10-Q 1 kcs10q03312012.htm FORM 10-Q KCS 10Q 03.31.2012
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2012
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to        
Commission File Number 1-4717
KANSAS CITY SOUTHERN
(Exact name of registrant as specified in its charter)
Delaware
 
 
44-0663509
(State or other jurisdiction of
incorporation or organization)
 
 
(I.R.S. Employer
Identification No.)
 
427 West 12th Street,
Kansas City, Missouri
 
 
 
64105
(Address of principal executive offices)
 
 
(Zip Code)
816.983.1303
(Registrant’s telephone number, including area code)
No Change
(Former name, former address and former fiscal year, if changed since last report.)
____________________________________________________ 
Indicate by check mark whether the registrant (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 registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    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  ý    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  ý    Accelerated filer  ¨    Non-accelerated filer  ¨    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  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
April 16, 2012
Common Stock, $0.01 per share par value
 
109,986,851 Shares
 






Kansas City Southern
Form 10-Q
March 31, 2012
Index
 
 
Page
PART I — FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II — OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 


2


Kansas City Southern
Form 10-Q
March 31, 2012
PART I — FINANCIAL INFORMATION

Item 1.
Financial Statements
Introductory Comments
The unaudited Consolidated Financial Statements included herein have been prepared by Kansas City Southern pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). As used herein, “KCS” or the “Company” may refer to Kansas City Southern or, as the context requires, to one or more subsidiaries of Kansas City Southern. 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 Management’s 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 Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Results for the three months ended March 31, 2012 are not necessarily indicative of the results expected for the full year ending December 31, 2012.


3


Kansas City Southern
Consolidated Statements of Income
 
 
Three Months Ended
 
March 31,
 
2012
 
2011
 
(In millions, except share and per share amounts)
(Unaudited)
Revenues
$
547.5

 
$
488.6

Operating expenses:
 
 
 
Compensation and benefits
109.3

 
100.4

Purchased services
54.4

 
48.1

Fuel
88.3

 
79.5

Equipment costs
38.3

 
41.4

Depreciation and amortization
48.4

 
45.7

Materials and other
51.0

 
45.7

Total operating expenses
389.7

 
360.8

Operating income
157.8

 
127.8

Equity in net earnings of unconsolidated affiliates
5.8

 
3.6

Interest expense
(27.2
)
 
(33.1
)
Debt retirement costs
(12.9
)
 

Foreign exchange gain (loss)
3.9

 
(0.1
)
Other income, net
0.1

 
1.7

Income before income taxes
127.5

 
99.9

Income tax expense
52.2

 
35.8

Net income
75.3

 
64.1

Less: Net income attributable to noncontrolling interest
0.3

 
0.1

Net income attributable to Kansas City Southern and subsidiaries
75.0

 
64.0

Preferred stock dividends
0.1

 
1.4

Net income available to common stockholders
$
74.9

 
$
62.6

 
 
 
 
Earnings per share:
 
 
 
Basic earnings per share
$
0.68

 
$
0.60

Diluted earnings per share
$
0.68

 
$
0.58

 
 
 
 
Average shares outstanding (in thousands):
 
 
 
Basic
109,622

 
104,269

Potentially dilutive common shares
374

 
5,482

Diluted
109,996

 
109,751

 
 
 
 
Cash dividends declared per common share
$
0.195

 
$

See accompanying notes to consolidated financial statements.


4


Kansas City Southern
Consolidated Statements of Comprehensive Income

 
 
Three Months Ended
 
 
March 31,
 
 
2012
 
2011
 
 
(In millions)
(Unaudited)
Net income
 
$
75.3

 
$
64.1

Other comprehensive income:
 
 
 
 
Unrealized loss on cash flow hedges arising during the period, net of tax of $(0.2) million
 
(0.3
)
 

Reclassification adjustment from cash flow hedges included in net income, net of tax of $0.2 million
 

 
0.2

Foreign currency translation adjustments, net of tax of $0.3 million and $0.1 million
 
0.6

 
0.3

Other comprehensive income
 
0.3

 
0.5

Comprehensive income
 
75.6

 
64.6

Less: Comprehensive income attributable to noncontrolling interest
 
0.3

 
0.1

Comprehensive income attributable to Kansas City Southern and subsidiaries
 
$
75.3

 
$
64.5

See accompanying notes to consolidated financial statements.


5


Kansas City Southern
Consolidated Balance Sheets
 
 
March 31,
2012
 
December 31,
2011
 
(In millions, except share amounts)
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
101.8

 
$
72.4

Accounts receivable, net
186.6

 
166.0

Materials and supplies
120.9

 
109.6

Deferred income taxes
205.1

 
225.0

Other current assets
69.5

 
69.5

Total current assets
683.9

 
642.5

Investments
57.5

 
50.4

Restricted funds
16.7

 
21.7

Property and equipment (including concession assets), net
5,388.0

 
5,349.5

Other assets
107.9

 
108.9

Total assets
$
6,254.0

 
$
6,173.0

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Debt due within one year
$
46.4

 
$
36.3

Accounts payable and accrued liabilities
400.1

 
401.1

Total current liabilities
446.5

 
437.4

Long-term debt
1,585.5

 
1,602.8

Deferred income taxes
863.4

 
861.4

Other noncurrent liabilities and deferred credits
228.4

 
212.7

Total liabilities
3,123.8

 
3,114.3

Commitments and contingencies

 

Stockholders’ equity:
 
 
 
$25 par, 4% noncumulative, preferred stock, 840,000 shares authorized, 649,736 shares issued, 242,170 shares outstanding
6.1

 
6.1

$.01 par, common stock, 400,000,000 shares authorized; 123,352,185 shares issued; 109,986,851 and 109,910,857 shares outstanding at March 31, 2012 and December 31, 2011, respectively
1.1

 
1.1

Paid-in capital
901.6

 
884.2

Retained earnings
1,928.8

 
1,875.3

Accumulated other comprehensive loss
(1.9
)
 
(2.2
)
Total stockholders’ equity
2,835.7

 
2,764.5

Noncontrolling interest
294.5

 
294.2

Total equity
3,130.2

 
3,058.7

Total liabilities and equity
$
6,254.0

 
$
6,173.0

See accompanying notes to consolidated financial statements.


