Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
The discussion below, as well as other portions of this Form 10-Q, contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended and the Private Securities Litigation Reform Act of 1995. In addition, management may make forward-looking statements orally or in other writing, including, but not limited to, in press releases, quarterly earnings calls, executive presentations, in the annual report to stockholders and in other filings with the Securities and Exchange Commission (the “SEC”). Readers can usually identify these forward-looking statements by the use of such words as “may,” “will,” “should,” “likely,” “plans,” “projects,” “expects,” “anticipates,” “believes” or similar words. These statements involve a number of risks and uncertainties. Actual results could materially differ from those anticipated by such forward-looking statements. Such differences could be caused by a number of factors or combination of factors including, but not limited to, the factors identified below and those discussed under the captions “Part II - Item 1A - Risk Factors” herein and Item 1A, “Risk Factors”, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 (the “Annual Report”). Readers are strongly encouraged to consider these factors and the following factors when evaluating any forward-looking statements concerning the Company: public health threats or outbreaks of communicable diseases, such as the ongoing COVID-19 pandemic (including its variants) and its impact on KCS’s business, suppliers, consumers, customers, employees and supply chains; rail accidents or other incidents or accidents on KCS’s rail network or at KCS’s facilities or customer facilities involving the release of hazardous materials, including toxic inhalation hazards; legislative and regulatory developments and disputes, including tax disputes and environmental regulations; loss of the rail concession of Kansas City Southern’s subsidiary, Kansas City Southern de México, S.A. de C.V.; North American and global economic, political and social conditions; disruptions to the Company’s technology infrastructure, including its computer systems; increased demand and traffic congestion; the level of trade between the United States and Asia or Mexico; fluctuations in the peso-dollar exchange rate; natural events such as severe weather, hurricanes and floods; the outcome of claims and litigation involving the Company or its subsidiaries; changes in business strategy and strategic opportunities; competition and consolidation within the transportation industry; the business environment in industries that produce and use items shipped by rail; the termination of, or failure to renew, agreements with customers, other railroads and third parties; the satisfaction of by third parties of their obligations; fluctuation in prices or availability of key materials, fluctuations in commodity demand; in particular diesel fuel; insurance coverage limitations; access to capital; sufficiency of budgeted capital expenditures in carrying out business plans; services infrastructure; climate change and the market and regulatory responses to climate change; dependency on certain key suppliers of core rail equipment; changes in securities and capital markets; unavailability of qualified personnel; difficulty attracting, motivating, and retaining executives and other key employees due to the uncertainty of the merger transaction with Canadian Pacific Railway Limited (“CP”); significant demands placed on the Company as a result of the merger of the Company with CP; labor difficulties, including strikes and work stoppages; acts of terrorism or risk of terrorist activities, war or other acts of violence; and other factors affecting the operation of the business. For more discussion about each risk factor, see “Part II - Item 1A - Risk Factors” herein and Part I, Item 1A - “Risk Factors” in the Company’s Annual Report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein and in the Company’s Annual Report, in each case as updated by the Company’s periodic filings with the SEC.
Forward-looking statements reflect the information only as of the date on which they are made. The Company does not undertake any obligation to update any forward-looking statements to reflect future events, developments, or other information. If KCS does update one or more forward-looking statements, no inference should be drawn that additional updates will be made regarding that statement or any other forward-looking statements.
This discussion is intended to clarify and focus on KCS’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 1 of this Quarterly Report on Form 10-Q for the quarter ended June 30, 2022. This discussion should be read in conjunction with those consolidated financial statements and the related notes and is qualified by reference to them.
Critical Accounting Policies and Estimates
The Company’s discussion and analysis of its financial position and results of operations is based upon its consolidated financial statements. The preparation of these consolidated financial statements requires estimation and judgment that affect the reported amounts of revenue, expenses, assets and liabilities. The Company bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the accounting for assets and liabilities that are not readily apparent from other sources. If the estimates differ materially from actual results, the impact on the consolidated financial statements may be material. The Company’s critical accounting policies are disclosed in its 2021 Annual Report.
Overview
The Company is engaged primarily in the freight rail transportation business, operating a single coordinated rail network under one reportable business segment. The primary operating subsidiaries of the Company consist of the following: The Kansas City Southern Railway Company (“KCSR”), Kansas City Southern de México, S.A. de C.V. (“KCSM”), Meridian Speedway, LLC (“MSLLC”), and The Texas Mexican Railway Company (“TexMex”). The Company generates revenues and cash flows by providing customers with freight delivery services both within its regions and throughout North America through connections with other Class I rail carriers. KCS’s customers conduct business in a number of different industries, including chemical and petroleum, industrial and consumer products, agriculture and minerals, energy, automotive, and intermodal transportation. Appropriate eliminations and reclassifications have been recorded in preparing the consolidated financial statements.
Merger Agreement
On September 15, 2021, KCS and CP entered into a merger agreement (the “Merger Agreement”) and on December 14, 2021, CP acquired the outstanding common and preferred stock of KCS. Each share of common stock, par value $0.01 per share, of KCS that was outstanding immediately prior to the merger was converted into the right to receive (1) 2.884 common shares of CP and (2) $90 in cash (together, the “Merger Consideration”), and each share of preferred stock, par value $25 per share, that was outstanding immediately prior to the merger was converted into the right to receive $37.50 in cash. The Merger Consideration value received by KCS stockholders was $301.20 per KCS common share.
The merger transaction was completed through a series of mergers as outlined in the Merger Agreement. These mergers ultimately resulted in KCS being merged with and into Cygnus Merger Sub 1 Corporation (“Surviving Merger Sub”), a wholly owned subsidiary of CP, with Surviving Merger Sub continuing as the surviving entity. Pursuant to the Merger Agreement, Surviving Merger Sub was renamed “Kansas City Southern” and as successor company of KCS, continued to own the assets of KCS. Immediately following the consummation of the mergers, CP caused the contribution, directly and indirectly, of all of the outstanding shares of capital stock of Surviving Merger Sub, as successor to KCS, to be deposited into an independent, irrevocable voting trust (the “Voting Trust”) under a voting trust agreement (the “Voting Trust Agreement”) approved by the U.S. Surface Transportation Board (“STB”), pending receipt of the final and non-appealable approval or exemption by the STB pursuant to 49 U.S.C. § 11323 et seq., of the transactions contemplated by the Merger Agreement (“STB Final Approval”). The Voting Trust prevents CP, or any affiliate of CP, from controlling or having the power to control KCS prior to STB Final Approval. Following receipt of STB Final Approval and approval from other applicable regulatory authorities, the Voting Trust will be terminated and CP will acquire control over KCS’s railroad operations. STB Final Approval is expected to be granted in the first quarter of 2023, subject to the regulatory review process.
On December 14, 2021, the merger of KCS and Surviving Merger Sub was accounted for as a recapitalization of KCS’s equity. Upon STB Final Approval, the transaction will be accounted for as a business combination using the acquisition method of accounting.
