Table of Contents


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2018
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to        
Commission File Number 1-4717
KANSAS CITY SOUTHERN
(Exact name of registrant as specified in its charter)
Delaware
 
KCSLINESLOGO2016A09.JPG
 
44-0663509
(State or other jurisdiction of
incorporation or organization)
 
 
(I.R.S. Employer
Identification No.)
 
427 West 12th Street,
Kansas City, Missouri
 
 
 
64105
(Address of principal executive offices)
 
 
(Zip Code)
816.983.1303
(Registrant’s telephone number, including area code)
No Change
(Former name, former address and former fiscal year, if changed since last report.)
____________________________________________________  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ý     No   ¨
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes   ý     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer   ý Accelerated filer   ¨ Non-accelerated filer  ¨    Smaller reporting company   ¨
Emerging growth company   ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
October 12, 2018
Common Stock, $0.01 per share par value
 
101,697,441 Shares
 


Table of Contents


Kansas City Southern and Subsidiaries
Form 10-Q
September 30, 2018
Index
 
 
Page
PART I — FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II — OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 


2

Table of Contents


PART I — FINANCIAL INFORMATION

Item 1.
Financial Statements (unaudited)

Kansas City Southern and Subsidiaries
Consolidated Statements of Income
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
 
(In millions, except share and per share amounts)
(Unaudited)
Revenues
$
699.0

 
$
656.6

 
$
2,020.0

 
$
1,922.5

Operating expenses:
 
 
 
 
 
 
 
Compensation and benefits
123.5

 
129.0

 
367.4

 
371.6

Purchased services
52.6

 
46.3

 
149.2

 
146.5

Fuel
90.2

 
80.1

 
257.0

 
234.4

Mexican fuel excise tax credit
(9.4
)
 
(11.1
)
 
(26.6
)
 
(35.6
)
Equipment costs
33.0

 
30.9

 
95.9

 
93.3

Depreciation and amortization
87.5

 
81.9

 
257.1

 
241.6

Materials and other
65.6

 
65.7

 
199.5

 
186.9

Gain on insurance recoveries related to hurricane damage
(9.4
)
 

 
(9.4
)
 

Total operating expenses
433.6

 
422.8

 
1,290.1

 
1,238.7

Operating income
265.4

 
233.8

 
729.9

 
683.8

Equity in net earnings (losses) of affiliates
(0.2
)
 
2.8

 
1.8

 
9.7

Interest expense
(28.3
)
 
(25.2
)
 
(81.8
)
 
(74.9
)
Debt retirement costs

 

 
(2.2
)
 

Foreign exchange gain
9.5

 
0.8

 
16.3

 
61.8

Other income (expense), net
0.6

 
(0.3
)
 
0.8

 
0.7

Income before income taxes
247.0

 
211.9

 
664.8

 
681.1

Income tax expense
73.0

 
82.0

 
197.2

 
269.6

Net income
174.0

 
129.9

 
467.6

 
411.5

Less: Net income attributable to noncontrolling interest
0.4

 
0.6

 
1.3

 
1.2

Net income attributable to Kansas City Southern and subsidiaries
173.6

 
129.3

 
466.3

 
410.3

Preferred stock dividends
0.1

 
0.1

 
0.2

 
0.2

Net income available to common stockholders
$
173.5

 
$
129.2

 
$
466.1

 
$
410.1

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic earnings per share
$
1.71

 
$
1.24

 
$
4.56

 
$
3.89

Diluted earnings per share
$
1.70

 
$
1.23

 
$
4.55

 
$
3.88

 
 
 
 
 
 
 
 
Average shares outstanding (in thousands):
 
 
 
 
 
 
 
Basic
101,658

 
104,324

 
102,106

 
105,297

Potentially dilutive common shares
452

 
354

 
418

 
285

Diluted
102,110

 
104,678

 
102,524

 
105,582

See accompanying notes to the unaudited consolidated financial statements.


3

Table of Contents


Kansas City Southern and Subsidiaries
Consolidated Statements of Comprehensive Income

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
 
(In millions)
(Unaudited)
Net income
$
174.0

 
$
129.9

 
$
467.6

 
$
411.5

Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized gain (loss) on interest rate derivative instruments during the period, net of tax of $1.1 million, $(0.3) million, $3.2 million and $(1.8) million, respectively
3.5

 
(0.5
)
 
9.5

 
(2.8
)
Foreign currency translation adjustments, net of tax of $(0.1) million and $0.7 million, respectively, for 2017
0.7

 
(0.2
)
 
0.7

 
1.1

Other comprehensive income (loss)
4.2

 
(0.7
)
 
10.2

 
(1.7
)
Comprehensive income
178.2

 
129.2

 
477.8

 
409.8

Less: Comprehensive income attributable to noncontrolling interest
0.4

 
0.6

 
1.3

 
1.2

Comprehensive income attributable to Kansas City Southern and subsidiaries
$
177.8

 
$
128.6

 
$
476.5

 
$
408.6

See accompanying notes to the unaudited consolidated financial statements.


4

Table of Contents


Kansas City Southern and Subsidiaries
Consolidated Balance Sheets
 
 
September 30,
2018
 
December 31,
2017
 
(In millions, except share and per share amounts)
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
107.1

 
$
134.1

Accounts receivable, net
272.0

 
237.8

Materials and supplies
155.2

 
150.8

Other current assets
81.6

 
157.4

Total current assets
615.9

 
680.1

Investments
46.5

 
44.6

Property and equipment (including concession assets), net
8,644.5

 
8,403.8

Other assets
102.2

 
70.2

Total assets
$
9,409.1

 
$
9,198.7

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Long-term debt due within one year
$
10.5

 
$
38.8

Short-term borrowings

 
345.1

Accounts payable and accrued liabilities
455.4

 
587.8

Total current liabilities
465.9

 
971.7

Long-term debt
2,680.7

 
2,235.5

Deferred income taxes
1,069.2

 
987.2

Other noncurrent liabilities and deferred credits
102.5

 
138.9

Total liabilities
4,318.3

 
4,333.3

Stockholders’ equity:
 
 
 
$25 par, 4% noncumulative, preferred stock, 840,000 shares authorized, 649,736 shares issued; 232,945 and 242,170 shares outstanding at September 30, 2018 and December 31, 2017, respectively
5.9

 
6.1

$.01 par, common stock, 400,000,000 shares authorized; 123,352,185 shares issued; 101,697,129 and 103,036,805 shares outstanding at September 30, 2018 and December 31, 2017, respectively
1.0

 
1.0

Additional paid-in capital
949.9

 
943.3

Retained earnings
3,818.4

 
3,611.4

Accumulated other comprehensive loss
(3.4
)
 
(12.9
)
Total stockholders’ equity
4,771.8

 
4,548.9

Noncontrolling interest
319.0

 
316.5

Total equity
5,090.8

 
4,865.4

Total liabilities and equity
$
9,409.1

 
$
9,198.7

See accompanying notes to the unaudited consolidated financial statements.


5

Table of Contents


Kansas City Southern and Subsidiaries
Consolidated Statements of Cash Flows

 
Nine Months Ended
 
September 30,
 
2018
 
2017
 
(In millions)
(Unaudited)
Operating activities:
 
 
 
Net income
$
467.6

 
$
411.5

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
257.1

 
241.6

Deferred income taxes
78.8

 
146.6

Equity in net earnings of affiliates
(1.8
)
 
(9.7
)
Share-based compensation
16.0

 
14.6

Distributions from affiliates
2.5

 
5.0

Settlement of foreign currency derivative instruments
13.8

 
(14.4
)
Gain on foreign currency derivative instruments
(10.3
)
 
(45.5
)
Mexican fuel excise tax credit
(26.6
)
 
(35.6
)
Gain on insurance recoveries related to hurricane damage
(9.4
)
 

Deemed mandatory repatriation tax
(18.7
)
 

Changes in working capital items:
 
 
 
Accounts receivable
(39.2
)
 
(46.8
)
Materials and supplies
1.3

 
1.1

Other current assets
2.2

 
(24.4
)
Accounts payable and accrued liabilities
(22.5
)
 
109.0

Other, net
(5.0
)
 
(19.3
)
Net cash provided by operating activities
705.8

 
733.7

 
 
 
 
Investing activities:
 
 
 
Capital expenditures
(396.8
)
 
(446.9
)
Purchase or replacement of equipment under operating leases
(98.9
)
 
(42.6
)
Property investments in MSLLC
(24.0
)
 
(23.7
)
Investments in and advances to affiliates
(10.3
)
 
(20.3
)
Proceeds from disposal of property
7.2

 
6.6

Other, net
(2.2
)
 
(15.1
)
Net cash used for investing activities
(525.0
)
 
(542.0
)
 
 
 
 
Financing activities:
 
 
 
Proceeds from short-term borrowings
4,158.0

 
9,772.2

Repayment of short-term borrowings
(4,506.1
)
 
(9,600.9
)
Proceeds from issuance of long-term debt
499.4

 

Repayment of long-term debt
(78.7
)
 
(20.2
)
Dividends paid
(110.9
)
 
(105.1
)
Shares repurchased
(163.3
)
 
(320.4
)
Debt issuance and retirement costs paid
(8.0
)
 

Proceeds from employee stock plans
1.8

 
0.5

Net cash used for financing activities
(207.8
)
 
(273.9
)
Cash and cash equivalents:
 
 
 
Net decrease during each period
(27.0
)
 
(82.2
)
At beginning of year
134.1

 
170.6

At end of period
$
107.1

 
$
88.4

See accompanying notes to the unaudited consolidated financial statements.

6

Table of Contents


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

1. Basis of Presentation
In the opinion of the management of KCS, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal and recurring adjustments) necessary to reflect a fair statement of the results for interim periods in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). Pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 . The results of operations for the three and nine months ended September 30, 2018 , are not necessarily indicative of the results to be expected for the full year ending December 31, 2018 .
During the first quarter of 2018, the Company adopted Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which is also known as Accounting Standard Codification ("ASC") Topic 606, for all contracts, using the modified retrospective method. Results from reporting periods beginning after January 1, 2018, are presented under ASC Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company's historical accounting under ASC Topic 605, Revenue Recognition . The adoption of this guidance did not have a significant impact on the Company's consolidated financial statements; thus no adjustment was made to the opening balance of equity at January 1, 2018. See Note 3 - Revenue for additional information.
During the first quarter of 2018, the Company adopted ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows for a reclassification from accumulated other comprehensive loss to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The Company applied the guidance as of the beginning of the period of adoption and reclassified $0.7 million , due to the change in federal corporate tax rate, from accumulated other comprehensive loss to retained earnings. It is the Company’s policy to release income tax effects from accumulated other comprehensive loss using the portfolio approach.

2. New Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, Leases , which requires lessees to recognize for all leases a right-to-use asset and a lease obligation in the consolidated balance sheet. Expenses are recognized in the consolidated statement of income in a manner similar to current accounting guidance. Lessees are permitted to make an accounting policy election to not recognize an asset and liability for leases with a term of twelve months or less. Lessor accounting under the new standard is substantially unchanged. Additional qualitative and quantitative disclosures, including significant judgments made by management, will be required. The new standard will become effective for the Company beginning with the first quarter 2019. The Company plans to adopt the accounting standard using a prospective transition approach, which applies the provisions of the new guidance at the effective date without adjusting the comparative periods presented. The Company continues to assess the contractual arrangements that may qualify as a lease under the new standard and is implementing a lease accounting system. At December 31, 2017, KCS disclosed approximately $282 million of undiscounted operating leases in the leases and debt maturities table within Note 11, Long-Term Debt in the Company’s most recent Form 10-K and will evaluate those contracts as well as other existing arrangements to determine if they qualify for lease accounting under the new standard. The Company is continuing to evaluate the impacts the adoption of this accounting guidance will have on the consolidated financial statements.

3. Revenue
Significant Accounting Policy
The primary performance obligation for the Company is to move customers’ freight from an origin to a destination. A performance obligation is created when a customer under a transportation contract or public tariff submits a bill of lading for the transport of goods. The Company recognizes revenue proportionally as a shipment moves from origin to destination, using the distance shipped to measure progress, as the customer simultaneously receives and consumes the benefit over time. Related expenses are recognized as incurred. Revenue associated with in-transit shipments at period end is recognized based on the distance shipped as of the balance sheet date. Payment is received at or shortly after the performance obligation is satisfied.
The transaction price is generally in the form of a fixed fee determined at the inception of the transportation contract or the inception of the bill of lading. Certain customer agreements have variable consideration that are based on milestone achievements in the form of rebates, discounts or incentives. The Company makes judgments to determine whether the variable consideration is p

7


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

robable of occurring and should be included in the estimated transaction price at the beginning of the period to apply a more consistent rate throughout the year based on an analysis of historical experience with the customer, forecasted shipments, and other economic indicators. The Company adjusts the estimate on a quarterly basis.
Other revenues, including switching, storage, and demurrage are distinct services and are recognized as services are performed or as contractual obligations are fulfilled. The consideration for other revenue is allocated between the separate services based upon the stand-alone transaction price.
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 14 for revenues by geographical area.
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
(ASC 606)
 
2017
(ASC 605)
 
2018
(ASC 606)
 
2017
(ASC 605)
Chemical & Petroleum
 
 
 
 
 
 
 
Chemicals
$
60.9

 
$
57.0

 
$
179.0

 
$
167.6

Petroleum
64.5

 
47.6

 
171.3

 
137.2

Plastics
35.2

 
32.3

 
107.8

 
97.4

Total
160.6

 
136.9

 
458.1

 
402.2

 
 
 
 
 
 
 
 
Industrial & Consumer Products
 
 
 
 
 
 
 
Forest Products
68.7

 
64.3

 
203.2

 
190.0

Metals & Scrap
50.1

 
58.9

 
157.9

 
170.5

Other
33.7

 
29.3

 
90.4

 
80.7

Total
152.5

 
152.5

 
451.5

 
441.2

 
 
 
 
 
 
 
 
Agriculture & Minerals
 
 
 
 
 
 
 
Grain
68.5

 
68.6

 
209.1

 
207.9

Food Products
34.9

 
34.7

 
107.4

 
111.1

Ores & Minerals
5.4

 
5.8

 
16.1

 
14.9

Stone, Clay & Glass
7.4

 
6.9

 
22.1

 
21.8

Total
116.2

 
116.0

 
354.7

 
355.7

 
 
 
 
 
 
 
 
Energy
 
 
 
 
 
 
 
Utility Coal
35.4

 
46.0

 
88.6

 
127.8

Coal & Petroleum Coke
11.9

 
9.4

 
33.3

 
30.7

Frac Sand
8.8

 
13.8

 
30.4

 
38.5

Crude Oil
17.1

 
5.3

 
38.7

 
17.0

Total
73.2

 
74.5

 
191.0

 
214.0

 
 
 
 
 
 
 
 
Intermodal
100.0

 
92.3

 
284.6

 
266.4

 
 
 
 
 
 
 
 
Automotive
66.2

 
61.4

 
193.3

 
170.2

 
 
 
 
 
 
 
 
Total Freight Revenues
668.7

 
633.6

 
1,933.2

 
1,849.7

 
 
 
 
 
 
 
 
Other Revenue
30.3

 
23.0

 
86.8

 
72.8

 
 
 
 
 
 
 
 
Total Revenues
$
699.0

 
$
656.6

 
$
2,020.0

 
$
1,922.5

Major customers
No individual customer makes up greater than 10% of total consolidated revenues.
Contract Balances
The amount of revenue recognized in the third quarter of 2018 from performance obligations partially satisfied in previous periods was $25.8 million . The performance obligations that were unsatisfied or partially satisfied as of September 30, 2018 , were $30.1 million , which represents in-transit shipments that are fully satisfied the following month.

8


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

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, 2018 , and December 31, 2017 , the accounts receivable, net balance was $272.0 million and $237.8 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, 2018 , and December 31, 2017.
Contract liabilities represent advance consideration received 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 2018 that was included in the opening contract liability balance was $9.3 million . The Company has recognized contract liabilities within the accounts payable and accrued liabilities financial statement caption on the balance sheet. These are considered current liabilities as they will be settled in less than 12 months.
The following tables summarize the changes in contract liabilities (in millions) :
Contract liabilities
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
(ASC 606)
 
2017
(ASC 605)
 
2018
(ASC 606)
 
2017
(ASC 605)
Beginning balance
 
$
16.6

 
$
5.9

 
$
26.8

 
$
13.7

Revenue recognized that was included in the contract liability balance at the beginning of the period
 
(9.3
)
 
(4.6
)
 
(23.7
)
 
(13.7
)
Increases due to cash received, excluding amounts recognized as revenue during the period
 
0.9

 
2.2

 
5.1

 
3.5

Ending balance
 
$
8.2

 
$
3.5

 
$
8.2

 
$
3.5


4. Hurricane Harvey
In late August 2017, Hurricane Harvey made landfall on the Texas coast and caused flood damage to the Company’s track infrastructure and significantly disrupted the Company’s rail service. The Company filed a claim in the fourth quarter of 2017 under its insurance program for property damage, incremental expenses, and lost profits caused by Hurricane Harvey. In the third quarter of 2017, the Company recognized a receivable for probable insurance recovery offsetting the impact of incremental expenses recognized in the quarter. During the third quarter of 2018, the Company partially settled its insurance claim for $27.0 million . As a result of this nonrefundable partial settlement, the Company recognized a gain on insurance recoveries of $9.4 million , net of the self-insured retention and insurance receivable. The Company received the nonrefundable cash proceeds from this partial settlement in October 2018.

5. Income Taxes
Tax Cuts and Jobs Act. On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (the “Tax Reform Act”). The legislation significantly changed U.S. tax law by, among other things, lowering corporate income tax rates, implementing a territorial tax system and imposing a repatriation tax on deemed repatriated earnings of foreign subsidiaries. The Tax Reform Act permanently reduced the U.S. corporate income tax rate from a maximum of 35% to a 21% rate, effective January 1, 2018.
While the Tax Reform Act provides for a territorial tax system, beginning in 2018, it includes the global intangible low-taxed income (“GILTI”) provision. The Company elected to account for GILTI tax in the period in which it is incurred. The GILTI provisions require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary’s tangible assets. The GILTI tax expense is primarily caused by two aspects of U.S. foreign tax credit limitation provisions. First, required allocations of interest expense to the GILTI income effectively renders the expense non-deductible. Secondly, as enacted in the Tax Reform Act, U.S. income tax return income inclusion of the foreign taxes paid on the GILTI income is subject to U.S. tax without any associated foreign tax credit, resulting in incremental U.S. income tax. During the third quarter of 2018, the Treasury Department acknowledged in writing that proposed regulations related to the foreign tax credit aspects of GILTI are forthcoming, which they anticipate will allow for a credit against the U.S. income tax on the income inclusion for foreign taxes paid on the GILTI income. Therefore, the Company concluded that this aspect of the foreign tax credit limitations is more likely than not to be sustained despite the conflict with the enacted tax law, and accordingly, the Company adjusted the expected GILTI tax. As a result of the GILTI provisions, the Company’s effective tax rate decreased by 0.3% for the three months ended September 30, 2018 , and increased by 1.1% for the nine months ended September 30, 2018 .

