foreign exchange gain (loss) |
0.4 | (1.5 | ) | 1.9 | ||||||||
Other income, net |
0.3 | 1.0 | (0.7 | ) | ||||||||
Income before income taxes |
50.6 | 18.3 | 32.3 | |||||||||
Income tax expense |
18.4 | 3.2 | 15.2 | |||||||||
Net income |
$ | 32.2 | $ | 15.1 | $ | 17.1 | ||||||
Six Months Ended June 30, |
Change Dollars |
|||||||||||
2011 | 2010 | |||||||||||
Revenues |
$ | 464.9 | $ | 397.6 | $ | 67.3 | ||||||
Operating expenses |
317.6 | 283.0 | 34.6 | |||||||||
Operating income |
147.3 | 114.6 | 32.7 | |||||||||
Equity in net earnings of unconsolidated affiliates |
1.5 | 4.4 | (2.9 | ) | ||||||||
Interest expense |
(39.5 | ) | (53.2 | ) | 13.7 | |||||||
Debt retirement costs |
(10.3 | ) | (31.6 | ) | 21.3 | |||||||
Foreign exchange gain |
0.4 | 1.3 | (0.9 | ) | ||||||||
Other income, net |
2.1 | 1.5 | 0.6 | |||||||||
Income before income taxes |
101.5 | 37.0 | 64.5 | |||||||||
Income tax expense |
35.8 | 10.8 | 25.0 | |||||||||
Net income |
$ | 65.7 | $ | 26.2 | $ | 39.5 | ||||||
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Revenues
The following summarizes revenues (in millions), carload/unit statistics (in thousands) and revenue per carload/unit:
Revenues | Carloads and Units | Revenue per Carload/Unit | ||||||||||||||||||||||||||||||||||
Three Months Ended June 30, |
Three Months Ended June 30, |
Three Months Ended June 30, |
||||||||||||||||||||||||||||||||||
2011 | 2010 | % Change | 2011 | 2010 | % Change | 2011 | 2010 | % Change | ||||||||||||||||||||||||||||
Chemical and petroleum |
$ | 50.5 | $ | 43.7 | 16 | % | 26.4 | 25.5 | 4 | % | $ | 1,913 | $ | 1,714 | 12 | % | ||||||||||||||||||||
Industrial and consumer products |
59.0 | 47.5 | 24 | % | 41.6 | 36.8 | 13 | % | 1,418 | 1,291 | 10 | % | ||||||||||||||||||||||||
Agriculture and minerals |
58.4 | 55.5 | 5 | % | 31.6 | 33.1 | (5 | )% | 1,848 | 1,677 | 10 | % | ||||||||||||||||||||||||
Total general commodities |
167.9 | 146.7 | 14 | % | 99.6 | 95.4 | 4 | % | 1,686 | 1,538 | 10 | % | ||||||||||||||||||||||||
Coal |
5.6 | 3.8 | 47 | % | 5.3 | 4.7 | 13 | % | 1,057 | 809 | 31 | % | ||||||||||||||||||||||||
Intermodal |
36.5 | 29.5 | 24 | % | 97.9 | 81.3 | 20 | % | 373 | 363 | 3 | % | ||||||||||||||||||||||||
Automotive |
32.0 | 23.3 | 37 | % | 18.4 | 16.4 | 12 | % | 1,739 | 1,421 | 22 | % | ||||||||||||||||||||||||
Carload revenues, carloads and units |
242.0 | 203.3 | 19 | % | 221.2 | 197.8 | 12 | % | 1,094 | 1,028 | 6 | % | ||||||||||||||||||||||||
Other revenue |
4.7 | 3.5 | 34 | % | ||||||||||||||||||||||||||||||||
Total revenues (i) |
$ | 246.7 | $ | 206.8 | 19 | % | ||||||||||||||||||||||||||||||
(i) Included in revenues: |
||||||||||||||||||||||||||||||||||||
Fuel surcharge |
$ | 30.2 | $ | 21.0 | ||||||||||||||||||||||||||||||||
