Item 1.Financial Statements (unaudited)
Kansas City Southern and Subsidiaries
Consolidated Statements of Operations
(In millions)
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| |
Revenues | $ | 882.2 | | | $ | 744.0 | | | $ | 2,505.9 | | | $ | 2,199.5 | |
Operating expenses: | | | | | | | |
Compensation and benefits | 154.4 | | | 133.3 | | | 423.8 | | | 391.2 | |
Purchased services | 57.8 | | | 51.4 | | | 163.6 | | | 161.0 | |
Fuel | 121.0 | | | 78.0 | | | 341.1 | | | 227.9 | |
Equipment costs | 25.5 | | | 19.6 | | | 67.2 | | | 64.8 | |
Depreciation and amortization | 98.2 | | | 90.5 | | | 292.1 | | | 273.7 | |
Materials and other | 88.8 | | | 82.8 | | | 252.4 | | | 231.1 | |
Merger costs, net | 11.5 | | | 36.5 | | | 36.8 | | | 776.6 | |
Total operating expenses | 557.2 | | 492.1 | | | 1,577.0 | | | 2,126.3 | |
Operating income | 325.0 | | | 251.9 | | | 928.9 | | | 73.2 | |
Equity in net earnings (losses) of affiliates | (0.1) | | | 3.8 | | | 7.9 | | | 13.2 | |
Interest expense | (38.9) | | | (39.0) | | | (118.0) | | | (117.1) | |
Foreign exchange loss | (12.3) | | | (0.5) | | | (18.0) | | | (1.0) | |
Other income, net | 0.2 | | | 0.5 | | | 0.3 | | | 0.7 | |
Income (loss) before income taxes | 273.9 | | | 216.7 | | | 801.1 | | | (31.0) | |
Income tax expense | 72.2 | | | 60.2 | | | 217.3 | | | 37.1 | |
Net income (loss) | 201.7 | | | 156.5 | | | 583.8 | | | (68.1) | |
Less: Net income attributable to noncontrolling interest | 0.4 | | | 0.3 | | | 1.0 | | | 1.2 | |
Net income (loss) attributable to Kansas City Southern and subsidiaries | 201.3 | | | 156.2 | | | 582.8 | | | (69.3) | |
Preferred stock dividends | — | | | 0.1 | | | — | | | 0.2 | |
Net income (loss) available to common stockholder(s) | $ | 201.3 | | | $ | 156.1 | | | $ | 582.8 | | | $ | (69.5) | |
| | | | | | | |
See accompanying notes to the unaudited consolidated financial statements.
Kansas City Southern and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
(In millions)
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| |
Net income (loss) | $ | 201.7 | | | $ | 156.5 | | | $ | 583.8 | | | $ | (68.1) | |
Other comprehensive income (loss): | | | | | | | |
Unrealized gain (loss) on interest rate derivative instruments, net of tax of $9.9 million, $(0.4) million, $36.7 million and $11.6 million, respectively | 37.5 | | | (1.7) | | | 138.1 | | | 43.5 | |
Reclassification adjustment from cash flow hedges included in net income, net of tax of $0.2 million, $0.1 million, $0.4 million and $0.3 million, respectively | 0.5 | | | 0.5 | | | 1.5 | | | 1.5 | |
Foreign currency translation adjustments | (0.2) | | | (0.2) | | | 0.1 | | | (0.1) | |
Other comprehensive income (loss) | 37.8 | | | (1.4) | | | 139.7 | | | 44.9 | |
Comprehensive income (loss) | 239.5 | | | 155.1 | | | 723.5 | | | (23.2) | |
Less: Comprehensive income attributable to noncontrolling interest | 0.4 | | | 0.3 | | | 1.0 | | | 1.2 | |
Comprehensive income (loss) attributable to Kansas City Southern and subsidiaries | $ | 239.1 | | | $ | 154.8 | | | $ | 722.5 | | | $ | (24.4) | |
See accompanying notes to the unaudited consolidated financial statements.
Kansas City Southern and Subsidiaries
Consolidated Balance Sheets
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
| (In millions, except share and per share amounts) |
| (Unaudited) | | |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 163.8 | | | $ | 339.3 | |
Accounts receivable, net | 600.9 | | | 271.0 | |
Materials and supplies | 169.0 | | | 131.0 | |
Other current assets | 359.5 | | | 142.1 | |
Total current assets | 1,293.2 | | | 883.4 | |
Operating lease right-of-use assets | 86.4 | | | 69.6 | |
Investments | 58.9 | | | 48.3 | |
Property and equipment (including concession assets), net | 9,317.9 | | | 9,209.3 | |
Other assets | 110.9 | | | 217.5 | |
Total assets | $ | 10,867.3 | | | $ | 10,428.1 | |
LIABILITIES AND EQUITY | | | |
Current liabilities: | | | |
Long-term debt due within one year | $ | 455.2 | | | $ | 8.8 | |
Accounts payable and accrued liabilities | 600.1 | | | 479.7 | |
Total current liabilities | 1,055.3 | | | 488.5 | |
Long-term operating lease liabilities | 60.6 | | | 46.4 | |
Long-term debt | 3,326.4 | | | 3,768.8 | |
Deferred income taxes | 1,292.2 | | | 1,213.7 | |
Other noncurrent liabilities and deferred credits | 140.5 | | | 178.1 | |
Total liabilities | 5,875.0 | | | 5,695.5 | |
Stockholder equity: | | | |
| | | |
$.01 par, common stock, 100 shares authorized; 100 shares issued; 100 shares outstanding at September 30, 2022 and December 31, 2021 | — | | | — | |
Additional paid-in capital | 860.6 | | | 860.6 | |
Retained earnings | 3,642.2 | | | 3,524.4 | |
Accumulated other comprehensive income | 159.1 | | | 19.4 | |
Total stockholder equity | 4,661.9 | | | 4,404.4 | |
Noncontrolling interest | 330.4 | | | 328.2 | |
Total equity | 4,992.3 | | | 4,732.6 | |
Total liabilities and equity | $ | 10,867.3 | | | $ | 10,428.1 | |
See accompanying notes to the unaudited consolidated financial statements.
Kansas City Southern and Subsidiaries
Consolidated Statements of Cash Flows
(In millions)
(Unaudited)
| | | | | | | | | | | |
| Nine Months Ended |
| September 30, |
| 2022 | | 2021 |
| |
Operating activities: | | | |
Net income (loss) | $ | 583.8 | | | $ | (68.1) | |
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | | | |
Depreciation and amortization | 292.1 | | | 273.7 | |
Deferred income taxes | 41.4 | | | (129.5) | |
Equity in net earnings of affiliates | (7.9) | | | (13.2) | |
Share-based compensation | — | | | 20.5 | |
(Gain) loss on foreign currency derivative instruments | 18.9 | | | (0.8) | |
Foreign exchange (gain) loss | (0.9) | | | 1.8 | |
Merger costs, net | 36.8 | | | 776.6 | |
Distributions from affiliates | 2.0 | | | 2.5 | |
Settlement of foreign currency derivative instruments | (2.2) | | | (1.9) | |
Cash payments for merger costs | (32.3) | | | (2,125.7) | |
Reimbursement of merger termination fee | — | | | 2,100.0 | |
Refundable Mexican value added tax payments | — | | | (41.9) | |
Changes in working capital items: | | | |
Accounts receivable | (333.1) | | | (25.9) | |
Materials and supplies | (40.0) | | | 2.2 | |
Other current assets | 75.7 | | | 9.2 | |
Accounts payable and accrued liabilities | 82.3 | | | 39.5 | |
Other, net | (3.7) | | | 11.1 | |
Net cash provided by operating activities | 712.9 | | | 830.1 | |
| | | |
Investing activities: | | | |
Capital expenditures | (381.2) | | | (377.7) | |
Property investments in MSLLC | (25.1) | | | (22.3) | |
Investments in and advances to affiliates | (8.3) | | | (7.8) | |
Proceeds from disposal of property | 4.5 | | | 5.5 | |
Other, net | (3.3) | | | (5.0) | |
Net cash used for investing activities | (413.4) | | | (407.3) | |
| | | |
Financing activities: | | | |
| | | |
Repayment of long-term debt | (7.7) | | | (5.7) | |
Dividends paid | (465.0) | | | (138.4) | |
Proceeds from employee stock plans | — | | | 4.2 | |
Net cash used for financing activities | (472.7) | | | (139.9) | |
| | | |
Effect of exchange rate changes on cash | (2.3) | | | (1.1) | |
| | | |
Cash and cash equivalents: | | | |
Net increase (decrease) during each period | (175.5) | | | 281.8 | |
At beginning of year | 339.3 | | | 188.2 | |
At end of period | $ | 163.8 | | | $ | 470.0 | |
See accompanying notes to the unaudited consolidated financial statements.
