KANSAS CITY SOUTHERN - 10-K - Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following is a discussion of Kansas City Southern's results of operations,
certain changes in its financial position, liquidity, capital structure and
business developments for the periods covered by the consolidated financial
statements included under Item 8 of this Form 10-K. This discussion should be
read in conjunction with the included consolidated financial statements, the
related notes, and other information included in this report.
CAUTIONARY INFORMATION
The discussions set forth in this Annual Report on Form 10-K may contain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. In addition, management may make forward-looking statements orally
or in other writings, 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
verbs as "expects," "anticipates," "believes" or similar verbs or conjugations
of such verbs. 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 Item 1A of this Form 10-K, "Risk
Factors." Readers are strongly encouraged to consider these factors and the
following factors when evaluating any forward-looking statements concerning the
Company:
• the outcome of claims and litigation, including those related to
environmental contamination, personal injuries and property damage;
• changes in legislation and regulations or revisions of controlling authority;
• the adverse impact of any termination or revocation of KCSM's Concession
by the Mexican government;
• natural events such as severe weather, fire, floods, hurricanes,
earthquakes or other disruptions to the Company's operating systems,
structures and equipment or the ability of customers to produce or deliver
their products and the lack of adequate insurance for such catastrophic
losses;
•
United States
, Mexican and global economic, political and social conditions;
• the effects of the North American Free Trade Agreement, or NAFTA, on the
level of trade among
the United States
,
Mexico
and
Canada
;
• the level of trade between
the United States
and
Asia
or
Mexico
;
• the effects of fluctuations in the peso-dollar exchange rate;
• the effects of adverse general economic conditions affecting customer
demand and the industries and geographic areas that produce and consume
the commodities KCS carries;
• the dependence on the stability, availability and security of the
information technology systems to operate its business;
• the effect of demand for KCS's services exceeding network capacity or
traffic congestion on operating efficiencies and service reliability;
• uncertainties regarding the litigation KCS faces and any future claims and
litigation;
• the impact of competition, including competition from other rail carriers,
trucking companies and maritime shippers in
the United States
and
Mexico
;
• KCS's reliance on agreements with other railroads and third parties to
successfully implement its business strategy, operations and growth and
expansion plans, including the strategy to convert customers from using
trucking services to rail transportation services;
• compliance with environmental regulations;
• disruption in fuel supplies, changes in fuel prices and the Company's
ability to recapture its costs of fuel from customers;
• material adverse changes in economic and industry conditions, including
the availability of short and long-term financing, both within the United
States and
Mexico
and globally;
• market and regulatory responses to climate change;
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• changes in labor costs and labor difficulties, including strikes and work
stoppages affecting either operations or customers' abilities to deliver
goods for shipment;
• KCS's reliance on certain key suppliers of core rail equipment;
• availability of qualified personnel;
• acts of terrorism, war or other acts of violence or crime or risk of such
activities; and
• fluctuations in the market price for the Company's common stock.
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.
CORPORATE OVERVIEW
Kansas City Southern, a
Delaware
corporation, is a transportation holding
company that has railroad investments in the
U.S.
,
Mexico
and
Panama
. In the
U.S.
, the Company serves the central and south central
U.S.
Its international
holdings serve northeastern and central
Mexico
and the port cities of
Lazaro Cardenas
,
Tampico
and
Veracruz
, and a fifty percent interest in Panama Canal
Railway Company provides ocean-to-ocean freight and passenger service along the
Panama Canal. KCS's North American rail holdings and strategic alliances are
primary components of a NAFTA railway system, linking the commercial and
industrial centers of the
U.S.
,
Canada
and
Mexico
. Its principal subsidiaries
and affiliates include the following:
• The Kansas City Southern Railway Company ("KCSR"), a wholly-owned subsidiary;
• Kansas City Southern de México, S.A. de C.V. ("KCSM"), a wholly-owned
subsidiary;
• Mexrail, Inc. ("Mexrail"), a wholly-owned consolidated subsidiary; which,
in turn, wholly owns The Texas Mexican Railway Company ("Tex-Mex");
• KCSM Servicios, S.A. de C.V. ("KCSM Servicios"), a wholly-owned subsidiary;
• Meridian Speedway, LLC ("MSLLC"), a seventy percent-owned consolidated
affiliate;
• Panama Canal Railway Company ("PCRC"), a fifty percent-owned
unconsolidated affiliate,
• Ferrocarril y Terminal del Valle de México, S.A. de C.V. ("FTVM"), a
twenty-five percent-owned unconsolidated affiliate that provides railroad
services as well as ancillary services in the greater
Mexico City
area;
and
• PTC-220, LLC ("PTC-220"), a fourteen percent-owned unconsolidated
affiliate that holds the licenses to large blocks of radio spectrum and
other assets for the deployment of positive train control.
EXECUTIVE SUMMARY
2015 Financial Overview
Revenues in 2015 decreased 6% from 2014, due to a 4% decrease in revenue per
carload/unit and a 3% decrease in carload/unit volumes. Revenue per carload/unit
decreased due to the weakening of the Mexican peso against the
U.S.
dollar and
lower fuel surcharge, resulting from lower
U.S.
fuel prices. Energy revenue
decreased by $74.5 million due to lower volumes in utility coal as a result of
lower natural gas prices.
Frac
sand and metals volumes decreased due to the
significant decline in new
U.S
crude drilling operations and metals volumes were
further reduced by higher imports from foreign sources. In addition, the Company
experienced service-related issues in the second and third quarters of 2015,
which negatively affected revenue in certain commodities.
Operating expenses decreased 9% compared to 2014, due to the weakening of the
Mexican peso against the
U.S.
dollar, lower
U.S.
fuel prices and lower incentive
compensation. Expense reductions resulting from the weakening Mexican peso and
lower
U.S.
fuel prices largely offset the revenue reductions driven by these
same macroeconomic factors. These expense reductions were partially offset by
increased depreciation expense. The Company's continued focus on operating
expense control resulted in operating expenses as a percentage of revenues of
66.8%.
In 2015, the Company invested $648.7 million in capital expenditures. In
addition, the Company purchased $144.2 million of equipment under existing
operating leases and replacement equipment as certain operating leases expired,
which was
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primarily funded with internally generated cash flows and debt. The Company also
recognized $9.6 million of lease termination costs during 2015, which are
included in operating expenses, due to the early termination of certain
operating leases and the related purchase of the equipment.
The Company reported 2015 earnings of $4.40 per diluted share on consolidated
net income attributable to Kansas City Southern and subsidiaries of $483.5
million for the year ended December 31, 2015, compared to annual earnings of
$4.55 per diluted share on consolidated net income attributable to Kansas City
Southern and subsidiaries of $502.6 million for 2014.
In May 2015, the Company announced a share repurchase program of up to $500.0
million, which expires on June 30, 2017. During 2015, KCS repurchased 2,133,984
shares of common stock for $194.2 million at an average price of $90.99 per
share under this program. Management's assessment of market conditions,
available liquidity and other factors will determine the timing and volume of
any future repurchases.
