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ksu:restructuring_plans ksu:Segments ksu:agreements

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2020
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to        
Commission File Number 1-4717
KANSAS CITY SOUTHERN
(Exact name of registrant as specified in its charter)
Delaware
 
KCSLINESLOGO2016A19.JPG
 
44-0663509
(State or other jurisdiction of
incorporation or organization)
 
 
(I.R.S. Employer
Identification No.)
427 West 12th Street
 
 
 
Kansas City
,
Missouri
 
 
64105
(Address of principal executive offices)
 
 
(Zip Code)
816.983.1303
(Registrant’s telephone number, including area code)
No Change
(Former name, former address and former fiscal year, if changed since last report.)
____________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Preferred Stock, Par Value $25 Per Share, 4%, Noncumulative
KSU
New York Stock Exchange
Common Stock, $.01 Per Share Par Value
KSU
New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ý    No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer  ý  Accelerated filer   Non-accelerated filer  Smaller reporting company  
Emerging growth company  
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes       No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
July 10, 2020
Common Stock, $0.01 per share par value
 
94,349,268 Shares
 



Kansas City Southern and Subsidiaries
Form 10-Q
June 30, 2020
Index
 
 
Page
PART I — FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II — OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 


2


PART I — FINANCIAL INFORMATION

Item 1.
Financial Statements (unaudited)

Kansas City Southern and Subsidiaries
Consolidated Statements of Income
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2020
 
2019
 
2020
 
2019
 
(In millions, except share and per share amounts)
(Unaudited)
Revenues
$
547.9

 
$
714.0

 
$
1,279.6

 
$
1,388.8

Operating expenses:
 
 
 
 
 
 
 
Compensation and benefits
103.8

 
128.3

 
237.2

 
257.2

Purchased services
44.6

 
56.7

 
97.9

 
109.5

Fuel
39.5

 
87.7

 
114.4

 
170.7

Equipment costs
18.1

 
26.3

 
40.0

 
56.7

Depreciation and amortization
89.3

 
87.7

 
178.7

 
176.2

Materials and other
61.7

 
68.3

 
125.7

 
131.7

Restructuring charges
10.5

 
51.0

 
16.5

 
118.5

Total operating expenses
367.5

 
506.0

 
810.4

 
1,020.5

Operating income
180.4

 
208.0

 
469.2

 
368.3

Equity in net earnings (losses) of affiliates
0.2

 
(0.2
)
 
1.2

 
1.5

Interest expense
(38.1
)
 
(28.0
)
 
(72.3
)
 
(56.2
)
Debt retirement costs

 

 

 
(0.6
)
Foreign exchange gain (loss)
7.8

 
8.3

 
(51.7
)
 
12.9

Other income, net
0.8

 
0.1

 
2.2

 
0.2

Income before income taxes
151.1

 
188.2

 
348.6

 
326.1

Income tax expense
40.8

 
59.1

 
86.0

 
93.8

Net income
110.3

 
129.1

 
262.6

 
232.3

Less: Net income attributable to noncontrolling interest
0.6

 
0.4

 
1.1

 
0.8

Net income attributable to Kansas City Southern and subsidiaries
109.7

 
128.7

 
261.5

 
231.5

Preferred stock dividends

 

 
0.1

 
0.1

Net income available to common stockholders
$
109.7

 
$
128.7

 
$
261.4

 
$
231.4

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic earnings per share
$
1.16

 
$
1.29

 
$
2.75

 
$
2.31

Diluted earnings per share
$
1.16

 
$
1.28

 
$
2.74

 
$
2.30

 
 
 
 
 
 
 
 
Average shares outstanding (in thousands):
 
 
 
 
 
 
 
Basic
94,476

 
100,028

 
95,070

 
100,264

Potentially dilutive common shares
417

 
394

 
464

 
405

Diluted
94,893

 
100,422

 
95,534

 
100,669

See accompanying notes to the unaudited consolidated financial statements.


3


Kansas City Southern and Subsidiaries
Consolidated Statements of Comprehensive Income

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2020
 
2019
 
2020
 
2019
 
(In millions)
(Unaudited)
Net income
$
110.3

 
$
129.1

 
$
262.6

 
$
232.3

Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized gain (loss) on interest rate derivative instruments, net of tax of $1.5 million, $(2.4) million, $2.7 million and $(4.1) million, respectively
5.3

 
(7.6
)
 
10.1

 
(12.7
)
Reclassification adjustment from cash flow hedges included in net income, net of tax of $0.2 million and $0.3 million, respectively
0.4

 

 
0.9

 

Foreign currency translation adjustments
0.2

 
0.1

 
(1.5
)
 
0.3

Other comprehensive income (loss)
5.9

 
(7.5
)
 
9.5

 
(12.4
)
Comprehensive income
116.2

 
121.6

 
272.1

 
219.9

Less: Comprehensive income attributable to noncontrolling interest
0.6

 
0.4

 
1.1

 
0.8

Comprehensive income attributable to Kansas City Southern and subsidiaries
$
115.6

 
$
121.2

 
$
271.0

 
$
219.1

See accompanying notes to the unaudited consolidated financial statements.


4


Kansas City Southern and Subsidiaries
Consolidated Balance Sheets
 
 
June 30,
2020
 
December 31,
2019
 
(In millions, except share and per share amounts)
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
620.1

 
$
148.8

Accounts receivable, net
222.8

 
274.2

Materials and supplies
131.2

 
150.6

Other current assets
142.1

 
155.0

Total current assets
1,116.2

 
728.6

Operating lease right-of-use assets
80.8

 
158.4

Investments
44.0

 
47.6

Property and equipment (including concession assets), net
8,947.4

 
8,806.3

Other assets
99.7

 
45.9

Total assets
$
10,288.1

 
$
9,786.8

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Long-term debt due within one year
$
16.3

 
$
18.0

Accounts payable and accrued liabilities
440.6

 
473.3

Total current liabilities
456.9

 
491.3

Long-term operating lease liabilities
53.3

 
85.7

Long-term debt
3,765.4

 
3,228.0

Deferred income taxes
1,165.2

 
1,128.0

Other noncurrent liabilities and deferred credits
102.3

 
107.9

Total liabilities
5,543.1

 
5,040.9

Stockholders’ equity:
 
 
 
$25 par, 4% noncumulative, preferred stock, 840,000 shares authorized, 649,736 shares issued; 222,130 and 222,625 shares outstanding at June 30, 2020 and December 31, 2019, respectively
5.6

 
5.6

$.01 par, common stock, 400,000,000 shares authorized; 123,352,185 shares issued; 94,327,807 and 96,115,669 shares outstanding at June 30, 2020 and December 31, 2019, respectively
1.0

 
1.0

Additional paid-in capital
922.8

 
843.7

Retained earnings
3,510.7

 
3,601.3

Accumulated other comprehensive loss
(19.6
)
 
(29.1
)
Total stockholders’ equity
4,420.5

 
4,422.5

Noncontrolling interest
324.5

 
323.4

Total equity
4,745.0

 
4,745.9

Total liabilities and equity
$
10,288.1

 
$
9,786.8

See accompanying notes to the unaudited consolidated financial statements.