Revenues | Carloads and Units | Revenue per Carload/Unit | ||||||||||||||||||||||||||||||||||
Six Months Ended June 30, |
Six Months Ended June 30, |
Six Months Ended June 30, |
||||||||||||||||||||||||||||||||||
2011 | 2010 | % Change | 2011 | 2010 | % Change | 2011 | 2010 | % Change | ||||||||||||||||||||||||||||
Chemical and petroleum |
$ | 94.9 | $ | 85.9 | 10 | % | 50.7 | 50.7 | | % | $ | 1,872 | $ | 1,694 | 11 | % | ||||||||||||||||||||
Industrial and consumer products |
112.1 | 94.0 | 19 | % | 81.9 | 73.5 | 11 | % | 1,369 | 1,279 | 7 | % | ||||||||||||||||||||||||
Agriculture and minerals |
107.4 | 104.1 | 3 | % | 59.5 | 63.8 | (7 | )% | 1,805 | 1,632 | 11 | % | ||||||||||||||||||||||||
Total general commodities |
314.4 | 284.0 | 11 | % | 192.1 | 188.0 | 2 | % | 1,637 | 1,511 | 8 | % | ||||||||||||||||||||||||
Coal |
10.2 | 6.8 | 50 | % | 10.0 | 9.0 | 11 | % | 1,020 | 756 | 35 | % | ||||||||||||||||||||||||
Intermodal |
69.8 | 54.3 | 29 | % | 185.4 | 151.0 | 23 | % | 376 | 360 | 4 | % | ||||||||||||||||||||||||
Automotive |
61.1 | 43.9 | 39 | % | 36.7 | 32.7 | 12 | % | 1,665 | 1,343 | 24 | % | ||||||||||||||||||||||||
Carload revenues, carloads and units |
455.5 | 389.0 | 17 | % | 424.2 | 380.7 | 11 | % | 1,074 | 1,022 | 5 | % | ||||||||||||||||||||||||
Other revenue |
9.4 | 8.6 | 9 | % | ||||||||||||||||||||||||||||||||
Total revenues (i) |
$ | 464.9 | $ | 397.6 | 17 | % | ||||||||||||||||||||||||||||||
(i) Included in revenues: |
||||||||||||||||||||||||||||||||||||
Fuel surcharge |
$ | 55.4 | $ | 39.0 | ||||||||||||||||||||||||||||||||
Freight revenues include both revenue for transportation services and fuel surcharges. For the three and six months ended June 30, 2011, revenues increased $39.9 million and $67.3 million compared to the same periods in 2010, primarily due to positive pricing impacts, an increase in carload/unit volumes and increased fuel surcharge. In addition, revenues increased due to fluctuations in the value of the U.S. dollar against the value of the Mexican peso for revenues denominated in Mexican pesos. Revenue per carload/unit increased by 6% and 5% for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010, reflecting favorable commodity mix in addition to the factors discussed above.
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KCSMs fuel surcharge is a mechanism to adjust revenue based upon changing fuel prices. Fuel surcharges are calculated differently depending on the type of commodity transported. For most commodities, fuel surcharge is calculated using a fuel price from a prior time period that can be up to 60 days earlier. In a period of volatile fuel prices or changing customer business mix, changes in fuel expense and fuel surcharge may differ.