In the first quarter of 2022, pursuant to the Merger Agreement, KCS paid a cash dividend of $265.0 million to a wholly-owned subsidiary of CP. Periodic cash distributions may be made to a wholly-owned subsidiary of CP based upon cash generated, the timing of capital expenditures and working capital needs of the Company.
For the three and six months ended June 30, 2022, KCS reported $12.5 million and $25.3 million, respectively, of merger-related costs, which primarily related to incentive compensation costs. During the three and six months ended June 30, 2021, the Company recognized merger-related costs of $720.8 million and $740.1 million, respectively, which primarily related to the termination fee associated with the termination of the CP merger agreement by KCS of $700.0 million in May 2021. These costs were recognized in merger costs within the consolidated statements of operations.
Ukraine Crisis
The invasion of Ukraine by Russia in February 2022 has led to disruption, instability, and volatility in global markets and industries. The U.S. government and other foreign governments have imposed severe economic sanctions and export controls against Russia, certain regions of Ukraine and particular entities and individuals, removed Russia from the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”) system, and may impose additional sanctions and controls. The full impact of these sanctions and controls, as well as responses to them by Russia has and could in the future result in, among other things, severe or complete restrictions on exports to and other commerce and business dealings involving Russia, certain regions of Ukraine, and/or particular entities and individuals. In addition, this ongoing invasion has caused energy prices to rise, leading to increased inflationary impacts. To date, the Company has not experienced a material impact to operations or the consolidated financial statements as a result of the invasion of Ukraine; however, KCS will continue to monitor for events that could materially impact the Company.
Inflation
U.S. consumer price inflation rose at its fastest pace in over 40 years and Mexico inflation reached levels not seen for 20 years. Consumer price annual inflation rates as of June 30, 2022 were 9.1% and 8.0% in the U.S. and Mexico, respectively. KCS is closely monitoring the impact of rapidly increasing inflation on the Company’s financial results and procurement supply chain. As of June 30, 2022, higher inflation has not had a material impact on the Company’s financial results. Additionally, supply chain disruptions have not materially impacted the Company’s ability to procure essential materials and services on a timely basis.
Inflation is expected to be elevated for the near future. Inflationary factors, such as increases in interest rates, overhead costs and transportation costs may adversely affect the Company’s financial results. Although the Company does not believe that inflation has had a material impact on KCS’s financial results to date, the Company may experience some effect in the near future due to supply chain constraints, consequences associated with COVID-19, and the ongoing invasion of Ukraine by Russia, employee availability and wage increases.
Second Quarter Highlights
For the three months ended June 30, 2022, revenues increased 13% compared to the same period in 2021, primarily due to a 9% increase in revenue per carload/unit, and a 3% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix. Volumes increased due to strong demand, improved cycle times, and partial recovery of the global microchip shortage. These increases were partially offset by decreased volumes in chemicals and petroleum refined fuel products due to regulatory impacts.
Operating expenses decreased 55% during the three months ended June 30, 2022, as compared to the same period in 2021, primarily due to decreased merger costs related to the termination fee for the termination of the CP merger agreement by KCS of $700.0 million recognized in the second quarter of 2021, partially offset by higher diesel fuel prices. Operating expenses as a percentage of revenues was 63.0% for the three months ended June 30, 2022, compared to 157.6% for the same period in 2021.
Results of Operations
The following summarizes KCS’s consolidated statement of operations components (in millions):
| | | | | | | | | | | | | | | | | |
| Three Months Ended | | Change |
| June 30, | |
| 2022 | | 2021 | |
| Revenues | $ | 845.5 | | | $ | 749.5 | | | $ | 96.0 | |
| Operating expenses | 532.7 | | | 1,181.2 | | | (648.5) | |
| Operating income (loss) | 312.8 | | | (431.7) | | | 744.5 | |
| Equity in net earnings (losses) of affiliates | (0.8) | | | 3.4 | | | (4.2) | |
| Interest expense | (40.2) | | | (39.1) | | | (1.1) | |
| Foreign exchange gain (loss) | (4.3) | | | 6.8 | | | (11.1) | |
| Other income (expense), net | (0.8) | | | 1.0 | | | (1.8) | |
| Income (loss) before income taxes | 266.7 | | | (459.6) | | | 726.3 | |
| Income tax expense (benefit) | 72.6 | | | (81.6) | | | 154.2 | |
| Net income (loss) | 194.1 | | | (378.0) | | | 572.1 | |
| Less: Net income attributable to noncontrolling interest | — | | | 0.5 | | | (0.5) | |
| Net income (loss) attributable to Kansas City Southern and subsidiaries | $ | 194.1 | | | $ | (378.5) | | | $ | 572.6 | |
| | | | | | | | | | | | | | | | | |
| Six Months Ended | | Change |
| June 30, | |
| 2022 | | 2021 | |
| Revenues | $ | 1,623.7 | | | $ | 1,455.5 | | | $ | 168.2 | |
| Operating expenses | 1,019.8 | | | 1,634.2 | | | (614.4) | |
| Operating income (loss) | 603.9 | | | (178.7) | | | 782.6 | |
| Equity in net earnings of affiliates | 8.0 | | | 9.4 | | | (1.4) | |
| Interest expense | (79.1) | | | (78.1) | | | (1.0) | |
| Foreign exchange loss | (5.7) | | | (0.5) | | | (5.2) | |
| Other income, net | 0.1 | | | 0.2 | | | (0.1) | |
| Income (loss) before income taxes | 527.2 | | | (247.7) | | | 774.9 | |
| Income tax expense (benefit) | 145.1 | | | (23.1) | | | 168.2 | |
| Net income (loss) | 382.1 | | | (224.6) | | | 606.7 | |
| Less: Net income attributable to noncontrolling interest | 0.6 | | | 0.9 | | | (0.3) | |
| Net income (loss) available to common stockholder(s) | $ | 381.5 | | | $ | (225.5) | | | $ | 607.0 | |
Operating Metrics
The Company has established the following key metrics to measure precision scheduled railroading (“PSR”) progress and performance:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Improvement/ (Deterioration) | | Six Months Ended | | Improvement/ (Deterioration) | | |
| | June 30, | | June 30, | |
| | 2022 | | 2021 | | 2022 | | 2021 | |
Gross velocity (mph) (i) | | 13.7 | | 12.2 | | 12% | | 14.6 | | 12.6 | | 16% | | |
Terminal dwell (hours) (ii) | | 21.9 | | 26.1 | | 16% | | 20.8 | | 26.4 | | 21% | | |
Train length (feet) (iii) | | 6,421 | | 6,778 | | (5)% | | 6,443 | | 6,800 | | (5)% | | |
| | | | | | | | | | | | | | |
Fuel efficiency (gallons per 1,000 GTM's) (iv) | | 1.25 | | 1.22 | | (2)% | | 1.25 | | 1.24 | | (1)% | | |
| | | | | | | | | | | | | | | | | |
| (i) Gross velocity is the average train speed between origin and destination in miles per hour calculated as the sum of the miles traveled divided by the sum of total transit hours. Transit hours are measured as the difference between a train’s origin departure and destination arrival date and times broken down by segment across the train route (includes all time spent including crew changes, terminal dwell, delays, and incidents). |
| | | | |
| (ii) Terminal dwell is the average amount of time in hours between car arrival to and departure from the yard (excludes cars that move through a terminal on a run-through train, stored, bad ordered, and maintenance-of-way cars). Calculated by dividing the total number of hours cars spent in terminals by the total count of car dwell events. |
| | | | | |
| (iii) Train length is the average length of a train across its reporting stations, including the origin and intermediate stations. Length of a train is the sum of car and locomotive lengths measured in feet. |
| | | | | |
|
| | | | | |
| (iv) Fuel efficiency is calculated by taking locomotive fuel consumed in gallons divided by thousand gross ton miles (“GTM’s”) net of detours with no associated fuel gallons. GTM’s are the movement of one ton of train weight over one mile calculated by multiplying total train weight by distance the train moved. GTM’s exclude locomotive gross ton miles. |
For the three months ended June 30, 2022, the improvement in velocity and dwell, as compared to the same period in 2021, were due to efforts to improve network fluidity including reductions in train length, along with other operating initiatives and new capacity projects.
