KANSAS CITY SOUTHERN (Form: 10-Q, Received: 08/15/2005 17:49:04)

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005


o		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 Company as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		44-0663509 (I.R.S. Employer Identification No.)

427 West 12th Street, Kansas City, Missouri (Address of principal executive offices)		64105 (Zip Code)

(816) 983-1303
(Company’s telephone number, including area code)

No Changes
(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the Company (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 Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the Company is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


Class		Outstanding at July 31, 2005

Common Stock, $.01 per share par value		82,028,860 Shares

KANSAS CITY SOUTHERN

FORM 10-Q
JUNE 30, 2005

INDEX


	Page
PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Introductory Comments		1

Consolidated Statements of Income — Three and Six months ended June 30, 2005 and 2004		2

Consolidated Balance Sheets — June 30, 2005 and December 31, 2004		3

Consolidated Statements of Cash Flows — Six months ended June 30, 2005 and 2004		4

Consolidated Statement of Changes in Stockholders’ Equity — Six months ended June 30, 2005		5

Notes to Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		24

Item 3. Quantitative and Qualitative Disclosures About Market Risk		37

Item 4. Controls and Procedures		38

PART II – OTHER INFORMATION

Item 1. Legal Proceedings		38

Item 4. Submission of Matters to a Vote of Security Holders		38

Item 5. Other Information		38

Item 6. Exhibits		39

SIGNATURES		39
Second Supplemental Indenture
Supplemental Indenture
Financing Agreement
Pledge Agreement
Lease Agreement
Lease Agreement
Lease Agreement
Lease Agreement
Lease Agreement
Certification
Certification
Certification
Certification

KANSAS CITY SOUTHERN

FORM 10-Q
JUNE 30, 2005

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Introductory Comments

The Consolidated Financial Statements included herein have been prepared by Kansas City Southern (the “Company” or “KCS”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. The Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented. These Consolidated Financial Statements should be read in conjunction with the consolidated financial statements and the notes thereto, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-Q. For the three and six months ended June 30, 2005, these financial statements include the results of operations and cash flows of Mexrail, Inc. (“Mexrail”) and Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”) which were consolidated on January 1, 2005 and April 1, 2005, respectively, as a result of the acquisition of a controlling interest in each entity as of these respective dates. Accordingly results for the three and six months ended June 30, 2005 are not indicative of the results expected for the full year 2005.

KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF INCOME
(Dollars in millions, except share and per share data)
(Unaudited)


	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2005			2004			2005			2004
Revenues	$	381.1		$	153.9		$	579.3		$	301.7

Operating expenses
Compensation and benefits		93.4			52.2			154.7			103.0
Fuel		56.5			14.6			83.0			29.4
Purchased services		56.6			15.4			76.4			31.0
Equipment costs		41.5			11.6			58.6			24.6
Depreciation and amortization		40.4			13.1			54.7			25.9
Deferred profit sharing		38.7			—			38.7			—
Casualties and insurance		22.0			10.9			34.7			16.6
Other		40.3			16.6			62.0			34.3

Total operating expenses		389.4			134.4			562.8			264.8


Operating income (loss)		(8.3	)		19.5			16.5			36.9

Equity in net earnings (loss) of unconsolidated affiliates:
Grupo TFM, S.A. de C.V.		—			2.9			(1.0	)		4.2
Other		1.5			0.3			0.4			0.4
Interest expense		(38.7	)		(10.9	)		(51.0	)		(21.7	)
Debt retirement costs		(3.9	)		—			(3.9	)		(4.2	)
Foreign exchange gains (losses)		4.3			—			4.3			—
Other income		3.8			1.7			7.1			3.2


Income (loss) before income taxes and minority interest		(41.3	)		13.5			(27.6	)		18.8
Income tax provision		1.6			4.3			7.2			6.2


Income (loss) before minority interest		(42.9	)		9.2			(34.8	)		12.6
Minority interest		(17.8	)					(17.8	)


Net income (loss)		(25.1	)		9.2			(17.0	)		12.6
Preferred stock dividends		2.2			2.2			4.4			4.4

Net income (loss) available to common shareholders	$	(27.3	)	$	7.0		$	(21.4	)	$	8.2


Per Share Data
Earnings (loss) per Common share — basic	$	(0.33	)	$	0.11		$	(0.29	)	$	0.13


Earnings (loss) per Common share — diluted	$	(0.33	)	$	0.11		$	(0.29	)	$	0.13


Weighted average Common shares outstanding (in thousands)
Basic		81,707			62,655			72,604			62,570
Potential dilutive Common shares		—			1,175			—			1,242

Diluted		81,707			63,830			72,604			63,812

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

CONSOLIDATED BALANCE SHEETS
(Dollars in millions, except share amounts)


	June 30,			December 31,
	2005			2004
	*(Unaudited)*
ASSETS
Current Assets:
Cash and cash equivalents	$	41.8		$	38.6
Accounts receivable, net		287.1			131.4
Accounts receivable from related parties		0.6			8.2
Inventories		80.1			48.2
Other current assets		46.4			27.2

Total current assets		456.0			253.6


Investments		56.4			484.9
Properties (net of accumulated depreciation and amortization of $1,065.8 and $755.3, respectively)		2,142.7			1,424.0
Concession rights (net of $364.5 accumulated amortization) as of June 30, 2005		1,418.4			—
Goodwill		30.4			10.6
Restricted cash		9.0			200.0
Deferred tax assets		112.8			—
Other assets		73.6			67.5


Total assets	$	4,299.3		$	2,440.6


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Debt due within one year	$	118.1		$	9.9
Accounts and wages payable		157.8			52.8
Payable to related parties		2.1			34.7
Accrued liabilities		202.9			148.4

Total current liabilities		480.9			245.8


Other Liabilities
Long-term debt		1,479.1			655.8
Escrow note payable		47.0			—
Liability under participation agreement		118.7			—
Deferred income taxes		438.7			430.9
Other noncurrent liabilities and deferred credits		164.0			83.6

Total other liabilities		2,247.5			1,170.3


Minority Interest		256.9			—

Stockholders’ Equity:
$25 par, 4% noncumulative, Preferred stock, 840,000 shares authorized, 649,736 shares issued, 242,170 shares outstanding at June 30, 2005 and December 31, 2004		6.1			6.1
$1 par, Cumulative Preferred stock, 400,000 shares authorized, issued and outstanding at June 30, 2005 and December 31, 2004		0.4			0.4
$.01 par, Common stock, 400,000,000 shares authorized; 91,369,116 shares issued; 81,768,683 and 63,270,204 shares outstanding at June 30, 2005 and December 31, 2004, respectively		0.8			0.6
Paid in capital		470.5			155.3
Retained earnings		840.5			861.9

Unearned compensation from restricted stock		(4.8	)		—
Accumulated other comprehensive income		0.5			0.2

Total stockholders’ equity		1,314.0			1,024.5


Total liabilities and stockholders’ equity	$	4,299.3		$	2,440.6

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in millions)
(Unaudited )


	Six Months
	Ended June 30,
	2005			2004
CASH FLOWS PROVIDED BY (USED FOR):

OPERATING ACTIVITIES:
Net income (loss)	$	(17.0	)	$	12.6
Adjustments to reconcile net income (loss) to net cash Provided by operating activities
Depreciation and amortization		54.7			25.9
Deferred income taxes		34.9			3.3
Equity in undistributed earnings of unconsolidated affiliates		0.6			(4.6	)
Funding of restricted cash		(9.0	)		—
Minority interest		(17.8	)		—
Distributions from unconsolidated affiliates		8.3			8.8
(Gain) loss on sales of property		0.5			(0.7	)
Loss on sale of investments		0.2			—
Tax benefit realized upon exercise of stock options		0.9			0.9
Changes in working capital items
Accounts receivable		35.0			0.2
Inventories		(7.1	)		(7.9	)
Other current assets		2.5			(1.2	)
Accounts and wages payable		(3.8	)		4.9
Accrued liabilities		(42.3	)		6.1
Other, net		(7.8	)		2.0

Net cash provided by operating activities		32.8			50.3


INVESTING ACTIVITIES:
Property acquisitions		(67.1	)		(66.3	)
Proceeds from disposal of property		0.5			1.9
Investment in and loans to affiliates		(10.1	)		(4.8	)
Acquisition costs		(8.0	)		(3.7	)
Cash of Mexrail at date of acquisition		3.0			—
Cash of Grupo TFM at date of acquisition		5.5			—
Other, net		1.9			(1.3	)

Net cash used for investing activities		(74.3	)		(74.2	)


FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt		522.0			150.0
Repayment of long-term debt		(473.5	)		(100.6	)
Debt issuance costs		(2.8	)		(2.9	)
Proceeds from stock plans		3.4			2.9
Cash dividends paid		(4.4	)		(4.4	)

Net cash provided by financing activities		44.7			45.0


CASH AND CASH EQUIVALENTS:
Net increase in cash and cash equivalents		3.2			21.1
At beginning of year		38.6			135.4

At end of period		41.8		$	156.5

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(Dollars in millions, except share amounts)
(Unaudited)


			$1 Par												Accumulated
	$25 Par		Cumulative		$.01 Par										Other
	Preferred		Preferred		Common		Paid In		Retained			Unearned			Comprehensive
	Stock		Stock		Stock		Capital		Earnings			Compensation			Income		Total
Balance at December 31, 2004	$	6.1	$	0.4	$	0.6	$	155.3	$	861.9		$	—		$	0.2	$	1,024.5

Comprehensive income:
Net income (loss)										(17.0	)
Change in fair value of cash flow hedges																0.1
Amortization of accumulated other comprehensive loss related to interest rate swaps																0.2
Comprehensive income																		(16.7	)
Dividends on $25 Par Preferred Stock ($0.50/share)										(0.1	)							(0.1	)
Dividends on $1 Par Cumulative Preferred Stock ($10.625/share)										(4.3	)							(4.3	)
Issuance of restricted stock awards								5.3					(5.3	)				—
Amortization of unearned compensation													0.5					0.5
Stock issued in acquisition of Grupo TFM						0.2		304.2										304.4
Options exercised and stock subscribed								5.7										5.7

Balance at June 30, 2005	$	6.1	$	0.4	$	0.8	$	470.5	$	840.5		$	(4.8	)	$	0.5	$	1,314.0

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.		Accounting Policies and Interim Financial Statements. In the opinion of the management of KCS, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of the Company and its subsidiary companies as of June 30, 2005 and December 31, 2004, the results of its operations for the three and six months ended June 30, 2005 and 2004, its cash flows for the six months ended June 30, 2005 and 2004, and its changes in stockholders’ equity for the six months ended June 30, 2005. The accompanying consolidated financial statements have been prepared consistently with accounting policies described in Note 2 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2004. The results of operations for the three month and six month periods ended June 30, 2005 are not necessarily indicative of the results to be expected for the full year 2005. For information regarding the Company’s critical accounting policies and estimates, please see Item 7 of the Company’s Annual Report on Form 10-K “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates.” Certain prior year amounts have been reclassified to conform to the current year presentation.