In July 2015, KCSR issued $500.0 million principal amount of senior unsecured
notes, which bear interest semiannually at a fixed annual rate of 4.95%. The net
proceeds from the offering were used for the repayment of the outstanding
commercial paper issued by KCSR, the repurchase of shares of KCS common stock
and for other general corporate purposes.
During the fourth quarter of 2015, KCS completed an exchange offer for existing
senior notes outstanding at KCSR and KCSM and replaced its credit facility to
simplify its capital structure, improve its credit profile and enhance the
secondary market liquidity of its debt securities. Pursuant to the exchange
offer, approximately 96% or $2.0 billion of existing KCSR and KCSM senior notes
were exchanged by bondholders for new KCS senior notes with the same interest
rates, interest payment dates and maturity dates and substantially similar
redemption provisions to the existing senior notes. In addition to the senior
notes exchange, the combined KCSR and KCSM revolving credit facilities of $650.0
million were replaced with an $800.0 million KCS revolving credit facility.
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RESULTS OF OPERATIONS
Year Ended December 31, 2015, compared with the Year Ended December 31, 2014
The following summarizes KCS's consolidated income statement components (in
millions):
2015 2014 Change
Revenues $ 2,418.8 $ 2,577.1 $ (158.3 )
Operating expenses 1,615.0 1,768.0 (153.0 )
Operating income 803.8 809.1 (5.3 )
Equity in net earnings of unconsolidated
affiliates 18.3 21.1 (2.8 )
Interest expense (81.9 ) (72.8 ) (9.1 )
Debt retirement and exchange costs (7.6 ) (6.6 ) (1.0 )
Foreign exchange loss (56.6 ) (35.5 ) (21.1 )
Other expense, net (3.4 ) (2.2 ) (1.2 )
Income before income taxes 672.6 713.1 (40.5 )
Income tax expense 187.3 208.8 (21.5 )
Net income 485.3 504.3 (19.0 )
Less: Net income attributable to
noncontrolling interest 1.8 1.7
0.1
Net income attributable to
Kansas City
Southern and subsidiaries $ 483.5 $ 502.6 $ (19.1 )
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
2015 2014 % Change 2015 2014 % Change 2015 2014 % Change
Chemical and
petroleum $ 474.2 $ 453.0 5 % 259.7 246.9 5 % $ 1,826 $ 1,835 -
Industrial and
consumer
products 570.4 623.3 (8 %) 320.5 347.4 (8 %) 1,780 1,794 (1 %)
Agriculture and
minerals 429.3 446.6 (4 %) 238.8 233.9 2 % 1,798 1,909 (6 %)
Energy 252.3 326.8 (23 %) 280.8 299.2 (6 %) 899 1,092 (18 %)
Intermodal 381.5 395.8 (4 %) 990.3 1,019.6 (3 %) 385 388 (1 %)
Automotive 218.7 238.4 (8 %) 126.5 127.1 - 1,729 1,876 (8 %)
Carload
revenues,
carloads and
units 2,326.4 2,483.9 (6 %) 2,216.6
2,274.1 (3 %) $ 1,050 $ 1,092 (4 %) Other revenue 92.4 93.2 (1 %) Total revenues (i)
$ 2,418.8 $ 2,577.1 (6 %)
(i) Included in
revenues:
Fuel surcharge $ 230.1 $ 334.7
Revenues include revenue for transportation services and fuel surcharges. For
the year ended December 31, 2015, revenues and carload/unit volumes decreased 6%
and 3%, respectively, compared to the prior year. Revenue decreased by
approximately 3% or $79.0 million due to the weakening of the Mexican peso
against the
U.S.
dollar for revenue transactions denominated in Mexican pesos.
The average exchange rate of Mexican pesos per
U.S.
dollar was Ps.15.8 for 2015
compared to Ps.13.3 for 2014.
Energy revenue decreased $74.5 million for the year ended December 31, 2015,
compared to the prior year, driven by lower volumes in utility coal due to lower
natural gas prices.
Frac
sand and metals volumes decreased due to the
significant
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decline in new
U.S
crude drilling operations and metals volumes were further
reduced by higher imports from foreign sources. In addition, the Company
experienced service-related issues in the second and third quarters of 2015,
which negatively affected revenue in certain commodities.
Revenue per carload/unit decreased by 4% for the year ended December 31, 2015,
compared to the prior year, due to lower fuel surcharge and the weakening of the
Mexican peso against the
U.S.
dollar, partially offset by positive pricing
impacts.
KCS's fuel surcharges are a mechanism to adjust revenue based upon changing fuel
prices. Fuel surcharges are calculated differently depending on the type of
commodity transported. For most commodities, fuel surcharge is calculated using
a fuel price from a prior time period that can be up to 60 days earlier. In a
period of volatile fuel prices or changing customer business mix, changes in
fuel expense and fuel surcharge may differ.
The following discussion provides an analysis of revenues by commodity group:
Revenues by commodity
group for 2015
Chemical and petroleum. Revenues increased
$21.2 million for the year ended December 31,
2015, compared to 2014, due to a 5% increase
in carload/unit volumes. Petroleum volumes
increased as a result of new business and
plastics volumes increased due to lower [[Image Removed]]
commodity prices. Revenue per carload/unit was
flat for the year ended December 31, 2015,
compared to 2014, as positive pricing impacts
were offset by the weakening of the Mexican
peso against the
U.S.
dollar and lower fuel
surcharge.
Industrial and consumer products. Revenues
decreased $52.9 million for the year ended
December 31, 2015, compared to 2014, due to an
8% decrease in carload/unit volumes and a 1%
decrease in revenue per carload/unit. Metals
and scrap volumes decreased due to the decline [[Image Removed]]
in new drilling operations in the
U.S.
and
higher imports from foreign sources. Revenue
per carload/unit decreased due to lower fuel
surcharge and the weakening of the Mexican
peso against the
U.S.
dollar, partially offset
by positive pricing impacts.
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Revenues by commodity
group for 2015
Agriculture and minerals. Revenues decreased
$17.3 million for the year ended December 31,
2015, compared to 2014, due to a 6% decrease
in revenue per carload/unit, partially offset
by a 2% increase in carload/unit volumes.
Revenue per carload/unit decreased due to
lower fuel surcharge and the weakening of the [[Image Removed]]
Mexican peso against the
U.S.
dollar. Food
products volumes increased as a result of a
customer's temporary plant shutdown during the
third quarter of 2014. This increase was
partially offset by a decrease in grain
volumes due to service-related issues in the
second and third quarters of 2015.
Energy. Revenues decreased $74.5 million for
the year ended December 31, 2015, compared to
2014, due to an 18% decrease in revenue per
carload/unit and a 6% decrease in carload/unit
volumes. Revenue per carload/unit decreased
due to lower fuel surcharge, a short-term rate
concession provided to a customer during the
second half of 2015 and shorter average length [[Image Removed]]
of haul. Volumes decreased as low natural gas
prices have reduced the demand for utility
coal and the decline in new crude drilling
operations in the
U.S.
has reduced the demand
for frac sand. These decreases were partially
offset by increased crude oil volumes due to
new business.
