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
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
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.
Employees. As of December 31, 1998, the approximate number of employees of KCSI and its majority owned subsidiaries was as follows:
Item 2.
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.
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.
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):
* 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.
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.
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
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.
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.
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.
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.
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.
Part II
Item 5.
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.
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.
(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
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.
Item 7.
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
Item 8. Financial Statements and Supplementary Data
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.
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
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
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.
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:
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.
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.
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.
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.
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.
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.
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
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.
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.
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.
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 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").
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
(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
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.
(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
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.
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.
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.
See Note 3 for discussion of reserves established in 1997 for restructuring and other charges.
Note 7. Long-Term Debt
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.
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.
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.
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.
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
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.
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.
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
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
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.
(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.
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.
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.
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
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.
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
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.
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.
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.
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.
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.
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.
(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.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
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.
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.
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.
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.
Item 13. Certain Relationships and Related Transactions
None
Part IV
Item 14.
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
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
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
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)
(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.
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
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
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