Revenues
The following summarizes revenues (in millions), carload/unit statistics (in thousands) and revenue per carload/unit:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Revenues | | Carloads and Units | | Revenue per Carload/Unit |
| Three Months Ended | | | | Three Months Ended | | | | Three Months Ended | | |
| June 30, | | | | June 30, | | | | June 30, | | |
| 2022 | | 2021 | | % Change | | 2022 | | 2021 | | % Change | | 2022 | | 2021 | | % Change |
| Chemical and petroleum | $ | 200.3 | | | $ | 232.5 | | | (14 | %) | | 81.9 | | | 103.4 | | | (21 | %) | | $ | 2,446 | | | $ | 2,249 | | | 9 | % |
| Industrial and consumer products | 174.5 | | | 144.6 | | | 21 | % | | 86.0 | | | 74.4 | | | 16 | % | | 2,029 | | | 1,944 | | | 4 | % |
| Agriculture and minerals | 172.5 | | | 139.9 | | | 23 | % | | 73.2 | | | 65.9 | | | 11 | % | | 2,357 | | | 2,123 | | | 11 | % |
| Energy | 71.9 | | | 54.5 | | | 32 | % | | 63.1 | | | 63.1 | | | — | | | 1,139 | | | 864 | | | 32 | % |
| Intermodal | 117.5 | | | 91.1 | | | 29 | % | | 265.5 | | | 250.3 | | | 6 | % | | 443 | | | 364 | | | 22 | % |
| Automotive | 66.4 | | | 49.4 | | | 34 | % | | 33.1 | | | 27.7 | | | 19 | % | | 2,006 | | | 1,783 | | | 13 | % |
| Carload revenues, carloads and units | 803.1 | | | 712.0 | | | 13 | % | | 602.8 | | | 584.8 | | | 3 | % | | $ | 1,332 | | | $ | 1,218 | | | 9 | % |
| Other revenue | 42.4 | | | 37.5 | | | 13 | % | | | | | | | | | | | | |
| Total revenues (i) | $ | 845.5 | | | $ | 749.5 | | | 13 | % | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| (i) Included in revenues: | | | | | | | | | | | | | | | | | |
| Fuel surcharge | $ | 128.5 | | | $ | 69.9 | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Revenues | | Carloads and Units | | Revenue per Carload/Unit |
| Six Months Ended | | | | Six Months Ended | | | | Six Months Ended | | |
| June 30, | | | | June 30, | | | | June 30, | | |
| 2022 | | 2021 | | % Change | | 2022 | | 2021 | | % Change | | 2022 | | 2021 | | % Change |
| Chemical and petroleum | $ | 387.7 | | | $ | 463.8 | | | (16 | %) | | 162.3 | | | 205.0 | | | (21 | %) | | $ | 2,389 | | | $ | 2,262 | | | 6 | % |
| Industrial and consumer products | 335.2 | | | 278.6 | | | 20 | % | | 164.3 | | | 146.7 | | | 12 | % | | 2,040 | | | 1,899 | | | 7 | % |
| Agriculture and minerals | 335.9 | | | 264.3 | | | 27 | % | | 146.2 | | | 126.6 | | | 15 | % | | 2,298 | | | 2,088 | | | 10 | % |
| Energy | 143.5 | | | 112.0 | | | 28 | % | | 130.3 | | | 124.7 | | | 4 | % | | 1,101 | | | 898 | | | 23 | % |
| Intermodal | 213.4 | | | 172.4 | | | 24 | % | | 510.8 | | | 483.1 | | | 6 | % | | 418 | | | 357 | | | 17 | % |
| Automotive | 120.7 | | | 93.5 | | | 29 | % | | 64.1 | | | 54.1 | | | 18 | % | | 1,883 | | | 1,728 | | | 9 | % |
| Carload revenues, carloads and units | 1,536.4 | | | 1,384.6 | | | 11 | % | | 1,178.0 | | | 1,140.2 | | | 3 | % | | $ | 1,304 | | | $ | 1,214 | | | 7 | % |
| Other revenue | 87.3 | | | 70.9 | | | 23 | % | | | | | | | | | | | | |
| Total revenues (i) | $ | 1,623.7 | | | $ | 1,455.5 | | | 12 | % | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| (i) Included in revenues: | | | | | | | | | | | | | | | | | |
| Fuel surcharge | $ | 216.3 | | | $ | 120.8 | | | | | | | | | | | | | | | |
For the three months ended June 30, 2022, revenues increased 13% compared to the same period in 2021. Revenues increased due to a 9% increase in revenue per carload/unit and a 3% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix. Volumes increased due to strong demand, improved cycle times, and partial recovery of the global microchip shortage. These increases were partially offset by decreased volumes in chemicals and petroleum refined fuel products due to regulatory impacts.
For the six months ended June 30, 2022, revenues increased 12% compared to the same period in 2021. Revenues increased due to a 7% increase in revenue per carload/unit and a 3% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix. Volumes increased due to improved cycle times, strong demand, favorable comparable volumes as a result of network congestion driven by weather impacts in 2021, and partial recovery of the global microchip shortage. These increases were partially offset by decreased volumes in chemicals and petroleum refined fuel products due to regulatory impacts.
The fluctuations of the Mexican peso against the U.S. dollar during the three and six months ended June 30, 2022, resulted in an immaterial change compared to the same periods in 2021, for revenue transactions denominated in Mexican pesos. The average exchange rate of Mexican pesos per U.S. dollar was Ps.20.0 and Ps. 20.3 for the three and six months ended June 30, 2022, respectively, compared to Ps.20.1 and Ps. 20.2 for the same periods in 2021.