9


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

Provisional Tax Impacts. On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform Act. The Company recognized provisional tax impacts related to the deemed repatriated earnings and the revaluation of deferred tax assets and liabilities in its consolidated financial statements for the year ended December 31, 2017. Any adjustments made to the provisional amounts under SAB 118 should be recorded as discrete adjustments in the period identified (not to extend beyond the one-year measurement provided in SAB 118).
On April 2, 2018, the Internal Revenue Service (“IRS”) issued guidance on how to determine, report and pay the repatriation tax on deemed repatriated earnings of foreign subsidiaries provided in the Tax Reform Act and included in the consolidated financial statements for the year ended December 31, 2017. During the second quarter of 2018, the Company recognized a $4.3 million discrete tax benefit resulting from the additional guidance.
During the third quarter of 2018, the Company recognized a $16.6 million discrete tax benefit for adjustments to the provisional tax impacts of the Tax Reform Act included in its consolidated financial statement for the year ended December 31, 2017. These adjustments include a $14.4 million reduction in the provisional tax on deemed repatriated earnings and a $2.2 million tax benefit from changes in its revaluation of deferred tax assets and liabilities due to additional analysis, changes in interpretations and assumptions the Company made, additional regulatory guidance that was issued, and actions the Company took as a result of the Tax Reform Act. The Company expects that there could be more changes in interpretations and assumptions made by the Company or additional regulatory guidance issued that would further adjust the provisional tax amounts. As such, the deemed repatriated earnings and the revaluation of deferred tax assets and liabilities are provisional as of September 30, 2018. The accounting will be completed in the fourth quarter of 2018.

6. Earnings Per Share Data
Basic earnings per common share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share adjusts basic earnings per common share for the effects of potentially dilutive common shares, if the effect is not anti-dilutive. Potentially dilutive common shares include the dilutive effects of shares issuable under the stock option and performance award plans.
The following table reconciles the basic earnings per share computation to the diluted earnings per share computation (in millions, except share and per share amounts) :
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Net income available to common stockholders for purposes of computing basic and diluted earnings per share
$
173.5

 
$
129.2

 
$
466.1

 
$
410.1

Weighted-average number of shares outstanding ( in thousands ):
 
 
 
 
 
 
 
Basic shares
101,658

 
104,324

 
102,106

 
105,297

Effect of dilution
452

 
354

 
418

 
285

Diluted shares
102,110

 
104,678

 
102,524

 
105,582

Earnings per share:
 
 
 
 
 
 
 
Basic earnings per share
$
1.71

 
$
1.24

 
$
4.56

 
$
3.89

Diluted earnings per share
$
1.70

 
$
1.23

 
$
4.55

 
$
3.88


Potentially dilutive shares excluded from the calculation (in thousands):
Stock options excluded as their inclusion would be anti-dilutive
93

 
14

 
116

 
159



10


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

7. 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,
2018
 
December 31,
2017
Land
$
219.4

 
$
218.6

Concession land rights
141.2

 
141.2

Road property
7,507.4

 
7,557.1

Equipment
2,726.1

 
2,534.9

Technology and other
297.6

 
229.1

Construction in progress
196.2

 
223.7

Total property
11,087.9

 
10,904.6

Accumulated depreciation and amortization
2,443.4

 
2,500.8

Property and equipment (including concession assets), net
$
8,644.5

 
$
8,403.8

Concession assets, net of accumulated amortization of $578.4 million and $638.2 million , totaled $2,243.9 million and $2,208.1 million at September 30, 2018 and December 31, 2017 , respectively.

8. Fair Value Measurements
The Company’s derivative financial instruments are measured at fair value on a recurring basis and consist of foreign currency forward and option contracts and treasury lock agreements, which are classified as Level 2 valuations. The Company determines the fair value of its derivative financial instrument positions based upon pricing models using inputs observed from actively quoted markets and also takes into consideration the contract terms as well as other inputs, including market currency exchange rates and in the case of option contracts, volatility, the risk-free interest rate and the time to expiration.
The Company’s short-term financial instruments include cash and cash equivalents, accounts receivable, accounts payable and short-term borrowings. The carrying value of the short-term financial instruments approximates their fair value.
The fair value of the Company’s debt is estimated using quoted market prices when available. When quoted market prices are not available, fair value is estimated based on current market interest rates for debt with similar maturities and credit quality. The carrying value of the Company’s debt was $2,691.2 million and $2,274.3 million at September 30, 2018 and December 31, 2017 , 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, 2018
 
December 31, 2017
 
 
Level 2
 
Level 2
Assets
 
 
 
 
Foreign currency derivative instruments
 
$
4.4

 
$
7.9

Treasury lock agreements
 
7.1

 

Liabilities
 
 
 
 
Debt instruments
 
2,648.0

 
2,377.8

Treasury lock agreements
 

 
5.6


9 . 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.

11


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

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, 2018 , the Company did not expect any losses as a result of default of its counterparties.
Interest Rate Derivative Instruments . In May 2017, the Company executed four treasury lock agreements with an aggregate notional value of $275.0 million and a weighted average interest rate of 2.85% . 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 $275.0 million , 2.35% senior notes due May 15, 2020 . The Company has designated the treasury locks as cash flow hedges and recorded unrealized gains and losses in accumulated other comprehensive loss. Upon settlement, the unrealized gain or loss in accumulated other comprehensive income will be amortized to interest expense over the life of the future underlying debt issuance.
Foreign Currency Derivative Instruments. The Company’s Mexican subsidiaries have net U.S. dollar-denominated monetary liabilities which, for Mexican income tax purposes, are subject to periodic revaluation based on changes in the value of the Mexican peso against the U.S. dollar. This revaluation creates fluctuations in the Company’s Mexican income tax expense and the amount of income taxes paid in Mexico. The Company hedges its exposure to this cash tax risk by entering into foreign currency forward contracts and foreign currency option contracts known as zero-cost collars.
The foreign currency forward contracts involve the Company’s purchase of pesos at an agreed-upon weighted-average exchange rate to each U.S dollar. The zero-cost collars involve the Company’s purchase of a Mexican peso call option and a simultaneous sale of a Mexican peso put option, with equivalent U.S. dollar notional amounts for each option and no net cash premium paid by the Company. The Company’s foreign currency forward and zero-cost collar contracts are executed with counterparties in the U.S. and are governed by an International Swaps and Derivatives Association agreement that includes standard netting arrangements. Asset and liability positions from contracts with the same counterparty are net settled upon maturity/expiration and presented on a net basis in the consolidated balance sheets prior to settlement.
Below is a summary of the Company’s 2018 and 2017 foreign currency derivative contracts (amounts in millions, except Ps./USD) :
Foreign currency forward contracts
 
 
 
 
 
 
 
Contracts to purchase Ps./pay USD
 
Offsetting contracts to sell Ps./receive USD
 
 
 
Notional amount  
 
Notional amount  
 
Weighted-average exchange rate
(in Ps./USD)
 
Maturity date
 
Notional amount  
 
Notional amount  
 
Weighted-average exchange rate
(in Ps./USD)
 
Maturity date
 
Cash received/(paid) on settlement
Contracts executed in 2016 and settled in 2017
$
340.0

 
Ps.
6,207.7

 
Ps.
18.3

 
1/17/2017

 
$
287.0

 
Ps.
6,207.7

 
Ps.
21.6

 
1/17/2017
 
$
(53.0
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency zero-cost collar contracts
 
 
 
 
 
 
 
Notional amount  
 
Weighted-average call rate outstanding options
(in Ps./USD)
 
Weighted-average put rate outstanding options
(in Ps./USD)
 
Cash received/(paid) on settlement
 
 
 
 
 
 
 
 
 
 
Contracts executed in 2018 and outstanding
$
140.0

 
Ps.
19.3

 
Ps.
22.6

 

 
 
 
 
 
 
 
 
 
 
Contracts executed in 2018 and settled in 2018
$
200.0

 
 
 
 
 
$
3.8

 
 
 
 
 
 
 
 
 
 
Contracts executed in 2017 and settled in 2018
$
80.0

 
 
 
 
 
$
10.0

 
 
 
 
 
 
 
 
 
 
Contracts executed in 2017 and settled in 2017 (i)
$
450.0

 
 
 
 
 
$
42.2

 
 
 
 
 
 
 
 
 
 
(i) During the nine months ended September 30, 2017, the Company settled $415.0 million of zero-cost collar contracts, resulting in cash received of $38.6 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

12


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

value in foreign exchange gain within the consolidated statements of income. The cash flows associated with these instruments is classified as an operating activity within the consolidated statements of cash flows.

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,
2018
 
December 31, 2017
Derivatives designated as hedging instruments:
 
 
 
 
 
Treasury lock agreements
Other assets
 
$
7.1

 
$

Total derivatives designated as hedging instruments
 
 
7.1

 

Derivatives not designated as hedging instruments:
 
 
 
 
 
Foreign currency zero-cost collar contracts
Other current assets
 
$
4.4

 
$
7.9

Total derivatives not designated as hedging instruments
 
 
4.4

 
7.9

Total derivative assets
 
 
$
11.5

 
$
7.9

 
Derivative Liabilities
 
Balance Sheet Location
 
September 30,
2018
 
December 31, 2017
Derivatives designated as hedging instruments:
 
 
 
 
 
 Treasury lock agreements
Other noncurrent liabilities and deferred credits
 
$

 
$
5.6

Total derivatives designated as hedging instruments
 
 

 
5.6

Total derivative liabilities
 
 
$

 
$
5.6


The following tables summarize the gross and net fair value of derivative assets and liabilities (in millions):
Offsetting of Derivative Assets
 
 
 
 
 
 
As of September 30, 2018
 
Gross Assets
 
Gross Liabilities
 
Net Amounts Presented in the Consolidated Balance Sheets
Derivatives subject to a master netting arrangement or similar agreement
 
$
4.6

 
$
(0.2
)
 
$
4.4

As of December 31, 2017
 
 
 
 
 
 
Derivatives subject to a master netting arrangement or similar agreement
 
$
7.9

 
$

 
$
7.9


Offsetting of Derivative Liabilities
 
 
 
 
 
 
As of September 30, 2018
 
Gross Liabilities
 
Gross Assets
 
Net Amounts Presented in the Consolidated Balance Sheets
Derivatives subject to a master netting arrangement or similar agreement
 
$
(0.2
)
 
$
0.2

 
$

As of December 31, 2017
 
 
 
 
 
 
Derivatives subject to a master netting arrangement or similar agreement
 
$

 
$

 
$


13


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

The following table presents the effects of derivative instruments on the Consolidated Statements of Income and Consolidated Statements of Comprehensive Income (in millions) :
Derivatives in Cash Flow Hedging Relationships
 
 
 
Amount of Gain/(Loss) Recognized in OCI on Derivative
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
September 30,
 
September 30,
 
 
 
 
2018
 
2017
 
2018
 
2017
Treasury lock agreements
 
 
 
$
4.6

 
$
(0.8
)
 
$
12.7

 
$
(4.6
)
     Total
 
 
 
$
4.6

 
$
(0.8
)
 
$
12.7

 
$
(4.6
)


Derivatives Not Designated as Hedging Instruments
Location of Gain/(Loss) Recognized in Income on Derivative
 
 
Amount of Gain/(Loss) Recognized in Income on Derivative
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
September 30,
 
September 30,
 
 
 
 
2018
 
2017
 
2018
 
2017
Foreign currency zero-cost collar contracts
Foreign exchange gain
 
 
$
6.2

 
$
3.3

 
$
10.3

 
$
57.4

Foreign currency forward contracts
Foreign exchange gain
 
 

 

 

 
(11.9
)
     Total
 
 
 
$
6.2

 
$
3.3

 
$
10.3

 
$
45.5


10. 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, 2018 , KCS had no commercial paper outstanding. As of December 31, 2017 , KCS had $345.1 million of commercial paper outstanding, net of $0.1 million discount, at a weighted-average interest rate of 1.846% .

11. Long-Term Debt
Senior Notes
On May 3, 2018, KCS issued $500.0 million principal amount of senior unsecured notes due May 1, 2048 (the “4.700% Senior Notes”), which bear interest semiannually at a fixed annual rate of 4.700% . The 4.700% Senior Notes were issued at a discount to par value, resulting in a $0.6 million discount and a yield to maturity of 4.707% . The net proceeds from the offering were used to repay the outstanding commercial paper issued by KCS, repay a locomotive lease and certain equipment loans, and for general corporate purposes. The 4.700% Senior Notes are redeemable at the issuer’s option, in whole or in part, at any time, by paying the greater of either 100% of the principal amount to be redeemed or a formula price based on interest rates prevailing at the time of redemption and time remaining to maturity.
The 4.700% Senior Notes include certain covenants which are customary for this type of debt instrument issued by borrowers with similar credit ratings. The 4.700% Senior Notes are unsecured and unsubordinated obligations of the Company and are unconditionally guaranteed, jointly and severally, by The Kansas City Southern Railway Company (“KCSR”) and each current and future domestic subsidiary of KCS that guarantees the KCS revolving credit facility or certain other debt of KCS or a note guarantor.
On May 3, 2018, Kansas City Southern de México, S.A. de C.V. (“KCSM”) repurchased $5.3 million of the remaining $10.9 million aggregate principal amount of its 3.0% senior unsecured notes due May 15, 2023 , at a discounted price equal to 95.91% of the principal amount. As a result, the Company recognized a debt retirement benefit of $0.2 million within debt retirement costs in the consolidated statements of income.
Financing Agreements
During May 2018, the Company paid the remaining $23.0 million and $19.1 million principal amounts under its locomotive financing agreements with Export Development Canada and DVB Bank AG, respectively, using a portion of the proceeds from the issuance of the 4.700% Senior Notes. As a result of the early repayment, the Company recognized $2.4 million in debt retirement costs in the consolidated statements of income.


14


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

12 . Equity
The following tables summarize the changes in equity ( in millions):
    
 
Three Months Ended September 30, 2018
 
Three Months Ended September 30, 2017
 
Kansas City
Southern
Stockholders’
Equity
 
Noncontrolling
Interest
 
Total
Equity
 
Kansas City
Southern
Stockholders’
Equity
 
Noncontrolling
Interest
 
Total
Equity
Beginning balance
$
4,677.6

 
$
318.6

 
$
4,996.2

 
$
4,192.6

 
$
315.2

 
$
4,507.8

Net income
173.6

 
0.4

 
174.0

 
129.3

 
0.6

 
129.9

Other comprehensive income (loss)
4.2

 

 
4.2

 
(0.7
)
 

 
(0.7
)
Dividends on common stock
(36.6
)
 

 
(36.6
)
 
(37.3
)
 

 
(37.3
)
Dividends on $25 par preferred stock
(0.1
)
 

 
(0.1
)
 
(0.1
)
 

 
(0.1
)
Share repurchases
(54.8
)
 

 
(54.8
)
 
(200.0
)
 

 
(200.0
)
Options exercised and stock subscribed, net of shares withheld for employee taxes
3.5

 

 
3.5

 
2.7

 

 
2.7

Share-based compensation
4.4

 

 
4.4

 
4.1

 

 
4.1

Ending balance
$
4,771.8

 
$
319.0

 
$
5,090.8

 
$
4,090.6

 
$
315.8

 
$
4,406.4



 
Nine Months Ended September 30, 2018
 
Nine Months Ended September 30, 2017
 
Kansas City
Southern
Stockholders’
Equity
 
Noncontrolling
Interest
 
Total
Equity
 
Kansas City
Southern
Stockholders’
Equity
 
Noncontrolling
Interest
 
Total
Equity
Beginning balance
$
4,548.9

 
$
316.5

 
$
4,865.4

 
$
4,089.9

 
$
314.6

 
$
4,404.5

Cumulative-effect adjustment (i)

 

 

 
2.5

 

 
2.5

Net income
466.3

 
1.3

 
467.6

 
410.3

 
1.2

 
411.5

Other comprehensive income (loss)
10.2

 

 
10.2

 
(1.7
)
 

 
(1.7
)
Contribution from noncontrolling interest

 
1.2

 
1.2

 

 

 

Dividends on common stock
(110.3
)
 

 
(110.3
)
 
(107.2
)
 

 
(107.2
)
Dividends on $25 par preferred stock
(0.2
)
 

 
(0.2
)
 
(0.2
)
 

 
(0.2
)
Share repurchases
(163.3
)
 

 
(163.3
)
 
(320.4
)
 

 
(320.4
)
Options exercised and stock subscribed, net of shares withheld for employee taxes
4.2

 

 
4.2

 
2.8

 

 
2.8

Share-based compensation
16.0

 

 
16.0

 
14.6

 

 
14.6

Ending balance (ii)
$
4,771.8

 
$
319.0

 
$
5,090.8

 
$
4,090.6

 
$
315.8

 
$
4,406.4

(i)
The Company recognized a $2.5 million net cumulative-effect adjustment to equity as of January 1, 2017, due to the adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting .
(ii) The Company reclassified $0.7 million of stranded tax effects out of accumulated other comprehensive loss and into retained earnings during the first quarter of 2018 , due to the adoption of ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. For additional discussion, see Note 1 - Basis of Presentation.
Share Repurchases
In August 2017, the Company announced a new common share repurchase program authorizing the Company to repurchase up to $800.0 million of its outstanding shares of common stock through June 30, 2020 (the “2017 Program”). Share repurchases under the 2017 Program may be made in the open market, through privately negotiated transactions, or through an accelerated share repurchase

15


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

(“ASR”) program limited to $200.0 million . The Company entered into and settled an ASR program for the full ASR amount authorized under the 2017 Program during the second half of 2017.
During the three months ended September 30, 2018 , KCS repurchased 471,829 shares of common stock for $54.6 million at an average price of $115.58 per share. During the nine months ended September 30, 2018 , KCS repurchased 1,475,206 shares of common stock for $163.1 million at an average price of $110.54 per share. Since inception of the 2017 Program, KCS has repurchased 3,894,675 shares of common stock for $418.3 million at an average price of $107.39 per share. The excess of repurchase price over par value is allocated between additional paid-in capital and retained earnings.
During the three months ended September 30, 2018 , KCS repurchased 9,225 shares of its $25 par preferred stock for $0.2 million at an average price of $26.11 per share. The excess of repurchase price over par value is allocated between additional paid-in capital and retained earnings.
Cash Dividends on Common Stock
On August 14, 2018 , the Company’s Board of Directors declared a cash dividend of $0.36 per share payable on October 3, 2018 , to common stockholders of record as of September 10, 2018 . The aggregate amount of the dividends declared for the three and nine months ended September 30, 2018 was $36.6 million and $110.3 million , respectively.
The following table presents the amount of cash dividends declared per common share by the Company’s Board of Directors:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Cash dividends declared per common share
$
0.36

 
$
0.36

 
$
1.08

 
$
1.02


13 . 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, 2018 , the concession duty expense, which is recorded within materials and other in operating expenses, was $4.6 million and $13.3 million , respectively, compared to $4.2 million and $12.7 million for the same periods in 2017 .
Litigation. The Company is a party to various legal proceedings and administrative actions, all of which are of an ordinary, routine nature and incidental to its operations. Included in these proceedings are various tort claims brought by current and former employees for job-related injuries and by third parties for injuries related to railroad operations. KCS aggressively defends these matters and has established liability provisions, which management believes are adequate to cover expected costs. Although it is not possible to predict the outcome of any legal proceeding, in the opinion of management, such proceedings and actions should not, individually, or in the aggregate, have a material adverse effect on the Company’s consolidated financial statements.
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 Federal Water Pollution Control 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.