		As discussed in Note 4 to the Consolidated Financial Statements “Acquisitions”, beginning April 1, 2005, the financial position and results of operations of Grupo TFM are consolidated into KCS. Management is currently executing post-merger integration plans which include converting accounting information systems and ensuring that the accounting policies of Grupo TFM are consistent with those of the Company. Certain accounting policies relevant to Grupo TFM are described below. As we continue the integration, we may identify other differences that will require a modification of the current Grupo TFM policy; however, we do not believe those changes, if any, would have a material effect on the financial statements of the current quarter.

		Principles of Consolidation. The accompanying consolidated financial statements are presented using the accrual basis of accounting and include the Company and its majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year presentation.

		The equity method of accounting is used for all entities in which the Company or its subsidiaries have significant influence, but not more than 50% voting interest; the cost method of accounting is generally used for investments of less than 20% voting interest. The Surface Transportation Board’s approval of KCS’s application for control of The Texas Mexican Railway Company (“Tex-Mex”) was effective December 29, 2004. KCS obtained control of Mexrail on January 1, 2005. Accordingly, for both the quarter and year to date periods ended June 30, 2005, the Company has consolidated the financial results of Mexrail. KCS completed the purchase of the controlling interest in Grupo TFM on April 1, 2005. Beginning April 1, 2005, the financial results of Grupo TFM have been consolidated into KCS. Prior to acquisition of control on December 31, 2004 for Mexrail and April 1, 2005 for Grupo TFM, the investments were accounted for under the equity method.

		Minority Interest. Minority interest reflects the Mexican government’s 20% ownership of TFM, S.A. de C.V. (“TFM”) as well as a 4.9% indirect ownership interest in Grupo TFM through TFM. In the original formation of Grupo TFM, the Mexican government purchased a 24.6% limited-voting interest in Grupo TFM for $198.8 million. In June 2002, TFM repurchased the Mexican government’s 24.6% interest in Grupo TFM. Since the purchase of the Mexican government’s 24.6% interest was completed by Grupo TFM’s subsidiary, TFM, and the Mexican government maintains a 20% minority interest in TFM, the Mexican government retained an indirect 4.9% minority interest in Grupo TFM through its ownership of TFM.

		Liability under Participation Agreement

		On June 23, 1997, Grupo TFM and TFM entered into an Association in Participation Agreement under which TFM has the right to participate in the profit, or losses, as the case may be, derived from the sale of Grupo TFM of 469.3 million of TFM’s shares. The sale of the shares covered by this agreement shall be made no later than the fifteenth anniversary of the date of this agreement unless otherwise agreed to by Grupo TFM and TFM. In exchange, TFM has transferred to Grupo TFM an amount equal to $593.4 million, which Grupo TFM used to make the second payment of the stock purchase agreement.

		The price obtained from the sale of TFM’s shares covered by the agreement shall be applied as follows: (a) first, to TFM in payment of the principal amount of its non-interest bearing receivable; (b) second, to the taxes which may result from the sale of the TFM shares covered by this agreement, and (c) the remainder, if any, shall be distributed between TFM and Grupo TFM up to an amount of $3.2 billion depending on the sale date, with 99% to TFM and 1% to Grupo TFM and finally, the remaining amounts, if any, shall be distributed 1% to TFM and 99% to Grupo TFM.

		Based on the nature and terms of this receivable, although the intercompany note of $593.4 million has been eliminated in the consolidated financial statements of Grupo TFM, a portion of such intercompany note receivable is related to the Mexican Government’s minority interest (20%) in TFM and has been presented as a liability rather than minority interest.

		Mexican Peso to U.S. Dollar Translation. Grupo TFM and its subsidiaries are required to maintain for tax purposes their books and records in Mexican pesos (“Ps”). For financial reporting purposes, Grupo TFM and subsidiaries keep records and use the United States (US) dollar as their functional and reporting currency. The US dollar is the currency that reflects the economic substance of the underlying events and circumstances relevant to the entity (i.e. historical cost convention).

		Monetary assets and liabilities denominated in Mexican pesos are translated into US dollars using current exchange rates. The difference between the exchange rate on the date of the transaction and the exchange rate on the settlement date, or balance sheet date if not settled, is included in the income statement as a foreign exchange gain/loss.

		Concession rights and related assets. Costs incurred by the Company to acquire the concession rights and related assets were capitalized and are amortized on a straight-line basis over the estimated useful lives of the related assets and rights acquired. The purchase price to acquire the concession rights and related assets was allocated to the identifiable assets acquired and liabilities assumed in connection with the privatization process based on their estimated fair value.

		The assets acquired and liabilities assumed include:

	(i)		The tangible assets acquired pursuant to the asset purchase agreement, consisting of locomotives, rail cars and materials and supplies;

	(ii)		The rights to utilize the right of way, track structure, buildings and related maintenance facilities of the TFM lines;

	(iii)		The 25% equity interest in the company established to operate the Mexico City rail terminal facilities; and

	(iv)		Finance lease obligations assumed.

		TFM Employees’ statutory profit sharing. For TFM employees’, statutory profit sharing is determined by the Company at the rate of 10% on the taxable income of TFM, adjusted as prescribed by the Mexican Income Tax Law.

		TFM Seniority premiums. For TFM employees, seniority premiums to which they are entitled upon termination of employment after 15 years of service are expensed in the years in which the services are rendered. Other compensation based on length of service to which employees may be entitled in the event of dismissal, in accordance with the Mexican Federal Law, is charged to expense in the year in which it becomes payable.

		Deferred income tax. Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax basis of assets and liabilities and their carrying amounts in the financial statements. Currently enacted tax rates are used in the determination of deferred income tax.

		For Grupo TFM, the deferred tax calculation is dependent to a certain extent, on the Mexican rate of inflation and changes in the exchange rate between the U.S. dollar and the Mexican peso. No provision for deferred U.S. income taxes has been made for the temporary difference between the financial reporting basis and the income tax basis of the Company’s investment in Grupo TFM including these differences attributable to accumulated earnings, because the Company does not consider the reversal of the temporary differences to occur in the foreseeable future.

		Restricted Cash. In connection with KCS’s acquisition of control of TFM through the purchase of shares of common stock of Grupo TFM (the “Acquisition”), KCS has entered into a consulting agreement (the “Consulting Agreement”) with José F. Serrano International Business, S.A. de C.V. (“JSIB”), a consulting company controlled by Jose Serrano, Chairman of the Board of Grupo TMM, S.A. (“TMM”) which agreement became effective upon the closing of the Acquisition. Under this agreement, JSIB will provide consulting services to KCS in connection with the portion of the business of KCS in Mexico for a period of three years. As consideration for these services, subject to the terms and conditions of the Consulting Agreement, JSIB receives an annual fee of $3.0 million. The Consulting Agreement required KCS to deposit the total amount of annual fees payable under the Consulting Agreement ($9.0 million) in cash to be held and released in accordance with the terms and conditions of the Consulting Agreement and the applicable escrow agreement. JSIB directs the investment of the escrow fund and all gains and losses accrue in the fund to the benefit of JSIB. Such amounts are payable concurrent with the payment of the annual fee.

		As of December 31, 2004, $200.0 million had been deposited into an escrow account pending completion of the acquisition of the controlling interest in Grupo TFM. This $200.0 million was paid April 1, 2005 upon closing.

		Overhead Capitalization Rates. KCSR capitalizes certain overhead costs representing the indirect costs associated with construction and improvement projects. Overhead factors are periodically reviewed and adjusted to reflect current costs. As a result of revisions to rates used to capitalize indirect costs during the quarter ended June 30, 2004, operating expenses were reduced by approximately $1.8 million.

2.		Earnings Per Share Data. Basic earnings per common share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Restricted shares granted to employees and officers are included in weighted average shares for purposes of computing basic earnings per common share as they are earned. Diluted earnings per share reflects the potential dilution that could occur if convertible securities were converted into common stock or stock options were exercised.

		The following is a reconciliation from the weighted average shares used for the basic earnings per share computation to the shares used for the diluted earnings per share computation for the three and six months ended June 30, 2005 and 2004, respectively (in thousands):


	Three Months				Six Months
	Ended June 30,				Ended June 30,
	2005		2004		2005		2004
Basic shares		81,707		62,655		72,604		62,570
Effect of dilution: Stock options		—		1,175		—		1,242

Diluted shares		81,707		63,830		72,604		63,812


Partially dilutive shares excluded from the calculation:

Stock options where the exercise price is greater than the average market price of common shares		—		611		2,600		611


Stock options which are anti-dilutive as a result of the net loss for the period		1,352		—		1,330		—


Convertible preferred stock which are anti-dilutive		13,389		13,389		13,389		13,389

3.		Investments. Investments in unconsolidated affiliates and certain other investments accounted for under the equity method generally include all entities in which the Company or its subsidiaries have significant influence, but not more than 50% voting control. Investments in unconsolidated affiliates at June 30, 2005 include, among others, equity interests in Southern Capital Corporation, LLC (“Southern Capital”) and the Panama Canal Railway Company (“PCRC”).

		PCRC redemption of preferred shares held by International Finance Corporation. On March 28, 2005, PCRC and the International Finance Corporation (“IFC”) finalized an agreement whereby PCRC would redeem the shares subscribed and owned by IFC pursuant to the IFC Subscription. Under the agreement, PCRC paid to the IFC $10.5 million. The IFC preferred shares had a recorded value of $5.0 million and approximately $2.6 million in accrued unpaid dividends. When the transaction was completed, PCRC recorded an additional cost of approximately $2.9 million to reflect the premium paid to IFC. As a result, KCS recorded its share of this cost of approximately $1.5 million in recording its equity in earnings of PCRC in the first quarter of 2005.