The following discussion provides an analysis of revenues by commodity group:
Revenues by Commodity Group | ||
Chemical and petroleum. Revenues increased $6.8 million and $9.0 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to an increase in pricing. Petroleum revenues increased due to a Mexican government initiated oil export program that began in 2010 that effectively increased length of haul. Additionally, revenues increased in plastics and chemicals used to manufacture glass and paint as a result of continuing growth in the automotive industry. |
||
Industrial and consumer products. Revenues increased $11.5 million and $18.1 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to increases in volume. Metals and scrap business growth was primarily due to growing demand for slab and steel coil driven by continuing growth in the automotive industry and appliance manufacturing. |
| |
Agriculture and minerals. Revenues increased $2.9 million and $3.3 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to increases in price, fuel surcharge and fluctuations in the value of the U.S. dollar against the value of the Mexican peso, partially offset by a decrease in volume. Food products revenue increased due to increased demand for corn syrup, sugar and alternative grains. The increase for the six months ended June 30, 2011, compared to the same period in 2010, was partially offset by a decrease in grain volume and average length of haul in the first quarter of 2011 as traffic patterns shifted due to a decline in cross border traffic into Mexico as availability of crops from a strong Mexico local harvest has been sufficient to meet the local demand. |
|
Coal. Revenues increased $1.8 million and $3.4 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to increases in pricing and length of haul related to new petroleum coke business.
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Intermodal. Revenues increased $7.0 million and $15.5 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to increases in volume and fuel surcharge. Growth was driven by increased cross border business, conversion of truck traffic to rail and South American/trans-Pacific container volume.
Automotive. Revenues increased $8.7 million and $17.2 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to increases in volume, pricing and fluctuations in the value of the U.S. dollar against the value of the Mexican peso. The volume increase was driven by strong year over year growth in North American automobile sales, new cross border vehicle routings and the introduction of new automobile models.
Operating Expenses
Operating expenses, as shown below (in millions) increased $19.1 million and $34.6 million for the three and six months ended June 30, 2011, when compared to the same periods in 2010, primarily due to higher volumes, increases in fuel prices and compensation and benefits rates and the effect of fluctuations in the value of the U.S. dollar against the value of the Mexican peso for operating expenses denominated in Mexican pesos.
Three Months Ended June 30, |
Change | |||||||||||||||
2011 | 2010 | Dollars | Percent | |||||||||||||
Compensation and benefits |
$ | 32.8 | $ | 25.2 | $ | 7.6 | 30 | % | ||||||||
Purchased services |
34.8 | 31.7 | 3.1 | 10 | % | |||||||||||
Fuel |
40.8 | 32.4 | 8.4 | 26 | % | |||||||||||
Equipment costs |
22.0 | 19.9 | 2.1 | 11 | % | |||||||||||
Depreciation and amortization |
20.9 | 24.4 | (3.5 | ) | (14 | )% | ||||||||||
Materials and other |
16.3 | 14.9 | 1.4 | 9 | % | |||||||||||
Total operating expenses |
$ | 167.6 | $ | 148.5 | $ | 19.1 | 13 | % | ||||||||
Six Months Ended June 30, |
Change | |||||||||||||||
2011 | 2010 | Dollars | Percent | |||||||||||||
Compensation and benefits |
$ | 63.5 | $ | 47.7 | $ | 15.8 | 33 | % | ||||||||
Purchased services |
65.9 | 63.7 | 2.2 | 3 | % | |||||||||||
Fuel |
74.6 | 58.8 | 15.8 | 27 | % | |||||||||||
Equipment costs |
42.5 | 38.4 | 4.1 | 11 | % | |||||||||||
Depreciation and amortization |
42.1 | 48.3 | (6.2 | ) | (13 | )% | ||||||||||
Materials and other |
29.0 | 26.1 | 2.9 | 11 | % | |||||||||||
Total operating expenses |
$ | 317.6 | $ | 283.0 | $ | 34.6 | 12 | % | ||||||||
Compensation and benefits. Compensation and benefits increased $7.6 million and $15.8 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to an increase in statutory profit sharing expense and annual salary and benefit rate increases. In addition, compensation and benefits increased due to fluctuations in the value of the U.S. dollar against the value of the Mexican peso.
Purchased services. Purchased services expense increased $3.1 million and $2.2 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to an increase in volume-sensitive costs, primarily locomotive maintenance expense, freight cars repairs, and security and terminal services. These increases were partially offset by lower corporate expenses.
Fuel. Fuel expense increased $8.4 million and $15.8 million for the three and six months ended June 30, 2011, compared to the same periods in 2010. The increase was driven by higher diesel fuel prices as the average fuel price per gallon increased by approximately 14% and 17%, respectively, fluctuations in the value of the U.S. dollar against the value of the Mexican peso and higher volume.