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 Income | | Non- controlling Interest | | Total |
|
| | | | | | | | | | | | | |
Balance at December 31, 2020 | $ | 5.4 | | | $ | 0.9 | | | $ | 830.9 | | | $ | 3,219.6 | | | $ | 0.4 | | | $ | 326.4 | | | $ | 4,383.6 | |
Net income | | | | | | | 153.0 | | | | | 0.4 | | | 153.4 | |
Other comprehensive income | | | | | | | | | 79.4 | | | | | 79.4 | |
Dividends on common stock ($0.54/share) | | | | | — | | | (49.1) | | | | | | | (49.1) | |
Dividends on $25 par preferred stock ($0.25/share) | | | | | | | — | | | | | | | — | |
Share repurchases | — | | | — | | | (2.1) | | | (72.9) | | | | | | | (75.0) | |
Settlement of forward contract for accelerated share repurchases | | | | | 75.0 | | | | | | | | | 75.0 | |
Options exercised and stock subscribed, net of shares withheld for employee taxes | | | — | | | (3.0) | | | | | | | | | (3.0) | |
Share-based compensation | | | | | 8.2 | | | | | | | | | 8.2 | |
Balance at March 31, 2021 | 5.4 | | | 0.9 | | | 909.0 | | | 3,250.6 | | | 79.8 | | | 326.8 | | | 4,572.5 | |
Net income (loss) | | | | | | | (378.5) | | | | | 0.5 | | | (378.0) | |
Other comprehensive loss | | | | | | | | | (33.1) | | | | | (33.1) | |
Dividends on common stock ($0.54/share) | | | | | — | | | (49.1) | | | | | | | (49.1) | |
Dividends on $25 par preferred stock ($0.25/share) | | | | | | | (0.1) | | | | | | | (0.1) | |
| | | | | | | | | | | | | |
Options exercised and stock subscribed, net of shares withheld for employee taxes | | | — | | | (2.0) | | | | | | | | | (2.0) | |
Share-based compensation | | | | | 6.2 | | | | | | | | | 6.2 | |
Balance at June 30, 2021 | 5.4 | | | 0.9 | | | 913.2 | | | 2,822.9 | | | 46.7 | | | 327.3 | | | 4,116.4 | |
Net income | | | | | | | 156.2 | | | | | 0.3 | | | 156.5 | |
Other comprehensive loss | | | | | | | | | (1.4) | | | | | (1.4) | |
Dividends on common stock ($0.54/share) | | | | | — | | | (49.1) | | | | | | | (49.1) | |
Dividends on $25 par preferred stock ($0.25/share) | | | | | | | (0.1) | | | | | | | (0.1) | |
| | | | | | | | | | | | | |
Options exercised and stock subscribed, net of shares withheld for employee taxes | | | — | | | 4.4 | | | | | | | | | 4.4 | |
Share-based compensation | | | | | 6.1 | | | | | | | | | 6.1 | |
Balance at September 30, 2021 | 5.4 | | | 0.9 | | | 923.7 | | | 2,929.9 | | | 45.3 | | | 327.6 | | | 4,232.8 | |
Net income | | | | | | | 594.5 | | | | | 0.6 | | | 595.1 | |
Other comprehensive loss | | | | | | | | | (25.9) | | | | | (25.9) | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Options exercised and stock subscribed, net of shares withheld for employee taxes | | | — | | | 0.4 | | | | | | | | | 0.4 | |
Share-based compensation | | | | | 59.9 | | | | | | | | | 59.9 | |
Replacement of equity share awards with liability awards | | | | | (54.5) | | | | | | | | | (54.5) | |
Cash settlement of stock options | | | | | (75.2) | | | | | | | | | (75.2) | |
Recapitalization of stock | (5.4) | | | (0.9) | | | 6.3 | | | | | | | | | — | |
Balance at December 31, 2021 | — | | | — | | | 860.6 | | | 3,524.4 | | | 19.4 | | | 328.2 | | | 4,732.6 | |
Net income | | | | | | | 187.4 | | | | | 0.6 | | | 188.0 | |
Other comprehensive income | | | | | | | | | 48.1 | | | | | 48.1 | |
Dividend to Canadian Pacific | | | | | | | (265.0) | | | | | | | (265.0) | |
Balance at March 31, 2022 | — | | | — | | | 860.6 | | | 3,446.8 | | | 67.5 | | | 328.8 | | | 4,703.7 | |
Net income | | | | | | | 194.1 | | | | | — | | | 194.1 | |
Other comprehensive income | | | | | | | | | 53.8 | | | | | 53.8 | |
Contribution from noncontrolling interest | | | | | | | | | | | 1.2 | | | 1.2 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Balance at June 30, 2022 | — | | | — | | | 860.6 | | | 3,640.9 | | | 121.3 | | | 330.0 | | | 4,952.8 | |
Net income | | | | | | | 201.3 | | | | | 0.4 | | | 201.7 | |
Other comprehensive income | | | | | | | | | 37.8 | | | | | 37.8 | |
| | | | | | | | | | | | | |
Dividend to Canadian Pacific | | | | | | | (200.0) | | | | | | | (200.0) | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Balance at September 30, 2022 | $ | — | | | $ | — | | | $ | 860.6 | | | $ | 3,642.2 | | | $ | 159.1 | | | $ | 330.4 | | | $ | 4,992.3 | |
See accompanying notes to the unaudited consolidated financial statements.
Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements
For purposes of this Quarterly Report on Form 10-Q, “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, 2021. The results of operations for the three and nine months ended September 30, 2022, are not necessarily indicative of the results to be expected for the full year ending December 31, 2022.
On September 15, 2021, KCS and Canadian Pacific Railway Limited (“CP”), a Canadian corporation, entered into a merger agreement (the “Merger Agreement”) and on December 14, 2021, CP acquired the outstanding common and preferred stock of KCS. Therefore, earnings per share data is not presented as the Company does not have any outstanding or issued publicly traded stock. The merger is further discussed in Note 2, Merger Agreement.
In November 2021, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2021-10, Government Assistance (Topic 832), Disclosures by Business Entities about Government Assistance. The standard is intended to increase transparency of government assistance by requiring disclosures of the following: (1) the types of assistance, (2) an entity’s accounting for the assistance, and (3) the effect of the assistance on the entity’s financial statements. This ASU was effective for the Company on January 1, 2022 and the Company adopted the ASU prospectively. See Note 4, Property and Equipment for the newly required disclosure.
2. Merger Agreement
On December 14, 2021, CP acquired the outstanding common and preferred stock of KCS. Each share of common stock, par value $0.01 per share, of KCS that was outstanding immediately prior to the merger was converted into the right to receive (1) 2.884 common shares of CP and (2) $90 in cash (together, the “Merger Consideration”), and each share of preferred stock, par value $25 per share, that was outstanding immediately prior to the merger was converted into the right to receive $37.50 in cash. The Merger Consideration value received by KCS stockholders was $301.20 per KCS common share.
The merger transaction was completed through a series of mergers as outlined in the Merger Agreement. These mergers ultimately resulted in KCS being merged with and into Cygnus Merger Sub 1 Corporation (“Surviving Merger Sub”), a wholly owned subsidiary of CP, with Surviving Merger Sub continuing as the surviving entity. Pursuant to the Merger Agreement, Surviving Merger Sub was renamed “Kansas City Southern” and as successor company of KCS, continued to own the assets of KCS. Immediately following the consummation of the mergers, CP caused the contribution, directly and indirectly, of all of the outstanding shares of capital stock of Surviving Merger Sub, as successor to KCS, to be deposited into an independent, irrevocable voting trust (the “Voting Trust”) under a voting trust agreement (the “Voting Trust Agreement”) approved by the U.S. Surface Transportation Board (“STB”), pending receipt of the final and non-appealable approval or exemption by the STB pursuant to 49 U.S.C. § 11323 et seq., of the transactions contemplated by the Merger Agreement (“STB Final Approval”). The Voting Trust prevents CP, or any affiliate of CP, from controlling or having the power to control KCS prior to STB Final Approval. Following receipt of STB Final Approval, the Voting Trust will be terminated and CP will acquire control over KCS’s railroad operations.
On December 14, 2021, the merger of KCS and Surviving Merger Sub was accounted for as a recapitalization of KCS’s equity. Upon STB Final Approval, the transaction will be accounted for as a business combination using the acquisition method of accounting.
Pursuant to the Merger Agreement, KCS paid a cash dividend in the first and third quarters of 2022 of $265.0 million and $200.0 million, respectively, to a wholly-owned subsidiary of CP. Periodic cash distributions may be made to a wholly-owned subsidiary of CP based upon cash generated, the timing of capital expenditures and working capital needs of the Company.
For the three and nine months ended September 30, 2022, KCS reported $11.5 million and $36.8 million, respectively, of merger-related costs, which primarily related to incentive compensation costs. During the three and nine months ended September 30, 2021, the Company recognized merger-related costs of $36.5 million and $776.6 million, respectively. For the three months ended September 30, 2021, the merger costs primarily related to compensation and benefits costs and legal fees. For the nine months ended
Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)
September 30, 2021, merger costs included the fee associated with the termination of the Canadian National (“CN”) merger agreement by KCS of $700.0 million, in addition to compensation and benefits costs and bankers’ and legal fees. For the year ended December 31, 2021, KCS incurred $1,400.0 million of merger termination fees, completely offset by the recovery of $1,400.0 million of merger termination fees recognized in merger costs, net within the consolidated statements of operations.
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 10 for revenues by geographical area.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
Chemical & Petroleum | | | | | | | |
Chemicals | $ | 76.3 | | | $ | 71.0 | | | $ | 220.9 | | | $ | 196.4 | |
Petroleum | 85.4 | | | 93.7 | | | 245.8 | | | 361.8 | |
Plastics | 42.9 | | | 39.4 | | | 125.6 | | | 109.7 | |
Total | 204.6 | | | 204.1 | | | 592.3 | | | 667.9 | |
| | | | | | | |
Industrial & Consumer Products | | | | | | | |
Forest Products | 79.2 | | | 71.6 | | | 221.5 | | | 191.9 | |
Metals & Scrap | 70.2 | | | 54.1 | | | 191.5 | | | 151.4 | |
Other | 39.0 | | | 33.3 | | | 110.6 | | | 94.3 | |
Total | 188.4 | | | 159.0 | | | 523.6 | | | 437.6 | |
| | | | | | | |
Agriculture & Minerals | | | | | | | |
Grain | 99.9 | | | 87.0 | | | 316.7 | | | 250.6 | |
Food Products | 46.9 | | | 35.4 | | | 130.2 | | | 109.0 | |
Ores & Minerals | 9.6 | | | 7.5 | | | 25.3 | | | 18.8 | |
Stone, Clay & Glass | 11.2 | | | 9.9 | | | 31.3 | | | 25.7 | |
Total | 167.6 | | | 139.8 | | | 503.5 | | | 404.1 | |
| | | | | | | |
Energy | | | | | | | |
Utility Coal | 45.2 | | | 45.8 | | | 123.3 | | | 108.7 | |
Coal & Petroleum Coke | 12.3 | | | 12.8 | | | 37.3 | | | 35.2 | |
Frac Sand | 4.6 | | | 4.0 | | | 14.4 | | | 11.6 | |
Crude Oil | 20.8 | | | 12.0 | | | 51.4 | | | 31.1 | |
Total | 82.9 | | | 74.6 | | | 226.4 | | | 186.6 | |
| | | | | | | |
Intermodal | 121.9 | | | 86.9 | | | 335.3 | | | 259.3 | |
| | | | | | | |
Automotive | 70.1 | | | 40.1 | | | 190.8 | | | 133.6 | |
| | | | | | | |
Total Freight Revenues | 835.5 | | | 704.5 | | | 2,371.9 | | | 2,089.1 | |
| | | | | | | |
Other Revenue | 46.7 | | | 39.5 | | | 134.0 | | | 110.4 | |
| | | | | | | |
Total Revenues | $ | 882.2 | | | $ | 744.0 | | | $ | 2,505.9 | | | $ | 2,199.5 | |
Contract Balances
The amount of revenue recognized in the third quarter of 2022 from performance obligations partially satisfied in previous periods was $28.9 million. The performance obligations that were unsatisfied or partially satisfied as of September 30, 2022 were $21.8 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 September 30, 2022 and December 31, 2021, the accounts receivable, net balance was $600.9 million and $271.0 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 September 30, 2022 and December 31, 2021.
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 third quarter of 2022 that was included in the opening contract liability balance was $8.0 million. The Company has recognized contract liabilities within the accounts payable and accrued liabilities and other long-term liabilities financial statement captions on the consolidated balance sheets.