Condensed financial information of certain unconsolidated affiliates is shown below. All amounts are presented under U.S. GAAP. Financial information of immaterial unconsolidated affiliates has been omitted:

Financial Condition (dollars in millions) :


	June 30, 2005				December 31, 2004
			Southern				Grupo		Southern
	PCRC		Capital		PCRC		TFM		Capital		Mexrail
Current assets	$	3.5	$	3.1	$	4.2	$	252.7	$	2.3	$	29.8
Non-current assets		82.6		98.3		83.4		1,982.3		113.5		71.2

Assets	$	86.1	$	101.4	$	87.6	$	2,235.0	$	115.8	$	101.0


Current liabilities	$	9.3	$	—	$	10.7	$	211.5	$	1.2	$	47.3
Non-current liabilities		76.2		48.5		72.2		865.4		56.5		0.7
Minority interest		—		—		—		353.3		—		—
Equity of stockholders and partners		0.6		52.9		4.7		804.8		58.1		53.0

Liabilities and equity	$	86.1	$	101.4	$	87.6	$	2,235.0	$	115.8	$	101.0


KCS’s investment	$	0.3	$	26.4	$	2.4	$	389.6	$	29.1	$	30.0

Operating Results (dollars in millions) :


	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2005			2004			2005			2004
Revenues:
Southern Capital	$	2.8			6.0		$	5.8			12.0
PCRC		3.2			1.6			6.2			3.7
Grupo TFM (1)		NA			184.9			170.1			352.4

Operating costs and expenses:
Southern Capital	$	1.4			4.4		$	3.0			9.2
PCRC		1.6			2.1			3.3			4.2
Grupo TFM (1)		NA			148.8			144.1			291.8

Net income (loss):
Southern Capital	$	9.1			7.6		$	10.6			8.8
PCRC		(0.6	)		(0.8	)		(4.1	)		(1.6	)
Grupo TFM (1)		NA			7.7		$	0.1			10.6

(1)		Reflects operating results for the quarter ended March 31, 2005. For periods after April 1, 2005, Grupo TFM is reflected in consolidated operating results. Prior to July 1, 2004 Grupo TFM results included the results of Mexrail as a consolidated subsidiary.

4.		Acquisitions. In accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations”, the Company allocated the purchase price of its acquisitions to the tangible and intangible assets and liabilities of the acquired entity based on their fair values. We recorded the excess purchase price over the fair values as goodwill. The fair values assigned to assets acquired and liabilities assumed was based on valuations prepared by independent third party appraisal firms, published market prices and management estimates. In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, goodwill and intangible assets with indefinite useful lives are not amortized but are reviewed at least annually for impairment. An impairment loss would be recognized to the extent that the carrying amount exceeds the assets’ fair value. Intangible assets with estimable useful lives are amortized on a straight-line basis over their respective useful lives.

		Acquisition of Controlling Interest in Grupo TFM. In furtherance of the Company’s strategy for expansion into Mexico, on December 15, 2004, the Company entered into the Amended and Restated Acquisition Agreement (the “Acquisition Agreement”) with TMM and other parties under which KCS would acquire control of TFM through the purchase of shares of common stock of Grupo TFM. Grupo TFM holds an 80% interest in TFM and all of the shares of stock with full voting rights of TFM. The remaining 20% economic interest in TFM is owned by the Mexican government in the form of shares with limited voting rights.

		Under the terms of the Acquisition Agreement, KCS acquired all of TMM’s 48.5% effective interest in Grupo TFM on April 1, 2005 for $200.0 million in cash, 18 million shares of KCS common stock, and two-year promissory notes in the aggregate amount of $47.0 million (the “Escrow Notes”)’ as well as $27.0 million in transaction costs already incurred for a total purchase price of $590 million. Both the $200.0 million cash and the 18 million shares of KCS common stock were exchanged at closing. The $47.0 million Escrow Notes are subject to reduction pursuant to the indemnification provisions of the Acquisition Agreement for certain potential losses related to breaches of certain representations, warranties, or

		covenants in the Acquisition Agreement or claims relating thereto, or under other conditions specified in the Indemnity Escrow Agreement.

		In exchange for the purchase price of $590 million, KCS acquired 48.5% of Grupo TFM (or 38.8% of TFM) with a historical book value of $390 million. The excess of purchase price over the historical book value of the assets resulted in a net increase in the basis of the assets of approximately $180 million and goodwill of $20 million was recognized.

		Significant components of the distribution of the $180 million adjustment to reflect fair value are as follows:

	-		Increase in property and equipment of $35.1 million

	-		Increase in concession assets of $294.4 million

	-		Increase in deferred income tax liability of $82.6 million

	-		Reduction of deferred tax asset related to employee statutory profit sharing of $22.5 million

	-		Reduction of other current and noncurrent assets of $44.4 million

		In connection with the evaluation of the fair values of the assets and liabilities of Grupo TFM, certain assets were identified as having little or no value to KCS as the acquiring Company. Because KCS acquired only 48.5% of Grupo TFM (or 38.8% of TFM) in this transaction, the allocation of the excess purchase price over book value of net assets was limited to the acquired percentage. Accordingly, a reduction in the assets of Grupo TFM was limited to the acquired percentage and any residual was charged to expense. Grupo TFM operating expenses include $39.5 million relating to decreases in the basis of certain assets, the most significant of which was the write off of deferred employee profit sharing asset of approximately $35.6 million as a result of recent legal rulings in Mexico. A total of $15.9 million of these operating expenses were allocated to Grupo TFM’s minority interest. Grupo TFM also recognized $3.6 million in depreciation expense related to the increase in basis of tangible assets.

		The Company’s management has completed a preliminary evaluation of the fair value of the assets and liabilities of Grupo TFM in the second quarter of 2005. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V.
As of April 1, 2005
(Dollars in millions)


Current assets	$	254.6
Property, plant and equipment		594.5
Concession rights		1,431.8
Other assets		218.5

Total assets acquired	$	2,499.4


Current liabilities	$	247.5
Long-term debt acquired		813.7
Other liabilities		185.1
Minority Interest		274.6

Total liabilities acquired	$	1,520.9

		The allocation of the purchase price above reflects preliminary estimates to various amounts which are subject to change as the Company obtains additional information relating to the fair values of assets and liabilities of Grupo TFM. The preliminary purchase price allocation reflects $11.5 million relating to estimated severance and relocation costs. The preliminary allocation of the purchase price does not include any amounts related to certain pre-acquisition contingencies regarding the VAT Claim (defined below) or the Mexican government’s put rights. In addition, the existing excess in the carrying value of the Company’s investment over the book value of Grupo TFM ($13.7 million) was recorded as an addition to concession assets.

		Acquisition of Mexrail. On August 16, 2004, KCS, TMM and TFM entered into a new Stock Purchase Agreement. Pursuant to the terms of that agreement, KCS purchased from TFM 51% of the outstanding shares of Mexrail, a wholly-owned subsidiary of TFM, for $32.7 million and placed those shares into trust pending approval of the Surface Transportation Board (“STB”) to exercise common control over The Kansas City Southern Railway Company (“KCSR”), the Gateway Eastern Railway Company (“Gateway Eastern”) and Tex-Mex. On November 29, 2004, the STB approved

		the Company’s application for authority to control KCSR, Gateway Eastern and Tex-Mex. This approval became effective on December 29, 2004. The shares representing 51% ownership of Mexrail were transferred by the trustee to KCS, and KCS assumed control, on January 1, 2005.

		The aggregate purchase price was $57.4 million including $32.7 million of cash with the remaining amount consisting of net receivables and payables with Mexrail and Grupo TFM. The acquisition of Mexrail links KCSR to TFM. The Company’s management completed a preliminary evaluation of the fair value of the assets and liabilities of Mexrail in the first quarter of 2005. No significant adjustments were made to the preliminary purchase accounting in the second quarter of 2005.

		The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

Mexrail, Inc.
As of January 1, 2005
(Dollars in millions)


Current assets	$	29.6
Property, plant and equipment		101.0
Other assets		0.4

Total assets acquired	$	131.0


Current liabilities	$	66.8
Long-term debt		—
Other liabilities		6.8

Total liabilities acquired	$	73.6

		The allocation of the purchase price above reflects preliminary estimates to various amounts which are subject to change as the Company obtains additional information relating to the fair values of assets and liabilities of Mexrail.

		The financial results of Mexrail and Grupo TFM have been included within the consolidated KCS financial statements as of January 1, 2005 and April 1, 2005, respectively.

Pro Forma Earnings. The following table reflects the proforma financial results for the six months ended June 30, 2005 as though the Grupo TFM Acquisition had occurred on January 1, 2005: (unaudited, in millions except for shares outstanding, which are in thousands.)


	KCS and			Grupo TFM
	Mexrail			for the period
	Historical and			January 1,
	Grupo TFM			2005 through
	since April 1,			March 31,		Pro Forma
	2005			2005		Adjustments			Pro Forma
Revenues	$	579.3		$	170.1	$	—		$	749.4
Net income (loss)		(17.0	)		0.1		(3.5	)		(20.4	)
Income (loss) from continuing operations available to common shareholders		(21.4	)		0.1	$	(3.5	) (1)		(24.8	)


Basic earnings (loss) per common share:	$	(0.29	)						$	(0.30	)

Basic weighted average common shares outstanding		72,604					9,000			81,604


Diluted earnings (loss) per common share:	$	(0.29	)						$	(0.30	)

Diluted weighted average common shares outstanding		72,604					9,000			81,604

The following table reflects the proforma financial results for the three months ended June 30, 2004 as though the Mexrail and Grupo TFM acquisitions had occurred on January 1, 2004: (unaudited, in millions except for shares outstanding, which are in thousands.)


								Pro Forma
	KCS		Mexrail			Grupo TFM		Adjustments			Pro Forma
Revenues	$	153.9	$	15.6		$	169.3	$	—		$	338.8
Net Income (loss)		9.2		(0.2	)		7.9		(5.1	)		11.8
Income (loss) from continuing operations available to common shareholders	$	7.0	$	(0.2	)	$	7.9	$	(5.1	) (1)	$	9.6


Basic earnings per common share:	$	0.11									$	0.12

Basic weighted average common shares outstanding		62,655							18,000			80,655


Diluted earnings per common share:	$	0.11									$	0.12

Diluted weighted average common shares outstanding		63,830							18,000			81,830

The following table reflects the pro forma financial results for the six months ended June 30, 2004 as though the Mexrail and Grupo TFM acquisitions had occurred on January 1, 2004: (unaudited, in millions except for shares outstanding, which are in thousands.)