Equipment costs. Equipment costs increased $2.1 million and $4.1 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to the increase in the use of other railroads freight cars due to increased traffic volumes and higher car lease expense. These increases were partially offset by lower locomotive lease expense.
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Depreciation and amortization. Depreciation and amortization expense decreased $3.5 million and $6.2 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to a change in estimate related to certain locomotive depreciation rates based on reassessment of the adequacy of the accumulated depreciation provisions, which was effective October 1, 2010. This decrease was partially offset by higher depreciation expense due to larger asset base. Depreciation expense on the asset base as of year-end 2010 is expected to be lower on a quarterly basis by approximately $3.3 million as a result of the change in locomotive rates.
Materials and other. Materials and other expenses increased $1.4 million and $2.9 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to higher derailment expense and an increase in other employee expenses. These increases were partially offset by the settlement of a legal dispute and an increase in a legal provision recorded during the first half of 2010.
Non-Operating Income and Expenses
Equity in net earnings of unconsolidated affiliates. Equity in earnings from unconsolidated affiliates was $0.7 million and $1.5 million for the three and six months ended June 30, 2011, compared to $2.9 million and $4.4 million for the same periods in 2010. Significant components of this change are as follows:
| KCSMs equity in earnings of Ferrocarril y Terminal del Valle de México, S.A. de C.V. (FTVM) was $0.7 million and $1.5 million for the three and six months ended June 30, 2011, compared to $0.8 million and $1.0 million for the same periods in 2010. The increase during the first half of 2011 is primarily due to an increase in volumes. |
| KCSMs equity in earnings of Mexrail, Inc. (Mexrail) was $2.1 million and $3.4 million for the three and six months ended June 30, 2010. On June 30, 2010, KCSM sold its 49% ownership interest in Mexrail to Kansas City Southern (KCS). |
Interest expense. Interest expense decreased $6.1 million and $13.7 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily due to lower average debt balances and interest rates. During the three and six months ended June 30, 2011, the average debt balances were $932.6 million and $927.5 million, respectively, compared to $1,075.8 million and $1,106.0 million for the same periods in 2010.
Debt retirement cost. Debt retirement costs decreased $6.4 million and $21.3 million for the three and six months ended June 30, 2011, compared to the same periods in 2010. In the second quarter 2011, KCSM purchased and redeemed the remaining $32.4 million and all of the outstanding $165.0 million aggregate principal amount of its 7 5/8% senior notes due 2013 (the 7 5/8% Senior Notes) and 7 3/8% senior notes due 2014 (the 7 3/8% Senior Notes), respectively. KCSM recognized debt retirement costs of $10.3 million related to the call and tender premiums and the write-off of unamortized debt issuance costs. On June 4, 2010, KCSM redeemed $100.0 million and $70.0 million aggregate principal amount of its 9 3/8% senior notes due 2012 (the 9 3/8% Senior Notes) and 12 1/2% senior notes due 2016, respectively. KCSM recorded a total debt retirement cost of $16.7 million in the second quarter 2010 related to the call premium, discount amortization and unamortized debt issuance costs. In the first quarter of 2010, KCSM purchased $296.3 million of its 9 3/8% Senior Notes. KCSM recorded debt retirement costs of $14.9 million related to the tender premium and unamortized debt issuance costs.
Foreign exchange. Fluctuations in the value of the U.S. dollar against the value of the Mexican peso resulted in a foreign exchange gain of $0.4 million for the three and six months ended June 30, 2011, compared to a foreign exchange loss of $1.5 million and a gain of $1.3 million for the same periods in 2010.
Other income, net. Other income, net decreased $0.7 million and increased $0.6 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, primarily attributable to miscellaneous income.