6


Kansas City Southern
Consolidated Statements of Cash Flows
 
 
Three Months Ended
 
March 31,
 
2012
 
2011
 
(In millions)
(Unaudited)
Operating activities:
 
 
 
Net income
$
75.3

 
$
64.1

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
48.4

 
45.7

Deferred income taxes
34.9

 
35.0

Equity in net earnings of unconsolidated affiliates
(5.8
)
 
(3.6
)
Share-based compensation
3.2

 
4.0

Excess tax benefit from share-based compensation
(13.2
)
 

Deferred compensation
7.3

 
5.0

Cash payments related to hurricane damage

 
(1.0
)
Insurance proceeds related to hurricane damage

 
10.5

Gain on sale of assets

 
(0.2
)
Debt retirement costs
12.9

 

Changes in working capital items:
 
 
 
Accounts receivable
(21.1
)
 
(20.6
)
Materials and supplies
(11.5
)
 
(5.8
)
Other current assets
4.8

 
6.4

Accounts payable and accrued liabilities
0.2

 
(12.6
)
Other, net
4.1

 
(9.8
)
Net cash provided by operating activities
139.5

 
117.1

 
 
 
 
Investing activities:
 
 
 
Capital expenditures
(99.4
)
 
(95.2
)
Property investments in MSLLC
(6.7
)
 
(6.7
)
Insurance proceeds related to hurricane damage

 
4.5

Proceeds from disposal of property
2.7

 
1.5

Other, net
2.3

 
3.1

Net cash used for investing activities
(101.1
)
 
(92.8
)
 
 
 
 
Financing activities:
 
 
 
Proceeds from issuance of long-term debt
229.6

 

Repayment of long-term debt
(237.0
)
 
(5.8
)
Debt costs
(15.0
)
 

Proceeds from employee stock plans
0.3

 
0.4

Excess tax benefit from share-based compensation
13.2

 

Preferred stock dividends paid
(0.1
)
 
(2.8
)
Net cash used for financing activities
(9.0
)
 
(8.2
)
Cash and cash equivalents:
 
 
 
Net increase during each period
29.4

 
16.1

At beginning of year
72.4

 
85.4

At end of period
$
101.8

 
$
101.5

See accompanying notes to consolidated financial statements.

7


Kansas City Southern
Notes to Consolidated Financial Statements

1. Accounting Policies, Interim Financial Statements and Basis of Presentation
In the opinion of the management of KCS, 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 Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results to be expected for the full year ending December 31, 2012. Certain prior year amounts have been reclassified to conform to the current year presentation.
Effective January 1, 2012, the Company adopted, on a retrospective basis, the new accounting guidance on the presentation of comprehensive income. As a result of the adoption, the Company reports net income and other comprehensive income in two separate consecutive statements.

2. Earnings Per Share Data
Basic earnings per common share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share adjusts basic earnings per common share for the effects of potentially dilutive common shares, if the effect is not anti-dilutive. Potentially dilutive common shares include the dilutive effects of shares issuable upon the conversion of preferred stock to common stock and shares issuable under the Stock Option and Performance Award Plan. During the first quarter of 2011, the Company converted all of the remaining outstanding Cumulative Convertible Perpetual Preferred Stock, Series D, into 6,999,887 shares of common stock.
The following table reconciles the basic earnings per share computation to the diluted earnings per share computation (in millions, except share and per share amounts): 
 
 
 
Three Months Ended
 
 
 
March 31,
 
 
 
 
 
2012
 
2011
Net income available to common stockholders for purposes of computing basic earnings per share
 
 
 
 
$
74.9

 
$
62.6

Effect of dividends on conversion of convertible preferred stock
 
 
 
 

 
1.3

Net income available to common stockholders for purposes of computing diluted earnings per share
 
 
 
 
$
74.9

 
$
63.9

Weighted-average number of shares outstanding (in thousands):
 
 
 
 
 
 
 
Basic shares
 
 
 
 
109,622

 
104,269

Effect of dilution
 
 
 
 
374

 
5,482

Diluted shares
 
 
 
 
109,996

 
109,751

Earnings per share:
 
 
 
 
 
 
 
Basic earnings per share
 
 
 
 
$
0.68

 
$
0.60

Diluted earnings per share
 
 
 
 
$
0.68

 
$
0.58

 
 
 
 
 
 
 
 
Potentially dilutive shares excluded from the calculation (in thousands):
 
 
 
 
 
 
 
Stock options excluded as their inclusion would be anti-dilutive
 
 
 
 
93

 
101




8


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

3. Property and Equipment (including Concession Assets)
Property and equipment, including concession assets, and related accumulated depreciation and amortization are summarized below (in millions): 
 
March 31,
2012
 
December 31,
2011
Land
$
207.6

 
$
207.4

Concession land rights
141.2

 
141.2

Road property
5,398.2

 
5,326.0

Equipment
834.0

 
833.7

Technology and other
122.4

 
123.3

Construction in progress
156.9

 
153.1

Total property
6,860.3

 
6,784.7

Accumulated depreciation and amortization
1,472.3

 
1,435.2

Property and equipment (including concession assets), net
$
5,388.0

 
$
5,349.5

Concession assets, net of accumulated amortization of $358.3 million and $347.1 million, totaled $1,855.8 million and $1,855.1 million at March 31, 2012 and December 31, 2011, respectively.

4. Fair Value Measurements
Assets and liabilities recognized at fair value are required to be classified into a three-level hierarchy. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value in its entirety requires judgment and considers factors specific to the asset or liability.
The Company’s derivative financial instruments are measured at fair value on a recurring basis and consisted of interest rate swap liabilities of $0.5 million as of March 31, 2012, which are classified as Level 2. The Company determines the fair values of its derivative financial instrument positions based upon pricing models using inputs observed from actively quoted markets. Pricing models take into consideration the contract terms as well as other inputs, including forward interest rate curves.
The Company’s 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 Company’s 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 Company’s debt was $1,736.2 million and $1,741.3 million at March 31, 2012 and December 31, 2011, respectively. The carrying value was $1,631.9 million and $1,639.1 million at March 31, 2012 and December 31, 2011, respectively. If the Company’s debt was measured at fair value, it would have been classified as Level 1 and Level 2 in the fair value hierarchy.

5. Derivative Instruments
In general, the Company enters into derivative transactions in limited situations based on management’s assessment of current market conditions and perceived risks. However, management intends to respond to evolving business and market conditions and in doing so, may enter into such transactions more frequently as deemed appropriate.
Credit Risk. As a result of the use of derivative instruments, the Company is exposed to counterparty credit risk. The Company manages this risk by limiting its counterparties to large financial institutions which meet the Company’s credit rating standards and have established banking relationship with the Company. As of March 31, 2012, the Company did not expect any losses as a result of default of its counterparties.