16


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

The risk of incurring environmental liability is inherent in the railroad industry. As part of serving the petroleum and chemicals industry, the Company transports hazardous materials and has a professional team available to respond to and handle environmental issues that might occur in the transport of such materials.
The Company performs ongoing reviews and evaluations of the various environmental programs and issues within the Company’s operations, and, as necessary, takes actions intended to limit the Company’s exposure to potential liability. Although these costs cannot be predicted with certainty, management believes that the ultimate outcome of identified matters will not have a material adverse effect on the Company’s consolidated financial statements.
Personal Injury.  The Company’s personal injury liability is based on semi-annual actuarial studies performed on an undiscounted basis by an independent third party actuarial firm and reviewed by management. This liability is based on personal injury claims filed and an estimate of claims incurred but not yet reported. Actual results may vary from estimates due to the number, type and severity of the injury, costs of medical treatments and uncertainties in litigation. Adjustments to the liability are reflected within operating expenses in the period in which changes to estimates are known. Personal injury claims in excess of self-insurance levels are insured up to certain coverage amounts, depending on the type of claim and year of occurrence. The personal injury liability as of September 30, 2018 , was based on an updated actuarial study of personal injury claims through May 31, 2018, and review of the last four 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 2014 and in Mexico for periods after 2012 remain open to examination by the taxing authorities. In 2018, the IRS initiated an examination of the 2016 U.S. federal tax return. During the first quarter of 2017, the Company received audit assessments from the Servicio de Administración Tributaria (the “SAT”), the Mexican equivalent of the IRS, for the KCSM 2009 and 2010 Mexico tax returns. In 2017, the Company commenced administrative actions with the SAT. During the first quarter of 2018, the audit assessments were nullified by the SAT. In the third quarter of 2018, the SAT issued new assessments and the Company filed administrative appeals with the SAT. The Company believes that it has strong legal arguments in its favor and it is more likely than not that it will prevail in any challenge of the assessments.
The Company litigated a Value Added Tax (“VAT”) audit assessment from the SAT for KCSM for the year ended December 31, 2005. In November 2016, KCSM was notified of a resolution by the Mexican tax court annulling this assessment. The SAT appealed this resolution to the Mexican circuit court. In September 2017, KCSM was notified of a resolution by the circuit court which ordered the tax court to consider an argument made by KCSM in the original tax court proceeding that was not addressed in the tax court’s November 2016 resolution. In October 2017, the tax court ruled that the arguments made by KCSM asserting that the SAT unduly extended the audit process were not valid, and also annulled the assessment consistent with the tax court’s earlier November 2016 ruling. In December 2017, KCSM and the SAT filed an appeal with the Federal Courts of Appeals. The Company believes it is probable that the court will continue to annul the 2005 VAT assessment. Further, the Company believes it is more likely than not that the SAT will ultimately be precluded from issuing a new 2005 VAT audit assessment. In the unexpected event that the SAT is provided the opportunity to issue a new 2005 VAT audit assessment, the Company cannot predict if the SAT would issue a new assessment or the basis of any new assessment. Accordingly, the Company is not able to estimate any related potential exposure.
KCSM has not historically assessed VAT on international import transportation services provided to its customers based on a written ruling that KCSM obtained from the SAT in 2008 stating that such services were not subject to VAT (the “2008 Ruling”). Notwithstanding the 2008 Ruling, in December 2013, the SAT unofficially informed KCSM of an intended implementation of new criteria effective as of January 1, 2014, pursuant to which VAT would be assessed on all international import transportation services on the portion of the services provided within Mexico. Additionally, in November 2013, the SAT filed an action to nullify the 2008 Ruling, potentially exposing the application of the new criteria to open tax years. In February 2014, KCSM filed an action opposing the SAT’s nullification action. In December 2016, KCSM was notified of a resolution issued by the Mexican tax court confirming the 2008 Ruling. The SAT appealed this resolution. In October 2017, the circuit court resolved to not render a decision on the case but rather to send the SAT’s appeal to the Supreme Court. In February 2018, the Supreme Court decided not to hear the case and remanded the SAT’s appeal back to the circuit court for a decision. In July 2018, the circuit court ordered the tax court to consider certain arguments made by the SAT in the original court proceeding that were not addressed in the tax court’s December 2016 resolution. On October 2, 2018, the tax court issued a decision confirming the 2008 ruling. The SAT is permitted to appeal this decision. The Company believes it is more likely than not that it will continue to prevail in this matter. Further, as of the date of this filing, the SAT has not implemented any new criteria regarding this assessment of VAT on international import transportation services. The Company believes it is probable that any unexpected nullification of the 2008 Ruling and the implementation of any new VAT criteria would be applied on a prospective basis, in which case, due to the pass-through nature of VAT, KCSM would begin to assess its customers for VAT on international import transportation services, resulting in no material impact to the Company’s consolidated financial statements.

17


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

Contractual Agreements.  In the normal course of business, the Company enters into various contractual agreements related to commercial arrangements and the use of other railroads’ or governmental entities’ infrastructure needed for the operations of the business. The Company is involved or may become involved in certain disputes involving transportation rates, product loss or damage, charges, and interpretations related to these agreements. While the outcome of these matters cannot be predicted with certainty, the Company believes that, when resolved, these disputes will not have a material effect on its consolidated financial statements.
Credit Risk.  The Company continually monitors risks related to economic changes and certain customer receivables concentrations. Significant changes in customer concentration or payment terms, deterioration of customer creditworthiness, bankruptcy, insolvency or liquidation of a customer, or weakening in economic trends could have a significant impact on the collectability of the Company’s receivables and its operating results. If the financial condition of the Company’s customers were to deteriorate and result in an impairment of their ability to make payments, additional allowances may be required. The Company has recorded provisions for uncollectability based on its best estimate at September 30, 2018 .
Panama Canal Railway Company (“PCRC”) Guarantees and Indemnities.  At September 30, 2018 , the Company had issued and outstanding $5.5 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.

14 . 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
2018
 
2017
 
2018
 
2017
U.S.
$
373.3

 
$
345.9

 
$
1,060.2

 
$
1,011.5

Mexico
325.7

 
310.7

 
959.8

 
911.0

Total revenues
$
699.0

 
$
656.6

 
$
2,020.0

 
$
1,922.5

 
 
 
 
 
 
 
 
Property and equipment (including concession assets), net
 
 
 
 
September 30,
2018
 
December 31,
2017
U.S.
 
 
 
 
$
5,375.0

 
$
5,227.3

Mexico
 
 
 
 
3,269.5

 
3,176.5

Total property and equipment (including concession assets), net
 
 
 
 
$
8,644.5

 
$
8,403.8


18


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

15. Condensed Consolidating Financial Information
Pursuant to SEC Regulation S-X Rule 3-10 “Financial statements of guarantors and issuers of guaranteed securities registered or being registered,” the Company is required to provide condensed consolidating financial information for issuers of certain of its senior notes that are guaranteed.
As of September 30, 2018 , KCS, the parent, had outstanding $2,593.5 million senior notes due through 2048 . The senior notes are unsecured obligations of KCS, and are also jointly and severally and fully and unconditionally guaranteed on an unsecured senior basis by The Kansas City Southern Railway Company (“KCSR”) and certain wholly-owned domestic subsidiaries of KCS (the “Guarantor Subsidiaries”).
As of September 30, 2018 , KCSR had outstanding $2.9 million principal amount of senior notes due through 2045. The senior notes are unsecured obligations of KCSR, and are also jointly and severally and fully and unconditionally guaranteed on an unsecured senior basis by KCS and the Guarantor Subsidiaries.
The following condensed and consolidating financial information ( in millions ) of KCS, KCSR, the Guarantor Subsidiaries and the other KCS subsidiaries that are not guarantors (the "Non-Guarantor Subsidiaries") are being presented in order to meet the reporting requirements under Rule 3-10 of Regulation S-X. Pursuant to Rule 3-10(d) and (f) of Regulation S-X, separate financial statements for the Issuer, the Parent and the Guarantor Subsidiaries are not required to be filed with the SEC as the subsidiary debt issuer and the guarantors are directly or indirectly 100% owned by the Parent and the guarantees are full and unconditional and joint and several.

Condensed Consolidating Statements of Comprehensive Income
 
Three Months Ended September 30, 2018
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Revenues
$

 
$
339.1

 
$
12.1

 
$
359.1

 
$
(11.3
)
 
$
699.0

Operating expenses
0.7

 
219.2

 
10.6

 
214.4

 
(11.3
)
 
433.6

Operating income (loss)
(0.7
)
 
119.9

 
1.5

 
144.7

 

 
265.4

Equity in net earnings (losses) of affiliates
201.9

 
(0.4
)
 
0.7

 
(0.6
)
 
(201.8
)
 
(0.2
)
Interest expense
(22.4
)
 
(19.1
)
 

 
(7.3
)
 
20.5

 
(28.3
)
Debt retirement costs

 

 

 

 

 

Foreign exchange gain

 

 

 
9.5

 

 
9.5

Other income, net
20.2

 

 

 
0.9

 
(20.5
)
 
0.6

Income before income taxes
199.0

 
100.4

 
2.2

 
147.2

 
(201.8
)
 
247.0

Income tax expense
25.4

 
23.6

 
0.6

 
23.4

 

 
73.0

Net income
173.6

 
76.8

 
1.6

 
123.8

 
(201.8
)
 
174.0

Less: Net income attributable to noncontrolling interest

 

 

 
0.4

 

 
0.4

Net income attributable to Kansas City Southern and subsidiaries
173.6

 
76.8

 
1.6

 
123.4

 
(201.8
)
 
173.6

Other comprehensive income
4.2

 

 

 
0.7

 
(0.7
)
 
4.2

Comprehensive income attributable to Kansas City Southern and subsidiaries
$
177.8

 
$
76.8

 
$
1.6

 
$
124.1

 
$
(202.5
)
 
$
177.8









19


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

Condensed Consolidating Statements of Comprehensive Income—(Continued)
 
Three Months Ended September 30, 2017
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Revenues
$

 
$
310.7

 
$
9.9

 
$
344.9

 
$
(8.9
)
 
$
656.6

Operating expenses
0.8

 
216.5

 
9.6

 
204.8

 
(8.9
)
 
422.8

Operating income (loss)
(0.8
)
 
94.2

 
0.3

 
140.1

 

 
233.8

Equity in net earnings (losses) of affiliates
130.2

 
(0.3
)
 
1.5

 
2.2

 
(130.8
)
 
2.8

Interest expense
(20.3
)
 
(17.7
)
 

 
(8.8
)
 
21.6

 
(25.2
)
Debt retirement costs

 

 

 

 

 

Foreign exchange gain

 

 

 
0.8

 

 
0.8

Other income (expense), net
20.8

 
(0.3
)
 

 
0.7

 
(21.5
)
 
(0.3
)
Income before income taxes
129.9

 
75.9

 
1.8

 
135.0

 
(130.7
)
 
211.9

Income tax expense
0.6

 
25.4

 
1.0

 
55.0

 

 
82.0

Net income
129.3

 
50.5

 
0.8

 
80.0

 
(130.7
)
 
129.9

Less: Net income attributable to noncontrolling interest

 

 

 
0.6

 

 
0.6

Net income attributable to Kansas City Southern and subsidiaries
129.3

 
50.5

 
0.8

 
79.4

 
(130.7
)
 
129.3

Other comprehensive loss
(0.7
)
 

 

 
(0.3
)
 
0.3

 
(0.7
)
Comprehensive income attributable to Kansas City Southern and subsidiaries
$
128.6

 
$
50.5

 
$
0.8

 
$
79.1

 
$
(130.4
)
 
$
128.6


 
Nine Months Ended September 30, 2018
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Revenues
$

 
$
955.0

 
$
32.5

 
$
1,063.4

 
$
(30.9
)
 
$
2,020.0

Operating expenses
4.2

 
671.9

 
28.5

 
616.4

 
(30.9
)
 
1,290.1

Operating income (loss)
(4.2
)
 
283.1

 
4.0

 
447.0

 

 
729.9

Equity in net earnings (losses) of affiliates
481.9

 
(1.1
)
 
2.4

 
0.5

 
(481.9
)
 
1.8

Interest expense
(66.8
)
 
(54.2
)
 

 
(21.5
)
 
60.7

 
(81.8
)
Debt retirement costs

 

 

 
(2.2
)
 

 
(2.2
)
Foreign exchange gain

 

 

 
16.3

 

 
16.3

Other income, net
59.8

 
0.3

 

 
1.4

 
(60.7
)
 
0.8

Income before income taxes
470.7

 
228.1


6.4


441.5


(481.9
)
 
664.8

Income tax expense
4.4

 
48.6

 
1.9

 
142.3

 

 
197.2

Net income
466.3

 
179.5


4.5


299.2


(481.9
)
 
467.6

Less: Net income attributable to noncontrolling interest

 

 

 
1.3

 

 
1.3

Net income attributable to Kansas City Southern and subsidiaries
466.3

 
179.5


4.5


297.9


(481.9
)
 
466.3

Other comprehensive income
10.2

 

 

 
0.7

 
(0.7
)
 
10.2

Comprehensive income attributable to Kansas City Southern and subsidiaries
$
476.5

 
$
179.5

 
$
4.5

 
$
298.6

 
$
(482.6
)
 
$
476.5







20


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

Condensed Consolidating Statements of Comprehensive Income—(Continued)
 
Nine Months Ended September 30, 2017
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Revenues
$

 
$
906.4

 
$
33.0

 
$
1,011.2

 
$
(28.1
)
 
$
1,922.5

Operating expenses
4.9

 
647.0

 
29.4

 
585.5

 
(28.1
)
 
1,238.7

Operating income (loss)
(4.9
)
 
259.4

 
3.6

 
425.7

 

 
683.8

Equity in net earnings (losses) of affiliates
410.8

 
(0.6
)
 
2.7

 
8.2

 
(411.4
)
 
9.7

Interest expense
(61.0
)
 
(54.6
)
 

 
(27.1
)
 
67.8

 
(74.9
)
Debt retirement costs

 

 

 

 

 

Foreign exchange gain

 

 

 
61.8

 

 
61.8

Other income, net
66.7

 
0.5

 

 
1.3

 
(67.8
)
 
0.7

Income before income taxes
411.6

 
204.7

 
6.3

 
469.9

 
(411.4
)
 
681.1

Income tax expense
1.3

 
75.2

 
2.9

 
190.2

 

 
269.6

Net income
410.3

 
129.5

 
3.4

 
279.7

 
(411.4
)
 
411.5

Less: Net income attributable to noncontrolling interest

 

 

 
1.2

 

 
1.2

Net income attributable to Kansas City Southern and subsidiaries
410.3

 
129.5

 
3.4

 
278.5

 
(411.4
)
 
410.3

Other comprehensive income (loss)
(1.7
)
 

 

 
1.8

 
(1.8
)
 
(1.7
)
Comprehensive income attributable to Kansas City Southern and subsidiaries
$
408.6

 
$
129.5

 
$
3.4

 
$
280.3

 
$
(413.2
)
 
$
408.6


Condensed Consolidating Balance Sheets
 
September 30, 2018
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets
$
649.5

 
$
227.1

 
$
6.0

 
$
342.3

 
$
(609.0
)
 
$
615.9

Investments

 
3.8

 
2.7

 
40.0

 

 
46.5

Investments in consolidated subsidiaries
4,741.9

 
4.9

 
188.2

 

 
(4,935.0
)
 

Property and equipment (including concession assets), net

 
4,409.7

 
166.5

 
4,074.0

 
(5.7
)
 
8,644.5

Other assets
2,209.7

 
61.7

 

 
30.6

 
(2,199.8
)
 
102.2

Total assets
$
7,601.1

 
$
4,707.2

 
$
363.4

 
$
4,486.9

 
$
(7,749.5
)
 
$
9,409.1

Liabilities and equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities
$
253.6

 
$
518.9

 
$
83.2

 
$
220.7

 
$
(610.5
)
 
$
465.9

Long-term debt
2,561.9

 
1,508.2

 

 
810.4

 
(2,199.8
)
 
2,680.7

Deferred income taxes
6.6

 
779.1

 
86.0

 
198.9

 
(1.4
)
 
1,069.2

Other liabilities
7.2

 
66.9

 
0.2

 
28.2

 

 
102.5

Stockholders’ equity
4,771.8

 
1,834.1

 
194.0

 
2,909.7

 
(4,937.8
)
 
4,771.8

Noncontrolling interest

 

 

 
319.0

 

 
319.0

Total liabilities and equity
$
7,601.1

 
$
4,707.2

 
$
363.4

 
$
4,486.9

 
$
(7,749.5
)
 
$
9,409.1







21


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

Condensed Consolidating Balance Sheets—(Continued)
 
December 31, 2017
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets
$
292.0

 
$
214.1

 
$
8.8

 
$
475.5

 
$
(310.3
)
 
$
680.1

Investments

 
3.9

 

 
40.7

 

 
44.6

Investments in consolidated subsidiaries
4,462.4

 
7.4

 
182.2

 

 
(4,652.0
)
 

Property and equipment (including concession assets), net

 
4,283.2

 
171.6

 
3,954.9

 
(5.9
)
 
8,403.8

Other assets
2,159.6

 
46.8

 

 
252.5

 
(2,388.7
)
 
70.2

Total assets
$
6,914.0

 
$
4,555.4

 
$
362.6

 
$
4,723.6

 
$
(7,356.9
)
 
$
9,198.7

Liabilities and equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities
$
277.9

 
$
578.7

 
$
94.9

 
$
332.0

 
$
(311.8
)
 
$
971.7

Long-term debt
2,066.8

 
1,517.2

 

 
1,040.3

 
(2,388.8
)
 
2,235.5

Deferred income taxes
(7.1
)
 
734.8

 
84.0

 
177.0

 
(1.5
)
 
987.2

Other liabilities
13.5

 
70.0

 
0.3

 
55.1

 

 
138.9

Stockholders’ equity
4,562.9

 
1,654.7

 
183.4

 
2,802.7

 
(4,654.8
)
 
4,548.9

Noncontrolling interest

 

 

 
316.5

 

 
316.5

Total liabilities and equity
$
6,914.0

 
$
4,555.4

 
$
362.6

 
$
4,723.6

 
$
(7,356.9
)
 
$
9,198.7


22


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

Condensed Consolidating Statements of Cash Flows
 
Nine Months Ended September 30, 2018
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Operating activities:
 
 
 
 
 
 
 
 
 
 
 
Net cash provided
$
151.2

 
$
353.5

 
$
0.6

 
$
395.6

 
$
(195.1
)
 
$
705.8

Investing activities:
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures

 
(185.3
)
 
(0.5
)
 
(211.0
)
 

 
(396.8
)
Purchase or replacement of equipment under operating leases

 
(88.4
)
 

 
(10.5
)
 

 
(98.9
)
Property investments in MSLLC

 

 

 
(24.0
)
 

 
(24.0
)
Investments in and advances to affiliates
(6.1
)
 

 
(6.1
)
 
(7.6
)
 
9.5

 
(10.3
)
Proceeds from repayment of loans to affiliates
4,094.1

 

 

 
125.0

 
(4,219.1
)
 

Loans to affiliates
(4,061.9
)
 

 

 
(125.0
)
 
4,186.9

 

Proceeds from disposal of property

 
3.3

 

 
3.9

 

 
7.2

Other investing activities

 
(2.1
)
 

 
(0.1
)
 

 
(2.2
)
Net cash provided (used)
26.1

 
(272.5
)
 
(6.6
)
 