Intermodal. Revenues decreased $14.3 million for the year ended December 31,
2015, compared to 2014, due to a 3% decrease in carload/unit volumes and a 1%
decrease in revenue per carload/unit. Lower volumes due to service-related
issues in the second and third quarters of 2015 and the conversion of rail
traffic to truck were partially offset by volume growth driven by trans-Pacific
imports via the
Port of Lazaro Cardenas
. Revenue per carload/unit decreased due
to lower fuel surcharge.
Automotive. Revenues decreased $19.7 million for the year ended December 31,
2015, compared to 2014, due to an 8% decrease in revenue per carload/unit.
Revenue per carload/unit decreased due to the weakening of the Mexican peso
against the
U.S.
dollar, partially offset by positive pricing impacts. Volumes
were flat for the year ended December 31, 2015, compared to 2014, due to
service-related issues in the second and third quarters of 2015.
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Operating Expenses
Operating expenses, as shown below (in millions), decreased $153.0 million for
the year ended December 31, 2015, compared to 2014, due to the weakening of the
Mexican peso against the
U.S.
dollar and lower
U.S.
fuel prices, partially
offset by increased depreciation expense. The weakening of the Mexican peso
against the
U.S.
dollar resulted in an expense reduction of approximately $77.0
million for expense transactions denominated in Mexican pesos. The average
exchange rate of Mexican pesos per
U.S.
dollar was Ps.15.8 for 2015 compared to
Ps.13.3 for 2014. Lower
U.S.
fuel prices reduced 2015 expenses by $71.5 million.
Change
2015 2014 Dollars Percent
Compensation and benefits $ 442.2 $ 474.5 $ (32.3 ) (7 %)
Purchased services 223.0 245.2 (22.2 ) (9 %)
Fuel 306.9 415.9 (109.0 ) (26 %)
Equipment costs 119.4 119.2 0.2 -
Depreciation and amortization 284.6 258.1 26.5 10 %
Materials and other 229.3 216.8 12.5 6 %
Lease termination costs 9.6 38.3 (28.7 ) (75 %)
Total operating expenses $ 1,615.0 $ 1,768.0 $ (153.0 ) (9 %)
Compensation and benefits. Compensation and benefits decreased $32.3 million for
the year ended December 31, 2015, compared to 2014, due to the weakening of the
Mexican peso of approximately $23.0 million, lower incentive compensation of
$22.4 million and a reduction in post-employment liabilities due to changes in
discount rates. These decreases were partially offset by annual salary rate
increases and a 3% growth in headcount.
Purchased services. Purchased services expense decreased $22.2 million for the
year ended December 31, 2015, compared to 2014, due to renegotiation of
maintenance contracts during 2015, the weakening of the Mexican peso and lower
track maintenance and corporate expenses.
Fuel. Fuel expense decreased $109.0 million for the year ended December 31,
2015, compared to 2014, due to lower
U.S.
diesel fuel prices of $71.5 million
and the weakening of the Mexican peso of approximately $37.0 million. These
decreases were partially offset by approximately $12.0 million increase due to
Mexican diesel prices. The average price per gallon, including the weakening of
the Mexican peso, was $2.32 in 2015, compared to $3.03 in 2014. In addition,
fuel expense decreased due to improved fuel efficiency and lower fuel
consumption.
Equipment costs. Equipment costs increased $0.2 million for the year ended
December 31, 2015, compared to 2014, due to higher car hire expense due to
longer cycle times, partially offset by lower lease expense as a result of the
purchase of equipment under existing operating leases and replacement equipment
as certain operating leases expired.
Depreciation and amortization. Depreciation and amortization expense increased
$26.5 million for the year ended December 31, 2015, compared to 2014, due to a
larger asset base, including the purchase of equipment under existing operating
leases and replacement equipment as certain operating leases expired.
Materials and other. Materials and other expense increased $12.5 million for the
year ended December 31, 2015, compared to 2014, due to an increase in materials
and supplies, derailment expense, property taxes, environmental expense and the
settlement of a litigation dispute during 2015. These increases were partially
offset by the weakening of the Mexican peso, lower employee expenses and a
reduction in personal injury expense recognized during 2015 as a result of
changes in estimates due to favorable claim experience.
Lease termination costs. Lease termination costs were $9.6 million and $38.3
million for the years ended December 31, 2015 and 2014, respectively, due to the
early termination of certain operating leases and the related purchase of the
equipment.
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Non-Operating Expenses
Equity in net earnings of unconsolidated affiliates. Equity in net earnings from
unconsolidated affiliates decreased $2.8 million for the year ended December 31,
2015, compared to 2014. Equity in net earnings from the operations of
Ferrocarril y Terminal del Valle de Mexico, S.A. de C.V. decreased due to higher
operating expenses. In addition, equity in net earnings from the operations of
Panama Canal Railway Company decreased due to lower container volumes.
Interest expense. Interest expense increased $9.1 million for the year ended
December 31, 2015, compared to 2014, due to higher average interest rates and
average debt balances as a result of the Company's issuance of debt during the
third quarter of 2015. For the year ended December 31, 2015, the average debt
and short-term borrowing balances were $2,257.8 million, compared to $2,174.7
million in 2014. The average interest rate for the year ended December 31, 2015
was 3.7%, compared to 3.5% in 2014.
Debt retirement and exchange costs. Debt retirement and exchange costs were $7.6
million for the year ended December 31, 2015, related to costs that were payable
to parties other than the debt holders as a result of the KCSR and KCSM senior
notes exchanged with KCS. For the year ended December 31, 2014, debt retirement
costs were $6.6 million, related to the call premiums, original issue discounts
and write-off of unamortized debt issuance costs associated with the Company's
various debt redemption activities.
Foreign exchange loss. For the years ended December 31, 2015 and 2014, foreign
exchange loss was $56.6 million and $35.5 million, respectively. Foreign
exchange loss includes the re-measurement and settlement of monetary assets and
liabilities denominated in Mexican pesos and the loss on foreign currency
derivative contracts.
For the years ended December 31, 2015 and 2014, the re-measurement and
settlement of monetary assets and liabilities denominated in Mexican pesos
resulted in a foreign exchange loss of $9.5 million and $7.6 million,
respectively.
The Company enters into foreign currency derivative contracts to hedge its net
exposure to fluctuations in the Mexican cash tax obligation due to changes in
the value of the Mexican peso against the
U.S.
dollar. For the years ended
December 31, 2015 and 2014, foreign exchange loss on foreign currency derivative
contracts was $47.1 million and $27.9 million, respectively.
Other expense, net. Other expense, net, increased $1.2 million for the year
ended December 31, 2015 compared to 2014, due to lower miscellaneous income.
Income tax expense. Income tax expense decreased $21.5 million for the year
ended December 31, 2015, compared to 2014, due to lower pre-tax income and a
lower effective tax rate. The effective tax rate was 27.8% and 29.3% for the
years ended December 31, 2015 and 2014, respectively. The decrease in the
effective tax rate was primarily due to the more significant weakening of the
Mexican peso against the
U.S.
dollar in 2015 as compared to 2014.