KCS’s fuel surcharges are a mechanism to adjust revenue based upon changes in fuel prices above fuel price thresholds set in KCS’s tariffs or contracts. Fuel surcharge revenue is calculated using a fuel price from a prior time period that can be up to 60 days earlier. In a period of volatile fuel prices or changing customer business mix, changes in fuel expense and fuel surcharge revenue may differ.
For the three and six months ended June 30, 2022, fuel surcharge revenue increased $58.6 million and $95.5 million, respectively, compared to the same periods in 2021, primarily due to higher fuel prices.
The following discussion provides an analysis of revenues by commodity group: | | | | | |
| Revenues by commodity group
for the three months ended
June 30, 2022 |
Chemical and petroleum. Revenues decreased $32.2 million for the three months ended June 30, 2022, compared to the same period in 2021, due to a 21% decrease in carload/unit volumes, partially offset by a 9% increase in revenue per carload/unit. Revenues decreased $76.1 million for the six months ended June 30, 2022, compared to the same period in 2021, due to a 21% decrease in carload/unit volumes, partially offset by a 6% increase in revenue per carload/unit. Volumes decreased due to refined fuel product shipments into Mexico being negatively impacted by supply chain disruptions as a result of increased regulation. Refer to Mexico Regulatory and Legal Updates for further discussion. Revenue per carload/unit increased for the three months ended June 30, 2022 due to higher fuel surcharge, mix, positive pricing impacts, and longer average length of haul. Revenue per carload/unit increased for the six months ended June 30, 2022 due to higher fuel surcharge and positive pricing impacts. | |
| | | | | |
Industrial and consumer products. Revenues increased $29.9 million for the three months ended June 30, 2022, compared to the same period in 2021, due to a 16% increase in carload/unit volumes and a 4% increase in revenue per carload/unit. Revenues increased $56.6 million for the six months ended June 30, 2022, compared to the same period in 2021, due to a 12% increase in carload/unit volumes and a 7% increase in revenue per carload/unit. Metal volumes increased due to higher demand and new steel plants that opened on the KCSM network in 2021. Forest product volumes increased due to demand, improved cycle times, and equipment availability. Revenue per carload/unit increased for the three months ended June 30, 2022 due to higher fuel surcharge and positive pricing impacts, partially offset by mix and shorter average length of haul. Revenue per carload/unit increased for the six months ended June 30, 2022 due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix. | |
| | | | | |
| Revenues by commodity group
for the three months ended
June 30, 2022 |
Agriculture and minerals. Revenues increased $32.6 million for the three months ended June 30, 2022, compared to the same period in 2021, due to an 11% increase in both carload/unit volumes and revenue per carload/unit. Volumes increased due to improved cycle times. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix.
Revenues increased $71.6 million for the six months ended June 30, 2022, compared to the same period in 2021, due to a 15% increase in carload/unit volumes and a 10% increase in revenue per carload/unit. Volumes increased due to improved cycle times and favorable comparable volumes as a result of network congestion driven by weather impacts in 2021. Revenue per carload/unit increased due to higher fuel surcharge and positive pricing impacts, partially offset by mix. | |
| | | | | |
Energy. Revenues increased $17.4 million for the three months ended June 30, 2022, compared to the same period in 2021, due to a 32% increase in revenue per carload/unit. Revenue per carload/unit increased due to longer average length of haul, higher fuel surcharge, and positive pricing impacts, partially offset by mix.
Revenues increased $31.5 million for the six months ended June 30, 2022, compared to the same period in 2021, due to a 23% increase in revenue per carload/unit and a 4% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, longer average length of haul, and positive pricing impacts. Volumes increased in crude oil due to new business, partially offset by a decline in utility coal as a result of deteriorated interchange cycle times and utility plant maintenance outages. | |
Intermodal. Revenues increased $26.4 million for the three months ended June 30, 2022, compared to the same period in 2021, due to a 22% increase in revenue per carload/unit and a 6% increase in carload/unit volumes. Revenues increased $41.0 million for the six months ended June 30, 2022, compared to the same period in 2021, due to a 17% increase in revenue per carload/unit and a 6% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, mix, positive pricing impacts, and longer average length of haul. Volumes increased due to stronger demand, new business, and partial recovery of the global microchip shortage affecting auto parts shipments, partially offset by weaker Mexico domestic demand. Additionally for the six months ended June 30, 2022, volumes increased due to favorable comparable volumes as a result of network congestion driven by weather impacts in 2021.
Automotive. Revenues increased $17.0 million for the three months ended June 30, 2022, compared to the same period in 2021, due to a 19% increase in carload/unit volumes and a 13% increase in revenue per carload/unit. Revenues increased $27.2 million for the six months ended June 30, 2022, compared to the same period in 2021, due to a 18% increase in carload/unit volumes and a 9% increase in revenue per carload/unit. Volumes increased due to partial recovery of the global microchip shortage. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix.
Operating Expenses
Operating expenses, as shown below (in millions), decreased $648.5 million and $614.4 million for the three and six months ended June 30, 2022, respectively, compared to the same periods in 2021, primarily due to decreased merger costs related to the termination fee for the termination of the CP merger agreement by KCS of $700.0 million recognized in the second quarter of 2021, partially offset by higher diesel fuel prices. The fluctuations of the Mexican peso against the U.S. dollar during the three and six months ended June 30, 2022, resulted in an immaterial change compared to the same periods in 2021, for expense transactions denominated in Mexican pesos. The average exchange rate of Mexican pesos per U.S. dollar was Ps.20.0 and Ps. 20.3 for the three and six months ended June 30, 2022, respectively, compared to Ps.20.1 and Ps. 20.2 for the same periods in 2021.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | |
| June 30, | | Change |
| 2022 | | 2021 | | Dollars | | Percent |
| Compensation and benefits | $ | 136.4 | | | $ | 128.4 | | | $ | 8.0 | | | 6 | % |
| Purchased services | 54.5 | | | 55.8 | | | (1.3) | | | (2 | %) |
| Fuel | 123.0 | | | 79.0 | | | 44.0 | | | 56 | % |
| | | | | | | |
| Equipment costs | 23.1 | | | 24.1 | | | (1.0) | | | (4 | %) |
| Depreciation and amortization | 97.7 | | | 91.2 | | | 6.5 | | | 7 | % |
| Materials and other | 85.5 | | | 81.9 | | | 3.6 | | | 4 | % |
| Merger costs | 12.5 | | | 720.8 | | | (708.3) | | | (98 | %) |
| | | | | | | |
| | | | | | | |
| Total operating expenses | $ | 532.7 | | | $ | 1,181.2 | | | $ | (648.5) | | | (55 | %) |
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months Ended | | |
| June 30, | | Change |
| 2022 | | 2021 | | Dollars | | Percent |
| Compensation and benefits | $ | 269.4 | | | $ | 257.9 | | | $ | 11.5 | | | 4 | % |
| Purchased services | 105.8 | | | 109.6 | | | (3.8) | | | (3 | %) |
| Fuel | 220.1 | | | 149.9 | | | 70.2 | | | 47 | % |
| Equipment costs | 41.7 | | | 45.2 | | | (3.5) | | | (8 | %) |
| Depreciation and amortization | 193.9 | | | 183.2 | | | 10.7 | | | 6 | % |
| Materials and other | 163.6 | | | 148.3 | | | 15.3 | | | 10 | % |
| Merger costs | 25.3 | | | 740.1 | | | (714.8) | | | (97 | %) |
| Total operating expenses | $ | 1,019.8 | | | $ | 1,634.2 | | | $ | (614.4) | | | (38 | %) |
Compensation and benefits. Compensation and benefits increased $8.0 million for the three months ended June 30, 2022, compared to the same period in 2021, due to wage and benefit inflation of approximately $5.0 million and costs relating to Mexico outsourcing reform of approximately $3.0 million.