(249.3
)
 
(22.7
)
 
(525.0
)
Financing activities:
 
 
 
 
 
 
 
 
 
 
 
Proceeds from short-term borrowings
4,158.0

 

 

 

 

 
4,158.0

Repayment of short-term borrowings
(4,506.1
)
 

 

 

 

 
(4,506.1
)
Proceeds from issuance of long-term debt
499.4

 

 

 

 

 
499.4

Repayment of long-term debt

 
(2.8
)
 
(0.1
)
 
(75.8
)
 

 
(78.7
)
Debt issuance and retirement costs paid
(6.2
)
 

 

 
(1.8
)
 

 
(8.0
)
Dividends paid
(110.9
)
 

 

 
(195.1
)
 
195.1

 
(110.9
)
Shares repurchased
(163.3
)
 

 

 

 

 
(163.3
)
Proceeds from loans from affiliates
125.0

 
4,011.9

 

 
50.0

 
(4,186.9
)
 

Repayment of loans from affiliates
(125.0
)
 
(4,094.1
)
 

 

 
4,219.1

 

Contribution from affiliates

 

 
6.1

 
3.4

 
(9.5
)
 

Other financing activities
1.8

 

 

 

 

 
1.8

Net cash provided (used)
(127.3
)
 
(85.0
)
 
6.0

 
(219.3
)
 
217.8

 
(207.8
)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
Net increase (decrease)
50.0

 
(4.0
)
 

 
(73.0
)
 

 
(27.0
)
At beginning of year
0.7

 
17.6

 

 
115.8

 

 
134.1

At end of period
$
50.7

 
$
13.6

 
$

 
$
42.8

 
$

 
$
107.1


23


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

Condensed Consolidating Statements of Cash Flows—(Continued)
 
Nine Months Ended September 30, 2017
 
Parent
 
KCSR
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Consolidated
KCS
Operating activities:
 
 
 
 
 
 
 
 
 
 
 
Net cash provided
$
215.1

 
$
413.5

 
$
0.4

 
$
109.7

 
$
(5.0
)
 
$
733.7

Investing activities:
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures

 
(292.6
)
 
(0.3
)
 
(154.0
)
 

 
(446.9
)
Purchase or replacement of equipment under operating leases

 
(42.6
)
 

 

 

 
(42.6
)
Property investments in MSLLC

 

 

 
(23.7
)
 

 
(23.7
)
Investment in and advances to affiliates
(0.5
)
 

 
(0.5
)
 
(20.3
)
 
1.0

 
(20.3
)
Proceeds from repayment of loans to affiliates
9,814.6

 

 

 

 
(9,814.6
)
 

Loans to affiliates
(9,772.2
)
 

 

 

 
9,772.2

 

Proceeds from disposal of property

 
5.2

 

 
1.4

 

 
6.6

Other investing activities

 
(16.5
)
 

 
1.4

 

 
(15.1
)
Net cash provided (used)
41.9

 
(346.5
)
 
(0.8
)
 
(195.2
)
 
(41.4
)
 
(542.0
)
Financing activities:
 
 
 
 
 
 
 
 
 
 
 
Proceeds from short-term borrowings
9,772.2

 

 

 

 

 
9,772.2

Repayment of short-term borrowings
(9,600.9
)
 

 

 

 

 
(9,600.9
)
Proceeds from issuance of long-term debt

 

 

 

 

 

Repayment of long-term debt

 
(2.6
)
 
(0.1
)
 
(17.5
)
 

 
(20.2
)
Debt issuance and retirement costs paid

 

 

 

 

 

Dividends paid
(105.1
)
 

 

 
(5.0
)
 
5.0

 
(105.1
)
Shares repurchased
(320.4
)
 

 

 

 

 
(320.4
)
Proceeds from loans from affiliates

 
9,772.2

 

 

 
(9,772.2
)
 

Repayment of loans from affiliates

 
(9,814.6
)
 

 

 
9,814.6

 

Contribution from affiliates

 

 
0.5

 
0.5

 
(1.0
)
 

Other financing activities
0.5

 

 

 

 

 
0.5

Net cash provided (used)
(253.7
)
 
(45.0
)
 
0.4

 
(22.0
)
 
46.4

 
(273.9
)
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
Net increase (decrease)
3.3

 
22.0

 

 
(107.5
)
 

 
(82.2
)
At beginning of year
0.2

 
32.6

 

 
137.8

 

 
170.6

At end of period
$
3.5

 
$
54.6

 
$

 
$
30.3

 
$

 
$
88.4



24



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 that are not based upon historical information. Readers can identify these forward-looking statements by the use of such verbs as “expects,” “anticipates,” “believes” or similar verbs or conjugations of such verbs. Such forward-looking statements are based upon information currently available to management and management’s perception thereof as of the date of this Form 10-Q. However, such statements are dependent on and, therefore, can be influenced by, a number of external variables over which management has little or no control, including: competition and consolidation within the transportation industry; the business environment in industries that produce and use items shipped by rail; loss of the rail concession of Kansas City Southern’s subsidiary, Kansas City Southern de México, S.A. de C.V.; the termination of, or failure to renew, agreements with customers, other railroads and third parties; access to capital; disruptions to the Company’s technology infrastructure, including its computer systems; natural events such as severe weather, hurricanes and floods; market and regulatory responses to climate change; legislative and regulatory developments and disputes; 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; fluctuation in prices or availability of key materials, in particular diesel fuel; dependency on certain key suppliers of core rail equipment; changes in securities and capital markets; unavailability of qualified personnel; labor difficulties, including strikes and work stoppages; acts of terrorism or risk of terrorist activities; war or risk of war; domestic and international economic, political and social conditions; the level of trade between the United States and Asia or Mexico; fluctuations in the peso-dollar exchange rate; increased demand and traffic congestion; the outcome of claims and litigation involving the Company or its subsidiaries; and other factors affecting the operation of the business. For more discussion about each risk factor, see Part II Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 , which is on file with the U.S. Securities and Exchange Commission (File No. 1-4717) and Part I Item 1A — “Risk Factors” in the Form 10-K and any updates contained herein. Readers are strongly encouraged to consider these factors when evaluating forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the timing when, or by which, such performance or results will be achieved. As a result, actual outcomes or results could materially differ from those indicated in forward-looking statements. We are not under any obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements.
This discussion is intended to clarify and focus on Kansas City Southern’s (“KCS” or the “Company”) 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 Form 10-Q. 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 the 2017 Annual Report on Form 10-K filed with the SEC.
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.

25

Table of Contents


Third Quarter Analysis
Revenues increased 6% for the three months ended September 30, 2018 , as compared to the same period in 2017 , due to a 4% increase in carload/unit volumes and a 2% increase in revenue per carload/unit. The increase in volumes is primarily attributable to increased refined product shipments to Mexico and favorable comparative volumes due to Hurricane Harvey service interruptions in 2017, partially offset by network congestion in northern Mexico during the third quarter of 2018. Revenue per carload/unit increased due to higher fuel surcharge and positive pricing impacts, partially offset by the weakening of the Mexican peso against the U.S. dollar and shorter average length of haul.
Operating expenses increased 3% during the three months ended September 30, 2018 , as compared to the same period in 2017 , primarily due to higher fuel prices, increased costs due to network congestion in northern Mexico, and increased depreciation expense. These increases were partially offset by a gain on insurance recoveries related to hurricane damage and the weakening of the Mexican peso against the U.S. dollar. Expense fluctuations resulting from the weakening Mexican peso and higher fuel prices were partially offset by revenue fluctuations driven by these same macroeconomic factors. Operating expenses as a percentage of revenues was 62.0% for the three months ended September 30, 2018 , compared to 64.4% for the same period in 2017 .
The Company reported quarterly earnings of $1.70 per diluted share on consolidated net income of $173.6 million for the three months ended September 30, 2018 , compared to earnings of $1.23 per diluted share on consolidated net income of $129.3 million for the same period in 2017 , due to higher operating income, a lower effective tax rate, and a foreign exchange gain.
Fourth Quarter 2018 Outlook
KCS expects to continue to experience network congestion in the fourth quarter of 2018; however, does not believe this will have a significant impact on its fourth quarter operating results.

Results of Operations
The following summarizes KCS’s consolidated statement of income components (in millions) :
 
Three Months Ended
 
Change
 
September 30,
 
 
2018
 
2017
 
Revenues
$
699.0

 
$
656.6

 
$
42.4

Operating expenses
433.6

 
422.8

 
10.8

Operating income
265.4

 
233.8

 
31.6

Equity in net earnings (losses) of affiliates
(0.2
)
 
2.8

 
(3.0
)
Interest expense
(28.3
)
 
(25.2
)
 
(3.1
)
Foreign exchange gain
9.5

 
0.8

 
8.7

Other income (expense), net
0.6

 
(0.3
)
 
0.9

Income before income taxes
247.0

 
211.9

 
35.1

Income tax expense
73.0

 
82.0

 
(9.0
)
Net income
174.0

 
129.9

 
44.1

Less: Net income attributable to noncontrolling interest
0.4

 
0.6

 
(0.2
)
Net income attributable to Kansas City Southern and subsidiaries
$
173.6

 
$
129.3

 
$
44.3

 
Nine Months Ended
 
Change
 
September 30,
 
 
2018
 
2017
 
Revenues
$
2,020.0

 
$
1,922.5

 
$
97.5

Operating expenses
1,290.1

 
1,238.7

 
51.4

Operating income
729.9

 
683.8

 
46.1

Equity in net earnings of affiliates
1.8

 
9.7

 
(7.9
)
Interest expense
(81.8
)
 
(74.9
)
 
(6.9
)
Debt retirement costs
(2.2
)
 

 
(2.2
)
Foreign exchange gain
16.3

 
61.8

 
(45.5
)
Other income, net
0.8

 
0.7

 
0.1

Income before income taxes
664.8

 
681.1

 
(16.3
)
Income tax expense
197.2

 
269.6

 
(72.4
)
Net income
467.6

 
411.5

 
56.1

Less: Net income attributable to noncontrolling interest
1.3

 
1.2

 
0.1

Net income attributable to Kansas City Southern and subsidiaries
$
466.3

 
$
410.3

 
$
56.0


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Revenues
The following summarizes revenues ( in millions ), carload/unit statistics (in thousands) and revenue per carload/unit:
 
Revenues
 
Carloads and Units
 
Revenue per Carload/Unit
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
September 30,
 
 
 
September 30,
 
 
 
September 30,
 
 
 
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
Chemical and petroleum
$
160.6

 
$
136.9

 
17
%
 
77.7

 
67.6

 
15
%
 
$
2,067

 
$
2,025

 
2
%
Industrial and consumer products
152.5

 
152.5

 

 
81.3

 
82.3

 
(1
%)
 
1,876

 
1,853

 
1
%
Agriculture and minerals
116.2

 
116.0

 

 
59.9

 
61.2

 
(2
%)
 
1,940

 
1,895

 
2
%
Energy
73.2

 
74.5

 
(2
%)
 
70.4

 
76.7

 
(8
%)
 
1,040

 
971

 
7
%
Intermodal
100.0

 
92.3

 
8
%
 
267.9

 
249.5

 
7
%
 
373

 
370

 
1
%
Automotive
66.2

 
61.4

 
8
%
 
40.7

 
39.1

 
4
%
 
1,627

 
1,570

 
4
%
Carload revenues, carloads and units
668.7

 
633.6

 
6
%
 
597.9

 
576.4

 
4
%
 
$
1,118

 
$
1,099

 
2
%
Other revenue
30.3

 
23.0

 
32
%
 
 
 
 
 
 
 
 
 
 
 
 
Total revenues (i)
$
699.0

 
$
656.6

 
6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(i) Included in revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fuel surcharge
$
69.0

 
$
44.3

 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
Revenues
 
Carloads and Units
 
Revenue per Carload/Unit
 
Nine Months Ended
 
 
 
Nine Months Ended
 
 
 
Nine Months Ended
 
 
 
September 30,
 
 
 
September 30,
 
 
 
September 30,
 
 
 
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
Chemical and petroleum
$
458.1

 
$
402.2

 
14
%
 
219.4

 
205.8

 
7
%
 
$
2,088

 
$
1,954

 
7
%
Industrial and consumer products
451.5

 
441.2

 
2
%
 
248.3

 
245.8

 
1
%
 
1,818

 
1,795

 
1
%
Agriculture and minerals
354.7

 
355.7

 

 
179.4

 
183.6

 
(2
%)
 
1,977

 
1,937

 
2
%
Energy
191.0

 
214.0

 
(11
%)
 
185.2

 
218.0

 
(15
%)
 
1,031

 
982

 
5
%
Intermodal
284.6

 
266.4

 
7
%
 
762.1

 
716.6

 
6
%
 
373

 
372

 

Automotive
193.3

 
170.2

 
14
%
 
123.0

 
114.6

 
7
%
 
1,572

 
1,485

 
6
%
Carload revenues, carloads and units
1,933.2

 
1,849.7

 
5
%
 
1,717.4

 
1,684.4

 
2
%
 
$
1,126

 
$
1,098

 
3
%
Other revenue
86.8

 
72.8

 
19
%
 
 
 
 
 
 
 
 
 
 
 
 
Total revenues (i)
$
2,020.0

 
$
1,922.5

 
5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(i) Included in revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fuel surcharge
$
183.4

 
$
121.3

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues include both revenue for transportation services and fuel surcharges. For the three months ended September 30, 2018 , revenues and carload/unit volumes increased 6% and 4% , respectively, compared to the same period in 2017. For the nine months ended September 30, 2018 , revenues and carload/unit volumes increased 5% and 2% , respectively, compared to the same period in 2017. Revenue and volume increased primarily due to increased refined product shipments to Mexico, partially offset by a decline in Energy, driven primarily by a reduction in utility coal volume due to a Texas utility closure in January 2018. Additionally, the increase in revenues and volumes is attributable to favorable comparative volumes due to Hurricane Harvey service interruptions in 2017, partially offset by network congestion in northern Mexico during the third quarter of 2018.
For the three and nine months ended September 30, 2018, revenue per carload/unit increased by 2% and 3% , respectively, compared to the same periods in 2017, due to higher fuel surcharge and positive pricing impacts. These increases were partially offset by the weakening of the Mexican peso against the U.S. dollar for revenue transactions denominated in Mexican pesos and shorter average length of haul. The average exchange rate of Mexican pesos per U.S. dollar was Ps.19.0, for the three months ended September 30, 2018, compared to Ps.17.8 for the same period in 2017, which resulted in a decrease to revenues of approximately $10.0 million. The average exchange rate of Mexican pesos per U.S. dollar was Ps.19.0 for the nine months ended September 30, 2018, compared to Ps.18.9 for the same period in 2017, which resulted in a decrease to revenues of approximately $4.0 million.

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Table of Contents


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, 2018 , fuel surcharge revenue increased $24.7 million and $62.1 million , respectively, compared to the same periods in 2017, primarily due to higher fuel prices and increased fuel surcharge rates.
The following discussion provides an analysis of revenues by commodity group:
 
Revenues by commodity group
for the three months ended
September 30, 2018
Chemical and petroleum . Revenues increased $23.7 million for the three months ended September 30, 2018, compared to the same period in 2017, due to a 15% increase in carload/unit volumes and a 2% increase in revenue per carload/unit. Revenues increased $55.9 million for the nine months ended September 30, 2018, compared to the same period in 2017, due to a 7% increase in both carload/unit volumes and revenue per carload/unit. Volumes increased primarily due to increased refined fuel product shipments to Mexico and favorable comparative volumes due to Hurricane Harvey service interruptions in 2017. Revenue per carload/unit increased due to longer average length of haul, higher fuel surcharge, and positive pricing impacts.

   CHEMANDPETROQ32018REVGRAPH.JPG
Industrial and consumer products . Revenues were flat for the three months ended September 30, 2018, compared to the same period in 2017, driven by a 1% increase in revenue per carload/unit, offset by a 1% decrease in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, mix, and positive pricing impacts, partially offset by shorter average length of haul due to a change in sourcing location for a metals plant. Volume decreased due to a change in sourcing location for a metals customer and network congestion in northern Mexico, partially offset by favorable comparative volumes due to Hurricane Harvey service interruptions in 2017.
Revenues increased $10.3 million for the nine months ended September 30, 2018, compared to the same period in 2017, due to a 1% increase in both revenue per carload/unit and carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge, mix, and positive pricing impacts, partially offset by shorter average length of haul due to change in sourcing location for a metals plant. Volumes increased due to favorable comparative volumes due to Hurricane Harvey service interruptions in 2017, as well as increases in forest products and appliance volumes due to market demand and tight truck capacity, partially offset by a change in sourcing location for a metals customer and network congestion in northern Mexico.

 
INDANDCONQ32018REVGRAPH.JPG

28

Table of Contents


 
Revenues by commodity group
for the three months ended
September 30, 2018
 
 
Agriculture and minerals. Revenues were flat and decreased $1.0 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in 2017, due to a 2% increase in revenue per carload/unit offset by a 2% decrease in carload/unit volumes. Revenue per carload/unit increased due to higher fuel surcharge and positive pricing impacts. Additionally, for the nine months ended September 30, 2018, revenue per carload/unit increased due to longer average length of haul. Volume decreased for the three and nine months due to network congestion in northern Mexico and changes in food products due to less market demand, a facility outage, and shift in sourcing trends.
AGANDMINQ32018REVGRAPH.JPG
Energy. Revenues decreased $1.3 million for the three months ended September 30, 2018, compared to the same period in 2017, due to an 8% decrease in carload/unit volumes, partially offset by a 7% increase in revenue per carload/unit. Revenues decreased $23.0 million for the nine months ended September 30, 2018, compared to the same period in 2017, due to a 15% decrease in carload/unit volumes, partially offset by a 5% increase in revenue per carload/unit. Utility coal volumes decreased due to a Texas utility closure in January 2018 and lower natural gas prices. Frac sand volumes decreased due to changes in sourcing patterns. These decreases were partially offset by increased crude oil volumes due to tight pipeline capacity and demand for Canadian crude. Revenue per carload/unit increased due to higher fuel surcharge, mix, and positive pricing impacts, partially offset by a shorter average length of haul.
ENERGYQ32018REVGRAPH.JPG
Intermodal. Revenues increased $7.7 million for the three months ended September 30, 2018 , compared to the same period in 2017, due to a 7% increase in carload/unit volumes and a 1% increase in revenue per carload/unit. Revenues increased $18.2 million for the nine months ended September 30, 2018 , compared to the same period in 2017, due to a 6% increase in carload/unit volumes. The volume increase was attributable to growth in the U.S domestic and cross-border lanes, which was aided by tight truck capacity. This was partially offset by lower international volumes as a result of lost business to truck competition primarily due to the weakness of the Mexican peso against the U.S. dollar. Additionally, for the three months ended September 30, 2018 , the increase in volumes is attributable to favorable comparative volumes due to Hurricane Harvey service interruptions in 2017. Revenue per carload/unit increased for the three and nine months ended September 30, 2018, due to higher fuel surcharge, partially offset by shorter length of haul.
Automotive. Revenues increased $4.8 million for the three months ended September 30, 2018 , compared to the same period in 2017, due to a 4% increase in both carload/unit volumes and revenue per carload/unit. Revenues increased $23.1 million for the nine months ended September 30, 2018 , compared to the same period in 2017, due to a 7% increase in carload/unit volumes and a 6% increase in revenue per carload/unit. Volumes increased due to higher carryover inventory, an increase in plant production, an increase in Lazaro Cardenas import volumes, and favorable comparative volumes due to Hurricane Harvey service interruptions in 2017. These factors were partially offset by network congestion in northern Mexico. Revenue per carload/unit increased due to higher fuel surcharge and positive pricing impacts, partially offset by the weakening of the Mexican peso against the U.S. dollar and shorter average length of haul.

