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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ____ to ____
Commission file number 1-4717
KANSAS CITY SOUTHERN INDUSTRIES, INC.
(Exact name of Company as specified in its charter)
Delaware 44-0663509
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
114 West 11th Street, Kansas City, Missouri 64105
(Address of principal executive offices) (Zip Code)
Company's telephone number, including area code (816) 983-1303
Securities registered pursuant to Section 12 (b) of the Act:
Name of each exchange on
Title of each class which registered
Preferred Stock, Par Value $25 Per New York Stock Exchange
Share, 4%, Noncumulative
Common Stock, $.01 Per Share Par Value New York Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark whether the Company (1) has filed all reports required to
be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Company's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Company Stock. The Company's common stock is listed on the New York Stock
Exchange under the symbol "KSU." As of March 8, 1999, 109,694,604 shares of
common stock and 242,710 shares of voting preferred stock were outstanding. On
such date, the aggregate market value of the voting and non-voting common and
preferred stock was $5,159,408,393 (amount computed based on closing prices of
preferred and common stock on New York Stock Exchange).
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the following documents are incorporated herein by reference into
Part of the Form 10-K as indicated:
Document Part of Form 10-K into which incorporated
Company's Definitive Proxy Statement Parts I, III
for the 1999 Annual Meeting of
Stockholders, which will be filed no
later than 120 days after December 31, 1998
KANSAS CITY SOUTHERN INDUSTRIES, INC.
1998 FORM 10-K ANNUAL REPORT
Table of Contents
Page
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 5
Item 3. Legal Proceedings........................................... 9
Item 4. Submission of Matters to a Vote of Security Holders......... 9
Executive Officers of the Company........................... 9
PART II
Item 5. Market for the Company's Common Stock and
Related Stockholder Matters............................... 11
Item 6. Selected Financial Data..................................... 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................... 13
Item 7(A) Quantitative and Qualitative Disclosures About Market Risk.. 56
Item 8. Financial Statements and Supplementary Data................. 60
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure....................... 104
PART III
Item 10. Directors and Executive Officers of the Company............. 105
Item 11. Executive Compensation...................................... 105
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 105
Item 13. Certain Relationships and Related Transactions.............. 105
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K............................................... 106
Signatures.................................................. 111
ii
1
Part I
Item 1. Business
(a) GENERAL DEVELOPMENT OF COMPANY BUSINESS
The information set forth in response to Item 101 of Regulation S-K under Part
II Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations, of this Form 10-K is incorporated by reference in partial
response to this Item 1.
(b) INDUSTRY SEGMENT FINANCIAL INFORMATION
Kansas City Southern Industries, Inc. ("Company" or "KCSI") reports its
financial information in two business segments: Transportation and Financial
Services.
Kansas City Southern Lines, Inc. ("KCSL") is the holding company for
Transportation segment subsidiaries and affiliates. This segment includes, among
others, The Kansas City Southern Railway Company ("KCSR"), Gateway Western
Railway Company ("Gateway Western"), and strategic joint venture interests in
Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V.("Grupo TFM"), which owns
80% of the common stock of TFM, S.A. de C.V. ("TFM"), Mexrail, Inc. ("Mexrail"),
which wholly owns the Texas Mexican Railway Company ("Tex Mex"), and Southern
Capital Corporation, LLC ("Southern Capital"), a 50% owned joint venture.
FAM Holdings, Inc. ("FAM HC") has been formed for the purpose of becoming the
holding company for the subsidiaries and affiliates comprising the Financial
Services segment. The primary entities included in this segment are Janus
Capital Corporation ("Janus" - 82% owned, diluted), Berger Associates, Inc.
("Berger" - 100% owned) and Nelson Money Managers plc ("Nelson" - 80% owned).
Additionally, the Company owns an approximate 32% equity interest in DST
Systems, Inc. ("DST," formerly a 41% owned investment prior to the merger
transaction in December 1998 as discussed below).
The information set forth in response to Item 101 of Regulation S-K relative to
financial information by industry segment for the three years ended December 31,
1998 under Part II Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, of this Form 10-K, and Item 8, Financial
Statements and Supplementary Data, at Note 13 - Industry Segments of this Form
10-K, is incorporated by reference in partial response to this Item 1.
(c) NARRATIVE DESCRIPTION OF THE BUSINESS
The information set forth in response to Item 101 of Regulation S-K under Part
II Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations, of this Form 10-K is incorporated by reference in partial
response to this Item 1.
Transportation
KCSL, along with its principal subsidiaries and joint ventures, owns and
operates a rail network of approximately 6,000 miles of main and branch lines
that links key commercial and industrial markets in the United States and
Mexico. Together with its strategic alliance with the Canadian National Railway
Company/Illinois Central Corporation ("CN/IC") and other marketing agreements,
KCSL's reach has been expanded to comprise a contiguous rail network of
approximately 25,000 miles of main and branch lines connecting Canada, the
United States and Mexico. The Company believes that the economic growth within
the United States, Mexico and Canada is developing along a north/south axis and
becoming more interconnected and interdependent as a result of the
implementation of the North American Free Trade
2
Agreement ("NAFTA"). In order to capitalize on the growing trade resulting from
NAFTA, KCSL has transformed itself from a regional rail carrier into an
extensive North American transportation network. During the mid-1990's, while
other railroad competitors concentrated on enlarging their share of the
east/west transcontinental traffic in the United States, KCSL aggressively
pursued acquisitions, joint ventures, strategic alliances and marketing
partnerships with other railroads to achieve its goal of creating the "NAFTA
Railway."
KCSL's rail network connects midwestern, eastern and Canadian shippers,
including shippers utilizing Chicago and Kansas City -- the two largest rail
centers in the United States -- with the largest industrial centers of Canada
and Mexico, including Toronto, Edmonton, Mexico City and Monterrey. KCSL's
principal subsidiary, KCSR, which traces its origins to 1887, offers the
shortest route between Kansas City and major port cities along the Gulf of
Mexico in Louisiana, Mississippi and Texas. KCSR, in conjunction with the
Norfolk Southern Railway Co. ("Norfolk Southern"), operates the most direct rail
route, referred to as the "Meridian Speedway," linking the Atlanta and Dallas
gateways for traffic moving between the rapidly-growing southeast and southwest
regions of the United States. The "Meridian Speedway" also provides eastern
shippers and other U.S. and Canadian railroads with an efficient connection to
Mexican markets.
In addition to KCSR, KCSL's railroad system includes Gateway Western, which
links Kansas City with East St. Louis and Springfield, Illinois and provides key
interchanges with the majority of other Class I railroads, as well as its
strategic joint venture interests in Grupo TFM and Mexrail, which provide direct
access to Mexico.
Through its joint ventures in Grupo TFM and Mexrail, operated in partnership
with Transportacion Maritima Mexicana, S.A. de C.V. ("TMM"), KCSL has
established a prominent position in the growing Mexican market. TFM's route
network provides the shortest connection to the major industrial and population
areas of Mexico from midwestern and eastern points in the United States. TFM,
which was privatized by the Mexican government in June 1997, passes through
Mexican states comprising approximately 69% of Mexico's population and
accounting for approximately 70% of Mexico's estimated gross domestic product.
Tex Mex connects with TFM at Laredo, Texas, (the single largest rail freight
transfer point between the United States and Mexico), other U.S. Class I
railroads, as well as with KCSR at Beaumont, Texas.
As a result of the KCSR/CN/IC strategic alliance to promote NAFTA traffic, the
Company has gained access to customers in Detroit, Michigan and Canada as well
as more direct access to Chicago. Separate marketing agreements with the Norfolk
Southern and I&M Rail Link, LLC provide KCSL with access to additional rail
traffic to and from the eastern and upper midwestern markets of the United
States. KCSL's system, through its core network, strategic alliances and
marketing partnerships, interconnects with all Class I railroads in North
America.
Financial Services
The Financial Services segment includes Janus, Berger, Nelson and a 32% interest
in DST. Janus and Berger, each headquartered in Denver, Colorado, are United
States investment advisors registered with the Securities and Exchange
Commission ("SEC"). Janus serves as an investment advisor to the Janus
Investment Funds ("Janus Funds") and Janus Aspen Series ("Janus Aspen"), as well
as to institutional and individual private accounts (including pension,
profit-sharing and other employee benefit plans, trusts, estates, charitable
organizations, endowments and foundations) and other investment companies.
Berger is also engaged in the business of providing financial asset management
services and products, principally through sponsorship of a family of mutual
funds (the "Berger Complex"). Nelson, a United Kingdom company, provides
investment planning and investment management services to individuals that are
retired or contemplating retirement. DST, together with its subsidiaries and
joint ventures, provides sophisticated information processing and computer
software services and products to the financial services industry (primarily to
mutual funds and investment managers), communications industries and
3
other service industries. DST is organized into three operating segments:
financial services, customer management and output solutions.
Janus derives its revenues and net income primarily from diversified advisory
services provided to the Janus Funds, Janus Aspen, other financial services
firms and private accounts. In order to perform its investment advisory
functions, Janus conducts fundamental investment research and valuation
analysis. In general, Janus' approach tends to focus on companies that are
experiencing or expected to experience above average growth relative to their
peers or the economy, or that are realizing or expected to realize positive
change due to new product development, new management, changing demographics or
regulatory developments. This approach utilizes research provided by outside
parties, as well as in-house research.
Janus has three wholly-owned subsidiaries: Janus Service Corporation ("Janus
Service"), Janus Capital International, Ltd. ("Janus International") and Janus
Distributors, Inc. ("Janus Distributors").
o Pursuant to transfer agency agreements, which are subject to renewal
annually, Janus Service provides full service accounting, recordkeeping,
administration and shareowner services to the Janus Funds and Janus Aspen
and their shareholders. To provide the consistent and reliable level of
service required to compete effectively in the direct distribution channel,
Janus Service maintains a highly trained group of telephone representatives
and utilizes leading edge technology to provide immediate data to support
call center and shareholder processing operations. This approach includes
the utilization of automated phone lines and an interactive Internet web
site ("Virtual Janus") both of which are integrated into the shareholder
services system. These customer service related enhancements provide Janus
Service with additional capacity to handle the high shareholder volume that
can be experienced during market volatility.
o Janus International is an investment advisor registered with the SEC that
executes securities trades from London, England. Beginning in fourth
quarter 1998, Janus launched a series of funds domiciled in Ireland, the
Janus World Funds PLC ("Janus World").
o Pursuant to a distribution agreement, Janus Distributors serves as the
distributor of the Janus Funds, Janus World and certain classes of Janus
Aspen and is a registered broker-dealer.
Berger is an investment advisor to the Berger Complex, which includes a series
of Berger mutual funds, as well as sub-advised mutual funds and pooled asset
trusts. Berger derives its revenues and net income from these advisory services.
Additionally, Berger is a 50% owner in a joint venture with the Bank of Ireland
Asset Management (U.S.) Limited ("BIAM"). The joint venture, BBOI Worldwide LLC,
serves as the investment advisor to the Berger/BIAM Funds and Berger acts as the
sub-administrator.
Nelson provides two distinct, but interrelated services to individuals that
generally are retired or contemplating retirement: investment advice and
investment management. Clients are assigned a specific investment advisor, who
meets with each client individually and conducts an analysis of the client's
investment objectives and then recommends the construction of a portfolio to
meet those objectives. The design and ongoing maintenance of the portfolio
structure is the responsibility of the investment advisor. The selection and
management of the instruments/securities which constitute the portfolio is the
responsibility of Nelson's investment management team. Revenues are earned based
on a percentage of the initial client investment as well as from a monthly fee
based on the level of assets under management.
DST operates throughout the United States, with operations in Kansas City,
Northern California and various locations on the East Coast, as well as
internationally in Canada, Europe, Africa and the Pacific Rim. DST has a single
class of stock, its common stock, which is publicly traded on the New York Stock
Exchange and the Chicago Stock Exchange. Prior to November 1995, KCSI owned all
of the stock of DST. In November 1995, a public offering reduced KCSI's
ownership interest in DST to approximately 41%. In December 1998, a wholly-owned
subsidiary of DST merged with USCS International, Inc. The merger resulted in a
reduction of KCSI's ownership of DST to approximately 32%. KCSI reports DST as
an equity investment in the consolidated financial statements.
4
Employees. As of December 31, 1998, the approximate number of employees of KCSI
and its majority owned subsidiaries was as follows:
Transportation:
KCSR 2,665
Gateway Western 235
Other 90
-----
Total 2,990
-----
Financial Services:
Janus 1,300
Berger 80
Nelson 145
Other 20
-----
Total 1,545
-----
Total KCSI 4,535
=====
5
Item 2. Properties
In the opinion of management, the various facilities, office space and other
properties owned and/or leased by the Company (and its subsidiaries and
affiliates) are adequate for existing operating needs.
TRANSPORTATION (KCSL)
KCSR
KCSR owns and operates approximately 2,756 miles of main and branch lines, and
approximately 1,175 miles of other tracks, in a nine state region, including
Missouri, Kansas, Arkansas, Oklahoma, Mississippi, Alabama, Tennessee,
Louisiana, and Texas. Approximately 215 miles of main and branch lines and 85
miles of other tracks are operated by KCSR under trackage rights and leases.
Kansas City Terminal Railway Company (of which KCSR is a partial owner with
other railroads) owns and operates approximately 80 miles of track, and operates
an additional eight miles of track under trackage rights in greater Kansas City,
Missouri. KCSR also leases for operating purposes certain short sections of
trackage owned by various other railroad companies and jointly owns certain
other facilities with such railroads.
KCSR and the Union Pacific Railroad ("UP") have a haulage and trackage rights
agreement, which gives KCSR access to Nebraska and Iowa, and additional routes
in Kansas, Missouri and Texas for movements of certain limited types of traffic.
The haulage rights require the UP to move KCSR traffic in UP trains; the
trackage rights allow KCSR to operate its trains over UP tracks.
KCSR, in support of its transportation operations, owns and operates repair
shops, depots and office buildings along its right-of-way. A major facility,
Deramus Yard, is located in Shreveport, Louisiana and includes a general office
building, locomotive repair shop, car repair shops, customer service center,
material warehouses and fueling facilities totaling approximately 227,000 square
feet. KCSR owns a 107,800 square foot major diesel locomotive repair facility in
Pittsburg, Kansas and freight and truck maintenance buildings in Dallas, Texas
totaling approximately 125,200 square feet. KCSR and KCSI executive offices are
located in an eight story office building in Kansas City, Missouri and are
leased from a subsidiary of the Company. Other facilities owned by KCSR include
a 21,000 square foot car repair shop in Kansas City, Missouri and approximately
15,000 square feet of office space in Baton Rouge, Louisiana.
KCSR owns and operates seven intermodal facilities. These facilities are located
in Dallas and Port Arthur, Texas; Kansas City, Missouri; Sallisaw, Oklahoma;
Shreveport and New Orleans, Louisiana; and Jackson, Mississippi. The facility in
Port Arthur is owned and operated jointly with the Norfolk Southern. The
facility in Jackson was completed in December 1996. The various locations
include strip tracks, cranes and other equipment used in facilitating the
transfer and movement of trailers and containers.
6
KCSR's fleet of rolling stock at December 31 consisted of:
1998 1997 1996
Leased Owned Leased Owned Leased Owned
------- ------- ------- ------ ------ ------
Locomotives:
Road Units 258 108 238 113 213 160
Switch Units 52 - 52 - 52 -
Other 8 - 9 - 10 -
------- ------- ------- ------ ------ ------
Total 318 108 299 113 275 160
======= ======= ======= ====== ====== ======
Rolling Stock:
Box Cars 6,634 2,023 7,168 2,027 6,366 1,558
Gondolas 748 56 819 61 819 65
Hopper Cars 2,660 1,185 2,680 1,198 2,588 1,213
Flat Cars (Intermodal
and Other) 1,617 676 1,249 554 1,249 551
Tank Cars 34 58 35 59 40 60
Other Freight Cars - - 547 123 554 164
------- ------- ------- ------ ------ ------
Total 11,693 3,998 12,498 4,022 11,616 3,611
======= ======= ======= ====== ====== ======
As of December 31, 1998, KCSR's fleet of locomotives and rolling stock consisted
of 426 diesel locomotives, of which 108 were owned, 298 leased from affiliates
and 20 leased from non-affiliates, as well as 15,691 freight cars, of which
3,998 were owned, 3,113 leased from affiliates and 8,580 leased from
non-affiliates. A significant portion of the locomotives and rolling stock
leased from affiliates include equipment leased through Southern Capital, a
joint venture with GATX Capital Corporation formed in October 1996.
Some of the owned equipment is subject to liens created under conditional sales
agreements, equipment trust certificates and leases in connection with the
original purchase or lease of such equipment. KCSR indebtedness with respect to
equipment trust certificates, conditional sales agreements and capital leases
totaled approximately $78.8 million at December 31, 1998.
Certain KCSR property statistics follow:
1998 1997 1996
Route miles - main and branch line 2,756 2,845 2,954
Total track miles 3,931 4,036 4,147
Miles of welded rail in service 2,031 2,030 1,981
Main line welded rail (% of total) 65% 63% 58%
Cross ties replaced 255,591 332,440 438,170
Average Age (in years):
Wood ties in service 15.8 15.1 15.5
Rail in main and branch line 25.5 26.0 27.0
Road locomotives 23.3 22.1 21.9
All locomotives 23.9 22.8 22.5
Maintenance expenses for Way and Structure and Equipment (pursuant to regulatory
accounting rules, which include depreciation) for the three years ended December
31, 1998 and as a percent of KCSR revenues are as follows (dollars in millions):
7
KCSR Maintenance
Way and Structure Equipment
Percent of Percent of
Amount Revenue Amount Revenue
1998 $ 82.4 14.9% $ 118.3 21.4%
1997 122.2* 23.6 112.3 21.7
1996 92.6 18.8 99.8 20.3
* Way and structure expenses include $33.5 million related to asset
impairments. See Part II Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations, of this Form 10-K for further
discussion.
Gateway Western
Gateway Western operates a 402 mile rail line extending from Kansas City,
Missouri to East St. Louis and Springfield, Illinois. Additionally, Gateway
Western has restricted haulage rights extending to Chicago, Illinois. The
Gateway Western acquisition provides interchanges with various eastern rail
carriers and gave the Company access to the St. Louis rail gateway. The Surface
Transportation Board approved the Company's acquisition of Gateway Western in
May 1997.
Certain Gateway Western property statistics follow:
1998 1997 1996
Route miles - main and branch line 402 402 402
Total track miles 564 564 564
Miles of welded rail in service 121 109 109
Main line welded rail (% of total) 40% 39% 39%
Mexrail
Mexrail, a 49% owned KCSI affiliate, owns 100% of the Tex Mex and certain other
assets, including the northern U.S. half of a rail traffic bridge at Laredo,
Texas spanning the Rio Grande river. Grupo TFM operates the southern half of the
bridge. This bridge is a significant entry point for rail traffic between Mexico
and the U.S. The Tex Mex operates a 157 mile rail line extending from Corpus
Christi to Laredo, Texas, and also has trackage rights (from Union Pacific
Railroad) totaling approximately 360 miles between Corpus Christi and Beaumont,
Texas.
The Tex Mex is currently in the process of constructing a new rail yard in
Laredo, Texas. Phase I of the project was completed in December 1998 and
includes four tracks comprising approximately 6.5 miles. Phase II of the
project, which consists of two new intermodal tracks totaling approximately 2.8
miles, is expected to be completed in March 1999. Ground work for an additional
ten tracks has been completed; however, construction on the tracks has not yet
begun. Current capacity of the yard is approximately 800 freight cars. Upon
completion of all tracks, expected capacity will be 2,000 freight cars.
Certain Tex Mex property statistics follow:
1998 1997 1996
Route miles - main and branch line 157 157 157
Total track miles 530 521 521
Miles of welded rail in service 5 5 5
Main line welded rail (% of total) 3% 3% 3%
Locomotives (average years) 25 25 24
Grupo TFM Grupo TFM owns 80% of the common stock of TFM. TFM holds the
concession to operate Mexico's "Northeast Rail Lines" for 50 years, with the
option of a 50 year extension (subject to certain conditions). TFM operates
approximately 2,661 miles of main line and an additional 838 miles of sidings
and spur tracks, and main line under trackage rights. Approximately 80% of TFM's
main line consists of welded rail. TFM has the right to operate the rail, but
does not own the land, roadway or associated structures. 331 locomotives are
owned by TFM and approximately 4,034 freight cars are either owned by TFM or
8
leased from affiliates. 89 locomotives and 2,846 freight cars are leased
from non-affiliates. Grupo TFM (through TFM) also has office space at which
various operational, accounting, managerial and other activities are performed.
The primary facilities are located in Mexico City and Monterrey, Mexico. TFM
leases 140,354 square feet of office space in Mexico City and owns an 115,157
square foot facility in Monterrey. Grupo TFM was a 37% owned KCSI affiliate at
December 31, 1998.
Other Transportation
Southern Group, Inc. leases approximately 4,150 square feet of office space in
downtown Kansas City, Missouri from an affiliate of DST.
The Company is an 80% owner of Wyandotte Garage Corporation, which owns a
parking facility in downtown Kansas City, Missouri. The facility is located
adjacent to the Company's and KCSR's executive offices, and consists of 1,147
parking spaces utilized by the employees of the Company and its affiliates, as
well as the general public.
Trans-Serve, Inc. operates a railroad wood tie treating plant in Vivian,
Louisiana under an industrial revenue bond lease arrangement with an option to
purchase. This facility includes buildings totaling approximately 12,000 square
feet.
Pabtex, Inc. owns a 70 acre coal and petroleum coke bulk handling facility in
Port Arthur, Texas.
Mid-South Microwave, Inc. owns and operates a microwave system, which extends
essentially along the right-of-way of KCSR from Kansas City, Missouri to Dallas,
Beaumont and Port Arthur, Texas and New Orleans, Louisiana. This system is
leased to KCSR.
Other subsidiaries of the Company own approximately 8,000 acres of land at
various points adjacent to the KCSR right-of-way. Other properties also include
a 354,000 square foot warehouse at Shreveport, Louisiana, a bulk handling
facility at Port Arthur, Texas, and several former railway buildings now being
rented to non-affiliated companies, primarily as warehouse space.
The Company owns 1,025 acres of property located on the waterfront in the Port
Arthur, Texas area, which includes 22,000 linear feet of deep water frontage and
three docks. Port Arthur is an uncongested port with direct access to the Gulf
of Mexico. Approximately 75% of this property is available for development.
FINANCIAL SERVICES (FAM HC)
Janus
Janus leases from non-affiliates 340,000 square feet of office space in three
facilities for investment, administrative, marketing, information technology,
and shareowner processing operations, and approximately 33,500 square feet for
mail processing and storage requirements. These corporate offices and mail
processing facilities are located in Denver, Colorado. In September 1998, Janus
opened a 51,500 square foot investor service and data center in Austin, Texas.
Janus also leases 2,200 square feet of office space in Westport, Connecticut for
development of the Janus World Funds PLC and 2,500 square feet of office space
in London, England for securities research and trading. In December 1998, Janus
closed its investor service center in Kansas City, Missouri to focus efforts on
providing quality service through various electronic communication avenues.
Berger
Berger leases approximately 29,800 square feet of office space in Denver,
Colorado from a non-affiliate for its administrative and corporate functions.
9
Nelson
Nelson leases 8,000 square feet of office space in Chester, England, the
location of its corporate headquarters, investment operations and one of its
marketing offices. During 1998, Nelson acquired additional office space adjacent
to its Chester location to accommodate expansion efforts. Also, Nelson leases
five branch marketing offices totaling approximately 8,500 square feet in the
following locations in England: London, Lichfield, Bath, Durham and Edinburgh.
Item 3. Legal Proceedings
The information set forth in response to Item 103 of Regulation S-K under Part
II Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations, "Other - Litigation and Environmental Matters" of this
Form 10-K is incorporated by reference in response to this Item 3. In addition,
see discussion in Part II Item 8, Financial Statements and Supplementary Data,
at Note 11 - Commitments and Contingencies of this Form 10-K.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the three month
period ended December 31, 1998.
Executive Officers of the Company
Pursuant to General Instruction G(3) of Form 10-K and instruction 3 to paragraph
(b) of Item 401 of Regulation S-K, the following list is included as an
unnumbered Item in Part I of this Form 10-K in lieu of being included in KCSI's
Definitive Proxy Statement which will be filed no later than 120 days after
December 31, 1998. All executive officers are elected annually and serve at the
discretion of the Board of Directors (or in the case of Mr. T. H. Bailey, the
Janus Board of Directors). Certain of the executive officers have employment
agreements with the Company.
Name Age Position(s)
L.H. Rowland 61 Chairman, President and
Chief Executive Officer of the Company
M.R. Haverty 54 Executive Vice President, Director
T.H. Bailey 61 Chairman, President and
Chief Executive Officer of
Janus Capital Corporation
P.S. Brown 62 Vice President, Associate General
Counsel and Assistant Secretary
R.P. Bruening 60 Vice President, General Counsel and
Corporate Secretary
D.R. Carpenter 52 Vice President - Finance
W.K. Erdman 40 Vice President - Corporate Affairs
A.P. McCarthy 52 Vice President and Treasurer
J.D. Monello 54 Vice President and Chief Financial Officer
L.G. Van Horn 40 Vice President and Comptroller
The information set forth in the Company's Definitive Proxy Statement in the
description of the Board of Directors with respect to Mr. Rowland and Mr.
Haverty is incorporated herein by reference.
Mr. Bailey has continuously served as Chairman, President and Chief Executive
Officer of Janus Capital Corporation since 1978.
10
Mr. Brown has continuously served as Vice President, Associate General Counsel
and Assistant Secretary since July 1992.
Mr. Bruening has continuously served as Vice President, General Counsel and
Corporate Secretary since July 1995. From May 1982 to July 1995, he served as
Vice President and General Counsel. He also serves as Senior Vice President and
General Counsel of KCSR.
Mr. Carpenter has continuously served as Vice President - Finance since November
1996. He was Vice President - Finance and Tax from May 1995 to November 1996. He
was Vice President - Tax from June 1993 to May 1995. Prior to June 1993, he was
a member in the law firm of Watson & Marshall L.C., Kansas City, Missouri.
Mr. Erdman has continuously served as Vice President - Corporate Affairs since
April 1997. From January 1997 to April 1997 he served as Director - Corporate
Affairs. From 1987 to January 1997 he served as Chief of Staff for United States
Senator from Missouri, Christopher ("Kit") Bond.
Mr. McCarthy has continuously served as Vice President and Treasurer since May
1996. He was Treasurer from December 1989 to May 1996.
Mr. Monello has continuously served as Vice President and Chief Financial
Officer since March 1994. From October 1992 to March 1994, he served as Vice
President - Finance.
Mr. Van Horn has continuously served as Vice President and Comptroller since May
1996. He was Comptroller from October 1992 to May 1996.
There are no arrangements or understandings between the executive officers and
any other person pursuant to which the executive officer was or is to be
selected as an officer, except with respect to the executive officers who have
entered into employment agreements, which agreements designate the position(s)
to be held by the executive officer.
None of the above officers are related to one another by family.
11
Part II
Item 5. Market for the Company's Common Stock and Related Stockholder Matters
The information set forth in response to Item 201 of Regulation S-K on the cover
(page i) under the heading "Company Stock," and in Part II Item 8, Financial
Statements and Supplementary Data, at Note 14 - Quarterly Financial Data
(Unaudited) of this Form 10-K is incorporated by reference in partial response
to this Item 5.
The payment and amount of dividends will be reviewed periodically and
adjustments considered that are consistent with growth in real earnings and
prevailing business conditions. In July 1997, the Board authorized a 3-for-1
split in the Company's common stock.
Unrestricted retained earnings of the Company at December 31, 1998 were $480.9
million.
As of March 8, 1999, there were 5,709 holders of the Company's common stock
based upon an accumulation of the registered stockholder listing.
Item 6. Selected Financial Data
(in millions, except per share and ratio data)
The selected financial data below should be read in conjunction with the
consolidated financial statements and the related notes thereto, and the Report
of Independent Accountants thereon, included under Item 8 of this Form 10-K, and
such data is qualified by reference thereto.
1998 (i) 1997 (ii) 1996 (iii) 1995 (iv) 1994 (v)
Revenues $ 1,284.3 $ 1,058.3 $ 847.3 $ 775.2 $ 1,088.4
Income (loss) from continuing
operations $ 190.2 $ (14.1) $ 150.9 $ 236.7 $ 104.9
Income (loss) from continuing
operations per common share:
Basic $ 1.74 $ (0.13) $ 1.33 $ 1.86 $ 0.80
Diluted 1.66 (0.13) 1.31 1.80 0.77
Total assets $ 2,619.7 $ 2,434.2 $ 2,084.1 $ 2,039.6 $ 2,230.8
Long-term obligations $ 825.6 $ 805.9 $ 637.5 $ 633.8 $ 928.8
Cash dividends per
common share $ .16 $ .15 $ .13 $ .10 $ .10
Ratio of earnings to
fixed charges 4.44 (vi) 1.60 (vii) 3.30 6.14 (viii) 3.28
(i) Includes a one-time non-cash charge of $36.0 million ($23.2 million
after-tax, or $0.21 per basic and diluted share) resulting from the merger
of a wholly-owned subsidiary of DST with USCS International, Inc. ("USCS").
The merger was accounted for by DST under the pooling of interests method.
The charge reflects the Company's reduced ownership of DST (from 41% to
approximately 32%), together with the Company's proportionate share of DST
and USCS fourth quarter merger-related charges. See note 2 to the
consolidated financial statements in this Form 10-K.
(ii) Includes $196.4 million ($158.1 million after-tax, or $1.47 per basic and
diluted share) of restructuring, asset impairment and other charges
recorded during fourth quarter 1997. The charges reflect: a $91.3 million
impairment of goodwill associated with KCSR's acquisition of MidSouth
Corporation in 1993; $38.5 million of long-lived assets held for disposal;
$9.2 million of
12
impaired long-lived assets; approximately $27.1 million in reserves related
to termination of a union productivity fund and employee separations; a
$12.7 million impairment of goodwill associated with the Company's
investment in Berger; and $17.6 million of other reserves for leases,
contracts and other reorganization costs. See Notes 1 and 3 to the
consolidated financial statements in this Form 10-K.
(iii)Includes a one-time after-tax gain of $47.7 million (or $0.42 per basic
share, $0.41 per diluted share), representing the Company's proportionate
share of the one-time gain recognized by DST in connection with the merger
of The Continuum Company, Inc., formerly a DST unconsolidated equity
affiliate, with Computer Sciences Corporation in a tax-free share exchange
(see Note 2 to the consolidated financial statements in this Form 10-K).
(iv) Reflects DST as an unconsolidated affiliate as of January 1, 1995 due to
the DST public offering and associated transactions completed in November
1995, which reduced the Company's ownership of DST to approximately 41% and
resulted in deconsolidation of DST from the Company's consolidated
financial statements. The public offering and associated transactions
resulted in a $144.6 million after-tax gain (or $1.14 per basic share,
$1.10 per diluted share) to the Company.
(v) Reflects DST as a consolidated subsidiary. See (iv) above for discussion of
DST public offering in 1995.
(vi) Financial information from which the ratio of earnings to fixed charges was
computed for the year ended December 31, 1998 includes the one-time
non-cash charge resulting from the DST and USCS merger discussed in (i)
above. If the ratio was computed to exclude this charge, the 1998 ratio of
earnings to fixed charges would have been 4.75.
(vii)Financial information from which the ratio of earnings to fixed charges
was computed for the year ended December 31, 1997 includes the
restructuring, asset impairment and other charges discussed in (ii) above.
If the ratio was computed to exclude these charges, the 1997 ratio of
earnings to fixed charges would have been 3.60.
(viii) Financial information from which the ratio of earnings to fixed charges
was computed for the year ended December 31, 1995 reflects DST as a
majority owned unconsolidated subsidiary through October 31, 1995, and an
unconsolidated 41% owned affiliate thereafter, in accordance with
applicable U.S. Securities and Exchange Commission rules and regulations.
If the ratio was computed to exclude the one-time pretax gain of $296.3
million associated with the November 1995 public offering and associated
transactions, the 1995 ratio of earnings to fixed charges would have been
3.04.
All years reflect the 3-for-1 common stock split to shareholders of record on
August 25, 1997, paid September 16, 1997.
Certain prior year information has been restated to conform to the current year
presentation. All years reflect the reclassification of certain income/expense
items from "Revenues" and "Costs and Expenses" to a separate "Other, net" line
item in the Consolidated Statements of Operations.
The information set forth in response to Item 301 of Regulation S-K under Part
II Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations, of this Form 10-K is incorporated by reference in partial
response to this Item 6.
13
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
The discussion set forth below, as well as other portions of this Form 10-K,
contains comments not based upon historical fact. Such forward-looking comments
are based upon information currently available to management and management's
perception thereof as of the date of this Form 10-K. Readers can identify these
forward-looking comments by the use of such verbs as expects, anticipates,
believes or similar verbs or conjugations of such verbs. The actual results of
operations of Kansas City Southern Industries, Inc. ("KCSI" or the " Company")
could materially differ from those indicated in forward-looking comments. The
differences could be caused by a number of factors or combination of factors
including, but not limited to, those factors identified in the Company's Current
Report on Form 8-K dated November 12, 1996 and its Amendment, Form 8-K/A dated
June 3, 1997, which have been filed with the U.S. Securities and Exchange
Commission (Files No. 1-4717) and are hereby incorporated by reference herein.
Readers are strongly encouraged to consider these factors when evaluating any
forward-looking comments. The Company will not update any forward-looking
comments set forth in this Form 10-K.
The discussion herein is intended to clarify and focus on the Company's results
of operations, certain changes in its financial position, liquidity, capital
structure and business developments for the periods covered by the consolidated
financial statements included under Item 8 of this Form 10-K. This discussion
should be read in conjunction with these consolidated financial statements, the
related notes and the Report of Independent Accountants thereon, and is
qualified by reference thereto.
KCSI, a Delaware corporation organized in 1962, is a diversified holding company
with principal operations in rail transportation and financial services. The
Company supplies its various subsidiaries with managerial, legal, tax, financial
and accounting services, in addition to managing other "non-operating" and more
passive investments.
The Company's business activities by industry segment and principal subsidiary
companies are:
Transportation. The Transportation segment consists of all
Transportation-related subsidiaries and investments, including:
* The Kansas City Southern Railway Company ("KCSR"), a wholly-owned
subsidiary of the Company, operating a Class I Common Carrier railroad
system;
* Gateway Western Railway Company ("Gateway Western"), a wholly-owned
subsidiary of KCS Transportation Company ("KCSTC," a wholly-owned
subsidiary of the Company), operating a regional railroad system;
* Southern Group, Inc. ("SGI"), a wholly-owned subsidiary of KCSR, owning
100% of Carland, Inc. and managing the loan portfolio for Southern Capital
Corporation, LLC ("Southern Capital," a 50% owned joint venture);
* Equity investments in Southern Capital, Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. ("Grupo TFM" ), a 37% owned affiliate, Mexrail, Inc.
("Mexrail") a 49% owned affiliate along with its wholly owned subsidiary,
The Texas Mexican Railway Company ("Tex Mex"), and Panama Canal Railway
Company ("PCRC"), a 50% owned joint venture;
* Various other consolidated subsidiaries;
* Kansas City Southern Lines, Inc. ("KCSL"), a wholly-owned subsidiary of the
Company, serving as a holding company for Transportation-related entities;
14
Financial Services. The Financial Services segment consists of all subsidiaries
engaged in the management of investments for mutual funds, private and other
accounts, as well as any Financial Services-related investments. Included are:
* Janus Capital Corporation ("Janus"), an 82% owned subsidiary, diluted;
* Berger Associates, Inc. ("Berger"), a wholly-owned subsidiary;
* Nelson Money Managers plc ("Nelson"), an 80% owned subsidiary
* DST Systems, Inc. ("DST"), an approximate 32% owned equity investment (see
ownership interest discussion below);
* FAM Holdings, Inc. ("FAM HC"), a wholly-owned subsidiary of the Company
formed for the purpose of becoming a holding company for Financial
Services-related subsidiaries and affiliates.
Upon the completion of a public offering of DST common stock and associated
transactions in November 1995, the Company's ownership of DST was reduced from
100% to approximately 41%. As discussed below, the fourth quarter 1998 merger
between a wholly-owned subsidiary of DST and USCS International, Inc. ("USCS")
reduced KCSI's ownership of DST to approximately 32% and resulted in a one-time
pretax non-cash charge of approximately $36.0 million.
All per share information included in this Item 7 is presented on a diluted
basis, unless specifically identified otherwise.
RECENT DEVELOPMENTS
DST Merger. On December 21, 1998, DST and USCS announced the completion of the
merger of USCS with a wholly-owned DST subsidiary. The merger, accounted for as
a pooling of interests by DST, expands DST's presence in the output solutions
and customer management software and services industries. USCS is a leading
provider of customer management software to the cable television and convergence
industries. Under the terms of the merger, USCS became a wholly-owned subsidiary
of DST. DST issued approximately 13.8 million shares of its common stock in the
transaction.
The issuance of additional DST common shares reduced KCSI's ownership interest
from 41% to approximately 32%. Additionally, the Company recorded a one-time
pretax non-cash charge of approximately $36.0 million ($23.2 million after-tax,
or $0.21 per share), reflecting the Company's reduced ownership of DST and the
Company's proportionate share of DST and USCS fourth quarter merger-related
costs. KCSI accounts for its investment in DST under the equity method.
Option to Purchase Mexican Government's Ownership Interest in TFM, S.A. de
C.V. ("TFM"). On January 28, 1999, the Company, along with other direct and
indirect owners of TFM, entered into a preliminary agreement with the Mexican
Government ("Government"). As part of that agreement, an option was granted to
the Company, Transportacion Maritima Mexicana, S.A. de C.V. ("TMM") and Grupo
Servia, S.A. de C.V. ("Grupo Servia") to purchase all or a portion of the
Government's 20% ownership interest in TFM at a discount. The option to purchase
all or a portion of the Government's interest expires on November 30, 1999. If
the purchase of at least 35% of the Government's stock is not completed by May
31, 1999, the entire option will expire on that date. If the option is fully
exercised, the Company's additional cash investment is not expected to exceed
$88 million. As part of this agreement and as a condition to exercise this
option, the parties have agreed to settle the outstanding claims against the
Government regarding a refund of Mexican Value Added Tax (VAT) payments. TFM has
also agreed to sell to the Government a small section of redundant trackage for
inclusion in another railroad concession. In addition, under the terms of the
agreement, the Government would be released from its capital call obligations
(as described below in "Results of Operations") at the moment that the option is
exercised in whole or in part. Furthermore, TFM, TMM, Grupo Servia and the
Company have agreed to sell, in a public offering, a direct or indirect
participation in at least the same percentage currently represented by the
shares exercised in this option, by October 31, 2003, at the latest, subject to
market conditions. The
15
option and the other described agreements are conditioned on the parties
entering into a final written agreement and obtaining all necessary consents and
authorizations.