The following tables summarize the changes in contract liabilities (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Contract liabilities | | Three Months Ended | | Nine Months Ended |
| | September 30, | | September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
Beginning balance | | $ | 49.4 | | | $ | 19.7 | | | $ | 68.4 | | | $ | 29.9 | |
Revenue recognized that was included in the contract liability balance at the beginning of the period | | (8.0) | | | (9.6) | | | (30.1) | | | (25.3) | |
Increases due to consideration received, excluding amounts recognized as revenue during the period | | 4.7 | | | 2.4 | | | 7.8 | | | 7.9 | |
Ending balance | | $ | 46.1 | | | $ | 12.5 | | | $ | 46.1 | | | $ | 12.5 | |
4. Property and Equipment (including Concession Assets)
Property and equipment, including concession assets, and related accumulated depreciation and amortization are summarized below (in millions):
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
Land | $ | 244.7 | | | $ | 243.0 | |
Concession land rights | 141.1 | | | 141.1 | |
Road property | 8,630.7 | | | 8,430.6 | |
Equipment | 2,868.0 | | | 2,842.4 | |
Technology and other | 433.4 | | | 372.6 | |
Construction in progress | 393.0 | | | 335.8 | |
Total property | 12,710.9 | | | 12,365.5 | |
Accumulated depreciation and amortization | 3,393.0 | | | 3,156.2 | |
Property and equipment (including concession assets), net | $ | 9,317.9 | | | $ | 9,209.3 | |
Concession assets, net of accumulated amortization of $775.5 million and $744.8 million, totaled $2,475.3 million and $2,459.3 million at September 30, 2022 and December 31, 2021, respectively.
The Company has historically received assistance from governmental entities, typically in the form of cash, for purposes of making improvements to its rail network as part of public safety and/or economic revitalization initiatives. The governmental entity generally specifies how the monetary assistance is to be spent, and may include limited conditions requiring the Company to return the assistance. The Company accounts for this assistance received as reductions to property and equipment in the period in which the improvement is made, with the assistance being amortized as an offset to depreciation expense over the life of the improvement. As of September 30, 2022 and December 31, 2021, the total governmental assistance received, net of accumulated amortization, was $35.5 million and $37.3 million, respectively. For the three and nine months ended September 30, 2022, governmental assistance amortization was $0.7 million and $1.9 million, respectively.
5. Fair Value Measurements
The Company’s derivative financial instruments are measured at fair value on a recurring basis and consist of foreign currency forward 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.
Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)
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 $3,781.6 million and $3,777.6 million at September 30, 2022 and December 31, 2021, 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):
| | | | | | | | | | | | | | |
| | September 30, 2022 | | December 31, 2021 |
| | Level 2 | | Level 2 |
Assets | | | | |
| | | | |
Treasury lock agreements | | $ | 232.2 | | | $ | 57.4 | |
| | | | |
Liabilities | | | | |
Debt instruments | | 3,235.8 | | | 4,311.1 | |
Foreign currency derivative instruments | | 18.5 | | | 1.8 | |
6. 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 have an established banking relationship with the Company. As of September 30, 2022, the Company did not expect any losses as a result of default of its counterparties.
Interest Rate Derivative Instruments. In 2020, the Company executed six 30-year treasury lock agreements with an aggregate notional value of $650.0 million and a weighted average interest rate of 1.58%. 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 principal amount of 3.00% senior notes due May 15, 2023 (the “3.00% Senior Notes”) and the $200.0 million principal amount of 3.85% senior notes due November 15, 2023 (the “3.85% Senior Notes”). The Company has designated the treasury locks as cash flow hedges and recorded unrealized gains and losses in accumulated other comprehensive income (loss). For the nine months ended September 30, 2022, the total unrealized gain of $232.2 million recognized in accumulated other comprehensive income increased by $174.8 million compared to December 31, 2021, reflecting a change in the value of the treasury locks as U.S. treasury rates rose. Upon settlement, the unrealized gain or loss in accumulated other comprehensive income (loss) 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 in the consolidated statements of operations and the amount of income taxes paid in Mexico. The Company also has net monetary assets denominated in Mexican pesos that are subject to periodic re-measurement and settlement that create fluctuations in foreign currency gains and losses in the consolidated statements of operations. The Company hedges its net exposure to foreign currency fluctuations in earnings by entering into foreign currency forward contracts. The foreign currency forward contracts involve the Company’s agreement to buy or sell pesos at an agreed-upon exchange rate on a future date.
Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)
Below is a summary of the Company’s 2022 and 2021 foreign currency derivative contracts (amounts in millions, except Ps./USD):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Foreign currency forward contracts | | | | | | |
| Contracts to sell Ps./receive USD | | Offsetting contracts to purchase Ps./pay 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 2022 and outstanding | $ | 460.0 | | | Ps. | 9,797.1 | | | Ps. | 21.3 | | | — | | | — | | | — | | | — | |
Contracts executed in 2022 and settled in 2022 | $ | 50.0 | | | Ps. | 1,105.3 | | | Ps. | 22.1 | | | $ | 50.5 | | | Ps. | 1,105.3 | | | Ps. | 21.9 | | | $ | (0.5) | |
Contracts executed in 2021 and settled in 2022 | $ | 270.0 | | | Ps. | 5,583.3 | | | Ps. | 20.7 | | | $ | 271.7 | | | Ps. | 5,583.3 | | | Ps. | 20.6 | | | $ | (1.7) | |
| 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 2021 and settled in 2021 (i) | $ | 100.0 | | | Ps. | 1,993.5 | | | Ps. | 19.9 | | | $ | 98.1 | | | Ps. | 1,993.5 | | | Ps. | 20.3 | | | $ | (1.9) | |
(i) During the nine months ended September 2021, the Company settled $100.0 million of these forward contracts, resulting in cash paid of $1.9 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 operations. The cash flows associated with these instruments is classified as an operating activity within the consolidated statements of cash flows.
Offsetting. The Company’s treasury lock agreements and foreign currency forward 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. The following tables present the fair value of derivative instruments included in the Consolidated Balance Sheets (in millions): | | | | | | | | | | | | | | | | | | | | |
| | Derivative Assets |
| | Balance Sheet Location | | September 30, 2022 | | December 31, 2021 |
Derivatives designated as hedging instruments: | | | | | | |
Treasury lock agreements | | Other current assets | | $ | 232.2 | | | $ | — | |
| | Other assets | | — | | | 57.4 | |
Total derivatives designated as hedging instruments | | | | 232.2 | | | 57.4 | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
Total derivative assets | | | | $ | 232.2 | | | $ | 57.4 | |
| | | | | | | | | | | | | | | | | |
| Derivative Liabilities |
| Balance Sheet Location | | September 30, 2022 | | December 31, 2021 |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
Derivatives not designated as hedging instruments: | | | | | |
Foreign currency forward contracts | Accounts payable and accrued liabilities | | $ | 18.5 | | | $ | 1.8 | |
| | | | | |
Total derivatives not designated as hedging instruments | | | 18.5 | | | 1.8 | |
Total derivative liabilities | | | $ | 18.5 | | | $ | 1.8 | |
Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)
The following table summarizes the gross and net fair value of derivative liabilities (in millions):
| | | | | | | | | | | | | | | | | | | | |
As of September 30, 2022 | | Gross Liabilities | | Gross Assets | | Net Amounts Presented in the Consolidated Balance Sheets |
Derivatives subject to a master netting arrangement or similar agreement | | $ | 18.5 | | | $ | — | | | $ | 18.5 | |
As of December 31, 2021 | | | | | | |
Derivatives subject to a master netting arrangement or similar agreement | | $ | 2.8 | | | $ | (1.0) | | | $ | 1.8 | |
The following table presents the effects of derivative instruments on the Consolidated Statements of Operations and Consolidated Statements of Comprehensive Income (Loss) for the three months ended September 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 |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | 2022 | | 2021 | | | | | | | | 2022 | | 2021 |
Treasury lock agreements | | | | | | | $ | 47.4 | | | $ | (2.1) | | | Interest expense | | | | | | $ | (0.7) | | | $ | (0.6) | |
Total | | | | | | | $ | 47.4 | | | $ | (2.1) | | | | | | | | | $ | (0.7) | | | $ | (0.6) | |
| | | | | | | | | | |
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| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Derivatives Not Designated as Hedging Instruments | | | Location of Gain/(Loss) Recognized in Income on Derivative | | | | | | Amount of Gain/(Loss) Recognized in Income on Derivative |
| | | | | | | |
| | | | | | | |
| | | | | | | | | 2022 | | 2021 |
Foreign currency forward contracts | | Foreign exchange loss | | | | | $ | (8.1) | | | $ | 4.9 | |
| | | | | | | | | | |
Total | | | | | | | | | $ | (8.1) | | | $ | 4.9 | |
The following table presents the effects of derivative instruments on the Consolidated Statements of Operations and Consolidated Statements of Comprehensive Income (Loss) for the nine months ended September 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 |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | 2022 | | 2021 | | | | | | | | 2022 | | 2021 |
Treasury lock agreements | | | | | | | $ | 174.8 | | | $ | 55.1 | | | Interest expense | | | | | | $ | (1.9) | | | $ | (1.8) | |
Total | | | | | | | $ | 174.8 | | | $ | 55.1 | | | | | | | | | $ | (1.9) | | | $ | (1.8) | |
| | | | | | | | | | |
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| | | | | | | | | | | | | | | | | | | | | | | | | |
Derivatives Not Designated as Hedging Instruments | | | Location of Gain/(Loss) Recognized in Income on Derivative | | | | | | Amount of Gain/(Loss) Recognized in Income on Derivative |
| | | | | | | |
| | | | | | | |
| | | | | | | | | 2022 | | 2021 |
Foreign currency forward contracts | | Foreign exchange loss | | | | | $ | (18.9) | | | $ | 0.8 | |
| | | | | | | | | | |
Total | | | | | | | | | $ | (18.9) | | | $ | 0.8 | |
See Note 5, Fair Value Measurements, for the determination of the fair values of derivatives.
7. Short-Term Borrowings
Commercial Paper. The Company’s commercial paper program generally serves as the primary means of short-term funding. As of September 30, 2022 and December 31, 2021, KCS had no commercial paper outstanding. For the nine months ended September 30, 2022 and 2021, 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.
8. Refundable Mexican Value Added Tax
Kansas City Southern de México, S.A. de C.V. (“KCSM”) is not required to charge its customers value added tax (“VAT”) on international import or export transportation services, which prior to 2022 resulted in KCSM paying more VAT on its expenses than it
Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)
collected from customers. These excess VAT payments are refundable by the Mexican government. Prior to 2019, Mexican companies could offset their monthly refundable VAT balance with other tax obligations. In January 2019, Mexico tax reform eliminated the ability to offset other tax obligations with refundable VAT. Over 2019 through 2021, KCSM generated a refundable VAT balance and filed refund claims with the Servicio de Administración Tributaria (the “SAT”), which have not been refunded.