29

Table of Contents


Operating Expenses     
Operating expenses, as shown below ( in millions ), increased $10.8 million for the three months ended September 30, 2018 , compared to the same period in 2017, due to higher fuel prices, increased costs due to network congestion in northern Mexico, and increased depreciation expense. These increases were partially offset by a gain on insurance recoveries related to hurricane damage and the weakening of the Mexican peso against the U.S. dollar. The weakening of the Mexican peso against the U.S. dollar during the three months ended September 30, 2018 , resulted in reduced expense of approximately $7.0 million, compared to the same period in 2017, for expense transactions denominated in Mexican pesos. The average exchange rate of Mexican pesos per U.S. dollar was Ps.19.0 for the three months ended September 30, 2018, compared to Ps.17.8 for the same period in 2017.
Operating expenses, as shown below ( in millions ), increased $51.4 million for the nine months ended September 30, 2018 , compared to the same period in 2017, primarily due to higher fuel prices, increases in depreciation, and a reduction in Mexican fuel excise tax credit. These increases were partially offset by a gain on insurance recoveries related to hurricane damage and the weakening of the Mexican peso against the U.S. dollar. The weakening of the Mexican peso against the U.S. dollar during the nine months ended September 30, 2018 , resulted in reduced expense of approximately $4.0 million, compared to the same period in 2017, for expense transactions denominated in Mexican pesos. The average exchange rate of Mexican pesos per U.S. dollar was Ps.19.0 for the nine months ended September 30, 2018 , compared to Ps.18.9 for the same period in 2017.

 
Three Months Ended
 
 
 
September 30,
 
Change
 
2018
 
2017
 
Dollars
 
Percent
Compensation and benefits
$
123.5

 
$
129.0

 
$
(5.5
)
 
(4
%)
Purchased services
52.6

 
46.3

 
6.3

 
14
%
Fuel
90.2

 
80.1

 
10.1

 
13
%
Mexican fuel excise tax credit
(9.4
)
 
(11.1
)
 
1.7

 
(15
%)
Equipment costs
33.0

 
30.9

 
2.1

 
7
%
Depreciation and amortization
87.5

 
81.9

 
5.6

 
7
%
Materials and other
65.6

 
65.7

 
(0.1
)
 

Gain on insurance recoveries related to hurricane damage
(9.4
)
 

 
(9.4
)
 
100
%
Total operating expenses
$
433.6

 
$
422.8

 
$
10.8

 
3
%


 
Nine Months Ended
 
 
 
September 30,
 
Change
 
2018
 
2017
 
Dollars
 
Percent
Compensation and benefits
$
367.4

 
$
371.6

 
$
(4.2
)
 
(1
%)
Purchased services
149.2

 
146.5

 
2.7

 
2
%
Fuel
257.0

 
234.4

 
22.6

 
10
%
Mexican fuel excise tax credit
(26.6
)
 
(35.6
)
 
9.0

 
(25
%)
Equipment costs
95.9

 
93.3

 
2.6

 
3
%
Depreciation and amortization
257.1

 
241.6

 
15.5

 
6
%
Materials and other
199.5

 
186.9

 
12.6

 
7
%
Gain on insurance recoveries related to hurricane damage
(9.4
)
 

 
(9.4
)
 
100
%
Total operating expenses
$
1,290.1

 
$
1,238.7

 
$
51.4

 
4
%
Compensation and benefits.  Compensation and benefits decreased $5.5 million for the three months ended September 30, 2018 , compared to the same period in 2017 , due to a decrease in incentive compensation of approximately $11.0 million and the weakening of the Mexican peso of approximately $2.0 million, partially offset by increased headcount and wages of approximately $6.0 million and increased costs due to network congestion in northern Mexico of approximately $2.0 million. Compensation and benefits decreased $4.2 million for the nine months ended September 30, 2018 , compared to the same period in 2017 , due to a decrease in incentive compensation of approximately $13.0 million, a decrease in labor claims of approximately $3.0 million, reduced benefits of approximately $2.0 million, and the weakening of the Mexican peso of approximately $2.0 million, partially offset by increases in headcount and wages of approximately $16.0 million.
Purchased services.  Purchased services expense increased $6.3 million and $2.7 million for the three and nine months ended September 30, 2018 , respectively, compared to the same periods in 2017, due to higher repairs and maintenance expense and increases

30

Table of Contents


in computer software and programming expenses, partially offset by mechanical in-sourcing starting in the fourth quarter of 2017. Additionally, for the three months ended September 30, 2018, purchased services increased due to higher detour expense.
Fuel. Fuel increased $10.1 million for the three months ended September 30, 2018 , compared to the same period in 2017 , due to higher diesel fuel prices of approximately $9.0 million and $6.0 million in the U.S. and Mexico, respectively, and inefficiencies of approximately $1.0 million, partially offset by the weakening of the Mexican peso of approximately $3.0 million and lower consumption of approximately $3.0 million. Fuel increased $22.6 million for the nine months ended September 30, 2018 , compared to the same period in 2017 , due to higher diesel fuel prices of approximately $23.0 million and $10.0 million in the U.S. and Mexico, respectively, partially offset by lower consumption of approximately $8.0 million and the weakening of the Mexican peso of approximately $2.0 million. The average price per gallon was $2.66 and $2.55 for the three and nine months ended September 30, 2018 , compared to $2.30 and $2.24, respectively, for the same periods in 2017 .
Mexican fuel excise tax credit. For the three and nine months ended September 30, 2018 , the Company recognized a $9.4 million and $26.6 million benefit , respectively, compared to a $11.1 million and $35.6 million benefit for the same periods in 2017 . The reduced benefit was due to a lower excise tax rate in effect for 2018, as compared to 2017.
Equipment costs. Equipment costs increased $2.1 million and $2.6 million for the three and nine months ended September 30, 2018 , respectively, compared to the same periods in 2017 , due to higher car hire expense resulting from network congestion in northern Mexico, partially offset by lower lease expense.
Depreciation and amortization.  Depreciation and amortization expense increased $5.6 million and $15.5 million for the three and nine months ended September 30, 2018 , respectively, compared to the same periods in 2017 , due to a larger asset base, including positive train control equipment.
Materials and other. Materials and other expense was flat for the three months ended September 30, 2018 , compared to the same period in 2017. Materials and other expense increased $12.6 million for the nine months ended September 30, 2018 , compared to the same period in 2017 , due to an increase in personal injury expense of approximately $2.0 million recognized in 2018, compared to an approximate $2.0 million reduction in personal injury expense recognized in 2017 as a result of changes in estimates. Additional increased expense was due to higher derailment activity of $4.0 million, mechanical insourcing, which resulted in additional materials purchased of approximately $3.0 million, and a one-time parts credit of approximately $2.0 million received during the first quarter of 2017.
Gain on insurance recoveries related to hurricane damage. In the third quarter of 2018, the Company partially settled its insurance claim for $27.0 million related to Hurricane Harvey. As a result of this nonrefundable partial settlement, the Company recognized a gain on insurance recoveries of $9.4 million, net of the self-insured retention and insurance receivable.

Non-Operating Income and Expenses
Equity in net earnings (losses) of affiliates.  Equity in net earnings (losses) from affiliates decreased $3.0 million and $7.9 million for the three and nine months ended September 30, 2018 , respectively, compared to the same periods in 2017, as a result of lower equity in net earnings from the operations of Ferrocarril y Terminal del Valle de México, S.A. de C.V. (“FTVM”) and Panama Canal Railway Company (“PCRC”), due to a decrease in volumes.
Interest expense.  For the three and nine months ended September 30, 2018 , interest expense increased $3.1 million and $6.9 million , respectively, compared to the same periods in 2017 , due to higher average interest rates and debt balances. During the three and nine months ended September 30, 2018 , the average debt balances (including commercial paper) were $2,718.2 million and $2,693.4 million , respectively, compared to $2,640.6 million and $2,594.1 million for the same periods in 2017. Average interest rates during the three and nine months ended September 30, 2018 were 4.2% and 4.1% , respectively, compared to 3.8% and 3.9% for the same periods in 2017.
Debt retirement costs . The Company did not incur debt retirement costs during the third quarter 2018. Debt retirement costs were $2.2 million for the nine months ended September 30, 2018, related to the call premiums and write-off of unamortized debt issuance costs and original issue discounts associated with the Company’s various debt redemption activities in the second quarter of 2018. The Company did not incur debt retirement costs during 2017.
Foreign exchange gain. For the three and nine months ended September 30, 2018 , foreign exchange gain was $9.5 million and $16.3 million , respectively, compared to $0.8 million and $61.8 million , for the same periods in 2017. Foreign exchange gain includes the re-measurement and settlement of net monetary assets denominated in Mexican pesos and the gain on foreign currency derivative contracts.

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For the three and nine months ended September 30, 2018 , the re-measurement and settlement of monetary assets and liabilities denominated in Mexican pesos resulted in a foreign exchange gain of $3.3 million and $6.0 million , respectively, compared to a loss of $2.5 million and a gain of $16.3 million , for the same periods in 2017.
The Company enters into foreign currency derivative contracts to hedge its net exposure to fluctuations in the Mexican cash tax obligation due to changes in the value of the Mexican peso against the U.S. dollar. For the three and nine months ended September 30, 2018 , the Company incurred a foreign exchange gain on foreign currency derivative contracts of $6.2 million and $10.3 million , respectively, compared to a gain of $3.3 million and $45.5 million , for the same periods in 2017.
Other income (expense), net . Other income (expense), net remained flat for the three and nine months ended September 30, 2018 , compared to the same periods in 2017 .
Income tax expense. Income tax expense decreased $9.0 million and $72.4 million for the three and nine months ended September 30, 2018 , respectively, compared to the same periods in 2017 , due to a lower effective tax rate. The decrease in the effective tax rate was primarily due to the reduced U.S. corporate income tax rate from a maximum of 35% to a 21% rate provided in the Tax Cuts and Jobs Act (the “Tax Reform Act”) enacted on December 22, 2017, and effective January 1, 2018 (see tax rate reconciliation table below). The Company also recognized a $16.6 million and $20.9 million tax benefit during the three and nine months ended September 30, 2018, respectively, related to adjustments to the provisional tax impacts of the Tax Reform Act as provided for in Staff Accounting Bulletin No. 118 for the deemed repatriated earnings and the revaluation of deferred tax assets and liabilities included in its consolidated financial statements for the year ended December 31, 2017.
The decrease in the effective tax rate for the nine months ended September 30, 2018 was partially offset by the impact of the global intangible low-taxed income (“GILTI”) provisions included in the Tax Reform Act. The Company elected to account for GILTI tax in the period in which it is incurred. The GILTI provisions require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary’s tangible assets. While it appears the GILTI tax impact is partially, if not entirely, unintended for U.S. companies with subsidiaries operating in foreign countries with a tax rate of at least 13.125%, there are two aspects of U.S. foreign tax credit limitation provisions that result in incremental U.S. tax expense from the GILTI income inclusion. First, required allocations of interest expense to the GILTI income effectively renders the expense non-deductible when the GILTI income is taxed outside the U.S. at a rate higher than 13.125%. Secondly, U.S. income tax return income inclusion of the foreign taxes paid on the GILTI income is subject to U.S. tax without any associated foreign tax credit, resulting in incremental U.S. income tax. During the third quarter of 2018, the Treasury Department acknowledged in writing that proposed regulations related to the foreign tax credit aspects of GILTI are forthcoming, which they anticipate will allow for a credit against the U.S. income tax on the income inclusion for foreign taxes paid on the GILTI income. Therefore, the Company concluded that this aspect of the foreign tax credit limitations is more likely than not to be sustained despite the conflict with the enacted tax law. The Company revised its expected GILTI tax in the third quarter of 2018 to reflect the forthcoming proposed regulations and as a result, estimates its incremental U.S. tax for GILTI to be $10.0 million for the 2018 tax year.
The components of the effective tax rates for the three and nine months ended September 30, 2018 , compared to the same periods in 2017 , are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Statutory rate in effect
21.0
%
 
35.0
%
 
21.0
%
 
35.0
%
Tax effect of:
 
 
 
 
 
 
 
Difference between U.S. and foreign tax rate
5.2
%
 
(3.2
%)
 
5.5
%
 
(3.2
%)
Global intangible low-taxed income (“GILTI”) tax
(0.3
%)
 

 
1.1
%
 

State and local income tax provision, net
1.4
%
 
1.0
%
 
1.2
%
 
1.0
%
Foreign exchange (i)
7.1
%
 
6.1
%
 
3.6
%
 
5.8
%
Tax Cuts and Jobs Act - Adjustments to 2017 provisional income tax benefit
(6.7
%)
 

 
(3.1
%)
 

Other, net
1.9
%
 
(0.2
%)
 
0.4
%
 
1.0
%
Effective tax rate
29.6
%
 
38.7
%
 
29.7
%
 
39.6
%
(i)
Mexican income taxes are paid in Mexican pesos, and as a result, the effective income tax rate reflects fluctuations in the value of the Mexican peso against the U.S. dollar measured by the forward exchange rate. The foreign exchange impact on income taxes includes the gain or loss from the revaluation of net U.S. dollar-denominated monetary liabilities into Mexican pesos which is included in Mexican taxable income under Mexican tax law. As a result, a strengthening of the Mexican peso against the U.S. dollar for the reporting period will generally increase the Mexican cash tax obligation and the effective income tax rate, and a weakening of the Mexican peso against the U.S. dollar for the reporting period will generally decrease

32

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the Mexican cash tax obligation and the effective tax rate. To hedge its exposure to this cash tax risk, the Company enters into foreign currency derivative contracts, which are measured at fair value each period and any change in fair value is recognized in foreign exchange gain within the consolidated statements of income as described above. Refer to Note 9 , Derivative Instruments for more information.

Liquidity and Capital Resources
Overview
The Company focuses its cash and capital resources on investing in the business, shareholder returns and optimizing its capital structure.
The Company believes, based on current expectations, that cash and other liquid assets, operating cash flows, access to debt and equity capital markets, and other available financing resources will be sufficient to fund anticipated operating expenses, capital expenditures, debt service costs, dividends, share repurchases, and other commitments in the foreseeable future. The Company’s current financing instruments contain restrictive covenants which limit or preclude certain actions; however, the covenants are structured such that the Company expects to have sufficient flexibility to conduct its operations. The Company was in compliance with all of its debt covenants as of September 30, 2018 .
Though KCS’s cash flows from operations are expected to be sufficient to fund operations, capital expenditures, debt service and dividends, the Company may, from time to time, incur debt to refinance existing indebtedness, purchase equipment under operating leases, repurchase shares, or fund equipment additions or new investments.
During the nine months ended September 30, 2018 , the Company invested $383.2 million in capital expenditures. See the Capital Expenditures section for further details.
During the third quarter of 2018 , the Company repurchased 471,829 shares of common stock for $54.6 million at an average price of $115.58 per share under the $800.0 million common share repurchase program announced in August 2017. During the nine months ended September 30, 2018 , KCS repurchased 1,475,206 shares of common stock for $163.1 million at an average price of $110.54 per share. Since inception of this program, KCS has repurchased 3,894,675 shares of common stock for $418.3 million at an average price of $107.39 per share. Management’s assessment of market conditions, available liquidity and other factors will determine the timing and volume of any future repurchases. Refer to Note 12 , Equity for additional detail on the Company’s common share repurchase program.
During the third quarter of 2018, the Company repurchased 9,225 shares of its $25 par preferred stock for $0.2 million at an average price of $26.11 per share.
During the nine months ended September 30, 2018 , the Company’s Board of Directors declared quarterly cash dividends on its common stock of $0.36 per share (total of $110.3 million ). Subject to the discretion of the Board of Directors, capital availability and a determination that cash dividends continue to be in the best interest of its stockholders, the Company intends to pay a quarterly dividend on an ongoing basis.
On May 3, 2018, KCS issued $500.0 million principal amount of senior unsecured notes, which bear interest semiannually at a fixed annual rate of 4.700% (the “4.700% Senior Notes”). The net proceeds from the offering were used to repay the outstanding commercial paper issued by KCS, repay a locomotive lease and certain equipment loans, and for general corporate purposes.
On May 3, 2018, KCSM repurchased $5.3 million of the remaining $10.9 million aggregate principal amount of its 3.0% senior unsecured notes due May 15, 2023 , at a discounted price equal to 95.91% of the principal amount.
During May 2018, the Company paid the remaining $23.0 million and $19.1 million principal amounts under its locomotive financing agreements with Export Development Canada and DVB Bank AG, respectively, using a portion of the proceeds from the issuance of the 4.700% Senior Notes.
For additional discussion of the agreements representing the indebtedness of KCS, see Note 10, Short-Term Borrowings and Note 11, 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, 2017 .
On September 30, 2018 , total available liquidity (the cash balance plus revolving credit facility availability) was $907.1 million , compared to availability at December 31, 2017 , of $588.9 million . This increase was primarily due to the issuance of the 4.700% Senior Notes, a portion of which was used to pay down KCS’s outstanding commercial paper in the second quarter of 2018.

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As of September 30, 2018 , the total cash and cash equivalents held outside of the U.S. in foreign subsidiaries was $39.9 million after repatriating $192.6 million during 2018. The Company expects that this cash will be available to fund operations without incurring significant additional income taxes.
KCS’s operating results and financing alternatives can be unexpectedly impacted by various factors, some of which are outside of its control. For example, if KCS were to experience a reduction in revenues or a substantial increase in operating costs or other liabilities, its earnings could be significantly reduced, increasing the risk of non-compliance with debt covenants. Additionally, the Company is subject to external factors impacting debt and equity capital markets and its ability to obtain financing under reasonable terms is subject to market conditions. Volatility in capital markets and the tightening of market liquidity could impact KCS’s access to capital. Further, KCS’s cost of debt can be impacted by independent rating agencies which assign debt ratings based on certain factors including competitive position, credit measurements such as interest coverage and leverage ratios, and liquidity.

Cash Flow Information
Summary cash flow data follows (in millions) :
 
Nine Months Ended
 
September 30,
 
2018
 
2017
Cash flows provided by (used for):
 
 
 
Operating activities
$
705.8

 
$
733.7

Investing activities
(525.0
)
 
(542.0
)
Financing activities
(207.8
)
 
(273.9
)
Net decrease in cash and cash equivalents
(27.0
)
 
(82.2
)
Cash and cash equivalents beginning of year
134.1

 
170.6

Cash and cash equivalents end of period
$
107.1

 
$
88.4

Cash flows from operating activities decreased $27.9 million for the nine months ended September 30, 2018 , compared to the same period in 2017 , primarily due to an increase in Mexican income tax payments, partially offset by an increase in net income and cash received for the settlement of foreign currency derivative instruments.
Net cash used for investing activities decreased $17.0 million for the nine months ended September 30, 2018 , compared to the same period in 2017, due to a decrease in capital expenditures of $50.1 million and a decrease in investments in and advances to affiliates of $10.0 million , partially offset by a $56.3 million increase in the purchase or replacement of equipment under existing operating leases. Additional information regarding capital expenditures is provided below.
Net cash used for financing activities decreased $66.1 million for the nine months ended September 30, 2018 , compared to the same period in 2017, primarily due to an increase in proceeds from long-term debt of $499.4 million and a decrease in shares repurchased of $157.1 million as a result of the $200.0 million accelerated share repurchase program that was executed in the third quarter of 2017. These decreases were partially offset by an increase in net repayment of short term borrowings of $519.4 million and an increase in repayment of long-term debt of $58.5 million.