The Company enters into foreign currency derivative contracts to hedge its net
exposure to fluctuations in the Mexican cash tax obligation due to changes in
the value of the Mexican peso against the
U.S.
dollar, and losses on these
foreign currency derivative contracts are recorded in foreign exchange loss. The
weakening of the Mexican peso during 2015 and 2014 decreased the cash tax
obligation by $46.4 million and $27.7 million for the years ended December 31,
2015 and 2014, respectively. Further information on the components of the
effective tax rates for the years ended December 31, 2015 and 2014, is presented
in Note 11 to the Consolidated Financial Statements in Item 8.
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Year Ended December 31, 2014, compared with the Year Ended December 31, 2013
The following summarizes KCS's consolidated income statement components (in
millions):
2014 2013 Change
Revenues $ 2,577.1 $ 2,369.3 $ 207.8
Operating expenses 1,768.0 1,630.7 137.3
Operating income 809.1 738.6 70.5
Equity in net earnings of unconsolidated
affiliates 21.1 18.8
2.3
Interest expense (72.8 ) (80.6 )
7.8
Debt retirement and exchange costs (6.6 ) (119.2 ) 112.6
Foreign exchange loss (35.5 ) (5.2 ) (30.3 )
Other expense, net (2.2 ) (0.8 ) (1.4 )
Income before income taxes 713.1 551.6 161.5
Income tax expense 208.8 198.3 10.5
Net income 504.3 353.3 151.0
Less: Net income attributable to
noncontrolling interest 1.7 1.9 (0.2 )
Net income attributable to
Kansas City
Southern and subsidiaries $ 502.6 $ 351.4 $ 151.2
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
2014 2013 % Change 2014 2013 % Change 2014 2013 % Change
Chemical and
petroleum $ 453.0 $ 426.7 6 % 246.9 243.4 1 % $ 1,835 $ 1,753 5 %
Industrial and
consumer
products 623.3 583.8 7 % 347.4 337.8 3 % 1,794 1,728 4 %
Agriculture and
minerals 446.6 383.9 16 % 233.9 212.0 10 % 1,909 1,811 5 %
Energy 326.8 326.6 - 299.2 295.7 1 % 1,092 1,104 (1 %)
Intermodal 395.8 356.6 11 % 1,019.6 965.6 6 % 388 369 5 %
Automotive 238.4 201.5 18 % 127.1 110.3 15 % 1,876 1,827 3 %
Carload
revenues,
carloads and
units 2,483.9 2,279.1 9 % 2,274.1 2,164.8 5 % $ 1,092 $ 1,053 4 %
Other revenue 93.2 90.2 3 %
Total revenues
(i) $ 2,577.1 $ 2,369.3 9 %
(i) Included in
revenues:
Fuel surcharge $ 334.7 $ 320.2
Revenues include both revenue for transportation services and fuel surcharges.
For the year ended December 31, 2014, revenues and carload/unit volumes
increased 9% and 5%, respectively, compared to the prior year. Agriculture and
minerals revenues increased $62.7 million for the year ended December 31, 2014,
compared to the prior year, due to an increase of $57.4 million in grain
revenues. During the first half of 2013, grain volumes and average length of
haul were adversely affected as a result of the severe drought conditions
experienced in the Midwest region of
the United States
during 2012. Revenue per
carload/unit increased by 4% for the year ended December 31, 2014, compared to
the prior year, due to positive pricing impacts, partially offset by the
weakening of the Mexican peso against the
U.S.
dollar.
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Revenue decreased by approximately 1% or $18.0 million due to the weakening of
the Mexican peso for revenue transactions denominated in Mexican pesos. The
average exchange rate of Mexican pesos per
U.S.
dollar was Ps.13.3 for 2014
compared to Ps.12.8 for 2013.
KCS's fuel surcharges are a mechanism to adjust revenue based upon changing fuel
prices. Fuel surcharges are calculated differently depending on the type of
commodity transported. For most commodities, fuel surcharge is calculated using
a fuel price from a prior time period that can be up to 60 days earlier. In a
period of volatile fuel prices or changing customer business mix, changes in
fuel expense and fuel surcharge may differ.
The following discussion provides an analysis of revenues by commodity group:
Revenues by commodity
group for 2014
Chemical and petroleum. Revenues increased
$26.3 million for the year ended December 31,
2014, compared to 2013, due to a 5% increase
in revenue per carload/unit and a 1% increase [[Image Removed]]
in carload/unit volumes. Revenues increased
due to positive pricing impacts in petroleum,
plastics and chemicals.
Industrial and consumer products. Revenues
increased $39.5 million for the year ended
December 31, 2014, compared to 2013, due to a
4% increase in revenue per carload/unit and a
3% increase in carload/unit volumes. Metals [[Image Removed]]
and scrap revenues increased due to strong
demand, positive pricing impacts and increased
length of haul. Pulp and paper revenues
increased due to positive pricing impacts.
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Revenues by commodity
group for 2014
Agriculture and minerals. Revenues increased
$62.7 million for the year ended December 31,
2014, compared to 2013, due to a 10% increase
in carload/unit volumes and a 5% increase in
revenue per carload/unit. Grain revenues
increased $57.4 million, compared to 2013, as
volumes and average length of haul were [[Image Removed]]
adversely affected in the first half of 2013
as a result of the severe drought conditions
experienced in the Midwestern region of
the United States
during 2012. Record corn
harvests in 2013 and 2014 also contributed to
revenue growth.
Energy. Revenues increased $0.2 million for
the year ended December 31, 2014, compared to
2013, due to a 1% increase in carload/unit
volumes and a 1% decrease in revenue per
carload/unit. The volume increase was due to
strong frac sand demand driven by higher [[Image Removed]]
natural gas prices in the first half of the
year and new drilling technologies. This
increase was partially offset by volume
decreases due to longer cycle times and
connecting carrier fluidity in moving utility
coal.
Intermodal. Revenues increased $39.2 million for the year ended December 31,
2014, compared to 2013, due to a 6% increase in in carload/unit volumes and a 5%
increase in revenue per carload/unit. Volume growth was driven by conversion of
cross border and domestic general commodity truck traffic to rail, and
trans-Pacific imports via the
Port of Lazaro Cardenas
. Revenue per carload/unit
increased as a result of positive pricing impacts and increased average length
of haul.
Automotive. Revenues increased $36.9 million for the year ended December 31,
2014, compared to 2013, due to a 15% increase in carload/unit volumes and a 3%
increase in revenue per carload/unit. Growth was driven by the opening of three
automotive plants in
Mexico
and an increase in import/export volumes through the
Port of Lazaro Cardenas
. The increase in
revenues was partially offset by the weakening of the Mexican peso against the
U.S.
dollar.
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Operating Expenses
Operating expenses, as shown below (in millions), increased $137.3 million for
the year ended December 31, 2014, when compared to 2013, due to higher
carload/unit volumes and lease termination costs. Volume-based expenses
increased by approximately $64.0 million in 2014, as compared to 2013. The
weakening of the Mexican peso against the
U.S.
dollar resulted in an expense
reduction of approximately $19.0 million for expense transactions denominated in
Mexican pesos. The average exchange rate of Mexican pesos per
U.S.
dollar was
Ps.13.3 for 2014 compared to Ps.12.8 for 2013.