5


Kansas City Southern and Subsidiaries
Consolidated Statements of Cash Flows

 
Six Months Ended
 
June 30,
 
2020
 
2019
 
(In millions)
(Unaudited)
Operating activities:
 
 
 
Net income
$
262.6

 
$
232.3

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
178.7

 
176.2

Deferred income taxes
34.3

 
12.2

Equity in net earnings of affiliates
(1.2
)
 
(1.5
)
Share-based compensation
13.5

 
12.0

Distributions from affiliates
2.5

 
3.0

Settlement of foreign currency derivative instruments
(29.0
)
 
4.8

(Gain) loss on foreign currency derivative instruments
27.3

 
(10.9
)
Foreign exchange (gain) loss
24.4

 
(2.0
)
Restructuring charges
16.5

 
118.5

Cash payments for restructuring charges
(3.2
)
 
(1.4
)
Changes in working capital items:
 
 
 
Accounts receivable
44.1

 
16.0

Materials and supplies
19.3

 
4.5

Other current assets
(47.1
)
 
(15.0
)
Accounts payable and accrued liabilities
(16.2
)
 
(6.4
)
Other, net
(1.0
)
 
(1.1
)
Net cash provided by operating activities
525.5

 
541.2

 
 
 
 
Investing activities:
 
 
 
Capital expenditures
(194.7
)
 
(350.4
)
Purchase or replacement of assets under operating leases
(78.2
)
 
(0.9
)
Property investments in MSLLC
(20.0
)
 
(22.3
)
Investments in and advances to affiliates
(4.9
)
 
(15.3
)
Proceeds from disposal of property
8.0

 
12.3

Other, net
(9.4
)
 
2.5

Net cash used for investing activities
(299.2
)
 
(374.1
)
 
 
 
 
Financing activities:
 
 
 
Proceeds from issuance of long-term debt
545.6

 

Repayment of long-term debt
(4.8
)
 
(5.5
)
Dividends paid
(76.9
)
 
(72.6
)
Shares repurchased
(211.7
)
 
(142.7
)
Debt issuance costs paid
(6.6
)
 
(2.5
)
Proceeds from employee stock plans
4.5

 
3.3

Net cash provided by (used for) financing activities
250.1

 
(220.0
)
 
 
 
 
Effect of exchange rate changes on cash
(5.1
)
 

 
 
 
 
Cash and cash equivalents:
 
 
 
Net increase (decrease) during each period
471.3

 
(52.9
)
At beginning of year
148.8

 
100.5

At end of period
$
620.1

 
$
47.6

See accompanying notes to the unaudited consolidated financial statements.

6


Kansas City Southern and Subsidiaries
Consolidated Statements of Changes in Equity
(in millions, except per share amounts)
(Unaudited)
 
 
$25 Par
Preferred
Stock
 
$.01 Par
Common
Stock
 
Additional Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Non-
controlling
Interest
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
$
5.7

 
$
1.0

 
$
946.6

 
$
3,870.6

 
$
(10.9
)
 
$
319.7

 
$
5,132.7

Net income
 
 
 
 
 
 
102.8

 
 
 
0.4

 
103.2

Other comprehensive loss
 
 
 
 
 
 
 
 
(4.9
)
 
 
 
(4.9
)
Contribution from noncontrolling interest
 
 
 
 
 
 
 
 
 
 
1.8

 
1.8

Dividends on common stock ($0.36/share)
 
 
 
 

 
(36.3
)
 
 
 
 
 
(36.3
)
Dividends on $25 par preferred stock ($0.25/share)
 
 
 
 
 
 
(0.1
)
 
 
 
 
 
(0.1
)
Share repurchases

 

 
(4.4
)
 
(45.9
)
 
 
 
 
 
(50.3
)
Options exercised and stock subscribed, net of shares withheld for employee taxes
 
 

 
(2.1
)
 
 
 
 
 
 
 
(2.1
)
Share-based compensation
 
 
 
 
6.0

 
 
 
 
 
 
 
6.0

Balance at March 31, 2019
5.7

 
1.0

 
946.1

 
3,891.1

 
(15.8
)
 
321.9

 
5,150.0

Net income
 
 
 
 
 
 
128.7

 
 
 
0.4

 
129.1

Other comprehensive loss
 
 
 
 
 
 
 
 
(7.5
)
 
 
 
(7.5
)
Dividends on common stock ($0.36/share)
 
 
 
 

 
(36.0
)
 
 
 
 
 
(36.0
)
Dividends on $25 par preferred stock ($0.25/share)
 
 
 
 
 
 

 
 
 
 
 

Share repurchases
(0.1
)
 

 
(7.3
)
 
(85.0
)
 
 
 
 
 
(92.4
)
Options exercised and stock subscribed, net of shares withheld for employee taxes
 
 

 
2.3

 
 
 
 
 
 
 
2.3

Share-based compensation
 
 
 
 
6.0

 
 
 
 
 
 
 
6.0

Balance at June 30, 2019
5.6

 
1.0

 
947.1

 
3,898.8

 
(23.3
)
 
322.3

 
5,151.5

Net income
 
 
 
 
 
 
180.2

 
 
 
0.4

 
180.6

Other comprehensive loss
 
 
 
 
 
 
 
 
(7.3
)
 
 
 
(7.3
)
Dividends on common stock ($0.36/share)
 
 
 
 

 
(35.6
)
 
 
 
 
 
(35.6
)
Dividends on $25 par preferred stock ($0.25/share)
 
 
 
 
 
 
(0.1
)
 
 
 
 
 
(0.1
)
Share repurchases

 

 
(7.7
)
 
(92.1
)
 
 
 
 
 
(99.8
)
Options exercised and stock subscribed, net of shares withheld for employee taxes
 
 

 
2.7

 
 
 
 
 
 
 
2.7

Share-based compensation
 
 
 
 
5.2

 
 
 
 
 
 
 
5.2

Balance at September 30, 2019
5.6

 
1.0

 
947.3

 
3,951.2

 
(30.6
)
 
322.7

 
5,197.2

Net income
 
 
 
 
 
 
127.2

 
 
 
0.7

 
127.9

Other comprehensive income
 
 
 
 
 
 
 
 
1.5

 
 
 
1.5

Dividends on common stock ($0.40/share)
 
 
 
 

 
(38.6
)
 
 
 
 
 
(38.6
)
Dividends on $25 par preferred stock ($0.25/share)
 
 
 
 
 
 

 
 
 
 
 

Share repurchases

 

 
(29.0
)
 
(438.5
)
 
 
 
 
 
(467.5
)
Forward contract for accelerated share repurchases
 
 
 
 
(82.5
)
 
 
 
 
 
 
 
(82.5
)
Options exercised and stock subscribed, net of shares withheld for employee taxes
 
 

 
1.2

 
 
 
 
 
 