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Capital Expenditures
KCS has funded, and expects to continue to fund capital expenditures with operating cash flows and short and long-term debt.
The following table summarizes capital expenditures by type (in millions):
 
Nine Months Ended
 
September 30,
 
2018
 
2017
Roadway capital program
$
190.5

 
$
201.0

Locomotives and freight cars
88.4

 
64.7

Capacity
43.1

 
79.3

Positive train control
22.1

 
40.0

Information technology
20.4

 
24.6

Other
18.7

 
9.7

Total capital expenditures (accrual basis)
383.2

 
419.3

Change in capital accruals
13.6

 
27.6

Total cash capital expenditures
$
396.8

 
$
446.9

 
 
 
 
Purchase or replacement of equipment under operating leases
 
 
 
Locomotives
$
50.6

 
$

Freight cars
49.9

 
42.6

Total purchase or replacement of equipment under operating leases (accrual basis)
100.5

 
42.6

Change in capital accruals
(1.6
)
 

Total cash purchase or replacement of equipment under operating leases
$
98.9

 
$
42.6

Generally, the Company’s capital program consists of capital replacement and equipment. For 2018 , internally generated cash flows are expected to fund cash capital expenditures, which are currently estimated to be at the low end of $530.0 million to $550.0 million. In addition, the Company periodically reviews its equipment under operating leases. Any purchase or replacement of equipment under operating leases during 2018 is expected to be funded with internally generated cash flows and/or debt. The locomotive operating lease buyout shown in the table above was completed using a portion of the proceeds from the issuance of the 4.700% Senior Notes.

Other Matters

Regulatory Updates
Mexican Antitrust Law . Pursuant to the Mexican Antitrust Law and the Regulatory Railroad Service Law, the Investigating Authority of the Mexican government’s antitrust commission (Comisión Federal de Competencia Económica or the “COFECE”) announced in September 2016 that it would review competitive conditions in the Mexican railroad industry, with respect to the existence of effective competition in the provision of interconnection services, trackage rights, switching rights and interline services used to render public freight transport in Mexico. The review included the entire freight rail transportation market in Mexico and was not targeted to any single rail carrier.
On March 15, 2017, the Investigating Authority published an executive summary of its preliminary report in the Federal Official Gazette (Diario Oficial de la Federación). The preliminary report concluded that there was a lack of effective competition in the market for trackage rights (“Relevant Market”) throughout the entire networks of KCSM, Ferrocarril Mexicano, S.A. de C.V., Ferrosur, S.A. de C.V., and FTVM.
The Company disagreed with the Investigating Authority’s reasoning and preliminary conclusions, and responded on April 20, 2017, with its evidence and arguments to support its position, as provided in the Mexican antitrust law. The Company’s response argued that the investigation which supported the conclusions in the preliminary report was conducted contrary to the rule of law, the rules of procedure, and relied upon faulty economic analysis.
On March 7, 2018, KCSM received the Final Resolution handed down by the COFECE Panel in connection with the investigation regarding effective competition in the market for interconnection services, trackage rights and switching rights used to provide railway freight public services in the rail freight industry.

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The Final Resolution dismissed the preliminary report issued by the Investigating Authority along with that report’s finding of a lack of effective competition for interconnection services. The Final Resolution represents the end of the investigation and no further amendments or modifications may be made to the preliminary report.
NAFTA. On September 30, 2018, the United States, Canada, and Mexico reached a new trilateral trade agreement, the United States-Mexico-Canada Agreement (“USMCA”), designed to replace the existing North American Free Trade Agreement (“NAFTA”). The USMCA will not become effective until all three parties have completed their respective domestic ratification procedures.
U.S. Tariff Imposition on Imports. The administration of U.S. President Donald J. Trump has implemented new U.S. tariffs, that could impact the level of trade between the U.S and Mexico and global commerce. U.S. trading partners have responded by announcing retaliatory tariffs on some U.S. exports. At this time, the Company cannot determine the impacts these tariffs will have on the Company’s consolidated financial statements.

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 75% of KCSR employees are covered by collective bargaining agreements. Long-term agreements were reached voluntarily or through the arbitration process during 2017 and the first three quarters of 2018 covering all of the participating unions, effectively bringing the current bargaining round to a close. These agreements will be in effect through December 2019.
KCSM Servicios, S.A. de C.V. (“KCSM Servicios”), a wholly owned subsidiary of KCS, provides employee services to KCSM, and KCSM pays KCSM Servicios market-based rates for these services. KCSM Servicios union employees are covered by one labor agreement, which was signed on April 16, 2012, between KCSM Servicios and the Sindicato de Trabajadores Ferrocarrileros de la República Mexicana (“Mexican Railroad Union”), for an indefinite period of time, for the purpose of regulating the relationship between the parties. Approximately 80% of KCSM Servicios employees are covered by this labor agreement. The compensation terms under this labor agreement are subject to renegotiation on an annual basis and all other benefits are subject to negotiation every two years. During the third quarter of 2018, KCSM Servicios and the Mexican Railroad Union concluded their negotiation over compensation terms for the period covering July 1, 2018, to June 30, 2019. The finalization of the compensation terms did not have a significant effect on the consolidated financial statements.
Union labor negotiations have not historically resulted in any strike, boycott, or other disruption in the Company’s business operations.

Item 3.
Quantitative and Qualitative Disclosures about Market Risk
There was no material change during the quarter from the information set forth in Part II, Item 7A. “Quantitative and Qualitative Disclosure about Market Risk” in the Annual Report on Form 10-K for the year ended December 31, 2017 .

Item 4.
Controls and Procedures
(a) Disclosure Controls and Procedures
As of the end of the period for which this Quarterly Report on Form 10-Q is filed, the Company’s Chief Executive Officer and Chief Financial Officer have each reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have each concluded that the Company’s current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
(b) Changes in Internal Control over Financial Reporting
There have not been any changes in the Company’s internal control over financial reporting that occurred during the third quarter of 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Table of Contents


PART II — OTHER INFORMATION

Item 1.
Legal Proceedings
For information related to the Company’s legal proceedings, see Note  13 , Commitments and Contingencies, under Part I, Item 1 of this quarterly report on Form 10-Q.

Item 1A.
Risk Factors
There were no material changes during the quarter to the Risk Factors disclosed in Item 1A - “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2017.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

Purchases of Equity Securities

The following table presents stock repurchases during each month for the third quarter of 2018:
Period
 
(a) Total  
Number  
of Shares  
(or Units)  
Purchased   (1)  
 
(b) Average  
Price Paid  
per Share (or Unit)  
 
(c) Total  
Number of  
Shares  
(or Units)  
Purchased  
as Part of  
Publicly  
Announced  
Plans or
Programs   (2)  
 
(d) Maximum  
Number (or  
Approximate  
Dollar Value)  
of Shares (or Units)  
that may yet be  
purchased under  
the Plans
or   Programs   (2)
 
Common stock
 
 
 
 
 
 
 
 
 
 
 
 
 
July 1-31, 2018
 
81,998

 
 
$
114.39

 
 
81,998

 
 
$
426,886,253

 
 
August 1-31, 2018
 
330,086

 
 
$
115.55

 
 
330,086

 
 
$
388,744,897

 
 
September 1-30, 2018
 
59,745

 
 
$
117.37

 
 
59,745

 
 
$
381,732,724

 
 
Total
 
471,829

 
 
 

 
 
471,829

 
 
 

 
 
$25 Par preferred stock
 
 
 
 
 
 
 
 
 
 
 
 
 
July 1-31, 2018
 

 
 
$

 
 

 
 
$

 
 
August 1-31, 2018
 
8,025

 
 
$
25.88

 
 

 
 
$

 
 
September 1-30, 2018
 
1,200

 
 
$
27.62

 
 

 
 
$

 
 
Total
 
9,225

 
 
 
 
 

 
 
 
 
 
 
(1
)
All $25 par preferred stock repurchases were made other than through a publicly disclosed plan or program. Repurchases of $25 par preferred stock were made through open market purchases and/or privately negotiated transactions.
(2
)
On August 15, 2017, the Company announced that the Board of Directors approved a share repurchase program, pursuant to which up to $800.0 million in shares of common stock could be repurchased through June 30, 2020. The authorization included a $200.0 million Accelerated Share Repurchase (“ASR”) program and a $600.0 million open market share repurchase program.
 
 

Item 3.
Defaults upon Senior Securities
None.

Item 4.
Mine Safety Disclosures
Not applicable.

Item 5.
Other Information
None.


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Item 6.
Exhibits
Exhibit
No.
 
Exhibits
 
 
 
10.1*
 
 
 
 
31.1*
 
 
 
 
31.2*
 
 
 
 
32.1*
 
 
 
 
32.2*
 
 
 
 
101
 
The following unaudited financial information from Kansas City Southern’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2018, formatted in XBRL (Extensible Business Reporting Language) includes: (i) Consolidated Statements of Income for the three and nine months ended September 30, 2018 and 2017, (ii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2018 and 2017, (iii) Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017, (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017, and (v) the Notes to Consolidated Financial Statements.
 
 
 
 
 
* Filed with this Report.
 
 
 


38

Table of Contents


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized and in the capacities indicated on October 19, 2018 .

Kansas City Southern
 
/s/    M ICHAEL  W. U PCHURCH        
Michael W. Upchurch
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
 
/s/    S UZANNE  M. G RAFTON        
Suzanne M. Grafton
Vice President and Chief Accounting Officer
(Principal Accounting Officer)


39
Exhibit 10.1

















KANSAS CITY SOUTHERN
EXECUTIVE DEFERRED COMPENSATION PLAN



















Effective generally as of October 1, 2018



    


Kansas City Southern
Executive Deferred Compensation Plan


 
 
1

 
 
1

 
 
7

 
 
8

 
 
11

 
 
13

 
 
14

 
 
15

 
 
16

 
 
17

 
 
18

 
 
20








Kansas City Southern
Executive Deferred Compensation Plan

ARTICLE I
Establishment and Purpose
1.1
Establishment . Kansas City Southern (the "Company") hereby establishes the Kansas City Southern Executive Deferred Compensation Plan (the "Plan"), effective as of October 1, 2018.
 
1.2
Purpose . The purpose of the Plan is to attract and retain key employees by providing Participants with an opportunity to defer receipt of a portion of their salary, bonus, and other specified compensation. The Plan is not intended to meet the qualification requirements of Code Section 401(a), but is intended to meet the requirements of Code Section 409A, and shall be operated and interpreted consistent with that intent.

1.3
Top-Hat Status and Unfunded Plan . The Plan constitutes an unsecured promise by a Participating Employer to pay benefits in the future. Participants in the Plan shall have the status of general unsecured creditors of the Company or the Adopting Employer, as applicable. Each Participating Employer shall be solely responsible for payment of the benefits of its employees and their beneficiaries. The Plan is unfunded for Federal tax purposes and is intended to be an unfunded arrangement for eligible employees who are part of a select group of management or highly compensated employees of the Employer within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA. Any amounts set aside to defray the liabilities assumed by the Company or an Adopting Employer will remain the general assets of the Company or the Adopting Employer and shall remain subject to the claims of the Company's or the Adopting Employer's creditors until such amounts are distributed to the Participants.


ARTICLE II
Definitions

Aggregate Sub-Account Balance. Aggregate Sub-Account Balance means, with respect to each Participant, the aggregate value of that Participant's Sub-Accounts.

Adopting Employer. Adopting Employer means an Affiliate who, with the consent of the Company, has adopted the Plan for the benefit of its Eligible Employees.

Affiliate. Affiliate means a corporation, trade or business that, together with the Company, is treated as a single employer under Code Section 414(b) or (c).

Beneficiary. Beneficiary means a natural person, estate, or trust designated by a Participant to receive payments to which a Beneficiary is entitled in accordance with


    




provisions of the Plan. The Participant's spouse, if living, otherwise the Participant's estate, shall be the Beneficiary if: (i)     the Participant has failed to properly designate a Beneficiary, or (ii) all designated Beneficiaries have predeceased the Participant.

Board . Board means the Board of Directors of the Company.

Business Day . Business Day means each day on which the New York Stock Exchange is open for business.

Change in Control . Change in Control means, with respect to the Company, any of the following events: (i) a "Change in the Ownership of the Company", (ii) a "Change in the Effective Control of the Company", or (iii) a "Change in the Ownership of a Substantial Portion of the Assets of the Company".

For purposes of this definition:

(1)    A "Change in the Ownership of the Company" occurs on the date on which any one person, or more than one person acting as a group, acquires ownership of stock of the Company that, together with stock held by such person or group constitutes more than 50% of the total fair market value or total voting power of the stock of the Company.

(2)     A "Change in the Effective Control of the Company" occurs on the date on which either: (a) a person, or more than one person acting as a group, acquires ownership of stock of the Company possessing 30% or more of the total voting power of the stock of the Company, taking into account all such stock acquired during the 12-month period ending on the date of the most recent acquisition, or (b) a majority of the members of the Board is replaced during any 12-month period by directors whose appointment or election is not endorsed by a majority of the members of such Board before the date of the appointment or election, but only if no other corporation is a majority shareholder of the Company.

(3)    A "Change in the Ownership of a Substantial Portion of the Assets of the Company" occurs on the date on which any one person, or more than one person acting as a group, other than a person or group of persons that is related to the Company, acquires assets from the Company that have a total gross fair market value equal to or more than 40% of the total gross fair market value of all of the assets of the Company immediately before such acquisition or acquisitions, taking into account all such assets acquired during the 12-month period ending on the date of the most recent acquisition.

The determination as to the occurrence of a Change in Control shall be based on objective facts and in accordance with the requirements of Code Section 409A.

    


2






Claimant. Claimant means a Participant or Beneficiary filing a claim under Article XI of this Plan.

Class Year Bonus Deferral Sub-Account. Class Year Bonus Deferral Sub-Account means the Sub-Account to which a Deferral from the incentive bonus under the Company's Annual Incentive Plan is made during a single calendar year. A separate Class Year Bonus Deferral Sub-Account will be established for each separate calendar year for which an incentive bonus deferral has been made.

Class Year Salary Deferral Sub-Account . Class Year Salary Deferral Sub-Account means the Sub-Account to which a Deferral from base salary is made during a single calendar year. A separate Class Year Salary Deferral Sub-Account will be established for each separate calendar year for which a base salary deferral has been made.

Code. Code means the Internal Revenue Code of 1986, as amended from time to time.

Code Section 409A. Code Section 409A means section 409A of the Code, and regulations and other guidance issued by the Treasury Department and Internal Revenue Service thereunder.

Committee. Committee means the Compensation and Organization Committee of the Board of the Company (or the appropriate committee of such board) appointed to oversee the administration of the Plan. The Committee shall have the full authority to delegate any of its authority, powers and responsibility with respect to the administration of the Plan, or any other responsibility or power conferred hereunder to the Committee, to officers and key employees of the Company or any of its Affiliates.

Company. Company means Kansas City Southern, a Delaware corporation.

Company Contribution. Company Contribution means a discretionary credit by a Participating Employer to a Participant's Company Sub-Account in accordance with the provisions of Section 4.6 of the Plan. Company Contributions are credited at the sole discretion of the Participating Employer and the fact that a Company Contribution is credited in one year shall not obligate the Participating Employer to continue to make such Company Contribution in subsequent years. Unless the context clearly indicates otherwise, a reference to Company Contribution shall include Earnings attributable to such contribution.

Company Sub-Account . Company Sub-Account means the Sub-Account pursuant to which all credits relating to any Company Contribution are made in accordance with Section 4.6.

Compensation. Compensation means either a Participant's (i) base salary or (ii) incentive bonuses paid under the Company's Annual Incentive Plan. Compensation

    


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shall not include any equity-based compensation (e.g., compensation paid in Company Shares), compensation that has been previously deferred under this Plan or any other arrangement subject to Code Section 409A, or any bonuses that are not paid under the Company's Annual Incentive Plan.

Compensation Deferral Agreement. Compensation Deferral Agreement means an agreement between a Participant and a Participating Employer that specifies with respect to each Deferral: (i) the amount of each component of Compensation (e.g., base salary or annual incentive bonus) that the Participant has elected to defer to the Plan in accordance with the provisions of Article IV, and (ii) the payment schedule applicable to one or more Sub-Accounts. The Committee may permit different deferral amounts for each component of Compensation and may establish a minimum or maximum deferral amount for each such component. Unless otherwise specified by the Committee in the Compensation Deferral Agreement, Participants may defer up to 50% of their base salary and up to 75% of their incentive bonuses under the Company's Annual Incentive Plan (which may or may not constitute Performance-Based Compensation). Unless otherwise determined by the Company, all required tax withholding associated with any deferral of Compensation will be withheld from the Participant's other compensation. A Compensation Deferral Agreement may also specify the investment allocation described in Section 7.4.

Deferral. Deferral means a credit to a Sub-Account that records that portion of the Participant's Compensation that the Participant has elected to defer for a single calendar year pursuant to his or her Compensation Deferral Agreement deferring either base salary or incentive bonus for that year, and with respect to such deferral specifying both (i) the designated payment commencement date or event and (ii) the payment schedule applicable for those deferrals. Unless the context of the Plan clearly indicates otherwise, a reference to a Deferral includes Earnings attributable to such Deferrals. Deferrals shall be calculated with respect to the gross cash Compensation payable to the Participant before any deductions or withholdings, but shall be reduced by the Committee as necessary so that it does not exceed 100% of the cash Compensation of the Participant remaining after deduction of all required income and employment taxes, 401(k) and other employee benefit deductions, and other deductions required by law. Changes to payroll withholdings that affect the amount of Compensation being deferred to the Plan shall be allowed only to the extent permissible under Code Section 409A.

Determination Date . Determination Date means the date on which the amount of a Participant’s Sub-Account eligible to be paid is determined as provided in Article V. The applicable Determination Date is the date the Plan's recordkeeper processes a payment for distribution.

Earnings. Earnings means an adjustment to the value of a Sub-Account in accordance with Article VII.


    


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Effective Date. Effective Date means October 1, 2018, provided, however, deferral elections made in accordance with Article IV may be submitted to the Company before the Effective Date.

Eligible Employee. Eligible Employee means a member of a "select group of management or highly compensated employees" of a Participating Employer within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA, as determined by the Committee from time to time in its sole discretion.

Employee. Employee means a common-law employee of an Employer.

Employer. Employer means, with respect to Employees it employs, the Company and each Affiliate.

ERISA. ERISA means the Employee Retirement Income Security Act of 1974, as amended from time to time.

Initial Enrollment Period . Initial Enrollment Period means September 4, 2018 through September 30, 2018.

Participant. Participant means an Eligible Employee who has received notification of his or her eligibility to defer Compensation under the Plan under Section 3.1 and any other person with an Aggregate Sub-Account Balance greater than zero, regardless of whether such individual continues to be an Eligible Employee. A Participant's continued participation in the Plan shall be governed by Section 3.2 of the Plan.

Participating Employer. Participating Employer means the Company and each Adopting Employer.