Change
2014 2013 Dollars Percent
Compensation and benefits $ 474.5 $ 441.6 $ 32.9 7 %
Purchased services 245.2 217.6 27.6 13 %
Fuel 415.9 389.6 26.3 7 %
Equipment costs 119.2 160.5 (41.3 ) (26 %)
Depreciation and amortization 258.1 223.3 34.8 16 %
Materials and other 216.8 198.1 18.7 9 %
Lease termination costs 38.3 - 38.3 100 %
Total operating expenses $ 1,768.0 $ 1,630.7 $ 137.3 8 %
Compensation and benefits. Compensation and benefits increased $32.9 million for
the year ended December 31, 2014, compared to 2013, due to carload/unit volumes,
including higher headcount resulting in an increase of approximately $18.0
million and annual salary rate increases of approximately $17.0 million,
partially offset by the weakening of the Mexican peso.
Purchased services. Purchased services increased $27.6 million for the year
ended December 31, 2014, compared to 2013, due to carload/unit volumes,
increases in track and equipment maintenance and corporate expenses.
Fuel. Fuel expense increased $26.3 million for the year ended December 31, 2014,
compared to 2013, due to higher consumption of $30.2 million. Higher diesel fuel
prices were more than offset by the effects of the weakening of the Mexican
peso. The average price per gallon, including the effects of the weakening of
the Mexican peso, was $3.03 in 2014, compared to $3.05 in 2013.
Equipment costs. Equipment costs decreased $41.3 million for the year ended
December 31, 2014, compared to 2013, primarily due to lower lease expense as a
result of the purchase of equipment under existing operating leases and
replacement equipment as certain operating leases expired, which resulted in a
$30.7 million decrease. In addition, equipment costs decreased due to lower net
car hire expense as a result of the increase in owned equipment.
Depreciation and amortization. Depreciation and amortization increased $34.8
million for the year ended December 31, 2014, compared to 2013, due to a larger
asset base, including $14.8 million related to the purchase of equipment under
existing operating leases and replacement equipment as certain operating leases
expired.
Materials and other. Materials and other increased $18.7 million for the year
ended December 31, 2014, compared to 2013, due to increases in casualty expense,
materials and supplies expense, and employee expenses. In addition, the Company
recognized a recovery from a legal dispute in the first quarter of 2013.
Lease termination costs. Lease termination costs were $38.3 million for the year
ended December 31, 2014, due to the early termination of certain operating
leases and the related purchase of the equipment. The Company did not incur
lease termination costs during 2013.
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Non-Operating Expenses
Equity in net earnings of unconsolidated affiliates. Equity in net earnings from
unconsolidated affiliates increased $2.3 million for the year ended December 31,
2014, compared to 2013. Equity in earnings from the operations of Panama Canal
Railway Company ("PCRC") increased as PCRC's volumes were adversely affected
during the first half of 2013 as the movement of containers was either trucked
or rerouted to other destinations as a result of delays caused by a system
implementation at the Port of Balboa.
Interest expense. Interest expense decreased $7.8 million for the year ended
December 31, 2014, compared to 2013, due to lower average interest rates as a
result of the Company's refinancing activities during 2013 and the utilization
of the commercial paper program during 2014. These decreases were partially
offset by higher average debt balances driven by financing incurred during 2013.
The average interest rate for the year ended December 31, 2014 was 3.5%,
compared to 4.2% in 2013. For the year ended December 31, 2014, the average debt
and short-term borrowing balances were $2,174.7 million, compared to $1,852.3
million in 2013.
Debt retirement and exchange costs. Debt retirement and exchange costs were $6.6
million and $119.2 million for the years ended December 31, 2014, and 2013,
respectively. The debt retirement costs include tender and call premiums,
original issue discounts and the write-off of unamortized debt issuance costs
associated with the Company's various debt refinancing and redemption
activities.
Foreign exchange loss. For the years ended December 31, 2014 and December 31,
2013, foreign exchange loss was $35.5 million and $5.2 million, respectively.
Foreign exchange loss includes the re-measurement and settlement of monetary
assets and liabilities denominated in Mexican pesos and the loss on foreign
currency derivative contracts.
For the years ended December 31, 2014 and 2013, the re-measurement and
settlement of monetary assets and liabilities denominated in Mexican pesos
resulted in a foreign exchange loss of $7.6 million and $4.5 million,
respectively.
The Company enters into foreign currency derivative contracts to hedge its net
exposure to fluctuations in the Mexican cash tax obligation due to changes in
the value of the Mexican peso against the
U.S.
dollar. For the years ended
December 31, 2014 and 2013, foreign exchange loss on foreign currency derivative
contracts was $27.9 million and $0.7 million, respectively.
Other expense, net. Other expense, net, increased $1.4 million for the year
ended December 31, 2014, compared to 2013, due to higher miscellaneous expense.
Income tax expense. Income tax expense increased $10.5 million for the year
ended December 31, 2014, compared to 2013, due to higher pre-tax income, offset
by a lower effective tax rate. The effective tax rate was 29.3% and 35.9% for
the years ended December 31, 2014 and 2013, respectively. The decrease in the
effective tax rate was primarily due to the more significant weakening of the
Mexican peso against the
U.S.
dollar in 2014 as compared to 2013.
The Company enters into foreign currency derivative contracts to hedge its net
exposure to fluctuations in the Mexican cash tax obligation due to changes in
the value of the Mexican peso against the
U.S.
dollar, and losses on these
foreign currency derivative contracts are recorded in foreign exchange loss. The
weakening of the Mexican peso during 2014 and 2013 decreased the cash tax
obligation by $27.7 million and $0.5 million for the years ended December 31,
2014 and 2013, respectively. Further information on the components of the
effective tax rates for the years ended December 31, 2014 and 2013, is presented
in Note 11 to the Consolidated Financial Statements in Item 8.
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, access to debt and equity capital markets, and
other available financing resources will be sufficient to fund anticipated
operating expenses, capital expenditures, debt service costs, dividends, share
repurchases and other commitments in the foreseeable future. The Company may,
from time to time, incur debt to refinance existing indebtedness, purchase
equipment under operating leases, repurchase shares or fund equipment additions
or new investments.
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During 2015, the Company invested $648.7 million in capital expenditures and
purchased $144.2 million of equipment under existing operating leases and
replacement equipment as certain operating leases expired.
In May 2015, the Company announced a share repurchase program of up to $500.0
million, which expires on June 30, 2017. Management's assessment of market
conditions, available liquidity and other factors will determine the timing and
volume of any future repurchases. Share repurchases are expected to be funded by
cash on hand, cash generated from operations and debt. During 2015, KCS
repurchased 2,133,984 shares of common stock for $194.2 million at an average
price of $90.99 per share under this program.
In July 2015, KCSR issued $500.0 million amount of senior unsecured notes, which
bear interest semiannually at a fixed annual rate of 4.95%. The net proceeds
from the offering were used for the repayment of the outstanding commercial
paper issued by KCSR, the repurchase of shares of KCS common stock and other
general corporate purposes.