 
1.2

Share-based compensation
 
 
 
 
6.7

 
 
 
 
 
 
 
6.7

Balance at December 31, 2019
5.6

 
1.0

 
843.7

 
3,601.3

 
(29.1
)
 
323.4

 
4,745.9

Net income
 
 
 
 
 
 
151.8

 
 
 
0.5

 
152.3

Other comprehensive income
 
 
 
 
 
 
 
 
3.6

 
 
 
3.6

Dividends on common stock ($0.40/share)
 
 
 
 

 
(38.2
)
 
 
 
 
 
(38.2
)
Dividends on $25 par preferred stock ($0.25/share)
 
 
 
 
 
 
(0.1
)
 
 
 
 
 
(0.1
)
Share repurchases
 
 

 
(11.4
)
 
(182.8
)
 
 
 
 
 
(194.2
)
Settlement of forward contract for accelerated share repurchases
 
 
 
 
82.5

 
 
 
 
 
 
 
82.5

Options exercised and stock subscribed, net of shares withheld for employee taxes
 
 

 
(0.1
)
 
 
 
 
 
 
 
(0.1
)
Share-based compensation
 
 
 
 
10.3

 
 
 
 
 
 
 
10.3

Balance at March 31, 2020
$
5.6

 
$
1.0

 
$
925.0

 
$
3,532.0

 
$
(25.5
)
 
$
323.9

 
$
4,762.0

Net income
 
 
 
 
 
 
109.7

 
 
 
0.6

 
110.3

Other comprehensive income
 
 
 
 
 
 
 
 
5.9

 
 
 
5.9

Dividends on common stock ($0.40/share)
 
 
 
 

 
(37.8
)
 
 
 
 
 
(37.8
)
Dividends on $25 par preferred stock ($0.25/share)
 
 
 
 
 
 

 
 
 
 
 

Share repurchases

 

 
(6.8
)
 
(93.2
)
 
 
 
 
 
(100.0
)
Options exercised and stock subscribed, net of shares withheld for employee taxes
 
 

 
(0.3
)
 
 
 
 
 
 
 
(0.3
)
Share-based compensation
 
 
 
 
4.9

 
 
 
 
 
 
 
4.9

Balance at June 30, 2020
$
5.6

 
$
1.0

 
$
922.8

 
$
3,510.7

 
$
(19.6
)
 
$
324.5

 
$
4,745.0


See accompanying notes to the unaudited consolidated financial statements.

7


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements
For purposes of this report, “KCS” or the “Company” may refer to Kansas City Southern or, as the context requires, to one or more subsidiaries of Kansas City Southern.

1. Basis of Presentation
In the opinion of the management of KCS, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal and recurring adjustments) necessary to reflect a fair statement of the results for interim periods in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). Pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. The results of operations for the three and six months ended June 30, 2020, are not necessarily indicative of the results to be expected for the full year ending December 31, 2020. Certain prior year amounts have been reclassified to conform to the current year presentation.
During the first quarter of 2020, the Company adopted Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments - Credit Losses,” which required the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaced the existing incurred loss model and is applicable to the measurement of credit losses on financial assets, including trade receivables. Adoption of the new standard did not have a material impact on the Company’s consolidated financial statements.
During the first quarter of 2020, the Company early adopted the SEC’s, Financial Disclosures About Guarantors and Issuers of Guaranteed Securities and Affiliates Whose Securities Collateralize a Registrant’s Securities rules, which simplify the disclosure requirements related to the Company’s registered securities under Rule 3-10 of Regulation S-X. The final rule also allows for the simplified disclosure to be included within Management’s Discussion and Analysis of Financial Condition and Results of Operations.

2. Restructuring Charges
COVID-19. In March 2020, the World Health Organization categorized Coronavirus Disease 2019 (“COVID-19”) as a pandemic, and the President of the United States declared the COVID-19 outbreak a national emergency. The U.S. and Mexico governments have deemed rail transportation as “critical infrastructure” providing essential services during this global emergency. As a provider of critical infrastructure, Kansas City Southern has an obligation to keep employees working and freight moving. KCS remains focused on protecting the health and wellbeing of its employees and the communities in which it operates while assuring the continuity of its business operations.
On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) which includes modifications to the limitation on business interest expense and net operating loss provisions, and provides a payment delay of employer payroll taxes during 2020 after the date of enactment. The Company estimates the payment of approximately $11.0 million of employer payroll taxes otherwise due in 2020 will be delayed with 50% due by December 31, 2021 and the remaining 50% by December 31, 2022. The CARES Act did not have a material impact on the Company’s consolidated financial statements.
The Company began to experience the impacts of COVID-19 on customer demand in late March 2020. Revenues for the three months ended June 30, 2020 decreased by 23% as compared to the same period in 2019, primarily due to an overall decline in demand due to COVID-19. As revenues declined, the Company responded quickly and implemented cost-saving measures and accelerated precision scheduled railroading (“PSR”) initiatives by further consolidating trains, which increased train length and reduced crew costs. In June of 2020, the Company offered a voluntary separation program, which resulted in a restructuring charge of $9.2 million for the three months ended June 30, 2020, consisting of severance and benefit costs that will be paid out in either lump-sum payments or over a six to twelve-month period. Approximately 6% of management employees were irrevocably accepted into the voluntary separation program.
PSR. During 2019, the Company began implementing principles of PSR, which focus on providing reliable customer service, facilitating growth, improving asset utilization, and improving the cost profile of the Company. As a result of the PSR initiatives in 2019, management approved four separate restructuring plans that totaled $168.8 million, including restructuring plans of $67.5 million and $51.0 million in the first and second quarters of 2019, respectively. The restructuring plans were substantially completed in 2019.
During the first quarter of 2020, the Company purchased 91 locomotives for $78.2 million that were part of two existing leases. Of the 91 locomotives, 13 were impaired during the fourth quarter of 2019. The purchase of the impaired lease locomotives resulted in $6.0 million of make-whole payments recorded as incremental restructuring charges in the first quarter of 2020. During the second

8


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)

quarter of 2020, the Company recognized approximately $1.3 million of restructuring charges from the disposal of held for sale equipment.
    