Performance-Based Compensation. Performance-Based Compensation means Compensation where the amount of, or entitlement to, the Compensation is contingent on the satisfaction of pre-established organizational or individual performance criteria relating to a performance period of at least 12 consecutive months. Organizational or individual performance criteria are considered pre-established if established in writing by not later than 90 days after the commencement of the period of service to which the criteria relate, provided that the outcome is substantially uncertain at the time the criteria are established. The determination of whether Compensation qualifies as "Performance-Based Compensation" will be made in accordance with Treas. Reg. Section 1.409A-1(e) and subsequent guidance.

Plan. Generally, the term Plan means the "Kansas City Southern Executive Deferred Compensation Plan" as documented herein and as may be amended from time to time hereafter. However, to the extent permitted or required under Code Section 409A, the term Plan may in the appropriate context also mean a portion of the Plan that is treated as a single plan under Treas. Reg. Section 1.409A-1(c), or the Plan or portion of the

    


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Plan and any other nonqualified deferred compensation plan or portion thereof that is treated as a single plan under such section.

Plan Year. Plan Year means the January 1 through December 31.

Separation from Service. Separation from Service means an Employee's termination of employment with the Employer. Whether a Separation from Service has occurred shall be determined by the Committee in accordance with Code Section 409A.

Except in the case of an Employee on a bona fide leave of absence as provided below, an Employee is deemed to have incurred a Separation from Service if the Employer and the Employee reasonably anticipated that the level of services to be performed after a date certain as an employee, an independent contractor, or in any other capacity would be reduced to 20% or less of the average services rendered by the Employee during the immediately preceding 36-month period (or the total period of employment, if less than 36 months), disregarding periods during which the Employee was on a bona fide leave of absence.

An Employee who is absent from work due to military leave, sick leave, or other bona fide leave of absence shall incur a Separation from Service on the first date immediately following the later of: (i) the six month anniversary of the commencement of the leave, or (ii) the expiration of the Employee's right, if any, to reemployment under statute or contract. Notwithstanding the preceding, however, an Employee who is absent from work due to a physical or mental impairment that is expected to result in death or last for a continuous period of at least six months and that prevents the Employee from performing the duties of his position of employment or a similar position shall incur a Separation from Service on the first date immediately following the 29-month anniversary of the commencement of the leave.

For purposes of determining whether a Separation from Service has occurred, the Employer means the Employer as defined above, except that in applying Code sections 1563(a)(1), (2) and (3) for purposes of determining whether another organization is an Affiliate of the Company under Code Section 414(b), and in applying Treasury Regulation Section 1.414(c)-2 for purposes of determining whether another organization is an Affiliate of the Company under Code Section 414(c), "at least 50 percent" shall be used instead of "at least 80 percent" each place it appears in those sections.

The Committee specifically reserves the right to determine whether a sale or other disposition of substantial assets to an unrelated party constitutes a Separation from Service with respect to a Participant providing services to the seller immediately before the transaction and providing services to the buyer after the transaction. Such determination shall be made in accordance with the requirements of Code Section 409A.


    


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Specified Employee. Specified Employee has the meaning in Section 409A of the Code. Each Participant in the Plan shall be deemed to be a Specified Employee at all times while participating in the Plan such that any payment on account of Separation from Service (other than death) will be delayed for six-months in accordance with Section 409A of the Code.

In the event of corporate transactions described in Treas. Reg. Section 1.409A-1(i)(6), the identification of Specified Employees shall be determined in accordance with the default rules described therein, unless the Employer elects to utilize the available alternative methodology through designations made within the timeframes specified therein.

Sub-Account. Sub-Account means a Participant's Class Year Bonus Deferral Sub-Account, Class Year Salary Deferral Sub-Account, or Company Sub-Account. Except for the Company Sub-Account, each sub-account is a bookkeeping account maintained by the Company to record the Deferrals made to that sub-account for a specific year. The Company Sub-Account is a bookkeeping account maintained by the Company to record all Company Contributions (regardless of any specific year). Each Sub-Account is intended to constitute an unfunded obligation within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA.

Substantial Risk of Forfeiture. Substantial Risk of Forfeiture means the description specified in Treas. Reg. Section 1.409A-1(d).

Unforeseeable Emergency. Unforeseeable Emergency means a severe financial hardship to the Participant resulting from an illness or accident of the Participant, the Participant's spouse, the Participant's dependent (as defined in Code Section 152, without regard to Section 152(b)(1), (b)(2), and (d)(1)(B)), or a Beneficiary; loss of the Participant's property due to casualty (including the need to rebuild a home following damage to a home not otherwise covered by insurance, for example, as a result of a natural disaster); or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant. The types of events which may qualify as an Unforeseeable Emergency may be limited by the Committee.

Year of Service . Year of Service means each 12-month period of continuous service with the Employer.

ARTICLE III
Eligibility and Participation
3.1
Eligibility and Participation. An Eligible Employee becomes a Participant upon the earlier of (i) the receipt of notification from the Committee of his or her eligibility to participate in the Plan or (ii) a credit of Company Contributions to the Eligible Employee's Company Sub-Account under Section 4.6. Except for those Employees that are eligible on the Effective Date and submit a Compensation Deferral Agreement

    


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during the Initial Enrollment Period, Eligible Employees will only be able to make Deferrals on January 1 of the year following the year the Employee first becomes eligible.

3.2
Duration. A Participant shall be eligible to defer Compensation and receive allocations of Company Contributions, subject to the terms of the Plan, for as long as such Participant remains an Eligible Employee. A Participant who is no longer an Eligible Employee but has not Separated from Service may not make a new deferral of Compensation under the Plan beyond the Plan Year in which he or she became ineligible but may otherwise exercise all of the rights of a Participant under the Plan with respect to his or her Sub-Account(s). To the extent a Participant has made an election to defer cash Compensation, on and after a Separation from Service, a Participant shall remain a Participant as long as his or her Aggregate Sub-Account Balance is greater than zero (0), and during such time may continue to make allocation elections as provided in Section 7.4. An individual shall cease being a Participant in the Plan when all benefits under the Plan to which he or she is entitled have been paid.

ARTICLE IV
Deferrals
4.1
Deferral Elections, Generally.

(a)
A Participant may elect to defer Compensation by submitting a Compensation Deferral Agreement during the enrollment periods established by the Committee and in the manner specified by the Committee, but in any event, in accordance with Section 4.2. A Compensation Deferral Agreement that is not timely filed with respect to a service period or component of Compensation shall be considered void and shall have no effect with respect to such service period or Compensation. The Committee may modify any Compensation Deferral Agreement before the date the election becomes irrevocable under the rules of Section 4.2.

(b)
The Participant shall specify on his or her Compensation Deferral Agreement:

(i) the amount or percentage of a type of Compensation (e.g., base salary or bonus) that is to be deferred for the upcoming deferral period;

(ii) whether those Deferrals for the designated year and type of Compensation are to commence to be paid upon the first day of the seventh month following Separation from Service or, if earlier than the date of Separation from Service, on a specified date and/or on a Change in Control; and

(iii) the payment schedule for the Sub-Account (other than the Company Sub-Account) as permitted by the Company. Deferrals payable either upon the

    


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first day of the seventh month following Separation from Service or upon a Change in Control will be permitted to be paid in substantially equal annual installments over a period of two (2) to ten (10) years or a lump sum payment and Deferrals payable upon a specified date (if earlier than the Separation from Service or Change in Control date, if elected) will be permitted to be paid in equal annual installments over a period of two (2) to five (5) years or a lump sum payment).

If no designation is made with respect to a year's Deferrals, all Deferrals shall be scheduled to be paid in a lump sum on the first day of the seventh month following the date of the Participant's Separation from Service.

4.2     Timing Requirements for Compensation Deferral Agreements.

(a)
Initial Eligibility. For Eligible Employees that have become eligible to participate on the Effective Date, Compensation Deferral Agreements made before the Effective Date shall be effective on the Effective Date, and applies to Compensation earned on and after the date the Compensation Deferral Agreement becomes irrevocable. For any other Participant that becomes eligible, Compensation Deferral Agreements will be effective only as provided in Section 4.2(b).

(b)
Prior Year Election. Except as otherwise provided in this Section 4.2, Participants may defer Compensation by filing a Compensation Deferral Agreement no later than December 31 of the year before the year in which the Compensation to be deferred is earned. A Compensation Deferral Agreement described in this paragraph shall become irrevocable with respect to such Compensation as of 11:59 p.m. on the December 31 of the year immediately preceding the year in which such Compensation is to be earned.

(c)
Performance-Based Compensation. If permitted by the Committee, Participants may file a Compensation Deferral Agreement with respect to Performance-Based Compensation after the beginning of the performance period and no later than the date that is six months before the end of the performance period, provided that:

(i)
the Participant performs services continuously from the later of the beginning of the performance period or the date the criteria are established through the date the Compensation Deferral Agreement is submitted; and

(ii)
the Compensation is not readily ascertainable as of the date the Compensation Deferral Agreement is filed.


    


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A Compensation Deferral Agreement becomes irrevocable with respect to Performance-Based Compensation as of the day immediately following the latest date for filing such election. Any election to defer Performance-Based Compensation that is made in accordance with this paragraph and that becomes payable as a result of the Participant's death or upon a Change in Control (as defined in Treas. Reg. Section 1.409A-3(i)(5)) before the satisfaction of the performance criteria will be void.

(d)
Short-Term Deferrals. Compensation that meets the definition of a "short-term deferral" described in Treas. Reg. Section 1.409A-1(b)(4) may be deferred in accordance with the rules of Article VI, applied as if the date the Substantial Risk of Forfeiture lapses is the date payments were originally scheduled to commence, provided, however, that the provisions of Section 6.3 shall not apply to payments attributable to a Change in Control (as defined in Treas. Reg. Section 1.409A-3(i)(5)).

(e)
Certain Forfeitable Rights. With respect to a legally binding right to a payment in a subsequent year that is subject to a forfeiture condition requiring the Participant's continued services for a period of at least 12 months from the date the Participant obtains the legally binding right, an election to defer such Compensation may be made on or before the 30 th day after the Participant obtains the legally binding right to the Compensation, provided that the election is made at least 12 months in advance of the earliest date at which the forfeiture condition could lapse. The Compensation Deferral Agreement described in this paragraph becomes irrevocable after such 30 th day. If the forfeiture condition applicable to the payment lapses before the end of the required service period as a result of the Participant's death or disability (as defined in Treas. Reg. Section 1.409A-3(i)(4)) or upon a Change in Control (as defined in Treas. Reg. Section 1.409A-3(i)(5)), the Compensation Deferral Agreement will be void unless it would be considered timely under another rule described in this Section.

(f)
No "Evergreen" Deferral Elections. No "Evergreen" deferral elections shall be permitted under the Plan such that all Participants will be required to affirmatively submit a new Compensation Deferral Agreement for an upcoming year to have Compensation deferred for that year.

4.3
Deductions from Pay. The Committee has the authority to determine the payroll practices under which any component of Compensation subject to a Compensation Deferral Agreement will be deducted from a Participant's Compensation.

4.4
Vesting. Participant Deferrals shall be 100% vested at all times.

4.5
Cancellation of Compensation Deferral Agreement. The Committee may cancel a Participant's Compensation Deferral Agreement: (i) for the balance of the Plan Year in which an Unforeseeable Emergency occurs, (ii) if the Participant receives a hardship

    


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distribution under the Employer's qualified 401(k) plan, through the end of the Plan Year in which the six month anniversary of the hardship distribution falls, and (iii) during periods in which the Participant is unable to perform the duties of his or her position or any substantially similar position due to a mental or physical impairment that can be expected to result in death or last for a continuous period of at least six months, provided cancellation occurs by the later of the end of the taxable year of the Participant or the 15 th day of the third month following the date the Participant incurs the disability (as defined in Treas. Reg. Section 1.409A-3(i)(4)).

4.6
Company Contributions. A Participating Employer may, from time to time, in its sole and absolute discretion, credit Company Contributions to any Participant's Company Sub-Account in any amount determined by the Participating Employer. Company Contributions may be made in the form of a matching contribution, a nonelective contribution or both and may be made in accordance with any formula selected by the Participating Employer, which formula may be different from year to year. Company Contributions may be subject to any vesting schedule determined by the Participating Employer at the time of the credit. The Committee may, in its sole discretion, fully vest the Participants' Company Sub-Accounts on a Change in Control. All Company Contributions will be credited to the same Company Sub-Account.

ARTICLE V
Benefit Payments
5.1
Benefit Commencement and Form of Payment . With the exception of the Company Sub-Account, each Sub-Account of a Participant as determined under Section 5.5 (other than a Company Sub-Account) shall commence to be paid in accordance with the Compensation Deferral Agreement relating to such Sub-Account. The Participant's Company Sub-Account as determined under Section 5.5 shall be paid in a single lump sum on the first day of the seventh month following the Participant's Separation from Service. Notwithstanding the foregoing and any election made by a Participant, the following payment rules shall apply:

(a)
Separation from Service. Following a Participant's Separation from Service, any Sub-Account that is scheduled to be paid or commence to be paid after the date of Separation from Service shall instead be paid or commence to be paid on the first day of the seventh month following the Participant's Separation from Service. Any Sub-Account that is scheduled to be paid (either on a specified date or on account of a Change in Control) earlier than the date of Separation from Service shall be paid on that earlier date. The Sub-Accounts (other than a Company Sub-Account) will be paid in the form selected by the Participant in the Compensation Deferral Agreement. If a payment scheduled to be paid upon a specified date or on a Change in Control is accelerated and paid on the first day of the seventh month following the Participant's Separation from Service, the method of payment (e.g., lump sum or installments) selected by the Participant on account of payments on account of a Separation from Service

    


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shall govern and not any different payment schedule that would have applied if such payment had commenced on the specified date.

(b)
Death. Upon the Participant's Death, the Participant shall be paid his or her Aggregate Sub-Account Balance in a single lump sum within 90 days following the Participant's death.

(c)
Unforeseeable Emergency Payments. A Participant who experiences an Unforeseeable Emergency may submit a written request to the Committee to receive payment of all or any portion of his or her Sub-Accounts. Whether a Participant or Beneficiary is faced with an Unforeseeable Emergency permitting an emergency payment shall be determined by the Committee based on the relevant facts and circumstances of each case, but, in any case, a distribution on account of Unforeseeable Emergency may not be made to the extent that such emergency is or may be reimbursed through insurance or otherwise, by liquidation of the Participant's assets, to the extent the liquidation of such assets would not cause severe financial hardship, or by cessation of Deferrals under this Plan. If an emergency payment is approved by the Committee, the amount of the payment shall not exceed the amount reasonably necessary to satisfy the need, taking into account the additional compensation that is available to the Participant as the result of cancellation of deferrals to the Plan, including amounts necessary to pay any taxes or penalties that the Participant reasonably anticipates will result from the payment. The amount of the emergency payment shall be subtracted first from the Participant's Sub-Accounts commencing on a specified date, beginning with the Sub-Account with the latest payment commencement date. Emergency payments shall be paid in a single lump sum within the 90-day period following the date the payment is approved by the Committee.

5.2
Small Aggregate Sub-Account Balances . Notwithstanding any Participant election or other provisions of the Plan, all of a Participant's Sub-Account(s) will be paid in a single lump sum if, on the first day of the seventh month following the Participant's Separation from Service, the Aggregate Sub-Account Balance is not greater than $25,000. Such single lump sum shall be paid on the first day of the seventh month following the Participant's Separation from Service.

5.3
Rules Applicable to Installment Payments . If a payment schedule specifies installment payments, annual payments will be made beginning as of the payment commencement date for such installments and shall continue to be made on each anniversary thereof (or within the 15-day period thereafter) until the number of installment payments specified in the payment schedule has been paid. The amount of each installment payment shall be determined by dividing (a) by (b), where (a) equals the Sub-Account balance as of the applicable Business Day relating to the payment and (b) equals the remaining number of installment payments.


    


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For purposes of Article VI, a series of installment payments will be treated as a single payment for purposes of Code Section 409A.

5.4
Acceleration of or Delay in Payments. The Committee, in its sole and absolute discretion, may elect to accelerate the time or form of payment of a benefit owed to the Participant hereunder, provided such acceleration is permitted under Treas. Reg. Section 1.409A-3(j)(4). The Committee may also, in its sole and absolute discretion, delay the time for payment of a benefit owed to the Participant hereunder, to the extent permitted under Treas. Reg. Section 1.409A-2(b)(7).

5.5
Determination of Amount of Sub-Account . Each Participant's Sub-Account shall equal the value of the Sub-Account as determined under Article VII as of the Determination Date applicable to such payment.

ARTICLE VI
Modifications to Payment Schedules
6.1
Participant's Right to Modify. A Participant may modify the designated or elected payment schedules with respect to a Sub-Account, consistent with the permissible payment schedules available under the Plan, provided such modification complies with the requirements of this Article VI. Any modification of the payment schedule remains subject to the payment distribution rules provided in Section 5.1.

6.2
Time of Election. If a modification applies with respect to a payment scheduled to be payable (or commence to be payable) on a specified date, the date on which a modification election is submitted to the Committee must be at least 12 months before the date on which payment is scheduled to commence under the payment schedule in effect before the modification. If a modification applies with respect to a payment scheduled to be payable (or commence to be payable) on the first day of the seventh month following Participant's Separation from Service or upon a Change in Control, the modification will not be effective if the Participant's Separation from Service or the Change in Control occurs before the 12-month anniversary of the date the modification is submitted to the Committee.

6.3
Date of Payment under Modified Payment Schedule. The date payments are to commence under the modified payment schedule must be no earlier than five years after the date payment would have commenced under the original payment schedule. Under no circumstances may a modification election result in an acceleration of payments in violation of Code Section 409A.

6.4
Effective Date. A modification election submitted in accordance with this Article VI is irrevocable upon receipt by the Committee and becomes effective 12 months after such date.


    


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6.5
Effect on Sub-Accounts. An election to modify a payment schedule is specific to the Sub-Account or payment event to which it applies, and shall not be construed to affect the payment schedules of any other Sub-Accounts.

ARTICLE VII
Valuation of Sub-Account Balances; Investments
7.1
Valuation. Deferrals shall be credited to appropriate Sub-Accounts on the date such Compensation would have been paid to the Participant absent the Compensation Deferral Agreement. Company Contributions shall be credited to the Company Sub-Account at the times determined by the Committee. Valuation of Sub-Accounts shall be performed under procedures approved by the Committee.

7.2
Earnings Credit. With respect to all deferrals, each Sub-Account will be credited with Earnings on each Business Day, based upon the Participant's investment allocation among a menu of investment options selected in advance by the Committee, in accordance with the provisions of this Article VII ("investment allocation").

7.3
Investment Options . Investment options for all Sub-Accounts will be determined by the Company. The Company, in its sole discretion, shall be permitted to add or remove investment options from the Plan menu from time to time, provided that any such additions or removals of investment options shall not be effective with respect to any period before the effective date of such change.

7.4
Investment Allocations. A Participant's investment allocation constitutes a deemed, not actual, investment among the investment options comprising the investment menu. At no time shall a Participant have any real or beneficial ownership in any investment option included in the investment menu, nor shall the Participating Employer or any trustee acting on its behalf have any obligation to purchase actual securities as a result of a Participant's investment allocation. A Participant's investment allocation shall be used solely for purposes of adjusting the value of a Participant's Sub-Account balances.