Planned Separation of the Company Business Segments. As previously disclosed,
the Company announced its intention to separate the Transportation and Financial
Services segments through a proposed dividend of the stock of a new holding
company for its Financial Services businesses (the "Separation"). On February
27, 1998, a filing was made with the Internal Revenue Service ("IRS") requesting
a favorable tax ruling on the proposed Separation. On October 20, 1998, the
Company announced that a favorable ruling on the initial structure proposed to
the IRS was not expected and, accordingly, KCSI withdrew its request for a tax
ruling. As a result, the Separation did not occur during 1998 as previously
contemplated. The Company resubmitted a request for a tax ruling in January
1999. Subject to receipt of a favorable ruling from the IRS and consideration of
other relevant factors, the Separation is expected to occur before the end of
1999.
Additionally, in contemplation of the Separation, the Company's stockholders
approved a reverse stock split at a special stockholders' meeting held on July
15, 1998. The Company will not effect the reverse stock split until the
Separation is completed.
Houston Emergency Service Order. On October 31, 1997 the Surface Transportation
Board ("STB") issued an emergency service order which took effect on November 5,
1997 and extended through August 2, 1998. On July 31, 1998, the STB announced
that it would not extend the emergency service order. This decision provided for
a "45-day wind down" period until September 17, 1998, during which the Tex Mex
continued to provide service under the terms of the emergency service order. As
a result of this emergency service order, Tex Mex revenues increased during
fourth quarter 1997 and through the first three quarters of 1998. However,
expenses associated with accommodating the increase in traffic and
congestion-related problems of the UP system offset this revenue increase.
As previously disclosed, the KCSR and Tex Mex, along with the Texas Railroad
Commission and several shipper advocate groups, filed the Houston Area Consensus
Plan ("Consensus Plan") with the STB during second quarter 1998. The Consensus
Plan sought to provide the Tex Mex with permanent access to the Houston/Gulf
Coast markets and to expand neutral switching to hundreds of shippers. On
December 21, 1998, the STB announced its ruling against the Consensus Plan,
denying the Tex Mex permanent access to the Houston area.
RESULTS OF OPERATIONS
In addition to the developments mentioned above, consolidated operating results
from 1996 to 1998 were affected by the following significant developments.
Acquisition of Nelson. On April 20, 1998, the Company completed its acquisition
of 80% of Nelson, an investment advisor and manager based in the United Kingdom
("UK"). Nelson has six offices throughout the UK and offers planning based asset
management services directly to private clients. Nelson managed approximately
$1.2 billion of assets as of December 31, 1998. The acquisition, accounted for
as a purchase, was completed using a combination of cash, KCSI common stock and
notes payable. The total purchase price was approximately $33 million. The
purchase price is in excess of the fair market value of the net tangible and
identifiable intangible assets received and this excess was recorded as goodwill
to be amortized over a period of 20 years. Assuming the transaction had been
completed January 1, 1998, inclusion of Nelson's results on a pro forma basis,
as of and for the year ended December 31, 1998, would not have been material to
the Company's consolidated results of operations.
16
Marketing Alliance with Canadian National Railway Company ("CN")/Illinois
Central Corporation ("IC"). On April 16, 1998, KCSR, CN and IC announced a
15-year marketing alliance that offers shippers new competitive options in a
rail freight transportation network that links key north-south continental
freight markets. The marketing alliance did not require approval from the STB
and was effective immediately. This alliance connects points in Canada with the
major U.S. Midwest markets of Detroit, Chicago, Kansas City and St. Louis, as
well as key Southern markets of Memphis, Dallas and Houston. It also provide
shippers with access to Mexico's rail system through Grupo TFM.
In addition to providing access to key north-south international and domestic
U.S. traffic corridors, the railways' seek to increase business in existing
markets, primarily automotive and intermodal, but also in other key carload
markets, including those for chemical and forest products. Traffic increases,
although not significant in 1998, have already been evident and Transportation
management expects this alliance to provide opportunities for revenue growth and
position the railway as a key provider of rail service to the North American
Free Trade Agreement ("NAFTA") corridor.
Under a separate access agreement, subject to STB approval of the proposed CN-IC
merger, CN and KCSR plan investments in automotive, intermodal and transload
facilities at Memphis, Dallas, Kansas City and Chicago to capitalize on the
growth potential represented by the marketing alliance. Access to proposed
terminals would be assured for the 25-year life span of the facilities,
regardless of any change in corporate control. Under the terms of this access
agreement, KCSR would extend its rail system in the Gulf area and, in the year
2000, gain access to three additional chemical customers in the Geismar,
Louisiana industrial area, one of the largest chemical production areas in the
world, through a haulage agreement. Management expects this access to provide
additional revenue opportunities for the Company. Prior to this access
agreement, the Company received preliminary STB approval for construction of a
nine-mile rail line from KCSR's main line into the Geismar industrial area,
which the chemical manufacturers requested be built to provide them with
competitive rail service. The Company will continue to hold the option of the
Geismar build-in provided that it is able to obtain the requisite approvals.
Voluntary Coordination Agreement with the Norfolk Southern Railway Company
("Norfolk Southern"). The Company entered into a Voluntary Coordination
marketing agreement with the Norfolk Southern that allows the Company to
capitalize on the east-west corridor between Meridian, Mississippi and Dallas,
Texas through incremental traffic volume gained through interchange with the
Norfolk Southern. This agreement provides the Norfolk Southern run-through
service with access to Dallas and Mexico while avoiding the congested rail
gateways of Memphis, Tennessee and New Orleans, Louisiana. In addition, KCSR and
Norfolk Southern have a new joint intermodal operation at Port Arthur, Texas,
which provides an alternative route for traffic from the Houston market by
utilizing KCSR's rail network.
Termination of the Kansas City Southern Industries, Inc. Employee Plan Funding
Trust ("EPFT" or "Trust"). Effective September 30, 1998, the Company terminated
the EPFT, which was established as a grantor trust for the purpose of holding
shares of KCSI Series B Convertible Preferred Stock ("Series B Preferred Stock")
for the benefit of various KCSI employee benefit plans, including the Employee
Stock Ownership Plan, Stock Option Plans and Employee Stock Purchase Plan
(collectively, "Benefit Plans"). The EPFT was administered by an independent
bank trustee ("Trustee") and included in the Company's consolidated financial
statements.
In 1993, KCSI transferred one million shares of Series B Preferred Stock to the
EPFT for a purchase price of $200 million (based on an independent valuation),
which the Trust financed through KCSI. The indebtedness of the EPFT to KCSI was
repayable over 27 years with interest at 6% per annum, with no principal
payments for the first three years. Principal payments from the EPFT to the
Company of $21.3 million since the date of inception decreased the indebtedness
to $178.7 million, plus accrued interest, on the date of termination. As a
result of these principal payments, 127,638 shares of Series B Preferred
17
Stock were released from the Trust's suspense account and available for
distribution to the Benefit Plans. None of these shares, however, were
distributed prior to termination of the EPFT.
In accordance with the agreement to terminate the EPFT, the Company received
872,362 shares of Series B Preferred Stock in full repayment of the indebtedness
from the Trust. In addition, the remaining 127,638 shares of Series B Preferred
Stock were converted by the Trustee into KCSI Common Stock, at the rate of 12 to
1, resulting in the issuance to the EPFT of 1,531,656 shares of such Common
Stock. This Common Stock was then transferred by the Trustee to KCSI and the
Company has set these shares aside for use in connection with the KCSI 1991
Stock Option and Performance Award Plan, as amended and restated effective July
15, 1998. Following the foregoing transactions, the EPFT was terminated.
The impact of the EPFT termination on the Company's consolidated financial
statements was a reclassification among the components of the stockholders'
equity accounts, with no change in the consolidated assets and liabilities of
the Company.
Restructuring, Asset Impairment and Other Charges. In connection with the
Company's review of its accounts for the year ended December 31, 1997 in
accordance with its established accounting policies, as well as a change in the
Company's methodology for evaluating the recoverability of goodwill during 1997
(as set forth in Note 1 to the consolidated financial statements), $196.4
million of restructuring, asset impairment and other charges were recorded
during fourth quarter 1997. After consideration of related tax effects, these
charges reduced consolidated earnings by $158.1 million, or $1.47 per share. The
charges included:
o A $91.3 million impairment of goodwill associated with KCSR's 1993
acquisition of MidSouth Corporation ("MidSouth"). In response to the
changing competitive and business environment in the rail industry, in 1997
the Company revised its accounting methodology for evaluating the
recoverability of intangibles from a business unit approach to analyzing
each of the Company's significant investment components. Based on this
analysis, the remaining purchase price in excess of fair value of the
MidSouth assets acquired was not recoverable.
o A $38.5 million charge representing long-lived assets held for disposal.
Certain branch lines on the MidSouth route and certain non-operating real
estate were designated for sale. During 1998, one of the branch lines was
sold for a pretax gain of approximately $2.9 million. Efforts are ongoing
to procure bids on the other branch line and non-operating real estate.
o Approximately $27.1 million in reserves related to termination of a union
productivity fund and employee separations. The union productivity fund was
established in connection with prior collective bargaining agreements and
required KCSR to pay employees when reduced crew levels were used. The
termination of this fund has resulted in a reduction of salaries and wages
expense for the year ended December 31, 1998 of approximately $4.8 million.
During 1998, approximately $23.1 million in cash payments reduced these
reserves and approximately $2.5 million of the reserves were reduced based
primarily on changes in the estimate of claims made relating to the union
productivity fund. Approximately $1.5 million of accruals related to the
union productivity fund and employee separations remain at December 31,
1998.
o A $12.7 million impairment of goodwill associated with the Company's
investment in Berger. In connection with the Company's review of the
carrying value of its various assets, management determined that a portion
of the intangibles recorded in connection with the Berger investment were
not recoverable, primarily due to below-peer performance and growth of the
core Berger funds.
o A $9.2 million impairment of assets at Pabtex, Inc. (a subsidiary of the
Company) as a result of continued operating losses and a decline in its
customer base.
o Approximately $17.6 million of other charges and reserves related to
leases, contracts, impaired investments and other reorganization costs.
Based on the Company's review of its assets and liabilities, certain
charges were recorded to reflect recoverability and/or obligation as of
December 31, 1997. During 1998, approximately $8.0 million in cash payments
were made leaving approximately $5.0 million accrued at December 31, 1998.
18
Operating Difficulties of the Union Pacific Railroad. As reported in the press,
the Union Pacific Railroad ("UP") experienced difficulties with its railroad
operations, reportedly linked to its acquisition of the Southern Pacific
Railroad ("SP"). UP is one of KCSR's largest interchange partners. The UP's
difficulties resulted in overall traffic congestion of the U.S. railroad system
and impacted KCSR's ability to interchange traffic with UP, both for domestic
and international traffic (i.e., to and from Mexico). This system congestion
resulted in certain equipment shortages due to KCSR's rolling stock being
retained within the UP system for unusually extended periods of time, for which
UP remits car hire amounts. During the fourth quarter of 1997, KCSR agreed to
accept certain UP trains in diverted traffic to assist in the easing of the UP's
system congestion, resulting in revenues of approximately $3.9 million.
Grupo TFM. As disclosed previously, Grupo TFM, a joint venture of the Company
and TMM, was awarded the right to purchase 80% of the common stock of TFM for
approximately 11.072 billion Mexican pesos (approximately $1.4 billion based on
the U.S. dollar/Mexican peso exchange rate on December 5, 1996). TFM holds the
concession to operate over Mexico's Northeast Rail Lines for 50 years, with the
option of a 50 year extension (subject to certain conditions).
The remaining 20% of TFM was retained by the Government, which has the option of
selling its 20% interest through a public offering, or selling it to Grupo TFM
after October 31, 2003 at the initial share price paid by Grupo TFM plus
interest computed at the Mexican Base Rate (the Unidad de Inversiones (UDI)
published by Banco de Mexico). In the event that Grupo TFM does not purchase the
Government's 20% interest in TFM, the Government may require TMM and KCSI to
purchase the Government's holdings in proportion to each partner's respective
ownership interest in Grupo TFM (without regard to the Government's interest in
Grupo TFM - see below).
On January 31, 1997, Grupo TFM paid the first installment of the purchase price
(approximately $565 million based on the U.S. dollar/Mexican peso exchange rate)
to the Government, representing approximately 40% of the purchase price. This
initial installment of the TFM purchase price was funded by Grupo TFM through
capital contributions from TMM and the Company. The Company contributed
approximately $298 million to Grupo TFM, of which approximately $277 million was
used by Grupo TFM as part of the initial installment payment. The Company
financed this contribution using borrowings under existing lines of credit.
On June 23, 1997, Grupo TFM completed the purchase of 80% of TFM through the
payment of the remaining $835 million to the Government. This payment was funded
by Grupo TFM using a significant portion of the funds obtained from: (i) senior
secured term credit facilities ($325 million); (ii) senior notes and senior
discount debentures ($400 million); (iii) proceeds from the sale of 24.6% of
Grupo TFM to the Government (approximately $199 million based on the U.S.
dollar/Mexican peso exchange rate on June 23, 1997); and (iv) additional capital
contributions from TMM and the Company (approximately $1.4 million from each
partner). Additionally, Grupo TFM entered into a $150 million revolving credit
facility for general working capital purposes. The Government's interest in
Grupo TFM is in the form of limited voting right shares, and the purchase
agreement includes a call option for TMM and the Company, which is exercisable
at the original amount (in U.S. dollars) paid by the Government plus interest
based on one-year U.S. Treasury securities.
In February and March 1997, the Company entered into two separate forward
contracts - $98 million in February 1997 and $100 million in March 1997 - to
purchase Mexican pesos in order to hedge against a portion of the Company's
exposure to fluctuations in the value of the Mexican peso versus the U.S.
dollar. In April 1997, the Company realized a $3.8 million pretax gain in
connection with these contracts. This gain was deferred, and has been accounted
for as a component of the Company's investment in Grupo TFM. These contracts
were intended to hedge only a portion of the Company's exposure related to the
final installment of the purchase price and not any other transactions or
balances.
19
Concurrent with the financing transactions, Grupo TFM, TMM and the Company
entered into a Capital Contribution Agreement ("Contribution Agreement") with
TFM, which includes a possible capital call of $150 million from TMM and the
Company if certain performance benchmarks, outlined in the agreement, are not
met. The Company would be responsible for approximately $74 million of the
capital call. The term of the Contribution Agreement is three years. In a
related agreement between Grupo TFM, TFM and the Government, among others, the
Government agreed to contribute up to $37.5 million of equity capital to Grupo
TFM if TMM and the Company were required to contribute under the capital call
provisions of the Contribution Agreement prior to July 16, 1998. As of July 16,
1998, no additional contributions from the Company were requested or made and,
therefore, the Government did not contribute additional equity capital to Grupo
TFM. The Government also committed that if it had not made any contributions by
July 16, 1998, it would, up to July 31, 1999, make additional capital
contributions to Grupo TFM (of up to an aggregate amount of $37.5 million) on a
proportionate basis with TMM and the Company if capital contributions are
required. Any capital contributions to Grupo TFM from the Government would be
used to reduce the contribution amounts required to be paid by TMM and the
Company pursuant to the Contribution Agreement. As of December 31, 1998 no
additional contributions from the Company have been requested or made.
At December 31, 1998, the Company's investment in Grupo TFM was approximately
$285.1 million. The Company's interest in Grupo TFM is approximately 37% (with
TMM and a TMM affiliate owning the remaining 38.4%). The Company accounts for
its investment in Grupo TFM under the equity method.
See "Recent Developments" above for discussion of the Company's option to
purchase a portion of the Government's interest in TFM.
I&M Rail Link. During 1997, KCSR entered into a marketing agreement with I&M
Rail Link, LLC, which provides KCSR with access to customers (primarily new
grain origins) in the upper Midwest, as well as Chicago and Minneapolis. This
agreement is similar to a haulage rights agreement, but without the restrictions
on traffic. The Company believes this agreement provides KCSR with the ability
to increase its traffic, particularly with respect to agricultural and mineral
products.
Berger Ownership Interest. As a result of certain transactions during 1997, the
Company increased its ownership in Berger to 100% from approximately 80% at
December 31, 1996. In January and December 1997, Berger purchased, for treasury,
the common stock of minority shareholders. Also in December 1997, the Company
acquired additional Berger shares from a minority shareholder through the
issuance of KCSI common stock. In connection with these transactions, Berger
granted options to acquire shares of Berger stock to certain of its employees.
At December 31, 1998, the Company's ownership would have been diluted to
approximately 91% if all of the outstanding options had been exercised. These
transactions resulted in approximately $17.8 million of goodwill, which is being
amortized over 15 years. However, see discussion of impairment of a portion of
this goodwill in "Restructuring, Asset Impairment and Other Charges" above.
The Company's 1994 acquisition of a controlling interest in Berger was completed
under a Stock Purchase Agreement ("Agreement") covering a five-year period
ending in October 1999. Pursuant to the Agreement, the Company may be required
to make additional purchase price payments (up to $36.6 million) based upon
Berger attaining certain incremental levels of assets under management up to $10
billion by October 1999. The Company made no payments under the Agreement during
1998. In 1997 and 1996, the Company made additional payments of $3.1 and $23.9
million, respectively, resulting in adjustments to the purchase price. The
goodwill amounts are amortized over 15 years.
Stock Split and 20% Increase in Quarterly Common Stock Dividend. On July 29,
1997, the Company's Board of Directors ("Board") authorized a 3-for-1 split in
the Company's common stock effected in the form of a stock dividend. The Board
also voted to increase the quarterly dividend 20% to
20
$0.04 per share (post-split). Both dividends were paid on September 16, 1997 to
stockholders of record as of August 25, 1997. Amounts reported in this Form 10-K
reflect this stock split.
Common Stock Repurchases. The Company's Board has authorized management to
repurchase a total of 33 million shares of KCSI common stock under two programs
- - the 1995 program for 24 million shares and the 1996 program for nine million
shares. During 1998, there were no repurchases under these programs. During
1997, the Company purchased approximately 2.9 million shares (post-split) at an
aggregate cost of approximately $50 million. With these transactions, the
Company has repurchased approximately 27.6 million shares of its common shares,
completing the 1995 program and part of the 1996 program. In connection with
these programs, the Company entered into a forward stock purchase contract in
1995 for the repurchase of shares, which was completed during 1997. See
discussion in "Financial Instruments and Purchase Commitments" below.
Gateway Western. KCSTC acquired beneficial ownership of the outstanding stock of
Gateway Western in December 1996. The stock acquired by KCSTC was held in an
independent voting trust until the Company received approval from the STB on the
acquisition effective May 5, 1997. The consideration paid for Gateway Western
(including various acquisition costs and liabilities) was approximately $12.2
million, which exceeded the fair value of the underlying net assets by
approximately $12.1 million. The resulting intangible is being amortized over a
period of 40 years.
Because the Gateway Western stock was held in trust during first quarter 1997,
the Company accounted for Gateway Western under the equity method as a
wholly-owned unconsolidated subsidiary. Upon STB approval of the acquisition,
the Company consolidated Gateway Western in the Transportation segment.
Additionally, the Company restated first quarter 1997 to include Gateway Western
as a consolidated subsidiary as of January 1, 1997, and results of operations
for the year ended December 31, 1997 reflect this restatement.
Under a prior agreement with The Atchison, Topeka & Santa Fe Railway Company,
Burlington Northern Santa Fe Corporation has the option of purchasing the assets
of Gateway Western (based on a fixed formula in the agreement) through the year
2004.
Southern Capital Joint Venture. In October 1996, the Company and GATX Capital
Corporation ("GATX") completed the formation and financing of a joint venture to
perform certain leasing and financing activities. The venture, Southern Capital,
was formed through a GATX contribution of $25 million in cash and a Company
contribution (through KCSR and Carland) of $25 million in net assets, comprising
a negotiated fair value of locomotives and rolling stock and long-term
indebtedness owed to KCSI and its subsidiaries. In an associated transaction,
Southern Leasing Corporation (an indirect wholly-owned subsidiary of the Company
prior to dissolution in October 1996) sold to Southern Capital approximately $75
million of loan portfolio assets and rail equipment.
As a result of these transactions and subsequent repayment by Southern Capital
of indebtedness owed to KCSI and its subsidiaries, the Company received cash
which exceeded the net book value of its assets by approximately $44.1 million.
Concurrent with the formation of the joint venture, KCSR entered into operating
leases with Southern Capital for the majority of the rail equipment acquired by
or contributed to Southern Capital. Accordingly, this excess fair value over
book value is being recognized over the terms of the leases (approximately $4.4
million in 1998 and $4.9 million in 1997).
The cash received by the Company was used to reduce outstanding indebtedness by
approximately $217 million, after consideration of applicable income taxes,
through repayments on various lines of credit and subsidiary indebtedness. The
Company reports its 50% ownership interest in Southern Capital under the equity
method of accounting.
21
1998 and 1997 net income was positively impacted as a result of the Southern
Capital transaction. Reduced depreciation and interest expense, together with
equity earnings from Southern Capital, has more than offset the increase in
fixed lease expense related to the transaction.
Under a prior agreement, GATX had an option to notify the Company of its intent
to cause disposal of the loan portfolio assets of Southern Capital. GATX
exercised its option with regard to this agreement and the Company and GATX are
jointly reviewing options for disposition of these loan portfolio assets. The
portfolio of rail assets would remain with Southern Capital. The disposal of the
loan portfolio assets is not expected to have a material impact on the Company's
results of operations, financial position or cash flows.
DST's Investment in Continuum. On August 1, 1996, The Continuum Company, Inc.
("Continuum"), formerly an approximate 23% owned DST equity affiliate, merged
with Computer Sciences Corporation ("CSC," a publicly traded company) in a
tax-free share exchange. In exchange for its ownership interest in Continuum,
DST received CSC common stock, which DST accounts for as available for sale
securities as defined in Statement of Financial Accounting Standards No. 115
"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115").
As a result of the transaction, the Company's 1996 earnings included
approximately $47.7 million (after-tax), or $0.41 per share, representing the
Company's proportionate share of the one-time gain recognized by DST in
connection with the merger. Continuum ceased to be an equity affiliate of DST,
thereby eliminating any future Continuum equity earnings or losses. DST
recognized equity losses in Continuum of $4.9 million for the first six months
of 1996.
Railroad Industry Trends and Competition. During the period from 1996 to 1998,
the railroad industry has continued to experience ongoing consolidation.
Following the 1995 mergers involving the Burlington Northern, Inc. and Santa Fe
Pacific Corporation ("BN/SF") and the UP and the Chicago and North Western
Transportation Company ("UP/CNW"), in 1996, the UP merged with SP ("UP/SP"). In
1997, CSX Corporation ("CSX") and Norfolk Southern completed negotiations to
purchase parts of Conrail, Inc. ("Conrail"). The STB has approved this
transaction. Finally, in February 1998, the CN announced its intention to
acquire the IC, which is still awaiting STB approval.
The Company believes that KCSR revenues were negatively affected (primarily in
1996 and early 1997) by the UP/SP and BN/SF mergers as a result of the increased
competition which led to diversions of rail traffic away from KCSR lines. The
ongoing impact to KCSR of these mergers, as well as the merger of the CN/IC and
the CSX/Norfolk Southern/Conrail transaction is uncertain. Management believes,
however, that because of its investments and strategic alliances, it is well
positioned to attract additional rail traffic through its "NAFTA Railway."
In addition to competition within the railroad industry, highway carriers
compete with KCSR throughout its operating area. Since deregulation of the
railroad industry, competition has resulted in extensive downward pressure on
freight rates. Truck carriers have eroded the railroad industry's share of total
transportation revenues. However, rail carriers, including KCSR, have placed an
emphasis on competing in the intermodal marketplace, working together to provide
end-to-end transportation of products.
Mississippi and Missouri River barge traffic, among others, also competes with
KCSR in the transportation of bulk commodities such as grains, steel and
petroleum products.
In response to the changing competitive and business environment in the rail
industry, in 1997 the Company revised its accounting methodology for evaluating
the recoverability of intangibles from a business unit approach to analyzing
each of the Company's significant investment components. Based on this analysis,
$91.3 million of the remaining purchase price in excess of fair value of the
MidSouth assets acquired was not recoverable. This charge was recorded as of
December 31, 1997.
22
See "Union Labor Negotiations" below for a discussion of the impact of labor
issues and regulations on competition in the transportation industry.
Berger Joint Venture. During 1996, Berger entered into a joint venture agreement
with Bank of Ireland Asset Management (U.S.) Limited, a subsidiary of Bank of
Ireland, to develop and market a series of international and global mutual
funds. The new venture, named BBOI Worldwide LLC ("BBOI"), is headquartered in
Denver, Colorado. Regulatory approvals were received in October 1996, and the
first no-load mutual fund product - the Berger/BIAM International Fund - was
introduced in fourth quarter 1996. Currently, BBOI manages five funds and assets
under management for these funds totaled $522 million at December 31, 1998
compared with $161 million at December 31, 1997. Berger accounts for its 50%
investment in BBOI under the equity method.
Union Labor Negotiations. Approximately 84% of KCSR employees and 88% of Gateway
Western employees are covered under various collective bargaining agreements.
In 1996, national labor contracts governing the KCSR were negotiated with all
major railroad unions, including the United Transportation Union, the
Brotherhood of Locomotive Engineers, the Transportation Communications
International Union, the Brotherhood of Maintenance of Way Employees, and the
International Association of Machinists and Aerospace Workers. The provisions of
the various labor agreements, which extend to December 31, 1999, generally
include periodic general wage increases, lump-sum payments to workers, and
greater work rule flexibility, among other provisions. These agreements did not
have a material effect on the Company's consolidated results of operations,
financial position or cash flows. As a result of the operating efficiencies
gained by the existing agreements, management believes the Company is better
positioned to compete effectively with alternative forms of transportation.
Railroads continue, however, to be restricted by certain remaining restrictive
work rules and are thus prevented from achieving optimum productivity with
existing technology and systems. Currently, informal discussions are being held
with certain national labor unions with regard to the next labor contract. These
discussions are preliminary and formal negotiations will not begin until
November 1999. Management does not expect that this process or the resulting
labor agreements will have a material impact on its consolidated results of
operations, financial condition or cash flows.
Labor agreements related to former MidSouth employees covered by collective
bargaining agreements reopened for negotiations in 1996. These agreements entail
eighteen separate groups of employees and are not included in the national labor
contracts. KCSR management is currently in the process of meeting with these
unions representing its employees. While these discussions are ongoing, the
Company does not anticipate that this process or the resulting labor agreements
will have a material impact on its consolidated results of operations, financial
condition or cash flows.
The majority of employees of the Gateway Western are covered by collective
bargaining agreements which extend through December 1999. Unions representing
machinists and electrical workers, however, are operating under 1994 contracts
and are currently in negotiations to extend these contracts. Negotiations on the
agreements which extend through December 1999 are expected to begin in late
1999. The Company does not anticipate that this process or the resulting labor
agreements will have a material impact on its consolidated results of
operations, financial condition or cash flows.
KCSR, Gateway and other railroads continue to be affected by labor regulations
which are more burdensome than those governing non-rail industries, such as
trucking competitors. The Railroad Retirement Act requires up to a 23.75%
contribution by railroad employers on eligible wages, while the Social Security
and Medicare Acts only require a 7.65% employer contribution on similar wage
bases. Other programs, such as The Federal Employees Liability Act (FELA), when
compared to worker's compensation laws, vividly illustrate the competitive
disadvantage placed upon the rail industry by federal labor regulations.
23
During 1998, the Brotherhood of Locomotive Engineers and the United
Transportation Union, the two unions representing a majority of the Company's
employees, have agreed to merge. Currently, details of the merged union are
being discussed and determined by the involved parties. The merger of these two
unions is not expected to have a material impact on the Company's results of
operations, financial position or cash flows.
Safety and Quality Programs. During 1997, KCSR continued its implementation of
important safety and quality programs, including an extensive, cross-functional
"Pro-Formance" initiative focusing on continuous improvements in all aspects of
the organization. Because of the continued focus on safety and quality programs,
KCSR has experienced a decline in accident related statistics in recent years;
however reportable injuries increased slightly during 1998. Although total
derailments declined 18% from the period 1996-1998, two significant derailments
experienced during the latter half of 1998 led to an increase in derailment
costs during 1998. One of KCSR management's primary objectives is to operate in
the safest environment possible and efforts are ongoing to improve its safety
experience. "Safety" and "Quality" programs comprise two important ongoing
elements of KCSR management's goal of reducing employee injuries and related
benefits are expected to be recurring in nature and realizable over future
years. Program expenses are not anticipated to have a material impact on
operating results in future years.
INDUSTRY SEGMENT RESULTS
The Company's revenues, operating income and net income by industry segment are
as follows (in millions):
1998(i) 1997(ii) 1996(iii)
----------- ----------- -----------
Revenues
Transportation $ 613.5 $ 573.2 $ 517.7
Financial Services 670.8 485.1 329.6
----------- ----------- -----------
Total $ 1,284.3 $ 1,058.3 $ 847.3
=========== =========== ===========
Operating Income (Loss)
Transportation $ 113.9 $ (92.7) $ 72.1
Financial Services 280.6 199.2 131.8
----------- ----------- -----------
Total $ 394.5 $ 106.5 $ 203.9
=========== =========== ===========
Net Income (Loss)
Transportation $ 38.0 $ (132.1) $ 16.3
Financial Services 152.2 118.0 134.6
----------- ----------- -----------
Total $ 190.2 $ (14.1) $ 150.9
=========== =========== ===========
(i) Includes a one-time non-cash charge of $36.0 million ($23.2 million
after-tax) resulting from the merger of a wholly-owned subsidiary of DST
with USCS. The merger was accounted for by DST under the pooling of
interests method. The charge reflects the Company's reduced ownership of
DST (from 41% to approximately 32%), together with the Company's
proportionate share of DST and USCS fourth quarter merger-related charges.
See Note 2 to the consolidated financial statements in this Form 10-K.
(ii) Includes $196.4 million ($158.1 million after-tax, comprised of $141.9
million -Transportation segment and $16.2 million Financial Services
segment) of restructuring, asset impairment and other charges recorded
during fourth quarter 1997. The charges reflect impairment of goodwill
associated with KCSR's 1993 acquisition of the MidSouth and the Company's
investment in Berger, long-lived assets held for disposal, impaired
long-lived assets, reserves related to termination of a union productivity
fund and employee separations, and other reserves for leases, contracts and
reorganization costs. See Notes 1 and 3 to the consolidated financial
statements in this Form 10-K. Additionally, Transportation results for the
year ended 1997 include revenues and expenses from Gateway Western.
24
(iii)Includes a one-time after-tax gain of $47.7 million representing the
Company's proportionate share of the one-time gain recognized by DST in
connection with the merger of Continuum with CSC (see Note 2 to the
consolidated financial statements in this Form 10-K).
Consolidated net income for 1998 increased to $190.2 million from a consolidated
loss of $14.1 million in 1997. Exclusive of the 1998 and 1997 one-time charges,
consolidated net income grew $69.4 million, or 48%, to $213.4 million from
$144.0 million in 1997, reflecting earnings improvements in both the
Transportation and Financial Services segments. Consolidated revenues for the
year ended December 31, 1998 were $226 million (21%) higher than 1997 as a
result of increases in both segments. Operating income, exclusive of 1997
restructuring, asset impairment and other charges, increased $91.6 million (30%)
year to year, driven by higher revenues as well as improved consolidated
operating margins.
Consolidated 1997 revenues increased $211.0 million over 1996, reflecting
improvements in both the Transportation and Financial Services segments year to
year, as well as the inclusion of Gateway Western revenues. While 1997 total
operating income decreased from 1996 by 48%, operating income exclusive of the
restructuring, asset impairment and other charges increased nearly $100 million,
indicative of a higher rate of revenue growth compared to expenses. The
consolidated loss of $14.1 million for the year ended December 31, 1997 includes
$196.4 million ($158.1 million after-tax) in restructuring, asset impairment and
other charges, as previously discussed. Consolidated net income of $150.9
million for the year ended 1996 includes a one-time gain of $47.7 million
resulting from the Continuum transaction. Exclusive of these amounts,
consolidated net income in 1997 of $144.0 million was $40.8 million, or 40%,
higher than 1996. This increase reflects improvement in ongoing operations for
both the Transportation and the Financial Services segments, primarily from
higher revenues and improved operating margins.
A discussion of each business segment's results of operations follows.
TRANSPORTATION (KCSL)
The following summarizes the income statement components of the Transportation
segment and provides a reconciliation to ongoing domestic Transportation
earnings:
1998 1997 1996
---------- ---------- ----------
Revenues $ 613.5 $ 573.2 $ 517.7
Costs and expenses 442.9 426.1 382.7
Depreciation and amortization 56.7 61.8 62.9
Restructuring, asset impairment
and other charges - 178.0 -
---------- ---------- ----------
Operating income (loss) 113.9 (92.7) 72.1
Equity in net earnings (losses) of
unconsolidated affiliates (2.9) (9.7) 1.5
Interest expense (59.6) (53.3) (52.8)
Other, net 13.7 5.0 7.9
---------- ---------- ----------
Pretax income (loss) 65.1 (150.7) 28.7
Income tax expense (benefit) 27.1 (18.6) 12.4
---------- ---------- ----------
Transportation net income (loss) 38.0 (132.1) 16.3
Restructuring, asset impairment and
other charges, net of tax - 141.9 -
Grupo TFM losses and interest, net of tax 14.3 17.6 -
---------- ---------- ----------
Ongoing domestic Transportation
earnings $ 52.3 $ 27.4 $ 16.3
========== ========== ==========
25
Ongoing domestic Transportation segment earnings increased $24.9 million, or
90.9%, to $52.3 million for the year ended December 31, 1998. This increase
resulted from higher revenues, which grew $40.3 million, or 7.0% (primarily from
a 6.5% increase in revenues at KCSR) and lower operating costs as a percentage
of revenue. The Transportation segment's operating income, exclusive of 1997
restructuring, asset impairment and other charges, increased 33.5% to $113.9
million from $85.3 million in 1997. This increase was driven by improved
operating margins as a result of a slower rate of growth in operating expenses
compared to revenues. Exclusive of depreciation and amortization and 1997
restructuring, asset impairment and other charges, the Transportation segment's
operating costs as a percentage of revenues decreased by more than 2% as a
result of continuing cost containment efforts. The termination of the union
productivity fund resulted in a savings of approximately $4.8 million during
1998 and these savings are expected to continue in the future. Depreciation and
amortization expenses declined $5.1 million, or 8.3%, chiefly due to the
reduction of amortization and depreciation expense of approximately $5.6 million
arising from the impairment of goodwill and certain branch lines held for sale
recorded during December 1997, partially offset by increased depreciation from
property additions. See "Results of Operations" above for further discussion.
Ongoing domestic Transportation segment earnings of $27.4 million for the year
ended December 31, 1997 were compared to $16.3 million for the prior year, an
increase of $11.1 million or 68%. This increase was driven by revenue growth
from $517.7 million to $573.2 million, chiefly due to higher KCSR revenues and
the addition of the Gateway Western, partially offset by the loss of revenues
from Southern Leasing Corporation, which was dissolved in the fourth quarter of
1996. In addition, cost containment initiatives by management in the second half
of 1997 helped to increase operating margins and contributed to higher earnings.
Transportation expenses, exclusive of the restructuring, asset impairment and
other charges, increased $42.3 million, or 9.5% to $487.9 million for 1997
compared with $445.6 million for 1996. The increase was attributable to
operating lease expenses resulting from the Southern Capital transaction and the
inclusion of Gateway Western expenses in 1997 (variable operating expenses were
essentially unchanged year to year). Depreciation and amortization expenses in
1997 for the Transportation segment decreased $1.1 million (1.7%) from 1996 due
to the transfer of assets to Southern Capital during the fourth quarter of 1996,
offset by the inclusion of Gateway Western.
Interest Expense and Other, net
Interest expense for the year ended December 31, 1998 increased $6.3 million, or
11.8%, to $59.6 million as a result of the inclusion of a full year's interest
associated with the debt related to the Company's investment in Grupo TFM,
partially offset by a decrease in average debt balances due to net repayments
and a slight decrease in interest rates relating to the lines of credit.
Additionally during 1997, interest of $7.4 million was capitalized as part of
the investment in Grupo TFM until operations commenced (June 23, 1997). Other,
net increased $8.7 million to $13.7 million for the year ended December 31,
1998. Included in this increase is a one-time gain of $2.9 million (pretax) from
the sale of a branch line and $2.8 million of interest related to a tax refund
in 1998. Other non-operating real estate sales comprised the majority of the
remaining increase.
The 1% increase in 1997 Transportation interest expense (to $53.3 million) is
due to interest associated with the investment in Grupo TFM, together with
interest on Gateway Western indebtedness, offset by debt repayments made at the
end of 1996 associated with the Southern Capital transaction. Capitalized
interest related to the Company's Grupo TFM investment totaled $7.4 million for
the year ended December 31, 1997, which ceased upon gaining operational control
of TFM on June 23, 1997. Other, net decreased $2.9 million, or 36.7%, to $5.0
million for 1997 from $7.9 million in 1996, primarily attributable to the 1996
one-time gain of approximately $2.9 million recorded by KCSR in connection with
the sale of real estate.
Income Taxes
Income taxes increased $45.7 million from a 1997 benefit of $18.6 million to a
$27.1 million expense for the year ended December 31, 1998. This fluctuation
resulted primarily because of the restructuring, asset
26
impairment and other charges in 1997. Exclusive of these charges, income
tax expense from year to year increased by $9.6 million, or 54.8%, primarily due
to higher operating income in 1998.
Income taxes decreased $31.0 million from $12.4 million of expense in 1996 to
$18.6 million of benefit for 1997, primarily as a result of the impact of
restructuring, asset impairment and other charges on pretax income. Exclusive of
these charges, income tax expense for 1997 would have been approximately $17.5
million.
KCSL Subsidiaries
Following is a detailed discussion of the primary subsidiaries and
unconsolidated affiliates comprising the Transportation segment. Results of less
significant subsidiaries have been omitted.
The Kansas City Southern Railway Company
KCSR operates in a nine state region, including Missouri, Kansas, Arkansas,
Oklahoma, Mississippi, Alabama, Tennessee, Louisiana, and Texas. KCSR has the
shortest rail route between Kansas City and the Gulf of Mexico, serving the
ports of Beaumont and Port Arthur, Texas; and New Orleans, Baton Rouge, Reserve
and West Lake Charles, Louisiana. Through haulage rights, KCSR has access to the
states of Nebraska and Iowa and serves the ports of Houston and Galveston,
Texas. Kansas City, Missouri, as the second largest rail center in the United
States, represents an important interchange gateway for KCSR. KCSR also has
interchange gateways in New Orleans and Shreveport, Louisiana; Dallas and
Beaumont, Texas; and Jackson and Meridian, Mississippi.
Major commodities moved by KCSR include coal, grain and farm products,
petroleum, chemicals, paper and forest products, intermodal, as well as other
general commodities. Management believes that KCSR, in conjunction with the
Norfolk Southern, operates the most direct rail route, referred to as the
"Meridian Speedway," linking the Atlanta and Dallas gateways for traffic moving
between the rapidly-growing southeast and southwest regions of the United
States. The "Meridian Speedway" also provides eastern shippers and other U.S.
and Canadian railroads with an efficient connection to the Mexican markets and
has allowed KCSR to be more competitive in transcontinental intermodal
transportation.
For the year ended December 31, 1998, KCSR's contribution to the Company's
consolidated earnings increased $25.6 million to $53.0 million, compared to
$27.4 million (exclusive of restructuring, asset impairment and other charges)
in 1997. This increase was primarily due to a $33.8 million increase in
revenues, partially offset by a $4.0 million increase in variable and fixed
operating costs.