3. Revenue
Disaggregation of Revenue
The following table presents revenues disaggregated by the major commodity groups as well as the product types included within the major commodity groups (in millions). The Company believes disaggregation by product type best depicts how cash flows are affected by economic factors. See Note 12 for revenues by geographical area.
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2020
 
2019
 
2020
 
2019
Chemical & Petroleum
 
 
 
 
 
 
 
Chemicals
$
52.2

 
$
61.6

 
$
114.7

 
$
122.1

Petroleum
70.6

 
90.0

 
166.4

 
164.3

Plastics
35.7

 
36.7

 
76.0

 
70.5

Total
158.5

 
188.3

 
357.1

 
356.9

 
 
 
 
 
 
 
 
Industrial & Consumer Products
 
 
 
 
 
 
 
Forest Products
57.8

 
63.2

 
126.7

 
129.6

Metals & Scrap
40.4

 
59.9

 
102.7

 
116.9

Other
22.4

 
27.2

 
50.2

 
53.6

Total
120.6

 
150.3

 
279.6

 
300.1

 
 
 
 
 
 
 
 
Agriculture & Minerals
 
 
 
 
 
 
 
Grain
64.1

 
73.2

 
141.9

 
145.9

Food Products
39.0

 
34.7

 
81.7

 
70.4

Ores & Minerals
5.3

 
5.8

 
11.1

 
12.3

Stone, Clay & Glass
6.0

 
8.7

 
14.2

 
16.7

Total
114.4

 
122.4

 
248.9

 
245.3

 
 
 
 
 
 
 
 
Energy
 
 
 
 
 
 
 
Utility Coal
23.2

 
27.5

 
46.8

 
60.0

Coal & Petroleum Coke
9.5

 
10.1

 
21.1

 
20.6

Frac Sand
1.7

 
6.7

 
5.5

 
14.7

Crude Oil
4.9

 
9.6

 
22.2

 
23.2

Total
39.3

 
53.9

 
95.6

 
118.5

 
 
 
 
 
 
 
 
Intermodal
63.5

 
92.6

 
152.2

 
172.5

 
 
 
 
 
 
 
 
Automotive
15.6

 
70.9

 
69.5

 
128.5

 
 
 
 
 
 
 
 
Total Freight Revenues
511.9

 
678.4

 
1,202.9

 
1,321.8

 
 
 
 
 
 
 
 
Other Revenue
36.0

 
35.6

 
76.7

 
67.0

 
 
 
 
 
 
 
 
Total Revenues
$
547.9

 
$
714.0

 
$
1,279.6

 
$
1,388.8


Contract Balances
The amount of revenue recognized in the second quarter of 2020 from performance obligations partially satisfied in previous periods was $18.2 million. The performance obligations that were unsatisfied or partially satisfied as of June 30, 2020, were $17.7 million, which represents in-transit shipments that are fully satisfied the following month.
A receivable is any unconditional right to consideration, and is recognized as shipments have been completed and the relating performance obligation has been fully satisfied. At June 30, 2020 and December 31, 2019, the accounts receivable, net balance was $222.8 million and $274.2 million, respectively. Contract assets represent a conditional right to consideration in exchange for goods or services. The Company did not have any contract assets at June 30, 2020 and December 31, 2019.

9


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)

Contract liabilities represent consideration received in advance from customers, and are recognized as revenue over time as the relating performance obligation is satisfied. The amount of revenue recognized in the second quarter of 2020 that was included in the opening contract liability balance was $7.8 million. The Company has recognized contract liabilities within the accounts payable and accrued liabilities financial statement caption on the balance sheet. These are considered current liabilities as they will be settled in less than 12 months.
The following tables summarize the changes in contract liabilities (in millions):
Contract liabilities
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2020
 
2019
 
2020
 
2019
Beginning balance
 
$
21.1

 
$
22.3

 
$
30.5

 
$
32.4

Revenue recognized that was included in the contract liability balance at the beginning of the period
 
(7.8
)
 
(10.1
)
 
(17.9
)
 
(24.2
)
Increases due to consideration received, excluding amounts recognized as revenue during the period
 
2.8

 
6.8

 
3.5

 
10.8

Ending balance
 
$
16.1

 
$
19.0

 
$
16.1

 
$
19.0



4. Earnings Per Share Data
Basic earnings per common share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share adjusts basic earnings per common share for the effects of potentially dilutive common shares, if the effect is not anti-dilutive. Potentially dilutive common shares include the dilutive effects of shares issuable under the stock option and performance award plans.
The following table reconciles the basic earnings per share computation to the diluted earnings per share computation (in millions, except share and per share amounts):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2020
 
2019
 
2020
 
2019
Net income available to common stockholders for purposes of computing basic and diluted earnings per share
$
109.7

 
$
128.7

 
$
261.4

 
$
231.4

Weighted-average number of shares outstanding (in thousands):
 
 
 
 
 
 
 
Basic shares
94,476

 
100,028

 
95,070

 
100,264

Effect of dilution
417

 
394

 
464

 
405

Diluted shares
94,893

 
100,422

 
95,534

 
100,669

Earnings per share:
 
 
 
 
 
 
 
Basic earnings per share
$
1.16

 
$
1.29

 
$
2.75

 
$
2.31

Diluted earnings per share
$
1.16

 
$
1.28

 
$
2.74

 
$
2.30



Potentially dilutive shares excluded from the calculation (in thousands):
Stock options excluded as their inclusion would be anti-dilutive
72

 
134

 
72

 
212




10


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)

5. Property and Equipment (including Concession Assets)
Property and equipment, including concession assets, and related accumulated depreciation and amortization are summarized below (in millions):
 
June 30,
2020
 
December 31,
2019
Land
$
225.6

 
$
224.9

Concession land rights
141.1

 
141.1

Road property
7,997.6

 
7,962.1

Equipment
2,757.5

 
2,652.6

Technology and other
352.2

 
345.1

Construction in progress
228.5

 
170.2

Total property
11,702.5

 
11,496.0

Accumulated depreciation and amortization
2,755.1

 
2,689.7

Property and equipment (including concession assets), net
$
8,947.4

 
$
8,806.3


Concession assets, net of accumulated amortization of $671.6 million and $678.1 million, totaled $2,355.1 million and $2,335.5 million at June 30, 2020 and December 31, 2019, respectively.

6. Fair Value Measurements
The Company’s derivative financial instruments are measured at fair value on a recurring basis and consist of foreign currency forward and option contracts and treasury lock agreements, which are classified as Level 2 valuations. The Company determines the fair value of its derivative financial instrument positions based upon pricing models using inputs observed from actively quoted markets and also takes into consideration the contract terms as well as other inputs, including market currency exchange rates and in the case of option contracts, volatility, the risk-free interest rate and the time to expiration.
The Company’s short-term financial instruments include cash and cash equivalents, accounts receivable, accounts payable and short-term borrowings. The carrying value of the short-term financial instruments approximates their fair value.
The fair value of the Company’s debt is estimated using quoted market prices when available. When quoted market prices are not available, fair value is estimated based on current market interest rates for debt with similar maturities and credit quality. The carrying value of the Company’s debt was $3,781.7 million and $3,246.0 million at June 30, 2020 and December 31, 2019, respectively. If the Company’s debt were measured at fair value, the fair value measurements of the individual debt instruments would have been classified as Level 2 in the fair value hierarchy.