Compensation and benefits increased $11.5 million for the six months ended June 30, 2022, compared to the same period in 2021, due to wage and benefit inflation of approximately $11.0 million, an increase in headcount and hours worked of approximately $5.0 million, and costs relating to Mexico outsourcing reform of approximately $5.0 million, partially offset by decreased incentive compensation of approximately $8.0 million and decreased costs due to COVID-19 of approximately $1.0 million.
Purchased services. Purchased services expense decreased $1.3 million for the three months ended June 30, 2022, compared to the same period in 2021, due to cost reductions of approximately $5.0 million as a result of Mexico outsourcing reform, and lower trackage rights expense of approximately $2.0 million, partially offset by an increase in repairs and maintenance of approximately $3.0 million and increased software and programming expense of approximately $2.0 million.
Purchased services expense decreased $3.8 million for the six months ended June 30, 2022 compared to the same period in 2021, due to cost reductions of approximately $11.0 million as a result of Mexico outsourcing reform, and lower corporate services of approximately $3.0 million, partially offset by an increase in software and programming expense of approximately $5.0 million and higher repairs and maintenance of approximately $2.0 million.
Fuel. Fuel increased $44.0 million for the three months ended June 30, 2022, compared to the same period in 2021, due to higher diesel fuel prices in the U.S. and Mexico of approximately $30.0 million and $11.0 million, respectively, decreased efficiency of approximately $2.0 million, and increased consumption of approximately $2.0 million. These increases were partially offset by the weakening of the Mexican peso against the U.S. dollar of approximately $1.0 million.
Fuel increased $70.2 million for the six months ended June 30, 2022, compared to the same period in 2021, due to higher diesel fuel prices in the U.S. and Mexico of approximately $48.0 million and $18.0 million, respectively, increased consumption of approximately $3.0 million, and decreased efficiency of approximately $2.0 million, partially offset by the weakening of the Mexican peso against the U.S. dollar of approximately $1.0 million. The average price per gallon was $3.70 and $3.36 for the three and six months ended June 30, 2022, respectively, compared to $2.51 and $2.38 for the same periods in 2021.
Equipment costs. Equipment costs decreased $1.0 million for the three months ended June 30, 2022, compared to the same period in 2021, due to lower lease expense.
Equipment costs decreased $3.5 million for the six months ended June 30, 2022, compared to the same period in 2021, due to lower car hire expense of approximately $3.0 million due to decreased cycle times and rate, and lower lease expense of approximately $1.0 million.
Depreciation and amortization. Depreciation and amortization expense increased $6.5 million and $10.7 million for the three and six months ended June 30, 2022, respectively, compared to the same periods in 2021, due to a larger asset base and an increase in depreciation rates on equipment as a result of an updated depreciation study.
Materials and other. Materials and other expense increased $3.6 million for the three months ended June 30, 2022 compared to the same period in 2021, due to higher employee expenses of approximately $4.0 million, increased material purchases resulting from Mexico outsourcing reform of approximately $4.0 million, increased expense of approximately $3.0 million related to the non-creditable VAT due to VAT law changes in Mexico, and increased materials and supplies expense of approximately $2.0 million. These increases were partially offset by a one-time contract dispute of approximately $9.0 million recognized in 2021.
Materials and other expense increased $15.3 million for the six months ended June 30, 2022, respectively, compared to the same period in 2021, due to increased expense of approximately $8.0 million related to the non-creditable VAT due to VAT law changes in Mexico, higher employee expenses of approximately $8.0 million, and increased material purchases resulting from Mexico outsourcing reform of approximately $7.0 million. These increases were partially offset by a one-time contract dispute of approximately $9.0 million recognized in 2021.
Merger costs. During the three and six months ended June 30, 2022, the Company recognized merger costs of $12.5 million and $25.3 million, respectively, which are primarily related to incentive compensation. During the three and six months ended June 30, 2021, the Company recognized merger costs of $720.8 million and $740.1 million, respectively, which are primarily related to the termination fee associated with the termination of the CP merger agreement by KCS of $700.0 million. See Note 2, Merger Agreement for more information.
Non-Operating Income and Expenses
Equity in net earnings of affiliates. For the three months ended June 30, 2022, equity in net earnings of affiliates decreased $4.2 million, compared to the same period in 2021, primarily due to decreased net earnings from unrealized depreciation of investments held in a fifteen percent-owned equity investment.
For the six months ended June 30, 2022, equity in net earnings of affiliates decreased $1.4 million, compared to the same period in 2021, primarily due to a decrease in net earnings from the operations of TFCM, S. de R.L de C.V. (“TCM”) due to decreased interest and tax expense in 2021, partially offset by increased net earnings from unrealized appreciation of investments held in a fifteen percent-owned equity investment.
Interest expense. For the three and six months ended June 30, 2022, interest expense increased $1.1 million and $1.0 million, respectively, compared to the same periods in 2021 due to higher average debt balances. During both the three and six months ended June 30, 2022, the average debt balance (including commercial paper) was $3,812.5 million, compared to $3,810.5 million and $3,807.5 million for the same periods in 2021. The average interest rate during both the three and six months ended June 30, 2022 was 4.1%, compared to 4.1% for the same periods in 2021.
Foreign exchange gain (loss). For the three and six months ended June 30, 2022, the Company incurred a foreign exchange loss of $4.3 million and $5.7 million, respectively, compared to a foreign exchange gain of $6.8 million and a loss of $0.5 million, for the
same periods in 2021. Foreign exchange gain (loss) includes the re-measurement and settlement of net monetary assets denominated in Mexican pesos and the gain (loss) on foreign currency derivative contracts.
For the three and six months ended June 30, 2022, the re-measurement and settlement of monetary assets and liabilities denominated in Mexican pesos resulted in a foreign exchange loss of $1.6 million and a gain of $5.1 million, respectively, compared to a gain of $8.5 million and $3.6 million for the same periods in 2021.