Exclusive of the restructuring, asset impairment and other charges recorded in
fourth quarter 1997, KCSR contributed $27.4 million to the Company's
consolidated earnings compared to $17.1 million in 1996. This increase is
primarily due to a $25.3 million increase in KCSR revenues offset by a lesser
increase in variable and fixed operating costs.
27
Revenues
The following summarizes revenues, carloads and net ton miles of KCSR by
commodity mix:
Carloads and
Revenues Intermodal Units Net Ton Miles
------------------------- ----------------------- -----------------------
(in millions) (in thousands) (in millions)
1998 1997 1996 1998 1997 1996 1998 1997 1996
-------- ------- ------- ----- ----- ----- ------ ------ ------
General commodities:
Chemical and petroleum $ 138.3 $ 133.1 $ 129.0 165.4 162.9 165.9 4,510 4,199 4,070
Paper and forest 108.8 106.4 103.5 172.5 175.8 177.3 3,121 3,072 2,910
Agricultural and mineral 94.7 85.0 75.0 130.8 119.6 113.2 4,574 4,002 3,306
Other 20.2 20.5 18.7 25.4 24.4 22.6 649 913 1,007
-------- ------- ------- ----- ----- ----- ------ ------ ------
Total general commodities 362.0 345.0 326.2 494.1 482.7 479.0 12,854 12,186 11,293
Intermodal 46.3 43.2 40.3 182.6 161.6 149.4 1,325 1,240 1,402
Coal 117.6 102.6 102.5 204.4 177.1 179.6 7,477 6,249 5,735
-------- ------- ------- ----- ----- ----- ------ ------ ------
Subtotal 525.9 490.8 469.0 881.1 821.4 808.0 21,656 19,675 18,430
Other 25.7 27.0 23.5 - - - - - -
-------- ------- ------- ----- ----- ----- ------ ------ ------
Total $ 551.6 $ 517.8 $ 492.5 881.1 821.4 808.0 21,656 19,675 18,430
======== ======= ======= ===== ===== ===== ====== ====== ======
KCSR revenues for 1998 were $551.6 million, a $33.8 million increase over 1997
as a result of higher revenues in all major commodity groups. 1998 coal revenues
increased $15.0 million, or 14.7%, compared to 1997 while intermodal revenues
were 7.3% higher. General commodities, led by an increase of 11.4% in
agricultural and mineral products revenues, improved $17.0 million, or nearly
5%. A portion of increased revenues relate to traffic with Mexico, which
increased approximately 118% during 1998, resulting in an additional $10 million
of revenue. Also, increased carloads resulting from the CN/IC alliance
contributed to the higher revenues.
1997 KCSR revenues were $25.3 million, or 5.1%, higher than 1996 due to a 5.8%
increase in general commodities and a 7.2% increase in intermodal revenues.
Agricultural and mineral products led general commodities with a 13.3% increase
over 1996 comprised primarily of domestic and export grain and food products.
The following is a discussion of KCSR's major commodity groups.
Coal
Coal continues to be the largest single commodity handled by KCSR, which
delivers coal to seven electric generating plants, located at Amsterdam,
Missouri; Flint Creek, Arkansas; Welsh, Texas; Mossville, Louisiana; Kansas
City, Missouri; Pittsburg, Kansas; and Hugo, Oklahoma. Two coal customers,
Southwestern Electric Power Company ("SWEPCO") and Entergy Gulf States (formerly
Gulf States Utility Company), comprised approximately 81%, 82% and 83% of total
coal revenues generated by KCSR in 1998, 1997and 1996, respectively. KCSR also
delivers lignite to an electric generating plant at Monticello, Texas ("TUMCO").
KCSR's contract with SWEPCO, its largest customer, extends through the year
2006. During 1998, coal revenues increased notably over prior years; however,
historically coal revenues have a tendency to equalize on an annual basis.
Coal movements generated $117.6 million of revenue during 1998, a 14.7% increase
over 1997. This 1998 increase resulted from higher unit coal traffic (increase
in carloads of nearly 16%) arising from several factors. 1) In 1998,
unseasonably warm weather resulted in a higher demand for electric power in
certain regions served by the KCSR and several utility customers requested more
coal to handle this increased demand. Additionally, in order to replenish
inventory levels depleted from this excess demand, several locations increased
their coal shipments. 2) During 1997, unit coal revenues were negatively
28
affected by unplanned outages (primarily during first and second quarters) at
several utilities served by KCSR, and first quarter weather problems which
affected carriers and the mines originating the coal. During 1998, the level of
unplanned outages declined and, thus, more unit coal trains were delivered to
customers. Additionally, although KCSR experienced certain weather related
slow-downs due to flooding during fourth quarter 1998, it did not significantly
impact coal revenues. 3) 1998 results reflect a full year of revenues for a
utility customer not served by KCSR until after the first quarter of 1997. Coal
accounted for 22.4% of carload revenues during 1998 compared with 20.9% for
1997.
Coal revenues during 1997 were $102.6 million, virtually unchanged from 1996.
Coal traffic comprised 20.9% of carload revenues and 21.6% of carloads in 1997
compared with 21.9% and 22.2%, respectively, in 1996 indicating the growth
realized in other commodities.
Chemicals and Petroleum
Chemical and petroleum products, serviced via tank and hopper cars primarily to
markets in the Southeast and Northeast through interchange with other rail
carriers, as a combined group represent the largest commodity to KCSR in terms
of revenue. Management expects that revenues in this commodity group could grow
in future years as a result of KCSR's marketing agreement with the CN/IC, which
is expected to provide KCSR access to the manufacturing facilities of BASF
Corporation, Shell Chemical Company and Borden Chemical and Plastics in Geismar,
Louisiana, a large industrial corridor.
Chemical and petroleum revenues increased $5.2 million to $138.3 million in 1998
compared to 1997. Increases in miscellaneous chemicals and soda ash carloads,
coupled with higher revenues per carload for plastic and petroleum products,
were offset by lower carloads for plastics, petroleum products and petroleum
coke. The higher revenues per carload for plastics and petroleum products
resulted from a combination of rate increases and length of hauls, while the
increased miscellaneous chemical and soda ash carloads arose from the continued
strength of these markets. Shipments of plastic products have decreased as a
result of a reduced emphasis on low margin business, while petroleum and
petroleum coke carload declines are a result of economic turmoil overseas
(primarily Asia) affecting the export market. Chemical and petroleum products
accounted for 26.3% of total 1998 carload revenues compared with 27.1% for 1997.
During 1997, chemical and petroleum revenues increased to $133.1 million from
$129.0 million. This $4.1 million increase, or 3.2%, resulted primarily from
increased revenues in plastics, miscellaneous chemical, soda ash and petroleum
shipments offset by reduced petroleum coke shipments. Chemical and petroleum
products accounted for 27.1% of total 1997 carload revenues compared with 27.5%
for 1996.
Paper and Forest
KCSR, whose rail line runs through the heart of the southeastern U.S. timber
producing region, serves eleven paper mills directly (including International
Paper Co. and Georgia Pacific, Riverwood International, among others) and six
others indirectly through short-line connections, and transports pulpwood,
woodchips and raw fiber used in the production of paper, pulp and paperboard.
Paper and forest product revenues increased $2.4 million to $108.8 million for
1998, primarily as a result of increased carloads and revenues per carload for
pulp, paper and lumber products, offset by a reduction in pulpwood chip
shipments. Improved lumber shipments have resulted from the strong home building
and remodeling market in 1998, while pulp/paper increases are primarily a result
of paper mill expansions for several customers served by KCSR. Although paper
and forest revenues increased for 1998, fourth quarter carloads and revenues
decreased compared with fourth quarter of 1997. Paper and forest product
revenues are expected to remain somewhat flat during 1999 due to a reduced
demand for these products and higher current inventories and stockpiles. Paper
and forest traffic comprised 20.7% of carload revenues during 1998 compared to
21.7% in 1997.
Paper and forest products revenues increased $2.9 million, or 2.8%, to $106.4
million for the year ended December 31, 1997 from $103.5 million from the year
ended December 31, 1996 as a result of increased carloads for lumber/plywood and
higher revenues per carload for pulpwood and woodchips offset by
29
decreased pulpwood and woodchips carloads. Paper and forest traffic
comprised 21.7% of carload revenues in 1997 as compared to 22.1% in 1996.
Agricultural and Mineral
Agricultural and Mineral product revenues for the year ended December 31, 1998
were $94.7 million, an increase of $9.7 million, or 11.4%, compared to 1997.
Increased carloads for most agricultural and mineral products, including
domestic and export grain, food, nonmetallic ores, cement, glass and stone
contributed to the increase. Higher revenues per carload, most notably in export
grain and food products, were partially offset by a reduction in revenues per
carload from domestic grain movements. Changes in revenues per carload are
primarily due to mix in the length of haul. A portion of the volume increases
can be attributed to increased traffic flow with Mexico. Over the long-term, the
Company expects to continue to supply carloads of grain to Mexico through Grupo
TFM because of Mexico's reliance on imports of grain to meet its minimum needs.
Agricultural and mineral products comprised 18.0% of carload revenues in 1998
compared with 17.3% in 1997.
Agricultural and mineral products revenues for 1997 increased $10 million, or
13.3%, compared to 1996 primarily as a result of higher carloads of grain,
especially corn, due to a strong harvest. Additionally, carloads of nonmetallic
minerals increased approximately 18% over 1996 volume. Agricultural and mineral
products accounted for 17.3% of carload revenues in 1997 compared with 16% in
1996.
Intermodal
The intermodal freight business consists of hauling freight containers or truck
trailers by a combination of water, rail and motor carriers, with rail carriers
serving as the links between motor carriers and ports. KCSR increased its share
of the U.S. intermodal traffic primarily through the acquisition of the
MidSouth, which extended the Company's east/west line running from Dallas, Texas
to Shreveport, Louisiana to Meridian, Mississippi. During 1997, the Company
committed to a plan to pursue intermodal business based on operating margin
versus growth through carload volume. This strategy continues as the Company
increases its access to the intermodal marketplace through strategic alliances
with the Norfolk Southern and CN/IC.
During 1998, intermodal revenues increased $3.1 million, or 7.3%, over 1997
primarily as a result of higher unit shipments of approximately 13% year over
year, offset partially by a decrease in revenue per unit. Almost all of the 13%
volume growth related to containers. Container shipments have a lower rate per
unit shipped than trailers and, as a result revenues per unit shipped declined.
Container movements, however, also have more favorable profit margins due to
their lower inherent cost structure compared to trailers. Intermodal revenues
accounted for 8.8% of carload revenues in both 1998 and 1997.
Intermodal revenues for 1997 of $43.2 million increased $2.9 million, or 7.2%
from 1996 revenues of $40.3 million primarily as a result of increased units
shipped, offset by a slight decrease in revenue per unit. Revenues from United
Parcel Service of America, one of KCSR's largest customers, declined slightly
due to the International Brotherhood of Teamsters strike in August 1997;
however, the strike's overall impact on KCSR's operating results and financial
condition was not material. Intermodal traffic accounted for 8.8% of carload
revenues in 1997 compared with 8.6% in 1996.
Certain segments of KCSR's freight traffic, especially intermodal, face highly
price and service sensitive competition from trucks, although management
believes recent improvements in railroad operating efficiencies are lessening
the truckers' cost advantages. Trucks are not obligated to provide or to
maintain rights of way and do not have to pay real estate taxes on their routes.
In prior years, the trucking industry diverted a substantial amount of freight
from the railroads as truck operators' efficiency over long distances increased.
Because fuel costs constitute a larger percentage of the trucking industry's
costs, declining fuel prices disproportionately benefit trucking operations as
compared to railroad operations. Changing regulations, subsidized highway
improvement programs and favorable labor regulations have improved the
competitive position of trucks as an alternative mode of surface transportation
for many commodities. In recent years, railroad industry management has sought
avenues for improving its competitive positions and forged alliances with truck
companies in order to move more traffic by rail and provide faster, safer and
more
30
efficient service to its customers. KCSR has streamlined its intermodal
operations in the last few years, making its service competitive both in price
and service with trucking, and has entered into agreements with several trucking
companies for through train intermodal service between Dallas and Meridian. KCSR
has increased its intermodal traffic through its connections with eastern
railroads.
Other
KCSR's remaining freight business consists of scrap and slab steel, waste,
military equipment and automobiles. Other revenues accounted for 3.8% of carload
revenues during 1998, 4.2% during 1997, and 4.0% in 1996 with no material
variances. During the year ended December 31, 1997, KCSR accepted only a minimal
amount of diverted UP trains as a result of traffic congestion, resulting in
approximately $3.9 million in revenue. Revenue from these diverted trains was
recorded in other miscellaneous revenues, not in other carload revenues.
Costs and Expenses
The following table summarizes KCSR's operating expenses (dollars in millions):
1998 1997 1996
--------- -------- --------
Salaries, wages and benefits $ 168.9 $ 173.6 $ 173.2
Fuel 31.9 34.7 32.3
Material and supplies 33.9 30.9 29.6
Car hire 9.8 3.6 7.4
Purchased services 38.1 35.5 33.8
Casualties and insurance 27.0 21.4 23.1
Operating leases 56.5 56.8 40.1
Depreciation and amortization 50.6 54.7 59.1
Restructuring, asset impairment and other charges - 163.8 -
Other 25.0 26.5 19.8
--------- -------- --------
Total $ 441.7 $ 601.5 $ 418.4
========= ======== ========
General
For the year ended December 31, 1998, KCSR's costs and expenses increased $4.0
million compared with 1997, exclusive of restructuring, asset impairment and
other charges recorded during fourth quarter 1997, primarily as a result of
increased materials and supplies, car hire, purchased services, and casualties
and insurance, largely offset by decreased salaries, wages and benefits, fuel
costs and depreciation and amortization. Salaries, wages and benefits and
depreciation and amortization expenses declined as expected primarily as a
result of the restructuring, asset impairment and other charges as discussed in
the "Results of Operations" above. Fuel costs decreased due to lower fuel prices
somewhat offset by higher usage.
1998 KCSR variable operating expenses declined 1.5% as a percentage of revenues,
exclusive of 1997 restructuring, asset impairment and other charges. This
improvement relates to the increase in revenues and the continuation of
management's cost control initiatives.
Exclusive of restructuring, asset impairment and other charges of $163.8 million
in 1997, total costs and expenses would have increased only $19.3 million, or
4.6% over 1996, primarily as a result of increased fuel costs and operating
lease expenses. Diesel fuel usage increased due to both an increase in ton miles
and carloads, while fuel prices were essentially unchanged. Costs related to
fixed equipment operating leases increased as a result of the Southern Capital
transaction (note, however, that the Company records equity earnings from
Southern Capital which partially mitigates this increase).
31
Overall, 1997 KCSR variable operating expenses, exclusive of restructuring,
asset impairment and other charges, declined 2.9% as a percentage of revenues
from 1996 indicative of a higher rate of growth for KCSR revenues than costs.
The improved cost structure resulted from cost containment initiatives
implemented by management. Improvements in variable expenses were somewhat
offset by increases in fixed expenses, primarily related to lease expenses
associated with Southern Capital in the fourth quarter of 1996, as discussed
above.
Fuel
KCSR locomotive fuel usage represented 7.2% of KCSR operating expenses in 1998 (
7.9% in 1997, exclusive of restructuring, asset impairment and other charges).
1998 fuel costs declined $2.8 million, or 8.1%, arising from a 15% decrease in
average fuel cost per gallon (primarily due to market driven factors) partially
offset by an increase in fuel usage of 9%.
Fuel costs are affected by traffic levels, efficiency of operations and
equipment, and petroleum market conditions. Control of fuel expenses is a
constant concern of management, and fuel savings remains a top priority. To
control fuel costs, based on favorable market conditions at the end of 1995, the
Company entered into purchase commitments for approximately 50% of expected 1996
diesel fuel usage. As a result of increasing fuel prices during 1996, these
commitments saved KCSR approximately $3.7 million. Due to higher fuel prices,
minimal commitments were made for 1997. At the end of 1997, the Company entered
into purchase commitments for approximately 27% of its expected 1998 diesel fuel
usage, as well as hedge transactions (fuel swaps) for approximately 37% of its
expected 1998 usage. As a result of fuel prices remaining below the committed
price during 1998, these purchase commitments resulted in a higher cost of
approximately $1.7 million. Additionally, the Company made payments of
approximately $2.3 million relating to the fuel swap transactions as a result of
actual fuel prices remaining lower than the swap price.
At December 31, 1998, the Company has entered into purchase commitments for
approximately 32% of its expected 1999 usage. Further, the Company has entered
into fuel swap transactions for approximately 16% of expected 1999 usage. See
"Financial Instruments and Purchase Commitments" for further information.
Roadway Maintenance
Portions of roadway maintenance costs are capitalized and other portions
expensed (as components of material and supplies, purchased services and other),
as appropriate. Expenses aggregated $40, $47 and $51 million for 1998, 1997 and
1996, respectively. Maintenance and capital improvement programs are in
conformity with the Federal Railroad Administration's track standards and are
accounted for in accordance with applicable regulatory accounting rules.
Management expects to continue to fund roadway maintenance expenditures with
internally generated cash flows.
Car Hire
Expenses for car hire payable, net of receivables increased $6.2 million for the
year ended December 31, 1998 compared to 1997. This increase in net expense
results from a change in equipment utilization (i.e. as certain leases expire,
KCSR is electing to use more foreign cars rather than renewing the lease and
switching fixed payment leases to utilization leases), increased carloads, track
congestion (primarily weather-related in third and fourth quarter) and decreased
amounts of car hire receivable, primarily due to the easing of the UP congestion
prevalent in 1997. A portion of the increased car hire costs were offset by a
decrease in related operating lease expenses as a result of these changes in
equipment utilization.
Expenses for car hire payable, net of receivables declined $3.8 million, or
51.3% for the year ended December 31, 1997 compared to 1996. This reduction in
net expense results from several factors including better fleet utilization and
increased amounts of car hire receivable related to KCSR owned equipment
utilization on foreign railroads. This was particularly evident as a result of
the congestion difficulties of the UP where KCSR equipment was held on UP lines
for longer than normal periods.
32
Casualties and Insurance
1998 casualties and insurance expense increased $5.6 million, or 26.2%, over
1997, primarily as a result of $3.7 million in higher derailment related costs
experienced during the latter half of 1998, as well as an increase in personal
injury related expenses. A primary objective of KCSR is to operate in the safest
environment possible and efforts are ongoing to improve its safety experience.
Casualties and insurance expense declined $1.7 million, or 7.4% to $21.4 million
for the year ended December 31, 1997 compared to $23.1 million in 1996. The
reduction in casualties and insurance costs from 1996 resulted from lower
derailment costs and reduced injuries, in part, caused by KCSR ongoing safety
initiatives.
Depreciation and amortization
For the year ended December 31, 1998, KCSR depreciation and amortization expense
declined $4.1 million, or 7.5%, to $50.6 million, primarily as a result of the
reduction of amortization and depreciation expense of approximately $5.6 million
arising from the impairment of goodwill and certain branch lines held for sale
recorded during December 1997, the effect of which was not realized until 1998.
See discussion above in "Results of Operations." This decline was partially
offset by increased depreciation from property additions.
KCSR depreciation and amortization expense declined $4.4 million, or 7.4% to
$54.7 million for the year ended December 31, 1997 from $59.1 million from the
year ended December 31, 1996, primarily due to the transfer of assets to
Southern Capital during the fourth quarter of 1996, offset by 1997 capital
expenditures.
Operating Income and Operating Ratio
Exclusive of 1997 restructuring, asset impairment and other charges, KCSR's
operating income increased $28.6 million, or 33.5%, to $113.9 million in 1998
from $85.3 million in 1997. This improved operating income, which was driven by
increased revenues and the continued containment of operating expenses, resulted
in a 1998 operating ratio of 79.9% compared with 83.4% in 1997 (exclusive of
restructuring, asset impairment and other charges). The operating ratio is a
common efficiency measurement among Class I railroads and management expects to
maintain its operating ratio below 80%, despite its substantial use of lease
financing for its locomotives and rolling stock.
Exclusive of the restructuring, asset impairment and other charges in 1997,
operating income increased $6.0 million, or 8.1%, from 1996, reflecting the
impact of KCSR's increased revenues and reduced costs. These improvements were
reflected in an improved KCSR operating ratio of 83.4% for the year ended
December 31, 1997, which is below the 84.5% operating ratio for 1996. This
reflects the marked improvement made during the last six months of 1997 in which
the average operating ratio was 79.3%, as a result of increased margins arising
primarily from cost containment initiatives by management.
KCSR Interest
For the year ended December 31, 1998, interest expense decreased 6%, to $35.6
million from $37.9 million in 1997. This decrease primarily reflects the
reduction in average debt balances during the year as a result of debt
repayments.
Interest expense decreased $11.5 million, or 23.3%, to $37.9 million in 1997
from $49.4 million in 1996 due to a full year's impact of the debt reduction
associated with the Southern Capital transaction.
Gateway Western
For the year ended December 31, 1998, Gateway Western contributed $4.1 million
to the Company's net income, a $1.1 million increase ( 36.7%) over the $3.0
million contributed in 1997. Freight revenues increased $2.5 million to $45.2
million from $42.7 million in 1997, while operating expenses increased
33
about $0.9 million to $36.1 million. These results helped lower Gateway
Western's operating ratio to 79.9% for 1998 from 82.4% in 1997.
At December 31, 1996, while the Company awaited approval from the STB of KCSI's
purchase, Gateway Western was accounted for under the equity method as a
majority-owned unconsolidated subsidiary.
Unconsolidated Affiliates
During 1998 and 1997, the Transportation segment's unconsolidated affiliates
were comprised primarily of Grupo TFM, Mexrail, and Southern Capital. The PCRC
has yet to begin operations. During 1996, the two primary unconsolidated
affiliates were Mexrail and Southern Capital.
For the year ended December 31, 1998, the Transportation segment recorded equity
in net losses of $2.9 million from unconsolidated affiliates compared to equity
in net losses of $9.7 million in 1997. The majority of this improvement relates
to the operations of Grupo TFM. In 1998, equity in net losses related to Grupo
TFM were $3.2 million compared to equity in net losses of $12.9 million in 1997
(for the period from June 23, 1997 to December 31, 1997). This improvement in
Grupo TFM is primarily attributable to higher revenues and operating income,
coupled with a higher tax benefit associated with the devaluation of the peso
(on a U.S. GAAP accounting basis) and one-time impact of a $10 million bridge
loan fee in 1997. Equity in net losses from Mexrail were $2.0 million in 1998
compared with equity in net earnings of $0.9 million in 1997. Tex Mex revenues
increased during the first three quarters of 1998 as a result of the Emergency
Service Order; however, expenses associated with accommodating the increase in
traffic and congestion-related problems of the UP system offset this revenue
growth. In 1998, equity in net earnings from Southern Capital was $2.0 million
compared with $2.1 million in 1997.
For the year ended December 31, 1997, the Transportation segment recorded a loss
of $9.7 million from unconsolidated affiliates compared to income of $1.5
million for 1996. In 1997, estimated losses of $12.9 million (from June 23,
1997, excluding interest) related to Grupo TFM were partially offset by equity
in earnings from Southern Capital and Mexrail. Grupo TFM experienced higher than
expected revenues during 1997 based on increased carloads, offset by higher
operating expenses necessary to maintain expected customer service levels. Grupo
TFM's results included a write-off of a bridge loan commitment fee during 1997
(of which the Company recorded $2.6 million as its proportionate share).
Grupo TFM
Similar to KCSR, Grupo TFM's subsidiary, TFM, derives its freight revenues from
a wide variety of commodity movements, including chemical and petroleum,
automotive, food and grain, manufacturing industry, metals, minerals and ores
and intermodal. For the year ended December 31, 1998, revenues improved to
$431.3 million from $206.4 million for the initial period of operations (June
23, 1997 - December 31, 1997) with average monthly revenues increasing
approximately 8%. In addition, during 1998 Grupo TFM management was able to
successfully implement cost reduction strategies while continuing to increase
revenues, thus improving operating income. Most notably, salaries and wages
declined due to headcount reductions while locomotive fuel expense decreased due
to favorable fuel prices. Evidence of these improvements is reflected in TFM's
1998 operating ratio, which improved to 85.5% from approximately 94% for 1997.
Grupo TFM management believes this trend will continue in 1999 as expenses are
expected to continue to decline as a percentage of revenues through effective
cost control measures and more efficient operations. As an example, salaries and
wages are expected to decrease further during 1999 as TFM continues to improve
its operating efficiency and reduce headcount.
34
Other Transportation-Related Affiliates and Holding Company Components
Other subsidiaries in the Transportation segment include:
* Trans-Serve, Inc., an owner of a railroad wood tie treating facility;
* Pabtex (located in Port Arthur, Texas with deep water access to the Gulf of
Mexico), an owner and operator of a bulk materials handling facility which
stores and transfers coal and petroleum coke from trucks and rail cars to
ships and barges primarily for export;
* Mid-South Microwave, Inc., which owns and leases a 1,600 mile industrial
frequency microwave transmission system that is the primary communications
facility used by KCSR;
* Rice-Carden Corporation and Tolmak, Inc., both owning and operating various
industrial real estate and spur rail trackage contiguous to the KCSR
right-of-way;
* Southern Development Company, the owner of the executive office building in
downtown Kansas City, Missouri used by KCSI and KCSR;
* Wyandotte Garage Corporation, an owner and operator of a parking facility
located in downtown Kansas City, Missouri used by KCSI and KCSR; and
* KCSL, a wholly-owned subsidiary of the Company, serving as a holding
company for Transportation-related entities.
1998 contributions to net income from other Transportation-related affiliates
and KCSL increased $10.0 million from 1997, primarily as a result of the asset
impairment charges recorded during fourth quarter 1997 as discussed below.
Exclusive of these charges, contributions to net income increased approximately
$1.0 million.
During 1997, contributions to net income from other Transportation-related
affiliates decreased $12.4 million, primarily as a result of $14.2 million of
asset impairment charges recorded during fourth quarter 1997 relating to Pabtex
and certain real estate. In addition, Pabtex continued to experience decreased
revenues resulting from the loss of petroleum coke customers.
TRANSPORTATION SEGMENT TRENDS and OUTLOOK
Assuming no major economic deterioration occurs in the region serviced by the
Company's Transportation segment, management expects the NAFTA Railway to
continue to have an attractive service offering for shippers. KCSR and Gateway
Western 1999 carloads and revenues are expected to increase over 1998 levels and
management expects to realize continued benefits from traffic with Mexico and
the KCSR/CN/IC alliance. Variable costs are expected to continue at levels
proportionate with revenues, assuming continued success of cost containment
efforts.
The Company expects to record equity in net earnings from its investment in
Grupo TFM during 1999. Initial projections did not anticipate recording equity
in net earnings until 2000. Revenues have continued to grow since inception
(June 23, 1997) and are expected to continue to grow during 1999. Costs were
reduced significantly during 1998 compared to 1997 levels, resulting in higher
operating profit. The anticipated equity in net earnings of Grupo TFM for 1999
will be offset by interest expense associated with the debt related to the
Company's investment in Grupo TFM, which is expected to result in an overall net
loss related to the Company's investment in Grupo TFM. These expected results
for Grupo TFM are based on current projections on the valuation of the peso for
1999. Management does not make any assurances as to the impact that a change in
the value of the peso will have on the results of Grupo TFM. See "Foreign
Exchange Matters" below and Item 7(A), Quantitative and Qualitative Disclosures
About Market Risk, of this Form 10-K for further information. Management also
expects to record equity in net earnings from its Southern Capital and Mexrail
investments during 1999. Similar to Grupo TFM, Mexrail's expected equity
earnings are expected to be offset by interest expense and amortization and
result in a slight overall net loss related to the Company's investment in
Mexrail.
35
FINANCIAL SERVICES
The Financial Services segment ("Financial Services") contributed $152.2 million
to the Company's consolidated earnings in 1998 versus $118.0 million in 1997.
Exclusive of the one-time items recorded in both years as discussed in the
"Results of Operations" section above, earnings were $36.6 million (27%) higher
than 1997. Revenues increased $185.7 million, or 38%, over 1997, leading to
higher operating income. While operating income increased, efforts to ensure an
adequate infrastructure to provide for consistent, reliable and accurate service
to investors caused a decrease in operating margins in 1998, from 45% for the
year ended December 31, 1997 to 42% for 1998. Total assets under management
increased $41.9 billion (59%) during 1998, reaching $113.5 billion at December
31, 1998. Janus and Berger shareowner accounts exceeded three million as of
December 31, 1998, a 12% increase over 1997.
Financial Services contributed $118.0 million to the Company's consolidated
results in 1997, a $16.6 million decline from 1996. Exclusive of certain
one-time items in both years as discussed in "Results of Operations" above,
however, earnings improved 54%. Revenues increased $155.5 million over 1996,
leading to higher operating income and improved operating margins. Operating
margins increased from 40% for the year ended December 31, 1996 to 45% for 1997.
Assets under management increased 42% during 1997, reaching $71.6 billion at
December 31, 1997. Further, Janus and Berger shareowner accounts neared 2.7
million as of December 31, 1997.
The following table highlights key information:
1998 1997 1996
Assets Under Management (in billions):
JANUS
Janus Investment Funds (i) $ 75.9 $ 47.5 $ 33.2
Janus Aspen Series (ii) 6.2 3.3 1.4
Janus World Funds (iii) 0.1 - -
Janus Money Market Funds 4.8 3.8 2.5
Subadvised and private accounts 21.3 13.2 9.6
------------- -------------- -------------
Total Janus 108.3 67.8 46.7
------------- -------------- -------------
BERGER
Berger No-Load Funds 3.3 3.3 3.2
Subadvised and private accounts 0.7 0.5 0.4
------------- -------------- -------------
Total Berger 4.0 3.8 3.6
------------- -------------- -------------
NELSON 1.2 - -
------------- -------------- -------------
Total Assets Under Management $ 113.5 $ 71.6 $ 50.3
============= ============== =============
(i) Excludes money market funds
(ii) The Janus Aspen Series consists of eleven portfolios offered through
variable annuity and variable life insurance contracts, and certain
qualified pension plans
(iii)Janus World Funds PLC is a group of Ireland-domiciled funds introduced in
December 1998.
36
1998 1997 1996
Operating Results (in millions):
Revenues:
Janus $ 626.2 $ 450.1 $ 295.3
Berger 33.5 34.9 34.6
Other 11.1 0.1 (0.3)
------------- -------------- -------------
Total $ 670.8 $ 485.1 $ 329.6
============= ============== =============
Operating Income (Loss):
Janus $ 294.1 $ 224.4 $ 136.6
Berger 0.4 (14.3) 5.7
Other (13.9) (10.9) (10.5)
------------- -------------- ------------
Total $ 280.6 $ 199.2 $ 131.8
============= ============== =============
Net Income (Loss):
Janus $ 161.4 $ 117.7 $ 70.3
Berger (3.2) (17.8) (1.2)
Other (6.0) 18.1 65.5
------------- -------------- ------------
Total $ 152.2 $ 118.0 $ 134.6
============= ============== =============
Increases in Financial Services revenue and operating income are a direct result
of growth in assets under management. Assets under management and shareholder
accounts have grown in recent years from a combination of new money investments
(i.e., fund sales) and market appreciation. Fund sales have risen in response to
marketing efforts, favorable fund performance, introduction and market reception
of new products, and the current popularity of no-load mutual funds. Market
appreciation has resulted from increases in investment values.
Following is a detailed discussion of the operating results of the primary
subsidiaries comprising the Financial Services segment.
Janus Capital Corporation
1998
In 1998, assets under management increased 59.7% to $108.3 billion as a result
of net sales of $13.4 billion and $27.1 billion in market appreciation.
Approximately $87.0 billion was invested in the Janus Investment Funds
(including money market funds), the Janus Aspen Series and the Janus World
Funds, with the remainder held by sub-advised and private accounts. Equity
portfolios comprised 94% of total assets under management at December 31, 1998.
Excluding money market funds, 1998 net sales of the Janus Investment Funds,
Janus Aspen Series and Janus World Funds were $11.3 billion and net sales of
sub-advised and private accounts totaled $1.6 billion. Total Janus shareowner
accounts increased 353,000, or 15%, to 2.7 million.
Janus' revenues, derived largely from fees based upon a percent of assets under
management, increased $176.0 million (39%) to $626.2 million in 1998, driven by
the significant growth in assets under management year to year.
Exclusive of $2.7 and $2.2 million in amortization costs attributed to Janus in
1998 and 1997, respectively, operating expenses increased 47% from $223.5
million in 1997 to $329.4 million in 1998. This increase reflects the
significant growth in assets under management and revenues, as well as Janus'
efforts to
37
develop its infrastructure to ensure consistent quality of service.
Approximately 47% of Janus' 1998 operating expenses were variable (e.g.,
incentive compensation, mutual fund supermarket fees, etc.), 19% were
discretionary (principally marketing, pension plan contributions, etc.) and the
remainder fixed.
A brief discussion of key expense increases follows:
o Employee compensation and benefits increased $45 million, or 40%, in 1998
compared to 1997 due to an increased number of employees (including senior
investment management, marketing and administration employees, as well as
additional shareholder servicing and technology support personnel) and
incentive compensation. Incentive compensation increased principally due to
growth in assets under management combined with strong investment
performance. In particular, portfolio management incentive compensation --
formulated to reward top investment performance -- approached its highest
possible rate in 1998 as a result of more than 93% of assets under
management ending 1998 in the top quartile of investment performance
compared to their respective peer groups (as defined pursuant to
compensation agreements).
o Alliance and mutual fund supermarket fees increased 65% in 1998 to $62.3
million. This increase was principally due to an increase in assets under
management being distributed through these channels, from $19.0 billion at
December 31, 1997 to $32.3 billion at December 31, 1998.
o Marketing, promotional and advertising expenditures increased $17.5 million
during 1998 to capitalize on generally favorable market conditions, to
respond to market volatility and to continue establishing the Janus brand.
o Depreciation and amortization increased $2.3 million in 1998 compared to
1997 due to increased infrastructure spending as discussed below.
1997
Assets under management increased 45% during 1997 to $67.8 billion as a result
of net fund sales of $10.7 billion and market appreciation of $10.4 billion.
Approximately $54.6 billion was invested in the Janus Investment Funds and the
Janus Aspen Series, with the remainder held by sub-advised and private accounts.
Equity portfolios comprised 92% of total assets under management at December 31,
1997. Total shareowner accounts grew 10% during 1997 to 2.4 million.
Driven by the increase in assets under management from 1996 to 1997, Janus
revenues improved 52% during 1997. Additionally, as a result of a slower rate of
growth in expenses compared to revenues during 1997, operating margins improved
to 50% versus 46% in 1996. Approximately 43% of Janus' 1997 operating expenses
consisted of variable costs, 18% were discretionary and the remainder
represented fixed costs. The following discussion highlights changes in key
expense categories.
o Salaries and wages increased year to year, primarily from a higher number
of employees in 1997 compared to 1996 and variable compensation tied to
investment and financial performance.
o Alliance and mutual fund supermarket fees were higher in 1997 as a result
of a greater amount of assets being distributed through these channels --
approximately 28% of Janus' December 31, 1997 assets under management were
generated through these distribution arrangements compared to 23% as of
December 31, 1996.
General
The 60% and 45% increases in assets under management in 1998 and 1997,
respectively, are attributable to several factors including, among others: (i)
strong securities markets, particularly equities; (ii) strong investment
performance across all of Janus' products; (iii) strategic marketing and public
relations; (iv)
38
effective use of third party distribution channels for both
retail and sub-advised products; and (v) a strong brand awareness.
During December 1998, Janus introduced the Janus World Funds PLC ("Janus
World"), a group of offshore multiclass funds modeled after certain of the Janus
Investment Funds and domiciled in Dublin, Ireland. There are currently seven
investment portfolios offered for sale, including two equity portfolios, three
fixed income portfolios, a balanced portfolio and a money market portfolio.
Total assets at December 31, 1998 were $66 million. More than 80% of sales were
made into the funds' class B shares, which require Janus to advance sales
commissions to various financial intermediaries. Payment of these commissions,
although currently minor in relation to Janus' investment holdings, may impact
future liquidity and cash resources.
Janus introduced the following domestic funds during the three year period
ended December 31, 1998:
o 1998 - Janus Global Technology Fund; Janus Global Life Sciences Fund; Janus
Aspen Growth and Income Portfolio
o 1997 - Janus Aspen Capital Appreciation Portfolio; Janus Aspen Equity
Income Portfolio
o 1996 - Janus Aspen High Yield Portfolio; Janus Equity Income Fund; Janus
Special Situations Fund
In 1998 and 1997, Janus spent $41 and $11 million, respectively, on its
infrastructure to ensure uninterrupted service to shareholders; to provide
up-to-the-minute investment and securities trading data; to improve operating
efficiency; to integrate information systems; and to obtain additional physical
space for expansion. These efforts produced, among other things:
o an enterprise-wide reporting system, producing more efficient and timely
management reporting and allowing full integration
of portfolio management, human resources, budgeting and financial systems;
o a second investor service and data center opened in Austin, Texas in 1998,
including redundant data and telephone connections to allow the facility to
operate in the event that Denver facilities and personnel become
unavailable;
o an upgrade of Janus' web site, providing shareholders the opportunity to
customize their personal Janus home page and to process most transactions
on-line; and
o improvements of physical facilities, producing a more efficient workspace
and allowing Janus to accommodate additional growth and technology.
Berger Associates, Inc.
1998
Berger reported 1998 net earnings of $3.9 million compared to $4.3 million in
1997, exclusive of interest and amortization charges attributed to Berger in
both years and the 1997 one-time charges discussed in "Results of Operations"
above. Including the interest and amortization charges in both years, Berger
reported a net loss of $3.2 million in 1998 versus a loss of $3.5 million in
1997 (exclusive of the 1997 one-time charges). Total assets under management
held by the Berger Complex of funds increased to $4.0 billion as of December 31,
1998, a 5% increase over comparable 1997. This increase was attributable to
market appreciation of $0.9 billion, largely offset by net redemptions of $0.7
billion. While total Berger shareowner accounts decreased approximately 13%
during 1998, primarily within the Berger 100 Fund, the number of accounts in the
funds introduced during 1997 and 1998 increased 88% year to year. These
fluctuations in shareholder accounts generally are indicative of recent
performance compared to peer groups.
As a result of fluctuations in the level of assets under management throughout
1998, revenues decreased approximately 4% in 1998 from 1997. Berger's 1998
operating expenses were essentially even with 1997. While reductions in
marketing costs resulted from a more targeted advertising program, these savings
were offset by higher salaries and wages resulting from an increased average
39
number of employees during 1998 versus 1997. Amortization expense attributed to
Berger was lower in 1998 due to reduced goodwill from the 1997 impairment
discussed previously.
Berger recorded $1.5 million in equity earnings from its joint venture
investment, BBOI, for the year ended December 31, 1998 compared to $0.6 million
in 1997. This increase reflects continued growth in BBOI assets under
management, which totaled $522 million at December 31, 1998 versus $161 million
at December 31, 1997.
1997
Berger reported net earnings of $4.3 million in 1997 compared to $5.2 million in
1996, excluding interest and amortization charges attributed to Berger in both
years and the one-time 1997 charges. Including interest and amortization, Berger
reported net losses of $3.5 and $1.2 million in 1997 and 1996, respectively.