The fair value of the Company’s financial instruments is presented in the following table (in millions):
 
 
June 30, 2020
 
December 31, 2019
 
 
Level 2
 
Level 2
Assets
 
 
 
 
Foreign currency derivative instruments
 
$
4.2

 
$
2.5

Treasury lock agreements
 
12.8

 

Liabilities
 
 
 
 
Debt instruments
 
4,356.7

 
3,535.7



7. Derivative Instruments
The Company enters into derivative transactions in certain situations based on management’s assessment of current market conditions and perceived risks. Management intends to respond to evolving business and market conditions and in doing so, may enter into such transactions as deemed appropriate.
Credit Risk. As a result of the use of derivative instruments, the Company is exposed to counterparty credit risk. The Company manages this risk by limiting its counterparties to large financial institutions which meet the Company’s credit rating standards and

11


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)

have an established banking relationship with the Company. As of June 30, 2020, the Company did not expect any losses as a result of default of its counterparties.
Interest Rate Derivative Instruments. In March 2020, the Company executed three 30-year treasury lock agreements with an aggregate notional value of $400.0 million and a weighted average interest rate of 1.45%. The purpose of the treasury locks is to hedge the U.S. Treasury benchmark interest rate associated with future interest payments related to the anticipated refinancing of the $444.7 million, 3.00% senior notes due May 15, 2023 (the “3.00% Senior Notes”). The Company has designated the treasury locks as cash flow hedges and recorded unrealized gains and losses in accumulated other comprehensive loss. Upon settlement, the unrealized gain or loss in accumulated other comprehensive income will be amortized to interest expense over the life of the future underlying debt issuance.
Foreign Currency Derivative Instruments. 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 and the amount of income taxes paid in Mexico. The Company hedges its exposure to this cash tax risk by entering into foreign currency forward contracts and foreign currency option contracts known as zero-cost collars.
The foreign currency forward contracts involve the Company’s purchase of pesos at an agreed-upon weighted-average exchange rate to each U.S dollar. The zero-cost collars involve the Company’s purchase of a Mexican peso call option and a simultaneous sale of a Mexican peso put option, with equivalent U.S. dollar notional amounts for each option and no net cash premium paid by the Company. The Company’s foreign currency forward and zero-cost collar contracts are executed with counterparties in the U.S. and are governed by International Swaps and Derivatives Association agreements that include standard netting arrangements. Asset and liability positions from contracts with the same counterparty are net settled upon maturity/expiration and presented on a net basis in the consolidated balance sheets prior to settlement.
Below is a summary of the Company’s 2020 and 2019 foreign currency derivative contracts (amounts in millions, except Ps./USD):
Foreign currency forward contracts
 
 
 
 
 
 
 
Contracts to purchase Ps./pay USD
 
Offsetting contracts to sell Ps./receive USD
 
 
 
Notional amount 
 
Notional amount 
 
Weighted-average exchange rate
(in Ps./USD)
 
Notional amount 
 
Notional amount 
 
Weighted-average exchange rate
(in Ps./USD)
 
Cash received/(paid) on settlement
Contracts executed in 2020 and outstanding
$
125.0

 
Ps.
3,002.6

 
Ps.
24.0

 

 

 

 

Contracts executed in 2020 and settled in 2020
$
430.0

 
Ps.
8,251.7

 
Ps.
19.2

 
$
397.4

 
Ps.
8,251.7

 
Ps.
20.8

 
$
(32.6
)
Contracts executed in 2019 and settled in 2020
$
105.0

 
Ps.
2,041.2

 
Ps.
19.4

 
$
108.6

 
Ps.
2,041.2

 
Ps.
18.8

 
$
3.6

Contracts executed in 2019 and settled in 2019 (i)
$
400.0

 
Ps.
7,892.5

 
Ps.
19.7

 
$
410.7

 
Ps.
7,892.5

 
Ps.
19.2

 
$
10.7

Contracts executed in 2018 and settled in 2019 (i)
$
20.0

 
Ps.
410.9

 
Ps.
20.5

 
$
20.9

 
Ps.
410.9

 
Ps.
19.6

 
$
0.9

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency zero-cost collar contracts
 
 
 
 
 
Notional amount
 
Cash received/(paid) on settlement
 
 
 
 
 
 
 
 
 
 
Contracts executed in 2018 and settled in 2019 (i)
$
120.0

 
$
0.3

 
 
 
 
 
 
 
 
 
 

(i) During the first half of 2019, the Company settled $120.0 million and $240.0 million of zero-cost collar contracts and forward contracts, respectively, resulting in cash received of $0.3 million and $4.5 million.
The Company has not designated any of the foreign currency derivative contracts as hedging instruments for accounting purposes. The Company measures the foreign currency derivative contracts at fair value each period and recognizes any change in fair value in foreign exchange gain (loss) within the consolidated statements of income. The cash flows associated with these instruments is classified as an operating activity within the consolidated statements of cash flows.

12


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)

The following tables present the fair value of derivative instruments included in the Consolidated Balance Sheets (in millions):
 
Derivative Assets
 
Balance Sheet Location
 
June 30,
2020
 
December 31, 2019
Derivatives designated as hedging instruments:
 
 
 
 
 
Treasury lock agreements
Other assets
 
$
12.8

 
$

Total derivatives designated as hedging instruments
 
 
12.8

 

Derivatives not designated as hedging instruments:
 
 
 
 
 
Foreign currency forward contracts
Other current assets
 
4.2

 
2.5

Total derivatives not designated as hedging instruments
 
 
4.2

 
2.5

Total derivative assets
 
 
$
17.0

 
$
2.5

 


The following tables summarize the gross and net fair value of derivative assets and liabilities (in millions):
Offsetting of Derivative Assets
 
 
 
 
 
 
As of June 30, 2020
 
Gross Assets
 
Gross Liabilities
 
Net Amounts Presented in the Consolidated Balance Sheets
Derivatives subject to a master netting arrangement or similar agreement
 
$
5.0

 
$
(0.8
)
 
$
4.2

As of December 31, 2019
 
 
 
 
 
 
Derivatives subject to a master netting arrangement or similar agreement
 
$
2.5

 
$

 
$
2.5



13


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)

The following table presents the effects of derivative instruments on the Consolidated Statements of Income and Consolidated Statements of Comprehensive Income for the three months ended June 30 (in millions):
Derivatives in Cash Flow Hedging Relationships
 
Amount of Gain/(Loss) Recognized in OCI on Derivative
 
Location of Gain/(Loss) Reclassified from AOCI into Income
 
Amount of Gain/(Loss) Reclassified from AOCI into Income
 
 
2020
 
2019
 
 
 
2020
 
2019
Treasury lock agreements
 
$
6.8

 
$
(10.0
)
 
Interest expense
 
$
(0.6
)
 
$

     Total
 
$
6.8

 
$
(10.0
)
 
 
 
$
(0.6
)
 
$

Derivatives Not Designated as Hedging Instruments
 
Location of Gain/(Loss) Recognized in Income on Derivative
 
Amount of Gain/(Loss) Recognized in Income on Derivative
 
 
 
 
2020
 
2019
Foreign currency forward contracts
 
Foreign exchange gain (loss)
$
6.4

 
$
7.3

     Total
 
 
 
$
6.4

 
$
7.3


The following table presents the effects of derivative instruments on the Consolidated Statements of Income and Consolidated Statements of Comprehensive Income for the six months ended June 30 (in millions):
Derivatives in Cash Flow Hedging Relationships
 
Amount of Gain/(Loss) Recognized in OCI on Derivative
 
Location of Gain/(Loss) Reclassified from AOCI into Income
 
Amount of Gain/(Loss) Reclassified from AOCI into Income
 
 
2020
 
2019
 
 
 
2020
 
2019
Treasury lock agreements
 
$
12.8

 
$
(16.8
)
 
Interest expense
 
$
(1.2
)
 
$

     Total
 
$
12.8

 
$
(16.8
)
 
 
 
$
(1.2
)
 
$

Derivatives Not Designated as Hedging Instruments
 
Location of Gain/(Loss) Recognized in Income on Derivative
 
Amount of Gain/(Loss) Recognized in Income on Derivative
 
 
 
 
2020
 
2019
Foreign currency forward contracts
 
Foreign exchange gain (loss)
$
(27.3
)
 
$
10.9

     Total
 
 
 
$
(27.3
)
 
$
10.9



See Note 6, Fair Value Measurements, for the determination of the fair values of derivatives.