9


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

Interest Rate Swaps. On March 5, 2012, the Company entered into four amortizing interest rate swaps with an aggregate notional amount of $320.0 million, which have been designated as cash flow hedges. The interest rate swaps effectively convert interest payments on a portion of outstanding term loans of The Kansas City Southern Railway Company (“KCSR”), a wholly-owned subsidiary of KCS, from variable rates to fixed rates. The swaps are highly effective and as a result there will be minimal earnings impact associated with ineffectiveness of these hedges. As of March 31, 2012, the hedging instruments have an aggregate notional amount of $316.8 million at a fixed rate of 0.4942%. Settlements are indexed to the one-month London Interbank Offered Rate (“LIBOR”) and will occur monthly beginning March 30, 2012 through March 31, 2014.
The following table presents the fair value of derivative instruments included in the consolidated balance sheet (in millions):
 
Liability Derivatives
 
Balance Sheet Location
 
March 31,
2012
 
December 31, 2011
Derivatives designated as hedging instruments:
 
 
 
 
 
Interest rate swaps
Other noncurrent liabilities & deferred credits
 
$
0.5

 
$

Total derivatives designated as hedging instruments

 
0.5

 

Total liability derivatives
 
 
$
0.5

 
$

The following table presents the amounts affecting the consolidated statements of income for the three months ended March 31 (in millions):
Derivatives in Cash
Flow Hedging
Relationships
Amount of
Gain/(Loss)
Recognized in OCI
on Derivative
(Effective Portion)
 
Location of Gain/(Loss) Reclassified from Accumulated 
OCI into Income 
(Effective Portion)
 
Amount of Gain/(Loss) Reclassified 
from Accumulated 
OCI into Income (Effective Portion)
 
Location of Gain/
(Loss) Recognized in
Income on Derivative
(Ineffective Portion
and Amount Excluded
from Effectiveness
Testing)
 
Amount of Gain/
(Loss) Recognized in
Income on  Derivative
(Ineffective Portion
and Amount Excluded
from Effectiveness
Testing)
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
2012
 
2011
Interest rate swaps
$
(0.5
)
 
$

 
Interest expense
 
$

 
$
(0.4
)
 
Interest expense
 
$

 
$

Total
$
(0.5
)
 
$

 
 
 
$

 
$
(0.4
)
 
 
 
$

 
$


6. Long-Term Debt
KCSR 8.0% Senior Notes. On January 25, 2012, pursuant to an offer to purchase and related solicitation of consents, KCSR commenced a cash tender offer for all of its $275.0 million outstanding aggregate principal amount of 8.0% Senior Notes due June 1, 2015 (the “8.0% Senior Notes”) and a consent solicitation to amend the related indenture (the “Proposed Amendments”) to eliminate substantially all of the restrictive covenants contained therein. In conjunction with receiving the requisite consents, on February 13, 2012, the Company entered into the First Supplemental Indenture to effect the Proposed Amendments, which became operative on February 24, 2012.
On February 24, 2012, KCSR purchased $174.7 million principal amount of the tendered 8.0% Senior Notes in accordance with the terms and conditions of the tender offer set forth in the offer to purchase using the proceeds received under the Amendment No. 1 and Additional Term Advance Agreement (“Amendment No. 1”) to the existing KCSR Amended and Restated Credit Agreement dated as of July 12, 2011 (the “Credit Agreement”) and available cash. KCSR intends to redeem the remaining $100.3 million principal amount of the 8.0% Senior Notes in June 2012 as permitted under the terms of the indenture for the notes.
KCSR Credit Agreement and Additional Term A Advances. On February 24, 2012, KCS, KCSR and certain other subsidiaries of the Company that guaranty KCSR’s Credit Agreement entered into Amendment No. 1 to the Credit Agreement, which provides for additional Term A advances to KCSR in an aggregate principal amount of $275.0 million (the “Additional Term A Advances”) on substantially the same terms as those applicable to the existing Term A facility under the Credit Agreement. KCSR borrowed $175.0 million of the Additional Term A Advances on February 24, 2012, the effective date of Amendment No. 1, and may borrow the remaining $100.0 million of Additional Term A Advances in up to five separate tranches on or prior to June 30, 2012.
The proceeds of the initial $175.0 million borrowing under the Additional Term A Advances and available cash were used to purchase all of KCSR’s 8.0% Senior Notes that were accepted in accordance with the cash tender offer and pay associated fees and

10


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

expenses. The remaining Additional Term A Advances may be used to finance any redemption of the 8.0% Senior Notes which remain outstanding following the cash tender offer, pay any transaction costs related to the redemption of any 8.0% Senior Notes or for general corporate purposes.
The outstanding principal balance of the Additional Term A Advances bear interest at floating rates. At KCSR’s option, the loans will bear interest at either the (i) greater of the (a) Bank of Nova Scotia’s base rate, (b) federal funds rate plus 0.50% or (c) one-month LIBOR plus 1.00% (the “Base Rate”) plus a margin of 0.25% or (ii) LIBOR plus a margin of 1.25%.
Except as amended and supplemented by Amendment No. 1, all terms of the Credit Agreement remain in full force and effect.
KCSR RRIF Loan Agreement. On February 21, 2012, KCSR, as borrower, entered into a financing agreement with the United States of America represented by the Secretary of Transportation acting through the Administrator of the Federal Railroad Administration.
The financing agreement provides KCSR with a twenty-five year $54.6 million loan under the Railroad Rehabilitation and Improvement Financing Program (the “KCSR RRIF Loan”). The proceeds of the KCSR RRIF Loan were used to reimburse KCSR for 80% of the purchase price of thirty new locomotives (the “Locomotives”) acquired by KCSR in the fourth quarter of 2011. The outstanding principal balance bears interest at 2.96% per annum. KCSR is required to make quarterly principal and interest payments on the KCSR RRIF Loan commencing March 15, 2012, except for the first payment that was comprised solely of interest accrued from the date the funds were advanced to KCSR, which was February 24, 2012.
The obligations under the financing agreement are secured by a first priority security interest in the Locomotives and certain related rights. In addition, the Company has agreed to guarantee repayment of the amounts due under the financing agreement and certain related agreements.
The financing agreement contains representations, warranties, covenants and events of default that are similar to those contained in other KCSR debt agreements. The occurrence of an event of default could result in the acceleration of the repayment of any outstanding principal balance of the KCSR RRIF Loan.
KCSR Revolving Credit Facility. During the first quarter of 2012, the Company repaid the outstanding balance of $50.0 million on KCSR’s revolving credit facility.