The Company enters into foreign currency derivative contracts to hedge its net exposure to fluctuations in foreign currency caused by fluctuations in the value of the Mexican peso against the U.S. dollar. For the three and six months ended June 30, 2022, the Company incurred a foreign exchange loss on foreign currency derivative contracts of $2.7 million and $10.8 million, respectively, compared to a loss of $1.7 million and $4.1 million, for the same periods in 2021.
Other income, net. Other income (expense), net decreased $1.8 million and $0.1 million for the three and six months ended June 30, 2022, compared to the same periods in 2021, due to a decrease in miscellaneous income.
Income tax expense. Income tax expense increased $154.2 million and $168.2 million for the three and six months ended June 30, 2022, respectively, compared to the same periods in 2021, primarily due to higher pre-tax income resulting from the recognition of the CP termination fee during the three and six months ended June 30, 2021. A discrete tax benefit of $147.0 million was recognized on the CP termination fee resulting in a tax benefit for the three and six months ended June 30, 2021.
See the discussion regarding the Company’s tax contingencies in Item 1, Financial Statements and Supplementary Data — Note 9, Commitments and Contingencies.
The components of the effective tax rates for the three and six months ended June 30, 2022, compared to the same periods in 2021, are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| June 30, | | June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Statutory rate in effect | 21.0 | % | | 21.0 | % | | 21.0 | % | | 21.0 | % |
| Tax effect of: | | | | | | | |
| Difference between U.S. and foreign tax rate | 5.7 | % | | (3.0 | %) | | 5.6 | % | | (10.6 | %) |
| | | | | | | |
| Inflation | (2.4 | %) | | 0.2 | % | | (1.9 | %) | | 0.9 | % |
| State and local income tax provision, net | 1.3 | % | | (0.7 | %) | | 1.3 | % | | (2.3 | %) |
| Foreign exchange (i) | 0.9 | % | | (0.5 | %) | | 1.0 | % | | (1.3 | %) |
| Other, net | 0.7 | % | | 0.8 | % | | 0.5 | % | | 1.6 | % |
| Effective tax rate | 27.2 | % | | 17.8 | % | | 27.5 | % | | 9.3 | % |
(i)The Company’s Mexican subsidiaries have net U.S. dollar-denominated monetary liabilities which, for Mexican income tax purposes, are subject to periodic revaluation based on changes in the value of the Mexican peso against the U.S dollar. This revaluation creates fluctuations in the Company’s Mexican income tax expense in the consolidated income statements and the amount of income taxes paid in Mexico. The Company also has net monetary assets denominated in Mexican pesos, that are subject to periodic re-measurement and settlement that creates fluctuations in foreign currency gains and losses in the consolidated income statements. The Company hedges its net exposure to variations in earnings by entering into foreign currency forward contracts. The foreign currency forward contracts involve the Company’s agreement to buy or sell pesos at an agreed-upon exchange rate on a future date. Refer to Note 6, Derivative Instruments for more information.
Mexico Regulatory and Legal Updates
Hydrocarbons Law. On May 5, 2021, new legislation pertaining to the transport and handling of hydrocarbons in Mexico became effective. This legislation addresses a wide array of issues related to the storage, transportation and handling of petroleum products, as well as the illegal import of hydrocarbons. The legislation is being challenged in the court system by a number of stakeholders and is currently subject to a court-ordered injunction, resulting in a suspension of the implementation and enforcement of this new law. To date, this law has not had a material effect on the Company or its operations. However, the Company is continuing to monitor this law and is evaluating the effect on the Company and its business operations.
Inspections Related to Imports and Terminals. During 2021, the Ministry of Infrastructure, Communications, and Transportation (“SICT”) and other relevant Mexican authorities increased inspections of imports and enforcement of various regulations and permit requirements related to terminal operations, with specific focus on imports of refined products and refined fuel transloading terminals and freight terminals, in order to prevent the illegal importation of refined fuel products. These inspections resulted in delays related to
the import of shipments into Mexico as well as the shutdown of several refined fuel terminals in the second half of 2021. The SICT has instructed KCSM to provide railway service only to those terminals that have the applicable permits. If KCSM were to fail to comply with the SICT requirements, the Company could be subject to fines and potential revocation of the Concession. As a result, KCS’s freight revenue from refined products decreased in the second half of 2021 and continued to decrease in the first half of 2022. See further discussion in the Revenues section.
Value-Added Tax Law. KCSM is not required to charge its customers value added tax (“VAT”) on international import or export transportation services, which prior to 2022 resulted in KCSM paying more VAT on its expenses than it collected from customers. These excess VAT payments are refundable by the Mexican government. Prior to 2019, Mexican companies could offset their monthly refundable VAT balance with other tax obligations. In January 2019, Mexico tax reform eliminated the ability to offset other tax obligations with refundable VAT. Over 2019 through 2021, KCSM generated a refundable VAT balance and filed refund claims with the Servicio de Administración Tributaria (the “SAT”), which have not been refunded.
In November 2021, changes to the VAT law were announced and became effective beginning January 1, 2022. These changes reduced the recoverability of VAT paid by KCSM on its expenditures that support international import transportation service revenues that are not subject to a VAT charge. VAT that is unrecoverable from the Mexican government results in incremental VAT expense for KCSM. Beginning in 2022, KCSM changed certain service offerings to either require VAT to be charged to customers on revenue, or impose a rate increase to offset the incremental VAT expense. These measures implemented by KCSM increased the VAT to be collected from customers and payable to the Mexican government.
As of June 30, 2022 and December 31, 2021, the KCSM refundable VAT balance was $119.6 million and $152.2 million, respectively. KCSM has prior favorable Mexican court decisions and a legal opinion supporting its right under Mexican law to recover the refundable VAT balance from the Mexican government and believes the VAT to be fully recoverable. KCSM will recover the refundable VAT balance as VAT billed to customers exceeds creditable VAT charged by vendors. As of June 30, 2022 and December 31, 2021, $79.0 million and $78.0 million, respectively, of the refundable VAT balance was classified as a short-term asset.
Carta Porte. In the second quarter of 2021, KCSM was notified by the SAT that shipping companies (cargo airlines, trucks, maritime, railroads, and other similar companies) must include additional bill of lading information (referred to in Mexico as “Carta Porte”) with the invoice for all merchandise shipped in Mexico, including cross-border, international and Mexico domestic shipments. The Carta Porte requirements and deadline were modified several times throughout 2021. The effective date of January 1, 2022 included a three month grace period during which penalties and fines for inaccurate information would not be imposed. In the first quarter of 2022, the grace period was extended to September 30, 2022. KCSM adapted its systems to comply with the Carta Porte requirements, which delayed KCSM’s invoicing and cash collections by approximately 60 days in the second quarter of 2022.
Failure to comply with Carta Porte requirements subsequent to the grace period could result in penalties and fines imposed by the SAT, shipping delays causing network congestion and delayed invoicing and cash collections. In addition, in the event of repeated noncompliance with Carta Porte requirements, the SAT has the power to preventively shut down operations of a company.