								Pro Forma
	KCS		Mexrail			Grupo TFM		Adjustments			Pro Forma
Revenues	$	301.7	$	29.4		$	323.0	$	—		$	654.1
Net Income (loss)		12.6		(2.0	)		12.6		(11.9	)		11.3
Income (loss) from continuing operations available to common shareholders	$	8.2	$	(2.0	)	$	12.6	$	(11.9	) (1)	$	6.9


Basic earnings per common share:	$	0.13									$	0.09

Basic weighted average common shares outstanding		62,570							18,000			80,570


Diluted earnings per common share:	$	0.13									$	0.08

Diluted weighted average common shares outstanding		63,812							18,000			81,812

		The pro forma results reflected above are not necessarily indicative of the results of operations for the periods presented, had the acquisition actually occurred, nor are they indicative of projected results for future periods.

5.		Noncash Investing and Financing Activities. The Company initiated the Sixteenth Offering of KCS common stock under the Employee Stock Purchase Plan (“ESPP”) during 2004. Stock subscribed under the Sixteenth Offering will be issued to employees in 2006 and is being paid for through employee payroll deductions in 2005. For the six months ended June 30, 2005, the Company has received approximately $0.9 million from payroll deductions associated with the Sixteenth Offering of the ESPP. In the first quarter of 2005, the Company issued approximately 206,000 shares of KCS common stock under the Fifteenth Offering of the ESPP. These shares, with an aggregate a purchase price of approximately $2.5 million, were subscribed and paid for through employee payroll deductions in 2004.

6.		Derivative Financial Instruments. The Company does not engage in the trading of derivatives for speculative purposes but uses them for risk management purposes only. The Company’s objective for using derivative instruments is to manage the risk of volatility in prices of diesel fuel. In general, the Company enters into derivative transactions in limited situations based on management’s assessment of current market conditions and perceived risks. Management intends to respond to evolving business and market conditions in order to manage risks and exposures associated with the Company’s various operations, and in doing so, may enter into such transactions more frequently as deemed appropriate.

		Fuel Derivative Transactions

		At June 30, 2005, the Company was a party to one fuel swap agreement for a notional amount of approximately 1.3 million gallons of fuel. Under the terms of the swap, the Company receives a variable price based upon an average of the spot prices calculated on a monthly basis as reported through a petroleum price reporting service, and pays a fixed price determined at the time the Company enters into the swap transaction. The variable price the Company receives is approximately equal to the price the Company pays in the market for locomotive fuel. By entering into these swap transactions, the Company is able to fix the cost of fuel for the notional amount of gallons hedged.

A summary of the swap agreements to which KCSR was a party as of June 30, 2005 follows:

Trade Dates

Notional Amount

Fixed pay per gallon

Expiration Date

October 31, 2003

1.3 million gallons

68.0¢

December 31, 2005

		Cash settlements of the swap occur on a monthly basis on the fifth business day of the month following the month in which the settlement is calculated. As of June 30, 2005, the fair market value of the benefit of the swap was $1.2 million. For the years ended December 31, 2004 and 2003, KCSR consumed 59.2 million and 55.4 million gallons of fuel, respectively. Fuel hedging transactions resulted in a decrease in fuel expense of $0.9 million and $0.9 million in the six months ended 2005 and 2004, respectively.

7.		Tex-Mex Loan Agreement. On July 13, 2005, Tex-Mex entered into an agreement with the Federal Railroad Administration (“FRA”) with an effective date of June 28, 2005 to borrow $50.0 million to be used for safety and infrastructure improvements. These improvements are expected to increase efficiency and capacity in order to accommodate growing freight rail traffic related to the NAFTA corridor. Tex-Mex drew the first $10.0 million on July 13, 2005 to apply to capital projects currently in progress. The loan is being made under the Railroad Rehabilitation and Improvement Financing Program (RRIF) administered by the FRA. The loan is guaranteed by Mexrail, who has issued a Pledge Agreement in favor of the lender equal to the gross revenues earned by Mexrail on per-car fees charged for traffic crossing the International Rail Bridge located in Laredo, Texas.

8.		KCSR Branch Line Lease Agreement. On July 20, 2005, KCSR and Watco Companies announced the lease of five of KCSR’s branch lines in Oklahoma, Arkansas, Louisiana and Alabama to three subsidiary railroads of Watco, a shortline railroad company. These lease agreements are for a period of ten years, subject to earlier termination in accordance with the terms of the applicable lease agreement. The lease agreements are renewable for an additional ten years upon mutual agreement by KCS and the applicable lessee. Under each of these agreements, the lessee has agreed to pay KCS rent annually for the leased property in an amount based on the lessee’s revenue derived from the leased property that is received from traffic interchanged to carriers other than KCS for the annual period for which the lease amounts are due. Under the lease agreements, these branch lines will continue to receive rail service, but from the three railroads owned by Watco instead of KCSR. KCSR will continue to build the revenues and pay a per car fee to Watco for the services provided.

9.		Modifications of Debt Agreements. On June 10, 2005, KCSR completed the successful solicitation of consents to amend the indentures, as supplemented where applicable, under which KCSR’s outstanding 9 ¹ / 2 % Senior Notes due 2008 and outstanding 7 ¹ / 2 % Senior Notes due 2009 were issued. KCSR received the requisite consents from a majority of the outstanding aggregate principal amount of each series of Notes. Costs of $0.8 million were incurred in relation to this solicitation and are reflected in other expenses.

		Upon the terms and subject to the conditions set forth in the Consent Solicitation Statement dated May 11, 2005 and as thereafter amended, KCSR, KCS, the other note guarantors, and the trustee under each of the indentures, respectively, signed supplemental indentures with respect to each such series of Notes to permit TFM to effect a settlement of certain disputes among TFM, Grupo TFM, and the Mexican government. KCS is unable to predict when or if a settlement of these disputes will be consummated.

		On April 1, 2005, TFM commenced a cash tender offer for any and all outstanding $443.5 million aggregate principal amount of 11.75% Senior Discount Debentures due 2009 (the “2009 Debentures”) on the terms and subject to the conditions set forth in TFM’s Offer to Purchase and Consent Solicitation Statement dated April 1, 2005. TFM also solicited consents for amendments to the indenture under which the 2009 Debentures were issued. Holders who tendered their 2009 Debentures were required to consent to the proposed amendments and holders who consented were required to tender their 2009 Debentures.

		On April 14, 2005, $386.0 million principal amount of the outstanding $443.5 million principal amount of the 2009 Debentures had been tendered on or prior to the consent deadline pursuant to the consent solicitation and tender offer for the 2009 Debentures, representing approximately 87% of the outstanding 2009 Debentures. As a result of such consents and early tenders, TFM received the requisite consents to execute a supplemental indenture relating to the 2009 Debentures. As part of its tender offer for the 2009 Debentures, TFM was soliciting consents to eliminate substantially all of the restrictive covenants included in the indenture under which the 2009 Debentures were issued and to reduce the minimum prior notice period with respect to a redemption date for outstanding 2009 Debentures from 30 to 3 days. The supplemental indenture relating to the 2009 Debentures containing the proposed changes was executed by TFM and the Trustee under the indenture. TFM made payment for these 2009 Debentures pursuant to the early tender provisions of the tender offer on April 20, 2005. Pursuant to the terms of the 2009 Debentures as amended by the supplemental indenture, TFM called for redemption of its remaining outstanding 2009 Debentures that were not tendered in TFM’s previously announced tender offer and on April 29, 2005, paid an aggregate of $60.0 million, including principal and interest, to the

		holders of such 2009 Debentures to complete the redemption of all of such remaining outstanding 2009 Debentures.

		On April 18, 2005, TFM entered into a first waiver and amendment (the “Waiver and Amendment”) to its amended and restated credit agreement with the banks which are a party thereto and J.P. Morgan Chase Bank, N.A., as administrative agent. The Waiver and Amendment allowed TFM to issue $460.0 million principal amount of its 9 3/8% Senior Notes due 2012, (the “9 3/8% Notes”), in a principal amount in excess of the principal amount of 2009 Debentures outstanding and to use the amount of proceeds from the private placement of the 9 3/8% Notes in excess of the principal amount of the 2009 Debentures outstanding to pay accrued and unpaid interest on the 2009 Debentures repurchased or redeemed, to pay the fees of the underwriter associated with the issuance of the 9 3/8% Notes, as well as the tender offer for the 2009 Debentures, to pay the premium related to the tender offer and to pay certain other expenses relating to the tender offer and issuance of the 9 3/8% Notes. The Waiver and Amendment also amends the amended and restated credit agreement to allow TFM to borrow up to $25 million from KCS on a fully subordinated basis.

		Costs of $3.9 million were incurred relating to the consent solicitation and waiver and are included as debt retirement cost on the income statement.

10.		Loss of Foreign Private Issuer Status for Grupo TFM. KCS acquired a controlling interest in Grupo TFM effective April 1, 2005. As a consequence of this change in control, Grupo TFM has ceased to qualify as a foreign private issuer for purposes of our reporting obligations to the SEC. Accordingly, Grupo TFM has begun filing current reports on From 8-K, and will begin filing quarterly reports on Form 10-Q (beginning with respect to the second fiscal quarter of 2005) and annual reports on Form 10-K (beginning with respect to fiscal year 2005).

11.		Stock Options and Other Stock Plans. Proceeds received from the exercise of stock options and tax benefits or subscriptions are credited to the appropriate capital accounts in the period they are exercised.

		Stock Options. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”) in October 1995. SFAS 123 allows companies to continue under the approach set forth in Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”), for recognizing stock-based compensation expense in their financial statements. KCS’s practice is to set the option price equal to the market price of the stock at date of grant, therefore, no compensation expense is recognized under APB 25. Under SFAS 123, companies must either record compensation expense based on the estimated grant date fair value of stock options granted or disclose the impact on net income as if they had adopted the fair value method (for grants subsequent to December 31, 1994).