During the fourth quarter of 2015, KCS completed an exchange offer for existing
senior notes outstanding at KCSR and KCSM and replaced its credit facility to
simplify its capital structure, improve its credit profile and enhance the
secondary market liquidity of its debt securities. Pursuant to the exchange
offer, approximately 96% or $2.0 billion of existing KCSR and KCSM senior notes
were exchanged by bondholders for new KCS senior notes with the same interest
rates, interest payment dates and maturity dates and substantially similar
redemption provisions to the existing senior notes. In addition to the senior
notes exchange, the combined KCSR and KCSM revolving credit facilities of $650.0
million were replaced with an $800.0 million KCS revolving credit facility.
The Company's current financing instruments contain restrictive covenants which
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 was in compliance with all of its debt covenants as of
December 31, 2015.
For discussion regarding the agreements representing the indebtedness of KCS,
see "Note 9, Short-Term Borrowings" and "Note 10, Long-Term Debt" in the "Notes
to the Consolidated Financial Statements" section of this annual report on Form
10-K.
During 2015, the Company's Board of Directors declared quarterly cash dividends
of $0.33 per share or $144.8 million on its common stock. On January 28, 2016,
the Company's Board of Directors declared a cash dividend of $0.33 per share
payable on April 6, 2016, to common stockholders of record as of March 14, 2016.
Subject to the discretion of the Board of Directors, capital availability and a
determination that cash dividends continue to be in the best interest of its
stockholders, the Company intends to pay a quarterly dividend on an ongoing
basis.
On December 31, 2015, total available liquidity (the cash balance plus revolving
credit facility availability) was $856.6 million, compared to available
liquidity at December 31, 2014 of $847.9 million. During 2016, KCS and KCSM
floating rate senior notes totaling $250.0 million will mature. The Company
expects to either repay this obligation using available liquidity or refinance
this obligation prior to the maturity date.
As of December 31, 2015, the total cash and cash equivalents held outside of the
U.S.
in foreign subsidiaries was $115.1 million. The Company expects that this
cash will be available to fund company operations without incurring additional
income taxes.
KCS's operating results and financing alternatives can be unexpectedly impacted
by various factors, some of which are outside of its control. For example, if
KCS were to experience a reduction in revenues or a substantial increase in
operating costs or other liabilities, its earnings could be significantly
reduced, increasing the risk of non-compliance with debt covenants.
Additionally, the Company is subject to external factors impacting debt and
equity capital markets and its ability to obtain financing under reasonable
terms is subject to market conditions. Volatility in capital markets and the
tightening of market liquidity could impact KCS's access to capital. Further,
KCS's cost of debt can be impacted by independent rating agencies which assign
debt ratings based on certain factors including competitive position, credit
measurements such as interest coverage and leverage ratios, and liquidity.
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Cash Flow Information and Contractual Obligations
Summary cash flow data follows (in millions):
2015 2014
2013
Cash flows provided by (used for):
Operating activities $ 909.3 $ 906.0 $ 798.3
Investing activities (873.0 ) (982.9 ) (833.3 )
Financing activities (247.7 ) (4.6 ) 391.9
Net increase (decrease) in cash and cash equivalents (211.4 ) (81.5 )
356.9
Cash and cash equivalents beginning of year 348.0 429.5
72.6
Cash and cash equivalents end of year $ 136.6 $ 348.0
$ 429.5
During 2015, cash and cash equivalents decreased $211.4 million as a result of
the repurchase of common stock of $194.2 million and higher dividend payments.
During 2014, cash and cash equivalents decreased $81.5 million as a result of
the purchase or replacement of certain equipment under existing leases and
increased capital expenditures which were funded with borrowings incurred in
2013 and cash flows from operating activities.
Operating Cash Flows. Net cash provided by operating activities increased $3.3
million for 2015, as compared to 2014, as a decrease in net income was more than
offset by higher non-cash depreciation and amortization expense and unrealized
foreign exchange loss on foreign currency contracts. Additionally, materials and
supplies increased due to timing of construction activities and fuel purchases.
Net cash provided by operating activities increased $107.7 million for 2014, as
compared to 2013, due to increased net income.
Investing Cash Flows. Net cash used for investing activities decreased $109.9
million for 2015, as compared to 2014, due to lower expenditures for the
purchase or replacement of equipment under existing operating leases, partially
offset by higher capital expenditures and other investing activities. Net cash
used for investing activities increased $149.6 million for 2014, as compared to
2013, due higher expenditures for the purchase or replacement of equipment under
operating leases and capital expenditures. Additional capital expenditure
information is included within the Capital Expenditure section of Liquidity and
Capital Resources.
Financing Cash Flows. Financing cash inflows are generated from the issuance of
long-term debt, short-term borrowings and proceeds from the issuance of common
stock under employee stock plans. Financing cash outflows are used for the
repayment of debt, short-term borrowings, share repurchases and the payment of
dividends and debt costs. Financing cash flows for 2015, 2014, and 2013 are
discussed in more detail below:
• Net financing cash outflows for 2015 were $247.7 million due to the net
repayment of short-term borrowings of $371.1 million, the repurchase of
common stock of $194.2 million, the payment of dividends of $140.1 million
and the payment of debt costs of $20.3 million. These cash outflows were
partially offset by net proceeds from long-term debt of $473.9 million.
• Net financing cash outflows for 2014 were $4.6 million due to the net
repayment of $333.0 million of long-term debt and the payment of $116.6
million of dividends, offset by the net proceeds of $448.6 million from
short-term borrowings.
• Net financing cash inflows for 2013 were $391.9 million due to the net
proceeds of $575.2 million from long-term borrowings, offset by the
payment of $117.8 million in debt costs and $71.2 million of dividends.
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Contractual Obligations. The following table outlines the material obligations and commitments as of December 31, 2015 (in millions):
Payments Due by Period
Less Than More than
Total 1 Year 1-3 Years 3-5 Years 5 years
Long-term debt and short-term
borrowings (including interest and
capital lease obligations) (i) $ 3,960.4 $ 445.4 $ 231.8 $ 434.3 $ 2,848.9
Operating leases 311.3 68.6 103.6 60.4 78.7
Obligations due to uncertainty in
income taxes 1.7 1.7 - - -
Capital expenditure obligations (ii) 478.1 212.2 227.8 38.1 -
Other contractual obligations (iii) 531.0 142.4 237.7 68.2 82.7
Total $ 5,282.5 $ 870.3 $ 800.9 $ 601.0 $ 3,010.3
_____________________
(i) For variable rate obligations, interest payments were calculated using the
December 31, 2015 rate. For fixed rate obligations, interest payments were
calculated based on the applicable rates and payment dates.
(ii) Capital expenditure obligations include minimum capital expenditures under
the KCSM Concession agreement and other regulatory requirements.
(iii) Other contractual obligations include purchase commitments and certain
maintenance agreements.
In the normal course of business, the Company enters into long-term contractual
commitments for future goods and services needed for the operations of the
business. Such commitments are not in excess of expected requirements and are
not reasonably likely to result in performance penalties or payments that would
have a material adverse effect on the Company's liquidity. Such commitments are
not included in the above table.