In November 2021, changes to the VAT law were announced and became effective beginning January 1, 2022. These changes reduced the recoverability of VAT paid by KCSM on its expenditures that support international import transportation service revenues that are not subject to a VAT charge. VAT that is unrecoverable from the Mexican government results in incremental VAT expense for KCSM. Beginning in 2022, KCSM changed certain service offerings to either require VAT to be charged to customers on revenue, or impose a rate increase to offset the incremental VAT expense. These measures implemented by KCSM increased the VAT to be collected from customers and payable to the Mexican government.
As of September 30, 2022 and December 31, 2021, the KCSM refundable VAT balance was $98.6 million and $152.2 million, respectively. KCSM has prior favorable Mexican court decisions and a legal opinion supporting its right under Mexican law to recover the refundable VAT balance from the Mexican government and believes the VAT to be fully recoverable. KCSM will recover the refundable VAT balance as VAT billed to customers exceeds creditable VAT charged by vendors. As of September 30, 2022 and December 31, 2021, $81.0 million and $78.0 million, respectively, of the refundable VAT balance was classified as a short-term asset.
9. Commitments and Contingencies
Concession Duty. Under 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 nine months ended September 30, 2022, the concession duty expense, which is recorded within materials and other in operating expenses, was $5.5 million and $16.0 million, respectively, compared to $4.7 million and $14.1 million, for the same periods in 2021.
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. 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.
Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)
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 September 30, 2022, is based on an updated actuarial study of personal injury claims through April 30, 2022, and review of the last five 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 authority. The Internal Revenue Service (“IRS”) has completed its examination of the 2017 deemed mandatory repatriation tax included in the 2017 U.S. federal tax return and the 2016 U.S. federal tax return with no material impact to the consolidated financial statements. The Servicio de Administración Tributaria (the “SAT”), the Mexican equivalent of the IRS, has initiated examinations of the KCSM 2013 through 2020 Mexico tax returns and the Financiera Inspira, S.A. de C.V. SOFOM, E.N.R. 2016 and 2017 Mexico tax returns. The Company does not expect that these examinations will have a material impact on the consolidated financial statements. During 2017, the Company received audit assessments from the SAT for the KCSM 2009 and 2010 Mexico tax returns. The Company commenced administrative actions with the SAT and the audit assessments were subsequently nullified. In the third quarter of 2018, the SAT issued new assessments and the Company filed administrative appeals with the SAT. During the first quarter of 2022, the Company received an audit assessment from the SAT for the KCSM 2013 Mexico tax return and filed an administrative appeal of the assessment in the second quarter of 2022.
On April 13, 2022, the SAT used an electronic tax mailbox to deliver an audit assessment on the 2014 KCSM tax returns, which as of September 30, 2022 was Ps.5.7 billion (approximately $280.0 million USD) of tax, interest, penalties and inflation (the “2014 Audit Assessment”). In 2014, KCSM filed an amparo lawsuit with the district court, objecting to the SAT’s electronic accounting requirements, including the SAT’s use of the electronic tax mailbox, and KCSM was granted a permanent injunction in 2015 preventing the SAT from delivering any notification of assessments using the electronic tax mailbox. The permanent injunction remained in effect through the date the SAT issued the 2014 Audit Assessment. The Company became aware of the 2014 Audit Assessment on June 30, 2022 and based on the permanent injunction on the electronic accounting requirements, the Company believed it had thirty business days from that date to file an appeal. On July 7, 2022, the Company filed an administrative appeal of the 2014 Audit Assessment with the SAT. During the third quarter of 2022, the SAT dismissed the administrative appeal of the 2014 Audit Assessment on the basis it wasn’t filed timely. The Company plans to challenge in Mexican court the SAT's use of the electronic mailbox and the dismissal of the administrative appeal of the 2014 Audit Assessment. The Company believes that it has strong legal arguments in its favor and it is more likely than not that the administrative appeal of the 2014 Audit Assessment was timely filed.
The 2014 Audit Assessment includes tax positions where KCSM has prior favorable court decisions or strong legal arguments in its favor. Management believes it is more likely than not it will prevail in any challenge of the 2014 Audit Assessment. Historically, the Company has not been required to pay to settle previous SAT audit assessments or has settled SAT audit assessments for an immaterial amount.
On July 1, 2022, the SAT froze KCSM’s Mexico bank accounts without any request for payment of the 2014 Audit Assessment or notification of the freeze. The Company filed an amparo lawsuit challenging the legality of the bank account freeze. The district court issued a permanent injunction requiring the SAT to remove the freeze subject to KCSM posting a performance bond or other collateral upon the SAT demonstrating a tax obligation exists. In August 2022, KCSM posted a performance bond in the amount of Ps.5.6 billion (approximately $278.0 million USD) and the bank account freeze was removed. The freeze and cost of obtaining the performance bond did not have a significant impact on KCSM’s cash flows or operations. The provision of the performance bond is not an agreement or concession with regard to the 2014 Audit Assessment and in no way impacts KCSM’s ability to further defend its tax position.
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.
Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)
U.S. Collective Bargaining. KCSR participates in industry-wide multi-employer bargaining as a member of the National Carriers’ Conference Committee (“NCCC”), as well as local bargaining for agreements that are limited to KCSR's property. Approximately 72% of KCSR employees are covered by collective bargaining agreements. For the 2016 bargaining round, 5-year agreements were reached voluntarily or through the arbitration process during 2017 and 2018 covering all of the participating unions. The terms of these agreements remain in effect until new agreements are reached in the 2020 national bargaining round. In November 2019, KCSR and its unions commenced negotiations in connection with the 2020 collective bargaining round.
On July 15, 2022, President Biden signed an executive order creating a Presidential Emergency Board (“PEB”) to assist the railroads and its unions in ongoing national labor negotiations. The PEB reviewed the parties’ proposals, held hearings and issued non-binding settlement recommendations to the President. Under the terms of the PEB, the parties had until September 16, 2022 to reach a voluntary settlement based on those recommendations. On September 15, 2022, the NCCC and unions reached a tentative agreement resulting in the Company recognizing estimated retroactive union wages and bonuses of approximately $9.0 million in compensation and benefits on the consolidated statements of operations.
The union ratification began in mid-September and is expected to be complete by mid-November. As of October 26, 2022, six of the twelve railroad unions have ratified their respective tentative agreements; however, the third largest union rejected the tentative agreement. The NCCC and this union agreed to continue negotiations through November 19, 2022, before the union seeks other self-help remedies, including strikes or work stoppages. Under the Railway Labor Act, Congress can impose a resolution based upon the PEB recommendations or order trains to operate as usual while the two sides continue to negotiate and ultimately reach a new agreement. A strike or work stoppage could result in a significant disruption of the Company’s operations and have significant financial impacts, such as lower revenues and higher operating costs.
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.
On July 14, 2022, KCSM reached an agreement with the Mexican Ministry of Infrastructure, Communications and Transportation (“SICT”) to fund a new investment in the Celaya-NBA Line Railway Bypass and related infrastructure in an amount not to exceed Ps.4.0 billion (approximately $200.0 million USD). In exchange for the investment, the SICT agreed to amend KCSM’s Concession Title effective July 14, 2022, to extend the exclusivity rights granted to KCSM for an additional period of 10 years. Under this amendment, KCSM’s exclusivity will now expire in 2037.
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 credit losses based on its best estimate at September 30, 2022.
Panama Canal Railway Company (“PCRC”) Guarantees and Indemnities. At September 30, 2022, the Company had issued and outstanding $5.7 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.
Kansas City Southern and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements—(Continued)
10. 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 | | Nine Months Ended |
| September 30, | | September 30, |
Revenues | 2022 | | 2021 | | 2022 | | 2021 |
U.S. | $ | 476.0 | | | $ | 409.5 | | | $ | 1,351.6 | | | $ | 1,160.5 | |
Mexico | 406.2 | | | 334.5 | | | 1,154.3 | | | 1,039.0 | |
Total revenues | $ | 882.2 | | | $ | 744.0 | | | $ | 2,505.9 | | | $ | 2,199.5 | |
| | | | | | | |
Property and equipment (including concession assets), net | | | | | September 30, 2022 | | December 31, 2021 |
U.S. | | | | | $ | 5,849.2 | | | $ | 5,744.4 | |
Mexico | | | | | 3,468.7 | | | 3,464.9 | |
Total property and equipment (including concession assets), net | | | | | $ | 9,317.9 | | | $ | 9,209.3 | |
11. Subsequent Event
On October 26, 2022, the Company’s Board of Directors declared a cash dividend of up to $225.0 million, to be paid to a wholly-owned subsidiary of CP on October 31, 2022.
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
The discussion below, as well as other portions of this Form 10-Q, contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended and the Private Securities Litigation Reform Act of 1995. In addition, management may make forward-looking statements orally or in other writing, including, but not limited to, in press releases, quarterly earnings calls, executive presentations, in the annual report to stockholders and in other filings with the Securities and Exchange Commission (the “SEC”). Readers can usually identify these forward-looking statements by the use of such words as “may,” “will,” “should,” “likely,” “plans,” “projects,” “expects,” “anticipates,” “believes” or similar words. These statements involve a number of risks and uncertainties. Actual results could materially differ from those anticipated by such forward-looking statements. Such differences could be caused by a number of factors or combination of factors including, but not limited to, the factors identified below and those discussed under the captions “Part II - Item 1A - Risk Factors” herein and Item 1A, “Risk Factors”, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 (the “Annual Report”). Readers are strongly encouraged to consider these factors and the following factors when evaluating any forward-looking statements concerning the Company: public health threats or outbreaks of communicable diseases, such as the ongoing COVID-19 pandemic (including its variants) and its impact on KCS’s business, suppliers, consumers, customers, employees and supply chains; rail accidents or other incidents or accidents on KCS’s rail network or at KCS’s facilities or customer facilities involving the release of hazardous materials, including toxic inhalation hazards; legislative and regulatory developments and disputes, including tax disputes and environmental regulations; loss of the rail concession of Kansas City Southern’s subsidiary, Kansas City Southern de México, S.A. de C.V.; North American and global economic, political and social conditions; disruptions to the Company’s technology infrastructure, including its computer systems; increased demand and traffic congestion; the level of trade between the United States and Asia or Mexico; fluctuations in the peso-dollar exchange rate; natural events such as severe weather, hurricanes and floods; the outcome of claims and litigation involving the Company or its subsidiaries; changes in business strategy and strategic opportunities; competition and consolidation within the transportation industry; the business environment in industries that produce and use items shipped by rail; the termination of, or failure to renew, agreements with customers, other railroads and third parties; the satisfaction of by third parties of their obligations; fluctuation in prices or availability of key materials, fluctuations in commodity demand; in particular diesel fuel; insurance coverage limitations; access to capital; sufficiency of budgeted capital expenditures in carrying out business plans; services infrastructure; climate change and the market and regulatory responses to climate change; dependency on certain key suppliers of core rail equipment; changes in securities and capital markets; unavailability of qualified personnel; difficulty attracting, motivating, and retaining executives and other key employees due to the uncertainty of the merger transaction with Canadian Pacific Railway Limited (“CP”); significant demands placed on the Company as a result of the merger of the Company with CP; labor difficulties, including strikes and work stoppages; acts of terrorism or risk of terrorist activities, war or other acts of violence; and other factors affecting the operation of the business. For more discussion about each risk factor, see “Part II - Item 1A - Risk Factors” herein and Part I, Item 1A - “Risk Factors” in the Company’s Annual Report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein and in the Company’s Annual Report, in each case as updated by the Company’s periodic filings with the SEC.