		If KCS had measured compensation cost for the KCS stock options granted to its employees and shares subscribed by its employees under the ESPP, under the fair value based method prescribed by SFAS 123, net income and earnings per share would have been as follows:


	Three months ended June 30,						Six months ended June 30,
	2005			2004			2005			2004
Net income (loss) *(in millions):*
As reported	$	(25.1	)	$	9.2		$	(17.0	)	$	12.6
Total stock-based compensation expense determined under fair value method, net of income taxes		(0.3	)		(0.4	)		(0.4	)		(0.9	)

Pro forma	$	(25.4	)	$	8.8		$	(17.4	)	$	11.7
Earnings (loss) per Basic share:
As reported	$	(0.33	)	$	0.11		$	(0.29	)	$	0.13
Pro forma	$	(0.33	)	$	0.11		$	(0.29	)	$	0.12
Earnings (loss) per Diluted share:
As reported	$	(0.33	)	$	0.11		$	(0.29	)	$	0.13
Pro forma	$	(0.33	)	$	0.10		$	(0.29	)	$	0.12

		Restricted Stock. The Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan provides for the granting of restricted stock awards to officers and other designated employees. These awards are subject to forfeiture if employment terminates during the vesting period, which is generally five years for employees and one year for directors. For the six months ended June 30, 2005, 274,591 restricted shares were granted at a weighted-average fair value of $19.39 per share. The value of restricted shares is amortized to expense over the vesting period. For the six-months ended June 30, 2005, the Company expensed $0.5 million related to restricted stock compensation earned.

12.		Commitments and Contingencies. The Company has had no significant changes in its outstanding litigation or other commitments and contingencies from that previously reported in Note 9 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, except as described in the following paragraphs:

		Mexican Government’s Put Rights With Respect to TFM Stock. Under the terms of the January 31, 1997 share purchase agreement through which Grupo TFM agreed to purchase the shares of TFM, as amended by the parties on June 9, 1997 (the “TFM Share Purchase Agreement”), the Mexican government has the right to compel the purchase of its 20% interest in TFM (referred to as the “Put”) by Grupo TFM following its compliance with the terms and conditions of the TFM Share Purchase Agreement. Upon exercise of the Put in accordance with the terms of the TFM Share Purchase Agreement, Grupo TFM would be obligated to purchase the TFM capital stock at the initial share price paid by Grupo TFM adjusted for interest and inflation. Prior to October 30, 2003, Grupo TFM filed suit in the Federal District Court of Mexico City seeking, among other things, a declaratory judgment interpreting whether Grupo TFM was obligated to honor its obligation under the TFM Share Purchase Agreement, as the Mexican government had not made any effort to sell the TFM shares subject to the Put prior to October 31, 2003. In its suit, Grupo TFM named TMM and KCS as additional interested parties. The Mexican court has admitted Grupo TFM’s complaint, Grupo TFM also filed a suit seeking constitutional protection against the Mexican government exercising the Put, and that court issued an injunction that blocked the Mexican government from exercising the Put. The Mexican government provided Grupo TFM with notice of its intention to sell its interest in TFM on October 30, 2003. Grupo TFM has responded to the Mexican government’s notice reaffirming its right and interest in purchasing the Mexican government’s remaining interest in TFM, but also advising the Mexican government that it would not take any action until its lawsuit seeking a declaratory judgment was resolved. KCS management believes it is unlikely that the Mexican government will seek to exercise the Put until the litigation is resolved. On completion of the Acquisition, KCS assumed TMM’s rights and obligations to make any payment upon the exercise by the Mexican government of the Put and indemnified TMM and its affiliates, and their respective officers, directors, employees and shareholders, against obligations or liabilities relating thereto. If KCS had been required to purchase this interest as of June 30, 2005, the total purchase price would have been approximately $520.0 million.

		Commercial Suit. On December 3, 2004, the Mexican government filed a commercial lawsuit against TFM, Grupo TFM, TMM and KCS with a Mexican federal civil court. In the lawsuit, the Mexican government has requested a finding from the court as to whether the defendants had complied with all of their legal obligations arising out of the process of privatization of the Mexican National Railway (Ferrocarriles Nacionales de Mexico), in particular, those related to the purchase by Grupo TFM of the 20% limited voting stock that the Mexican government holds in TFM (the “Put shares”). The court initially refused to accept all of the claims asserted by the Mexican government, but an Appellate Court found that all of the Mexican government’s allegations should have been admitted for trial, and ordered the trial court to admit and serve the Mexican government’s original petition. The Appellate Court rejected the Mexican government’s request to provisionally attach the VAT certificate and any replacement certificate the Mexican Federal Treasury may issue in the future. The Court initially ruled that the Mexican government could effect service of process on KCS by delivering the complaint to TMM’s offices. TFM, Grupo TFM and TMM appealed the resolution of the trial court. The appeal was resolved by the Federal Court, which ruled that KCS must be served at its corporate offices in the United States. The trial court entered an order consistent with the instructions of the Appellate Court, and ordered the Mexican government to serve each of the defendants with the original petition. The Mexican government appealed the trial court’s new resolution, and that appeal is still pending.

		We believe that this suit is without merit and that TFM, Grupo TFM, TMM and KCS have fully satisfied their legal obligations relating to the privatization of TFM. However, there can be no assurance that we or the other defendants will prevail. In the event that the Mexican government prevails and no further right of appeal is available to or exercised by the defendants, KCS could be obligated to purchase the Put shares at the price established in the 1997 TFM Share Purchase Agreement, and to pay the Mexican government damages for failing to comply with the Put obligation in accordance with the terms of that Agreement.

		Value Added Tax (“VAT”) Lawsuit and VAT Contingency Payment under the Acquisition Agreement. The VAT lawsuit (“VAT Claim”) arose out of the Mexican Federal Treasury’s delivery of a VAT credit certificate to a Mexican governmental agency rather than to TFM in 1997. The face value of the VAT credit at issue is 2,111,111,790 pesos or approximately $196.0 million in US dollars, based on current exchange rates. The amount of the VAT refund will, in accordance with Mexican law, reflect the face value of the VAT credit adjusted for inflation and interest from 1997.

		On January 19, 2004, TFM received a Special Certificate from the Mexican Federal Treasury in the amount of $2.1 billion pesos. The Special Certificate delivered to TFM on January 19, 2004 has the same face amount as the original VAT refund claimed by TFM in 1997. TFM also filed a complaint against the Mexican government, seeking to have the amount of the Special Certificate adjusted to reflect interest and inflation in accordance with Mexican law. The Mexican Fiscal Court initially denied TFM’s claim. In a decision dated November 24, 2004, the Mexican Federal Appellate Court upheld TFM’s claim that it is entitled to inflation and interest from 1997 on the VAT refund. The Federal Appellate Court remanded the case to the Mexican Fiscal Court with instructions to enter a new order consistent with this decision. On January 26, 2005, the Mexican Fiscal Court issued from the bench an oral order implementing the Appellate Court decision. On February 18, 2005, TFM was served with the confirming written order from the Mexican Fiscal Court.

		On June 21, 2005 the Mexican Government filed an additional appeal seeking the Mexican Federal Appellate Court’s review of the written order issued by the Mexican Fiscal Court on February 18, 2005 in order to determine whether the Mexican Fiscal Court had properly carried out the November 24, 2004 decision of the Mexican Federal Appellate Court. The Company believes that the appeal lacks merit and that it cannot modify in any way the prior order of the Mexican Federal Appellate Court, but its effect has been to delay the issuance of the new Special Certificate until the appeal is resolved.

		Under the Acquisition Agreement, in the event of the Final Resolution of the VAT Claim and Put (as such term is defined in the Acquisition Agreement), KCS will be obligated to pay to TMM the VAT Contingency Payment of up to $110 million, payable in a combination of cash and KCS common stock, or at KCS’s election, in KCS common stock. KCS continues discussions with the Mexican government to resolve the outstanding disputes between the parties, however the outcome continues to be uncertain.

		1997 Tax Audit Summary. TFM was served on January 20, 2004 with an official letter notifying TFM of the Mexican government’s preliminary findings and conclusions arising from its tax audit of TFM’s 1997 tax returns (“Tax Audit Summary”). In the Tax Audit Summary, the Mexican government notified TFM of its preliminary conclusion that the documentation provided by TFM in support of the VAT refund claim and depreciation of the TFM concession title, and the assets reported on TFM’s 1997 tax return do not comply with the formalities required by the applicable tax legislation. In addition, the Mexican government attached the Special Certificate pending resolution of the audit. TFM has advised that it has, within the time allowed by the Tax Audit Summary, contested the conclusions of the Mexican tax authorities. On March 16, 2005, TFM was notified by the Mexican Fiscal Administration Service (“Servicio de Administracion Tributaria” or the “SAT”) that it had finished its audit of TFM’s 1997 tax returns. In the notice, the SAT affirmed its preliminary findings described above and continued the attachment of the Special Certificate. The SAT has not yet assessed any penalties or taxes against TFM as a result of the audit. KCS continues discussions with the Mexican government to resolve the outstanding disputes between the parties; however the outcome continues to be uncertain.

		Concession Duty. Under the concession, the Mexican government has the right to receive a payment from Grupo TFM equivalent to 0.5% of the gross revenue during the first 15 years of the concession period and 1.25% during the remaining years of the concession period. For the year ended December 31, 2004 the concession duty expense amounted to $3.3 million, and for the six months ended on June 30, 2005 to $1.9 million, which was recorded as an operating expense.

		Insurance Coverage. The Company has established its personal injury and casualty reserves based on an assumption that it would have the benefit of insurance under existing policies for any liability above the applicable self-insured retention. With respect to certain claims that present substantial risk of losses in excess of the Company’s self-insured retention limit, the Company’s insurance carriers have challenged their obligation to provide coverage. Several of those insurers have filed a declaratory judgment lawsuit in Vermont federal court to determine their obligations. The Company has answered and

		filed counterclaims to establish its right to coverage. The Company presently believes that it has a strong basis to prevail in its position that it remains entitled to insurance coverage on the claims in question, and that it is probable that its position will be sustained. However, in the event the Company is unsuccessful in the litigation with the insurance carriers, the Company would likely incur additional costs in settling the related personal injury and casualty claims. While the Company is not presently able to reliably estimate such amounts, those additional costs could be material. The accompanying financial statements do not include any accruals related to such possible additional costs.

13.		Other Post Employment Benefits. The Company provides certain medical, life and other post employment benefits other than pensions to its retirees. The medical and life plans are available to employees not covered under collective bargaining arrangements, who have attained age 60 and rendered ten years of service. Individuals employed as of December 31, 1992 were excluded from a specific service requirement. The medical plan is contributory and provides benefits for retirees, their covered dependents and beneficiaries. The medical plan provides for an annual adjustment of retiree contributions, and also contains, depending on the plan coverage selected, certain deductibles, co-payments, coinsurance and coordination with Medicare. The life insurance plan is non-contributory and covers retirees only. The Company’s policy, in most cases, is to fund benefits payable under these plans as the obligations become due. However, certain plan assets (money market funds held by a life insurance company) exist with respect to life insurance benefits. A life insurance company holds these assets and the Company receives an investment return on these assets based on the six-month Treasury Bill rate plus 25 basis points.