Income tax expense. Income tax expense increased $15.2 million and $25.0 million for the three and six months ended June 30, 2011, compared to the same periods in 2010, due to higher pre-tax income. The effective income tax rate was 36.4% and 35.3% for the three and six months ended June 30, 2011, as compared to 17.5% and 29.2% for the same periods in 2010. The increases in the effective tax rate were due to the recognition of a tax benefit in 2010 from the sale of KCSMs 49% ownership interest in Mexrail, Inc. to KCS, partially offset by foreign exchange rate fluctuations and higher pre-tax income.
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Liquidity and Capital Resources
Overview
KCSMs primary uses of cash are to support operations; maintain and improve its railroad; pay debt service costs; acquire new and maintain existing locomotives, rolling stock and other equipment; and meet other obligations. KCSMs cash flow from operations has historically been sufficient to fund operations, maintenance capital expenditures and debt service. External sources of cash (principally bank debt, public and private debt and leases) have historically been used to refinance existing indebtedness and to fund acquisitions, new investments and equipment additions. As a result of the Companys recent improvement in cash flows, the Company has the ability to fund certain investments and equipment additions using available cash. On June 30, 2011, total available liquidity (the unrestricted cash balance plus revolving credit facility availability) was approximately $200.7 million.
On May 6, 2011, pursuant to an offer to purchase, KCSM commenced a cash tender offer for all of its 7 5/8% Senior Notes and, pursuant to a separate offer to purchase, KCSM commenced a cash tender offer for all of its 7 3/8% Senior Notes. Through June 7, 2011, the Company purchased and redeemed the remaining $32.4 million of the 7 5/8% Senior Notes and all of the outstanding $165.0 million of the 7 3/8% Senior Notes using the proceeds received from the issuance of $200.0 million principal amount of 6 1/8% senior unsecured notes due June 15, 2021 (the 6 1/8% Senior Notes) and cash on hand. KCSM recorded debt retirement costs of $10.3 million in the second quarter of 2011.
On May 20, 2011, KCSM issued $200.0 million principal amount of 6 1/8% Senior Notes, at par, bearing interest semiannually at a fixed annual rate of 6 1/8%. The Company used proceeds from the issuance of the 6 1/8% Senior Notes and cash on hand to purchase and redeem the 7 5/8% Senior Notes and 7 3/8% Senior Notes as discussed above, and pay all fees and expenses incurred in connection with the 6 1/8% Senior Notes offering and the tender offers. The 6 1/8% Senior Notes are redeemable at KCSMs option, in whole or in part, on and after June 15, 2016, at the following redemption prices (expressed as percentages of principal amount) if redeemed during the 12-month period commencing on June 15 of the following years, plus any accrued and unpaid interest to the date of redemption: 2016 103.063%, 2017 102.042%, 2018 101.021% and 2019 100.000%. In addition, the Company may redeem up to 35% of the 6 1/8% Senior Notes at a redemption price equal to 106.125% any time prior to June 15, 2014 from the proceeds of the sale of KCSMs capital stock or the capital stock of KCS and the notes are redeemable, in whole but not in part, at KCSMs option at their principal amount, plus any accrued unpaid interest in the event of certain changes in the Mexican withholding tax rate.
The 6 1/8% Senior Notes are denominated in dollars and are unsecured, unsubordinated obligations, rank pari passu in right of payment with the Companys existing and future unsecured, unsubordinated obligations, and are senior in right of payment to KCSMs future subordinated indebtedness. In addition, the 6 1/8% Senior Notes include certain covenants which are customary for these types of debt instruments and borrowers with similar credit ratings. The 6 1/8% Senior Notes contain certain covenants that, among other things, prohibit or restrict KCSM from taking certain actions, including the ability to incur debt, pay dividends or make other distributions in respect of KCSMs stock, issue guarantees, enter into certain transactions with affiliates, make restricted payments, sell certain assets, create liens, engage in sale-leaseback transactions and engage in mergers, divestitures and consolidations. However, these limitations are subject to a number of important qualifications and exceptions.
The Company believes, based on current expectations, that cash and other liquid assets, operating cash flows, access to debt capital markets and other available financing resources will be sufficient to fund anticipated operating, capital and debt service requirements and other commitments in the foreseeable future.