Forward-looking statements reflect the information only as of the date on which they are made. The Company does not undertake any obligation to update any forward-looking statements to reflect future events, developments, or other information. If KCS does update one or more forward-looking statements, no inference should be drawn that additional updates will be made regarding that statement or any other forward-looking statements.
This discussion is intended to clarify and focus on KCS’s results of operations, certain changes in its financial position, liquidity, capital structure and business developments for the periods covered by the consolidated financial statements included under Item 1 of this Quarterly Report on Form 10-Q for the quarter ended September 30, 2022. This discussion should be read in conjunction with those consolidated financial statements and the related notes and is qualified by reference to them.
Critical Accounting Policies and Estimates
The Company’s discussion and analysis of its financial position and results of operations is based upon its consolidated financial statements. The preparation of these consolidated financial statements requires estimation and judgment that affect the reported amounts of revenue, expenses, assets and liabilities. The Company bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the accounting for assets and liabilities that are not readily apparent from other sources. If the estimates differ materially from actual results, the impact on the consolidated financial statements may be material. The Company’s critical accounting policies are disclosed in its 2021 Annual Report.
Overview
The Company is engaged primarily in the freight rail transportation business, operating a single coordinated rail network under one reportable business segment. The primary operating subsidiaries of the Company consist of the following: The Kansas City Southern Railway Company (“KCSR”), Kansas City Southern de México, S.A. de C.V. (“KCSM”), Meridian Speedway, LLC (“MSLLC”), and The Texas Mexican Railway Company (“TexMex”). The Company generates revenues and cash flows by providing customers with freight delivery services both within its regions and throughout North America through connections with other Class I rail carriers. KCS’s customers conduct business in a number of different industries, including chemical and petroleum, industrial and consumer products, agriculture and minerals, energy, automotive, and intermodal transportation. Appropriate eliminations and reclassifications have been recorded in preparing the consolidated financial statements.
Merger Agreement
On September 15, 2021, KCS and CP entered into a merger agreement (the “Merger Agreement”) and on December 14, 2021, CP acquired the outstanding common and preferred stock of KCS. Each share of common stock, par value $0.01 per share, of KCS that was outstanding immediately prior to the merger was converted into the right to receive (1) 2.884 common shares of CP and (2) $90 in cash (together, the “Merger Consideration”), and each share of preferred stock, par value $25 per share, that was outstanding immediately prior to the merger was converted into the right to receive $37.50 in cash. The Merger Consideration value received by KCS stockholders was $301.20 per KCS common share.
The merger transaction was completed through a series of mergers as outlined in the Merger Agreement. These mergers ultimately resulted in KCS being merged with and into Cygnus Merger Sub 1 Corporation (“Surviving Merger Sub”), a wholly owned subsidiary of CP, with Surviving Merger Sub continuing as the surviving entity. Pursuant to the Merger Agreement, Surviving Merger Sub was renamed “Kansas City Southern” and as successor company of KCS, continued to own the assets of KCS. Immediately following the consummation of the mergers, CP caused the contribution, directly and indirectly, of all of the outstanding shares of capital stock of Surviving Merger Sub, as successor to KCS, to be deposited into an independent, irrevocable voting trust (the “Voting Trust”) under a voting trust agreement (the “Voting Trust Agreement”) approved by the U.S. Surface Transportation Board (“STB”), pending receipt of the final and non-appealable approval or exemption by the STB pursuant to 49 U.S.C. § 11323 et seq., of the transactions contemplated by the Merger Agreement (“STB Final Approval”). The Voting Trust prevents CP, or any affiliate of CP, from controlling or having the power to control KCS prior to STB Final Approval. Following receipt of STB Final Approval, the Voting Trust will be terminated and CP will acquire control over KCS’s railroad operations. STB Final Approval is expected to be granted in the first quarter of 2023, subject to the regulatory review process.
On December 14, 2021, the merger of KCS and Surviving Merger Sub was accounted for as a recapitalization of KCS’s equity. Upon STB Final Approval, the transaction will be accounted for as a business combination using the acquisition method of accounting.
Pursuant to the Merger Agreement, KCS paid a cash dividend in the first and third quarters of 2022 of $265.0 million and $200.0 million, respectively, to a wholly-owned subsidiary of CP. On October 26, 2022, the Company’s Board of Directors declared a cash dividend of up to $225.0 million, to be paid to a wholly-owned subsidiary of CP on October 31, 2022. Periodic cash distributions may be made to a wholly-owned subsidiary of CP based upon cash generated, the timing of capital expenditures and working capital needs of the Company.
For the three and nine months ended September 30, 2022, KCS reported $11.5 million and $36.8 million, respectively, of merger-related costs, which primarily related to incentive compensation costs. During the three and nine months ended September 30, 2021, the Company recognized merger-related costs of $36.5 million and $776.6 million, respectively. For the three months ended September 30, 2021, the merger costs primarily related to compensation and benefits costs and legal fees. For the nine months ended September 30, 2021, merger costs included the fee associated with the termination of the CN merger agreement by KCS of $700.0 million, in addition to compensation and benefits costs and bankers’ and legal fees. These costs were recognized in merger costs, net within the consolidated statements of operations.
Ukraine Crisis
The invasion of Ukraine by Russia in February 2022 has led to disruption, instability, and volatility in global markets and industries. The U.S. government and other foreign governments have imposed severe economic sanctions and export controls against Russia, certain regions of Ukraine and particular entities and individuals, removed Russia from the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”) system, and may impose additional sanctions and controls. The full impact of these sanctions and controls, as well as responses to them by Russia has and could in the future result in, among other things, severe or complete restrictions on exports to and other commerce and business dealings involving Russia, certain regions of Ukraine, and/or particular entities and individuals. In addition, this ongoing invasion has caused energy prices to rise, leading to increased inflationary impacts. To date, the Company has not experienced a material impact to operations or the consolidated financial statements as a result of the invasion of Ukraine; however, KCS will continue to monitor for events that could materially impact the Company.
Inflation
U.S. consumer price inflation rose at its fastest pace in over 40 years and Mexico inflation reached levels not seen for 20 years. Consumer price annual inflation rates as of September 30, 2022 were 8.2% and 8.7% in the U.S. and Mexico, respectively. KCS continues to closely monitor the impact of rapidly increasing inflation on the Company’s financial results and procurement supply chain. As of September 30, 2022, higher inflation has not had a material impact on the Company’s financial results. Additionally, supply chain disruptions have not materially impacted the Company’s ability to procure essential materials and services on a timely basis.
Inflation is expected to remain elevated for the near future. Inflationary factors, such as increases in interest rates, overhead costs and transportation costs may adversely affect the Company’s financial results. Although the Company does not believe that inflation has had a material impact on KCS’s financial results to date, the Company may experience some effect in the near future due to supply chain constraints, consequences associated with COVID-19, and the ongoing invasion of Ukraine by Russia, employee availability and wage increases.
Third Quarter Highlights
For the three months ended September 30, 2022, revenues increased 19% compared to the same period in 2021, primarily due to a 10% increase in carload/unit volumes and an 8% increase in revenue per carload/unit. Volumes increased due to partial recovery of the global microchip shortage, strong demand, new business, and new steel plants that opened on the KCSM network in 2021. These increases were partially offset by decreased volumes in chemicals and petroleum refined fuel products due to regulatory impacts. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix and unfavorable foreign currency impacts.
Operating expenses increased 13% during the three months ended September 30, 2022, as compared to the same period in 2021, primarily due to higher diesel fuel prices, tentative agreements with U.S. unions resulting in incremental estimated retroactive wage and bonus expense, and wage and benefit inflation, partially offset by decreased merger costs. Operating expenses as a percentage of revenues was 63.2% for the three months ended September 30, 2022, compared to 66.1% for the same period in 2021.