11


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

7. Equity
The following table summarizes the changes in equity (in millions):
 
Three Months Ended March 31, 2012
 
Three Months Ended March 31, 2011
 
Kansas City
Southern
Stockholders’
Equity
 
Noncontrolling
Interest
 
Total
Equity
 
Kansas City
Southern
Stockholders’
Equity
 
Noncontrolling
Interest
 
Total
Equity
Beginning balance
$
2,764.5

 
$
294.2

 
$
3,058.7

 
$
2,431.1

 
$
282.6

 
$
2,713.7

Net income
75.0

 
0.3

 
75.3

 
64.0

 
0.1

 
64.1

Other comprehensive income
0.3

 

 
0.3

 
0.5

 

 
0.5

Conversion of series D cumulative convertible preferred stock

 

 

 
(0.2
)
 

 
(0.2
)
Common stock issued for conversion of series D cumulative convertible preferred stock

 

 

 
0.2

 

 
0.2

Dividends on common stock
(21.4
)
 

 
(21.4
)
 

 

 

Dividends on $25 par preferred stock
(0.1
)
 

 
(0.1
)
 
(0.1
)
 

 
(0.1
)
Dividends on series D cumulative preferred stock

 

 

 
(2.7
)
 

 
(2.7
)
Options exercised and stock subscribed, net of shares withheld for employee taxes
1.0

 

 
1.0

 
(0.9
)
 

 
(0.9
)
Tax benefit from share-based compensation
13.2

 

 
13.2

 

 

 

Share-based compensation
3.2

 

 
3.2

 
4.0

 

 
4.0

Ending balance
$
2,835.7

 
$
294.5

 
$
3,130.2

 
$
2,495.9

 
$
282.7

 
$
2,778.6

Common Stock Dividend
On March 30, 2012, the Company’s Board of Directors declared a cash dividend of $0.195 per share payable on April 27, 2012, to common stockholders of record as of April 16, 2012. The aggregate amount of the dividend declared was approximately $21.4 million.

8. Commitments and Contingencies
Concession Duty. Under Kansas City Southern de México, S.A. de C.V.’s (“KCSM”) 50-year railroad concession from the Mexican government (the “Concession”), the Mexican government has the right to receive a payment from KCSM equivalent to 0.5% of KCSM’s gross revenue during the first 15 years of the Concession period and, beginning on June 24, 2012, 1.25% of KCSM’s gross revenue for the remaining years of the Concession period. For the three months ended March 31, 2012, the concession duty expense, which is recorded within operating expenses, was $1.3 million, compared to $1.1 million for the same period in 2011.
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. Included in these proceedings are various tort claims brought by current and former employees for job-related injuries and by third parties for injuries related to railroad operations. KCS 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 Company’s consolidated financial statements.
Environmental Liabilities. The Company’s U.S. operations are subject to extensive federal, state and local environmental laws and regulations. The major U.S. environmental laws to which the Company is subject include, among others, the Federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA,” also known as the Superfund law), the Toxic Substances Control Act, the Federal Water Pollution Control Act, and the Hazardous Materials Transportation Act. CERCLA can impose joint and several liabilities for cleanup and investigation costs, without regard to fault or legality of the original conduct, on current and predecessor owners and operators of a site, as well as those who generate, or arrange for the disposal of, hazardous substances. The Company does not believe that compliance with the requirements imposed by the environmental legislation will

12


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

impair its competitive capability or result in any material additional capital expenditures, operating or maintenance costs. The Company is, however, subject to environmental remediation costs as described below.
The Company’s Mexico 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.
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 to and handle environmental issues that might occur in the transport of such materials.
The Company performs ongoing reviews and evaluations of the various environmental programs and issues within the Company’s operations, and, as necessary, takes actions intended to limit the Company’s 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 Company’s consolidated financial statements.
Personal Injury. The Company’s personal injury liability is based on semi-annual actuarial studies performed on an undiscounted basis by an independent third party actuarial firm and reviewed by management. This liability is based on personal injury claims filed and an estimate of claims incurred but not yet reported. Actual results may vary from estimates due to the number, type and severity of the injury, costs of medical treatments and uncertainties in litigation. Adjustments to the liability are reflected within operating expenses in the period in which changes to estimates are known. Personal injury claims in excess of self-insurance levels are insured up to certain coverage amounts, depending on the type of claim and year of occurrence. The personal injury liability as of March 31, 2012 is based on an updated actuarial study of personal injury claims through November 30, 2011 and review of the last four months’ experience.
The personal injury liability activity was as follows (in millions): 
 
Three Months Ended March 31,
 
2012
 
2011
Balance at beginning of year
$
40.1

 
$
62.2

Accruals
2.5

 
2.7

Change in estimate

 
(1.5
)
Payments
(0.8
)
 
(8.0
)
Balance at end of period
$
41.8

 
$
55.4

Certain Disputes with Ferromex. KCSM and Ferrocarril Mexicano, S.A. de C.V. (“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 Mexican Secretaría de Comunicaciones y Transportes (“Secretary of Communications and Transportation” or “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 discussions 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 resolved, that these disputes will have a material effect on its consolidated financial statements.
SCT Sanction Proceedings. 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

13


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

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 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 February 27, 2012, the SCT dismissed this proceeding on the basis that the extent of the Ferromex trackage rights had not been determined prior to the time KCSM refused Ferromex access.
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 resolved, that these disputes will have a material effect on its consolidated financial statements.
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 creditworthiness or further weakening in economic trends could have a significant impact on the collectability of the Company’s receivables and operating results. If the financial condition of the Company’s 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 March 31, 2012.
Income Tax. Tax returns filed in the U.S. from 2008 through the current year and in Mexico for 2005 and from 2007 through the current year remain open to examination by the taxing authorities. The 2006 Mexico tax return is closed to examination except for certain depreciation adjustments included on an amended return. In March 2012, the 2004 Mexico audit was completed without adjustment. The 2005 Mexico tax return is currently under examination. The Company believes that an adequate provision has been made for any adjustment (tax and interest) that may be due for all open years. However, an unexpected adverse resolution could have a material effect on the consolidated financial statements in a particular quarter or fiscal year.
Panama Canal Railway Company (“PCRC”) Guarantees and Indemnities. The Company has issued four irrevocable standby letters of credit totaling approximately $1.2 million to fulfill the Company’s fifty percent guarantee of additional equipment loans. The Company agreed to fund fifty percent of any debt service reserve or liquidity reserve shortfall by PCRC, reserves which were established by PCRC in connection with the issuance of the 7.0% Senior Secured Notes due November 1, 2026 (the “Notes”). At March 31, 2012, the Company had issued and outstanding $3.8 million under a standby letter of credit. Additionally, KCS has pledged its shares of PCRC as security for the Notes.