Liquidity and Capital Resources
Overview
The Company focuses its cash and capital resources on investing in the business, shareholder returns and optimizing its capital structure.
The Company believes, based on current expectations, that cash and other liquid assets, operating cash flows, and other available financing resources will be sufficient to fund anticipated operating expenses, capital expenditures, debt service costs, dividends, and other commitments for the foreseeable future.
During the six months ended June 30, 2022, the Company invested $219.9 million in capital expenditures. See the Capital Expenditures section for further details.
In the first quarter of 2022, pursuant to the Merger Agreement, KCS paid a cash dividend of $265.0 million, to a wholly-owned subsidiary of CP. KCS plans to make further periodic cash distributions based upon cash generated, the timing of capital expenditures and working capital needs of the Company.
The Company’s current financing instruments contain restrictive covenants that limit or preclude certain actions; however, the covenants are structured such that the Company expects to have sufficient flexibility to conduct its operations. The Company has been, and expects to continue to be, in compliance with all of its debt covenants. For additional discussion of the agreements representing the indebtedness of KCS, see Note 11, Short-Term Borrowings and Note 12, Long-Term Debt in the “Notes to the Consolidated Financial Statements” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.
KCS believes it has a strong liquidity position to continue business operations and service its debt obligations. The Company has total available liquidity of $722.5 million as of June 30, 2022, consisting of cash on hand and a revolving credit facility, compared to available liquidity at December 31, 2021 of $939.3 million.
As of June 30, 2022, the total cash and cash equivalents held outside of the U.S. in foreign subsidiaries was $22.7 million, after repatriating $42.9 million during 2022. The Company expects that this cash will be available to fund operations without incurring significant additional income taxes.
On January 1, 2022, KCSM complied with Carta Porte requirements, providing customers with additional bill of lading information with the invoice for all merchandise shipped in Mexico. KCSM adapted its systems to comply with the Carta Porte requirements, which delayed KCSM’s invoicing and cash collections by approximately 60 days in the second quarter of 2022, resulting in the accounts receivable as of June 30, 2022 to be elevated compared to historical levels. The Company believes cash collections will normalize in the second half of 2022.
Cash Flow Information
Summary cash flow data follows (in millions):
| | | | | | | | | | | |
| Six Months Ended |
| June 30, |
| 2022 | | 2021 |
| Cash flows provided by (used for): | | | |
| Operating activities | $ | 283.0 | | | $ | 507.3 | |
| Investing activities | (227.8) | | | (279.0) | |
| Financing activities | (270.0) | | | (90.3) | |
| Effect of exchange rate changes on cash | (2.0) | | | (0.4) | |
| Net increase (decrease) in cash and cash equivalents | (216.8) | | | 137.6 | |
| Cash and cash equivalents beginning of year | 339.3 | | | 188.2 | |
| Cash and cash equivalents end of period | $ | 122.5 | | | $ | 325.8 | |
Cash flows from operating activities decreased $224.3 million for the six months ended June 30, 2022, compared to the same period in 2021, primarily due to a delay in invoicing and decreased cash collections resulting from implementation of Carta Porte regulations, partially offset by lower Mexican value added tax payments.
Net cash used for investing activities decreased $51.2 million for the six months ended June 30, 2022, compared to the same period in 2021, primarily due to a decrease in capital expenditures of $53.2 million.
Net cash used for financing activities increased $179.7 million for the six months ended June 30, 2022, compared to the same period in 2021, primarily due to the cash dividend payment of $265.0 million to a wholly-owned subsidiary of CP.
Capital Expenditures
KCS has funded, and expects to continue to fund capital expenditures with operating cash flows and short and long-term debt.
The following table summarizes capital expenditures by type (in millions):
| | | | | | | | | | | |
| Six Months Ended |
| June 30, |
| 2022 | | 2021 |
| Roadway capital program | $ | 132.1 | | | $ | 116.9 | |
| Locomotives and freight cars | 24.6 | | | 44.1 | |
| Capacity | 36.0 | | | 57.1 | |
| Information technology | 24.0 | | | 19.3 | |
| Positive train control | 1.9 | | | 9.6 | |
| Other | 1.3 | | | 2.2 | |
| Total capital expenditures (accrual basis) | 219.9 | | | 249.2 | |
| Change in capital accruals | (22.6) | | | 1.3 | |
| Total cash capital expenditures | $ | 197.3 | | | $ | 250.5 | |
| | | |
| | | |
| | | |
Supplemental Guarantor Financial Information
The following is a description of the terms and conditions of the guarantees with respect to senior notes for which KCS is an issuer or provides full and unconditional guarantee.
Note Guarantees
As of June 30, 2022, KCS had outstanding $3,736.2 million principal amount of senior notes due through 2069. KCSR had outstanding $2.7 million principal amount of senior notes due through 2045 (together, the “Senior Notes”). The senior notes for which KCS is the issuer are unconditionally guaranteed, jointly and severally, on an unsecured senior basis, by each of KCS’s current and future domestic consolidated subsidiaries that from time to time guarantees certain of KCS’s credit agreements, or any other debt of KCS, or any of KCS’s significant subsidiaries that is a guarantor (each, a “Guarantor Subsidiary,” and collectively, the “Guarantor Subsidiaries”). In addition, the senior notes for which KCSR is the issuer are unconditionally guaranteed, jointly and severally, on an unsecured senior basis, by KCS and each of its current and future domestic consolidated subsidiaries that from time to time guarantees KCSR’s credit agreement, or any other debt of KCSR or any of KCSR’s significant subsidiaries that is a Guarantor Subsidiary. The obligations of each Guarantor Subsidiary under its note guarantee are limited as necessary to prevent such note guarantee from constituting a fraudulent conveyance under applicable law. A guarantee of the Senior Notes by KCS or a Guarantor Subsidiary is subject to release in the following circumstances: (i) the sale, disposition, exchange or other transfer (including through merger, consolidation, amalgamation or otherwise) of the capital stock of the Guarantor Subsidiary made in a manner not in violation of the indenture; (ii) the designation of the subsidiary as an “Unrestricted Subsidiary” under the indenture; (iii) the legal defeasance or covenant defeasance of the Senior Notes in accordance with the terms of the indenture; or (iv) the Guarantor Subsidiary ceasing to be KCS’s subsidiary as a result of any foreclosure of any pledge or security interest securing KCS’s Revolving Credit Facility or other exercise of remedies in respect thereof.
KCSM and any other foreign subsidiaries of KCS do not and will not guarantee the Senior Notes (“Non-Guarantor Subsidiaries”).
The following tables present summarized financial information for KCS and the Guarantor Subsidiaries on a combined basis after intercompany transactions have been eliminated, including adjustments to remove the receivable and payable balances, investment in, and equity in earnings from the Non-Guarantor Subsidiaries.