Results of Operations
The following summarizes KCS’s consolidated statement of operations components (in millions):
| | | | | | | | | | | | | | | | | |
| Three Months Ended | | Change |
| September 30, | |
| 2022 | | 2021 | |
Revenues | $ | 882.2 | | | $ | 744.0 | | | $ | 138.2 | |
Operating expenses | 557.2 | | | 492.1 | | | 65.1 | |
Operating income | 325.0 | | | 251.9 | | | 73.1 | |
Equity in net earnings (losses) of affiliates | (0.1) | | | 3.8 | | | (3.9) | |
Interest expense | (38.9) | | | (39.0) | | | 0.1 | |
Foreign exchange loss | (12.3) | | | (0.5) | | | (11.8) | |
Other income, net | 0.2 | | | 0.5 | | | (0.3) | |
Income before income taxes | 273.9 | | | 216.7 | | | 57.2 | |
Income tax expense | 72.2 | | | 60.2 | | | 12.0 | |
Net income | 201.7 | | | 156.5 | | | 45.2 | |
Less: Net income attributable to noncontrolling interest | 0.4 | | | 0.3 | | | 0.1 | |
Net income attributable to Kansas City Southern and subsidiaries | $ | 201.3 | | | $ | 156.2 | | | $ | 45.1 | |
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| Nine Months Ended | | Change |
| September 30, | |
| 2022 | | 2021 | |
Revenues | $ | 2,505.9 | | | $ | 2,199.5 | | | $ | 306.4 | |
Operating expenses | 1,577.0 | | | 2,126.3 | | | (549.3) | |
Operating income | 928.9 | | | 73.2 | | | 855.7 | |
Equity in net earnings of affiliates | 7.9 | | | 13.2 | | | (5.3) | |
Interest expense | (118.0) | | | (117.1) | | | (0.9) | |
Foreign exchange loss | (18.0) | | | (1.0) | | | (17.0) | |
Other income, net | 0.3 | | | 0.7 | | | (0.4) | |
Income (loss) before income taxes | 801.1 | | | (31.0) | | | 832.1 | |
Income tax expense | 217.3 | | | 37.1 | | | 180.2 | |
Net income (loss) | 583.8 | | | (68.1) | | | 651.9 | |
Less: Net income attributable to noncontrolling interest | 1.0 | | | 1.2 | | | (0.2) | |
Net income (loss) available to common stockholder(s) | $ | 582.8 | | | $ | (69.3) | | | $ | 652.1 | |
Operating Metrics
The Company has established the following key metrics to measure precision scheduled railroading (“PSR”) progress and performance:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Improvement/ (Deterioration) | | Nine Months Ended | | Improvement/ (Deterioration) | | |
| | September 30, | | September 30, | |
| | 2022 | | 2021 | | 2022 | | 2021 | |
Gross velocity (mph) (i) | | 14.1 | | 15.3 | | (8)% | | 14.4 | | 13.4 | | 7% | | |
Terminal dwell (hours) (ii) | | 23.3 | | 21.5 | | (8)% | | 21.7 | | 24.9 | | 13% | | |
Train length (feet) (iii) | | 6,510 | | 6,481 | | — | | 6,465 | | 6,690 | | (3)% | | |
| | | | | | | | | | | | | | |
Fuel efficiency (gallons per 1,000 GTM's) (iv) | | 1.26 | | 1.22 | | (3)% | | 1.25 | | 1.24 | | (1)% | | |
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(i) Gross velocity is the average train speed between origin and destination in miles per hour calculated as the sum of the miles traveled divided by the sum of total transit hours. Transit hours are measured as the difference between a train’s origin departure and destination arrival date and times broken down by segment across the train route (includes all time spent including crew changes, terminal dwell, delays, and incidents). |
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(ii) Terminal dwell is the average amount of time in hours between car arrival to and departure from the yard (excludes cars that move through a terminal on a run-through train, stored, bad ordered, and maintenance-of-way cars). Calculated by dividing the total number of hours cars spent in terminals by the total count of car dwell events. |
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(iii) Train length is the average length of a train across its reporting stations, including the origin and intermediate stations. Length of a train is the sum of car and locomotive lengths measured in feet. |
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(iv) Fuel efficiency is calculated by taking locomotive fuel consumed in gallons divided by thousand gross ton miles (“GTM’s”) net of detours with no associated fuel gallons. GTM’s are the movement of one ton of train weight over one mile calculated by multiplying total train weight by distance the train moved. GTM’s exclude locomotive gross ton miles. |
For the three months ended September 30, 2022, the decrease in velocity and increase in dwell, as compared to the same period in 2021, were due to congestion and resource pressure in northern Mexico. For the nine months ended September 30, 2022, the improvement in velocity and dwell, as compared to the same period in 2021, were due to efforts to improve network fluidity and customer service, along with other operating initiatives, investments in crew resources and new capacity projects.
Revenues
The following summarizes revenues (in millions), carload/unit statistics (in thousands) and revenue per carload/unit:
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| Revenues | | Carloads and Units | | Revenue per Carload/Unit |
| Three Months Ended | | | | Three Months Ended | | | | Three Months Ended | | |
| September 30, | | | | September 30, | | | | September 30, | | |
| 2022 | | 2021 | | % Change | | 2022 | | 2021 | | % Change | | 2022 | | 2021 | | % Change |
Chemical and petroleum | $ | 204.6 | | | $ | 204.1 | | | — | | | 82.6 | | | 86.9 | | | (5 | %) | | $ | 2,477 | | | $ | 2,349 | | | 5 | % |
Industrial and consumer products | 188.4 | | | 159.0 | | | 18 | % | | 85.9 | | | 79.0 | | | 9 | % | | 2,193 | | | 2,013 | | | 9 | % |
Agriculture and minerals | 167.6 | | | 139.8 | | | 20 | % | | 68.4 | | | 67.1 | | | 2 | % | | 2,450 | | | 2,083 | | | 18 | % |
Energy | 82.9 | | | 74.6 | | | 11 | % | | 73.2 | | | 73.4 | | | — | | | 1,133 | | | 1,016 | | | 12 | % |
Intermodal | 121.9 | | | 86.9 | | | 40 | % | | 269.8 | | | 231.6 | | | 16 | % | | 452 | | | 375 | | | 21 | % |
Automotive | 70.1 | | | 40.1 | | | 75 | % | | 34.0 | | | 22.4 | | | 52 | % | | 2,062 | | | 1,790 | | | 15 | % |
Carload revenues, carloads and units | 835.5 | | | 704.5 | | | 19 | % | | 613.9 | | | 560.4 | | | 10 | % | | $ | 1,361 | | | $ | 1,257 | | | 8 | % |
Other revenue | 46.7 | | | 39.5 | | | 18 | % | | | | | | | | | | | | |
Total revenues (i) | $ | 882.2 | | | $ | 744.0 | | | 19 | % | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
(i) Included in revenues: | | | | | | | | | | | | | | | | | |
Fuel surcharge | $ | 147.9 | | | $ | 75.3 | | | | | | | | | | | | | | | |
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| Revenues | | Carloads and Units | | Revenue per Carload/Unit |
| Nine Months Ended | | | | Nine Months Ended | | | | Nine Months Ended | | |
| September 30, | | | | September 30, | | | | September 30, | | |
| 2022 | | 2021 | | % Change | | 2022 | | 2021 | | % Change | | 2022 | | 2021 | | % Change |
Chemical and petroleum | $ | 592.3 | | | $ | 667.9 | | | (11 | %) | | 244.9 | | | 291.9 | | | (16 | %) | | $ | 2,419 | | | $ | 2,288 | | | 6 | % |
Industrial and consumer products | 523.6 | | | 437.6 | | | 20 | % | | 250.2 | | | 225.7 | | | 11 | % | | 2,093 | | | 1,939 | | | 8 | % |
Agriculture and minerals | 503.5 | | | 404.1 | | | 25 | % | | 214.6 | | | 193.7 | | | 11 | % | | 2,346 | | | 2,086 | | | 12 | % |
Energy | 226.4 | | | 186.6 | | | 21 | % | | 203.5 | | | 198.1 | | | 3 | % | | 1,113 | | | 942 | | | 18 | % |
Intermodal | 335.3 | | | 259.3 | | | 29 | % | | 780.6 | | | 714.7 | | | 9 | % | | 430 | | | 363 | | | 18 | % |
Automotive | 190.8 | | | 133.6 | | | 43 | % | | 98.1 | | | 76.5 | | | 28 | % | | 1,945 | | | 1,746 | | | 11 | % |
Carload revenues, carloads and units | 2,371.9 | | | 2,089.1 | | | 14 | % | | 1,791.9 | | | 1,700.6 | | | 5 | % | | $ | 1,324 | | | $ | 1,228 | | | 8 | % |
Other revenue | 134.0 | | | 110.4 | | | 21 | % | | | | | | | | | | | | |
Total revenues (i) | $ | 2,505.9 | | | $ | 2,199.5 | | | 14 | % | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
(i) Included in revenues: | | | | | | | | | | | | | | | | | |
Fuel surcharge | $ | 364.2 | | | $ | 196.0 | | | | | | | | | | | | | | | |
For the three months ended September 30, 2022, revenues increased 19% compared to the same period in 2021. Revenues increased due to a 10% increase in carload/unit volumes and an 8% increase in revenue per carload/unit. Volumes increased due to partial recovery of the global microchip shortage, strong demand, new business, and new steel plants that opened on the KCSM network in 2021. These increases were partially offset by decreased volumes in chemicals and petroleum refined fuel products due to regulatory impacts. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix and unfavorable foreign currency impacts.
For the nine months ended September 30, 2022, revenues increased 14% compared to the same period in 2021. Revenues increased due to an 8% increase in revenue per carload/unit and a 5% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix. Volumes increased due to partial recovery of the global microchip shortage, improved cycle times, strong demand, and new steel plants that
opened on the KCSM network in 2021. These increases were partially offset by decreased volumes in chemicals and petroleum refined fuel products due to regulatory impacts.
The fluctuations of the Mexican peso against the U.S. dollar during the three and nine months ended September 30, 2022, resulted in a decrease in revenues of approximately $2.0 million compared to the same periods in 2021, for revenue transactions denominated in Mexican pesos. The average exchange rate of Mexican pesos per U.S. dollar was Ps.20.2 and Ps.20.3 for the three and nine months ended September 30, 2022, respectively, compared to Ps.20.0 and Ps.20.1 for the same periods in 2021.
KCS’s fuel surcharges are a mechanism to adjust revenue based upon changes in fuel prices above fuel price thresholds set in KCS’s tariffs or contracts. Fuel surcharge revenue is calculated using a fuel price from a prior time period that can be up to 60 days earlier. In a period of volatile fuel prices or changing customer business mix, changes in fuel expense and fuel surcharge revenue may differ.
For the three and nine months ended September 30, 2022, fuel surcharge revenue increased $72.6 million and $168.2 million, respectively, compared to the same periods in 2021, primarily due to higher fuel prices.
The following discussion provides an analysis of revenues by commodity group: | | | | | |
| Revenues by commodity group for the three months ended September 30, 2022 |
Chemical and petroleum. Revenues increased $0.5 million for the three months ended September 30, 2022, compared to the same period in 2021, due to a 5% decrease in carload/unit volumes, offset by a 5% increase in revenue per carload/unit. Revenues decreased $75.6 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to a 16% decrease in carload/unit volumes, partially offset by a 6% increase in revenue per carload/unit. Volumes decreased due to refined fuel product shipments into Mexico being negatively impacted by supply chain disruptions as a result of increased regulation. Refer to Mexico Regulatory and Legal Updates for further discussion. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and mix, partially offset by shorter average length of haul. | |
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Industrial and consumer products. Revenues increased $29.4 million for the three months ended September 30, 2022, compared to the same period in 2021, due to a 9% increase in both carload/unit volumes and revenue per carload/unit. Revenues increased $86.0 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to an 11% increase in carload/unit volumes and an 8% increase in revenue per carload/unit. Metal volumes increased for the three and nine months ended September 30, 2022 due to higher demand and new steel plants that opened on the KCSM network in 2021. Additionally for the three months ended September 30, 2022, volumes increased due to cement shipments in the Mexican market, partially offset by slower paper and appliance shipments due to customer rationalization of inventory. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix. | |
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| Revenues by commodity group for the three months ended September 30, 2022 |
Agriculture and minerals. Revenues increased $27.8 million for the three months ended September 30, 2022, compared to the same period in 2021, due to an 18% increase in revenue per carload/unit and a 2% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, mix, and longer average length of haul. Volumes increased due to higher demand.