		The Company’s health care costs, excluding former Gateway Western Railway Company (“Gateway Western”) employees and certain former MidSouth Railroad employees, are limited to the increase in the Consumer Price Index (“CPI”) with a maximum annual increase of 5%. Accordingly, health care costs in excess of the CPI limit will be borne by the plan participants, and therefore assumptions regarding health care cost trend rates are not applicable.

		Based upon current regulations, the KCS plans are actuarially equivalent to Medicare part D benefits; however, provisions within the plans contain retiree cost-sharing features which make any potential benefit to KCS from the subsidy entitlement unlikely to be material.

		Net periodic post employment benefit cost included the following components (in millions):


	Three months ended June 30,				Six months ended June 30,
	2005		2004		2005		2004
Service cost	$	—	$	0.1	$	0.1	$	0.2
Interest cost		0.1		0.1		0.2		0.2
Expected return on plan assets		—		—		—		—

Net periodic postretirement benefit cost	$	0.1	$	0.2	$	0.3	$	0.4

		Under collective bargaining agreements, KCSR participates in a multi-employer benefit plan, which provides certain post-retirement health care and life insurance benefits to eligible union employees and certain retirees. Premiums under this plan are expensed as incurred and were $1.9 million in the year ended December 31, 2004. Based on existing rates, premium amounts are not expected to change substantially during the remainder of 2005 compared to 2004.

14.		Business Segments. KCS reports financial information regarding its reportable operating segments on a basis consistent with that used internally for evaluating segment operating performance and allocating resources to segments. The Company manages the segments separately since each require different operating and marketing strategies and evaluates performance primarily on operating income.

KCS has two reportable segments, domestic rail operations (which includes corporate expenses) and international rail operations. Appropriate eliminations of revenue and expenses are recorded in deriving consolidated data. Domestic operations consists of KCSR, Mexrail, and Tex-Mex. International operations consist of Grupo TFM and Arrendadora TFM. Each of these segments are supported by separate executive management, separate boards of directors, operate and serve different geographical regions, and are subject to different customs, laws, and tax regulations.

The following table summarizes the Company’s operations by business segment. The three months ended June 30, 2005 represents the first quarter after the acquisition of control of Grupo TFM. Additionally, prior year amounts for Grupo TFM and Arrendadora TFM are not provided as these entities were not under the common control of KCS and accordingly, were not managed as a segment at the time.


	Three Months					Six Months
	Ended June 30,					Ended June 30,
	2005			2004		2005			2004
Segment Revenues
Domestic	$	197.0		$	153.9	$	395.2		$	301.7
International		184.1			—		184.1			—

Consolidated revenues	$	381.1		$	153.9	$	579.3		$	301.7


Segment operating income (loss)
Domestic operating income (loss)	$	17.8		$	19.5	$	42.6		$	36.9
International operating income (loss)		(26.1	)		—		(26.1	)		—


Consolidated operating income (loss)	$	(8.3	)	$	19.5	$	16.5		$	36.9


Consolidated net income (loss)	$	(25.1	)	$	9.2	$	(17.0	)	$	12.6


As of June 30, 2005
Assets: Domestic									$	1,897.5
International										2,401.8

Total Assets									$	4,299.3

15.

New Accounting Pronouncements.

SFAS 123R

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 123 (Revised), “Share-Based Payments” (“SFAS 123R”), which was initially effective for the first fiscal period ending after June 15, 2005. Under SFAS 123R, the Company will be required to measure the cost of employee service received in exchange for awards of stock options based upon the fair value of the options as of their grant date. The cost of the employee service will be recognized as compensation cost ratably over the option vesting period. Currently, the Company recognizes compensation expense pursuant to APB 25, whereby compensation expense is recognized to the extent that an option price is less than the market price of the stock at the date of the grant (the “Intrinsic Value”). Because KCS’s practice is to set the option exercise price equal to the market price of the stock as of the date of the grant, no compensation expense is recognized for financial reporting purposes. SFAS 123R allows the use of either the Black-Scholes or a lattice option-pricing model to calculate the fair value of options. SFAS 123R allows either a Modified Prospective Application, which applies to new awards and modified awards after the effective date, and to any unvested awards as service is rendered on or after the effective date, or a Modified Retrospective Application, which would apply to all prior years for which SFAS 123 was effective. Currently, the Company is evaluating these adoption alternatives and expects to complete this evaluation during the fourth quarter of 2005. Using the Black-Scholes method, the expense related to share-based compensation would have been $0.3 million and $0.4 million for the quarters ended June 30, 2005 and 2004, respectively. The impact on future operating results will be dependent on the type and extent of stock-based compensation to be granted as determined by the Company’s Compensation Committee and cannot be determined at this time. Effective April 21, 2005, SFAS 123R was amended to change the effective date to the first interim or annual reporting period of the registrant’s first fiscal year beginning after June 15, 2005. Accordingly, the Company anticipates implementing SFAS 123R during the first quarter of 2006.

Conditional Asset Retirement Obligations

In March 2005, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations — and interpretation of FASB Statement No. 143. This Interpretation clarifies that the term conditional asset retirement obligation, as used in FASB Statement No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing or method of settlement, or both, are conditional on a future event that may or may not be within the control of the entity. An entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The Company is assessing the impact of the interpretation on its financial statements. The Interpretation will require the recording of a cumulative effect of a change in accounting principle in the fourth quarter of 2005, if applicable.

16.

Transactions with Affiliates. On June 1, 2005, Southern Capital, a 50% owned joint venture investment of the Company, completed the sale of 77 locomotives to KCSR. These locomotives had previously been leased to KCSR under a single lease agreement, which contained an option for KCSR to purchase the locomotives. Upon the expiration of this lease on June 1, 2005, KCSR exercised its option and purchased the locomotives for $16.5 million resulting in a gain to Southern Capital of approximately $7.7 million. This gain has been recognized by Southern Capital. The Company accounts for its investment in Southern Capital under the equity method of accounting. Accordingly, the Company has deferred recognition of its portion of the gain of approximately $3.9 million and is amortizing this gain into income as a reduction to depreciation expense over the depreciable lives of the locomotives.

17.

Condensed Consolidating Financial Information. KCSR has outstanding $200 million of 9 ¹ / 2 % Senior Notes due 2008 and $200 million of 7 ¹ / 2 % Senior Notes due 2009. Both of these note issues are unsecured obligations of KCSR, however, they are also jointly and severally and fully and unconditionally guaranteed on an unsecured senior basis by KCS and certain of the subsidiaries (all of which are wholly-owned) within the KCS consolidated group. Both TFM and Mexrail are non-guarantor subsidiaries. These notes were registered with the SEC and issued in exchange for privately placed notes having substantially identical terms and associated guarantees to the respective exchange note issues. All of the privately placed senior notes for each issue were exchanged for $200 million of registered exchange notes for each respective note issue.

The accompanying condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X, Rule 3-10 ‘‘Financial statements of guarantors and issuers of guaranteed securities registered or being registered.’’ This information is not intended to present the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with U.S. GAAP.

CONDENSED CONSOLIDATING STATEMENTS OF INCOME


	Six months ended June 30, 2005 (dollars in millions)
										Non-
							Guarantor			Guarantor			Consolidating			Consolidated
	Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS
Revenues	$	—		$	357.7		$	9.7		$	226.2		$	(14.3	)	$	579.3
Operating expenses		9.0			302.5			9.3			256.3			(14.3	)		562.8

Operating income (loss)		(9.0	)		55.2			0.4			(30.1	)		—			16.5

Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries		(11.5	)		(0.4	)		—			(2.1	)		13.4			(0.6	)
Interest expense		(0.9	)		(25.8	)		(0.2	)		(25.0	)		0.9			(51.0	)
Debt retirement costs		—			—			—			(3.9	)		—			(3.9	)
Exchange gain											4.3			—			4.3
Other income		1.9			3.3			—			2.7			(0.8	)		7.1

Income (loss) before income taxes and minority interest		(19.5	)		32.3			0.2			(54.1	)		13.5			(27.6	)
Income tax provision (benefit)		(2.5	)		12.0			—			(2.3	)		—			7.2

Income before minority interest		(17.0	)		20.3			0.2			(51.8	)		13.5			(34.8	)
Minority interest		—			—			—			(17.8	)		—			(17.8	)

Net income (loss)	$	(17.0	)	$	20.3		$	0.2		$	(34.0	)	$	13.5		$	(17.0	)


	Six months ended June 30, 2004 (dollars in millions)
										Non-
				Subsidiary			Guarantor			Guarantor			Consolidating			Consolidated
	Parent			Issuer			Subsidiaries			Subsidiaries			Adjustments			KCS
Revenues	$	—		$	299.7		$	10.6		$	6.7		$	(15.3	)	$	301.7
Operating expenses		7.0			256.0			10.2			6.9			(15.3	)		264.8

Operating income (loss)		(7.0	)		43.7			0.4			(0.2	)		—			36.9

Equity in net earnings (losses) of Unconsolidated affiliates and Subsidiaries		17.3			4.6			—			3.9			(21.2	)		4.6
Interest expense		(0.3	)		(21.4	)		(0.2	)		—			0.2			(21.7	)
Debt retirement costs		—			(4.2	)		—			—			—			(4.2	)
Other income		0.1			2.6			0.1			0.6			(0.2	)		3.2

Income (loss) before income taxes		10.1			25.3			0.3			4.3			(21.2	)		18.8
Income tax provision (benefit)		(2.5	)		8.5			0.1			0.1			—			6.2

Net income (loss)	$	12.6		$	16.8		$	0.2		$	4.2		$	(21.2	)	$	12.6

CONDENSED CONSOLIDATING BALANCE SHEETS


	As of June 30, 2005 (dollars in millions)
							Non-
					Guarantor		Guarantor		Consolidating			Consolidated
	Parent		KCSR		Subsidiaries		Subsidiaries		Adjustments			KCS
ASSETS
Current assets	$	3.2	$	222.7	$	14.9	$	274.1	$	(58.9	)	$	456.0
Investments		1,489.4		421.3		—		432.2		(2,286.5	)		56.4
Properties, net		0.1		1,448.0		3.7		691.0		(0.1	)		2,142.7
Concession rights		—		—		—		1,418.4		—			1,418.4
Intangibles and other assets		10.8		26.1		3.3		199.6		(14.0	)		225.8