Assets under management increased to $3.8 billion at December 31, 1997 from $3.6
billion at December 31, 1996. Shareholder accounts declined 16% from 1996,
totaling 317,400 at December 31, 1997. This decrease generally reflects
shareholder reaction to below-peer performance by certain of the larger funds.
Due to higher average assets under management during 1997, Berger experienced a
slight increase in revenues year to year. Operating costs, however, increased
more than revenues thereby resulting in a higher net loss than prior year.
Higher expenses (e.g., consulting fees and advertising) reflected Berger's
efforts to enhance product awareness and acceptance. Additionally, during 1997,
the Company increased its ownership in Berger to 100% through several
transactions by Berger and the Company. The Company recorded approximately $17.8
million in goodwill as a result of these transactions. Accordingly, amortization
expense was higher in 1997 than in 1996.
In connection with the Company's review of the recoverability of its assets, the
Company determined that $12.7 million of goodwill associated with Berger was not
recoverable as of December 31, 1997, primarily due to below-peer performance and
growth of the core Berger funds. Accordingly, a portion of the goodwill recorded
in connection with the repurchase of Berger minority interest was charged to
expense.
General
During 1998 and 1997, Berger introduced five new equity funds: the Berger Mid
Cap Value Fund; the Berger Small Cap Value Fund; the Berger Balanced Fund; the
Berger Mid Cap Growth Fund; and the Berger Select Fund. These funds held
approximately $493 million of assets under management at December 31, 1998, more
than three times the $155 million at December 31, 1997.
While the core Berger Funds (i.e., those introduced prior to 1997) experienced
declines in assets under management during 1998 and 1997, the newer Berger
offerings, as noted above, reported a growth in assets. Berger made certain
changes in the portfolio management of these core equity funds during 1998 and
1997 and believes these changes improve Berger's opportunity for growth in the
future.
At December 31, 1998 and 1997, approximately 27.6% and 26.3%, respectively, of
Berger's total assets under management were generated through mutual fund
"supermarkets."
Other Financial Services-Related Affiliates and Holding Company Components
Nelson Money Managers plc
As noted in the "Results of Operation" section above, the Company acquired
Nelson in April 1998. Nelson contributed $0.6 million to consolidated earnings
in 1998, exclusive of charges attributed to Nelson
40
relating to the amortization of intangibles recorded in connection with the
acquisition. Including the amortization costs, Nelson reported a net loss of
$0.7 million for the period from acquisition to December 31, 1998. Nelson
revenues -- $11.1 million for the period from acquisition to year end 1998 --
are earned based on a percentage of funds under management, together with a fee
on the client's initial investment. Operating expenses, exclusive of
amortization of intangibles, totaled $9.9 million. The intangible amounts
associated with the acquisition of Nelson are being amortized over a 20 year
period.
Equity in Earnings of DST
Exclusive of the one-time fourth quarter merger-related charges resulting from
the DST and USCS merger, equity earnings from DST increased $6.3 million to
$30.6 million for the year ended December 31, 1998. This improvement over 1997
was attributable to revenue growth resulting from a 10.7% increase in mutual
fund shareowner accounts serviced (reaching 49.8 million at December 31, 1998),
improved international operating results and higher operating margins year to
year (15.1% versus 14.2% in 1997).
As discussed in the "Recent Developments" section above, fourth quarter and year
ended 1998 include a one-time $23.2 million (after-tax, $0.21 per share)
non-cash charge resulting from the merger of a wholly-owned subsidiary of DST
and USCS. This charge reflects the Company's reduced ownership of DST (from 41%
to approximately 32%), together with the Company's proportionate share of DST
and USCS fourth quarter merger-related costs.
Equity in net earnings of DST for the year ended December 31, 1997 totaled $24.3
million. Exclusive of the 1996 one-time gain on the Continuum merger discussed
in "Results of Operations" above, equity earnings from DST increased 48% year to
year. This increase in DST earnings reflects an increase in 1997 DST revenues
compared to 1996 (improvements in both domestic and international revenues) and
improved operating margins in 1997 (14.2% versus 9.8% in 1996).
Interest Expense and Other, net
Fluctuations in interest expense from 1996 through 1998 reflect changes in the
average debt balances during the respective years. In 1998, average debt
balances were lower than 1997 as repayments reduced outstanding balances early
in 1998; accordingly, 1998 interest expense declined from 1997. Interest expense
in 1997 was higher than 1996 as a result of borrowings in connection with KCSI
common stock repurchases. All of the indebtedness incurred to repurchase KCSI
common stock was allocated to the Financial Services segment.
Other, net increased in 1998 versus 1997 as a result of an $8.8 million (pretax)
gain on the sale of Janus' 50% interest in IDEX Management, Inc. ("IDEX"). Janus
continues as sub-advisor to the five portfolios in the IDEX group of mutual
funds it served prior to the sale. This gain was partially offset by reduced
1998 other income recorded at the Financial Services holding company level
relating to a sales agreement with a former affiliate. The change in other, net
between 1997 and 1996 was not material.
FINANCIAL SERVICES TRENDS and OUTLOOK
Future growth of the Company's Financial Services revenues and operating income
will be largely dependent on prevailing financial market conditions, relative
performance of Janus, Berger and Nelson products, introduction and market
reception of new products, as well as other factors, including changes in the
stock and bond markets, increases in the rate of return of alternative
investments, increasing competition as the number of mutual funds continues to
grow, and changes in marketing and distribution channels.
41
As a result of the rapid revenue growth during the last two years, operating
margins for the Financial Services segment have been strong. Management expects
that Financial Services will experience margin pressures in the future as the
various subsidiaries strive to ensure that the operational and administrative
infrastructure continues to meet the high standards of quality and service
historically provided to investors. Additionally, a higher rate of growth in
costs compared to revenues is expected in connection with Nelson's efforts to
expand its operations.
The Company expects to continue to participate in the earnings or losses from
its DST investment.
LIQUIDITY
Summary cash flow data is as follows (in millions):
1998 1997 1996
----------- ----------- -----------
Cash flows provided by (used for):
Operating activities $ 222.8 $ 233.8 $ 121.0
Investing activities (154.6) (409.3) 20.9
Financing activities (74.5) 186.1 (150.8)
----------- ----------- -----------
Net increase (decrease) in
cash and equivalents (6.3) 10.6 (8.9)
Cash and equivalents at beginning of year 33.5 22.9 31.8
----------- ----------- -----------
Cash and equivalents at end of year $ 27.2 $ 33.5 $ 22.9
=========== =========== ===========
Operating Cash Flows. The Company's cash flow from operations has historically
been positive and sufficient to fund operations, KCSR roadway capital
improvements, other capital improvements and debt service. External sources of
cash -- principally negotiated bank debt, public debt and sales of investments
- -- have typically been used to fund acquisitions, new investments, equipment
additions and Company stock repurchases.
The following table summarizes consolidated operating cash flow information.
Certain reclassifications have been made to prior years' information to conform
to current year presentation.
(in millions):
1998 1997 1996
----------- ----------- -----------
Net income (loss) $ 190.2 $ (14.1) $ 150.9
Depreciation and amortization 73.5 75.2 76.1
Equity in undistributed earnings (16.8) (15.0) (66.4)
Reduction in ownership of DST 29.7 - -
Restructuring, asset impairment and
other charges - 196.4 -
Deferred income taxes 23.2 (16.6) 18.6
Gains on sales of assets (20.2) (6.9) (2.6)
Minority interest in consolidated earnings 0.6 12.0 5.2
Change in working capital items (59.5) (7.4) (74.2)
Other 2.1 10.2 13.4
----------- ----------- -----------
Net operating cash flow $ 222.8 $ 233.8 $ 121.0
=========== =========== ===========
1998 operating cash flows decreased by approximately $11.0 million from 1997.
This decrease was largely attributable to the first quarter 1998 KCSR payment
with respect to the productivity fund liability, lower interest payable as a
result of reduced indebtedness during 1998 and declines in contract
42
allowances and prepaid freight charges due other railroads. Also, due to
quarterly dividend payments by Janus in 1998 (in contrast to annual dividends in
previous years), minority interest in consolidated earnings did not increase as
it did in 1997. These decreases in operating cash flows from year to year were
offset by higher ongoing earnings (approximately $69 million) and increased
deferred tax expense (due to benefits booked in 1997 in connection with
restructuring, asset impairment and other charges).
Operating cash flows for the year ended December 31, 1997 nearly doubled when
compared to the prior year, primarily because of the 1996 payment of
approximately $74 million in federal and state income taxes resulting from the
taxable gains associated with the DST public stock offering completed in
November 1995. Also, exclusive of the restructuring, asset impairment and other
charges recorded in fourth quarter 1997, the one-time Continuum gain in 1996 and
equity earnings from unconsolidated affiliates for both years, earnings were
approximately $44.0 million higher in 1997 than 1996.
Investing Cash Flows. Cash was used for the following investing activities: i)
property acquisitions of $105, $83, and $144 million in 1998, 1997, and 1996,
respectively; and ii) investments in and loans with affiliates of $25, $304, and
$42 million in 1998, 1997 and 1996, respectively. Included in the 1997
investments in affiliates was the Company's approximate $298 million capital
contribution to Grupo TFM.
Due to growth throughout the 1996 to 1998 period, Janus had invested an
additional $43, $35 and $39 million in short-term investments representing
invested cash at December 31, 1998, 1997 and 1996, respectively. Also, cash
received during 1996 in connection with the Southern Capital joint venture
formation and associated transactions (approximately $217 million, after
consideration of related income taxes) is included as proceeds from disposal of
property and from disposal of other investments based on the underlying assets
contributed/sold to Southern Capital.
Generally, operating cash flows and borrowings under lines of credit have been
used to finance property acquisitions and investments in and loans with
affiliates during the period from 1996 to 1998.
Financing Cash Flows. Financing cash flows include: (i) borrowings of $152,
$340, and $234 million in 1998, 1997 and 1996, respectively; (ii) repayment of
indebtedness in the amounts of $239, $110 and $233 million in 1998, 1997 and
1996, respectively; (iii) proceeds from stock plans of $30, $27 and $15 million
in 1998, 1997 and 1996, respectively; and (iv) cash dividends of $18, $15 and
$15 million in 1998, 1997 and 1996, respectively.
During 1998, proceeds from borrowings under existing lines of credit were used
to repay $100 million of 5.75% Notes which were due on July 1, 1998. Other 1998
borrowings were used to fund the KCSR union productivity fund termination ($23
million), for a portion of the Nelson acquisition ($24 million) and for working
capital purposes ($5 million). 1997 debt proceeds were used to fund the $298
million Grupo TFM capital contribution, repurchase Company common stock ($39
million) and for additional investment in Berger ($3 million). Proceeds from the
issuance of debt in 1996 were used for stock repurchases ($151 million),
additional investment in Berger ($24 million) and for working capital purposes
($59 million, including payments of federal and state income taxes associated
with the DST public offering).
During 1998, repayments of scheduled maturities (except for the $100 million
5.75% Notes discussed above) and outstanding lines of credit were funded through
operating cash flows. In 1997, operating cash flows were used to reduce amounts
outstanding under the Company's lines of credit. In 1996, proceeds
(approximately $217 million, after consideration of income taxes) received in
connection with the Southern Capital joint venture formation and associated
transactions were used to repay outstanding amounts under the Company's lines of
credit.
Repurchases of Company common stock during 1997 ($50 million) and 1996 ($151
million) were funded with borrowings under existing lines of credit (as noted
above), proceeds received from the DST public offering and repayment by DST of
indebtedness to KCSI, and the $150 million dividend from DST in 1995.
43
See discussion under "Financial Instruments and Purchase Commitments" for
information relative to certain anticipated 1999 cash expenditures. Also see
information under "Minority Purchase Agreements" for information relative to
other existing contingencies.
CAPITAL STRUCTURE
Capital Requirements. The Company has traditionally funded KCSR capital
expenditures using Equipment Trust Certificates for major purchases of
locomotive and rolling stock, while using internally generated cash flows or
leasing for other equipment. Capital improvements for KCSR roadway track
structure have historically been funded with cash flows from operations. KCSR
has, however, increasingly used lease financing alternatives for its locomotive
and rolling stock. Capital requirements for Janus, Berger, Nelson, and holding
company and other subsidiaries have been funded with cash flows from operations
and negotiated term financing. The Company has the ability to finance railroad
equipment through its Southern Capital joint venture.
Capital programs from 1996 to 1998 were primarily financed through internally
generated cash flows. These internally generated cash flows were used to finance
KCSR capital expenditures in 1998 ($65 million), 1997 ($68 million) and 1996
($135 million). The same source used for funding the Company's 1998 capital
programs are expected to be used in funding 1999 capital programs, currently
estimated at $123 million.
During 1998, Janus opened a new facility in Austin, Texas as an Investor Service
and Processing Center for transfer agent operations, allowing for continuous
service in the event the Denver facility is unavailable. Also, in 1998 and 1997,
Janus upgraded and expanded its information technology and facilities
infrastructure. These efforts were generally funded with existing cash flows.
Capital. Components of capital are shown as follows (in millions):
1998 1997 1996
---------- ----------- -----------
Debt due within one year $ 10.7 $ 110.7 $ 7.6
Long-term debt 825.6 805.9 637.5
---------- ----------- -----------
Total debt 836.3 916.6 645.1
Stockholders' equity 931.2 698.3 715.7
---------- ----------- -----------
Total debt plus equity $ 1,767.5 $ 1,614.9 $ 1,360.8
========== =========== ===========
Total debt as a percent of total debt plus equity 47.3% 56.8% 47.4%
---------- ----------- -----------
At December 31, 1998, the Company's consolidated debt ratio (total debt as a
percent of total debt plus equity) decreased 9.5 percentage points to 47.3%
compared to December 31, 1997. Total debt decreased $80.3 million as repayments
exceeded borrowings. Stockholder's equity increased $232.9 million primarily as
a result of $190.2 million in earnings, $24.1 million in non-cash equity
adjustments related to unrealized gains (net of tax) on "available for sale"
securities and stock options exercised of approximately $33.5 million, partially
offset by dividends paid of $17.8 million. This increase in stockholders' equity
coupled with the decrease in debt resulted in the decrease in the debt ratio
from December 31, 1997.
Management anticipates that the debt ratio will decrease during 1999 as a result
of continued debt repayments and profitable operations. Note, however, that
unrealized gains on "available for sale"
44
securities, which are included net of deferred taxes as accumulated other
comprehensive income in stockholders' equity, are contingent on market
conditions and thus, are subject to significant fluctuations in value.
Significant declines in the value of these securities would negatively impact
stockholders' equity and increase the Company's debt ratio.
The Company's consolidated debt ratio increased by 9.4 percentage points from
December 31, 1996 to December 31, 1997. Total debt increased $271.5 million
during 1997, primarily as a result of borrowings to fund the Company's
investment in Grupo TFM and common stock repurchases, partially offset by
repayments on outstanding lines of credit. Stockholders' equity decreased by
$17.4 million, reflecting the Company's net loss for 1997 and essentially
offsetting capital stock transactions (e.g., issuances of common stock, common
stock repurchases, non-cash equity adjustments related to unrealized gains,
etc.). The combination of increased debt and reduced equity resulted in a higher
consolidated debt ratio in 1997 than 1996.
Debt Securities Registration and Offerings. The U.S. Securities and Exchange
Commission declared the Company's Registration Statement on Form S-3 (File No.
33-69648) effective April 22, 1996, registering $500 million in securities.
However, no securities have been issued. The securities may be offered in the
form of Common Stock, New Series Preferred Stock $1 par value, Convertible Debt
Securities or other Debt Securities (collectively, "the Securities"). It is
expected that any net proceeds from the sale of the Securities would be added to
the general funds of the Company and used principally for general corporate
purposes, including working capital, capital expenditures, and acquisitions of
or investments in businesses and assets.
KCSI Credit Agreements. On May 5, 1995, the Company established a credit
agreement in the amount of $400 million, comprised of a $300 million five-year
facility and a $100 million 364-day facility. The $300 million facility was
renewed in May 1997, extending through May 2002, while the $100 million facility
is expected to be renewed annually. Proceeds of these facilities have been and
are anticipated to be used for general corporate purposes. The agreements
contain a facility fee ranging from .07-.25% per annum and interest rates below
prime. Additionally, in May 1998, the Company established a $100 million 364-day
credit agreement assumable by the Financial Services segment for its use upon
separation of the Company's two segments. This facility is expected to be
renewed annually and proceeds of this facility have been and are anticipated to
be used to repay Company debt and for general corporate purposes. This agreement
contains a facility fee of .15% and interest rates below prime. The Company also
has various other lines of credit totaling $106 million. These additional lines,
which are available for general corporate purposes, have interest rates below
prime and terms of less than one year. At December 31, 1998, the Company had
borrowings of $343 million under its various lines of credit leaving $263
million available for use, subject to any limitations within existing financial
covenants.
As discussed earlier, the Company funded its proportionate amount (approximately
$298 million) of the TFM purchase price payment made by Grupo TFM to the Mexican
Government using borrowings under its lines of credit.
Minority Purchase Agreements. Agreements between KCSI and certain Janus minority
owners contain, among other provisions, mandatory stock purchase provisions
whereby under certain circumstances, KCSI would be required to purchase the
minority interest of Janus. If all of the provisions of the Janus minority owner
agreements became effective, KCSI would be required to purchase the respective
minority interests at a cost estimated to be approximately $456 million as of
December 31, 1998, compared to $337 and $220 million at December 31, 1997 and
1996, respectively. Management is currently exploring various financing
alternatives available in the event this would be required.
45
Overall Liquidity. The Company believes it has adequate resources available -
including sufficient lines of credit (within the financial covenants referred to
below), businesses which have historically been positive cash flow generators,
and the $500 million Shelf Registration Statement - to meet anticipated
operating, capital and debt service requirements and other commitments. As
discussed earlier, there exists a possible capital call if certain Grupo TFM
benchmarks are not met.
During the 1996 to 1998 period, the Company continued to strengthen its
strategic positions in the Transportation and Financial Services businesses. The
Southern Capital joint venture transactions, which resulted in repayment of the
majority of borrowings then outstanding under the Company's lines of credit,
provided the Company with flexibility as to future financing requirements (e.g.,
the 1997 investment in Grupo TFM). Additionally, based on DST's stated dividend
policy, the Company does not anticipate receiving any dividends from DST in the
foreseeable future. Furthermore, based on the current debt structure of Grupo
TFM, the Company does not anticipate receiving any dividends from Grupo TFM in
the foreseeable future.
The Company's cash management approach generally reflects efforts to minimize
cash balances. Cash not required for immediate operating or investing activities
will be utilized to repay indebtedness under lines of credit. This approach is
used to help mitigate the Company's floating-rate debt exposure to fluctuations
in interest rates.
The Company's credit agreements contain, among other provisions, various
financial covenants. The Company was in compliance with these various
provisions, including the financial covenants, as of December 31, 1998. Because
of certain financial covenants contained in the credit agreements, however,
maximum utilization of the Company's available lines of credit may be
restricted.
As discussed above in the "Recent Developments", the Company has the option to
purchase a portion of the Mexican Government's 20% interest in TFM at a
discount. Management is currently exploring various financing alternatives
available to fund this transaction in the event it elects to exercise this
option.
As discussed in the "Results of Operations" above, TMM and the Company could be
required to purchase the Mexican Government's interest in TFM in proportion to
each partner's respective ownership interest in Grupo TFM (without regard to the
Mexican Government's interest in Grupo TFM); however, this provision is not
exercisable prior to October 31, 2003. Also, the Mexican Government's interest
in Grupo TFM may be called by TMM and the Company, exercisable at the original
amount (in U.S. dollars) paid by the Government plus interest based on one-year
U.S. Treasury securities.
Pursuant to contractual agreement, Janus is required to distribute at least 90%
of its net income to its shareholders each year. The Company uses its portion of
these dividends in accordance with its strategic plans, which have included,
among others, repayment of KCSI indebtedness, repurchase of Company common stock
and investments in affiliates. Additionally, Janus' agreement with the Janus
World group of offshore funds includes an arrangement by which investors
purchases of Janus World class B shares require a commission to be advanced by
Janus. Although advanced commissions were not material to the December 31, 1998
consolidated financial statements, required funding could become significant in
future years.
As discussed in the "Recent Developments" above, the Company announced a planned
separation of its Transportation and Financial Services businesses. The Company
is pursuing this separation subject to receipt of a favorable tax ruling from
the IRS and other relevant factors. The Company is currently investigating the
potential impact of the proposed transaction on the liquidity and capital
structure of the Company and expects that this impact will be material.
46
OTHER
Year 2000. The Year 2000 discussion below contains forward-looking statements,
including those concerning the Company's plans and expected completion dates,
cost estimates, assessments of Year 2000 readiness for the Company as well as
for third parties, and the potential risks of any failure on the part of the
Company or third parties to be Year 2000 ready on a timely basis.
Forward-looking statements involve a number of risks and uncertainties that
could cause actual results to differ from those projected. See the "Overview"
section for additional information.
While the Company continues to evaluate and pursue discussions with its various
customers, partners and vendors with respect to their preparedness for Year 2000
issues, no assurance can be made that all such parties will be Year 2000 ready.
While the Company cannot fully determine its impact, the inability to complete
Year 2000 readiness for its computer systems could result in significant
difficulties in processing and completing fundamental transactions. In such
events, the Company's results of operations, financial position and cash flows
could be materially adversely affected.
Many existing computer programs and microprocessors that use only two digits
(rather than four) to identify a year could fail or create erroneous results
with respect to dates after December 31, 1999 if not corrected to read all four
digits. This computer program flaw is expected to affect all companies and
organizations, either directly (through a company's own computer programs or
systems that use computer programs, such as telephone systems) or indirectly
(through customers and vendors of the company).
These Year 2000 related issues are of particular importance to the Company. The
Company depends upon its computer and other systems and the computers and other
systems of third parties to conduct and manage the Company's Transportation and
Financial Services businesses. Additionally, the Company's products and services
are heavily dependent upon using accurate dates in order to function properly.
These Year 2000 related issues may also adversely affect the operations and
financial performance of one or more of the Company's customers and suppliers.
As a result, the failure of the Company's computer and other systems, products
or services, the computer systems and other systems upon which the Company
depends, or the Company's customers or suppliers to be Year 2000 ready could
have a material adverse impact on the Company's results of operations, financial
position and cash flows. The Company is unable to assess the extent or duration
of that impact at this time, but they could be substantial.
In 1997, the Company and its key subsidiaries formed project teams comprised of
employees and third party consultants to identify and resolve the numerous
issues surrounding the Year 2000. The project teams, which are supervised by
members of senior management, regularly report their progress toward remediating
Year 2000 issues to management and the Company's Board of Directors. The areas
in which the project teams are focusing most of their efforts are information
technology ("IT") systems, non-IT systems, and third party issues. The project
teams also provide comprehensive corporate tracking, coordination and monitoring
of all Year 2000 activities. As part of resolving any potential Year 2000
issues, the Company expects to: identify all computer systems, products,
services and other systems (including systems provided by third parties) that
must be modified; evaluate the alternatives available to make any identified
systems, products or services Year 2000 ready (including modification,
replacement or abandonment); complete the modifications and/or replacement of
identified systems; and conduct adequate testing of the systems, products and
services, including testing of certain key systems used by various North
American railroads and interoperability testing with clients and key
organizations in the financial services industry.
The following provides a summary of each area and the progress toward
identifying and resolving Year 2000 issues:
IT Systems. In the Transportation segment, all IT systems, including
mission critical systems and non-critical systems have been analyzed and
are in the process of being modified and tested for Year 2000 readiness. To
date, management believes that approximately 99% of the necessary
remediation and 94% of the testing has been completed. Final remediation
and testing for certain non-critical support
47
systems has been completed and management believes these systems are Year
2000 ready. Final remediation and testing of mission critical systems is
scheduled for completion by the end of June 1999.
In addition, the IT hardware and software necessary to operate the
mainframe computer and associated equipment are currently being evaluated
for Year 2000 issues. A compilation of the hardware and software
inventories was completed in 1998. The hardware and software, including the
completion of integrated testing of the infrastructure software and network
components, are expected to be Year 2000 ready by September 30, 1999.
The IT systems (including mission critical and significant non-critical
operating, accounting and supporting systems) and underlying hardware for
the companies comprising the Financial Services segment have been analyzed
and are being modified and tested for Year 2000 readiness. Management
believes that approximately 70% of mission critical systems, and 75% of all
systems, have been tested and are believed to be Year 2000 ready. Final
remediation and testing is expected to be completed by the end of second
quarter 1999.
Non-IT Systems. All equipment that contains an internal clock or embedded
micro-processor is being analyzed for Year 2000 readiness. This includes
PC's, software, fax machines, telephone systems, elevator systems, security
and fire control systems, locomotives, signal and communications systems
and other miscellaneous equipment. Replacement and upgrades of this type of
equipment is underway and expected to be completed for both segments of the
Company by June 30, 1999.
As of December 31, 1998, management believes that 53% of all PC's and 74%
of related software in the Transportation companies were Year 2000 ready.
In addition, all customized programs and external data interfaces are being
evaluated, modified and tested for Year 2000 readiness, as are locomotives,
signals and communication systems and other equipment with internal clocks
and embedded micro-processors.
As of December 31, 1998, approximately 60% of replacement and/or upgrade
efforts on the Financial Services hardware and software inventory have been
completed.
Third Party Systems. Both segments of the Company depend heavily on third
party systems in the operation of their businesses. As part of the Year
2000 project, significant third party relationships are being evaluated to
determine the status of their Year 2000 readiness and the potential impact
on the Company's operations if those significant third parties fail to
become Year 2000 ready. Questionnaires have been sent to critical
suppliers, major customers, key banking and financial institutions, utility
providers and interchange railroads to determine the status of their Year
2000 readiness.
The Transportation companies are working with the Association of American
Railroads ("AAR") and other AAR-member railroads to coordinate the testing
and certification of the systems administered by the AAR. These systems,
including interline settlement, shipment tracing and waybill processing are
relied on by a number of North American railroads and their customers.
Initial testing between railroads started during second quarter 1998 and
these systems are expected to be Year 2000 ready on a timely basis.
Similarly, the Financial Services entities are participating in various
industry-wide efforts (e.g., trading and account maintenance, trade
execution, confirmation, etc.) to facilitate testing of Year 2000
preparedness and reliability. Additionally, Janus and Berger are required
to periodically report to the SEC their progress with respect to Year 2000
preparedness.
Based upon the responses received to the questionnaires and ongoing
discussions with these third parties, the Company believes that the
majority of the significant customers, banking and financial institutions,
suppliers and interchange railroads are or will be Year 2000 ready in all
material respects by mid-1999. The Company does not anticipate, however,
performing significant independent testing procedures to verify that the
information received by the Company from these third parties is accurate
48
(except for the above mentioned industry-wide testing efforts). For those
third parties who have not responded or who have expressed uncertainty as
to their Year 2000 readiness, management is exploring alternatives to limit
the impact this will have on the Company's operations and financial
results. The Company will continue to monitor its third party relationships
for Year 2000 issues.
DST, an approximate 32% owned equity investment, provides various services
to Janus and Berger. DST has completed its review and evaluation of its
mission critical U.S. shareowner accounting and U.S. portfolio accounting
related products, services and internal systems and believes it has
achieved material Year 2000 readiness in such products, services and
systems as of December 31, 1998. The Company anticipates internal readiness
for all of its other mission critical systems and products by September 30,
1999. Additionally, DST intends on testing its systems with clients and
other third parties for Year 2000 related issues as needed throughout 1999.
DST is developing contingency plans for its U.S. shareowner accounting and
U.S. portfolio accounting business units (with testing expected to be
completed by June 30, 1999), as well as for other mission critical
products, services and systems. Formal contingency plans for DST's
Winchester and Poindexter Data Centers have been completed.
Testing and Documentation Procedures. All material modifications to IT and
non-IT systems are being documented and maintained by the project teams for
purposes of tracking the Year 2000 project and as a part of the Company's due
diligence process. All modified systems have been or are in the process of being
tested for Year 2000 remediation, unit acceptance, system acceptance and user
acceptance. The testing procedures used and the results of these tests are being
documented and maintained as a part of the Year 2000 due diligence process.
The project teams meet regularly to discuss their progress and ensure that all
issues and problems are identified and properly addressed. Quarterly meetings
are held with senior management to keep them apprised of the progress of the
Year 2000 project.
Year 2000 Risks. The Company continues to evaluate the principal risks
associated with its IT and non-IT systems, as well as third party systems if
they were not to be Year 2000 ready on a timely basis. Areas that could be
affected include, but are not limited to, the ability to: accurately track
pricing and trading information, obtain and process customer orders and investor
transactions, properly track and record revenue movements (including train
movements), order and obtain critical supplies, and operate equipment and
control systems. These risks are presently under assessment and the Company has
no basis to form an estimate of costs or lost revenues at this time.
The Company believes, however, that the risks involved with the successful
completion of its Year 2000 conversion relate primarily to available resources
and third party readiness. The key success factors include the proper quality
and quantity of human and capital resources to address the complexity and costs
of the project tasks. The Company has allocated substantial resources to the
Year 2000 project and believes that it is adequately staffed by employees,
consultants and contractors. The inability to complete Year 2000 readiness for
the computer systems of the Company could result in significant difficulties in
processing and completing fundamental transactions.
In addition, the Company is taking precautions to ensure its third party
relationships have been adequately addressed. Based on work performed and
information received to date, the Company believes its key suppliers, customers
and other significant third party relationships will be prepared for the Year
2000 in all material respects within an acceptable time frame (or that
acceptable alternatives will be available); however, management of the Company
makes no assurances that all such parties will be Year 2000 ready within an
acceptable time frame.
In the event that the Company or key third parties are not Year 2000 ready, the
Company's results of operations, financial position and cash flows could be
materially adversely affected.
49
Contingency Plans. The Company and its subsidiaries are in the process of
identifying alternative plans in the event that the Year 2000 project is not
completed on a timely basis or otherwise does not meet anticipated needs. A
business contingency planning specialist was hired by KCSR and is working on the
contingency plans for critical business processes. Similarly, consulting
professionals have been utilized by Janus, Berger and Nelson in connection with
Year 2000 efforts, including contingency planning. The Company is also making
alternative arrangements in the event that critical suppliers, customers,
utility providers and other significant third parties are not Year 2000 ready.
The contingency planning process is scheduled to be completed by July 1999.
In addition, information system black out periods have been scheduled at the
various Company subsidiaries, generally from third quarter 1999 through second
quarter 2000. During this period, the project team and other members of the
information systems group will focus all of their efforts and time toward
addressing Year 2000 related issues. No new project requests or
hardware/software upgrades will be allowed during this time.
Year 2000 Costs. To date, the Company has spent approximately $10.9 million in
connection with ensuring that all Company and subsidiary computer programs are
compatible with Year 2000 requirements. In addition, the Company anticipates
future spending of approximately $11 million in connection with this process.
Current accounting principles require all costs associated with Year 2000 issues
to be expensed as incurred. A portion of these costs will not result in an
increase in expense to the Company because existing employees and equipment are
being used to complete the project.
Financial Instruments and Purchase Commitments. During 1995, the Company entered
into a forward stock purchase contract as a means of securing a potentially
favorable price for the repurchase of six million shares of its common stock.
During 1997 and 1996, the Company purchased 2.4 and 3.6 million shares,
respectively, under this contract at an aggregate cost of $39 and $56 million
(including transaction premium), respectively.
From time to time, KCSR enters into forward purchase commitments for diesel fuel
as a means of securing volumes and reducing overall cost. The contracts normally
require KCSR to purchase certain quantities of diesel fuel at defined prices
established at the origination of the contract. As noted earlier, these
commitments saved KCSR approximately $3.7 million in operating expenses in 1996.
Minimal commitments were negotiated for 1997 because of higher fuel costs. At
the end of 1997, KCSR entered into purchase commitments for diesel fuel for
approximately 27% of 1998 expected usage. As a result of fuel prices remaining
below the committed price during 1998, these purchase commitments resulted in a
higher cost in 1998 of approximately $1.7 million.
KCSR has a program to hedge against fluctuations in the price of its diesel fuel
purchases. Beginning in 1998, KCSR entered into fuel swaps for approximately two
million gallons per month, or 37% of its anticipated 1998 fuel requirements. The
fuel swap contracts had expiration dates through February 28, 1999 and are
correlated to market benchmarks. Hedge positions are monitored to ensure that
they will not exceed actual fuel requirements in any period. During 1998, KCSR
made payments of approximately $2.3 million relating to these fuel swap
transactions as a result of actual fuel prices remaining lower than the fuel
swap price.
As of December 31, 1998, KCSR has entered into purchase commitments for
approximately 32% of its expected 1999 usage and has entered into fuel swap
transactions for approximately 16% of its expected 1999 fuel usage. These
transactions are intended to mitigate the impact of rising fuel prices and will
be recorded using hedge accounting policies as set forth in Note 1 to the
consolidated financial statements of this Form 10-K.
In general, the Company enters into transactions such as those discussed above
in limited situations based on management's assessment of current market
conditions and perceived risks. Historically, the Company has engaged in a
limited number of such transactions and their impact has been insignificant.
50
However, the Company intends to respond to evolving business and market
conditions in order to manage risks and exposures associated with the Company's
various operations, and in doing so, may enter into transactions similar to
those discussed above.
Foreign Exchange Matters. In connection with the Company's investment in Grupo
TFM, a Mexican company, and Nelson, an 80% owned subsidiary with operations in
the United Kingdom, matters arise with respect to financial accounting and
reporting for foreign currency transactions and for translating foreign currency
financial statements into U.S. dollars. The Company follows the requirements
outlined in Statement of Financial Accounting Standards No. 52 "Foreign Currency
Translation" ("SFAS 52"), and related authoritative guidance.
The purchase price paid by Grupo TFM for 80% of the common stock of TFM was
fixed in Mexican pesos; accordingly, Grupo TFM was exposed to fluctuations in
the U.S. dollar/Mexican peso exchange rate. In the event that the proceeds from
the various financing arrangements did not provide funds sufficient for Grupo
TFM to complete the purchase of TFM, the Company may have been required to make
additional capital contributions to Grupo TFM. Accordingly, in order to hedge a
portion of the Company's exposure to fluctuations in the value of the Mexican
peso versus the U.S. dollar, the Company entered into two separate forward
contracts to purchase Mexican pesos - $98 million in February 1997 and $100
million in March 1997. In April 1997, the Company realized a $3.8 million pretax
gain in connection with these contracts. This gain was deferred and has been
accounted for as a component of the Company's investment in Grupo TFM. These
contracts were intended to hedge only a portion of the Company's exposure
related to the final installment of the purchase price and not any other
transactions or balances.
During 1997 and 1998, Mexico's economy was classified as "highly inflationary"
as defined in SFAS 52. Accordingly, the U.S. dollar was assumed to be Grupo
TFM's functional currency, and any gains or losses from translating Grupo TFM's
financial statements into U.S. dollars were included in the determination of its
net income. Equity losses from Grupo TFM included in the Company's results of
operations reflect the Company's share of such translation gains and losses.
Effective January 1, 1999, the SEC staff declared that Mexico should no longer
be considered a highly inflationary economy. Accordingly, the Company is in the
process of performing an analysis under the guidance of SFAS 52 to determine
whether the U.S. dollar or the Mexican peso should be used as the functional
currency for financial accounting and reporting purposes for periods subsequent
to December 31, 1998. Information for this analysis is currently being compiled
and reviewed. Management expects to complete this analysis by the end of the
first quarter 1999. If the peso is determined to be the appropriate functional
currency, the effect of translating Grupo TFM's 1999 financial statements could
have a material impact on the Company's results of operations and financial
position.
The Company completed its acquisition of 80% of Nelson on April 20, 1998.
Nelson's principal operations are in the United Kingdom and, therefore, its
financial statements are accounted for using the British pound as the functional
currency. Any gains or losses arising from transactions not denominated in the
British pound are recorded as a foreign currency gain or loss and included in
the results of operations of Nelson. The translation of Nelson's financial
statements from the British pound into the U.S. dollar results in an adjustment
to stockholders' equity as a cumulative translation adjustment. At December 31,
1998, the cumulative translation adjustment was not material.
The Company continues to evaluate existing alternatives with respect to
utilizing foreign currency instruments to hedge its U.S. dollar investment in
Grupo TFM and Nelson as market conditions change or exchange rates fluctuate. At
December 31, 1998, the Company had no outstanding foreign currency hedging
instruments.
51
New Accounting Pronouncements. In June 1998, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative financial
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires recognition of all
derivatives as either assets or liabilities measured at fair value. SFAS 133 is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999
and should not be retroactively applied to financial statements of periods prior
to adoption.
KCSR currently has a program to hedge against fluctuations in the price of
diesel fuel purchases, and also enters into fuel purchase commitments from time
to time. In addition, the Company continues to evaluate alternatives with
respect to utilizing foreign currency instruments to hedge its U.S. dollar
investments in Grupo TFM and Nelson as market conditions change or exchange
rates fluctuate. Currently, the Company has no outstanding foreign currency
hedges. The Company is reviewing the provisions of SFAS 133 and expects adoption
by the required date. The adoption of SFAS 133 with respect to existing hedge
transactions is not expected to have a material impact on the Company's results
of operations, financial position or cash flows.
Statement of Financial Accounting Standards No. 132 "Employers' Disclosure about
Pensions and Other Postretirement Benefits - an amendment of FASB Statements No.
87, 88, and 106" ("SFAS 132") was adopted by the Company in 1998 and prior year
information has been included pursuant to SFAS 132. SFAS 132 establishes
standardized disclosure requirements for pension and other postretirement
benefit plans, requires additional information on changes in the benefit
obligations and fair values of plan assets, and eliminates certain disclosures
that are no longer useful. The standard does not change the measurement or
recognition of pension or postretirement benefit plans. The adoption of SFAS 132
did not have a material impact on the Company's disclosures.
In 1998, the Company adopted the provisions of Statement of Financial Accounting
Standards No. 131 "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"). SFAS 131 establishes standards for the manner in
which public business enterprises report information about operating segments in
annual financial statements and requires disclosure of selected information
about operating segments in interim financial reports issued to shareholders.
SFAS 131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. The adoption of SFAS 131 did not
have a material impact on the disclosures of the Company. Segment financial
information is included in Note 13, Industry Segments, to the consolidated
financial statements included under Item 8 of this Form 10-K and prior year
information has been restated according to the provisions of SFAS 131.
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130 "Reporting Comprehensive Income" ("SFAS
130"), which establishes standards for reporting and disclosure of comprehensive
income and its components in the financial statements. Prior year information
has been included pursuant to SFAS 130. The Company's other comprehensive income
consists primarily of unrealized gains and losses relating to investments held
as "available for sale" securities as defined by SFAS 115. The Company records
its proportionate share of any unrealized gains or losses related to these
investments, net of deferred taxes, in stockholders' equity as accumulated other
comprehensive income. The unrealized gain related to these investments increased
$40.3 million, $42.6 million and $30.1 million ($24.1 million, $25.9 million and
$18.5 million, net of deferred taxes) for the years ended December 31, 1998,
1997 and 1996, respectively.