As of June 30, 2011, KCSM had a debt to capitalization ratio (total debt as a percentage of total debt plus total equity) of 37.1%. KCSMs primary sources of liquidity are cash flows generated from operations, access to debt capital markets and borrowings under its revolving credit facility. Although KCSM has had adequate access to the debt capital markets, as a non-investment grade company, the financial terms under which funding is obtained often contain restrictive covenants. The covenants constrain financial flexibility by restricting or prohibiting certain actions, including the ability to incur additional debt for any purpose other than refinancing existing debt, create or suffer to exist additional liens, make prepayments of particular debt, pay dividends on common stock, make investments, engage in transactions with stockholders and affiliates, sell certain assets, and engage in mergers and consolidations or in sale leaseback transactions. These restrictions, however, are subject to a number of qualifications and exceptions that provide the Company with varying levels of additional borrowing capacity. The Company was in compliance with all of its debt covenants as of June 30, 2011. For a discussion of the agreements representing the indebtedness of KCSM, see Item 8 Financial Statements and Supplemental Data Note 7. Long-Term Debt in the Annual Report on Form 10-K for the year ended December 31, 2010 of KCSM.
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KCSMs operating results and financing alternatives can be unexpectedly impacted by various factors, some of which are outside of its control. For example, if KCSM was to experience a reduction in revenues or a substantial increase in operating costs or other liabilities, its earnings could be significantly reduced, increasing the risk of non-compliance with debt covenants. Additionally, KCSM is subject to economic factors surrounding debt and capital markets and its ability to obtain financing under reasonable terms is subject to market conditions. Volatility in capital markets and the tightening of market liquidity could impact KCSMs access to capital. Further, KCSMs cost of debt can be impacted by independent rating agencies, which assign debt ratings based on certain factors including credit measurements such as interest coverage and leverage ratios, liquidity and competitive position.
Standard & Poors Rating Services (S&P) and Moodys Investors Service (Moodys) each rate the debt and corporate credit of KCSM as non-investment grade and provide their view of KCSMs outlook. On June 30, 2011, Moodys upgraded KCSMs non-investment grade ratings. These ratings and outlooks change from time to time and can be found on the websites of S&P and Moodys.
Cash Flow Information
Summary cash flow data follows (in millions):
Six Months Ended June 30, |
||||||||
2011 | 2010 | |||||||
Cash flows provided by (used for): |
||||||||
Operating activities |
$ | 140.0 | $ | 84.2 | ||||
Investing activities |
(57.4 | ) | 3.8 | |||||
Financing activities |
(18.9 | ) | (111.3 | ) | ||||
Net increase (decrease) in cash and cash equivalents |
63.7 | (23.3 | ) | |||||
Cash and cash equivalents beginning of year |
37.0 | 92.6 | ||||||
Cash and cash equivalents end of period |
$ | 100.7 | $ | 69.3 | ||||
Cash flows from operating activities increased $55.8 million for the six month period ended June 30, 2011, compared to the same period in 2010, primarily as a result of increased net income from positive pricing impacts, higher carload/unit volumes due to the continued improvement in the economy and insurance proceeds related to hurricane damage. These increases were partially offset by changes in working capital items resulting mainly from the timing of certain payments and receipts. Net cash used for investing activities increased $61.2 million, primarily due to an increase in capital expenditures, partially offset by insurance proceeds related to hurricane damage and the acquisition of an intermodal facility in Mexico in the first quarter of 2010. In addition in the first and second quarter of 2010, the Company received net proceeds from repayment of a loan to a related company and proceeds from the sale of KCSMs 49% ownership interest in Mexrail, respectively. Insurance proceeds related to hurricane damage recognized in investing cash flows are related to proceeds from property damage. All other insurance proceeds related to hurricane damage are recognized in operating cash flows. Additional information regarding capital expenditures is provided below. Net cash used for financing activities decreased $92.4 million primarily due to debt reduction and refinancing activities and associated debt cost payments incurred during the first half of 2010, partially offset by a capital contribution from KCSM shareholders of $95.0 million received in the second quarter of 2010.