Revenues increased $99.4 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to a 12% increase in revenue per carload/unit and an 11% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, longer average length of haul, and mix. Volumes increased due to improved cycle times and higher demand. | |
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Energy. Revenues increased $8.3 million for the three months ended September 30, 2022, compared to the same period in 2021, due to a 12% increase in revenue per carload/unit. Revenue per carload/unit increased due to higher fuel surcharge and positive pricing impacts, partially offset by shorter average length of haul and mix.
Revenues increased $39.8 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to an 18% increase in revenue per carload/unit and a 3% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, longer average length of haul, and positive pricing impacts, partially offset by mix. Volumes increased in crude oil due to new business, partially offset by a decline in utility coal as a result of deteriorated interchange cycle times and utility plant maintenance outages. | |
Intermodal. Revenues increased $35.0 million for the three months ended September 30, 2022, compared to the same period in 2021, due to a 21% increase in revenue per carload/unit and a 16% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, and mix, partially offset by a shorter average length of haul. Volumes increased due to service interruptions at the Lazaro Cardenas port in Mexico in 2021, new business, a partial recovery of the global microchip shortage affecting auto parts shipments, and stronger demand.
Revenues increased $76.0 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to an 18% increase in revenue per carload/unit and a 9% increase in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, mix, and positive pricing impacts. Volumes increased due to stronger demand, a partial recovery of the global microchip shortage affecting auto parts shipments, new business, and service interruptions at Lazaro Cardenas port in Mexico in 2021.
Automotive. Revenues increased $30.0 million for the three months ended September 30, 2022, compared to the same period in 2021, due to a 52% increase in carload/unit volumes and a 15% increase in revenue per carload/unit. Revenues increased $57.2 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to a 28% increase in carload/unit volumes and an 11% increase in revenue per carload/unit. Volumes increased for both the three months and nine months ended September 30, 2022, due to partial recovery of the global microchip shortage. For the three months ended September 30, 2022, revenue per carload/
unit increased due to higher fuel surcharge, positive pricing impacts, and longer average length of haul, partially offset by mix. For the nine months ended September 30, 2022, revenue per carload/unit increased due to higher fuel surcharge, positive pricing impacts, longer average length of haul, and mix.
Operating Expenses
Operating expenses, as shown below (in millions), increased $65.1 million for the three months ended September 30, 2022, compared to the same period in 2021, primarily due to higher diesel fuel prices, tentative agreements with U.S. unions resulting in incremental estimated retroactive wage and bonus expense, and wage and benefit inflation, partially offset by decreased merger costs.
Operating expenses, as shown below (in millions), decreased $549.3 million for the nine months ended September 30, 2022, compared to the same period in 2021, primarily due to decreased merger costs related to the termination fee for the termination of the CN merger agreement by KCS of $700.0 million, partially offset by higher diesel fuel prices, tentative agreements with U.S. unions resulting in incremental estimated retroactive wage and bonus expense, and wage and benefit inflation.
The fluctuations of the Mexican peso against the U.S. dollar during the three and nine months ended September 30, 2022, resulted in an immaterial change compared to the same periods in 2021, for expense transactions denominated in Mexican pesos. The average exchange rate of Mexican pesos per U.S. dollar was Ps.20.2 and Ps.20.3 for the three and nine months ended September 30, 2022, respectively, compared to Ps.20.0 and Ps.20.1 for the same periods in 2021.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | |
| September 30, | | Change |
| 2022 | | 2021 | | Dollars | | Percent |
Compensation and benefits | $ | 154.4 | | | $ | 133.3 | | | $ | 21.1 | | | 16 | % |
Purchased services | 57.8 | | | 51.4 | | | 6.4 | | | 12 | % |
Fuel | 121.0 | | | 78.0 | | | 43.0 | | | 55 | % |
| | | | | | | |
Equipment costs | 25.5 | | | 19.6 | | | 5.9 | | | 30 | % |
Depreciation and amortization | 98.2 | | | 90.5 | | | 7.7 | | | 9 | % |
Materials and other | 88.8 | | | 82.8 | | | 6.0 | | | 7 | % |
Merger costs, net | 11.5 | | | 36.5 | | | (25.0) | | | (68 | %) |
| | | | | | | |
| | | | | | | |
Total operating expenses | $ | 557.2 | | | $ | 492.1 | | | $ | 65.1 | | | 13 | % |
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended | | |
| September 30, | | Change |
| 2022 | | 2021 | | Dollars | | Percent |
Compensation and benefits | $ | 423.8 | | | $ | 391.2 | | | $ | 32.6 | | | 8 | % |
Purchased services | 163.6 | | | 161.0 | | | 2.6 | | | 2 | % |
Fuel | 341.1 | | | 227.9 | | | 113.2 | | | 50 | % |
Equipment costs | 67.2 | | | 64.8 | | | 2.4 | | | 4 | % |
Depreciation and amortization | 292.1 | | | 273.7 | | | 18.4 | | | 7 | % |
Materials and other | 252.4 | | | 231.1 | | | 21.3 | | | 9 | % |
Merger costs, net | 36.8 | | | 776.6 | | | (739.8) | | | (95 | %) |
Total operating expenses | $ | 1,577.0 | | | $ | 2,126.3 | | | $ | (549.3) | | | (26 | %) |
Compensation and benefits. Compensation and benefits increased $21.1 million for the three months ended September 30, 2022, compared to the same period in 2021, due to tentative agreements on the U.S. 2020 collective bargaining round resulting in estimated retroactive union wages and bonuses of approximately $9.0 million. In addition, compensation and benefits increased due to wage and benefit inflation of approximately $9.0 million, increased headcount and hours worked of approximately $4.0 million, and increased incentive compensation of approximately $2.0 million, partially offset by lower costs relating to Mexican outsourcing reform of approximately $3.0 million.
Compensation and benefits increased $32.6 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to wage and benefit inflation of approximately $20.0 million, increase in headcount and hours worked of approximately $9.0 million, and tentative agreements on the U.S. 2020 collective bargaining round resulting in estimated retroactive union wages and bonuses of approximately $9.0 million, partially offset by decreased incentive compensation of approximately $6.0 million.
The Company expects compensation and benefits will increase in 2023, as compared to 2022, by approximately $10.0 million due to an increase in U.S. union wages as a result of the tentative agreements on the 2020 collective bargaining round. As of October 26, 2022, six of the twelve unions have ratified their respective agreements; however, the third largest union rejected the tentative agreement. Negotiations will continue with this union and any other union that does not ratify, which could result in compensation and benefits that differs from current estimates upon settlement. See the Collective Bargaining section within Other Matters for further discussion.
Purchased services. Purchased services expense increased $6.4 million for the three months ended September 30, 2022, compared to the same period in 2021, primarily due to increased corporate services expense of approximately $4.0 million, increased software and programming expense of approximately $2.0 million, and increases in repairs and maintenance of approximately $2.0 million, partially offset by cost reductions of approximately $4.0 million as a result of Mexico outsourcing reform.
Purchased services expense increased $2.6 million for the nine months ended September 30, 2022 compared to the same period in 2021, due to increased software and programming expense of approximately $7.0 million, an increase in repairs and maintenance expense of approximately $4.0 million, an increase in intermodal lift services of approximately $3.0 million, and increases in security costs of approximately $2.0 million, partially offset by cost reductions of approximately $15.0 million as a result of Mexico outsourcing reform.
Fuel. Fuel increased $43.0 million for the three months ended September 30, 2022, compared to the same period in 2021, due to higher diesel fuel prices in the U.S. and Mexico of approximately $26.0 million and $9.0 million, respectively, increased consumption of approximately $6.0 million and decreased efficiency of approximately $2.0 million.
Fuel increased $113.2 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to higher diesel fuel prices in the U.S. and Mexico of approximately $74.0 million and $27.0 million, respectively, increased consumption of approximately $9.0 million, and decreased efficiency of approximately $4.0 million, partially offset by the weakening of the Mexican peso against the U.S. dollar of approximately $1.0 million. The average price per gallon was $3.61 and $3.44 for the three and nine months ended September 30, 2022, respectively, compared to $2.52 and $2.43 for the same periods in 2021.
Equipment costs. Equipment costs increased $5.9 million for the three months ended September 30, 2022, compared to the same period in 2021, due to increased car hire expense of approximately $5.0 million due to increased cycle times and volumes, and higher lease expense of approximately $1.0 million.
Equipment costs increased $2.4 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to increased car hire expense of approximately $2.0 million due to increased volumes.
Depreciation and amortization. Depreciation and amortization expense increased $7.7 million and $18.4 million for the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021, due to a larger asset base and an increase in depreciation rates on equipment as a result of an updated depreciation study.
Materials and other. Materials and other expense increased $6.0 million for the three months ended September 30, 2022, compared to the same period in 2021, due to increased materials expense of approximately $7.0 million, including approximately $3.0 million of material purchases resulting from Mexico outsourcing reform, increased expense of approximately $3.0 million related to the non-creditable VAT due to VAT law changes in Mexico, and higher employee expenses of approximately $2.0 million. These increases were partially offset by lower derailments and casualties of approximately $5.0 million.
Materials and other expense increased $21.3 million for the nine months ended September 30, 2022, compared to the same period in 2021, due to increased expense of approximately $11.0 million related to the non-creditable VAT due to VAT law changes in Mexico, increased material purchases resulting from Mexico outsourcing reform of approximately $10.0 million and higher employee expenses of approximately $10.0 million. These increases were partially offset by a one-time contract dispute of approximately $10.0 million recognized in 2021.
Merger costs, net. During the three and nine months ended September 30, 2022, the Company recognized merger costs of $11.5 million and $36.8 million, respectively, primarily related to incentive compensation. During the three and nine months ended September 30, 2021, the Company recognized merger costs of $36.5 million and $776.6 million, respectively. For the three months ended September 30, 2021, the merger costs primarily related to compensation and benefits costs and legal fees. For the nine months ended September 30, 2021, merger costs included the fee associated with the termination of the CN merger agreement by KCS of $700.0 million, in addition to compensation and benefits costs and bankers’ and legal fees. See Note 2, Merger Agreement for more information.
Non-Operating Income and Expenses
Equity in net earnings (losses) of affiliates. For the three months ended September 30, 2022, equity in net earnings (losses) of affiliates decreased $3.9 million, compared to the same period in 2021, primarily due to a decrease in net earnings from the operations of Panama Canal Railway Company (“PCRC”) resulting from a gain on insurance recoveries recognized in the third quarter of 2021, and decreased net earnings from unrealized depreciation of investments held in a fifteen percent-owned equity investment.
For the nine months ended September 30, 2022, equity in net earnings of affiliates decreased $5.3 million, compared to the same period in 2021, primarily due to a decrease in net earnings from the operations of TFCM, S. de R.L de C.V. (“TCM”) due to higher interest and tax expense and decreased net earnings from the operations of PCRC as a result of the aforementioned insurance recoveries in 2021, partially offset by increased net earnings from unrealized appreciation of investments held in a fifteen percent-owned equity investment.