9. Geographic Information
The Company strategically manages its rail operations as one reportable business segment over a single coordinated rail network that extends from the midwest and southeast portions of the United States south into Mexico and connects with other Class I railroads. Financial information reported at this level, such as revenues, operating income and cash flows from operations, is used by corporate management, including the Company’s chief operating decision-maker, in evaluating overall financial and operational performance, market strategies, as well as the decisions to allocate capital resources.
The Company’s strategic initiatives, which drive its operational direction, are developed and managed at the Company’s headquarters and targets are communicated to its various activity centers. Corporate management is responsible for, among others, KCS’s marketing strategy, the oversight of large cross border customer accounts, overall planning and control of infrastructure and rolling stock, the allocation of capital resources based upon growth and capacity constraints over the coordinated network, and other functions such as financial planning, accounting, and treasury.
The role of each region is to manage the operational activities and monitor and control costs over the coordinated rail network. Such cost control is required to ensure that pre-established efficiency standards set at the corporate level are attained. The activity centers are responsible for executing the overall corporate strategy and operating plan established by corporate management as a coordinated system.

14


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

The following tables provide information by geographic area (in millions): 
 
 
Three Months Ended
 
 
March 31,
Revenues
 
2012
 
2011
U.S.
 
$
302.3

 
$
270.4

Mexico
 
245.2

 
218.2

Total revenues
 
$
547.5

 
$
488.6

 
 
 
 
 
Property and equipment (including concession assets), net
 
March 31,
2012
 
December 31,
2011
U.S.
 
$
2,942.3

 
$
2,902.9

Mexico
 
2,445.7

 
2,446.6

Total property and equipment (including concession assets), net
 
$
5,388.0

 
$
5,349.5


10. Condensed Consolidating Financial Information
KCSR has outstanding $100.3 million principal amount of 8.0% Senior Notes due June 1, 2015, which are unsecured obligations of KCSR, and are also jointly and severally and fully and unconditionally guaranteed on an unsecured senior basis by KCS and certain wholly-owned domestic subsidiaries. As a result, the following accompanying condensed consolidating financial information (in millions) has been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 “Financial statements of guarantors and issuers of guaranteed securities registered or being registered.” The 8.0% Senior Notes were registered by means of an amendment to KCS’s shelf registration statement filed and automatically effective as of May 23, 2008.
CONDENSED CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
Three Months Ended March 31, 2012
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Revenues
$

 
$
270.2

 
$
5.4

 
$
280.5

 
$
(8.6
)
 
$
547.5

Operating expenses
1.1

 
204.0

 
7.1

 
186.8

 
(9.3
)
 
389.7

Operating income (loss)
(1.1
)
 
66.2

 
(1.7
)
 
93.7

 
0.7

 
157.8

Equity in net earnings (losses) of unconsolidated affiliates
70.0

 
(0.1
)
 

 
42.9

 
(107.0
)
 
5.8

Interest expense

 
(18.5
)
 

 
(22.9
)
 
14.2

 
(27.2
)
Debt retirement costs

 
(12.9
)
 

 

 

 
(12.9
)
Foreign exchange gain

 

 

 
3.9

 

 
3.9

Other income (expense), net
11.9

 
6.2

 

 
(3.1
)
 
(14.9
)
 
0.1

Income (loss) before income taxes
80.8

 
40.9

 
(1.7
)
 
114.5

 
(107.0
)
 
127.5

Income tax expense (benefit)
5.8

 
16.0

 
(0.6
)
 
31.0

 

 
52.2

Net income (loss)
75.0

 
24.9

 
(1.1
)
 
83.5

 
(107.0
)
 
75.3

Less: Net income attributable to noncontrolling interest

 

 

 
0.3

 

 
0.3

Net income (loss) attributable to Kansas City Southern and subsidiaries
75.0

 
24.9

 
(1.1
)
 
83.2

 
(107.0
)
 
75.0

Other comprehensive income (loss)
0.3

 
(0.3
)
 

 
0.9

 
(0.6
)
 
0.3

Comprehensive income (loss) attributable to Kansas City Southern and subsidiaries
$
75.3

 
$
24.6

 
$
(1.1
)
 
$
84.1

 
$
(107.6
)
 
$
75.3



15


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

CONDENSED CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME (LOSS) – (Continued)
 
Three Months Ended March 31, 2011
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Revenues
$

 
$
241.3

 
$
4.6

 
$
250.1

 
$
(7.4
)
 
$
488.6

Operating expenses
1.0

 
185.5

 
6.3

 
176.0

 
(8.0
)
 
360.8

Operating income (loss)
(1.0
)
 
55.8

 
(1.7
)
 
74.1

 
0.6

 
127.8

Equity in net earnings (losses) of unconsolidated affiliates
59.1

 
(0.1
)
 

 
37.1

 
(92.5
)
 
3.6

Interest expense

 
(22.8
)
 

 
(20.9
)
 
10.6

 
(33.1
)
Foreign exchange loss

 

 

 
(0.1
)
 

 
(0.1
)
Other income, net
9.8

 
2.2

 

 
0.9

 
(11.2
)
 
1.7

Income (loss) before income taxes
67.9

 
35.1

 
(1.7
)
 
91.1

 
(92.5
)
 
99.9

Income tax expense (benefit)
3.9

 
13.9

 
(0.6
)
 
18.6

 

 
35.8

Net income (loss)
64.0

 
21.2

 
(1.1
)
 
72.5

 
(92.5
)
 
64.1

Less: Net income attributable to noncontrolling interest

 

 

 
0.1

 

 
0.1

Net income (loss) attributable to Kansas City Southern and subsidiaries
64.0

 
21.2

 
(1.1
)
 
72.4

 
(92.5
)
 
64.0

Other comprehensive income
0.5

 
0.2

 

 
0.4

 
(0.6
)
 
0.5

Comprehensive income (loss) attributable to Kansas City Southern and subsidiaries
$
64.5

 
$
21.4

 
$
(1.1
)
 
$
72.8

 
$
(93.1
)
 
$
64.5

CONDENSED CONSOLIDATING BALANCE SHEETS
 
March 31, 2012
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets
$
1.4

 
$
291.1

 
$
4.6

 
$
471.2

 
$
(84.4
)
 