Capital Expenditures
KCSM has funded, and expects to continue to fund capital expenditures with funds from operating cash flows, equipment leases, and debt and equity financing.
The following table summarizes capital expenditures by type (in millions):
Six Months Ended June 30, |
||||||||
2011 | 2010 | |||||||
Roadway capital program |
$ | 41.5 | $ | 33.0 | ||||
Equipment |
1.9 | 3.1 | ||||||
Information technology |
1.9 | 3.3 | ||||||
Other |
16.0 | 2.7 | ||||||
Total capital expenditures (accrual basis) |
61.3 | 42.1 | ||||||
Change in capital accruals |
7.5 | 3.3 | ||||||
Total cash capital expenditures |
$ | 68.8 | $ | 45.4 | ||||
The Companys 2011 capital expenditures are currently expected to be approximately $175 million.
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Other Matters
KCSM union employees are covered by one labor agreement, which was signed on June 23, 1997, between KCSM and the Sindicato de Trabajadores Ferrocarrileros de la República Mexicana (Mexican Railroad Union), for a term of 50 years, for the purpose of regulating the relationship between the parties. Approximately 80% of KCSM employees are covered by this labor agreement. The compensation terms under this labor agreement are subject to renegotiation on an annual basis and all other terms are subject to negotiation every two years. In June of 2011, the negotiation of compensation terms and all other benefits was started with the Mexican Railroad Union. The anticipated resolution of this negotiation is not expected to have a material impact to the consolidated financial statements. The union labor negotiation with the Mexican Railroad Union has not historically resulted in any strike, boycott, or other disruption in KCSMs business operations.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Omitted pursuant to General Instruction H(2)(c) of Form 10-Q.
Item 4. | Controls and Procedures |
(a) Disclosure Controls and Procedures.
As of the end of the period for which this Quarterly Report on Form 10-Q is filed, the Companys President and Executive Representative and Chief Financial Officer have each reviewed and evaluated the effectiveness of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act)). Based on that evaluation, the President and Executive Representative and Chief Financial Officer have each concluded that the Companys current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Companys management, including the President and Executive Representative and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
(b) Changes in Internal Control over Financial Reporting.
There have not been any changes in the Companys internal controls over financial reporting that occurred during the second quarter of 2011 that have materially affected, or are reasonably likely to materially affect, the Companys internal controls over financial reporting.
Item 1. | Legal Proceedings |
For information related to the Companys settlements and other legal proceedings, see Note 8 Commitments and Contingencies, under Part I, Item 1, of this quarterly report on Form 10-Q.
Item 1A. | Risk Factors |
There were no material changes during the quarter in the Risk Factors disclosed in Item 1A, Risk Factors, in KCSMs Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Omitted pursuant to General Instruction H(2)(b) of Form 10-Q.
Item 3. | Defaults Upon Senior Securities |
Omitted pursuant to General Instruction H(2)(b) of Form 10-Q.
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Item 4. | (Removed and Reserved) |
Item 5. | Other Information |
None.