In Issue No. 96-16, the Emerging Issues Task Force ("EITF 96-16") of the FASB,
reached a consensus that substantive minority rights which provide the minority
shareholder with the right to effectively control significant decisions in the
ordinary course of an investee's business could impact whether the majority
shareholder should consolidate the investee. Management evaluated the rights of
the minority shareholders of its consolidated subsidiaries. Application of EITF
96-16 did not affect the Company's consolidated financial statements.
52
In 1998, the Company adopted the guidance outlined in American Institute of
Certified Public Accountant's Statement of Position 98-1 "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use" (SOP 98-1").
SOP 98-1 requires that computer software costs incurred in the preliminary
project stage, as well as training and maintenance costs be expensed as
incurred. This guidance also requires that direct and indirect costs associated
with the application development stage of internal use software be capitalized
until such time that the software is substantially complete and ready for its
intended use. Capitalized costs are to be amortized on a straight line basis
over the useful life of the software. The adoption of this guidance did not have
a material impact on the Company's results of operations, financial position or
cash flows.
Litigation. The Company and its subsidiaries are involved as plaintiff or
defendant in various legal actions arising in the normal course of business.
While the ultimate outcome of the various legal proceedings involving the
Company and its subsidiaries cannot be predicted with certainty, it is the
opinion of management (after consultation with legal counsel) that the Company's
litigation reserves are adequate and that these legal actions currently are not
material to the Company's consolidated results of operations or financial
position. The following outlines two significant ongoing cases:
Duncan case
In 1998, a jury in Beauregard Parish, Louisiana returned a verdict against KCSR
in the amount of $16.3 million. This Louisiana state case arose from a railroad
crossing accident which occurred at Oretta, Louisiana on September 11, 1994, in
which three individuals were injured. Of the three, one was injured fatally, one
was rendered quadriplegic and the third suffered less serious injuries.
Subsequent to the verdict, the trial court held that the plaintiffs were
entitled to interest on the judgment from the date the suit was filed, dismissed
the verdict against one defendant and reallocated the amount of that verdict to
the remaining defendants. The resulting total judgment against KCSR, together
with interest, was $25.4 million as of December 31, 1998.
The judgment has been appealed and independent trial counsel has informed KCSR
management that the evidence presented at trial established no negligent conduct
on the part of KCSR and expressed confidence that the verdict will ultimately be
reversed. KCSR management believes it has meritorious defenses in this case and
that it will ultimately prevail in appeal. If the verdict were to stand,
however, the judgment and interest are in excess of existing insurance coverage
and could have an adverse effect on the Company's consolidated results of
operations and financial position.
Bogalusa Cases
In July 1996, KCSR was named as one of twenty-seven defendants in various
lawsuits in Louisiana and Mississippi arising from the explosion of a rail car
loaded with chemicals in Bogalusa, Louisiana on October 23, 1995. As a result of
the explosion, nitrogen dioxide and oxides of nitrogen were released into the
atmosphere over parts of that town and the surrounding area causing evacuations
and injuries. Approximately 25,000 residents of Louisiana and Mississippi have
asserted claims to recover damages allegedly caused by exposure to the
chemicals.
KCSR neither owned nor leased the rail car or the rails on which it was located
at the time of the explosion in Bogalusa. KCSR did, however, move the rail car
from Jackson to Vicksburg, Mississippi, where it was loaded with chemicals, and
back to Jackson where the car was tendered to the IC. The explosion occurred
more than 15 days after the Company last transported the rail car. The car was
loaded by the shipper in excess of its standard weight when it was transported
by the Company to interchange with the IC.
The Mississippi lawsuit arising from the chemical release has now been scheduled
for trial in late March 1999. KCSR sought dismissal of these suits in the state
appellate courts, and ultimately in the United States Supreme Court, but was
unsuccessful in obtaining the relief sought.
53
KCSR believes that its exposure to liability in these cases is remote. If,
however, KCSR were to be found liable for punitive damages in these cases, such
a judgment could have a material adverse effect on the results of operations and
financial position of the Company.
Environmental Matters. The Company and certain of its subsidiaries are subject
to extensive regulation under environmental protection laws concerning, among
other things, discharges to waters and the generation, handling, storage,
transportation and disposal of waste and other materials where environmental
risks are inherent. In particular, the Company is subject to various laws and
certain legislation including, 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. This
legislation generally imposes joint and several liability for clean up and
enforcement costs, without regard to fault or legality of the original conduct,
on current and predecessor owners and operators of a site. The Company does not
foresee that compliance with the requirements imposed by the environmental
legislation will impair its competitive capability or result in any material
additional capital expenditures, operating or maintenance costs. As part of
serving the petroleum and chemicals industry, KCSR transports hazardous
materials and has a Shreveport, Louisiana-based hazardous materials emergency
team available to handle environmental issues which might occur in the transport
of such materials. Additionally, the Company performs ongoing review and
evaluation of the various environmental issues that arise in the Company's
operations, and, as necessary, takes actions to limit the Company's exposure to
potential liability.
In November 1997, representatives of KCSR met with representatives of the United
States Environmental Protection Agency ("EPA") at the site of two, contiguous
pieces of property in North Baton Rouge, Louisiana, abandoned leaseholds of
Western Petrochemicals and Export Drum. These properties had been the subjects
of voluntary clean up prior to the EPA's involvement. The site visit prompted
KCSR to obtain from the EPA, through the Freedom of Information Act, a
"Preliminary Assessment Report" concerning the properties, dated January, 1995,
and directing a "Site Investigation." The EPA's November 1997 visit to the site
was the start of that "Site Investigation." During the November 1997 site visit,
the EPA indicated it intended to recover, through litigation, all of its
investigation and remediation costs. At KCSR's request, the EPA agreed
informally to suspend its investigation pending an exchange of information and
negotiation of KCSR's participation in the "Site Investigation." Based upon
advice subsequently received from the Inactive and Abandoned Sites Division of
the Louisiana Department of Environmental Quality ("LADEQ"), KCSR will be
allowed to undertake the investigation and remediation of the site, pursuant to
the LADEQ's guidelines and oversight. The EPA's and LADEQ's involvement, and the
investigation and remediation of the sites pursuant to LADEQ's oversight and
guidelines, will increase the ultimate costs to KCSR beyond those anticipated.
However, those additional costs are not expected to have a material impact on
the Company's consolidated results of operations or financial position.
As previously reported, KCSR has been named as a "potentially responsible party"
by the Louisiana Department of Environmental Quality in a state environmental
proceeding, Louisiana Department of Environmental Quality, Docket No. IAS
88-0001-A, involving a location near Bossier City, Louisiana, which was the site
of a wood preservative treatment plant (Lincoln Creosoting). KCSR is a former
owner of part of the land in question. This matter was the subject of a trial in
the U.S. District Court in Shreveport, Louisiana which was concluded in July
1993. The court found that Joslyn Manufacturing Company ("Joslyn"), an operator
of the plant, was and is required to indemnify KCSR for damages arising out of
plant operations. (KCSR's potential liability is as a property owner rather than
as a generator or transporter of contaminants.) The case was appealed to the
U.S. Court of Appeals for the Fifth Circuit, which Court affirmed the U.S.
District Court ruling in favor of KCSR.
In early 1994, the EPA added the Lincoln Creosoting site to its CERCLA national
priority list. Since major remedial work has been performed at this site by
Joslyn, and KCSR has been held by the Federal District and Appeals Courts to be
entitled to indemnity for such costs, it would appear that KCSR should not incur
54
significant remedial liability. At this time, it is not possible to evaluate the
potential consequences of further remediation at the site.
The Louisiana Department of Transportation ("LDOT") has sued KCSR and a number
of other defendants in Louisiana state court to recover clean up costs incurred
by LDOT while constructing Interstate Highway 49 at Shreveport, Louisiana
(Louisiana Department of Transportation v. The Kansas City Southern Railway
Company, et al., Case No. 417190-B in the First Judicial District Court, Caddo
Parish, Louisiana). The clean up was associated with an old oil refinery site,
operated by the other named defendants. KCSR's main line was adjacent to that
site, and KCSR was included in the suit because LDOT claims that a 1966
derailment on the adjacent track released hazardous substances onto the site.
However, there is evidence that the derailment occurred on the side of the track
opposite from the refinery site. Furthermore, there appears to be no
relationship between the lading on the derailed train and any contaminants
identified at the site. Therefore, management believes that the Company's
exposure is limited.
In another proceeding, Louisiana Department of Environmental Quality, Docket No.
IE-0-91-0001, KCSR was named as a party in the alleged contamination of Capitol
Lake in Baton Rouge, Louisiana. During 1994, the list of potentially responsible
parties was significantly expanded to include the State of Louisiana, and the
City and Parish of Baton Rouge, among others. Studies commissioned by KCSR
indicate that contaminants contained in the lake were not generated by KCSR.
Management and counsel do not believe this proceeding will have a material
effect on the Company.
In the Ilada Superfund Site located in East Cape Girardeau, Ill., KCSR was cited
for furnishing one carload of used oil to this petroleum recycling facility.
Counsel advises that KCSR's liability, if any, should fall within the "de
minimus" provisions of the Superfund law, representing minimal exposure.
The Mississippi Department of Environmental Quality ("MDEQ") initiated a demand
on all railroads operating in Mississippi to clean up their refueling facilities
and investigate any soil and groundwater impacts resulting from past refueling
activities. KCSR has six facilities located in Mississippi. KCSR has developed a
plan, together with the State of Mississippi, that will satisfy the MDEQ's
initiative. Estimated costs to complete the studies and expected remediation
have been provided for in the Company's consolidated financial statements and
the resolution is not expected to have a material impact on the Company's
consolidated results of operations or financial position.
The Illinois Environmental Protection Agency ("IEPA") has sued the Gateway
Western for alleged violations of state environmental laws relating to the 1997
spill of methyl isobutyl carbinol in the East St. Louis yard. During switching
operations a tank car carrying this chemical was punctured and approximately
18,000 gallons were released. Emergency clean-up and removal of liquids and
contaminated soils occurred within two weeks and remaining residues of carbinol
in the soil and shallow groundwater were confined almost entirely to the Gateway
Western property. Remediation continues and progress is reported to the IEPA on
a quarterly basis and will continue until IEPA clean-up standards have been
achieved. Remediation is expected to be completed in the year 2000 and estimated
costs have been provided for in the Company's consolidated financial statements.
The parties reached a tentative negotiated settlement of the lawsuit in November
1998, which provides that the Gateway Western pay a penalty and further, that it
fund a Supplemental Environmental Project in St. Claire County, Illinois. The
clean-up costs and the settlement of the lawsuit are not expected to have a
material impact on the Company's consolidated results of operations or financial
position.
The Company has recorded liabilities with respect to various environmental
issues, which represent its best estimates of remediation and restoration costs
that may be required to comply with present laws and regulations. At December
31, 1998, these recorded liabilities were not material. Although these costs
cannot be predicted with certainty, management believes that the ultimate
outcome of identified matters will not have a material adverse effect on the
Company's consolidated results of operations, financial condition or cash flows.
55
Regulatory Influence. In addition to the environmental agencies mentioned above,
KCSR operations are regulated by the STB, various state regulatory agencies, and
the Occupational Safety and Health Administration ("OSHA"). Prior to January 1,
1996, the Interstate Commerce Commission ("ICC") had jurisdiction over
interstate rates charged, routes, service, issuance or guarantee of securities,
extension or abandonment of rail lines, and consolidation, merger or acquisition
of control of rail common carriers. As of January 1, 1996, Congress abolished
the ICC and transferred regulatory responsibility to the STB. State agencies
regulate some aspects of rail operations with respect to health and safety and
in some instances, intrastate freight rates. OSHA has jurisdiction over certain
health and safety features of railroad operations.
KCSR expects its railroad operations to be subject to future requirements
regulating exhaust emissions from diesel locomotives that may increase its
operating costs. During 1995 the EPA issued proposed regulations applicable to
locomotive engines. These regulations, which were issued as final in early 1998,
will be effective in stages for new or remanufactured locomotive engines
installed after year 2000. KCSR has reviewed these new regulations and
management does not expect that compliance with these regulations will have a
material impact on the Company's results of operations.
Financial Services businesses are subject to a variety of regulatory
requirements including, but not limited to, the rules and regulations of the
U.S. Securities and Exchange Commission and the guidelines set forth by the
National Association of Securities Dealers.
The Company does not foresee that compliance with the requirements imposed by
these agencies' standards under present statutes will impair its competitive
capability or result in any material effect on results of operations.
Inflation. Inflation has not had a significant impact on the Company's
operations in the past three years. Generally accepted accounting principles
require the use of historical costs. Replacement cost and related depreciation
expense of the Company's property would be substantially higher than the
historical costs reported. Any increase in expenses from these fixed costs,
coupled with variable cost increases due to significant inflation, would be
difficult to recover through price increases given the competitive environments
of the Company's principal subsidiaries. See "Foreign Exchange Matters" above
with respect to inflation in Mexico.
Strategic Review. The Company's management is responsible for the management of
the Company's primary assets - investments in subsidiaries and affiliates, as
described in detail in Item 1, Business, of this Form 10-K and in "Recent
Developments" and "Results of Operations" above. Accordingly, management of the
Company continually evaluates how to utilize the strength of the Company's
business lines and capabilities, provide for future growth opportunities, and
achieve the Company's financial objectives. This process has resulted in many
significant actions, including: the acquisition of Nelson in April of 1998; the
Company's investment and involvement in the Mexican rail privatization; the
December 1996 Gateway Western acquisition; the October 1996 Southern Capital
joint venture transactions; and the common stock repurchase program.
The Company's announcement to separate its Transportation and Financial Services
segments continues this process. A separation of the two segments would provide
the management of each segment the opportunity to focus on maximizing potential
as stand-alone entities.
1996 through 1998 have been, and future years will be, affected by these
strategic activities. Management's analysis and evaluation of the Company's
strategic alternatives are expected to continue to present growth opportunities
in future years.
56
Item 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company utilizes various financial instruments which entail certain inherent
market risks. Generally, these instruments have not been entered into for
trading purposes. The following information, together with information included
in Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations and Notes 11 and 13 to the Company's consolidated
financial statements in this Form 10-K, describe the key aspects of certain
financial instruments which have market risk to the Company.
Interest Rate Sensitivity
The Company's interest sensitive liabilities include its long-term fixed and
floating-rate debt obligations. The table below provides information about the
Company's fixed rate obligations:
1999 2000 2001 2002 2003
Fixed Rate Debt (in millions) $ 482.6 $ 471.6 $ 458.9 $ 346.1 $ 329.7
Average interest rate 7.89% 7.86% 7.84% 7.74% 7.68%
At December 31, 1998, the Company's floating-rate indebtedness totaled $343
million. A hypothetical 100 basis points increase in the LIBOR rate would result
in additional interest expense of approximately $3.4 million on an annualized
basis for the floating-rate indebtedness.
Based upon the borrowing rates currently available to the Company and its
subsidiaries for indebtedness with similar terms and average maturities, the
fair value of long-term debt was approximately $867 million at December 31,
1998.
The Company believes the mix of floating and fixed rate indebtedness contributes
to mitigating interest rate risk.
Commodity Price Sensitivity
KCSR has a program to hedge against fluctuations in the price of its diesel fuel
purchases. This program is primarily completed using various swap transactions.
These swap transactions are typically based on the price of heating oil #2,
which the Company believes to produce a reasonable correlation to the price of
diesel fuel. These transactions are generally settled monthly in cash with the
counterparty.
Additionally, from time to time, KCSR enters into forward purchase commitments
for diesel fuel as a means of securing volumes at competitive prices. These
contracts normally require the Company to purchase defined quantities of diesel
fuel at prices established at the origination of the contract.
The table below provides information about the various diesel fuel instruments
that are sensitive to fluctuations in commodity prices. The weighted average
contract prices presented below do not include taxes, transportation costs or
other incremental fuel handling costs.
57
1999
Diesel Fuel Swaps:
Gallons (in millions) 10.0
Weighted average Price per gallon $0.44
Diesel Fuel Purchase Commitments:
Gallons (in millions) 20.8
Weighted average Price per gallon $0.45
The unrecognized loss related to the diesel fuel swaps based on the average
price of heating oil #2 approximated $1.2 million at December 31, 1998.
At December 31, 1998, the Company held fuel inventories for use in normal
operations. These inventories were not material to the Company's overall
financial position.
Foreign Exchange Sensitivity
The Company owns an approximate 37% interest in Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. ("Grupo TFM"), incorporated in Mexico. Also, in April
1998, the Company acquired 80% of Nelson Money Managers plc ("Nelson"), a United
Kingdom based financial services corporation. In connection with these
investments, matters arise with respect to financial accounting and reporting
for foreign currency transactions and for translating foreign currency financial
statements into U.S. dollars. Therefore, the Company has exposure to
fluctuations in the value of the Mexican peso and the British pound.
During 1997 and 1998, Mexico's economy was classified as "highly inflationary"
as defined in Statement of Financial Accounting Standards No. 52 "Foreign
Currency Translation" ("SFAS 52"). Accordingly, the U.S. dollar was assumed to
be Grupo TFM's functional currency, and any gains or losses from translating
Grupo TFM's financial statements into U.S. dollars are included in the
determination of its net income. Equity earnings or losses from Grupo TFM
included in the Company's results of operations reflect the Company's share of
such translation gains and losses.
Effective January 1, 1999, the SEC staff declared that Mexico should no longer
be considered a highly inflationary economy. Accordingly, the Company is in the
process of performing an analysis under the guidance of SFAS 52 to determine
whether the U.S. dollar or the Mexican peso should be used as the functional
currency for financial accounting and reporting purposes subsequent to December
31, 1998. Information for this analysis is currently being compiled and
reviewed. Management expects to complete this analysis by the end of the first
quarter 1999. If the peso is determined to be the appropriate functional
currency, the effect of translating Grupo TFM's 1999 financial statements from
the peso to the U.S. dollar could have a material impact on the Company's
results of operations and financial position.
With respect to Nelson, as the relative price of the British pound fluctuates
versus the U.S. dollar, the Company's proportionate share of the earnings or
losses of Nelson is affected. The following table provides an example of the
potential impact of a 10% change in the price of the British pound assuming that
Nelson has earnings of $1,000 and using its ownership interest at December 31,
1998. The British pound is Nelson's functional currency.
58
Nelson
Assumed Earnings 1,000
Exchange Rate (to U.S. $) 0.5 to 1
---------------------
Converted U.S. Dollars $ 2,000
Ownership Percentage 80%
---------------------
Assumed Earnings $ 1,600
---------------------
Assumed 10% increase in Exchange Rate 0.55 to 1
---------------------
Converted to U.S. Dollars $ 1,818
Ownership Percentage 80%
---------------------
Assumed Earnings $ 1,454
---------------------
Effect of 10% increase in Exchange Rate $ (146)
=====================
The impact of changes in exchange rates on the balance sheet are reflected in a
cumulative translation adjustment account as a part of accumulated other
comprehensive income and do not affect earnings.
While not currently utilizing foreign currency instruments to hedge its U.S.
dollar investments in Grupo TFM and Nelson, the Company continues to evaluate
existing alternatives as market conditions and exchange rates fluctuate.
Available for Sale Investment Sensitivity
Both Janus and Berger invest a portion of the revenues earned from providing
investment advisory services in various of their respective sponsored funds.
These investments are classified as available for sale securities pursuant to
Statement of Financial Accounting Standards No. 115 "Accounting for Certain
Investments in Debt and Equity Securities." Accordingly, these investments are
carried in the Company's consolidated financial statements at fair market value
and are subject to the investment performance of the underlying sponsored fund.
Any unrealized gain or loss is recognized upon the sale of the investment.
Additionally, DST, a 32% owned equity investment, holds available for sale
investments which may affect the Company's consolidated financial statements.
Similarly to the Janus and Berger securities, any changes to the market value of
the DST available for sale investments are reflected, net of tax, in DST's
"accumulated comprehensive income" component of its equity. Accordingly, the
Company records its proportionate share of this amount as part of the investment
in DST. While these changes in market value do not result in any impact to the
Company's consolidated results of operations currently, upon disposition by DST
of these investments, the Company will record its proportionate share of the
gain or loss as a component of equity earnings.
Equity Price Sensitivity
As noted above, the Company owns 32% of DST, a publicly traded company. While
changes in the market price of DST are not reflected in the Company's
consolidated results of operation or financial position, they may affect the
perceived value of the Company's common stock. Specifically, the DST market
value at any given point in time multiplied by the Company's ownership
percentage provides an amount, which when divided by the outstanding number of
KCSI common shares, derives a per share "value" presumably attributable to the
Company's investment in DST. Fluctuations in this "value" as a result of changes
in the DST market price may affect the Company's stock price.
59
The revenues earned by Janus, Berger and Nelson are dependent on the underlying
assets under management in the funds to which investment advisory services are
provided. The portfolio of investments included in these various funds include
combinations of equity, bond, annuity and other types of securities.
Fluctuations in the value of these various securities are common and are
generated by numerous factors, including, among others, market volatility, the
overall economy, inflation, changes in investor strategies, availability of
alternative investment vehicles, and others. Accordingly, declines in any one or
a combination of these factors, or other factors not separately identified, may
reduce the value of investment securities and, in turn, the underlying assets
under management on which Financial Services revenues are earned.
60
Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
Page
Management Report on Responsibility for Financial Reporting....... 61
Financial Statements:
Report of Independent Accountants............................ 61
Consolidated Statements of Operations and Comprehensive
Income for the three years ended December 31, 1998......... 62
Consolidated Balance Sheets at December 31, 1998
1997 and 1996.............................................. 63
Consolidated Statements of Cash Flows for the three
years ended December 31, 1998.............................. 64
Consolidated Statements of Changes in Stockholders'
Equity for the three years ended December 31, 1998......... 65
Notes to Consolidated Financial Statements................... 66
Financial Statement Schedules:
All schedules are omitted because they are not applicable, insignificant or
the required information is shown in the consolidated financial statements
or notes thereto.
The consolidated financial statements and related notes, together with the
Report of Independent Accountants, of DST Systems, Inc. (an approximate 32%
owned affiliate of the Company accounted for under the equity method) for
the year ended December 31, 1998, which are included in the DST Systems,
Inc. Annual Report on Form 10-K for the year ended December 31, 1998
(Commission File No. 1-14036) have been incorporated by reference in this
Form 10-K as Exhibit 99.1.
61
Management Report on Responsibility for Financial Reporting
The accompanying consolidated financial statements and related notes of Kansas
City Southern Industries, Inc. and its subsidiaries were prepared by management
in conformity with generally accepted accounting principles appropriate in the
circumstances. In preparing the financial statements, management has made
judgments and estimates based on currently available information. Management is
responsible for not only the financial information, but also all other
information in this Annual Report on Form 10-K. Representations contained
elsewhere in this Annual Report on Form 10-K are consistent with the
consolidated financial statements and related notes thereto.
The Company has a formalized system of internal accounting controls designed to
provide reasonable assurance that assets are safeguarded and that its financial
records are reliable. Management monitors the system for compliance, and the
Company's internal auditors measure its effectiveness and recommend possible
improvements thereto. In addition, as part of their audit of the consolidated
financial statements, the Company's independent accountants, who are selected by
the stockholders, review and test the internal accounting controls on a
selective basis to establish the extent of their reliance thereon in determining
the nature, extent and timing of audit tests to be applied.
The Board of Directors pursues its oversight role in the area of financial
reporting and internal accounting control through its Audit Committee. This
committee, composed solely of non-management directors, meets regularly with the
independent accountants, management and internal auditors to monitor the proper
discharge of responsibilities relative to internal accounting controls and to
evaluate the quality of external financial reporting.
Report of Independent Accountants
To the Board of Directors and Stockholders of
Kansas City Southern Industries, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations and comprehensive income, of changes in
stockholders' equity and of cash flows present fairly, in all material respects,
the financial position of Kansas City Southern Industries, Inc. and its
subsidiaries at December 31, 1998, 1997 and 1996, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 1 to the consolidated financial statements, effective
December 31, 1997 the Company changed its method of evaluating the
recoverability of goodwill. We concur with the change in accounting.
/s/ PricewaterhouseCoopers LLP
Kansas City, Missouri
March 4, 1999
62
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
Years Ended December 31
Dollars in Millions, Except per Share Amounts
1998 1997 1996
Revenues $ 1,284.3 $ 1,058.3 $ 847.3
Costs and expenses 816.3 680.2 567.3
Depreciation and amortization 73.5 75.2 76.1
Restructuring, asset impairment
and other charges 196.4
------------- ------------ ------------
Operating income 394.5 106.5 203.9
Equity in net earnings (losses) of
unconsolidated affiliates (Notes 2, 5, 12):
DST Systems, Inc. 24.3 24.3 68.1
Grupo Transportacion Ferroviaria
Mexicana, S.A. de C.V. (3.2) (12.9)
Other 1.8 3.8 2.0
Interest expense (66.1) (63.7) (59.6)
Reduction in ownership of DST Systems, Inc. (29.7)
Other, net 32.8 21.2 22.9
------------- ------------ ------------
Pretax income 354.4 79.2 237.3
Income tax provision (Note 8) 130.8 68.4 70.6
Minority interest in consolidated
earnings (Note 11) 33.4 24.9 15.8
------------- ------------ ------------
Net income (loss) 190.2 (14.1) 150.9
Other comprehensive income, net of tax:
Unrealized gain on securities 24.1 25.9 18.5
Comprehensive income $ 214.3 $ 11.8 $ 169.4
============= ============ ============
Per Share Data (Note 1):
Basic earnings (loss) per share $ 1.74 $ (0.13) $ 1.33
============= ============ ============
Diluted earnings (loss) per share $ 1.66 $ (0.13) $ 1.31
============= ============ ============
Weighted average common shares
outstanding (in thousands):
Basic 109,219 107,602 113,169
Dilutive potential common shares 3,840 2,112
------------- ------------ ------------
Diluted 113,059 107,602 115,281
============= ============ ============
Dividends per share
Preferred $ 1.00 $ 1.00 $ 1.00
Common $ .16 $ .15 $ .13
See accompanying notes to consolidated financial statements.
63
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
at December 31
Dollars in Millions, Except per Share Amounts
1998 1997 1996
ASSETS
Current Assets:
Cash and equivalents $ 27.2 $ 33.5 $ 22.9
Investments in advised funds (Note 6) 149.1 100.3 67.8
Accounts receivable, net (Note 6) 208.4 177.0 138.1
Inventories 47.0 38.4 39.3
Other current assets (Note 6) 37.8 23.9 24.0
------------ ------------ ------------
Total current assets 469.5 373.1 292.1
Investments held for operating purposes (Notes 2, 5) 707.1 683.5 335.2
Properties, net (Notes 3, 6) 1,266.7 1,227.2 1,219.3
Intangibles and Other Assets, net (Notes 2, 3, 6) 176.4 150.4 237.5
------------ ------------ ------------
Total assets $ 2,619.7 $ 2,434.2 $ 2,084.1
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Debt due within one year (Note 7) $ 10.7 $ 110.7 $ 7.6
Accounts and wages payable 125.8 109.0 102.6
Accrued liabilities (Notes 3, 6) 159.7 217.8 134.4
------------ ------------ ------------
Total current liabilities 296.2 437.5 244.6
------------ ------------ ------------
Other Liabilities:
Long-term debt (Note 7) 825.6 805.9 637.5
Deferred income taxes (Note 8) 403.6 332.2 337.7
Other deferred credits (Note 2) 128.8 132.1 129.8
Commitments and contingencies
(Notes 2, 7, 8, 9, 11, 12)
------------ ------------ ------------
Total other liabilities 1,358.0 1,270.2 1,105.0
------------ ------------ ------------
Minority Interest in consolidated
subsidiaries (Note 11) 34.3 28.2 18.8
------------ ------------ ------------
Stockholders' Equity (Notes 1, 4, 7, 9):
$25 par, 4% noncumulative, Preferred stock 6.1 6.1 6.1
$1 par, Series B convertible,
Preferred stock 1.0 1.0
$.01 par, Common stock 1.1 1.1 0.4
Retained earnings 849.1 839.3 883.3
Accumulated other comprehensive income 74.9 50.8 24.9
Shares held in trust (200.0) (200.0)
------------ ------------ ------------
Total stockholders' equity 931.2 698.3 715.7
------------ ------------ ------------
Total liabilities and stockholders' equity $ 2,619.7 $ 2,434.2 $ 2,084.1
============ ============ ============
See accompanying notes to consolidated financial statements.
64
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31
Dollars in Millions
1998 1997 1996
CASH FLOWS PROVIDED BY (USED FOR):
Operating Activities:
Net income (loss) $ 190.2 $ (14.1) $ 150.9
Adjustments to net income (loss):
Depreciation and amortization 73.5 75.2 76.1
Deferred income taxes 23.2 (16.6) 18.6
Equity in undistributed earnings (16.8) (15.0) (66.4)
Minority interest in consolidated earnings 0.6 12.0 5.2
Reduction in ownership of DST 29.7
Restructuring, asset impairment and other charges 196.4
Gain on sale of assets (20.2) (6.9) (2.6)
Employee benefit and deferred compensation
expenses not requiring operating cash 3.8 8.7 18.3
Changes in working capital items:
Accounts receivable (29.9) (29.0) (2.5)
Inventories (8.6) 2.5 0.5
Accounts and wages payable 19.6 (3.1) 7.2
Accrued liabilities (32.4) 24.4 (73.4)
Other current assets (8.2) (2.2) (6.0)
Other, net (1.7) 1.5 (4.9)
------- -------- --------
Net 222.8 233.8 121.0
------- -------- --------
Investing Activities:
Property acquisitions (104.9) (82.6) (144.0)
Proceeds from disposal of property 8.2 7.4 187.0
Investments in and loans with affiliates (25.3) (303.5) (41.9)
Purchase of short-term investments (43.2) (34.9) (39.2)
Proceeds from disposal of other investments 10.4 0.3 55.7
Other, net 0.2 4.0 3.3
------- -------- --------
Net (154.6) (409.3) 20.9
------- -------- --------
Financing Activities:
Proceeds from issuance of long-term debt 151.7 339.5 233.7
Repayment of long-term debt (238.6) (110.1) (233.1)
Proceeds from stock plans 30.1 26.6 14.6
Stock repurchased (50.2) (151.3)
Cash dividends paid (17.8) (15.2) (14.8)
Other, net 0.1 (4.5) 0.1
------- -------- --------
Net (74.5) 186.1 (150.8)
------- -------- --------
Cash and Equivalents:
Net increase (decrease) (6.3) 10.6 (8.9)
At beginning of year 33.5 22.9 31.8
------- -------- --------
At end of year (Note 4) $ 27.2 $ 33.5 $ 22.9
======= ======== ========
See accompanying notes to consolidated financial statements.
65
KANSAS CITY SOUTHERN INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Dollars in Millions, Except per Share Amounts
$1 Par Accumulated
$25 Par Series B $.01 Par other Shares
Preferred Preferred Common Capital Retained comprehensive held
stock stock stock surplus earnings income in trust Total
Balance at
December 31, 1995 $ 6.1 $ 1.0 $ 0.4 $ 127.5 $ 753.8 $ 6.4 $ (200.0) $ 695.2
Net income 150.9 150.9
Dividends (15.3) (15.3)
Stock repurchased (145.2) (6.1) (151.3)
Stock plan shares
issued from treasury 5.9 5.9
Options exercised and
stock subscribed 11.8 11.8
Other comprehensive
income 18.5 18.5
------ -------- ------ -------- -------- -------- --------- ---------
Balance at
December 31, 1996 6.1 1.0 0.4 - 883.3 24.9 (200.0) 715.7
Net loss (14.1) (14.1)
Dividends (16.0) (16.0)
Stock repurchased (50.2) (50.2)
3-for-1 stock split 0.7 (0.7) -
Stock plan shares
issued from treasury 3.1 3.1
Stock issued in
acquisition (Notes 2,4) 10.1 10.1
Options exercised and
stock subscribed 23.8 23.8
Other comprehensive
income 25.9 25.9
------ -------- ------ -------- -------- -------- --------- ---------
Balance at
December 31, 1997 6.1 1.0 1.1 - 839.3 50.8 (200.0) 698.3
Net income 190.2 190.2
Dividends (17.7) (17.7)
Stock plan shares
issued from treasury 3.0 3.0
Stock issued in
acquisition (Notes 2,4) 3.2 3.2
Options exercised and
stock subscribed 30.1 30.1
Termination of shares
held in trust (Note 9) (1.0) (199.0) 200.0 -
Other comprehensive
income 24.1 24.1
------ -------- ------ -------- -------- -------- --------- ---------
Balance at
December 31, 1998 $ 6.1 $ - $ 1.1 $ - $ 849.1 $ 74.9 $ - $ 931.2
====== ======== ====== ======== ======== ======== ========= =========
See accompanying notes to consolidated financial statements.
66
KANSAS CITY SOUTHERN INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
Kansas City Southern Industries, Inc. ("Company" or "KCSI") is a diversified
company which reports its financial information in two business segments:
Transportation and Financial Services. Note 13 further describes the operations
of the Company.
Kansas City Southern Lines, Inc. ("KCSL") is the holding company for
Transportation segment subsidiaries and affiliates. This segment includes, among
others, The Kansas City Southern Railway Company ("KCSR"), the Gateway Western
Railway Company ("Gateway Western"), and strategic joint venture interests in
Grupo Transportacion Ferroviaria Mexicana, S.A de C.V. ("Grupo TFM"), which owns
80% of the common stock of TFM, S.A. de C.V. ("TFM"), Mexrail, Inc. ("Mexrail"),
which wholly owns The Texas Mexican Railway Company ("Tex Mex"), and Southern
Capital Corporation LLC ("Southern Capital").
FAM Holdings, Inc. ("FAM HC") was formed for the purpose of becoming the holding
company for Financial Services segment subsidiaries and affiliates. The primary
entities comprising this segment are Janus Capital Corporation ("Janus" - 82%
owned, diluted), Berger Associates, Inc. ("Berger" - 100% owned) and Nelson
Money Managers plc ("Nelson" - 80% owned). Additionally, the Company owns an
approximate 32% equity interest in DST Systems, Inc. ("DST").
The accounting and financial reporting policies of the Company conform with
generally accepted accounting principles. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Use of the term "Company" as described in these Notes to Consolidated Financial
Statements means Kansas City Southern Industries, Inc. and all of its
consolidated subsidiary companies. Significant accounting and reporting policies
are described below. Certain prior year amounts have been reclassified to
conform to the current year presentation.
Principles of Consolidation. The consolidated financial statements generally
include all majority owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated.
Cash Equivalents. Short-term liquid investments with an initial maturity of
generally three months or less are considered cash equivalents. Carrying value
approximates market value due to the short-term nature of these investments.
Inventories. Materials and supplies inventories for transportation operations
are valued at average cost.
Properties and Depreciation. Properties are stated at cost. Additions and
renewals constituting a unit of property are capitalized and all properties are
depreciated over the estimated remaining life of such assets. Ordinary
maintenance and repairs are charged to expense as incurred.
The cost of transportation equipment and road property normally retired, less
salvage value, is charged to accumulated depreciation. Conversely, the cost of
industrial and other property retired, and the cost of transportation property
abnormally retired, together with accumulated depreciation thereon, are
eliminated from the property accounts and the related gains or losses are
reflected in earnings.
67
Depreciation for transportation operations is computed using composite
straight-line rates for financial statement purposes. The Surface Transportation
Board ("STB") approves the depreciation rates used by KCSR. KCSR evaluates
depreciation rates for properties and equipment and implements approved rates.
Periodic revisions of rates have not had a material effect on operating results.
Unit depreciation methods, employing both accelerated and straight-line rates,
are employed in other business segments. Accelerated depreciation is used for
income tax purposes. The ranges of annual depreciation rates for financial
statement purposes are:
Transportation
Road and structures 1% - 20%
Rolling stock and equipment 1% - 24%
Other equipment 1% - 33%
Capitalized leases 3% - 20%
The Company adopted Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" ("SFAS 121") effective January 1, 1996. SFAS 121 provides
accounting standards for the impairment of long-lived assets, certain
identifiable intangibles, and goodwill, as well as for long-lived assets and
certain identifiable intangibles which are to be disposed. If events or changes
in circumstances of a long-lived asset indicate that the carrying amount of an
asset may not be recoverable, the Company must estimate the future cash flows
expected to result from the use of the asset and its eventual disposition. If
the sum of the expected future cash flows (undiscounted and without interest) is
lower than the carrying amount of the asset, an impairment loss must be
recognized to the extent that the carrying amount of the asset exceeds its fair
value. The adoption of SFAS 121 did not have a material effect on the Company's
financial position or results of operations. However, see Note 3 below with
respect to certain KCSR assets held for disposal and certain other impaired
assets.
Investments. The equity method of accounting is used for all entities in which
the Company or its subsidiaries have significant influence, but not more than
50% voting control interest; the cost method of accounting is generally used for
investments of less than 20% voting control interest. In December 1996 and the
first four months of 1997, Gateway Western was accounted for under the equity
method as a majority-owned unconsolidated subsidiary while the Company awaited
approval from the STB for the acquisition of Gateway Western. The STB approved
the Company's acquisition of Gateway Western effective May 5, 1997.
Subsequently, Gateway Western was included as a consolidated subsidiary of the
Company effective January 1, 1997. See Note 2 for additional information on the
Gateway Western acquisition.
Pursuant to Statement of Financial Accounting Standards No. 115 "Accounting for
Certain Investments in Debt and Equity Securities" ("SFAS 115"), investments
classified as "available for sale" are reported at fair value, with unrealized
gains and losses excluded from earnings and reported, net of deferred income
taxes, in accumulated other comprehensive income. Investments classified as
"trading" securities are reported at fair value, with unrealized gains and
losses included in earnings. Investments in advised funds are comprised of
shares of certain mutual funds advised by Janus and Berger. These investments
are generally used to fund operations and dividends. Realized gains and losses
are determined using the first-in, first-out method.
Revenue Recognition. Revenue is recognized by the Company's consolidated
railroad operations based upon the percentage of completion of a commodity
movement. Investment advisory revenues are recognized by Janus and Berger
primarily as a percentage of assets under management. Other subsidiaries, in
general, recognize revenue when the product is shipped or as services are
performed.
Advertising. The Company expenses all advertising as incurred. Direct response
advertising for which future economic benefits are probable and specifically
attributable to the advertising is not material.
68
Intangibles. Intangibles principally represent the excess of cost over the fair
value of net underlying assets of acquired companies using purchase accounting
and are amortized using the straight-line method over periods ranging from 5 to
40 years.
On an annual basis, the Company reviews the recoverability of goodwill. In
response to changes in the competitive and business environment in the rail
industry, the Company revised its methodology for evaluating goodwill
recoverability effective December 31, 1997. The change in this method of
measurement relates to the level at which assets are grouped from the business
unit level to the investment component level. At the same time, there were
changes in the estimates of future cash flows used to measure goodwill
recoverability. The effect of the change in method of applying the accounting
principle is inseparable from the changes in estimate. Accordingly, the combined
effects have been reported in the accompanying consolidated financial statements
as a change in estimate. The Company believes that the revised methodology
represents a preferable method of accounting because it more closely links the
fair value estimates to the asset whose recoverability is being evaluated. The
policy change did not impact the Company's Financial Services businesses as
their goodwill has always been evaluated on an investment component basis.