$
683.9

Investments

 
25.4

 

 
32.1

 

 
57.5

Investments in consolidated subsidiaries
1,956.3

 
0.2

 
1.9

 
1,593.9

 
(3,552.3
)
 

Restricted funds

 

 

 
16.7

 

 
16.7

Property and equipment (including concession assets), net

 
2,107.9

 
208.7

 
3,071.4

 

 
5,388.0

Other assets
1.3

 
263.6

 

 
121.5

 
(278.5
)
 
107.9

Total assets
$
1,959.0

 
$
2,688.2

 
$
215.2

 
$
5,306.8

 
$
(3,915.2
)
 
$
6,254.0

Liabilities and equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities
$
(884.7
)
 
$
1,029.3

 
$
132.2

 
$
254.1

 
$
(84.4
)
 
$
446.5

Long-term debt
0.2

 
603.4

 
0.3

 
1,199.0

 
(217.4
)
 
1,585.5

Deferred income taxes
2.8

 
571.0

 
75.5

 
214.1

 

 
863.4

Other liabilities
4.4

 
183.7

 
0.4

 
101.0

 
(61.1
)
 
228.4

Stockholders’ equity
2,836.3

 
300.8

 
6.8

 
3,244.1

 
(3,552.3
)
 
2,835.7

Noncontrolling interest

 

 

 
294.5

 

 
294.5

Total liabilities and equity
$
1,959.0

 
$
2,688.2

 
$
215.2

 
$
5,306.8

 
$
(3,915.2
)
 
$
6,254.0



16


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

CONDENSED CONSOLIDATING BALANCE SHEETS – (Continued)
 
December 31, 2011
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets
$
0.7

 
$
296.0

 
$
4.9

 
$
434.2

 
$
(93.3
)
 
$
642.5

Investments

 
24.6

 

 
25.8

 

 
50.4

Investments in consolidated subsidiaries
1,885.6

 
1.1

 
1.9

 
1,555.9

 
(3,444.5
)
 

Restricted funds

 

 

 
21.7

 

 
21.7

Property and equipment (including concession assets), net

 
2,086.4

 
210.6

 
3,052.5

 

 
5,349.5

Other assets
1.2

 
265.3

 

 
134.1

 
(291.7
)
 
108.9

Total assets
$
1,887.5

 
$
2,673.4

 
$
217.4

 
$
5,224.2

 
$
(3,829.5
)
 
$
6,173.0

Liabilities and equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities
$
(880.4
)
 
$
1,025.9

 
$
132.5

 
$
252.7

 
$
(93.3
)
 
$
437.4

Long-term debt
0.2

 
615.4

 
0.3

 
1,204.3

 
(217.4
)
 
1,602.8

Deferred income taxes
(1.8
)
 
571.2

 
76.3

 
215.7

 

 
861.4

Other liabilities
4.4

 
184.9

 
0.4

 
97.3

 
(74.3
)
 
212.7

Stockholders’ equity
2,765.1

 
276.0

 
7.9

 
3,160.0

 
(3,444.5
)
 
2,764.5

Noncontrolling interest

 

 

 
294.2

 

 
294.2

Total liabilities and equity
$
1,887.5

 
$
2,673.4

 
$
217.4

 
$
5,224.2

 
$
(3,829.5
)
 
$
6,173.0

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
 
Three Months Ended March 31, 2012
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Operating activities:
 
 
 
 
 
 
 
 
 
 
 
Net cash provided (used)
$
(12.5
)
 
$
58.1

 
$
1.0

 
$
92.9

 
$

 
$
139.5

Investing activities:
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures

 
(51.0
)
 
(1.0
)
 
(47.4
)
 

 
(99.4
)
Property investments in MSLLC

 

 

 
(6.7
)
 

 
(6.7
)
Other investing activities

 
(1.4
)
 

 
6.4

 

 
5.0

Net cash used

 
(52.4
)
 
(1.0
)
 
(47.7
)
 

 
(101.1
)
Financing activities:
 
 
 
 
 
 
 
 
 
 
 
Proceeds from issuance of long-term debt

 
229.6

 

 

 

 
229.6

Repayment of long-term debt

 
(231.2
)
 

 
(5.8
)
 

 
(237.0
)
Debt costs

 
(15.0
)
 

 

 

 
(15.0
)
Excess tax benefit from share-based compensation
13.2

 

 

 

 

 
13.2

Other financing activities
0.2

 

 

 

 

 
0.2

Net cash provided (used)
13.4

 
(16.6
)
 

 
(5.8
)
 

 
(9.0
)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
Net increase (decrease)
0.9

 
(10.9
)
 

 
39.4

 

 
29.4

At beginning of year

 
49.0

 

 
23.4

 

 
72.4

At end of period
$
0.9

 
$
38.1

 
$

 
$
62.8

 
$

 
$
101.8


17


Kansas City Southern
Notes to Consolidated Financial Statements—(Continued)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS – (Continued)
 
Three Months Ended March 31, 2011
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Operating activities:
 
 
 
 
 
 
 
 
 
 
 
Net cash provided
$
2.3

 
$
25.6

 
$
3.6

 
$
85.6

 
$

 
$
117.1

Investing activities:
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures

 
(45.8
)
 
(3.5
)
 
(45.9
)
 

 
(95.2
)
Property investments in MSLLC

 

 

 
(6.7
)
 

 
(6.7
)
Other investing activities

 
0.9

 

 
8.2

 

 
9.1

Net cash used

 
(44.9
)
 
(3.5
)
 
(44.4
)
 

 
(92.8
)
Financing activities:
 
 
 
 
 
 
 
 
 
 
 
Repayment of long-term debt

 
(1.4
)
 
(0.1
)
 
(4.3
)
 

 
(5.8
)
Other financing activities
(2.4
)
 

 

 

 

 
(2.4
)
Net cash used
(2.4
)
 
(1.4
)
 
(0.1
)
 
(4.3
)
 

 
(8.2
)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
Net increase (decrease)
(0.1
)
 
(20.7
)
 

 
36.9

 

 
16.1

At beginning of year
0.1

 
37.8

 

 
47.5

 