A Participant shall specify an investment allocation for each of his Sub-Accounts in accordance with procedures established by the Committee. Allocation among the investment options must be designated in increments of 1%. The Participant's investment allocation will become effective on the same Business Day or, in the case of investment allocations received after a time specified by the Committee, the next Business Day.

A Participant may change an investment allocation on any Business Day, both with respect to future credits to the Plan and with respect to existing Sub-Account balances, in accordance with procedures adopted by the Committee. Changes shall become effective on the same Business Day or, in the case of investment allocations received after a time specified by the Committee, the next Business Day, and shall be applied prospectively.

    


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7.5
Unallocated Deferrals and Sub-Accounts. If the Participant fails to make an investment allocation with respect to a Sub-Account, such Sub-Account shall be invested in an investment option, the primary objective of which is the preservation of capital, as determined by the Committee.

ARTICLE VIII
Administration
8.1
Plan Administration . This Plan shall be administered by the Committee which shall have discretionary authority to make, amend, interpret and enforce all appropriate rules and regulations for the administration of this Plan and to utilize its discretion to decide or resolve any and all questions, including but not limited to eligibility for benefits and interpretations of this Plan and its terms, as may arise in connection with the Plan. Claims for benefits shall be filed with the Committee and resolved in accordance with the claims procedures in Article XI.

The Committee may, as necessary, make a determination of the amount of, and manner in which, any payment erroneously made to a Participant or amounts that are overpaid are recovered, in accordance with applicable law, including, without limitation, by seeking repayment or by offsetting any other payment due under the Plan; provided that any offsets against amounts shall be made in compliance with Section 409A.

8.2
Administration Upon Change in Control. Upon a Change in Control, the Committee, as constituted immediately before such Change in Control, shall continue to act as the Committee. The individual who was the Chief Executive Officer of the Company (or if such person is unable or unwilling to act, the next highest ranking officer) before the Change in Control shall have the authority (but shall not be obligated) to appoint an independent third party to act as the Committee.

Upon such Change in Control, the Company may not remove the Committee, unless 2/3rds of the members of the Board of the Company consent to the removal and replacement of the Committee. Notwithstanding the foregoing, neither the Committee nor the officer described above shall have authority to direct investment of trust assets under any rabbi trust described in Section 10.2.

The Participating Employer shall, with respect to the Committee identified under this Section: (i) pay all reasonable expenses and fees of the Committee, (ii) indemnify the Committee (including individuals serving as Committee members) against any costs, expenses and liabilities including, without limitation, attorneys' fees and expenses arising in connection with the performance of the Committee's duties hereunder, except with respect to matters resulting from the Committee's gross negligence or willful misconduct, and (iii) supply full and timely information to the Committee on all matters related to the Plan, any rabbi trust, Participants, Beneficiaries and Sub-Accounts as the Committee may reasonably require.

    


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8.3
Withholding. The Participating Employer shall have the right to withhold from any payment due under the Plan (or with respect to any amounts credited to the Plan) any taxes required by law to be withheld in respect of such payment (or credit). Withholdings with respect to amounts credited to the Plan or vested with respect to Company Contributions and related Earnings shall be deducted from Compensation that has not been deferred to the Plan, or, with respect to any Participant who has terminated employment and as permitted by Code Section 409A, from the Participant's Sub-Account under the Plan.

8.4
Indemnification. The Participating Employers shall indemnify and hold harmless each employee, officer, director, agent or organization, to whom or to which are delegated duties, responsibilities, and authority under the Plan or otherwise with respect to administration of the Plan, including, without limitation, the Committee and its agents, against all claims, liabilities, fines and penalties, and all expenses reasonably incurred by or imposed upon him or it (including but not limited to reasonable attorney fees) which arise as a result of his or its actions or failure to act in connection with the operation and administration of the Plan to the extent lawfully allowable and to the extent that such claim, liability, fine, penalty, or expense is not paid for by liability insurance purchased or paid for by the Participating Employer. Notwithstanding the foregoing, the Participating Employer shall not indemnify any person or organization if his or its actions or failure to act are due to gross negligence or willful misconduct or for any such amount incurred through any settlement or compromise of any action unless the Participating Employer consents in writing to such settlement or compromise.

8.5
Delegation of Authority. In the administration of this Plan, the Committee may, from time to time, employ agents and delegate to them such administrative duties as it sees fit, and may from time to time consult with legal counsel who shall be legal counsel to the Company.

8.6
Binding Decisions or Actions. The decision or action of the Committee in respect of any question arising out of or in connection with the administration, interpretation and application of the Plan and the rules and regulations thereunder shall be final and conclusive and binding upon all persons having any interest in the Plan.

ARTICLE IX
Amendment and Termination
9.1
Amendment and Termination. The Company may at any time and from time to time amend the Plan or may terminate the Plan as provided in this Article IX. Each Participating Employer may also terminate its participation in the Plan.

9.2
Amendments. The Company, by action taken by the Committee, may amend the Plan at any time and for any reason, provided that any such amendment shall not reduce the

    


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Sub-Account balances of any Participant accrued as of the date of any such amendment or restatement (as if the Participant had incurred a voluntary Separation from Service on such date) or reduce any rights of a Participant under the Plan or other Plan features with respect to Deferrals made before the date of any such amendment or restatement without the consent of the Participant. In addition to other delegation powers set forth in Section 8.5, the Committee may delegate its authority to amend the Plan without the consent of the Committee for the purpose of: (i) conforming the Plan to the requirements of law; (ii) facilitating the administration of the Plan; (iii) clarifying provisions based on the delegate's interpretation of the document; and (iv) making such other amendments as the Committee may authorize.

9.3
Termination. The Committee may terminate the Plan and pay Participants and Beneficiaries their Aggregate Sub-Account Balances in a single lump sum at any time, to the extent and in accordance with Treas. Reg. Section 1.409A-3(j)(4)(ix). If a Participating Employer terminates its participation in the Plan, the benefits of affected Employees shall be paid at the time provided in Article V.

9.4
Sub-Accounts Taxable Under Code Section 409A. The Plan is intended to constitute a plan of deferred compensation that meets the requirements for deferral of income taxation under Code Section 409A. In the event that any provision of this Plan shall be determined to contravene Code Section 409A, the regulations promulgated thereunder, regulatory interpretations or announcements with respect to Code Section 409A, any such provision shall be void and have no effect and may be amended by the Company without the consent of the Participant, for the purpose of Code Section 409A compliance. Moreover, this Plan shall be interpreted at all times in such a manner that the terms and provisions of the Plan comply with Code Section 409A, the regulations promulgated thereunder, and regulatory interpretations or announcements with respect to Code Section 409A. The Company shall have the authority to void any Participant election hereunder if necessary to maintain the Plan in compliance with Code Section 409A and, pursuant to its authority to interpret the Plan, may sever from the Plan or any Compensation Deferral Agreement any provision or exercise of a right that otherwise would result in a violation of Code Section 409A.

ARTICLE X
Informal Funding
10.1
General Assets. Obligations established under the terms of the Plan may be satisfied from the general funds of the Participating Employers, or a trust described in this Article X. No Participant, spouse or Beneficiary shall have any right, title or interest whatever in assets of the Participating Employers. Nothing contained in this Plan, and no action taken pursuant to its provisions, shall create or be construed to create a trust of any kind, or a fiduciary relationship, between the Participating Employers and any Employee, spouse, or Beneficiary. To the extent that any person acquires a right to receive payments hereunder, such rights are no greater than the right of an unsecured general creditor of the Participating Employer.

    


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10.2
Rabbi Trust. A Participating Employer may, in its sole discretion, establish a grantor trust, commonly known as a rabbi trust, as a vehicle for accumulating assets to pay benefits under the Plan. Payments under the Plan may be paid from the general assets of the Participating Employer or from the assets of any such rabbi trust. Payment from any such source shall reduce the obligation owed to the Participant or Beneficiary under the Plan.

ARTICLE XI
Claims
11.1
Filing a Claim. Any controversy or claim arising out of or relating to the Plan shall be filed in writing with the Committee which shall make all determinations concerning such claim. Any claim filed with the Committee and any decision by the Committee denying such claim shall be in writing and shall be delivered to the Participant or Beneficiary filing the claim (the "Claimant").

(a)
In General. Notice of a denial of benefits will be provided within 90 days of the Committee's receipt of the Claimant's claim for benefits. If the Committee determines that it needs additional time to review the claim, the Committee will provide the Claimant with a notice of the extension before the end of the initial 90-day period. The extension will not be more than 90 days from the end of the initial 90-day period and the notice of extension will explain the special circumstances that require the extension and the date by which the Committee expects to make a decision.

(b)
Contents of Notice. If a claim for benefits is completely or partially denied, notice of such denial shall be in writing and shall set forth the reasons for denial in plain language. The notice shall: (i) cite the pertinent provisions of the Plan document, and (ii) explain, where appropriate, how the Claimant can perfect the claim, including a description of any additional material or information necessary to complete the claim and why such material or information is necessary. The claim denial also shall include an explanation of the claims review procedures and the time limits applicable to such procedures, including a statement of the Claimant's right to bring a civil action under Section 502(a) of ERISA following an adverse decision on review.

11.2
Appeal of Denied Claims. A Claimant whose claim has been completely or partially denied shall be entitled to appeal the claim denial by filing a written appeal with a committee designated to hear such appeals (the "Appeals Committee"). A Claimant who timely requests a review of the denied claim (or his or her authorized representative) may review, upon request and free of charge, copies of all documents, records and other information relevant to the denial and may submit written comments, documents, records and other information relevant to the claim to the Appeals Committee. All written comments, documents, records, and other information shall be considered

    


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"relevant" if the information: (i) was relied upon in making a benefits determination, (ii) was submitted, considered or generated in the course of making a benefits decision regardless of whether it was relied upon to make the decision, or (iii) demonstrates compliance with administrative processes and safeguards established for making benefit decisions. The Appeals Committee may, in its sole discretion and if it deems appropriate or necessary, decide to hold a hearing with respect to the claim appeal.

(a)
In General. Appeal of a denied benefits claim must be filed in writing with the Appeals Committee no later than 60 days after receipt of the written notification of such claim denial. The Appeals Committee shall make its decision regarding the merits of the denied claim within 60 days following receipt of the appeal (or within 120 days after such receipt, in a case where there are special circumstances requiring extension of time for reviewing the appealed claim). If an extension of time for reviewing the appeal is required because of special circumstances, written notice of the extension shall be furnished to the Claimant before the commencement of the extension. The notice will indicate the special circumstances requiring the extension of time and the date by which the Appeals Committee expects to render the determination on review. The review will take into account comments, documents, records and other information submitted by the Claimant relating to the claim without regard to whether such information was submitted or considered in the initial benefit determination.

(b)
Contents of Notice. If a benefits claim is completely or partially denied on review, notice of such denial shall be in writing and shall set forth the reasons for denial in plain language.

The decision on review shall set forth: (i) the specific reason or reasons for the denial, (ii) specific references to the pertinent Plan provisions on which the denial is based, (iii) a statement that the Claimant is entitled to receive, upon request and free of charge, reasonable access to and copies of all documents, records, or other information relevant (as defined above) to the Claimant's claim, and (iv) a statement describing any voluntary appeal procedures offered by the plan and a statement of the Claimant's right to bring an action under Section 502(a) of ERISA.

11.3
Claims Appeals Upon Change in Control. Upon a Change in Control, the Appeals Committee, as constituted immediately before such Change in Control, shall continue to act as the Appeals Committee. Upon such Change in Control, the Company may not remove any member of the Appeals Committee, but may replace resigning members if 2/3rds of the members of the Board of the Company and a majority of Participants and Beneficiaries with Sub-Account balances consent to the replacement.

The Appeals Committee shall have the exclusive authority at the appeals stage to interpret the terms of the Plan and resolve appeals under the Claims Procedure.


    


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Each Participating Employer shall, with respect to the Committee identified under this Section: (i) pay its proportionate share of all reasonable expenses and fees of the Appeals Committee, (ii) indemnify the Appeals Committee (including individual committee members) against any costs, expenses and liabilities including, without limitation, attorneys' fees and expenses arising in connection with the performance of the Appeals Committee hereunder, except with respect to matters resulting from the Appeals Committee's gross negligence or willful misconduct, and (iii) supply full and timely information to the Appeals Committee on all matters related to the Plan, any rabbi trust, Participants, Beneficiaries and Sub-Accounts as the Appeals Committee may reasonably require.

11.4
Legal Action. A Claimant may not bring any legal action, including commencement of any arbitration, relating to a claim for benefits under the Plan unless and until the Claimant has followed the claims procedures under the Plan and exhausted his or her administrative remedies under such claims procedures.

If a Participant or Beneficiary prevails in a legal proceeding brought under the Plan to enforce the rights of such Participant or any other similarly situated Participant or Beneficiary, in whole or in part, the Participating Employer shall reimburse such Participant or Beneficiary for all legal costs, expenses, attorneys' fees and such other liabilities incurred as a result of such proceedings. If the legal proceeding is brought in connection with a Change in Control, or a "change in control" as defined in a rabbi trust described in Section 10.2, the Participant or Beneficiary may file a claim directly with the trustee for reimbursement of such costs, expenses and fees. For purposes of the preceding sentence, the amount of the claim shall be treated as if it were an addition to the Participant's or Beneficiary's Aggregate Sub-Account Balance.

11.5
Discretion of Appeals Committee. All interpretations, determinations and decisions of the Appeals Committee with respect to any claim shall be made in its sole discretion, and shall be final and conclusive.

ARTICLE XII
General Provisions
12.1
Assignment. Except with respect to a Permitted Transferee, no interest of any Participant, spouse or Beneficiary under this Plan and no benefit payable hereunder shall be assigned as security for a loan, and any such purported assignment shall be null, void and of no effect, nor shall any such interest or any such benefit be subject in any manner, either voluntarily or involuntarily, to anticipation, sale, transfer, assignment or encumbrance by or through any Participant, spouse or Beneficiary. Notwithstanding anything to the contrary herein, however, pursuant to conditions and procedures established by the Committee from time to time, the Committee may permit Sub-Accounts to be paid to certain persons or entities related to a Participant, including members of the Participant’s immediate family, charitable institutions, or trusts or other entities whose beneficiaries or beneficial owners are members of the Participant’s

    


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immediate family and/or charitable institutions (a “Permitted Transferee”). Any permitted transfer shall be subject to the condition that the Committee receive evidence satisfactory to it that the transfer or payment is being made for estate and/or tax planning purposes on a gratuitous or donative basis and without consideration (other than nominal consideration).

The Company may assign any or all of its liabilities under this Plan in connection with any restructuring, recapitalization, sale of assets or other similar transactions affecting a Participating Employer without the consent of the Participant.

12.2
No Legal or Equitable Rights or Interest. No Participant or other person shall have any legal or equitable rights or interest in this Plan that are not expressly granted in this Plan. Participation in this Plan does not give any person any right to be retained in the service of the Participating Employer. The right and power of a Participating Employer to dismiss or discharge an Employee is expressly reserved. The Participating Employers make no representations or warranties as to the tax consequences to a Participant or a Participant's beneficiaries resulting from a deferral of income pursuant to the Plan.

12.3
No Employment Contract. Nothing contained herein shall be construed to constitute a contract of employment between an Employee and a Participating Employer.

12.4
Notice. Any notice or filing required or permitted to be delivered to the Committee under this Plan shall be delivered in writing, in person, or through such electronic means as is established by the Committee. Notice shall be deemed given as of the date of delivery or, if delivery is made by mail, as of the date shown on the postmark on the receipt for registration or certification. Written transmission shall be sent by certified mail to:

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
RE: EXECUTIVE DEFERRED COMPENSATION PLAN
ATTN: HUMAN RESOURCES
427 WEST 12TH STREET
KANSAS CITY, MO 64105

Any notice or filing required or permitted to be given to a Participant under this Plan shall be sufficient if in writing or hand-delivered, or sent by mail to the last known address of the Participant.

12.5
Headings. The headings of Sections are included solely for convenience of reference, and if there is any conflict between such headings and the text of this Plan, the text shall control.

12.6
Invalid or Unenforceable Provisions. If any provision of this Plan shall be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provisions hereof and the Committee may elect in its sole discretion to construe such

    


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invalid or unenforceable provisions in a manner that conforms to applicable law or as if such provisions, to the extent invalid or unenforceable, had not been included.

12.7
Lost Participants or Beneficiaries. Any Participant or Beneficiary who is entitled to a benefit from the Plan has the duty to keep the Committee advised of his or her current mailing address. If benefit payments are returned to the Plan or are not presented for payment after a reasonable amount of time, the Committee shall presume that the payee is missing. The Committee, after making such efforts as in its discretion it deems reasonable and appropriate to locate the payee, shall stop payment on any uncashed checks and may discontinue making future payments until contact with the payee is restored.

12.8
Facility of Payment to a Minor . If a distribution is to be made to a minor, or to a person who is otherwise incompetent, then the Committee may, in its discretion, make such distribution: (i) to the legal guardian, or if none, to a parent of a minor payee with whom the payee maintains his or her residence, or (ii) to the conservator or committee or, if none, to the person having custody of an incompetent payee. Any such distribution shall fully discharge the Committee, the Company, and the Plan from further liability on account thereof.

12.9
Governing Law . To the extent not preempted by ERISA, the laws of the State of Missouri shall govern the construction and administration of the Plan.

    


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The undersigned executed this Plan as of the 31 day of August, 2018, to be effective as of the Effective Date.

KANSAS CITY SOUTHERN

By:     Lora Cheatum             (Print Name)
Its:     SVP – HR & Labor         (Title)

/s/ Lora Cheatum         (Signature)


    


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Exhibit 31.1
PRINCIPAL EXECUTIVE OFFICER'S CERTIFICATION
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Patrick J. Ottensmeyer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kansas City Southern (the “registrant”);
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
 
/s/ P ATRICK  J. O TTENSMEYER
Patrick J. Ottensmeyer
President and Chief Executive Officer
Date: October 19, 2018





Exhibit 31.2
PRINCIPAL FINANCIAL OFFICER’S CERTIFICATION
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Michael W. Upchurch, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kansas City Southern (the “registrant”);
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
/s/ M ICHAEL  W. U PCHURCH
Michael W. Upchurch
Executive Vice President and Chief Financial Officer

Date: October 19, 2018





Exhibit 32.1
PRINCIPAL EXECUTIVE OFFICER’S CERTIFICATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Kansas City Southern (the “Company”) on Form 10-Q for the period ended September 30, 2018 , as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Patrick J. Ottensmeyer, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
/s/ P ATRICK  J. O TTENSMEYER
Patrick J. Ottensmeyer
President and Chief Executive Officer
Date: October 19, 2018
A signed original of this written statement required by Section 906 has been provided to Kansas City Southern and will be retained by Kansas City Southern and furnished to the Securities and Exchange Commission or its staff upon request.





Exhibit 32.2
PRINCIPAL FINANCIAL OFFICER’S CERTIFICATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Kansas City Southern (the “Company”) on Form 10-Q for the period ended September 30, 2018 , as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael W. Upchurch, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
/s/ M ICHAEL  W. U PCHURCH
Michael W. Upchurch
Executive Vice President and Chief Financial Officer
Date: October 19, 2018
A signed original of this written statement required by Section 906 has been provided to Kansas City Southern and will be retained by Kansas City Southern and furnished to the Securities and Exchange Commission or its staff upon request.