As a result of the changes discussed above, the Company determined that the
aggregate carrying value of the goodwill and other intangible assets associated
with the 1993 MidSouth Corporation ("MidSouth") purchase exceeded their fair
value. Accordingly, the Company recorded an impairment loss of $91.3 million in
the fourth quarter of 1997. Due to the fact that the change in accounting is
inseparable from the changes in estimates, the pro forma effects of retroactive
application cannot be determined.
Computer Software Costs. Costs incurred in conjunction with the purchase or
development of computer software for internal use are accounted for in
accordance with American Institute of Certified Public Accountant's Statement of
Position 98-1 "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP 98-1"). Costs incurred in the preliminary
project stage, as well as training and maintenance costs, are expensed as
incurred. Direct and indirect costs associated with the application development
stage of internal use software are capitalized until such time that the software
is substantially complete and ready for its intended use. Capitalized costs are
amortized on a straight line basis over the useful life of the software.
Derivative Financial Instruments. In 1997, the Company entered into foreign
currency contracts in order to reduce the impact of fluctuations in the value of
the Mexican peso on its investment in Grupo TFM. These contracts were intended
to hedge only a portion of the Company's exposure related to the final
installment of the purchase price and not any other transactions or balances.
The Company follows the requirements outlined in Statement of Financial
Accounting Standards No. 52 "Foreign Currency Translation" ("SFAS 52"), and
related authoritative guidance. Accordingly, gains and losses related to hedges
of the Company's investment in Grupo TFM were deferred and recognized as
adjustments to the carrying amount of the investment when the hedged transaction
occurred.
Any gains and losses qualifying as hedges of existing assets or liabilities are
included in the carrying amounts of those assets or liabilities and are
ultimately recognized in income as part of those carrying amounts. Any gains or
losses on derivative contracts that do not qualify as hedges are recognized
currently as other income. Gains and losses on hedges are reflected in operating
activities in the statement of cash flows.
See Note 11 for additional information with respect to derivative financial
instruments and purchase commitments.
69
Income Taxes. Deferred income tax effects of transactions reported in different
periods for financial reporting and income tax return purposes are recorded
under the liability method of accounting for income taxes. This method gives
consideration to the future tax consequences of the deferred income tax items
and immediately recognizes changes in income tax laws upon enactment. The income
statement effect is generally derived from changes in deferred income taxes on
the balance sheet.
Treasury Stock. The excess of par over cost of the Preferred shares held in
Treasury is credited to capital surplus. Common shares held in Treasury are
accounted for as if they were retired and the excess of cost over par value of
such shares is charged to capital surplus, if available, and then to retained
earnings.
Stock Plans. Proceeds received from the exercise of stock options or
subscriptions are credited to the appropriate capital accounts in the year they
are exercised.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS
123") in October 1995. This statement allows companies to continue under the
approach set forth in Accounting Principles Board Opinion No. 25 "Accounting for
Stock Issued to Employees" ("APB 25"), for recognizing stock-based compensation
expense in the financial statements, but encourages companies to adopt the fair
value method of accounting for employee stock options. The Company has elected
to retain its accounting approach under APB 25, and has presented the applicable
pro forma disclosures in Note 9 to the consolidated financial statements
pursuant to the requirements of SFAS 123.
All shares held in the Employer Stock Ownership Plan ("ESOP") are treated as
outstanding for purposes of computing the Company's earnings per share. See
additional information on the ESOP in Note 10.
Earnings Per Share. The Company adopted Statement of Financial Accounting
Standards No. 128 "Earnings per Share" ("SFAS 128") in 1997. The statement
specifies the computation, presentation and disclosure requirements for earnings
per share. The statement requires the computation of earnings per share under
two methods: "basic" and "diluted." Basic earnings per share is computed by
dividing income available to common stockholders by the weighted average number
of common shares outstanding during the period. Diluted earnings per share is
computed giving effect to all dilutive potential common shares that were
outstanding during the period (i.e., the denominator used in the basic
calculation is increased to include the number of additional common shares that
would have been outstanding if the dilutive potential shares had been issued).
SFAS 128 requires the Company to present basic and diluted per share amounts for
income (loss) from continuing operations and for net income (loss) on the face
of the statements of operations. All prior period earnings per share data have
been restated.
The effect of stock options to employees represent the only difference between
the weighted average shares used for the basic computation compared to the
diluted computation. The total incremental shares from assumed conversion of
stock options included in the computation of diluted earnings per share were
3,840,333 and 2,111,437 for the years ended December 31, 1998 and 1996,
respectively. Because of the net loss in 1997, all options were anti-dilutive
for the year ended December 31, 1997. The weighted average of options to
purchase 274,340 and 3,502,290 shares in 1998 and 1996, respectively, were
excluded from the diluted earnings per share computation because the exercise
prices were greater than the respective average market price of the common
shares.
The only adjustments that currently affect the numerator of the Company's
diluted earnings per share computation include preferred dividends and
potentially dilutive securities at subsidiaries and affiliates. These
adjustments totaled $2.3 million for the year ended December 31, 1998.
Adjustments for the years ended December 31, 1997 and 1996 were not material.
70
Stockholders' Equity. Information regarding the Company's capital stock at
December 31, 1998 follows:
Shares Shares
Authorized Issued
$25 Par, 4% noncumulative, Preferred stock 840,000 649,736
$1 Par, Preferred stock 2,000,000 None
$1 Par, Series A, Preferred stock 150,000 None
$1 Par, Series B convertible, Preferred stock 1,000,000 None
$.01 Par, Common stock 400,000,000 146,738,232
The Company's $1 Par Series B convertible Preferred stock ("Series B Preferred
stock"), issued in 1993, had a $200 per share liquidation preference and was
convertible to common stock at a ratio of twelve to one. As more fully discussed
in Note 9, effective September 30, 1998, the Company terminated the Employee
Plan Funding Trust ("EPFT" or "Trust"), which was established as a grantor trust
for the purpose of holding these shares of Series B Preferred stock for the
benefit of various KCSI employee benefit plans.
In accordance with the Agreement to terminate the EPFT, the Company received
872,362 shares of Series B Preferred stock in full repayment of the indebtedness
from the Trust ( $178.7 million plus accrued interest). In addition, the
remaining 127,638 shares of Series B Preferred stock were converted into KCSI
Common stock, resulting in the issuance to the EPFT of 1,531,656 shares of such
Common stock. This Common stock was then transferred to KCSI and the Company has
set these shares aside for use in connection with the KCSI Stock Option and
Performance Award Plan, as amended and restated effective July 15, 1998. As a
result of the termination of the Trust, the Series B Preferred stock is no
longer issued or outstanding and the converted Common stock has been included in
the shares issued above.
On July 29, 1997, the Company's Board of Directors authorized a 3-for-1 split in
the Company's common stock effected in the form of a stock dividend. All share
and per share data reflect this split.
The Company's stockholders approved a reverse stock split at a special
stockholders' meeting held on July 15, 1998. The Company will not effect a
reverse stock split until a separation of its two business segments
(Transportation and Financial Services) is completed.
Shares outstanding are as follows at December 31, (in thousands):
1998 1997 1996
$25 Par, 4% noncumulative, Preferred stock 242 242 242
$.01 Par, Common stock 109,815 108,084 108,918
Retained earnings include equity in unremitted earnings of unconsolidated
affiliates of $125.9, $109.1 and $99.2 million at December 31, 1998, 1997 and
1996, respectively.
New Accounting Pronouncements. In June 1998, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133").
SFAS 133 establishes accounting and reporting standards for derivative financial
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires recognition of all
derivatives as either assets or liabilities measured at fair value. SFAS 133 is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999
and should not be retroactively applied to financial statements of periods prior
to adoption.
71
The Company currently has a program to hedge against fluctuations in the price
of diesel fuel purchases, and also enters into fuel purchase commitments from
time to time. In addition, the Company continues to evaluate alternatives with
respect to utilizing foreign currency instruments to hedge its U.S. dollar
investments in Grupo TFM and Nelson as market conditions change or exchange
rates fluctuate. Currently, the Company has no outstanding foreign currency
hedges. The Company is reviewing the provisions of SFAS 133 and expects adoption
by the required date. The adoption of SFAS 133 with respect to existing hedge
transactions is not expected to have a material impact on the Company's results
of operations, financial position or cash flows.
Statement of Financial Accounting Standards No. 132 "Employers' Disclosure about
Pensions and Other Postretirement Benefits - an amendment of FASB Statements No.
87, 88, and 106" ("SFAS 132") was adopted by the Company in 1998 and prior year
information has been included pursuant to SFAS 132. SFAS 132 establishes
standardized disclosure requirements for pension and other postretirement
benefit plans, requires additional information on changes in the benefit
obligations and fair values of plan assets, and eliminates certain disclosures
that are no longer useful. The standard does not change the measurement or
recognition of pension or postretirement benefit plans. The adoption of SFAS 132
did not have a material impact on the Company's disclosures.
In 1998, the Company adopted the provisions of Statement of Financial Accounting
Standards No. 131 "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"). SFAS 131 establishes standards for the manner in
which public business enterprises report information about operating segments in
annual financial statements and requires disclosure of selected information
about operating segments in interim financial reports issued to shareholders.
SFAS 131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. The adoption of SFAS 131 did not
have a material impact on the disclosures of the Company. See Note 13 for
segment financial information. Prior year information is reflected pursuant to
SFAS 131.
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130 "Reporting Comprehensive Income" ("SFAS
130"), which establishes standards for reporting and disclosure of comprehensive
income and its components in the financial statements. Prior year information
has been included pursuant to SFAS 130. The Company's other comprehensive income
consists primarily of unrealized gains and losses relating to investments held
as "available for sale" securities as defined by SFAS 115. The unrealized gain
related to these investments increased $40.3 million, $42.6 million and $30.1
million ($24.1 million, $25.9 million and $18.5 million, net of deferred taxes)
for the years ended December 31, 1998, 1997 and 1996, respectively.
In Issue No. 96-16, the Emerging Issues Task Force ("EITF 96-16") of the FASB,
reached a consensus that substantive minority rights which provide the minority
shareholder with the right to effectively control significant decisions in the
ordinary course of an investee's business could impact whether the majority
shareholder should consolidate the investee. Management evaluated the rights of
the minority shareholders of its consolidated subsidiaries. Application of EITF
96-16 did not affect the Company's consolidated financial statements.
In 1998, the Company adopted the guidance outlined in SOP 98-1. SOP 98-1
requires that computer software costs incurred in the preliminary project stage,
as well as training and maintenance costs be expensed as incurred. This guidance
also requires that direct and indirect costs associated with the application
development stage of internal use software be capitalized until such time that
the software is substantially complete and ready for its intended use.
Capitalized costs are to be amortized on a straight line basis over the useful
life of the software. The adoption of this guidance did not have a material
impact on the Company's results of operations, financial position or cash flows.
72
Note 2. Acquisitions and Dispositions
DST Transactions. On December 21, 1998, DST and USCS International, Inc.
("USCS") announced the completion of the merger of USCS with a wholly-owned DST
subsidiary. The merger, accounted for as a pooling of interests by DST, expands
DST's presence in the output solutions and customer management software and
services industries. USCS is a leading provider of customer management software
to the cable television and convergence industries. Under the terms of the
merger, USCS became a wholly-owned subsidiary of DST. DST issued approximately
13.8 million shares of its common stock in the transaction.
The issuance of additional DST common shares reduced KCSI's ownership interest
from 41% to approximately 32%. Additionally, the Company recorded a one-time
non-cash charge of approximately $36.0 million pretax ($23.2 million after-tax,
or $0.21 per share), reflecting the Company's reduced ownership of DST and the
Company's proportionate share of DST and USCS fourth quarter merger-related
costs. KCSI accounts for its investment in DST under the equity method.
On August 1, 1996, The Continuum Company, Inc. ("Continuum"), formerly an
approximate 23% owned DST equity affiliate, merged with Computer Sciences
Corporation ("CSC," a publicly traded company) in a tax-free share exchange. In
exchange for its ownership interest in Continuum, DST received CSC common stock,
which DST accounts for as available for sale securities pursuant to SFAS 115.
As a result of this CSC/Continuum transaction, the Company's earnings for the
year ended December 31, 1996 include approximately $47.7 million (after-tax, or
$0.41 per diluted share), representing the Company's proportionate share of the
one-time gain recognized by DST in connection with the merger. Continuum ceased
to be an equity affiliate of DST, thereby eliminating any future Continuum
equity affiliate earnings or losses. DST recognized equity losses in Continuum
of $4.9 million for the first six months of 1996.
Acquisition of Nelson. On April 20, 1998, the Company completed its acquisition
of 80% of Nelson, an investment advisor and manager based in the United Kingdom
("UK"). Nelson has six offices throughout the UK and offers planning based asset
management services directly to private clients. Nelson managed approximately
$1.2 billion of assets as of December 31, 1998. The acquisition, accounted for
as a purchase, was completed using a combination of cash, KCSI common stock and
notes payable. The total purchase price was approximately $33 million. The
purchase price is in excess of the fair market value of the net tangible and
identifiable intangible assets received and this excess was recorded as goodwill
to be amortized over a period of 20 years. Assuming the transaction had been
completed January 1, 1998, inclusion of Nelson's results on a pro forma basis,
as of and for the year ended December 31, 1998, would not have been material to
the Company's consolidated results of operations.
Grupo TFM. In June 1996, the Company and Transportacion Maritima Mexicana, S.A.
de C.V. ("TMM") formed Grupo TFM. Grupo TFM was formed to participate in the
privatization of the Mexican rail industry.
On December 6, 1996, Grupo TFM, TMM and the Company announced that the Mexican
Government ("Government") had awarded to Grupo TFM the right to purchase 80% of
the common stock of TFM for approximately 11.072 billion Mexican pesos
(approximately $1.4 billion based on the U.S. dollar/Mexican peso exchange rate
on the award date). TFM holds the concession to operate Mexico's "Northeast Rail
Lines" for 50 years, with the option of a 50 year extension (subject to certain
conditions).
The Northeast Rail Lines are a strategically important rail link to Mexico and
the North American Free Trade Agreement ("NAFTA") corridor. The lines are
estimated to transport approximately 40% of Mexico's rail cargo and are located
next to primary north/south truck routes. The Northeast Rail Lines directly link
Mexico City and Monterrey, as well as Guadalajara (through trackage rights),
with the ports of Lazaro Cardenas, Veracruz, Tampico, and the cities of
Matamoros and Nuevo Laredo. Nuevo Laredo is a primary transportation gateway
between Mexico and the United States. The Northeast Rail Lines connect
73
in Laredo, Texas to the Union Pacific Railroad and the Tex Mex. The Tex Mex
links to KCSR at Beaumont, Texas through trackage rights. With the KCSR and Tex
Mex interchange at Beaumont, and through KCSR's connections with major rail
carriers at various other points, KCSR has developed a NAFTA rail system which
is expected to facilitate the economic integration of the North American
marketplace.
On January 31, 1997, Grupo TFM paid the first installment of the purchase price
(approximately $565 million based on the U.S. dollar/Mexican peso exchange rate)
to the Government, representing approximately 40% of the purchase price. This
initial installment of the TFM purchase price was funded by Grupo TFM through
capital contributions from TMM and the Company. The Company contributed
approximately $298 million to Grupo TFM, of which approximately $277 million was
used by Grupo TFM as part of the initial installment payment. The Company
financed this contribution using borrowings under existing lines of credit.
On June 23, 1997, Grupo TFM completed the purchase of 80% of TFM through the
payment of the remaining $835 million to the Government. This payment was funded
by Grupo TFM using a significant portion of the funds obtained from: (i) senior
secured term credit facilities ($325 million); (ii) senior notes and senior
discount debentures ($400 million); (iii) proceeds from the sale of 24.6% of
Grupo TFM to the Government (approximately $199 million based on the U.S.
dollar/Mexican peso exchange rate on June 23, 1997); and (iv) additional capital
contributions from TMM and the Company (approximately $1.4 million from each
partner). Additionally, Grupo TFM entered into a $150 million revolving credit
facility for general working capital purposes. The Government's interest in
Grupo TFM is in the form of limited voting right shares, and the purchase
agreement includes a call option for TMM and the Company, which is exercisable
at the original amount (in U.S. dollars) paid by the Government plus interest
based on one-year U.S. Treasury securities.
In February and March 1997, the Company entered into two separate forward
contracts - $98 million in February 1997 and $100 million in March 1997 - to
purchase Mexican pesos in order to hedge against a portion of the Company's
exposure to fluctuations in the value of the Mexican peso versus the U.S.
dollar. In April 1997, the Company realized a $3.8 million pretax gain in
connection with these contracts. This gain was deferred, and has been accounted
for as a component of the Company's investment in Grupo TFM. These contracts
were intended to hedge only a portion of the Company's exposure related to the
final installment of the purchase price and not any other transactions or
balances.
Concurrent with the financing transactions, Grupo TFM, TMM and the Company
entered into a Capital Contribution Agreement ("Contribution Agreement") with
TFM, which includes a possible capital call of $150 million from TMM and the
Company if certain performance benchmarks, outlined in the agreement, are not
met. The Company would be responsible for approximately $74 million of the
capital call. The term of the Contribution Agreement is three years. In a
related agreement between Grupo TFM, TFM and the Government, among others, the
Government agreed to contribute up to $37.5 million of equity capital to Grupo
TFM if TMM and the Company were required to contribute under the capital call
provisions of the Contribution Agreement prior to July 16, 1998. As of July 16,
1998, no additional contributions from the Company were requested or made and,
therefore, the Government did not contribute additional equity capital to Grupo
TFM. The Government also committed that if it had not made any contributions by
July 16, 1998, it would, up to July 31, 1999, make additional capital
contributions to Grupo TFM (of up to an aggregate amount of $37.5 million) on a
proportionate basis with TMM and the Company if capital contributions are
required. Any capital contributions to Grupo TFM from the Government would be
used to reduce the contribution amounts required to be paid by TMM and the
Company pursuant to the Contribution Agreement. As of December 31, 1998 no
additional contributions from the Company have been requested or made.
At December 31, 1998, the Company's investment in Grupo TFM was approximately
$285.1 million. With the sale of 24.6% of Grupo TFM to the Government, the
Company's interest in Grupo TFM declined from 49% to approximately 37% (with TMM
and a TMM affiliate owning the remaining 38.4%). The Company accounts for its
investment in Grupo TFM under the equity method.
74
On January 28, 1999, the Company, along with other direct and indirect
owners of TFM, entered into a preliminary agreement with the Government. As part
of that agreement, an option was granted to the Company, TMM and Grupo Servia,
S.A. de C.V. ("Grupo Servia") to purchase the Government's 20% ownership
interest in TFM at a discount. The option to purchase all or a portion of the
Government's interest expires on November 30, 1999. If the purchase of at least
35% of the Government's stock is not completed by May 31, 1999, the entire
option will expire on that date. If the option is fully exercised, the Company's
additional cash investment is not expected to exceed $88 million. As part of
this agreement and as a condition to exercise this option, the parties have
agreed to settle the oustanding claims against the Government regarding a refund
of Mexican Value Added Tax (VAT) payments. TFM has also agreed to sell to the
Government a small section of redundant trackage for inclusion in another
railroad concession. In addition, under the terms of the agreement, the
Government would be released from its capital call obligations at the moment
that the option is exercised in whole or in part. Furthermore, TFM, TMM, Grupo
Servia and the Company have agreed to sell, in a public offering, a direct or
indirect participation in at least the same percentage currently represented by
the shares exercised in this option, by October 31, 2003, at the latest, subject
to market conditions. The option and the other described agreements are
conditioned on the parties entering into a final written agreement and the
Company, TFM, TMM and Grupo Servia obtaining all necessary consents and
authorizations.
Gateway Western Acquisition. In May 1997, the STB approved the Company's
acquisition of Gateway Western, a regional rail carrier with operations from
Kansas City, Missouri to East St. Louis and Springfield, Illinois and haulage
rights between Springfield and Chicago, from the Southern Pacific Rail
Corporation. Prior to the STB approval -- from acquisition in December 1996
through May 1997 -- the Company's investment in Gateway Western was treated as a
majority-owned unconsolidated subsidiary accounted for under the equity method.
Upon approval from the STB, the assets, liabilities, revenues and expenses were
included in the Company's consolidated financial statements. The consideration
paid for Gateway Western (including various acquisition costs and liabilities)
was approximately $12.2 million, which exceeded the fair value of the underlying
net assets by approximately $12.1 million. The resulting intangible is being
amortized over a period of 40 years.
Under a prior agreement with The Atchison, Topeka & Santa Fe Railway Company,
Burlington Northern Santa Fe Corporation has the option of purchasing the assets
of Gateway Western (based on a fixed formula in the agreement) through the year
2004.
Assuming the transaction had been completed January 1, 1996, inclusion of
Gateway Western results on a pro forma basis, as of and for the year ended
December 31, 1996, would not have been material to the Company's consolidated
results of operations.
Berger Ownership Interest. As a result of certain transactions during 1997, the
Company increased its ownership in Berger to 100% from approximately 80% at
December 31, 1996. In January and December 1997, Berger purchased, for treasury,
the common stock of minority shareholders. Also in December 1997, the Company
acquired additional Berger shares from a minority shareholder through the
issuance of 330,000 shares of KCSI common stock. In connection with these
transactions, Berger granted options to acquire shares of Berger stock to
certain of its employees. At December 31, 1998, the Company's ownership would
have been diluted to approximately 91% if all of the outstanding options had
been exercised. These transactions resulted in approximately $17.8 million of
goodwill, which is being amortized over 15 years. However, see discussion of
impairment of a portion of this goodwill in Note 3.
The Company's 1994 acquisition of a controlling interest in Berger was completed
under a Stock Purchase Agreement ("Agreement") covering a five year period
ending in October 1999. Pursuant to the Agreement, the Company may be required
to make additional purchase price payments (up to $36.6 million) based upon
Berger attaining certain incremental levels of assets under management up to $10
billion by October 1999. The Company made no payments under the Agreement during
1998. In 1997 and 1996, the Company made additional payments of $3.1 and $23.9
million, respectively, resulting in adjustments to the purchase price. The
intangible amounts are amortized over 15 years.
75
Southern Capital. In October 1996, the Company and GATX Capital Corporation
("GATX") completed the transactions for the formation and financing of a joint
venture to perform certain leasing and financing activities. The venture,
Southern Capital, was formed through a GATX contribution of $25 million in cash,
and a Company contribution (through KCSR and Carland, Inc.) of $25 million in
net assets, comprising a negotiated fair value of locomotives and rolling stock
and long-term indebtedness owed to KCSI and its subsidiaries. In an associated
transaction, Southern Leasing Corporation ("SLC," an indirect wholly-owned
subsidiary of the Company prior to dissolution in October 1996), sold to
Southern Capital approximately $75 million of loan portfolio assets and rail
equipment at fair value which approximated historical cost.
As a result of these transactions and subsequent repayment by Southern Capital
of indebtedness owed to KCSI and its subsidiaries, the Company received cash
which exceeded the net book value of its assets by approximately $44.1 million.
Concurrent with the formation of the joint venture, KCSR entered into operating
leases with Southern Capital for the majority of the rail equipment acquired by
or contributed to Southern Capital. Accordingly, this excess fair value over
book value is being recognized over the terms of the leases (approximately $4.4
million in 1998 and $4.9 million in 1997).
The cash received by the Company was used to reduce outstanding indebtedness by
approximately $217 million, after consideration of applicable income taxes,
through repayments on various lines of credit and subsidiary indebtedness. The
Company reports its 50% ownership interest in Southern Capital under the equity
method of accounting. See Notes 4 and 5 for additional information.
Under a prior agreement, GATX had an option to notify the Company of its intent
to cause disposal of the loan portfolio assets of Southern Capital. GATX
exercised its option with regard to this agreement and the Company and GATX are
jointly reviewing options for disposition of these loan portfolio assets. The
portfolio of rail assets would remain with Southern Capital. The disposal of the
loan portfolio assets is not expected to have a material impact on the Company's
results of operations, financial position or cash flows.
Note 3. Restructuring, Asset Impairment and Other Charges
As discussed in Note 1, in response to changes in the competitive and business
environment in the rail industry, the Company revised its methodology for
evaluating goodwill recoverability effective December 31, 1997. As a result of
this revised methodology (as well as certain changes in estimate), the Company
determined that the aggregate carrying value of the goodwill and other
intangible assets associated with the 1993 MidSouth purchase exceeded their fair
value (measured by reference to the net present value of future cash flows).
Accordingly, the Company recorded an impairment loss of $91.3 million in 1997.
In connection with the review of its intangible assets, the Company determined
that the carrying value of the goodwill associated with Berger exceeded its fair
value (measured by reference to various valuation techniques commonly used in
the investment management industry) as a result of below-peer performance and
growth of the core Berger funds. Accordingly, the Company recorded an impairment
loss of $12.7 million.
During the fourth quarter of 1997, Transportation management committed to
dispose, as soon as practicable, certain under-performing branch lines acquired
in connection with the 1993 MidSouth purchase, as well as certain of the
Company's non-operating real estate. Accordingly, in accordance with SFAS 121,
the Company recognized losses aggregating $38.5 million which represented the
excess of carrying value over fair value less cost to sell. Results of
operations related to these assets included in the accompanying consolidated
financial statements cannot be separately identified. During 1998, one of the
branch lines was sold for a pretax gain of approximately $2.9 million.
Management efforts are ongoing to procure bids on the other branch line and
non-operating real estate.
76
In accordance with SFAS 121, the Company periodically evaluates the
recoverability of its operating properties. As a result of continuing operating
losses and a further decline in the customer base of the Transportation
segment's bulk coke handling facility (Pabtex, Inc.) the Company determined that
the long-lived assets related thereto may not be fully recoverable. Accordingly,
the Company recognized an impairment loss of $9.2 million in 1997 representing
the excess of carrying value over fair value.
Additionally, the Company recorded expenses aggregating $44.7 million related to
restructuring and other costs. This amount includes approximately $27.1 related
to the termination of a union productivity fund (which required KCSR to pay
certain employees when reduced crew levels were used) and employee separations,
as well as $17.6 million of other costs related to reserves for leases,
contracts, impaired investments and other reorganization costs. During 1998,
approximately $31.1 million of cash payments were made and approximately $2.5
million of the reserves were reduced based primarily on changes in the estimate
of claims made relating to the union productivity fund. Approximately $6.5
million of reserves remain accrued at December 31, 1998.
Note 4. Supplemental Cash Flow Disclosures
Supplemental Disclosures of Cash Flow Information.
1998 1997 1996
Cash payments (in millions):
Interest $ 74.2 $ 64.5 $ 56.0
Income taxes 83.2 65.3 121.0
Supplemental Schedule of Noncash Investing and Financing Activities. As
discussed in Note 2, during second quarter 1998, in connection with Company's
acquisition of Nelson, the Company issued approximately 67,000 shares of KCSI
Common stock (valued at $3.2 million) to certain of the sellers of the Nelson
shares. Also, notes payable of $4.9 million were recorded as part of the
purchase price, payable by March 31, 2005, bearing interest at 7 percent.
As discussed in Note 2, during 1997 the Company purchased a portion of the
Berger minority interest. The Company issued 330,000 shares of its common stock,
valued at $10.1 million, in exchange for the increased investment in Berger.
In connection with the Southern Capital joint venture formation, the Company
(through its subsidiaries KCSR, Carland, Inc. and SLC) contributed/sold to
Southern Capital rail equipment, current and non-current loan portfolio assets,
and long-term indebtedness owed to KCSI and its subsidiaries (see Note 2).
Southern Capital repaid the indebtedness owed KCSI and its subsidiaries with
borrowings under Southern Capital's credit facility. Cash received by KCSI from
Southern Capital of approximately $224 million is reflected in the Consolidated
Statement of Cash Flows for the year ended December 31, 1996 as proceeds from
disposal of property ($184 million) and proceeds from disposal of other
investments ($40 million). The Company accrued for expected income taxes on the
transaction and, as described in Note 2, deferred the excess cash received over
the book value of the assets contributed and sold.
Company subsidiaries and affiliates hold various investments which are accounted
for as "available for sale" securities as defined in SFAS 115. The Company
records its proportionate share of any unrealized gains or losses related to
these investments, net of deferred taxes, in accumulated other comprehensive
income. Stockholders' equity increased $24.1, $25.9, and $18.5 million in 1998,
1997 and 1996, respectively, as a result of unrealized gains related to these
investments.
During 1998, 1997 and 1996, the Company issued 227,178, 245,550 and 305,400
shares of KCSI Common stock, respectively, under various offerings of the
Employee Stock Purchase Plan ("ESPP").
77
These shares, totaling a purchase price of $3.0, $3.1 and $3.8 million in 1998,
1997 and 1996, respectively, were subscribed and paid for through employee
payroll deductions in years preceding the issuance of stock.
During 1998, 1997 and 1996, the Company's Board of Directors declared a
quarterly dividend totaling approximately $4.4, $4.5 and $3.6 million,
respectively, payable in January of the following year. The dividend declaration
reduced retained earnings and established a liability at the end of each
respective year. No cash outlay occurred until the subsequent year.
Note 5. Investments
Investments held for operating purposes, which include investments in
unconsolidated affiliates, are as follows (in millions):
Percentage
Ownership
Company Name December 31, 1998 Carrying Value
- --------------------------- ----------------- ---------------------------------------
1998 1997 1996
----------- ----------- -----------
DST (a) 32% $ 376.0 $ 345.3 $ 283.5
Grupo TFM (b) 37% 285.1 288.2 2.7
Southern Capital 50% 24.6 27.6 25.5
Mexrail 49% 13.0 14.9 14.1
Other 11.2 10.5 11.3
Market valuation allowances (2.8) (3.0) (1.9)
----------- ----------- -----------
Total (c) $ 707.1 $ 683.5 $ 335.2
=========== =========== ===========
(a) On December 21, 1998, DST and USCS announced the completion of the merger
of USCS with a wholly-owned DST subsidiary. Under the terms of the merger,
which was accounted for as a pooling of interests by DST, USCS became a
wholly-owned subsidiary of DST. DST issued approximately 13.8 million
shares of its common stock in the transaction, resulting in a reduction of
KCSI's ownership interest from 41% to approximately 32%. (See Note 2). Fair
market value at December 31, 1998 (based on DST's New York Stock Exchange
closing market price) was approximately $1,156.7 million.
(a) In June 1997, the Mexican Government purchased approximately 24.6% of Grupo
TFM, reducing the Company's ownership in Grupo TFM from 49% to
approximately 37% (see Note 2).
(b) Fair market value is not readily determinable for investments other than
noted above, and in the opinion of management, market value approximates
carrying value
Additionally, DST holds investments in the common stock of State Street
Corporation and CSC, among others, which are accounted for as "available for
sale" securities as defined by SFAS 115. The Company records its proportionate
share of any unrealized DST gains or losses related to these investments, net of
deferred taxes, in accumulated other comprehensive income.
Transactions With and Between Unconsolidated Affiliates. The Company and its
subsidiary, KCSR, paid certain expenses on behalf of Grupo TFM during 1997. In
addition, the Company has a management services agreement with Grupo TFM to
provide certain consulting and management services. At December 31, 1998, $1.5
million is reflected as an accounts receivable in the Company's consolidated
balance sheet.
In connection with the October 1996 formation of the Southern Capital joint
venture, KCSR entered into operating leases with Southern Capital for
locomotives and rolling stock at rental rates management believes reflect
market. KCSR paid Southern Capital $25.1, $23.5 and $4.5 million under these
operating leases in 1998, 1997 and 1996, respectively. Additionally, Southern
Group, Inc. ("SGI"), a wholly-owned subsidiary of KCSR, entered into a contract
with Southern Capital to manage the loan portfolio assets held
78
by Southern Capital, as well as to perform general administrative and accounting
functions for the venture. Payments under this contract were approximately $1.7
million in 1998 and 1997 and $0.3 million in 1996.
Together, Janus and Berger incurred approximately $5.5, $5.3 and $5.4 million in
1998, 1997 and 1996, respectively, in expenses associated with various services
provided by DST and its subsidiaries and affiliates.
Janus recorded $8.9, $7.1 and $5.9 million in revenues for the years ended
December 31, 1998, 1997 and 1996, respectively, representing management fees
earned from IDEX Management, Inc. ("IDEX"). IDEX was a 50% owned investment of
Janus prior to disposition during second quarter 1998. Janus recognized an $8.8
million pretax gain in connection with this disposition.
Throughout 1996, the Company repurchased KCSI common stock owned by DST's
portion of the ESOP. In total, 1,605,000 shares were repurchased for
approximately $24.2 million.
Financial Information. Combined financial information of all unconsolidated
affiliates that the Company and its subsidiaries account for under the equity
method follows. Note that information relating to DST (i.e., the equity in net
assets of unconsolidated affiliates, financial condition and operating results)
has been restated to combine the historical results of DST and USCS as a result
of their merger on December 21, 1998. All amounts are in millions.
December 31, 1998
--------------------------------------------------------
Grupo
DST TFM (i) Other Total
----------- ----------- ---------- -----------
Investment in unconsolidated affiliates $ 376.0 $ 285.1 $ 38.6 $ 699.7
Equity in net assets of
unconsolidated affiliates 376.0 282.4 34.6 693.0
Dividends and distributions received
from unconsolidated affiliates - - 6.1 6.1
Financial Condition:
Current assets $ 385.7 $ 109.9 $ 33.1 $ 528.7
Non-current assets 1,514.3 1,974.7 277.0 3,766.0
----------- ----------- ---------- -----------
Assets $ 1,900.0 $ 2,084.6 $ 310.1 $ 4,294.7
=========== =========== ========== ===========
Current liabilities $ 271.6 $ 233.9 $ 48.6 $ 554.1
Non-current liabilities 461.4 745.0 191.7 1,398.1
Minority interest 0.8 342.4 - 343.2
Equity of stockholders and partners 1,166.2 763.3 69.8 1,999.3
----------- ----------- ---------- -----------
Liabilities and equity $ 1,900.0 $ 2,084.6 $ 310.1 $ 4,294.7
=========== =========== ========== ===========
Operating results:
Revenues $ 1,096.1 $ 431.3 $ 87.7 $ 1,615.1
----------- ----------- ---------- -----------
Costs and expenses $ 976.6 $ 368.8 $ 85.4 $ 1,430.8
----------- ----------- ---------- -----------
Net Income (loss) $ 71.6 $ (7.3) $ 2.4 $ 66.7
----------- ----------- ---------- -----------
79
December 31, 1997
---------------------------------------------------------
Grupo
DST TFM (i) Other Total
----------- ----------- ---------- -----------
Investment in unconsolidated affiliates $ 345.3 $ 288.2 $ 44.6 $ 678.1
Equity in net assets of
unconsolidated affiliates 300.1 285.1 39.6 624.8
Dividends and distributions received
from unconsolidated affiliates - - 0.2 0.2
Financial Condition:
Current assets $ 351.2 $ 114.7 $ 29.9 $ 495.8
Non-current assets 1,197.3 1,990.4 255.1 3,442.8
----------- ----------- ---------- -----------
Assets $ 1,548.5 $ 2,105.1 $ 285.0 $ 3,938.6
=========== =========== ========== ===========
Current liabilities $ 212.0 $ 158.5 $ 13.2 $ 383.7
Non-current liabilities 404.2 830.6 191.7 1,426.5
Minority interest 1.4 345.4 - 346.8
Equity of stockholders and partners 930.9 770.6 80.1 1,781.6
----------- ----------- ---------- -----------
Liabilities and equity $ 1,548.5 $ 2,105.1 $ 285.0 $ 3,938.6
=========== =========== ========== ===========
Operating results:
Revenues $ 950.0 $ 206.4 $ 83.2 $ 1,239.6
----------- ----------- ---------- -----------
Costs and expenses $ 823.1 $ 190.5 $ 61.4 $ 1,075.0
----------- ----------- ---------- -----------
Net Income (loss) $ 79.4 $ (36.5) $ 5.9 $ 48.8
----------- ----------- ---------- -----------
December 31, 1996
---------------------------------------------------------
Grupo
DST TFM (i) Other Total
----------- ----------- ---------- -----------
Investment in unconsolidated affiliates $ 283.5 $ 2.7 $ 39.7 $ 325.9
Equity in net assets of
unconsolidated affiliates 256.7 2.1 35.2 294.0
Dividends and distributions received
from unconsolidated affiliates - - 3.7 3.7
Financial Condition:
Current assets $ 300.2 $ 1.2 $ 34.4 $ 335.8
Non-current assets 1,003.5 4.2 331.7 1,339.4
----------- ----------- ---------- -----------
Assets $ 1,303.7 $ 5.4 $ 366.1 $ 1,675.2
=========== =========== ========== ===========
Current liabilities $ 188.9 $ 1.2 $ 27.2 $ 217.3
Non-current liabilities 318.6 - 267.7 586.3
Equity of stockholders and partners 796.2 4.2 71.2 871.6
----------- ----------- ---------- -----------
Liabilities and equity $ 1,303.7 $ 5.4 $ 366.1 $ 1,675.2
=========== =========== ========== ===========
80
Operating results:
Revenues $ 844.0 $ - $ 76.4 $ 920.4
----------- ----------- ---------- -----------
Costs and expenses $ 765.8 $ - $ 62.0 $ 827.8
----------- ----------- ---------- -----------
Net Income $ 177.8 $ - $ 4.9 $ 182.7
----------- ----------- ---------- -----------
(i) Grupo TFM is presented on a U.S. GAAP basis.
Generally, the difference between the carrying amount of the Company's
investment in unconsolidated affiliates and the underlying equity in net assets
is attributable to certain equity investments whose carrying amounts have been
reduced to zero, and report a net deficit. For 1997 and 1996, the difference
between the Company's investment in DST and the underlying equity in net assets
is attributable to the effects of restating DST's financial statements for the
merger of a DST wholly-owned subsidiary with USCS. In addition, with respect to
the Company's investment in Grupo TFM, the effects of foreign currency
transactions and capitalized interest prior to June 23, 1997, which are not
recorded on the investee's books, also result in these differences.
Other. Interest income on cash and equivalents and investments in advised funds
was $8.1, $7.9 and $4.9 million in 1998, 1997 and 1996, respectively.
Note 6. Other Balance Sheet Captions
Investments in Advised Funds. Information with respect to investments in advised
funds is summarized as follows (in millions):
1998 1997 1996
----------- ----------- ----------
Available for sale:
Cost basis $ 140.8 $ 95.5 $ 58.9
Gross unrealized gains 5.4 2.0 2.4
----------- ----------- ----------
Sub-total 146.2 97.5 61.3
----------- ----------- ----------
Trading:
Cost basis 3.2 2.1 5.6
Gross unrealized gains - 0.7 0.9
Gross unrealized losses (0.3) - -
----------- ----------- ----------
Sub-total 2.9 2.8 6.5
----------- ----------- ----------
Total $ 149.1 $ 100.3 $ 67.8
=========== =========== ==========
Gross realized gains were not material to the Company's consolidated results of
operations for the years ended 1998, 1997 and 1996.
Investments in advised funds are generally used by Janus and Berger to fund
operations and dividends. Pursuant to contractual agreements, Janus is required
to pay at least 90% of its net income to its shareholders each year.