 
85.4

At end of period
$

 
$
17.1

 
$

 
$
84.4

 
$

 
$
101.5



18


Item 2.
Management’s 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 management’s 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: competition and consolidation within the transportation industry; the business environment in industries that produce and consume rail freight; revocation of the rail concession of KCS’s subsidiary, Kansas City Southern de Mexico, S.A. de C.V.; the termination, or failure to renew, agreements with customers, other railroads and third parties; interest rates; access to capital; disruptions to the Company’s technology infrastructure, including its computer systems; natural events such as severe weather, hurricanes and floods; market and regulatory responses to climate change; credit risk of customers and counterparties and their failure to meet their financial obligations; legislative and regulatory developments and disputes; rail accidents or other incidents or accidents along KCS’s rail network, facilities or customer facilities involving the release of hazardous materials, including toxic inhalation hazards; fluctuation in prices or availability of key materials, in particular diesel fuel; dependency on certain key suppliers of core rail equipment; changes in securities and capital markets; loss of key personnel; labor difficulties, including strikes and work stoppages; insufficiency of insurance to cover lost revenue, profits or other damages; acts of terrorism or risk of terrorist activities; war or risk of war; domestic and international economic conditions; political and economic conditions in Mexico and the level of trade between the United States and Mexico; and the outcome of claims and litigation. For more discussion about each risk factor, see Part II Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, which is on file with the U.S. Securities and Exchange Commission (File No. 1-4717) and Part I Item 1A — “Risk Factors” in the Form 10-K 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. We are not under any obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements.
This discussion is intended to clarify and focus on Kansas City Southern’s (“KCS” 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. 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 Company’s 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 Company’s critical accounting policies are disclosed in the 2011 Annual Report on Form 10-K.
Overview
The Company is engaged in the freight rail transportation business, operating a coordinated rail network under one reportable business segment. The primary operating subsidiaries of the Company consist of the following: The Kansas City Southern Railway Company (“KCSR”), Kansas City Southern de México, S.A. de C.V. (“KCSM”), Meridian Speedway, LLC (“MSLLC”), and The Texas Mexican Railway Company (“TexMex”). The Company generates revenues and cash flows by providing customers with freight delivery services within its regions, and throughout North America through connections with other Class I rail carriers. Customers conduct business in a number of different industries, including electric-generating utilities, chemical and petroleum products, industrial and consumer products, agriculture and mineral products, automotive products and intermodal transportation. Appropriate eliminations and reclassifications have been recorded in deriving the consolidated financial statements.
First Quarter Analysis
The Company reported quarterly earnings of $0.68 per diluted share on consolidated net income of $75.0 million for the three months ended March 31, 2012, compared to quarterly earnings of $0.58 per diluted share on consolidated net income of $64.0 million for the same period in 2011.

19


The Company reported a 12% increase in revenues during the three months ended March 31, 2012, as compared to the same period in 2011, driven primarily by positive pricing impacts, an increase in carload/unit volumes and increased fuel surcharge, partially offset by the effect of fluctuations in the value of the Mexican peso against the value of the U.S. dollar for revenues denominated in Mexican pesos.
Operating expenses increased 8% compared to the same period in 2011, primarily due to higher volumes, increases in fuel prices and compensation and benefit expense, partially offset by the effect of fluctuations in the value of the Mexican peso against the value of the U.S. dollar for operating expenses denominated in Mexican pesos. Operating expenses as a percentage of revenues declined to 71.2% for the three months ended March 31, 2012, as compared to 73.8% for the same period in 2011.
KCSM’s revenues and operating expenses are affected by fluctuations in the value of the Mexican peso against the value of the U.S. dollar. 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.
During the first quarter of 2012, the Company purchased $174.7 million principal amount of the outstanding 8.0% Senior Notes due June 1, 2015, and recognized debt retirement costs of $12.9 million.
On March 30, 2012, the Company’s Board of Directors declared a cash dividend of $0.195 per share payable on April 27, 2012, to common stockholders of record as of April 16, 2012. The aggregate amount of the dividend declared was approximately $21.4 million.
Recent Development
On April 19, 2012, KCSM presented for ratification a labor agreement between KCSM and the Sindicato de Trabajadores Ferrocarrileros de la República Mexicana (“Mexican Railroad Union") before the Mexican Junta Federal de Conciliacion y Arbitraje (“Federal Labor Board of Conciliation and Arbitration”), which the Federal Labor Board of Conciliation and Arbitration ratified. This labor agreement finalized compensation terms for the period from July 1, 2012 through June 30, 2013, and also contains terms that enable the Company to complete an organizational restructuring whereby all employees of KCSM will become employees of KCSM Servicios, S.A. de C.V. (“KCSM Servicios”), a wholly-owned subsidiary of the Company. KCSM Servicios will provide employee services to KCSM, and KCSM will pay KCSM Servicios market-based rates for these services. The effective date of this organizational restructuring is expected to be in the second quarter of 2012.
Mexican employees are statutorily entitled to receive Participación de los Trabajadores en las Utilidades (Mexican Statutory Profit Sharing). The related cash payment to employees is based on an employer’s net profit determined under accounting principles prescribed in Mexican law, rather than its net profit determined under U.S. generally accepted accounting principles. U.S. generally accepted accounting principles require the recording of deferred liabilities or assets for financial reporting purposes on the differences between the amounts determined under the two different accounting principles.
As a result of the organizational restructuring, KCSM’s obligation to pay Mexican Statutory Profit Sharing will terminate on the effective date. Accordingly, in the second quarter of 2012, KCSM will eliminate a related net deferred liability, resulting in approximately a cumulative $40 million pre-tax, non-cash reduction in operating expense. Also in the second quarter of 2012, KCSM will record a $7 million pre-tax, non-cash reversal of deferred Mexican Statutory Profit Sharing expense included in Compensation and Benefits in the first quarter of 2012.
KCSM Servicios will become obligated to pay Mexican Statutory Profit Sharing to its employees on the effective date of the organizational restructuring. On an annualized basis, the combined total of Mexican Statutory Profit Sharing cash payments and related cash payments made to union employees will increase by an average of approximately 37% per union employee compared to payments previously made by KCSM. Further, the labor agreement is expected to reduce variability for both KCSM Servicios and union employees regarding the level of future cash payments.
On an ongoing basis, due to the nature of KCSM Servicios’ operations, differences between KCSM Servicios’ net profit determined under accounting principles prescribed in Mexican law and net profit determined under U.S. generally accepted accounting principles are not expected to be significant, and the Company will not incur any significant net deferred Mexican Statutory Profit Sharing expense for financial reporting purposes.
Excluding the one-time impact of eliminating the Mexican Statutory Profit Sharing net deferred liability described above, the Company expects to realize an annual expense reduction equal to approximately 4% of the Company’s annual Compensation and Benefits expense for the year ended December 31, 2011, as a result of the organizational restructuring.