The Company is party to five utilization leases covering 874 railcars in which
car hire revenue as defined in the lease agreements is shared between the lessor
and the Company. The leases expire at various times through 2024. Amounts that
may be due to lessors under these utilization leases vary from month to month
based on car hire rental with the minimum monthly cost to the Company being
zero. Accordingly, the utilization leases have been excluded from contractual
obligations above.
The SCT requires KCSM to submit a five year capital expenditures plan every five
years. The five year plan was submitted in 2012 for the years 2013 - 2017. KCSM
expects to continue capital spending at current levels in future years and will
continue to have capital expenditure obligations past 2017, which are not
included in the table above.
Off-Balance Sheet Arrangements
On November 2, 2007, PCRC completed an offering of $100.0 million of 7.0% senior
secured notes due November 1, 2026 (the "Notes"). The Notes are senior
obligations of PCRC, secured by certain assets of PCRC. KCS has pledged its
shares of PCRC as security for the Notes. The Notes are otherwise non-recourse
to KCS. The Company has agreed, along with Mi-Jack Products, Inc. ("Mi-Jack"),
the other 50% owner of PCRC, to each fund one-half of any debt service reserve
and liquidity reserve (reserves which are required to be established by PCRC in
connection with the issuance of the Notes). As of December 31, 2015, the
Company's portion of these reserves was $5.3 million. The Company has issued a
standby letter of credit in the amount of $5.3 million to fund its share of
these reserves.
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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 for the years ended
December 31, 2015, 2014, and 2013, respectively (in millions):
2015 2014 2013
Roadway capital program $ 306.2 $ 311.1 $ 315.7
Locomotives and freight cars 205.9 245.1 194.7
Capacity 86.6 93.0 63.1
Information technology 39.0 31.9 15.6
Other 11.0 21.6 10.0
Total capital expenditures (accrual basis) 648.7 702.7
599.1
Change in capital accruals 39.3 (34.5 ) (4.3 )
Total cash capital expenditures $ 688.0 $ 668.2
$ 594.8
Purchase or replacement of equipment under
operating leases
Freight cars $ 144.2 $ 224.4 $ 57.9
Locomotives - 76.3 155.3
Total purchase or replacement of equipment
under operating leases (accrual basis) 144.2 300.7
213.2
Change in capital accruals - 1.4 (1.4 )
Total cash purchase or replacement of
equipment under operating leases $ 144.2 $ 302.1
$ 211.8
Generally, the Company's capital program consists of capital replacement and
equipment. For 2016, internally generated cash flows and short-term borrowings
are expected to fund cash capital expenditures, which are currently estimated to
be between $580.0 million and $590.0 million. In addition, the Company
continuously reviews its equipment under operating leases. Any additional
purchase or replacement of equipment under operating leases during 2016 is
expected to be funded with internally generated cash flows and/or short-term
debt.
Property Statistics
The following table summarizes certain property statistics as of December 31:
2015 2014 2013
Track miles of rail installed 177 169 138 Cross ties installed (thousands) 829 880 929
Shelf Registration Statements and Public Securities Offerings
KCS has one current, universal shelf registration statement on file with the SEC
(the "Universal Shelf" - Registration No. 333-200411). The Universal Shelf was
filed on November 20, 2014 in accordance with the securities offering reform
rules of the SEC that allow "well-known seasoned issuers" to register an
unspecified amount of different types of securities on an immediately effective
Form S-3 registration statement. The Universal Shelf will expire on November 20,
2017.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
KCS's accounting and financial reporting policies are in conformity with
U.S.
generally accepted accounting principles ("
U.S.
GAAP"). The preparation of
financial statements in conformity with
U.S.
GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Management believes that the following accounting
policies and estimates are critical to an understanding of KCS's historical and
future performance. Management has discussed the development and selection of
the following critical accounting estimates with the Audit Committee of KCS's
Board of Directors and the Audit Committee has reviewed the selection,
application and disclosure of the Company's critical accounting policies and
estimates.
Capitalization, Depreciation and Amortization of Property and Equipment
(including Concession Assets)
Due to the highly capital intensive nature of the railroad industry,
capitalization and depreciation of property and equipment are a substantial
portion of the Company's consolidated financial statements. Net property and
equipment, including concession assets, comprised approximately 92% of the
Company's total assets as of December 31, 2015, and related depreciation and
amortization comprised approximately 18% of total operating expenses for the
year ended December 31, 2015.
KCS capitalizes costs for self-constructed additions and improvements to
property including direct labor and material, indirect overhead costs, and
interest during long-term construction projects. Direct costs are charged to
capital projects based on the work performed and the material used. Indirect
overhead costs are allocated to capital projects as a standard percentage, which
is evaluated annually, and applied to direct labor and material costs. Asset
removal activities are performed in conjunction with replacement activities;
therefore, removal costs are estimated based on a standard percentage of direct
labor and indirect overhead costs related to capital replacement projects. For
purchased assets, all costs necessary to make the asset ready for its intended
use are capitalized. Expenditures that significantly increase asset values,
productive capacity, efficiency, safety or extend useful lives are capitalized.
Repair and maintenance costs are expensed as incurred.
Property and equipment are carried at cost and are depreciated primarily on the
group method of depreciation, which the Company believes closely approximates a
straight line basis over the estimated useful lives of the assets measured in
years. The group method of depreciation applies a composite rate to classes of
similar assets rather than to individual assets. Composite depreciation rates
are based upon the Company's estimates of the expected average useful lives of
assets as well as expected net salvage value at the end of their useful lives.
In developing these estimates, the Company utilizes periodic depreciation
studies performed by an independent engineering firm. Depreciation rate studies
are performed at least every three years for equipment and at least every six
years for road property (rail, ties, ballast, etc.). The depreciation studies
take into account factors such as:
• Statistical analysis of historical patterns of use and retirements of each
asset class;
• Evaluation of any expected changes in current operations and the outlook
for the continued use of the assets;
• Evaluation of technological advances and changes to maintenance practices; and
• Historical and expected salvage to be received upon retirement.
The depreciation studies may also indicate that the recorded amount of
accumulated depreciation is deficient or in excess of the amount indicated by
the study. Any such deficiency or excess is amortized as a component of
depreciation expense over the remaining useful lives of the affected asset
class, as determined by the study. The Company also monitors these factors in
non-study years to determine if adjustments should be made to depreciation
rates. The Company completed depreciation studies for its
U.S.
based assets in
2015 and KCSM in 2014. The impacts of the studies were immaterial to the
consolidated financial results for all periods.
Also under the group method of depreciation, the cost of railroad property and
equipment (net of salvage or sales proceeds) retired or replaced in the normal
course of business is charged to accumulated depreciation with no gain or loss
recognized. Actual historical costs are retired when available, such as with
equipment costs. The use of estimates in recording the retirement of roadway
assets is necessary as it is impractical to track individual, homogeneous
network-type assets. Certain types of roadway assets are retired using
statistical curves derived from the depreciation studies that indicate the
relative distribution of the age of the assets retired. For other roadway
assets, historical costs are estimated by (1) deflating current costs
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using inflation indices published by the U.S. Bureau of Labor Statistics and (2)
the estimated useful life of the assets as determined by the depreciation
studies. The indices applied to the replacement value are selected because they
closely correlate with the major costs of the items comprising the roadway
assets. Because of the number of estimates inherent in the depreciation and
retirement processes and because it is impossible to precisely estimate each of
these variables until a group of assets is completely retired, the Company
continually monitors the estimated useful lives of its assets and the
accumulated depreciation associated with each asset group to ensure the
depreciation rates are appropriate.