Accounts Receivable. Accounts receivable include the following allowances (in
millions):
1998 1997 1996
----------- ----------- ----------
Accounts receivable $ 214.2 $ 181.9 $ 141.4
Allowance for doubtful accounts (5.8) (4.9) (3.3)
----------- ----------- ----------
Accounts receivable, net $ 208.4 $ 177.0 $ 138.1
=========== =========== ==========
Doubtful accounts expense $ 0.9 $ 1.6 $ 1.4
----------- ----------- ----------
81
Other Current Assets. Other current assets include the following items (in
millions):
1998 1997 1996
----------- ----------- ----------
Deferred income taxes $ 14.8 $ 10.1 $ 8.6
Other 23.0 13.8 15.4
----------- ----------- ----------
Total $ 37.8 $ 23.9 $ 24.0
=========== =========== ==========
Properties. Properties and related accumulated depreciation and amortization are
summarized below (in millions):
1998 1997 1996
----------- ----------- ----------
Properties, at cost
Transportation
Road properties $ 1,381.4 $ 1,306.4 $ 1,308.2
Equipment, including $6.7, $15.4 and
$15.4 financed under capital leases 327.7 294.6 289.2
Other 55.1 106.2 76.8
Financial Services, including $0, $1.4
and $1.4 equipment financed under
capital leases 69.6 38.6 36.4
----------- ----------- ----------
Total 1,833.8 1,745.8 1,710.6
----------- ----------- ----------
Accumulated depreciation and amortization
Transportation
Road properties 384.9 346.2 330.3
Equipment, including $3.5, $10.8
and $10.2 for capital leases 127.6 116.8 109.3
Other 22.4 26.4 24.1
Financial Services
including $0, $1.4 and $1.4
for equipment capital leases 32.2 29.2 27.6
----------- ----------- ----------
Total 567.1 518.6 491.3
----------- ----------- ----------
Net Properties $ 1,266.7 $ 1,227.2 $ 1,219.3
=========== =========== ==========
As discussed in Note 3, effective December 31, 1997, the Company recorded a
charge representing long-lived assets held for disposal and impairment of assets
in accordance with SFAS 121.
Intangibles and Other Assets. Intangibles and other assets include the following
items (in millions):
1998 1997 1996
----------- ----------- ----------
Identifiable Intangibles $ 49.5 $ 49.5 $ 49.5
Goodwill 125.7 91.7 200.8
Accumulated amortization ( 24.2) (18.1) (40.6)
----------- ----------- ----------
Net 151.0 123.1 209.7
Other assets 25.4 27.3 27.8
----------- ----------- ----------
Total $ 176.4 $ 150.4 $ 237.5
=========== =========== ==========
82
As discussed in Note 1, effective December 31, 1997, the Company changed its
method of evaluating the recoverability of goodwill. Also, see Note 3 for
discussion of goodwill impairment recorded during fourth quarter 1997.
Accrued Liabilities. Accrued liabilities include the following items (in
millions):
1998 1997 1996
----------- ----------- ----------
Prepaid freight charges due other railroads $ 30.4 $ 38.6 $ 26.1
Current interest payable on indebtedness 13.2 17.2 15.2
Contract allowances 12.7 20.2 14.0
Productivity Fund liability - 24.2 -
Other 103.4 117.6 79.1
----------- ----------- ----------
Total $ 159.7 $ 217.8 $ 134.4
=========== =========== ==========
See Note 3 for discussion of reserves established in 1997 for restructuring and
other charges.
Note 7. Long-Term Debt
Indebtedness Outstanding. Long-term debt and pertinent provisions follow (in
millions):
1998 1997 1996
----------- ----------- ----------
KCSI
Competitive Advance & Revolving Credit
Facilities, through May 2002 $ 315.0 $ 282.0 $ 40.0
Rates: Below Prime
Notes and Debentures, due July
2002 to December 2025 400.0 500.0 500.0
Unamortized discount (2.4) (2.7) (3.0)
Rates: 6.625% to 8.80%
KCSR
Equipment trust indebtedness, due
serially to June 2009 78.8 88.9 96.1
Rates: 7.15% to 9.68%
Other
Short-term working capital lines 28.0 31.0 -
Rates: Below Prime
Subordinated and senior notes, secured term
loans and industrial revenue bonds, due
May 2004 to February 2018 16.9 17.4 12.0
Rates: 3.0% to 7.89%
----------- ----------- ----------
Total 836.3 916.6 645.1
Less: debt due within one year 10.7 110.7 7.6
----------- ----------- ----------
Long-term debt $ 825.6 $ 805.9 $ 637.5
=========== =========== ==========
83
KCSI Credit Agreements. The Company's lines of credit at December 31, 1998
follow (in millions):
Facility
Lines of Credit Fee Total Unused
- ------------------------------------------------------------- ------------ ------------
KCSI .07 to .25% $ 555.0 $ 240.0
KCSR .1875% 5.0 5.0
Gateway Western .1875% 40.0 12.0
Berger .125% 6.0 6.0
------------ ------------
Total $ 606.0 $ 263.0
============ ============
On May 5, 1995, the Company established a credit agreement in the amount of $400
million, comprised of a $300 million five-year facility and a $100 million
364-day facility. The $300 million facility was renewed in May 1997, extending
through May 2002, while the $100 million facility is expected to be renewed
annually. Proceeds of these facilities have been and are anticipated to be used
for general corporate purposes. The agreements contain a facility fee ranging
from .07-.25% per annum and interest rates below prime. Additionally, in May
1998, the Company established an additional $100 million 364-day credit
agreement assumable by the Financial Services segment for its use upon
separation of the Company's two segments. Proceeds of this facility have been
and are anticipated to be used to repay Company debt and for general corporate
purposes. This agreement contains a facility fee of .15% and interest rates
below prime. The Company also has various other lines of credit totaling $106
million. These additional lines, which are available for general corporate
purposes, have interest rates below prime and terms of less than one year. Among
other provisions, the agreements limit subsidiary indebtedness and sale of
assets, and require certain coverage ratios to be maintained. As of December 31,
1998, the Company was in compliance with all covenants of these agreements. At
December 31, 1998, the Company had borrowings of $343 million under its various
lines of credit leaving $263 million available for use, subject to limitations
within existing financial covenants as noted below.
As discussed in Note 2, in January 1997, the Company made an approximate $298
million capital contribution to Grupo TFM, of which approximately $277 million
was used by Grupo TFM for the purchase of TFM. This payment was funded using
borrowings under the Company's lines of credit.
Public Debt Transactions. During 1998, $100 million of 5.75% Notes which matured
on July 1, 1998 were repaid using borrowings under existing lines of credit.
Public indebtedness of the Company at December 31, 1998 includes: $100 million
of 7.875% Notes due 2002; $100 million of 6.625% Notes due in 2005; and $100
million of 8.8% Debentures due 2022; and $100 million of 7% Debentures due 2025.
The various Notes are not redeemable prior to their respective maturities. The
8.8% Debentures are redeemable on or after July 1, 2002 at a premium of 104.04%,
which declines to par on or after July 1, 2012. The 7% Debentures are redeemable
at the option of the Company, at any time, in whole or in part, at a redemption
price equal to the greater of (a) 100% of the principal amount of such
Debentures or (b) the sum of the present values of the remaining scheduled
payments of principal and interest thereon discounted to the date of redemption
on a semiannual basis at the Treasury Rate (as defined in the Debentures
agreement) plus 20 basis points, and in each case accrued interest thereon to
the date of redemption.
These various debt transactions were issued at a total discount of $4.1 million.
This discount is being amortized over the respective debt maturities on a
straight-line basis, which is not materially different from the interest method.
Deferred debt issue costs incurred in connection with these various transactions
(totaling approximately $4.8 million) are also being amortized on a
straight-line basis over the respective debt maturities.
84
KCSR Indebtedness. KCSR has purchased rolling stock under conditional sales
agreements, equipment trust certificates and capitalized lease obligations,
which equipment has been pledged as collateral for the related indebtedness.
Other Agreements, Guarantees, Provisions and Restrictions. The Company has debt
agreements containing restrictions on subsidiary indebtedness, advances and
transfers of assets, and sale and leaseback transactions, as well as requiring
compliance with various financial covenants. At December 31, 1998, the Company
was in compliance with the provisions and restrictions of these agreements.
Because of certain financial covenants contained in the credit agreements,
however, maximum utilization of the Company's available lines of credit may be
restricted. Unrestricted retained earnings at December 31, 1998 was $480.9
million.
Leases and Debt Maturities. The Company and its subsidiaries lease
transportation equipment, as well as office and other operating facilities under
various capital and operating leases. Rental expenses under operating leases
were $70, $64 and $42 million for the years 1998, 1997 and 1996, respectively.
As more fully described in Note 2, in connection with the Southern Capital joint
venture transactions completed in October 1996, KCSR entered into operating
leases with Southern Capital for locomotives and railroad rolling stock.
Accordingly, beginning in 1997 rental expense under operating leases was higher
than previous years.
Minimum annual payments and present value thereof under existing capital leases,
other debt maturities, and minimum annual rental commitments under
noncancellable operating leases are as follows (in millions):
Capital Leases Operating Leases
------------------------------------ ----------------------------------
Minimum Net
Lease Less Present Other Total
Payments Interest Value Debt Debt Affiliates Third Party Total
--------- --------- --------- --------- -------- -------- -------- -------
1999 $ 0.8 $ 0.4 $ 0.4 $ 10.3 $ 10.7 $ 25.1 $ 37.1 $ 62.2
2000 0.8 0.4 0.4 10.6 11.0 25.1 25.1 50.2
2001 0.8 0.3 0.5 12.3 12.8 25.1 18.6 43.7
2002 0.8 0.3 0.5 112.3 112.8 25.1 13.8 38.9
2003 0.8 0.2 0.6 15.8 16.4 25.1 11.4 36.5
Later years 2.5 0.6 1.9 670.7 672.6 105.4 17.1 122.5
--------- --------- --------- --------- -------- -------- -------- -------
Total $ 6.5 $ 2.2 $ 4.3 $ 832.0 $ 836.3 $ 230.9 $ 123.1 $ 354.0
========= ========= ========= ========= ======== ======== ======== =======
Fair Value of Long-Term Debt. Based upon the borrowing rates currently available
to the Company and its subsidiaries for indebtedness with similar terms and
average maturities, the fair value of long-term debt was approximately $867,
$947 and $663 million at December 31, 1998, 1997 and 1996, respectively.
Note 8. Income Taxes
Under the liability method of accounting for income taxes specified by Statement
of Financial Accounting Standards No. 109 "Accounting for Income Taxes,"
deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax basis of assets and liabilities as
measured by the enacted tax rates which will be in effect when these differences
reverse. Generally, deferred tax expense is the result of changes in the
liability for deferred taxes.
85
The following summarizes pretax income (loss) for the years ended December 31,
(in millions):
1998 1997 1996
----------- ----------- ----------
Domestic $ 357.5 $ 91.8 $ 237.1
International (3.1) (12.6) 0.2
----------- ----------- ----------
Total $ 354.4 $ 79.2 $ 237.3
=========== =========== ==========
Tax Expense. Income tax expense (benefit) attributable to continuing operations
consists of the following components (in millions):
1998 1997 1996
----------- ----------- ----------
Current
Federal $ 91.6 $ 73.4 $ 45.6
State and local 16.0 11.6 6.4
----------- ----------- ----------
Total current 107.6 85.0 52.0
----------- ----------- ----------
Deferred
Federal 20.8 (14.1) 15.7
State and local 2.4 (2.5) 2.9
----------- ----------- ----------
Total deferred 23.2 (16.6) 18.6
----------- ----------- ----------
Total income tax provision $ 130.8 $ 68.4 $ 70.6
=========== =========== ==========
The federal and state deferred tax liabilities (assets) recorded on the
Consolidated Balance Sheets at December 31, 1998, 1997 and 1996, respectively,
follow (in millions):
1998 1997 1996
----------- ----------- ----------
Liabilities:
Depreciation $ 345.2 $ 306.6 $ 302.7
Equity, unconsolidated affiliates 119.5 106.8 93.4
Other, net 0.4 0.4 -
----------- ----------- ----------
Gross deferred tax liabilities 465.1 413.8 396.1
----------- ----------- ----------
Assets:
NOL and AMT credit carryovers (11.2) (11.2) (14.6)
Book reserves not currently deductible
for tax (38.0) (57.8) (34.7)
Deferred compensation and other
employee benefits (14.5) (13.3) (7.7)
Deferred revenue (2.2) (2.9) (4.2)
Vacation accrual (4.3) (3.3) (2.7)
Other, net (6.1) (3.2) (3.1)
----------- ----------- ----------
Gross deferred tax assets (76.3) (91.7) (67.0)
----------- ----------- ----------
Net deferred tax liability $ 388.8 $ 322.1 $ 329.1
=========== =========== ==========
Based upon the Company's history of operating earnings and its expectations for
the future, management has determined that operating income of the Company will,
more likely than not, be sufficient to recognize fully the above gross deferred
tax assets.
86
Tax Rates. Differences between the Company's effective income tax rates
applicable to continuing operations and the U.S. federal income tax statutory
rates of 35% in 1998, 1997 and 1996, are as follows (in millions):
1998 1997 1996
----------- ----------- ----------
Income tax expense using the
statutory rate in effect $ 124.0 $ 27.7 $ 83.0
Tax effect of:
Earnings of equity investees (6.3) (7.0) (19.5)
Goodwill Impairment (see Note 3) 35.0
Other, net (5.3) 3.6 (2.2)
----------- ----------- ----------
Federal income tax expense 112.4 59.3 61.3
State and local income tax expense 18.4 9.1 9.3
----------- ----------- ----------
Total $ 130.8 $ 68.4 $ 70.6
=========== =========== ==========
Effective tax rate 36.9% 86.4% 29.7%
=========== =========== ==========
Tax Carryovers. At December 31, 1998, the Company had $4.0 million of
alternative minimum tax credit carryover generated by MidSouth and Gateway
Western prior to acquisition by the Company. These credits can be carried
forward indefinitely and are available on a "tax return basis" to reduce future
federal income taxes payable.
The amount of federal NOL carryover generated by MidSouth and Gateway Western
prior to acquisition was $67.8 million. The Company utilized approximately
$17.8, $0.7 and $31.9 million of these NOL's in 1998, 1997 and 1996,
respectively, leaving approximately $17.4 million of carryover available, with
expiration dates beginning in the year 2005. The use of preacquisition net
operating losses and tax credit carryovers is subject to limitations imposed by
the Internal Revenue Code. The Company does not anticipate that these
limitations will affect utilization of the carryovers prior to their expiration.
Tax Examinations. Examinations of the consolidated federal income tax returns
for the years 1993-1996 by the Internal Revenue Service ("IRS") have been
started. The IRS has completed examinations of the consolidated federal income
tax returns for the years 1990-1992 and has proposed certain tax assessments for
these years. For years prior to 1990, the statute of limitations has closed and
all issues raised by the IRS examinations have been resolved. In addition, other
taxing authorities are currently examining the years 1994-1996 and have proposed
additional tax assessments for which the Company believes it has recorded
adequate reserves.
Since most of these asserted tax deficiencies represent temporary differences,
subsequent payments of taxes will not require additional charges to income tax
expense. In addition, accruals have been made for interest (net of tax benefit)
for estimated settlement of the proposed tax assessments. Thus, management
believes that final settlement of these matters will not have a material adverse
effect on the Company's consolidated results of operations or financial
condition.
Note 9. Stockholders' Equity
Pro Forma Fair Value Information for Stock-Based Compensation Plans. At December
31, 1998, the Company had several stock-based compensation plans, which are
described separately below. The Company applies APB 25 and related
interpretations in accounting for its plans, and accordingly, no
87
compensation
cost has been recognized for the Company's fixed stock option plans or the ESPP
programs. Had compensation cost for the Company's stock-based compensation plans
been determined in accordance with the fair value accounting method prescribed
by SFAS 123 for options issued after December 31, 1994, the Company's net income
(loss) and earnings (loss) per share would have been reduced to the pro forma
amounts indicated below:
1998 1997 1996
-------- --------- --------
Net income (loss) (in millions):
As reported $ 190.2 $ (14.1) $ 150.9
Pro Forma 179.0 (21.1) 146.5
Earnings (loss) per Basic share:
As reported $ 1.74 $ (0.13) $ 1.33
Pro Forma 1.64 (0.20) 1.29
Earnings (loss) per Diluted share:
As reported $ 1.66 $ (0.13) $ 1.31
Pro Forma 1.58 (0.20) 1.26
Stock Option Plans. During 1998, various existing Employee Stock Option Plans
were combined and amended as the Kansas City Southern Industries, Inc. 1991
Amended and Restated Stock Option and Performance Award Plan (as amended and
restated effective July 15, 1998) This amended Plan provides for the granting of
options to purchase up to 26.0 million shares of the Company's common stock by
officers and other designated employees. Such options have been granted at 100%
of the average market price of the Company's stock on the date of grant and
generally may not be exercised sooner than one year, or longer than ten years
following the date of the grant, except that options outstanding with limited
rights ("LR's") or limited stock appreciation rights ("LSAR's"), become
immediately exercisable upon certain defined circumstances constituting a change
in control of the Company. The Plans include provisions for stock appreciation
rights, LRs and LSAR's. All outstanding options include LRs, except for options
granted to non-employee Directors.
For purposes of computing the pro forma effects of option grants under the fair
value accounting method prescribed by SFAS 123, the fair value of each option
grant is estimated on the date of grant using a version of the Black-Scholes
option pricing model. The following assumptions were used for the various grants
depending on the date of grant, nature of vesting and term of option:
1998 1997 1996
-------------- -------------- --------------
Dividend Yield .34% to .56% .47% to .82% .81% to .93%
Expected Volatility 30% to 42% 24% to 31% 30% to 32%
Risk-free Interest Rate 4.74% to 5.64% 5.73% to 6.57% 5.27% to 6.42%
Expected Life 3 years 3 years 3 years
88
A summary of the status of the Company's stock option plans as of December 31,
1998, 1997 and 1996, and changes during the years then ended, is presented
below:
1998 1997 1996
------------------ ------------------- -------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- ------ ---------- ------ ---------- ------
Outstanding at January 1 9,892,581 $12.12 10,384,149 $10.83 11,026,116 $ 9.68
Exercised (1,600,829) 13.07 (1,874,639) 10.33 (1,554,567) 5.48
Canceled/Expired (40,933) 21.75 (401,634) 15.40 (33,570) 14.57
Granted 1,177,123 39.62 1,784,705 18.51 946,170 15.57
--------- ------ ---------- ------ ---------- ------
Outstanding at December 31 9,427,942 15.35 9,892,581 12.12 10,384,149 10.83
========= ====== ========== ====== ========== ======
Exercisable at December 31 8,222,782 8,028,475 5,754,549
Weighted-Average Fair Value of options
granted during the year $12.31 $ 4.72 $ 4.10
The following table summarizes the information about stock options outstanding
at December 31, 1998:
OUTSTANDING EXERCISABLE
--------------------------------------------------- ------------------------------
Weighted- Weighted- Weighted-
Range of Number Average Average Number Average
Exercise Outstanding Remaining Exercise Exercisable Exercise
Prices at 12/31/98 Contractual Life Price at 12/31/98 Price
- ---------- ----------- ---------------- -------- ----------- ---------
$ 2 - 10 2,980,530 3.0 years $ 4.95 2,980,530 $ 4.95
10 - 15 1,057,963 7.0 12.94 1,000,138 12.86
15 - 20 3,600,998 7.4 15.73 3,590,198 15.73
20 - 30 879,205 7.4 23.62 624,341 21.67
30 - 40 3,888 9.6 35.94 1,487 32.52
40 - 48 905,358 10.0 42.79 26,088 42.31
--------- ---------
2 - 48 9,427,942 6.2 15.35 8,222,782 12.01
========= =========
Shares available for future grants at December 31, 1998 aggregated 9,206,449.
Stock Purchase Plan. The ESPP, established in 1977, provides to substantially
all full-time employees of the Company, certain subsidiaries and certain other
affiliated entities, the right to subscribe to an aggregate of 22.8 million
shares of common stock. The purchase price for shares under any stock offering
is to be 85% of the average market price on either the exercise date or the
offering date, whichever is lower, but in no event less than the par value of
the shares. At December 31, 1998, there were approximately 11.6 million shares
available for future offerings.
89
The following table summarizes activity related to the various ESPP offerings:
Date Shares Shares Date
Initiated Subscribed Price Issued Issued
--------- ---------- ------- -------- ----------
Eleventh Offering 1998 213,825 $35.97 - -
Tenth Offering 1996 251,079 13.35 233,133 1997/1998
Ninth Offering 1995 291,411 12.73 247,729 1996/1997
Eighth Offering 1993 661,728 12.73 481,929 1994 to 1996
For purposes of computing the pro forma effects of employees' purchase rights
under the fair value accounting method prescribed by SFAS 123, the fair value of
the Eleventh and Tenth Offerings under the ESPP are estimated on the date of
grant using a version of the Black-Scholes option pricing model. The following
weighted-average assumptions were used:
Eleventh Tenth
Offering Offering
-------- --------
Dividend Yield .95% .85%
Expected Volatility 42% 30%
Risk-free Interest Rate 4.63% 5.50%
Expected Life 1 year 1 year
The weighted-average fair value of purchase rights granted under the Eleventh
and Tenth Offerings of the ESPP were $10.76 and $3.56, respectively. There were
no offerings in 1997.
Forward Stock Purchase Contract. During 1995, the Company entered into a forward
stock purchase contract ("the contract") as a means of securing a potentially
favorable price for the repurchase of six million shares of its common stock in
connection with the stock repurchase program authorized by the Company's Board
of Directors on April 24, 1995. During 1998, no shares were purchased under this
arrangement. During 1997 and 1996, the Company purchased 2.4 and 3.6 million
shares, respectively, under this arrangement at an aggregate price of $39 and
$56 million (including transaction premium), respectively. The contract
contained provisions which allowed the Company to elect a net cash or net share
settlement in lieu of physical settlement of the shares; however, all shares
were physically settled. The transaction was recorded in the Company's financial
statements upon settlement of the contract in accordance with the Company's
accounting policies described in Note 1.
Employee Plan Funding Trust ("EPFT" or "Trust"). Effective September 30, 1998,
the Company terminated the EPFT, which was established by KCSI as a grantor
trust for the purpose of holding shares of Series B Preferred stock for the
benefit of various KCSI employee benefit plans, including the ESOP, Stock Option
Plans and ESPP (collectively, "Benefit Plans"). The EPFT was administered by an
independent bank trustee ("Trustee") and included in the Company's consolidated
financial statements.
In October 1993, KCSI transferred one million shares of Series B Preferred stock
to the EPFT for a purchase price of $200 million (based on an independent
valuation), which the Trust financed through KCSI. The indebtedness of the EPFT
to KCSI was repayable over 27 years with interest at 6% per annum, with no
principal payments for the first three years. Principal payments from the EPFT
to the Company of $21.3 million since the date of inception decreased the
indebtedness to $178.7 million, plus accrued interest, on the date of
termination. As a result of these principal payments, 127,638 shares of Series B
Preferred stock were released from the Trust's suspense account and available
for distribution to the Benefit Plans. None of these shares, however, were
distributed prior to termination of the EPFT.
In accordance with the Agreement to terminate the EPFT, the Company received
872,362 shares of Series B Preferred stock in full repayment of the indebtedness
from the Trust. In addition, the remaining
90
127,638 shares of Series B Preferred stock were converted by the Trustee into
KCSI Common stock, at the rate of 12 to 1, resulting in the issuance to the EPFT
of 1,531,656 shares of such Common stock. This Common stock was then transferred
by the Trustee to KCSI and the Company has set these shares aside for use in
connection with the KCSI Stock Option and Performance Award Plan, as amended and
restated effective July 15, 1998. Following the foregoing transactions, the EPFT
was terminated.
The impact of the termination of the EPFT on the Company's consolidated
condensed financial statements was a reclassification among the components of
the stockholder's equity accounts, with no change in the consolidated assets and
liabilities of the Company.
Treasury Stock. The Company issued shares of common stock from Treasury -
1,663,349 in 1998, 2,031,162 in 1997, 1,557,804 in 1996 - to fund the exercise
of options and subscriptions under various employee stock option and purchase
plans. Approximately 67,000 shares were issued in conjunction with the
acquisition of Nelson. Treasury stock previously acquired had been accounted for
as if retired. The 1,531,656 shares received in conjunction with the termination
of the EPFT were added to Treasury stock during 1998. The Company purchased
shares as follows: 2,863,983 in 1997 and 9,829,599 in 1996. Shares purchased
during 1998 were not material.
Note 10. Profit Sharing and Other Postretirement Benefits
The Company maintains various plans for the benefit of its employees as
described below. The Company's employee benefit expense for these plans
aggregated $7.7, $6.3 and $5.4 million in 1998, 1997 and 1996, respectively.
Profit Sharing. Qualified profit sharing plans are maintained for most employees
not included in collective bargaining agreements. Contributions for the Company
and its subsidiaries are made at the discretion of the Boards of Directors in
amounts not to exceed the maximum allowable for federal income tax purposes.
401(k) Plan. The Company's 401(k) plan permits participants to make
contributions by salary reduction pursuant to section 401(k) of the Internal
Revenue Code. The Company matches contributions up to a maximum of 3% of
compensation.
Employee Stock Ownership Plan. In 1987 and 1988, KCSI and DST established
leveraged ESOPs for employees not covered by collective bargaining agreements by
collectively purchasing $69 million of KCSI common stock from Treasury at a then
current market price of $49 per share ($4.08 per share effected for stock
splits). During 1990, the two plans were merged into one plan known as the KCSI
ESOP. The indebtedness was retired in full during 1995. In October 1995, the
ESOP became a multiple employer plan covering both KCSI employees and DST
employees, and was renamed The Employee Stock Ownership Plan. KCSI contributions
to its portion of the ESOP are based on a percentage (determined by the
Compensation Committee of the Board of Directors) of wages earned by eligible
employees.
Other Postretirement Benefits. The Company adopted Statement of Financial
Accounting Standards No. 106 "Employers' Accounting for Postretirement Benefits
Other Than Pensions" ("SFAS 106"), effective January 1, 1993. The Company and
several of its subsidiaries provide certain medical, life and other
postretirement benefits other than pensions to its retirees. With the exception
of the Gateway Western plans, which are discussed below, the medical and life
plans are available to employees not covered under collective bargaining
arrangements, who have attained age 60 and rendered ten years of service.
Individuals employed as of December 31, 1992 were excluded from a specific
service requirement. The medical plan is contributory and provides benefits for
retirees, their covered dependents and beneficiaries. Benefit expense begins to
accrue at age 40. The medical plan was amended effective January 1, 1993 to
provide for annual adjustment of retiree contributions, and also contains,
depending on the plan coverage
91
selected, certain deductibles, copayments, coinsurance and coordination with
Medicare. The life insurance plan is non-contributory and covers retirees only.
The Company's policy, in most cases, is to fund benefits payable under these
plans as the obligations become due. However, certain plan assets (e.g., money
market funds) do exist with respect to life insurance benefits.
During 1998, the Company adopted Statement of Financial Accounting Standards No.
132 "Employers' Disclosure about Pensions and Other Postretirement Benefits - an
amendment of FASB Statements No. 87, 88, and 106" ("SFAS 132") and prior year
information has been included pursuant to SFAS 132. SFAS 132 establishes
standardized disclosure requirements for pension and other postretirement
benefit plans, requires additional information on changes in the benefit
obligations and fair values of plan assets, and eliminates certain disclosures
that are no longer useful. The standard does not change the measurement or
recognition of pension or postretirement benefit plans.
Reconciliation of the accumulated postretirement benefit obligation, change in
plan assets, and funded status, respectively, at December 31 follows (in
millions):
1998 1997(i) 1996
----------- ----------- ----------
Accumulated postretirement
benefit obligation at beginning of year $ 13.7 $ 13.7 $ 10.5
Service cost 0.3 0.6 0.5
Interest cost 0.9 1.0 0.7
Amortization of transition obligation 0.1
Actuarial gain (0.2) (0.8) (0.1)
Benefits paid (ii) (0.8) (0.9) (0.7)
----------- ----------- ----------
Accumulated postretirement
benefit obligation at end of year 13.9 13.7 10.9
----------- ----------- ----------
Fair value of plan assets
at beginning of year 1.3 1.3 1.7
Actual return on plan assets 0.2 0.1 (0.2)
Benefits paid (ii) (0.1) (0.1) (0.2)
----------- ----------- ----------
Fair value of plan assets
at end of year 1.4 1.3 1.3
----------- ----------- ----------
Funded status and accrued benefit cost $ 12.5 $ 12.4 $ 9.6
=========== =========== ==========
(i) The accumulated postretirement benefit obligation for the beginning of
1997 does not agree to the ending accumulated post retirement benefit
obligation as of December 31, 1996 due to the addition of the Gateway
Western effective as of January 1, 1997.
(ii) Benefits paid for the reconciliation of accumulated postretirement
benefit obligation include both medical and life insurance benefits,
whereas benefits paid for the fair value of plan assets reconciliation
include only life insurance benefits. Plan assets relate only to the
life insurance benefits. Medical benefits are funded as obligations
become due.
92
Net periodic postretirement benefit cost included the following components (in
millions):
1998 1997 1996
----------- ----------- ----------
Service cost $ 0.3 $ 0.6 $ 0.5
Interest cost 0.9 1.0 0.7
Amortization of unrecognized
transition obligation 0.1
Expected return on plan assets (0.1) (0.1) (0.1)
----------- ----------- ----------
Net periodic postretirement benefit cost $ 1.1 $ 1.6 $ 1.1
=========== =========== ==========
The Company's health care costs, excluding Gateway Western, are limited to the
increase in the Consumer Price Index ("CPI") with a maximum annual increase of
5%. Accordingly, health care costs in excess of the CPI limit will be borne by
the plan participants, and therefore assumptions regarding health care cost
trend rates are not applicable.
The following assumptions were used to determine the postretirement obligations
and costs for the years ended December 31:
1998 1997 1996
------ ------ ------
Annual increase in the CPI 2.50% 3.00% 3.00%
Expected rate of return on life
insurance plan assets 6.50 6.50 6.50
Discount rate 6.75 7.25 7.75
Salary increase 4.00 4.00 4.00
Gateway Western's benefit plans are slightly different from those of the Company
and other subsidiaries. Gateway Western provides contributory health, dental and
life insurance benefits to substantially all of its active and retired
employees, including those covered by collective bargaining agreements.
Effective January 1, 1998, existing Gateway Western management employees
converted to the Company's benefit plans. In 1998, the assumed annual rate of
increase in health care costs for the non-management Gateway Western employees
choosing a preferred provider organization was 7.5% and 6.5% for those choosing
the health maintenance organization option, decreasing over five years to 5.5%
and 4.5%, respectively, to remain level thereafter.
The health care cost trend rate assumption has an effect on the Gateway Western
amounts represented. An increase in the assumed health care cost trend rates by
one percent in 1998 and 1997 would increase the accumulated postretirement
benefit obligation by $0.3 million and $0.4 million, respectively. A decrease in
the assumed health care cost trend by one percent would decrease the accumulated
postretirement benefit obligation by $0.2 million in 1998 and 1997. The effect
of this change on the aggregate of the service and interest cost components of
the net periodic postretirement benefit is not significant.
Note 11. Commitments and Contingencies
Minority Interest Purchase Agreements. Agreements between KCSI and Janus
minority owners contain, among other provisions, mandatory stock purchase
provisions whereby under certain circumstances, KCSI would be required to
purchase the minority interest of Janus. If all of the provisions of the Janus
minority owner agreements became effective, KCSI would be required to purchase
the respective minority interests at a cost estimated to be approximately $456
million as of December 31, 1998, compared to $337 and $220 million at December
31, 1997 and 1996, respectively.
93
Litigation Reserves. In the opinion of management, claims or lawsuits incidental
to the business of the Company and its subsidiaries have been adequately
provided for in the consolidated financial statements.
Duncan case
In 1998, a jury in Beauregard Parish, Louisiana returned a verdict against KCSR
in the amount of $16.3 million. This Louisiana state case arose from a railroad
crossing accident which occurred at Oretta, Louisiana on September 11, 1994, in
which three individuals were injured. Of the three, one was injured fatally, one
was rendered quadriplegic and the third suffered less serious injuries.
Subsequent to the verdict, the trial court held that the plaintiffs were
entitled to interest on the judgment from the date the suit was filed, dismissed
the verdict against one defendant and reallocated the amount of that verdict to
the remaining defendants. The resulting total judgment against KCSR, together
with interest, was $25.4 million as of December 31, 1998.
The judgment has been appealed and independent trial counsel has informed KCSR
management that the evidence presented at trial established no negligent conduct
on the part of KCSR and expressed confidence that the verdict will ultimately be
reversed. KCSR management believes it has meritorious defenses in this case and
that it will ultimately prevail on appeal. If the verdict were to stand,
however, the judgment and interest are in excess of existing insurance coverage
and could have an adverse effect on the Company's consolidated results of
operations and financial position.
Bogalusa Cases
In July 1996, KCSR was named as one of twenty-seven defendants in various
lawsuits in Louisiana and Mississippi arising from the explosion of a rail car
loaded with chemicals in Bogalusa, Louisiana on October 23, 1995. As a result of
the explosion, nitrogen dioxide and oxides of nitrogen were released into the
atmosphere over parts of that town and the surrounding area causing evacuations
and injuries. Approximately 25,000 residents of Louisiana and Mississippi have
asserted claims to recover damages allegedly caused by exposure to the
chemicals.
KCSR neither owned nor leased the rail car or the rails on which it was located
at the time of the explosion in Bogalusa. KCSR did, however, move the rail car
from Jackson to Vicksburg, Mississippi, where it was loaded with chemicals, and
back to Jackson where the car was tendered to the Illinois Central Railroad
Company ("IC"). The explosion occurred more than 15 days after the Company last
transported the rail car. The car was loaded by the shipper in excess of its
standard weight when it was transported by the Company to interchange with the
IC.
The Mississippi lawsuit arising from the chemical release has now been scheduled
for trial in late March 1999. KCSR sought dismissal of these suits in the state
appellate courts, and ultimately in the United States Supreme Court, but was
unsuccessful in obtaining the relief sought.
KCSR believes that its exposure to liability in these cases is remote. If KCSR
were to be found liable for punitive damages in these cases, such a judgment
could have a material adverse effect on the results of operations and financial
position of the Company.
Diesel Fuel Commitments and Hedging Activities. From time to time, KCSR enters
into forward purchase commitments for diesel fuel as a means of securing volumes
and reducing overall cost. The contracts normally require KCSR to purchase
certain quantities of diesel fuel at defined prices established at the
origination of the contract.
As a result of fuel commitments made in 1995, KCSR saved approximately $3.7
million in operating expenses in 1996. Minimal commitments were negotiated for
1997 because of higher fuel costs. At the end of 1997, KCSR entered into
purchase commitments for diesel fuel for approximately 27% of its 1998 expected
usage. As a result of fuel prices remaining below the committed price during
1998, these
94
purchase commitments resulted in a higher cost in 1998 of
approximately $1.7 million. At December 31, 1998, the Company has entered into
purchase commitments for approximately 32% of its expected 1999 usage.
KCSR has a program to hedge against fluctuations in the price of its diesel fuel
purchases. The program is currently comprised of swap transactions accounted for
as hedges. Any gains or losses associated with changes in market value of these
hedges are deferred and recognized as a component of fuel cost in the period in
which the hedged fuel is purchase and used. To the extent KCSR hedges portions
of its fuel purchases, it may not fully benefit from decreases in fuel prices.
Beginning in 1998, KCSR entered into fuel swaps for approximately two million
gallons per month, or 37% of its anticipated 1998 fuel requirements. The fuel
swap contracts had expiration dates through February 28, 1999 and are correlated
to market benchmarks. Hedge positions are monitored to ensure that they will not
exceed actual fuel requirements in any period. During 1998, KCSR made payments
of approximately $2.3 million relating to these fuel swap transactions as a
result of actual fuel prices remaining lower than the fuel swap price. As of
December 31, 1998, the Company has entered into fuel swap transactions for
approximately 16% of expected 1999 usage.
Foreign Exchange Matters. As discussed in Note 1, in connection with the
Company's investment in Grupo TFM, a Mexican company, and Nelson, an 80% owned
subsidiary with operations in the United Kingdom, the Company follows the
requirements outlined in SFAS 52 (and related authoritative guidance) with
respect to financial accounting and reporting for foreign currency transactions
and for translating foreign currency financial statements from the entity's
functional currency into U.S. dollars.
The purchase price paid by Grupo TFM for 80% of the common stock of TFM was
fixed in Mexican pesos; accordingly, the U.S. dollar equivalent fluctuated as
the U.S. dollar/Mexican peso exchange rate changed. The Company's capital
contribution (approximately $298 million U.S.) to Grupo TFM in connection with
the initial installment of the TFM purchase price was made based on the U.S.
dollar/Mexican peso exchange rate on January 31, 1997.
Grupo TFM paid the remaining 60% of the purchase price in Mexican pesos on June
23, 1997. As discussed above, the final installment was funded using proceeds
from Grupo TFM debt financing and the sale of 24.6% of Grupo TFM to the Mexican
Government. In the event that the proceeds from these arrangements would not
have provided funds sufficient for Grupo TFM to make the final installment of
the purchase price, the Company may have been required to make additional
capital contributions. Accordingly, in order to hedge a portion of the Company's
exposure to a fluctuations in the value of the Mexican peso versus the U.S.
dollar, the Company entered into two separate forward contracts to purchase
Mexican pesos - $98 million in February 1997 and $100 million in March 1997. In
April 1997, the Company realized a $3.8 million pretax gain in connection with
these contracts. This gain was deferred until the final installment of the TFM
purchase price was made in June 1997, at which time, it was accounted for as a
component of the Company's investment in Grupo TFM. These contracts were
intended to hedge only a portion of the Company's exposure related to the final
installment of the purchase price and not any other transactions or balances.
During 1997 and 1998, Mexico's economy was classified as "highly inflationary"
as defined in SFAS 52. Accordingly, the U.S. dollar was assumed to be Grupo
TFM's functional currency, and any gains or losses from translating Grupo TFM's
financial statements into U.S. dollars were included in the determination of its
net income. Equity losses from Grupo TFM included in the Company's results of
operations reflect the Company's share of such translation gains and losses.
95
Effective January 1, 1999, the SEC staff declared that Mexico should no longer
be considered a highly inflationary economy. Accordingly, the Company is in the
process of performing an analysis under the guidance of SFAS 52 to determine
whether the U.S. dollar or the Mexican peso should be used as the functional
currency for financial accounting and reporting purposes subsequent to December
31, 1998. Information for this analysis is currently being compiled and
reviewed. Management expects to complete this analysis by the end of the first
quarter 1999. If the peso is determined to be the appropriate functional
currency, the effect of translating Grupo TFM's financial statements could have
a material impact on the Company's results of operations and financial position.
The Company completed its acquisition of 80% of Nelson on April 20, 1998.
Nelson's principal operations are in the United Kingdom and, therefore, its
financial statements are accounted for using the British pound as the functional
currency. Any gains or losses arising from transactions not denominated in the
British pound are recorded as a foreign currency gain or loss and included in
the results of operations of Nelson. The translation of Nelson's financial
statements from the British pound into the U.S. dollar results in an adjustment
to stockholders' equity as a cumulative translation adjustment. At December 31,
1998, the cumulative translation adjustment was not material.