20


Results of Operations
The following summarizes KCS’s consolidated income statement components (in millions): 
 
Three Months Ended
 
Change
Dollars
 
March 31,
 
 
2012
 
2011
 
Revenues
$
547.5

 
$
488.6

 
$
58.9

Operating expenses
389.7

 
360.8

 
28.9

Operating income
157.8

 
127.8

 
30.0

Equity in net earnings of unconsolidated affiliates
5.8

 
3.6

 
2.2

Interest expense
(27.2
)
 
(33.1
)
 
5.9

Debt retirement costs
(12.9
)
 

 
(12.9
)
Foreign exchange gain (loss)
3.9

 
(0.1
)
 
4.0

Other income, net
0.1

 
1.7

 
(1.6
)
Income before income taxes
127.5

 
99.9

 
27.6

Income tax expense
52.2

 
35.8

 
16.4

Net income
75.3

 
64.1

 
11.2

Less: Net income attributable to noncontrolling interest
0.3

 
0.1

 
0.2

Net income attributable to Kansas City Southern and subsidiaries
$
75.0

 
$
64.0

 
$
11.0


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
 
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
March 31,
 
 
 
March 31,
 
 
 
March 31,
 
 
 
2012
 
2011
 
% Change
 
2012
 
2011
 
% Change
 
2012
 
2011
 
% Change
Chemical and petroleum
$
101.9

 
$
96.3

 
6
%
 
61.5

 
62.6

 
(2
%)
 
$
1,657

 
$
1,538

 
8
%
Industrial and consumer products
138.6

 
118.5

 
17
%
 
85.1

 
82.1

 
4
%
 
1,629

 
1,443

 
13
%
Agriculture and minerals
111.9

 
98.4

 
14
%
 
60.7

 
59.2

 
3
%
 
1,843

 
1,662

 
11
%
Total general commodities
352.4

 
313.2

 
13
%
 
207.3

 
203.9

 
2
%
 
1,700

 
1,536

 
11
%
Energy (ii)
71.0

 
71.9

 
(1
%)
 
69.7

 
74.2

 
(6
%)
 
1,019

 
969

 
5
%
Intermodal
68.1

 
54.2

 
26
%
 
208.1

 
175.9

 
18
%
 
327

 
308

 
6
%
Automotive
37.5

 
31.1

 
21
%
 
23.0

 
20.1

 
14
%
 
1,630

 
1,547

 
5
%
Carload revenues, carloads and units
529.0

 
470.4

 
12
%
 
508.1

 
474.1

 
7
%
 
$
1,041

 
$
992

 
5
%
Other revenue
18.5

 
18.2

 
2
%
 
 
 
 
 
 
 
 
 
 
 
 
Total revenues (i)
$
547.5

 
$
488.6

 
12
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(i) Included in revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fuel surcharge
$
66.6

 
$
49.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(ii) Effective January 1, 2012, the Company established the Energy commodity group, which includes the previous Coal commodity group and certain amounts previously included within the Agriculture and minerals and Chemicals and petroleum commodity groups. Prior period amounts have been reclassified to conform to the current year presentation.
Freight revenues include both revenue for transportation services and fuel surcharges. For the three months ended March 31, 2012, revenues increased $58.9 million compared to the same period in 2011, primarily due to positive pricing impacts, an increase in carload/unit volumes and increased fuel surcharge, partially offset by the effect of fluctuations in the value of the Mexican peso against the value of the U.S. dollar for revenues denominated in Mexican pesos. Revenue per carload/unit increased by 5% for the three months ended March 31, 2012, compared to the same period in 2011, reflecting favorable commodity mix in addition to the factors discussed above.
KCS’s 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

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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
for the three months ended
 
 
March 31, 2012
Chemical and petroleum. Revenues increased $5.6 million for the three months ended March 31, 2012, compared to the same period in 2011, primarily due to increases in pricing and fuel surcharge that were partially offset by a decrease in volume. Petroleum volumes decreased due to a customer’s lost business, partially offset by increased volumes 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 $20.1 million for the three months ended March 31, 2012, compared to the same period in 2011, primarily due to increases in pricing, fuel surcharge and 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, as well as increases in demand for pipe. Paper product revenue increased primarily due to increased rail market share as truck capacity tightened.
 
   
Agriculture and minerals. Revenues increased $13.5 million for the three months ended March 31, 2012, compared to the same period in 2011, primarily due to increases in pricing, fuel surcharge and volume. In the first quarter of 2011, revenues were negatively impacted as traffic patterns shifted due to a decline in cross border traffic into Mexico as availability of crops from a strong Mexico harvest was sufficient to meet the local demand. In the first quarter of 2012, cross border grain shipments have improved resulting in increased length of haul and higher rate per unit.
 
Energy. Revenues decreased $0.9 million for the three months ended March 31, 2012, compared to the same period in 2011, primarily due to a decrease in volume that was partially offset by an increase in pricing. The volume decrease was primarily due to utility coal as a result of utility maintenance outages, historic low natural gas prices and a warmer than average winter. This volume decrease was partially offset by a strong demand for frac sand.
Intermodal. Revenues increased $13.9 million for the three months ended March 31, 2012, compared to the same period in 2011, primarily due to an increase in volume. Growth was driven by increased cross border and domestic business, conversion of truck traffic to rail and South American/trans-Pacific container volume.
Automotive. Revenues increased $6.4 million for the three months ended March 31, 2012, compared to the same period in 2011, primarily due to increases in volume and pricing, partially offset by fluctuations in the value of the Mexican peso against the value of the U.S. dollar. The volume increase was driven by strong year over year growth in North American automobile sales for Original

22


Equipment Manufacturers, new cross border vehicle routings, increased import/export volume through the Port of Lazaro Cardenas and the shipment of new automobile models.

Operating Expenses
Operating expenses, as shown below (in millions), increased $28.9 million for the three months ended March 31, 2012, when compared to the same period in 2011, primarily due to higher volumes, increases in fuel prices and compensation and benefits expense, partially offset by the effect of fluctuations in the value of the Mexican peso against the value of the U.S. dollar for operating expenses denominated in Mexican pesos.
 
Three Months Ended
 
 
 
March 31,
 
Change
 
2012
 
2011
 
Dollars
 
Percent
Compensation and benefits
$
109.3

 
$
100.4

 
$
8.9

 
9
%
Purchased services
54.4

 
48.1

 
6.3

 
13
%
Fuel
88.3

 
79.5

 
8.8