Total assets	$	1,503.5	$	2,118.1	$	21.9	$	3,015.3	$	(2,359.5	)	$	4,299.3


LIABILITIES AND EQUITY
Current liabilities	$	99.9	$	115.0	$	1.1	$	320.1	$	(55.2	)	$	480.9
Long-term debt		0.2		653.0		0.7		825.2		—			1,479.1
Payable to affiliates		26.5		—		0.7		2.9		(30.1	)		—
Deferred income taxes		12.5		431.4		0.4		8.6		(14.2	)		438.7
Other liabilities		51.3		61.6		10.7		206.1		—			329.8
Minority interest		—		—		—		256.9		—			256.9
Stockholders’ equity		1,313.1		857.1		8.3		1,395.5		(2,260.0	)		1,314.0


Total liabilities and equity	$	1,503.5	$	2,118.1	$	21.9	$	3,015.3	$	(2,359.5	)	$	4,299.3


	As of December 31, 2004 (dollars in millions)
							Non
					Guarantor		Guarantor		Consolidating			Consolidated
	Parent		KCSR		Subsidiaries		Subsidiaries		Adjustments			KCS
ASSETS
Current assets	$	13.7	$	231.9	$	12.5	$	13.2	$	(17.7	)	$	253.6
Investments		878.6		436.5		—		420.1		(1,250.3	)		484.9
Properties, net		0.2		1,420.0		3.8		—		—			1,424.0
Restricted funds – consulting fees		200.0		—		—		—		—			200.0
Goodwill and other assets		51.9		26.2		1.7		11.0		(12.7	)		78.1


Total assets	$	1,144.4	$	2,114.6	$	18.0	$	444.3	$	(1,280.7	)	$	2,440.6


LIABILITIES AND EQUITY
Current liabilities	$	79.0	$	143.1	$	1.8	$	39.6	$	(17.7	)	$	245.8
Long-term debt		0.2		654.9		0.7		—		—			655.8
Payable to affiliates		17.1		—		0.7		—		(17.8	)		—
Deferred income taxes		19.7		422.3		0.2		1.4		(12.7	)		430.9
Other liabilities		3.9		57.8		6.5		15.4		—			83.6
Stockholders’ equity		1,024.5		836.5		8.1		387.9		(1,232.5	)		1,024.5


Total liabilities and equity	$	1,144.4	$	2,114.6	$	18.0	$	444.3	$	(1,280.7	)	$	2,440.6

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS


	Six months ended June 30, 2005 (dollars in millions)
										Non-
							Guarantor			Guarantor			Consolidating			Consolidated
	Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS
Net cash flows provided by (used for) operating activities:
Excluding intercompany activity	$	—		$	29.4		$	3.1		$	0.3		$	—		$	32.8
Intercompany activity		5.9			(9.1	)		(3.1	)		6.3			—			—

Net cash flows provided by (used for) operating activities:	$	5.9		$	20.3		$	—		$	6.6		$	—		$	32.8

Investing activities:
Property additions		—			(56.4	)		(0.2	)		(10.5	)		—			(67.1	)
Proceeds from disposal of property		—			0.3			—			0.2			—			0.5
Investments in and loans to affiliates		(5.5	)		(3.8	)		—			(11.4	)		10.6			(10.1	)
Acquisition Costs		(8.0	)		—			—			—			—			(8.0	)
Cash acquired from Mexrail		—			—			—			3.0			—			3.0
Cash acquired from Grupo TFM		—			—			—			5.5			—			5.5
Repayment of loans to affiliates		—			—			—			5.3			(5.3	)		—
Other, net		—			1.6			—			0.2			0.1			1.9

Net		(13.5	)		(58.3	)		(0.2	)		(7.7	)		5.4			(74.3	)


Financing activities:
Proceeds from issuance of long-term debt		—			62.0			—			460.0			—			522.0
Repayment of long-term debt		(1.0	)		(28.9	)		—			(443.6	)		—			(473.5	)
Capital contribution		—			—			—			5.5			(5.5	)		—
Proceeds from loans from affiliates		5.2			—			—			—			(5.2	)		—
Repayment of loans from affiliates		(5.3	)		—			—			—			5.3			—
Debt issuance costs		—			(2.4	)		—			(0.4	)		—			(2.8	)
Proceeds from stock plans		3.4			—			—			—			—			3.4
Cash dividends paid		(4.4	)		—			—			—			—			(4.4	)

Net		(2.1	)		30.7			—			21.5			(5.4	)		44.7


Cash and cash equivalents:
Net increase (decrease)		(9.7	)		(7.3	)		(0.2	)		20.4			—			3.2
At beginning of period		10.5			27.5			0.2			0.4			—			38.6

At end of period	$	0.8		$	20.2		$	—		$	20.8		$	—		$	41.8


	Six months ended June 30, 2004 (dollars in millions)
										Non-
				Subsidiary			Guarantor			Guarantor			Consolidating			Consolidated
	Parent			Issuer			Subsidiaries			Subsidiaries			Adjustments			KCS
Net cash flows provided by (used for) operating activities:	$	(28.1	)	$	75.8		$	0.7		$	4.6		$	(2.7	)	$	50.3


Investing activities:
Property acquisitions		(0.5	)		(65.6	)		(0.2	)		—			—			(66.3	)
Proceeds from disposal of property		—			1.9			—			—			—			1.9
Investments in and loans to affiliates		—			(3.2	)		—			(8.1	)		6.5			(4.8	)
Acquisition Costs		—															—
Other, net		(3.5	)		(4.1	)		(0.1	)		2.4			0.3			(5.0	)

Net		(4.0	)		(71.0	)		(0.3	)		(5.7	)		6.8			(74.2	)


Financing activities:
Proceeds from issuance of long-term debt		—			150.0			—			—			—			150.0
Repayment of long-term debt		—			(99.6	)		(1.0	)		—			—			(100.6	)
Proceeds from loans from affiliates		6.5			—			—			—			(6.5	)		—
Debt issuance costs		—			(2.9	)		—			—			—			(2.9	)
Proceeds from stock plans		2.9						—			—			—			2.9
Cash dividends paid		(4.4	)		—			—			—			—			(4.4	)
Other, net		(2.4	)		—			—			—			2.4			—

Net		2.6			47.7			(1.0	)		—			(4.1	)		45.0


Cash and cash equivalents:
Net increase (decrease)		(29.5	)		52.3			(0.6	)		(1.1	)		—			21.1
At beginning of period		39.9			94.0			0.1			1.4			—			135.4

At end of period	$	10.4		$	146.3		$	(0.5	)	$	0.3		$	—		$	156.5

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion set forth below, as well as other portions of this Form 10-Q, contains forward-looking statements that are not based upon historical information. 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. 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. The actual results of operations of Kansas City Southern (“We”, “Our”, “KCS” or the “Company”) could materially differ from those indicated in forward-looking statements. The differences could be caused by a number of factors or combination of factors including, but not limited to, those factors identified in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Risk Factors” and “- Cautionary Information” which is on file with the U.S. Securities and Exchange Commission (File No. 1-4717) and which “Risk Factors” and “Cautionary Information” sections are hereby incorporated by reference herein. Readers are strongly encouraged to consider these factors when evaluating forward-looking statements. We will not update any forward-looking statements set forth in this Form 10-Q.

The discussion herein is intended to clarify and focus on the Company’s results of operations, certain changes in its financial position, liquidity, capital structure and business developments for the periods covered by the consolidated financial statements included under Item 1 of this Form 10-Q. This discussion should be read in conjunction with these consolidated financial statements and the related notes thereto, and is qualified by reference thereto.

Corporate Overview

KCS, a Delaware corporation, is a holding company with principal subsidiaries and affiliates including the following:

•		The Kansas City Southern Railway Company (“KCSR”), a wholly-owned subsidiary;

•		Mexrail, Inc. (“Mexrail”), a wholly-owned consolidated affiliate; Mexrail owns 100% of the Texas-Mexican Railway Company (“Tex-Mex”);

•		Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”), a 95.1% effectively owned subsidiary, which owns 80% of the total capital stock of TFM, S.A. de C.V. (“TFM”) and 100% of the stock of TFM entitled to full voting rights. TFM owns 98% of Arrendadora TFM, S.A. de C.V. (“Arrendadora TFM”), with the remaing 2% owned by Grupo TFM. Arrendadora TFM was incorporated on September 27, 2002 under the Mexican Law regulations and its only operation is the leasing to TFM of the locomotives and cars acquired through the privatization and subsequently transferred to Arrendadora TFM by TFM (locomotives in 2002 and cars in 2003.) TFM owns 49% of Mexrail. On April 1, 2005 KCS completed its acquisition of control of Grupo TFM and as of that date, Grupo TFM became a consolidated subsidiary of KCS. For the first quarter of 2005, pending completion of the acquisition, KCS accounted for its investment in Grupo TFM on the equity basis of accounting.

•		Southern Capital Corporation, LLC (“Southern Capital”), a 50% owned unconsolidated affiliate that leases locomotive and rail equipment to KCSR;

•		Panama Canal Railway Company (“PCRC”), an unconsolidated affiliate of which KCSR owns 50% of the common stock. PCRC owns all of the common stock of Panarail Tourism Company (“Panarail”).

KCS, as the holding company, supplies its various subsidiaries with managerial, legal, tax, financial and accounting services, in addition to managing other “non-operating” investments.

EXECUTIVE SUMMARY

Overview

During the first quarter of 2005, we operated under one reportable business segment in the rail transportation industry. Beginning in the second quarter of 2005 with the acquisition of a controlling interest in Grupo TFM, we began operating

under two reportable business segments, which are defined geographically as domestic and international. Domestic rail operations consist primarily of KCSR and Mexrail while international rail operations includes primarily Grupo TFM. KCSR, our principal subsidiary within our domestic segment, is the smallest of the Class I railroads. In both the domestic segment and international segments, we generate our revenues and cash flows by providing our customers with freight delivery services both within our regions, and throughout the United States, Mexico and Canada through connections with other Class I rail carriers. Our customers conduct business in a number of different industries, including electric-generating utilities, chemical and petroleum products, paper and forest products, agriculture and mineral products, automotive products and intermodal transportation.

We use our cash flows to support our operations and invest in our infrastructure. The rail industry is a capital-intensive industry, and our capital expenditures are a significant use of cash each year. For the six months ended June 30, 2005, consolidated capital expenditures were approximately $67.1 million and are projected to be approximately $175 million during the remainder of 2005. A more detailed discussion of capital expenditures is found in the “Liquidity and Capital Resources” section below.