Estimation of the average useful lives of assets and net salvage values requires
management judgment. Estimated average useful lives may vary over time due to
changes in physical use, technology, asset strategies and other factors that
could have an impact on the retirement experience of the asset classes.
Accordingly, changes in the assets' estimated useful lives could significantly
impact future periods' depreciation expense. Depreciation and amortization
expense for the year ended December 31, 2015 was $284.6 million. If the weighted
average useful lives of assets were changed by one year, annual depreciation and
amortization expense would change approximately $10.0 million.
Gains or losses on dispositions of land or non-group property and abnormal
retirements of railroad property are recognized through income. A retirement of
railroad property would be considered abnormal if the cause of the retirement is
unusual in nature and its actual life is significantly shorter than what would
be expected for that group based on the depreciation studies. An abnormal
retirement could cause the Company to re-evaluate the estimated useful life of
the impacted asset class. There were no significant gains or losses from
abnormal retirements of property or equipment for any of the three years ended
December 31, 2015.
Costs incurred by the Company to acquire the concession rights and related
assets, as well as subsequent improvements to the concession assets, are
capitalized and amortized using the group method of depreciation over the lesser
of the current expected Concession term, including probable renewal of an
additional 50-year term, or the estimated useful lives of the assets and rights.
The Company's ongoing evaluation of the useful lives of concession assets and
rights considers the aggregation of the following facts and circumstances:
• The Company's executive management is dedicated to ensuring compliance
with the various provisions of the Concession and to maintaining positive
relationships with the SCT and other Mexican federal, state, and municipal
governmental authorities;
• During the time since the Concession was granted, the relationships
between KCSM and the various Mexican governmental authorities have matured
and the guidelines for operating under the Concession have become more
defined with experience;
• There are no known supportable sanctions or compliance issues that would
cause the SCT to revoke the Concession or prevent KCSM from renewing the
Concession; and
• KCSM operations are an integral part of the KCS operations strategy, and
related investment analyses and operational decisions assume that the
Company's cross border rail business operates into perpetuity, and do not
assume that
Mexico
operations terminate at the end of the current
Concession term.
Based on the above factors, as of December 31, 2015, the Company continues to
believe that it is probable that the Concession will be renewed for an
additional 50-year term beyond the current term.
Long-lived assets are reviewed for impairment when events or circumstances
indicate that the carrying amount of an asset may not be recoverable. If
impairment indicators are present and the estimated future undiscounted cash
flows are less than the carrying value of the long-lived assets, the carrying
value would be reduced to the estimated fair value. Future cash flow estimates
for an impairment review would be based on the lowest level of identifiable cash
flows, which are the Company's
U.S.
and Mexican operations. During the years
ended December 31, 2015 and 2014, management did not identify any indicators of
impairment.
Provision for Personal Injury Claims
Personal injury claims represent work-related injuries and third party
liabilities resulting from crossing collisions and derailments. Claims are
estimated and recorded for known reported occurrences as well as for incurred
but not reported ("IBNR") occurrences. Consistent with general practices within
the railroad industry, the estimated liability is actuarially
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determined on an undiscounted basis. The actuarial analysis is performed
semi-annually by an independent third party actuarial firm and reviewed by
management. In estimating the liability, the actuarial study calculates an
estimate using historical experience and estimates of claim costs as well as
numerous assumptions regarding factors relevant to the derivation of an estimate
of future claim costs.
Personal injury claims are subject to a significant degree of uncertainty,
especially estimates related to incurred but not reported personal injuries for
which a party has yet to assert a claim. In deriving an estimate of the
provision for personal injury claims, management must make assumptions related
to substantially uncertain matters (injury severity, claimant age and legal
jurisdiction). Changes in the assumptions used for actuarial studies could have
a material effect on the estimate of the provision for personal injury claims.
The most sensitive assumptions for personal injury accruals are the expected
average cost per claim and the projected frequency rates for the number of
claims that will ultimately result in payment. Management believes that the
accounting estimate related to the liability for personal injuries claims is
critical to KCS's results of operations. See also Note 15 to the Consolidated
Financial Statements in Item 8 of this Form 10-K.
Income Taxes
Deferred income taxes represent a net asset or liability of the Company. For
financial reporting purposes, management determines the current tax liability,
as well as deferred tax assets and liabilities, in accordance with the liability
method of accounting for income taxes. The provision for income taxes is the sum
of income taxes both currently payable and deferred into the future. Currently
payable income taxes represent the liability related to the Company's
U.S.
,
state and foreign income tax returns for the current year and anticipated tax
payments resulting from income tax audits, while the net deferred tax expense or
benefit represents the change in the balance of net deferred tax assets or
liabilities as reported on the balance sheet. The changes in deferred tax assets
and liabilities are determined based upon the estimated timing of reversal of
differences between the carrying amount of assets and liabilities for financial
reporting purposes and the basis of assets and liabilities for tax purposes as
measured using the currently enacted tax rates that will be in effect at the
time these differences are expected to reverse. Additionally, management
estimates whether taxable operating income in future periods will be sufficient
to fully recognize any deferred tax assets. Valuation allowances are recorded as
appropriate to reduce deferred tax assets to the amount considered likely to be
realized.
Income tax expense related to Mexican operations has additional complexities
such as the impact of exchange rate variations, which can have a significant
impact on the effective income tax rate.
Management believes that the assumptions and estimates related to the provision
for income taxes are critical to the Company's results of operations. For the
year ended December 31, 2015, income tax expense totaled $187.3 million. For
every 1% change in the 2015 effective rate, income tax expense would have
changed by approximately $6.7 million. For further information on the impact of
foreign exchange fluctuation on income taxes, refer to Foreign Exchange
Sensitivity in Item 7A.
OTHER MATTERS
Litigation. The Company is a party to various legal proceedings and
administrative actions, all of which are of an ordinary, routine nature and
incidental to its operations. Included in these proceedings are various tort
claims brought by current and former employees for job related injuries and by
third parties for injuries related to railroad operations. KCS aggressively
defends these matters and has established liability provisions that management
believes are adequate to cover expected costs. Although it is not possible to
predict the outcome of any legal proceeding, in the opinion of the Company's
management, other than those proceedings described in Note 15 to the
Consolidated Financial Statements in Item 8 of this Form 10-K, such proceedings
and actions should not, individually, or in the aggregate, have a material
adverse effect on the Company's consolidated financial statements.
Inflation.
U.S.
generally accepted accounting principles require the use of
historical cost, which does not reflect the effects of inflation on the
replacement cost of property. Due to the capital intensive nature of KCS's
business, the replacement cost of these assets would be significantly higher
than the amounts reported under the historical cost basis.
Recent Accounting Pronouncements. Refer to Note 2 to the Consolidated Financial
Statements in Item 8 of this Form
10-K for information relative to recent accounting pronouncements.
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