The Company continues to evaluate existing alternatives with respect to
utilizing foreign currency instruments to hedge its U.S. dollar investment in
Grupo TFM and Nelson as market conditions change or exchange rates fluctuate. At
December 31, 1998, the Company had no outstanding foreign currency hedging
instruments.
Environmental Liabilities. The Company's transportation operations are subject
to extensive regulation under environmental protection laws and its land
holdings have been used for transportation purposes or leased to third-parties
for commercial and industrial purposes. The Company records liabilities for
remediation and restoration costs related to past activities when the Company's
obligation is probable and the costs can be reasonably estimated. Costs of
ongoing compliance activities to current operations are expensed as incurred.
The Company's recorded liabilities for these issues represent its best estimates
(on an undiscounted basis) of remediation and restoration costs that may be
required to comply with present laws and regulations. At December 31, 1998,
these recorded liabilities were not material. Although these costs cannot be
predicted with certainty, management believes that the ultimate outcome of
identified matters will not have a material adverse effect on the Company's
consolidated results of operations or financial condition.
Panama Railroad Concession. The Government of Panama has granted a concession to
the Panama Canal Railway Company ("PCRC"), a joint venture of KCSI and Mi-Jack
Products, Inc., to operate a railroad between Panama City and Colon. Upon
completion of certain infrastructure improvements, the PCRC will operate an
approximate 47-mile railroad running parallel to the Panama Canal and connecting
parts of the Atlantic and Pacific Oceans. The PCRC has committed to making at
least $30 million in capital improvements and investments in Panama over the
next five year period. The Company expects its contribution related to the PCRC
project to be less than $15 million. PCRC is in the process of evaluating the
overall needs and requirements of the project and alternative financing
opportunities.
Note 12. Control
Subsidiaries and Affiliates. In connection with its acquisition of an interest
in Janus, the Company entered into an agreement which, among other things,
provides: i) that Janus management shall establish and implement policy with
respect to investment advisory and portfolio management activity of Janus; ii)
that any change in management philosophy, style or approach with respect to
investment advisory and
96
portfolio management policies of Janus shall be mutually agreed by KCSI and
Janus management; and iii) for rights of first refusal on the part of minority
stockholders, Janus and the Company with respect to certain sales of Janus stock
by the minority stockholders. The agreement also requires the Company to
purchase the shares of minority stockholders in certain circumstances. In
addition, in the event of a "change of ownership" of the Company, as defined in
the agreement, the Company may be required to sell its stock of Janus to the
minority stockholders or to purchase such holders' Janus stock. Purchase and
sales transactions under the agreements are to be made based upon a multiple of
the net earnings of Janus and/or fair market value determinations, as defined
therein (see Note 11 for additional details).
Under the Investment Company Act of 1940, certain changes in ownership of Janus
or Berger may result in termination of its investment advisory agreements with
the mutual funds and other accounts it manages, requiring approval of fund
shareholders and other account holders to obtain new agreements. Additionally,
there are Janus and Berger officers and directors that serve as officers and/or
directors of certain of the registered investment companies to which Janus and
Berger act as investment advisors.
DST, an approximate 32% owned unconsolidated affiliate of the Company, has a
Stockholders' Rights Agreement. Under certain circumstances following a "change
in control" of KCSI, as defined in DST's Stockholders' Rights Agreement,
substantial dilution of the Company's interest in DST could result.
The Company is party to certain agreements with TMM covering the Grupo TFM and
Mexrail ventures, which contain "change of control" provisions, provisions
intended to preserve Company's and TMM's proportionate ownership of the
ventures, and super majority provisions with respect to voting on certain
significant transactions. Such agreements also provide a right of first refusal
in the event that either party initiates a divestiture of its equity interest in
Grupo TFM or Mexrail. Under certain circumstances, such agreements could affect
the Company's ownership percentage and rights in these equity affiliates.
Employees. The Company and certain of its subsidiaries have entered into
agreements with employees whereby, upon defined circumstances constituting a
change in control of the Company or subsidiary, certain stock options become
exercisable, certain benefit entitlements are automatically funded and such
employees are entitled to specified cash payments upon termination of
employment.
Assets. The Company and certain of its subsidiaries have established trusts to
provide for the funding of corporate commitments and entitlements of officers,
directors, employees and others in the event of a specified change in control of
the Company or subsidiary. Assets held in such trusts at December 31, 1998 were
not material. Depending upon the circumstances at the time of any such change in
control, the most significant factor of which would be the highest price paid
for KCSI common stock by a party seeking to control the Company, funding of the
Company's trusts could be very substantial.
Debt. Certain loan agreements and debt instruments entered into or guaranteed by
the Company and its subsidiaries provide for default in the event of a specified
change in control of the Company or particular subsidiaries of the Company.
Stockholder Rights Plan. On September 19, 1995, the Board of Directors of the
Company declared a dividend distribution of one Right for each outstanding share
of the Company's common stock, $.01 par value per share (the "Common Stock"), to
the stockholders of record on October 12, 1995. Each Right entitles the
registered holder to purchase from the Company 1/1,000th of a share of Series A
Preferred Stock (the "Preferred Stock") or in some circumstances, Common Stock,
other securities, cash or other assets as the case may be, at a price of $210
per share, subject to adjustment.
97
The Rights, which are automatically attached to the Common Stock, are not
exercisable or transferable apart from the Common Stock until the tenth calendar
day following the earlier to occur of (unless extended by the Board of Directors
and subject to the earlier redemption or expiration of the Rights): (i) the date
of a public announcement that an acquiring person acquired, or obtained the
right to acquire, beneficial ownership of 20 percent or more of the outstanding
shares of the Common Stock of the Company (or 15 percent in the case that such
person is considered an "adverse person"), or (ii) the commencement or
announcement of an intention to make a tender offer or exchange offer that would
result in an acquiring person beneficially owning 20 percent or more of such
outstanding shares of Common Stock of the Company (or 15 percent in the case
that such person is considered an "adverse person"). Until exercised, the Right
will have no rights as a stockholder of the Company, including, without
limitation, the right to vote or to receive dividends. In connection with
certain business combinations resulting in the acquisition of the Company or
dispositions of more than 50% of Company assets or earnings power, each Right
shall thereafter have the right to receive, upon the exercise thereof at the
then current exercise price of the Right, that number of shares of the highest
priority voting securities of the acquiring company (or certain of its
affiliates) that at the time of such transaction would have a market value of
two times the exercise price of the Right. The Rights expire on October 12,
2005, unless earlier redeemed by the Company as described below.
At any time prior to the tenth calendar day after the first date after the
public announcement that an acquiring person has acquired beneficial ownership
of 20 percent (or 15 percent in some instances) or more of the outstanding
shares of the Common Stock of the Company, the Company may redeem the Rights in
whole, but not in part, at a price of $0.005 per Right. In addition, the
Company's right of redemption may be reinstated following an inadvertent trigger
of the Rights (as determined by the Board) if an acquiring person reduces its
beneficial ownership to 10 percent or less of the outstanding shares of Common
Stock of the Company in a transaction or series of transactions not involving
the Company.
The Series A Preferred shares purchasable upon exercise of the Rights will have
a cumulative quarterly dividend rate set by the Board of Directors or equal to
1,000 times the dividend declared on the Common Stock for such quarter. Each
share will have the voting rights of one vote on all matters voted at a meeting
of the stockholders for each 1/1,000th share of preferred stock held by such
stockholder. In the event of any merger, consolidation or other transaction in
which the common shares are exchanged, each Series A Preferred share will be
entitled to receive an amount equal to 1,000 times the amount to be received per
common share. In the event of a liquidation, the holders of Series A Preferred
shares will be entitled to receive $1,000 per share or an amount per share equal
to 1,000 times the aggregate amount to be distributed per share to holders of
Common Stock. The shares will not be redeemable. The vote of holders of a
majority of the Series A Preferred shares, voting together as a class, will be
required for any amendment to the Company's Certificate of Incorporation which
would materially and adversely alter or change the powers, preferences or
special rights of such shares.
Note 13. Industry Segments
As discussed in Note 1, in 1998, the Company adopted the provisions of SFAS 131.
SFAS 131 establishes standards for the manner in which public business
enterprises report information about operating segments in annual financial
statements and requires disclosure of selected information about operating
segments in interim financial reports issued to shareholders. SFAS 131 also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The adoption of SFAS 131 did not have a
material impact on the disclosures of the Company. Prior year information is
reflected pursuant to SFAS 131.
98
The Company's two segments, aligned to reflect the Company's current operations,
are as follows:
Transportation. The Company operates a Class I Common Carrier railroad system
through its wholly-owned subsidiary, KCSR. As a common carrier, KCSR's customer
base includes electric generating utilities and a wide range of companies in the
petroleum/chemical, agricultural and paper processing industries, among others.
The railroad system operates primarily in the United States, from the Midwest to
the Gulf of Mexico and on an East-West axis from Dallas, Texas to Meridian,
Mississippi. In addition, the Company's wholly-owned subsidiary Gateway Western,
operates a regional common carrier rail system primarily on an East-West axis
from East St. Louis, Illinois to Kansas City, Missouri. Like KCSR, Gateway
Western serves customers in a wide range of industries.
KCSR and Gateway Western's revenues and earnings are dependent on providing
reliable service to its customers at competitive rates, the general economic
conditions in the geographic region it serves, and its ability to effectively
compete against alternative forms of surface transportation, such as
over-the-road truck transportation. KCSR and Gateway Western's ability to
construct and maintain its roadway in order to provide safe and efficient
transportation service is important to its ongoing viability as a rail carrier.
Additionally, the containment of costs and expenses is important in maintaining
a competitive market position, particularly with respect to employee costs as
approximately 85% of KCSR and Gateway Western combined employees are covered
under various collective bargaining agreements.
The Transportation segment also includes the Company's equity investment in
Grupo TFM, a Mexican entity. Grupo TFM has certain risks associated with
operating in Mexico, including, among others, foreign currency exchange,
cultural differences, varying labor and operating practices, and differences
between the U.S. and Mexican economies.
Also included in the Transportation segment are several less material
subsidiaries (most of which provide support and/or services for KCSR), as well
as equity earnings from investments in certain unconsolidated affiliates other
than Grupo TFM (including Southern Capital and Mexrail), holding company
expenses and miscellaneous investment activities.
Financial Services. Janus (an 82% owned subsidiary, diluted) and Berger (a
wholly-owned subsidiary) manage investments for mutual funds and private
accounts. Both companies operate throughout the United States, with headquarters
in Denver, Colorado. Beginning in December 1998, Janus initiated portfolio
offerings in countries outside of the United States. Janus assets under
management at December 31, 1998, 1997 and 1996 were $108.3, $67.8 and $46.7
billion, respectively. Berger assets under management at December 31, 1998, 1997
and 1996 were $,4.0, $3.8 and $3.6 billion, respectively.
Nelson, an 80% owned United Kingdom subsidiary acquired in April 1998, provides
investment advice and investment management services to individuals that
generally are retired or contemplating retirement. At December 31, 1998, assets
under management approximated $1.2 billion.
Financial Services revenues and operating income are driven primarily by growth
in assets under management. The potential for growth may be negatively affected
by a decline in the stock and bond markets and/or an increase in the rate of
return of alternative investments, which could negatively impact the Financial
Services results of operations and financial position. In addition, the mutual
fund market, in general, faces increasing competition as the number of mutual
funds continues to increase, marketing and distribution channels become more
creative and complex, and investors place greater emphasis on published fund
recommendations and investment category rankings.
99
DST is included as an equity investment reported in the Financial Services
segment. DST, together with its subsidiaries and joint ventures, provides
sophisticated information processing and computer software services and products
to the financial services industry (primarily to mutual funds and investment
managers), communications industries and other service industries. DST is
organized into three operating segments: financial services, customer management
and output solutions. DST operates throughout the United States, with operations
in Kansas City, Northern California and various locations on the East Coast, as
well as internationally in Canada, Europe, Africa and the Pacific Rim.
As discussed in Note 2, on December 21, 1998, DST and USCS announced the
completion of the merger of USCS with a wholly-owned DST subsidiary. The merger
expands DST's presence in the output solutions and customer management software
and services industries. USCS is a leading provider of customer management
software to the cable television and convergence industries.
The earnings of DST are dependent in part upon the further growth of the mutual
fund industry in the United States, DST's ability to continue to adapt its
technology to meet increasingly complex and rapidly changing requirements and
various other factors including, but not limited to: reliance on a centralized
processing facility; further development of international businesses; continued
equity in earnings from joint ventures; and competition from other third party
providers of similar services and products as well as from in-house providers.
Segment Financial Information. Sales between segments were not material in 1998,
1997 or 1996. Certain amounts in prior years' segment information have been
reclassified to conform to the current year presentation.
100
Segment Financial Information, dollars in millions, years ended December 31,
FINANCIAL
TRANSPORTATION SERVICES KCSI
-------------------------------------- ------------ ------------
KCSR Other Consolidated Consolidated Consolidated
---- ----- ------------ ------------ ------------
1998
Revenues $ 551.6 $ 61.9 $ 613.5 $ 670.8 $ 1,284.3
Costs and expenses 391.1 51.8 442.9 373.4 816.3
Depreciation and amortization 50.6 6.1 56.7 16.8 73.5
-------- --------- --------- -------- ---------
Operating income 109.9 4.0 113.9 280.6 394.5
Equity in net earnings (losses) of
unconsolidated affiliates 2.0 (4.9) (2.9) 25.8 22.9
Interest expense (35.6) (24.0) (59.6) (6.5) (66.1)
Reduction in ownership of DST - - - (29.7) (29.7)
Other, net 10.7 3.0 13.7 19.1 32.8
-------- --------- --------- -------- ---------
Pretax income (loss) 87.0 (21.9) 65.1 289.3 354.4
Income taxes (benefit) 34.0 (6.9) 27.1 103.7 130.8
Minority interest - - - 33.4 33.4
-------- --------- --------- -------- ---------
Net income (loss) $ 53.0 $ (15.0) $ 38.0 $ 152.2 $ 190.2
======== ========= ========= ======== =========
Capital expenditures $ 64.5 $ 5.4 $ 69.9 $ 35.0 $ 104.9
======== ========= ========= ======== =========
1997
Revenues $ 517.8 $ 55.4 $ 573.2 $ 485.1 $ 1,058.3
Costs and expenses 383.0 43.1 426.1 254.1 680.2
Depreciation and amortization 54.7 7.1 61.8 13.4 75.2
Restructuring, asset impairment
and other charges 163.8 14.2 178.0 18.4 196.4
-------- --------- --------- -------- ---------
Operating income (loss) (83.7) (9.0) (92.7) 199.2 106.5
Equity in net earnings (losses)
of unconsolidated affiliates 2.1 (11.8) (9.7) 24.9 15.2
Interest expense (37.9) (15.4) (53.3) (10.4) (63.7)
Other, net 4.5 0.5 5.0 16.2 21.2
-------- --------- --------- -------- ---------
Pretax income (loss) (115.0) (35.7) (150.7) 229.9 79.2
Income taxes (benefit) (9.5) (9.1) (18.6) 87.0 68.4
Minority interest - - - 24.9 24.9
-------- --------- --------- -------- ---------
Net income (loss) $ (105.5) $ (26.6) $ (132.1) $ 118.0 $ (14.1)
======== ========= ========= ======== =========
Capital expenditures $ 67.6 $ 9.2 $ 76.8 $ 5.8 $ 82.6
======== ========= ========= ======== =========
1996
Revenues $ 492.5 $ 25.2 $ 517.7 $ 329.6 $ 847.3
Costs and expenses 359.3 23.4 382.7 184.6 567.3
Depreciation and amortization 59.1 3.8 62.9 13.2 76.1
-------- --------- --------- -------- ---------
Operating income (loss) 74.1 (2.0) 72.1 131.8 203.9
Equity in net earnings
of unconsolidated affiliates 0.4 1.1 1.5 68.6 70.1
Interest expense (49.4) (3.4) (52.8) (6.8) (59.6)
Other, net 6.1 1.8 7.9 15.0 22.9
-------- --------- --------- -------- ---------
Pretax income (loss) 31.2 (2.5) 28.7 208.6 237.3
Income taxes (benefit) 14.1 (1.7) 12.4 58.2 70.6
Minority interest - - - 15.8 15.8
-------- --------- --------- -------- ---------
Net income (loss) $ 17.1 $ (0.8) $ 16.3 $ 134.6 $ 150.9
======== ========= ========= ======== =========
Capital expenditures $ 135.1 $ 7.5 $ 142.6 $ 1.4 $ 144.0
======== ========= ========= ======== =========
101
Segment Financial Information, dollars in millions, at December 31,
FINANCIAL
TRANSPORTATION SERVICES KCSI
-------------------------------------- ------------ ------------
KCSR Other Consolidated Consolidated Consolidated
---- ----- ------------ ------------ ------------
1998
ASSETS
Current assets $ 173.3 $ 36.9 $ 210.2 $ 259.3 $ 469.5
Investments 28.2 299.7 327.9 379.2 707.1
Properties, net 1,135.2 94.1 1,229.3 37.4 1,266.7
Intangible assets, net 5.2 24.2 29.4 147.0 176.4
-------- --------- ---------- -------- ---------
Total $1,341.9 $ 454.9 $ 1,796.8 $ 822.9 $ 2,619.7
======== ========= ========== ======== =========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities $ 174.5 $ 34.0 $ 208.5 $ 87.7 $ 296.2
Long-term debt 445.5 380.1 825.6 - 825.6
Deferred income taxes 272.7 12.5 285.2 118.4 403.6
Other 73.1 13.3 86.4 76.7 163.1
Net worth 376.1 15.0 391.1 540.1 931.2
-------- --------- ---------- -------- ---------
Total $1,341.9 $ 454.9 $ 1,796.8 $ 822.9 $ 2,619.7
======== ========= ========== ======== =========
1997
ASSETS
Current assets $ 159.7 $ 19.3 $ 179.0 $ 194.1 $ 373.1
Investments 31.1 304.2 335.3 348.2 683.5
Properties, net 1,123.9 93.9 1,217.8 9.4 1,227.2
Intangible assets, net 6.5 23.0 29.5 120.9 150.4
-------- --------- ---------- -------- ---------
Total $1,321.2 $ 440.4 $ 1,761.6 $ 672.6 $ 2,434.2
======== ========= ========== ======== =========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities $ 254.0 $ 24.5 $ 278.5 $ 159.0 $ 437.5
Long-term debt 442.4 363.5 805.9 - 805.9
Deferred income taxes 232.8 4.1 236.9 95.3 332.2
Other 76.6 13.7 90.3 70.0 160.3
Net worth 315.4 34.6 350.0 348.3 698.3
-------- --------- ---------- -------- ---------
Total $1,321.2 $ 440.4 $ 1,761.6 $ 672.6 $ 2,434.2
======== ========= ========== ======== =========
1996
ASSETS
Current assets $ 149.3 $ 7.4 $ 156.7 $ 135.4 $ 292.1
Investments 29.2 18.1 47.3 287.9 335.2
Properties, net 1,148.2 62.5 1,210.7 8.6 1,219.3
Intangible assets, net 153.1 (31.9) 121.2 116.3 237.5
-------- --------- ---------- -------- ---------
Total $1,479.8 $ 56.1 $ 1,535.9 $ 548.2 $ 2,084.1
======== ========= ========== ======== =========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities $ 200.2 $ (6.8) $ 193.4 $ 51.2 $ 244.6
Long-term debt 484.8 36.4 521.2 116.3 637.5
Deferred income taxes 281.5 (32.3) 249.2 88.5 337.7
Other 85.2 6.0 91.2 57.4 148.6
Net worth 428.1 52.8 480.9 234.8 715.7
-------- --------- ---------- -------- ---------
Total $1,479.8 $ 56.1 $ 1,535.9 $ 548.2 $ 2,084.1
======== ========= ========== ======== =========
102
Note 14. Quarterly Financial Data (Unaudited)
Fourth quarter 1998 includes a one-time pretax non-cash charge of approximately
36.0 million ($23.2 million after-tax, or $0.21 per share) arising from the
merger of a wholly-owned DST subsidiary with USCS. This charge reflects the
Company's reduced ownership of DST (from 41% to approximately 32%), together
with the Company's proportionate share of DST and USCS fourth quarter related
merger costs. See detail discussion in Notes 2 and 5.
(in millions, except per share amounts):
1998
---------------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
---------- ----------- ----------- -----------
Revenues $ 331.8 $ 334.2 $ 322.6 $ 295.7
Costs and expenses 217.4 210.1 200.3 188.5
Depreciation and amortization 20.1 18.7 17.9 16.8
---------- ----------- ----------- -----------
Operating income 94.3 105.4 104.4 90.4
Equity in net earnings (losses) of unconsolidated affiliates:
DST 1.6 7.7 7.5 7.5
Grupo TFM 0.2 1.8 (2.1) (3.1)
Other 0.1 0.8 0.5 0.4
Interest expense (15.4) (17.1) (16.2) (17.4)
Reduction in ownership of DST (29.7) - - -
Other, net 6.8 4.2 15.2 6.6
---------- ----------- ----------- -----------
Pretax income 57.9 102.8 109.3 84.4
Income taxes 20.2 38.2 40.9 31.5
Minority interest 7.6 9.4 9.7 6.7
---------- ----------- ----------- -----------
Net income 30.1 55.2 58.7 46.2
Other Comprehensive Income (Loss), net of tax:
Unrealized gain (loss) on securities 8.2 (27.0) 13.0 29.9
---------- ----------- ----------- -----------
Comprehensive Income $ 38.3 $ 28.2 $ 71.7 $ 76.1
========== =========== =========== ===========
Earnings per share:
Basic $ 0.27 $ 0.50 $ 0.54 $ 0.43
========== =========== =========== ===========
Diluted $ 0.25 $ 0.49 $ 0.51 $ 0.41
========== =========== =========== ===========
Dividends per share:
Preferred $ .25 $ .25 $ .25 $ .25
Common $ .04 $ .04 $ .04 $ .04
Stock Price Ranges:
Preferred - High $ 17.000 $ 17.750 $ 18.000 $ 18.000
- Low 14.000 15.250 16.000 16.625
Common - High 49.563 57.438 49.813 46.000
- Low 23.000 29.000 39.625 26.250
103
Fourth Quarter 1997 includes an after-tax charge of $158.1 million, ($1.47 per
basic and diluted share) representing restructuring, asset impairment and other
charges. See detailed discussion in Notes 1, 3 and 6.
(in millions, except per share amounts):
1997
---------------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter (i)
---------- ----------- ----------- -----------
Revenues $ 294.3 $ 273.6 $ 252.6 $ 237.8
Costs and expenses 179.9 169.8 166.8 163.7
Depreciation and amortization 19.0 19.3 18.4 18.5
Restructuring, asset impairment and
other charges 196.4 - - -
---------- ----------- ----------- -----------
Operating income (loss) (101.0) 84.5 67.4 55.6
Equity in net earnings (losses) of unconsolidated affiliates:
DST 6.9 5.6 5.7 6.1
Grupo TFM (7.6) (2.3) (3.0) -
Other 1.0 1.0 1.2 0.6
Interest expense (17.1) (19.3) (13.6) (13.7)
Other, net 6.5 4.4 4.3 6.0
---------- ----------- ----------- -----------
Pretax income (loss) (111.3) 73.9 62.0 54.6
Income taxes (benefit) (2.7) 25.4 24.3 21.4
Minority interest 7.6 6.7 5.9 4.7
---------- ----------- ----------- -----------
Net income (loss) (116.2) 41.8 31.8 28.5
Other Comprehensive Income (Loss), net of tax:
Unrealized gain (loss) on securities 3.0 13.8 18.0 (8.9)
---------- ----------- ----------- -----------
Comprehensive Income (Loss) $ (113.2) $ 55.6 $ 49.8 $ 19.6
========== =========== =========== ===========
Earnings (loss) per share (ii):
Basic $ (1.08) $ 0.39 $ 0.29 $ 0.26
========== =========== =========== ===========
Diluted $ (1.08) $ 0.38 $ 0.29 $ 0.26
========== =========== =========== ===========
Dividends per share:
Preferred $ .25 $ .25 $ .25 $ .25
Common $ .040 $ .040 $ .033 $ .033
Stock Price Ranges:
Preferred - High $ 18.000 $ 19.000 $ 17.500 $ 17.000
- Low 17.000 15.500 15.500 16.000
Common - High 34.875 34.438 21.583 18.958
- Low 27.125 21.292 16.625 14.583
(i) The various components of the Statement of Operations were restated from
those reported in the Company's Form 10-Q for the three months ended March
31, 1997. This restatement was attributable to the inclusion of Gateway
Western as an unconsolidated wholly-owned subsidiary during first quarter
1997 pending approval of the Company's acquisition of Gateway Western from
the STB. Upon receiving STB approval in May 1997, Gateway Western was
included in the Company's consolidated financial statements retroactive to
January 1, 1997.
(ii) The accumulation of 1997's four quarters for Basic and Diluted earnings
(loss) per share does not total the Basic and Diluted loss per share,
respectively, for the year ended December 31, 1997 due to Common stock
repurchase and issuance transactions throughout the year, as well as the
anti-dilutive nature of options in the year ended December 31, 1997
calculations.
104
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
105
Part III
The Company has incorporated by reference certain responses to the Items of this
Part III pursuant to Rule 12b-23 under the Exchange Act and General Instruction
G(3) to Form 10-K. The Company's definitive proxy statement for the annual
meeting of stockholders scheduled for May 6, 1999 ("Proxy Statement") will be
filed no later than 120 days after December 31, 1998.
Item 10. Directors and Executive Officers of the Company
(a) Directors of the Company
The information set forth in response to Item 401 of Regulation S-K under the
heading "Proposal 1 - Election of Two Directors" and "The Board of Directors" in
the Company's Proxy Statement is incorporated herein by reference in partial
response to this Item 10.
(b) Executive Officers of the Company
The information set forth in response to Item 401 of Regulation S-K under
"Executive Officers of the Company," an unnumbered Item in Part I (immediately
following Item 4, Submission of Matters to a Vote of Security Holders), of this
Form 10-K is incorporated herein by reference in partial response to this Item
10.
The information set forth in response to Item 405 of Regulation S-K under the
heading "Section 16(a) of Beneficial Ownership Reporting Compliance" in the
Company's Proxy Statement is incorporated herein by reference in partial
response to this Item 10.
Item 11. Executive Compensation
The information set forth in response to Item 402 of Regulation S-K under
"Management Compensation" and "Compensation of Directors" in the Company's Proxy
Statement, (other than The Compensation and Organization Committee Report on
Executive Compensation and the Stock Performance Graph), is incorporated by
reference in response to this Item 11.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information set forth in response to Item 403 of Regulation S-K under the
heading "Principal Stockholders and Stock Owned Beneficially by Directors and
Certain Executive Officers" in the Company's Proxy Statement is hereby
incorporated by reference in response to this Item 12.
The Company has no knowledge of any arrangement the operation of which may at a
subsequent date result in a change of control of the Company.
Item 13. Certain Relationships and Related Transactions
None
106
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) List of Documents filed as part of this Report
(1) Financial Statements
The financial statements and related notes, together with the report of
PricewaterhouseCoopers LLP dated March 4, 1999, appear in Part II Item 8,
Financial Statements and Supplementary Data, of this Form 10-K.
(2) Financial Statement Schedules
The schedules and exhibits for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission appear in Part
II Item 8, Financial Statements and Supplementary Data, under the Index to
Financial Statements of this Form 10-K.
(3) List of Exhibits
(a) Exhibits
The Company has incorporated by reference herein certain exhibits as specified
below pursuant to Rule 12b-32 under the Exchange Act.
(2) Plan of acquisition, reorganization, arrangement, liquidation or succession
(Inapplicable)
(3) Articles of Incorporation and Bylaws
Articles of Incorporation
3.1 Exhibit 4 to Company's Registration Statement on Form S-8
originally filed September 19, 1986 (Commission File No.
33-8880), Certificate of Incorporation as amended through May
14, 1985, is hereby incorporated by reference as Exhibit 3.1
3.2 Exhibit 4.1 to Company's Current Report on Form 8-K dated
October 1, 1993 (Commission File No. 1-4717), Certificate of
Designation dated September 29, 1993 Establishing Series B
Convertible Preferred Stock, par value $1.00, is hereby
incorporated by reference as Exhibit 3.2
3.3 Exhibit 3.1 to Company's Form 10-K for the fiscal year ended
December 31, 1994 (Commission File No. 1-4717), Amendment to
Company's Certificate of Incorporation to set par value for
common stock and increase the number of authorized common
shares dated May 6, 1994, is hereby incorporated by reference
as Exhibit 3.3
3.4 Exhibit 3.4 to Company's Form 10-K for the fiscal year ended
December 31, 1996 (Commission File No. 1-4717), Amended
Certificate of Designation Establishing the New Series A
Preferred Stock, par value $1.00, dated November 7, 1995, is
hereby incorporated by reference as Exhibit 3.4
107
3.5 Exhibit 3.5 to Company's Form 10-K for the fiscal year ended
December 31, 1996 (Commission File No. 1-4717), The
Certificate of Amendment dated May 12, 1987 of the Company's
Certificate of Incorporation adding the Sixteenth paragraph,
is hereby incorporated by reference as Exhibit 3.5
Bylaws
3.6 The Company's By-Laws, as amended and restated September 17,
1998, are attached to this Form 10-K as Exhibit 3.6
(4) Instruments Defining the Right of Security Holders, Including Indentures
4.1 The Fourth, Seventh, Eighth, Twelfth, Thirteenth, Fifteenth
and Sixteenth paragraphs of Exhibit 3.1 hereto are
incorporated by reference as Exhibit 4.1
4.2 Article I, Sections 1,3 and 11 of Article II, Article V and
Article VIII of Exhibit 3.6 hereto are incorporated by
reference as Exhibit 4.2
4.3 The Certificate of Designation dated September 29, 1993
establishing Series B Convertible Preferred Stock, par value
$1.00, which is attached hereto as Exhibit 3.2, is
incorporated by reference as Exhibit 4.3
4.4 The Amended Certificate of Designation dated November 7, 1995
establishing the New Series A Preferred Stock, par value
$1.00, which is attached hereto as Exhibit 3.4, is
incorporated by reference as Exhibit 4.4
4.5 Exhibit 4 to Company's Form S-3 filed June 19, 1992
(Commission File No. 33-47198), the Indenture to a $300
million Shelf Registration of Debt Securities dated July 1,
1992, is hereby incorporated by reference as Exhibit 4.5
4.6 Exhibit 4(a) to Company's Form S-3 filed March 29, 1993
(Commission File No. 33-60192), the Indenture to a $200
million Medium Term Notes Registration of Debt Securities
dated July 1, 1992, is hereby incorporated by reference as
Exhibit 4.6
4.7 Exhibit 99 to Company's Form 8-A dated October 24, 1995
(Commission File No. 1-4717), which is the Stockholder Rights
Agreement by and between the Company and Harris Trust and
Savings Bank dated as of September 19, 1995, is hereby
incorporated by reference as Exhibit 4.7
(9) Voting Trust Agreement
(Inapplicable)
(10) Material Contracts
10.1 Exhibit I to Company's Form 10-K for the fiscal year ended
December 31, 1987 (Commission File No. 1-4717), The Director
Indemnification Agreement, is hereby incorporated by reference
as Exhibit 10.1
10.2 Exhibit B to Company's Definitive Proxy Statement for 1987
Annual Stockholder Meeting dated April 6, 1987, The Director
Indemnification Agreement, is hereby incorporated by reference
as Exhibit 10.2
108
10.3 The Indenture dated July 1, 1992 to a $300 million Shelf
Registration of Debt Securities, which is incorporated by
reference as Exhibit 4.5 hereto, is hereby incorporated by
reference as Exhibit 10.3
10.4 Exhibit H to Company's Form 10-K for the fiscal year ended
December 31, 1987 (Commission File No. 1-4717), The Officer
Indemnification Agreement, is hereby incorporated by reference
as Exhibit 10.4
10.5 Exhibit 10.1 to Company's Form 10-Q for the period ended March
31, 1997 (Commission File No. 1-4717), The Kansas City
Southern Railway Company Directors' Deferred Fee Plan as
adopted August 20, 1982 and the amendment thereto effective
March 19, 1997 to such plan, is hereby incorporated by
reference as Exhibit 10.5
10.6 Exhibit 10.4 to Company's Form 10-K for the fiscal year ended
December 31, 1990 (Commission File No. 1-4717), Description of
the Company's 1991 incentive compensation plan, is hereby
incorporated by reference as Exhibit 10.6
10.7 The Indenture dated July 1, 1992 to a $200 million Medium Term
Notes Registration of Debt Securities, which is incorporated
as Exhibit 4.6 hereto, is hereby incorporated by reference as
Exhibit 10.7
10.8 Exhibit 10.1 to the Company's Form 10-Q for the quarterly
period ended June 30, 1997 (Commission File No. 1-4717),
Five-Year Competitive Advance and Revolving Credit Facility
Agreement dated May 2, 1997, by and between the Company and
the lenders named therein, is hereby incorporated by reference
as Exhibit 10.8
10.9 Exhibit 10.4 in the DST Systems, Inc. Registration Statement
on Form S-1 dated October 30, 1995, as amended (Registration
No. 33-96526), Tax Disaffiliation Agreement, dated October 23,
1995, by and between the Company and DST Systems, Inc., is
hereby incorporated by reference as Exhibit 10.9
10.10 Exhibit 10.6 to the DST Systems, Inc. Annual Report on Form
10-K for the year ended December 31, 1995 (Commission File No.
1-14036), the 1995 Restatement of The Employee Stock Ownership
Plan and Trust Agreement, is hereby incorporated by reference
as Exhibit 10.10
10.11 Exhibit 4.1 to the DST Systems, Inc. Registration Statement on
Form S-1 dated October 30, 1995, as amended (Registration No.
33-96526), The Registration Rights Agreement dated October 24,
1995 by and between DST Systems, Inc. and the Company, is
hereby incorporated by reference as Exhibit 10.11
10.12 Exhibit 10.18 to Company's Form 10-K for the year ended
December 31, 1996 (Commission File No. 1-4717), Directors
Deferred Fee Plan, adopted August 20, 1982, amended and
restated February 1, 1997, is hereby incorporated by reference
as Exhibit 10.12
10.13 Appendix D to the Company's Notice and Proxy Statement
for A Special Meeting of Stockholders to held July 15,
1998, Kansas City Southern Industries, Inc. 1991 Amended
and Restated Stock Option and Performance Award Plan, as
amended and restated effective July 15, 1998, is hereby
incorporated by reference as Exhibit 10.13
10.14 Exhibit 10.20 to Company's Form 10-K for the year ended
December 31, 1997 (Commission File No. 1-4717), Employment
Agreement, as amended and restated September 18, 1997, by and
between the Company and Landon H. Rowland is hereby
incorporated by reference as Exhibit 10.14
109
10.15 Employment Agreement, as amended and restated January 1,
1999, by and between the Company, The Kansas City Southern
Railway Company and Michael R. Haverty, is attached to this
Form 10-K as Exhibit 10.15
10.16 Employment Agreement, as amended and restated January 1, 1999,
by and between the Company and Joseph D. Monello is attached
to this Form 10-K as Exhibit 10.16
10.17 Employment Agreement, as amended and restated January 1, 1999,
by and between the Company and Danny R. Carpenter is attached
to this Form 10-K as Exhibit 10.17
10.18 Kansas City Southern Industries, Inc. Executive Plan, as
amended and restated effective November 17, 1998, is attached
to this Form 10-K as Exhibit 10.18
(11) Statement Re Computation of Per Share Earnings
(Inapplicable)
(12) Statements Re Computation of Ratios
12.1 The Computation of Ratio of Earnings to Fixed Charges prepared
pursuant to Item 601(b)(12) of Regulation S-K is attached to
this Form 10-K as Exhibit 12.1
(13) Annual Report to Security Holders, Form 10-Q or Quarterly
Report to Security Holders
(Inapplicable)
(16) Letter Re Change in Certifying Accountant
(Inapplicable)
(18) Letter Re Change in Accounting Principles
(Inapplicable)
(21) Subsidiaries of the Company
21.1 The list of the Subsidiaries of the Company prepared pursuant
to Item 601(b)(21) of Regulation S-K is attached to this Form
10-K as Exhibit 21.1
(22) Published Report Regarding Matters Submitted to Vote of Security Holders
(Inapplicable)
(23) Consents of Experts and Counsel
23.1 The Consent of Independent Accountants prepared pursuant to
Item 601(b)(23) of Regulation S-K is attached to this Form
10-K as Exhibit 23.1
(24) Power of Attorney
(Inapplicable)
(27) Financial Data Schedule
27.1 The Financial Data Schedule prepared pursuant to Item
601(b)(27) of Regulation S-K is attached to this Form 10-K as
Exhibit 27.1
(28) Information from Reports Furnished to State Insurance Regulatory
Authorities
(Inapplicable)
110
(99) Additional Exhibits
99.1 The consolidated financial statements of DST Systems, Inc.
(including the notes thereto and the Report of Independent
Accountants thereon) set forth under Item 8 of the DST
Systems, Inc. Annual Report on Form 10-K for the year ended
December 31, 1998 (Commission File No. 1-14036), as listed
under Item 14(a)(2) herein, are hereby incorporated by
reference as Exhibit 99.1
(b) Reports on Form 8-K
The Company did not file any current reports on Form 8-K during the three months
ended December 31, 1998.
111
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Kansas City Southern Industries, Inc.
March 22, 1999 By: /s/ L.H. Rowland
L.H. Rowland
Chairman, President,
Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company and in
the capacities indicated on March 22, 1999.
Signature Capacity
/s/ L.H. Rowland Chairman, President, Chief Executive Officer
L.H. Rowland and Director
/s/ M.R. Haverty Executive Vice President and Director
M.R. Haverty
/s/ J.D. Monello Vice President and Chief Financial Officer
J.D. Monello (Principal Financial Officer)
/s/ L.G. Van Horn Vice President and Comptroller
L.G. Van Horn (Principal Accounting Officer)
/s/ A.E. Allinson Director
A.E. Allinson
/s/ P.F. Balser Director
P.F. Balser
/s/ J.E. Barnes Director
J.E. Barnes
/s/ M.G. Fitt Director
M.G. Fitt
/s/ J.R. Jones Director
J.R. Jones
/s/ J.F. Serrano Director
J.F. Serrano
/s/ M.I. Sosland Director
M.I. Sosland
112
KANSAS CITY SOUTHERN INDUSTRIES, INC.
1998 FORM 10-K ANNUAL REPORT
INDEX TO EXHIBITS
Regulation S-K
Exhibit Item 601(b)
No. Document Exhibit No.
3.6 The Company's By-Laws, as amended and restated
as of September 17, 1998 3
10.15 Employment Agreement as amended and restated
January 1, 1999, by and between the Company and
Michael R. Haverty 10
10.16 Employment Agreement as amended and restated
January 1, 1999, by and between the Company and
Joseph D. Monello 10
10.17 Employment Agreement as amended and restated
January 1, 1999, by and between the Company and
Danny R. Carpenter 10
10.18 Kansas City Southern Industries, Inc. Executive Plan,
as amended and restated effective November 17, 1998 10
12.1 Computation of Ratio of Earnings to Fixed Charges 12
21.1 Subsidiaries of the Company 21
23.1 Consent of Independent Accountants 23
27.1 Financial Data Schedule 27
-----------------------------