Interest expense. For the three and nine months ended September 30, 2022, interest expense decreased $0.1 million and increased $0.9 million, respectively, compared to the same periods in 2021, due to lower and higher average debt balances, respectively. During the three and nine months ended September 30, 2022, the average debt balance (including commercial paper) was $3,811.7 million and $3,812.3 million, respectively, compared to $3,812.4 million and $3,809.1 million for the same periods in 2021. The average interest rate during the three and nine months ended September 30, 2022 and 2021 was 4.1% for all periods.
Foreign exchange loss. For the three and nine months ended September 30, 2022, the Company incurred a foreign exchange loss of $12.3 million and $18.0 million, respectively, compared to a foreign exchange loss of $0.5 million and $1.0 million, for the same periods in 2021. Foreign exchange gain (loss) includes the re-measurement and settlement of net monetary assets denominated in Mexican pesos and the gain (loss) on foreign currency derivative contracts.
For the three and nine months ended September 30, 2022, the re-measurement and settlement of monetary assets and liabilities denominated in Mexican pesos resulted in a foreign exchange loss of $4.2 million and a gain of $0.9 million, respectively, compared to a loss of $5.4 million and $1.8 million for the same periods in 2021.
The Company enters into foreign currency derivative contracts to hedge its net exposure to fluctuations in foreign currency caused by fluctuations in the value of the Mexican peso against the U.S. dollar. For the three and nine months ended September 30, 2022, the Company incurred a foreign exchange loss on foreign currency derivative contracts of $8.1 million and $18.9 million, respectively, compared to a gain of $4.9 million and $0.8 million, for the same periods in 2021.
Other income, net. Other income, net decreased $0.3 million and $0.4 million for the three and nine months ended September 30, 2022, compared to the same periods in 2021, due to a decrease in miscellaneous income.
Income tax expense. Income tax expense increased $12.0 million for the three months ended September 30, 2022 compared to the same period in 2021, primarily due to higher pre-tax income. Income tax expense increased $180.2 million for the nine months ended September 30, 2022, compared to the same period in 2021, primarily due to higher pre-tax income resulting from the recognition of the CN termination fee, which was recognized as a discrete tax benefit of $147.0 million for the nine months ended September 30, 2021.
See the discussion regarding the Company’s tax contingencies in Item 1, Financial Statements and Supplementary Data — Note 9, Commitments and Contingencies.
The components of the effective tax rates for the three and nine months ended September 30, 2022, compared to the same periods in 2021, are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
Statutory rate in effect | 21.0 | % | | 21.0 | % | | 21.0 | % | | 21.0 | % |
Tax effect of: | | | | | | | |
Difference between U.S. and foreign tax rate | 5.6 | % | | 5.5 | % | | 5.6 | % | | (123.3 | %) |
| | | | | | | |
Inflation | (2.8 | %) | | (0.6 | %) | | (2.2 | %) | | 11.2 | % |
State and local income tax provision, net | 1.2 | % | | 1.3 | % | | 1.3 | % | | (28.1 | %) |
Foreign exchange (i) | 0.8 | % | | — | | | 0.9 | % | | (10.2 | %) |
Other, net | 0.6 | % | | 0.6 | % | | 0.5 | % | | 9.7 | % |
Effective tax rate | 26.4 | % | | 27.8 | % | | 27.1 | % | | (119.7 | %) |
(i)The Company’s Mexican subsidiaries have net U.S. dollar-denominated monetary liabilities which, for Mexican income tax purposes, are subject to periodic revaluation based on changes in the value of the Mexican peso against the U.S dollar. This revaluation creates fluctuations in the Company’s Mexican income tax expense in the consolidated income statements and the amount of income taxes paid in Mexico. The Company also has net monetary assets denominated in Mexican pesos, that are subject to periodic re-measurement and settlement that creates fluctuations in foreign currency gains and losses in the consolidated income statements. The Company hedges its net exposure to variations in earnings by entering into foreign currency forward contracts. The foreign currency forward contracts involve the Company’s agreement to buy or sell pesos at an agreed-upon exchange rate on a future date. Refer to Note 6, Derivative Instruments for more information.
Mexico Regulatory and Legal Updates
Hydrocarbons Law. On May 5, 2021, new legislation pertaining to the transport and handling of hydrocarbons in Mexico became effective. This legislation addresses a wide array of issues related to the storage, transportation and handling of petroleum products, as well as the illegal import of hydrocarbons. The legislation is being challenged in the court system by a number of stakeholders and is currently subject to a court-ordered injunction, resulting in a suspension of the implementation and enforcement of this new law. To date, this law has not had a material effect on the Company or its operations. However, the Company is continuing to monitor this law and is evaluating the effect on the Company and its business operations.
Inspections Related to Imports and Terminals. During 2021, the Ministry of Infrastructure, Communications, and Transportation (“SICT”) and other relevant Mexican authorities increased inspections of imports and enforcement of various regulations and permit requirements related to terminal operations, with specific focus on imports of refined products and refined fuel transloading terminals and freight terminals, in order to prevent the illegal importation of refined fuel products. These inspections resulted in delays related to the import of shipments into Mexico as well as the shutdown of several refined fuel terminals in the second half of 2021. The SICT has instructed KCSM to provide railway service only to those terminals that have the applicable permits. If KCSM were to fail to comply with the SICT requirements, the Company could be subject to fines and potential revocation of the Concession. As a result, KCS’s freight revenue from refined products decreased in the second half of 2021 and continued to decrease for the nine months ended September 30, 2022. See further discussion in the Revenues section.
Value-Added Tax Law. KCSM is not required to charge its customers value added tax (“VAT”) on international import or export transportation services, which prior to 2022 resulted in KCSM paying more VAT on its expenses than it collected from customers. These excess VAT payments are refundable by the Mexican government. Prior to 2019, Mexican companies could offset their monthly refundable VAT balance with other tax obligations. In January 2019, Mexico tax reform eliminated the ability to offset other tax obligations with refundable VAT. Over 2019 through 2021, KCSM generated a refundable VAT balance and filed refund claims with the Servicio de Administración Tributaria (the “SAT”), which have not been refunded.
In November 2021, changes to the VAT law were announced and became effective beginning January 1, 2022. These changes reduced the recoverability of VAT paid by KCSM on its expenditures that support international import transportation service revenues that are not subject to a VAT charge. VAT that is unrecoverable from the Mexican government results in incremental VAT expense for KCSM. Beginning in 2022, KCSM changed certain service offerings to either require VAT to be charged to customers on revenue, or impose a rate increase to offset the incremental VAT expense. These measures implemented by KCSM increased the VAT to be collected from customers and payable to the Mexican government.
As of September 30, 2022 and December 31, 2021, the KCSM refundable VAT balance was $98.6 million and $152.2 million, respectively. KCSM has prior favorable Mexican court decisions and a legal opinion supporting its right under Mexican law to recover the refundable VAT balance from the Mexican government and believes the VAT to be fully recoverable. KCSM will recover the refundable VAT balance as VAT billed to customers exceeds creditable VAT charged by vendors. As of September 30, 2022 and December 31, 2021, $81.0 million and $78.0 million, respectively, of the refundable VAT balance was classified as a short-term asset.
Carta Porte. In the second quarter of 2021, KCSM was notified by the SAT that shipping companies (cargo airlines, trucks, maritime, railroads, and other similar companies) must include additional bill of lading information (referred to in Mexico as “Carta Porte”) with the invoice for all merchandise shipped in Mexico, including cross-border, international and Mexico domestic shipments. The Carta Porte requirements and deadline were modified several times throughout 2021. The effective date of January 1, 2022 included a three month grace period during which penalties and fines for inaccurate information would not be imposed. In the first quarter of 2022, the grace period was extended to September 30, 2022 and in the third quarter of 2022, the grace period was further extended to December 31, 2022. KCSM adapted its systems to comply with the Carta Porte requirements, which delayed KCSM’s invoicing and cash collections by approximately 60 days in the second and third quarters of 2022.
Failure to comply with Carta Porte requirements subsequent to the grace period could result in penalties and fines imposed by the SAT, shipping delays causing network congestion and delayed invoicing and cash collections. In addition, in the event of repeated noncompliance with Carta Porte requirements, the SAT has the power to shut down operations of a company.
Liquidity and Capital Resources
Overview
The Company focuses its cash and capital resources on investing in the business, shareholder returns and optimizing its capital structure.
The Company believes, based on current expectations, that cash and other liquid assets, operating cash flows, and other available financing resources will be sufficient to fund anticipated operating expenses, capital expenditures, debt service costs, dividends, and other commitments for the foreseeable future.
During the nine months ended September 30, 2022, the Company invested $361.1 million in capital expenditures. See the Capital Expenditures section for further details.
Pursuant to the Merger Agreement, KCS paid a cash dividend in the first and third quarters of 2022 of $265.0 million and $200.0 million, respectively, to a wholly-owned subsidiary of CP. On October 26, 2022, the Company’s Board of Directors declared a cash dividend of up to $225.0 million, to be paid to a wholly-owned subsidiary of CP on October 31, 2022. KCS plans to make further periodic cash distributions based upon cash generated, the timing of capital expenditures, and working capital needs of the Company.
The Company’s current financing instruments contain restrictive covenants that limit or preclude certain actions; however, the covenants are structured such that the Company expects to have sufficient flexibility to conduct its operations. The Company has been, and expects to continue to be, in compliance with all of its debt covenants. For additional discussion of the agreements representing the indebtedness of KCS, see Note 11, Short-Term Borrowings and Note 12, Long-Term Debt in the “Notes to the Consolidated Financial Statements” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.
KCS believes it has a strong liquidity position to continue business operations and service its debt obligations. The Company has total available liquidity of $763.8 million as of September 30, 2022, consisting of cash on hand and a revolving credit facility, compared to available liquidity at December 31, 2021 of $939.3 million.
As of September 30, 2022, the total cash and cash equivalents held outside of the U.S. in foreign subsidiaries was $89.9 million, after repatriating $108.3 million during 2022. The Company expects that this cash will be available to fund operations without incurring significant additional income taxes.
On January 1, 2022, KCSM complied with Carta Porte requirements, providing customers with additional bill of lading information with the invoice for all merchandise shipped in Mexico. KCSM adapted its systems to comply with the Carta Porte requirements, which delayed KCSM’s invoicing and cash collections by approximately 60 days in the second and third quarters of 2022, resulting in the accounts receivable as of September 30, 2022 to be elevated compared to historical balances. The Company is targeting its accounts receivable balance to begin decreasing in the fourth quarter of 2022 and returning to historical balance levels during the first quarter of 2023.
Cash Flow Information
Summary cash flow data follows (in millions):