8. Short-Term Borrowings
Commercial Paper. The Company’s commercial paper program generally serves as the primary means of short-term funding. As of June 30, 2020 and December 31, 2019, KCS had no commercial paper outstanding. For the six months ended June 30, 2020 and 2019, any commercial paper borrowings were outstanding for less than 90 days and the related activity is presented on a net basis in the consolidated statements of cash flows.

9. Long-Term Debt
Senior Notes
On April 22, 2020, KCS issued $550.0 million principal amount of senior unsecured notes due May 1, 2050 (the “3.50% Senior Notes”), which bear interest semiannually at a fixed annual rate of 3.50%. The 3.50% Senior Notes were issued at a discount to par value, resulting in a $4.4 million discount and a yield to maturity of 3.543%. The Company intends to use the net proceeds from the offering for general corporate purposes, including to repurchase shares of KCS’s common stock. However, given the uncertainties of the impacts of COVID-19, the Company currently retains the net proceeds from the offering as cash. The 3.50% Senior Notes are redeemable at the issuer’s option, in whole or in part, at any time, by paying the greater of either 100% of the principal amount to be redeemed and a formula price based on interest rates prevailing at the time of redemption and time remaining to maturity, plus accrued interest thereon to, but excluding the redemption date.

14


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)

The 3.50% Senior Notes include certain covenants which are customary for this type of debt instrument issued by borrowers with similar credit ratings. The 3.50% Senior Notes are unsecured senior obligations of KCS and are unconditionally guaranteed, jointly and severally, on an unsecured senior basis by each current and future domestic subsidiary of KCS that from time to time guarantees the KCS revolving credit facility or any other debt of KCS or KCS’s significant subsidiaries that is a guarantor.

10. Share Repurchases
In November 2019, the Company announced a new common share repurchase program authorizing the Company to purchase up to $2.0 billion of its outstanding shares of common stock through December 31, 2022 (the “2019 Program”). Share repurchases may be made in the open market, through privately negotiated transactions, or through accelerated share repurchase (“ASR”) transactions.
Under an ASR agreement, the Company pays a specified amount to a financial institution and receives an initial delivery of shares. The final number and total cost of shares repurchased is then based on the volume-weighted average price of the Company’s common stock during the term of the agreements. The transactions are accounted for as equity transactions with any excess of repurchase price over par value allocated between additional paid-in capital and retained earnings. At the time the shares are received, there is an immediate reduction in the weighted-average number of shares outstanding for purposes of the basic and diluted earnings per share computation.
During the fourth quarter of 2019, the Company paid $550.0 million under two ASR agreements and received an aggregate initial delivery of shares, which represented approximately 85% of the total shares to be received under the agreements. The final number and total cost of shares repurchased was then based on the volume-weighted-average price of the Company’s common stock during the term of the agreements, which were settled in March 2020. The terms of the ASR agreements, structured as outlined above, were as follows:

Third Party Institution
 
Agreement Date
 
Settlement Date
 
Total Amount of Agreement (in millions)
 
Initial Shares Delivered
 
Fair Market Value of Initial Shares
(in millions)
 
Additional Shares Delivered
 
Fair Market Value of Additional Shares
(in millions)
 
Total Shares Delivered
 
Weighted-Average Price Per Share
ASR Agreement #1
 
November 2019
 
March 2020
 
$
275.0

 
1,511,380
 
$
233.75

 
224,244

 
$
41.25

 
1,735,624
 
$
158.44

ASR Agreement #2
 
November 2019
 
March 2020
 
$
275.0

 
1,511,380
 
$
233.75

 
221,692

 
$
41.25

 
1,733,072
 
$
158.68

Total
 
 
 
 
 
$
550.0

 
3,022,760

 
$
467.5

 
445,936

 
$
82.5

 
3,468,696

 
$
158.56



During the three months ended June 30, 2020, KCS repurchased 699,123 shares of common stock for $100.0 million at an average price of $143.05 per share. During the six months ended June 30, 2020, KCS repurchased 1,990,758 shares of common stock for $294.2 million, which includes shares delivered to settle the ASR agreements noted above. Since inception of the 2019 Program, KCS has repurchased 5,013,518 shares of common stock for $761.7 million at an average price of $151.94 per share. The excess of repurchase price over par value is allocated between additional paid-in capital and retained earnings.

11. Commitments and Contingencies
Concession Duty. Under Kansas City Southern de México, S.A. de C.V. (“KCSM”)’s 50-year railroad concession from the Mexican government (the “Concession”), which could expire in 2047 unless extended, KCSM pays annual concession duty expense of 1.25% of gross revenues. For the three and six months ended June 30, 2020, the concession duty expense, which is recorded within materials and other in operating expenses, was $3.5 million and $8.3 million, respectively, compared to $4.9 million and $9.1 million, for the same periods in 2019.
Litigation. Occasionally, the Company is a party to various legal proceedings, regulatory examinations, investigations,
administrative actions, and other legal matters, arising for the most part in the ordinary course of business, incidental to its operations. Included in these proceedings are various tort claims brought by current and former employees for job-related injuries and by third parties for injuries related to railroad operations. KCS aggressively defends these matters and has established liability provisions that management believes are adequate to cover expected costs. The outcome of litigation and other legal matters is always uncertain. KCS believes it has valid defenses to the legal matters currently pending against it, is defending itself vigorously, and has recorded accruals determined in accordance with U.S. GAAP, where appropriate. In making a determination regarding accruals, using available information, KCS evaluates the likelihood of an unfavorable outcome in legal or regulatory proceedings to which it is a party to and records a loss contingency when it is probable a liability has been incurred and the amount of the loss can be reasonably estimated.