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Item 6. | Exhibits |
Exhibit No. |
Description of Exhibits Filed with this Report | |
31.1 | Principal Executive Officers Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 is attached to this Form 10-Q as Exhibit 31.1. | |
31.2 | Principal Financial Officers Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 is attached to this Form 10-Q as Exhibit 31.2. | |
32.1 | Principal Executive Officers Certification furnished Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is attached to this Form 10-Q as Exhibit 32.1. | |
32.2 | Principal Financial Officers Certification furnished Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is attached to this Form 10-Q as Exhibit 32.2. | |
101 | The following financial information from Kansas City Southern de México, S.A. de C.V.s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, formatted in XBRL (Extensible Business Reporting Language) includes: (i) Consolidated Statements of Income for the three and six months ended June 30, 2011 and 2010, (ii) Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010, (iii) Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010, and (iv) the Notes to Consolidated Financial Statements, tagged as blocks of text. |
Exhibit No. |
Description of Exhibits Incorporated by Reference | |
4.1 | Form of Rule 144A Restricted Global Note representing the 6.625% Senior Notes due 2020 (previously filed as Exhibit 4.5 of the Companys Registration Statement on Form S-4 relating to the 6.625% Senior Notes due 2020 filed on June 16, 2011 (File No. 333-174927) is incorporated herein by reference as Exhibit 4.1) | |
4.2 | Form of Regulation S Restricted Global Note representing the 6.625% Senior Notes due 2020 (previously filed as Exhibit 4.6 of the Companys Registration Statement on Form S-4 relating to the 6.625% Senior Notes due 2020 filed on June 16, 2011 (File No. 333-174927) is incorporated herein by reference as Exhibit 4.2) | |
4.3 | Special Global Note representing the 6.625% Senior Notes due 2020 (previously filed as Exhibit 4.7 of the Companys Registration Statement on Form S-4 relating to the 6.625% Senior Notes due 2020 filed on June 16, 2011 (File No. 333-174927) is incorporated herein by reference as Exhibit 4.3) | |
4.4 | Indenture, dated May 20, 2011, between KCSM and U.S. Bank National Association, as trustee and paying agent, covering up to $200,000,000 of KCSMs 6.125% Senior Notes due 2021, (previously filed as Exhibit 4.1 of the Companys Current Report on Form 8-K filed on May 25, 2011 (File No. 333-08322) is incorporated herein by reference as Exhibit 4.4) | |
4.5 | Registration Rights Agreement, dated May 20, 2011, among Kansas City Southern de México, S.A. de C.V., and Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities LLC, Scotia Capital (USA) Inc., Banco Bilbao Vizcaya Argentaria, S.A. and Morgan Stanley & Co. Incorporated. (previously filed as Exhibit 4.2 of the Companys Current Report on Form 8-K filed on May 25, 2011 (File No. 333-08322) is incorporated herein by reference as Exhibit 4.5) | |
4.6 | Form of Rule 144A Restricted Global Note representing the 6.125% Senior Notes due 2021 (previously filed as Exhibit 4.10 of the Companys Registration Statement on Form S-4 relating to the 6.125% Senior Notes due 2021 filed on June 16, 2011 (File No. 333-174931) is incorporated herein by reference as Exhibit 4.6) | |
4.7 | Form of Regulation S Restricted Global Note representing the 6.125% Senior Notes due 2021 (previously filed as Exhibit 4.11 of the Companys Registration Statement on Form S-4 relating to the 6.125% Senior Notes due 2021 filed on June 16, 2011 (File No. 333-174931) is incorporated herein by reference as Exhibit 4.7) | |
4.8 | Special Global Note representing the 6.125% Senior Notes due 2021 (previously filed as Exhibit 4.12 of the Companys Registration Statement on Form S-4 relating to the 6.125% Senior Notes due 2021 filed on June 16, 2011( File No. 333-174931) is incorporated herein by reference as Exhibit 4.8) |
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Exhibit No. |
Description of Exhibits Incorporated by Reference | |
10.1 | Placement Agreement, dated May 6, 2011, among Kansas City Southern de México, S.A. de C.V., Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities LLC, Scotia Capital (USA) Inc., Banco Bilbao Vizcaya Argenteria, S.A. and Morgan Stanley & Co. Incorporated (previously filed as Exhibit 10.1 of the Companys Current Report on Form 8-K filed on May 12, 2011 (File No. 333-08322) is incorporated herein by reference as Exhibit 10.1) |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized and in the capacities indicated on July 21, 2011.
Kansas City Southern de México, S.A. de C.V. |
/s/ MICHAEL W. UPCHURCH |
Michael W. Upchurch |
Chief Financial Officer |
(Principal Financial Officer) |
/s/ MARY K. STADLER |
Mary K. Stadler |
Chief Accounting Officer |
(Principal Accounting Officer) |
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