Summarized Financial Information
| | | | | | | | | | | |
| Income Statements | KCS and Guarantor Subsidiaries |
| Six Months Ended | | Twelve Months Ended |
| June 30, 2022 | | December 31, 2021 |
| Revenues | $ | 865.2 | | | $ | 1,561.3 | |
| Operating expenses | 555.2 | | | 1,200.8 | |
| Operating income | 310.0 | | | 360.5 | |
| Income before income taxes | 237.0 | | | 207.7 | |
| Net income | 189.1 | | | 182.7 | |
| | | | | | | | | | | |
| Balance Sheets | KCS and Guarantor Subsidiaries |
| June 30, 2022 | | December 31, 2021 |
| Assets: | | | |
| Current assets | $ | 561.2 | | | $ | 524.6 | |
| Property and equipment (including concession assets), net | 4,888.4 | | | 4,876.5 | |
| Other non-current assets | 63.6 | | | 125.8 | |
| | | |
| Liabilities and equity: | | | |
| Current liabilities | $ | 802.5 | | | $ | 316.5 | |
| Non-current liabilities | 4,504.2 | | | 4,942.7 | |
| Noncontrolling interest | 330.0 | | | 328.2 | |
Excluded from current assets in the table above are $278.5 million and $199.8 million of current intercompany receivables due to KCS and the Guarantor Subsidiaries from the Non-Guarantor Subsidiaries as of June 30, 2022 and December 31, 2021, respectively. Excluded from current liabilities in the table above are $206.4 million and $267.5 million of current intercompany payables due to the Non-Guarantor Subsidiaries from KCS and the Guarantor Subsidiaries as of June 30, 2022 and December 31, 2021, respectively.
The Senior Notes are structurally subordinated to the indebtedness and other liabilities of the Non-Guarantor Subsidiaries. The Non-Guarantor Subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the Senior Notes or the indentures, or to make any funds available therefor, whether by dividends, loans, distributions or other payments. Any right that KCS or the Guarantor Subsidiaries have to receive any assets of any of the Non-Guarantor Subsidiaries upon the liquidation or reorganization of any Non-Guarantor Subsidiary, and the consequent rights of holders of Senior Notes to realize proceeds from the sale of any of a Non-Guarantor Subsidiary’s assets, would be effectively subordinated to the claims of such Non-Guarantor Subsidiary’s creditors, including trade creditors and holders of preferred equity interests, if any, of such Non-Guarantor Subsidiary. Accordingly, in the event of a bankruptcy, liquidation or reorganization of any of the Non-Guarantor Subsidiaries, the Non-Guarantor Subsidiaries will pay the holders of their debts, holders of preferred equity interests, if any, and their trade creditors before they will be able to distribute any of their assets to KCS or any Guarantor Subsidiary.
If a Guarantor Subsidiary were to become a debtor in a case under the U.S. Bankruptcy Code or encounter other financial difficulty, under federal or state fraudulent transfer or conveyance law, a court may avoid, subordinate or otherwise decline to enforce its guarantee of the Senior Notes. A court might do so if it is found that when such Guarantor Subsidiary entered into its guarantee of the Senior Notes, or in some states when payments became due under the Senior Notes, such Guarantor Subsidiary received less than reasonably equivalent value or fair consideration and either:
• was insolvent or rendered insolvent by reason of such incurrence;
• was left with unreasonably small or otherwise inadequate capital to conduct its business; or
• believed or reasonably should have believed that it would incur debts beyond its ability to pay.
The court might also avoid the guarantee of the Senior Notes without regard to the above factors, if the court found that a Guarantor Subsidiary entered into its guarantee with actual intent to hinder, delay or defraud its creditors.
A court would likely find that a Guarantor Subsidiary did not receive reasonably equivalent value or fair consideration for its guarantee of the Senior Notes, if such Guarantor Subsidiary did not substantially benefit directly or indirectly from the funding made available by the issuance of the Senior Notes. If a court were to avoid a guarantee of the Senior Notes provided by a Guarantor Subsidiary, holders of the Senior Notes would no longer have any claim against such Guarantor Subsidiary. The measures of insolvency for purposes of these fraudulent transfer or conveyance laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer or conveyance has occurred, such that the Company cannot predict what standards a court would use to determine whether or not a Guarantor Subsidiary was solvent at the relevant time or, regardless of the standard that a court uses, that the guarantee of a Guarantor Subsidiary would not be subordinated to such Guarantor Subsidiary’s other debt. As noted above, each guarantee provided by a Guarantor Subsidiary includes a provision intended to limit the Guarantor Subsidiary’s liability to the maximum amount that it could incur without causing the incurrence of obligations under its guarantee to be a fraudulent transfer or conveyance. This provision may not be effective to protect those guarantees from being avoided under fraudulent transfer or conveyance law, or it may reduce that Guarantor Subsidiary’s obligation to an amount that effectively makes its guarantee worthless, and the Company cannot predict whether a court will ultimately find it to be effective.
On the basis of historical financial information, operating history and other factors, the Company believes that each of the Guarantor Subsidiaries, after giving effect to the issuance of its guarantee of the Senior Notes when such guarantee was issued, was not insolvent, did not have unreasonably small capital for the business in which it engaged and did not and has not incurred debts beyond its ability to pay such debts as they mature. The Company cannot predict, however, as to what standard a court would apply in making these determinations or that a court would agree with the Company’s conclusions in this regard.
Other Matters
Collective Bargaining
KCSR participates in industry-wide multi-employer bargaining as a member of the National Carriers’ Conference Committee (“NCCC”), as well as local bargaining for agreements that are limited to KCSR's property. Approximately 71% of KCSR employees are covered by collective bargaining agreements. Long-term agreements were reached voluntarily or through the arbitration process during 2017 and 2018 covering all of the participating unions. The terms of these agreements will remain in effect until new agreements are reached in the current national bargaining round. In November 2019, KCSR and its unions commenced negotiations in connection with the 2020 bargaining round.
On July 15, 2022, President Biden signed an executive order creating a Presidential Emergency Board (“PEB”) to assist the railroads and its unions in ongoing national labor negotiations. The PEB will review the parties’ proposals, hold hearings and has thirty days to issue non-binding settlement recommendations to the President. The parties will have until September 18, 2022 to reach a voluntary settlement based on those recommendations.
KCSM union employees are covered by one labor agreement, which was signed on April 16, 2012, between KCSM Servicios, a previously wholly-owned subsidiary of KCS that was merged into KCSM in 2021, and the Sindicato de Trabajadores Ferrocarrileros de la República Mexicana (“Mexican Railroad Union”). This labor agreement remains in effect during the period of the Concession for the purpose of regulating the relationship between the parties. Approximately 77% of KCSM employees are covered by this labor agreement. The compensation terms under this labor agreement are subject to renegotiation on an annual basis and all other benefits are subject to negotiation every two years. The parties finalized negotiations over compensation terms and benefits that applied until June 30, 2021, along with other terms, and will remain in effect until new terms have been negotiated.
Union labor negotiations have not historically resulted in any strike, boycott, or other disruption in the Company’s business operations.