15


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)

These subjective determinations are based on the status of such legal or regulatory proceedings, the merits of KCS’s defenses and consultation with legal counsel. Actual outcomes of these legal and regulatory proceedings may materially differ from the current estimates. It is possible that resolution of one or more of the legal matters currently pending or threatened could result in losses material to KCS’s consolidated results of operations, liquidity or financial condition.
Environmental Liabilities. The Company’s U.S. operations are subject to extensive federal, state and local environmental laws and regulations. The major U.S. environmental laws to which the Company is subject include, among others, the federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA,” also known as the Superfund law), the Toxic Substances Control Act, the Clean Water Act, and the Hazardous Materials Transportation Act. CERCLA can impose joint and several liabilities for cleanup and investigation costs, without regard to fault or legality of the original conduct, on current and predecessor owners and operators of a site, as well as those who generate, or arrange for the disposal of hazardous substances. The Company does not believe that compliance with the requirements imposed by the environmental legislation will impair its competitive capability or result in any material additional capital expenditures, operating or maintenance costs. The Company is, however, subject to environmental remediation costs as described in the following paragraphs.
The Company’s Mexico operations are subject to Mexican federal and state laws and regulations relating to the protection of the environment through the establishment of standards for water discharge, water supply, emissions, noise pollution, hazardous substances and transportation and handling of hazardous and solid waste. The Mexican government may bring administrative and criminal proceedings, impose economic sanctions against companies that violate environmental laws, and temporarily or even permanently close non-complying facilities.
The risk of incurring environmental liability is inherent in the railroad industry. As part of serving the petroleum and chemicals industry, the Company transports hazardous materials and has a professional team available to respond to and handle environmental issues that might occur in the transport of such materials.
The Company performs ongoing reviews and evaluations of the various environmental programs and issues within the Company’s operations, and, as necessary, takes actions intended to limit the Company’s exposure to potential liability. Although these costs cannot be predicted with certainty, management believes that the ultimate outcome of identified matters will not have a material adverse effect on the Company’s consolidated financial statements.
Personal Injury. The Company’s personal injury liability is based on semi-annual actuarial studies performed on an undiscounted basis by an independent third party actuarial firm and reviewed by management. This liability is based on personal injury claims filed and an estimate of claims incurred but not yet reported. Actual results may vary from estimates due to the number, type and severity of the injury, costs of medical treatments and uncertainties in litigation. Adjustments to the liability are reflected within operating expenses in the period in which changes to estimates are known. Personal injury claims in excess of self-insurance levels are insured up to certain coverage amounts, depending on the type of claim and year of occurrence. The personal injury liability as of June 30, 2020, is based on an updated actuarial study of personal injury claims through April 30, 2020, and review of the last two months’ experience. Although these estimates cannot be predicted with certainty, management believes that the ultimate outcome will not have a material adverse effect on the Company’s consolidated financial statements.
Tax Contingencies. Tax returns filed in the U.S. for periods after 2015 and in Mexico for periods after 2012 remain open to examination by the taxing authorities. During the second quarter of 2020, the Internal Revenue Service (“IRS”) initiated an examination of the 2017 deemed mandatory repatriation tax included in the 2017 U.S. federal tax return. In 2018, the IRS initiated an examination of the 2016 U.S. federal tax return. In 2019, the Servicio de Administración Tributaria (the “SAT”), the Mexican equivalent of the IRS, initiated an audit of the KCSM 2013 and 2014 Mexico tax returns. The Company does not expect that these examinations will have a material impact on the consolidated financial statements. During the first quarter of 2017, the Company received audit assessments from the SAT for the KCSM 2009 and 2010 Mexico tax returns. In 2017, the Company commenced administrative actions with the SAT. During the first quarter of 2018, the audit assessments were nullified by the SAT. In the third quarter of 2018, the SAT issued new assessments and the Company filed administrative appeals with the SAT. The Company believes that it has strong legal arguments in its favor and it is more likely than not that it will prevail in any challenge of the assessments.
KCSM has not historically assessed VAT on international import transportation services provided to its customers based on a written ruling that KCSM obtained from the SAT in 2008 stating that such services were not subject to VAT (the “2008 Ruling”). Notwithstanding the 2008 Ruling, in December 2013, the SAT unofficially informed KCSM of an intended implementation of new criteria effective as of January 1, 2014, pursuant to which VAT would be assessed on all international import transportation services on the portion of the services provided within Mexico. Additionally, in November 2013, the SAT filed an action to nullify the 2008 Ruling, potentially exposing the application of the new criteria to open tax years. In February 2014, KCSM filed an action opposing

16


Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)

the SAT’s nullification action. In December 2016, KCSM was notified of a resolution issued by the Mexican tax court confirming the 2008 Ruling. The SAT appealed this resolution. In October 2017, the circuit court resolved to not render a decision on the case but rather to send the SAT’s appeal to the Supreme Court. In February 2018, the Supreme Court decided not to hear the case and remanded the SAT’s appeal back to the circuit court for a decision. In July 2018, the circuit court ordered the tax court to consider certain arguments made by the SAT in the original court proceeding that were not addressed in the tax court’s December 2016 resolution. In October 2018, the tax court issued a decision confirming the 2008 Ruling. The SAT has appealed this decision. The Company believes it is more likely than not that it will continue to prevail in this matter. Further, as of the date of this filing, the SAT has not implemented any new criteria regarding the assessment of VAT on international import transportation services. The Company believes it is probable that any unexpected nullification of the 2008 Ruling and the implementation of any new VAT criteria would be applied on a prospective basis, in which case, due to the pass-through nature of VAT, KCSM would begin to assess its customers for VAT on international import transportation services, resulting in no material impact to the Company’s consolidated financial statements.
Contractual Agreements. In the normal course of business, the Company enters into various contractual agreements related to commercial arrangements and the use of other railroads’ or governmental entities’ infrastructure needed for the operations of the business. The Company is involved or may become involved in certain disputes involving transportation rates, product loss or damage, charges, and interpretations related to these agreements. While the outcome of these matters cannot be predicted with certainty, the Company believes that, when resolved, these disputes will not have a material effect on its consolidated financial statements.
Credit Risk. The Company continually monitors risks related to economic changes and certain customer receivables concentrations. Significant changes in customer concentration or payment terms, deterioration of customer creditworthiness, bankruptcy, insolvency or liquidation of a customer, or weakening in economic trends could have a significant impact on the collectability of the Company’s receivables and its operating results. If the financial condition of the Company’s customers were to deteriorate and result in an impairment of their ability to make payments, additional allowances may be required. The Company has recorded provisions for uncollectability based on its best estimate at June 30, 2020.
Panama Canal Railway Company (“PCRC”) Guarantees and Indemnities. At June 30, 2020, the Company had issued and outstanding $5.6 million under a standby letter of credit to fulfill its obligation to fund fifty percent of the debt service reserve and liquidity reserve established by PCRC in connection with the issuance of the 7.0% Senior Secured Notes due November 1, 2026 (the “PCRC Notes”). Additionally, KCS has pledged its shares of PCRC as security for the PCRC Notes.

12. Geographic Information
The Company strategically manages its rail operations as one reportable business segment over a single coordinated rail network that extends from the midwest and southeast portions of the United States south into Mexico and connects with other Class I railroads. Financial information reported at this level, such as revenues, operating income and cash flows from operations, is used by corporate management, including the Company’s chief operating decision-maker, in evaluating overall financial and operational performance, market strategies, as well as the decisions to allocate capital resources. The Company’s chief operating decision-maker is the chief executive officer.
The following tables provide information by geographic area (in millions):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
Revenues
2020
 
2019
 
2020
 
2019
U.S.
$
304.4

 
$
363.8

 
$
684.3

 
$
729.4

Mexico
243.5

 
350.2

 
595.3

 
659.4

Total revenues
$
547.9

 
$
714.0

 
$
1,279.6

 
$
1,388.8

 
 
 
 
 
 
 
 
Property and equipment (including concession assets), net
 
 
 
 
June 30,
2020
 
December 31,
2019
U.S.
 
 
 
 
$
5,575.0

 
$
5,435.9

Mexico
 
 
 
 
3,372.4

 
3,370.4

Total property and equipment (including concession assets), net
 
 
 
 
$
8,947.4

 
$
8,806.3



17


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. 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, 2019 (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 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 environmental regulations; loss of the rail concession of Kansas City Southern’s subsidiary, Kansas City Southern de México, S.A. de C.V.; domestic and international 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; 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; fluctuation in prices or availability of key materials, in particular diesel fuel; access to capital; 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; 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 Securities and Exchange Commission (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, 2020. 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 2019 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

18


consumer products, agriculture and minerals, energy, automotive, and intermodal transportation. Appropriate eliminations and reclassifications have been recorded in preparing the consolidated financial statements.
COVID-19 Update
With the global outbreak of the Coronavirus Disease 2019 (“COVID-19”) and the declaration of a pandemic by the World Health Organization on March 11, 2020, the U.S. and Mexico governments have deemed rail transportation as “critical infrastructure” providing essential services during this global emergency. As a provider of critical infrastructure, Kansas City Southern has an obligation to keep employees working and freight moving. KCS remains focused on protecting the health and wellbeing of its employees and the communities in which it operates while assuring the continuity of its business operations. 
KCS created a dedicated crisis team that proactively implemented its business continuity plans to ensure the ongoing availability of its transportation services, while taking a variety of health and safety measures, including separating dispatching and crew operations, implementing enhanced cleaning and hygiene protocols in its facilities and locomotives, implementing remote work policies, where possible, performing temperature checks and requiring facial coverings. As a result, to date, the Company has not experienced disruptions in its railroad operations.
The Company began to experience the impacts of COVID-19 on customer demand in late March of 2020. Revenues for the three months ended June 30, 2020 decreased by 23% as compared to the second quarter of 2019, primarily due to a decline in demand as a result of COVID-19, unfavorable foreign currency impacts and lower fuel surcharge due to lower fuel prices. As revenues declined, the Company responded quickly and implemented a variety of cost-saving measures and accelerated Precision Scheduled Railroading (“PSR”) initiatives by further consolidating trains, which increased train length and reduced crew costs. Operating expenses decreased by 27% during the second quarter of 2020 compared to the same period in 2019, due to decreased restructuring charges, fuel consumption and price, headcount and hours worked, and savings related to PSR initiatives. By the end of June 2020, daily volumes had increased by approximately 40% since the low point in May, nearly returning to pre-COVID-19 levels. See Strategic Initiatives for further discussion of PSR savings.
In the second quarter of 2020, the Company offered a voluntary separation program, which resulted in a restructuring charge of $9.2 million for the three months ended June 30, 2020, consisting of severance and benefit costs that will be paid out in either lump-sum payments or over a six to twelve-month period. Approximately 6% of management employees were irrevocably accepted into the voluntary separation program. Management expects the voluntary separation program reductions to result in annualized savings of approximately $11.0 million.
COVID-19 costs increased total expense in the second quarter of 2020 by approximately $4.0 million primarily due to wages paid to certain high-risk employees that were allowed to stay home pursuant to a Mexican presidential decree, expenses related to cleaning and decontamination of locomotives and other workspaces, and costs of protective gear for employees. By the end of the second quarter of 2020, almost half of the high-risk employees allowed to stay home per the Mexican presidential degree returned to work. Management expects COVID-19 costs to decrease in the third and fourth quarters of 2020.
KCS believes it has a strong liquidity position to continue business operations and service its debt obligations. As disclosed in the Liquidity and Capital Resources section, the Company has total available liquidity of $1,220.1 million as of June 30, 2020, consisting of cash on hand and a revolving credit facility. Total liquidity increased during the quarter as a result of the issuance of $550.0 million of 3.50% Senior Notes on April 22, 2020. Furthermore, the Company does not have any debt maturities until 2023. During the second quarter of 2020, KCS did not significantly alter the terms of its freight agreements with customers. Cash flows from operations remain strong; however, growth-related capital expenditures were reduced by $75.0 million to approximately $425.0 million. If the Company experienced another significant reduction in revenues, the Company would have additional alternatives to maintain liquidity, including further decreases in capital expenditures and cost reductions as well as adjustments to its capital allocation policy. To date, the Company has not reduced or suspended its share repurchase program or dividend payments. See Liquidity and Capital Resources section for additional information.
KCS continues to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state, and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside KCS’ control requiring adjustments to operating plans. As such, given the dynamic nature of this situation, KCS cannot reasonably estimate with any degree of certainty the future impact COVID-19 may have on the Company’s results of operations, financial position, and liquidity. See Part II, Item 1A - “Risk Factors” - “Public health threats or outbreaks of communicable diseases, including the ongoing COVID-19 pandemic, could have a material adverse effect on the Company’s operations and financial results.”

19


Strategic Initiatives
During 2019, KCS began implementing principles of PSR, focusing on operational excellence and driving the following improvements:
Customer service improve and sustain consistency and reliability of service and create a more resilient and dependable network;
Facilitating growth — additional capacity for new opportunities;
Improving asset utilization — meet growing or changing demand with the same or fewer assets; and,
Improving the cost profile of the Company — increased profitability driven by volume and revenue growth and improved productivity and asset utilization.
As a result of the PSR initiatives in 2019, management approved four separate restructuring plans that totaled $168.8 million, including a $51.0 million restructuring plan in the second quarter of 2019. The PSR plans included asset impairments, workforce reductions, and contract restructuring, which resulted in 2019 operating expense savings of approximately $58.0 million.
The Company established the following key metrics and goals to measure PSR progress and performance:
 
 
Three Months Ended
 
Improvement/ (Deterioration)
 
Six Months Ended
 
Improvement/ (Deterioration)
 
FY 2020
Goal
 
 
June 30,
 
June 30,
 
 
 
2020
 
2019
 
2020
 
2019
 
Gross velocity (mph) (i)
 
17.1
 
12.5
 
37%
 
16.4
 
12.5
 
31%
 
17.0
Terminal dwell (hours) (ii)
 
20.3
 
21.2
 
4%
 
20.0
 
21.5
 
7%
 
18.0
Train length (feet) (iii)