For the first quarter of 2005, Grupo TFM was an unconsolidated affiliate, and we used the equity method of accounting to recognize our proportionate share of Grupo TFM’s earnings. As further described in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2004 (“2004 Form 10-K”), on December 15, 2004, KCS entered into the Amended and Restated Acquisition Agreement (the “Acquisition Agreement”) with Grupo TMM, S.A. (“TMM”) and other parties under which KCS ultimately acquired control of TFM through the purchase of TMM’s shares of Grupo TFM (the “Acquisition”). Grupo TFM holds an 80% economic interest in TFM and all of the shares of stock with full voting rights of TFM. The remaining 20% economic interest in TFM is owned by the Mexican government in the form of shares with limited voting rights. The Mexican government has certain limited put rights with respect to its TFM shares as discussed in Part II, Item 7 of our 2004 Form 10-K. On March 29, 2005, at a special meeting of the KCS shareholders, approval of the issuance of shares of KCS common stock in connection with the Acquisition was received and closing was completed on April 1, 2005. Accordingly, beginning in the second quarter of 2005, KCS began including the operating revenues and expenses of Grupo TFM in its consolidated financial statements.

Effective January 1, 2005, the financial results of Mexrail were consolidated into KCS as a result of the Surface Transportation Board’s approval of the Company’s application for authority to control KCSR, the Gateway Eastern Railway Company and Tex-Mex. This approval became effective on December 29, 2004 and shares representing 51% ownership of Mexrail were transferred from a trust by the trustee to KCS on January 1, 2005. An evaluation of the fair value of the assets and liabilities of Mexrail was completed in the first quarter of 2005 and the financial results of Mexrail have been consolidated into the consolidated financial statements of KCS.

Operating Segments

Operating units that are reported as segments include domestic rail operations and international rail operations. Appropriate eliminations of revenue and reclassifications of operating revenues and expenses have been recorded in deriving consolidated data. Domestic operations consists of KCSR and Tex-Mex. International operations consist of Grupo TFM and Arrendadora TFM. Each of these segments are supported by separate executive management, operate and serve different geographical regions, and are subject to different customs, laws, and tax regulations.

Second Quarter Analysis

Consolidated operating income for KCS for the second quarter 2005 decreased $27.8 million compared to the second quarter of 2004 resulting in a net loss of $25.1 million compared to net income of $9.2 million in the same quarter of 2004. The second quarter of 2005 represents the first quarter after the acquisition of control of Grupo TFM. The most significant component impacting operating income relates to costs and charges of $35.6 million related to the write off of deferred statutory employee profit sharing assets as a result of recent legal rulings in Mexico. Other factors impacting consolidated operating income for the quarter were an increase in revenues of $227.2 million (of which $184.1 million was related to the Grupo TFM acquisition and $17.3 was related to the Mexrail acquisition) to $381.1 versus $153.9 million in the second quarter of 2004. This increase in revenues was partially offset by an increase in operating expenses of $255.0 million. Compared to the second quarter of 2004, domestic rail revenue increased in all commodity groups. In addition to the acquisition of control of Grupo TFM and Mexrail, revenue growth for the second quarter of 2005 continued to be driven by three factors: increased volume, targeted rate increases and increased fuel surcharges to help offset rising fuel prices. Volume increases being experienced by KCS are indicative of increased industrial production related to an improving North American economy.

Consolidated operating costs increased consistent with the traffic growth experienced during the first quarter of 2005, as evidenced by increases in fuel costs related to rising prices, as well as increased consumption, compensation and benefits and equipment costs. Equipment costs increased consistent with traffic growth and in addition to factors related to increased volume. Compensation and benefits costs were increased by increased crew starts, additional headcount and wage increases in collective bargaining agreements.

Excluding equity in earnings from Grupo TFM, equity in net earnings from unconsolidated subsidiaries improved substantially in the second quarter of 2005 compared to the second quarter of 2004. This improvement was the result of equity in earnings from our investment in the Mexico City Terminal Railway operation through Grupo TFM, as well as improved operating results at PCRC. PCRC recorded its first $1.0 million freight revenue month. Freight traffic has grown steadily at PCRC during the second quarter of 2005 with container volumes approaching 1,900 versus approximately 700 in the same quarter of 2004.

2005 Outlook

For the remainder of 2005, we believe that the current trend of a strengthening North American economy will continue to drive improvements and gains in our operating income. Effective with the KCS acquisition of control of Mexrail on January 1, 2005 and of Grupo TFM on April 1, 2005, their financial results are being consolidated into KCS.

By combining KCSR, Grupo TFM and Tex-Mex under the common control of KCS, we believe KCS will be a stronger, more competitive railway network with improved operating efficiencies resulting from common control and ownership. Further, we believe that common control of these railroads will enhance competition and give shippers a stronger transportation alternative in moving goods between the United States, Mexico and Canada. As a result of the combination, however, factors that affect the Mexican economy and business climate, such as foreign exchange rates, tax laws and inflation, will directly impact the consolidated results of KCS. Due to their variability, we are unable to predict the impact of such factors on KCS’s consolidated results.

For the remainder of 2005, we expect an improving North American economy to continue to drive higher demand for rail transportation services. With certain exceptions, we expect increases in variable operating expenses to be proportionate to revenue activities. Gains in operating efficiencies are expected to continue to be realized as a result of continued utilization of the data available from our transportation operating system, Management Control System (“MCS’’), and implementation of this system in Mexico. Fuel prices are expected to fluctuate with market conditions and will continue to have a significant impact on our operating expenses. For the remainder of 2005, we have less than 2% of our projected consolidated volume hedged through fuel swaps. In 2005, we expect fuel surcharges to continue to be the primary hedge against fuel price volatility. In 2004, we began purchasing a significant amount of our fuel through a pipeline system which has resulted in improved fuel source stability. Insurance costs are expected to increase commensurate with market conditions.

RECENT DEVELOPMENTS

Tex-Mex enters into Loan Agreement. On July 13, 2005, Tex-Mex entered into an agreement with the Federal Railroad Administration (“FRA”) with an effective date of June 28, 2005 to borrow $50.0 million to b used for safety and infrastructure improvements. These improvements are expected to increase efficiency and capacity in order to accommodate growing freight rail traffic related to the NAFTA corridor. Tex-Mex drew the first $10.0 million on July 13, 2005 to apply to capital projects currently in progress. The loan is being made under the Railroad Rehabilitation and Improvement Financing Program (RRIF) administered by the FRA. The loan is guaranteed by Mexrail, who has issued a Pledge Agreement in favor of the lender equal to the gross revenues earned by Mexrail on per-car fees charged for traffic crossing the International Rail Bridge located in Laredo, Texas.

KCSR Branch Line Lease Agreement. On July 20, 2005, KCSR and Watco Companies announced the lease of five of KCSR’s branch lines in Oklahoma, Arkansas, Louisiana and Alabama to three subsidiary railroads of Watco, a shortline railroad company. These lease agreements are for a period of ten years, subject to earlier termination in accordance with the terms of the applicable lease agreement. The lease agreements are renewable for an additional ten years upon mutual agreement by KCS and the applicable lessee. Under each of these agreements, the lessee has agreed to pay KCS rent annually for the leased property in an amount based on the lessee’s revenue derived from the leased property that is received from traffic interchanged to carriers other than KCS for the annual period for which the lease amounts are due. Under the lease agreements, these branch lines will continue to receive rail service, but from the three railroads owned by Watco instead of KCSR. KCSR will continue to bill the revenue and pay a per car fee to Watco for the services provided.

KCSR Completes Successful Consent Solicitation. On June 10, 2005, KCSR completed the successful solicitation of consents to amend the indentures, as supplemented where applicable, under which KCSR’s outstanding 9 ¹ / 2 % Senior Notes due 2008 and outstanding 7 ¹ / 2 % Senior Notes due 2009 were issued. KCSR received the requisite consents from a majority of the outstanding aggregate principal amount of each series of Notes.

Upon the terms and subject to the conditions set forth in the Consent Solicitation Statement dated May 11, 2005 and as thereafter amended, KCSR, KCS, the other note guarantors, and the trustee under each of the indentures, respectively, signed supplemental indentures with respect to each such series of Notes to permit KCS, GTFM, and TFM to effect a settlement of certain disputes among TFM, Grupo TFM, and the Mexican government. KCS is unable to predict when or if a settlement of these disputes will be consummated.

TFM Completes Note Tender Offer and Consent Solicitation. On April 1, 2005, TFM commenced a cash tender offer for any and all outstanding $443.5 million aggregate principal amount of 11.75% Senior Discount Debentures due 2009 (the “2009 Debentures”) on the terms and subject to the conditions set forth in TFM’s Offer to Purchase and Consent Solicitation Statement dated April 1, 2005. TFM also solicited consents for amendments to the indenture under which the 2009 Debentures were issued. Holders who tendered their 2009 Debentures were required to consent to the proposed amendments and holders who consented were required to tender their 2009 Debentures.

On April 14, 2005 $386.0 million principal amount of the outstanding $443.5 million principal amount of the 2009 Debentures had been tendered on or prior to the consent deadline pursuant to the consent solicitation and tender offer for the 2009 Debentures, representing approximately 87% of the outstanding 2009 Debentures. As a result of such consents and early tenders, TFM received the requisite consents to execute a supplemental indenture relating to the 2009 Debentures. As part of its tender offer for the 2009 Debentures, TFM was soliciting consents to eliminate substantially all of the restrictive covenants included in the indenture under which the 2009 Debentures were issued and to reduce the minimum prior notice period with respect to a redemption date for outstanding 2009 Debentures from 30 to 3 days. The supplemental indenture relating to the 2009 Debentures containing the proposed changes was executed by TFM and the Trustee under the indenture. TFM made payment for these 2009 Debentures pursuant to the early tender provisions of the tender offer on April 20, 2005. Pursuant to the terms of the 2009 Debentures as amended by the supplemental indenture, TFM called for redemption of its remaining outstanding 2009 Debentures that were not tendered in TFM’s previously announced tender offer and on April 29, 2005, paid an aggregate of $60.0 million, including principal and interest, to the holders of such 2009 Debentures to complete the redemption of all of such remaining outstanding 2009 Debentures.

On April 18, 2005, TFM entered into a first waiver and amendment (the “Waiver and Amendment”) to its amended and restated credit agreement with the banks which are a party thereto and J.P. Morgan Chase Bank, N.A., as administrative agent. The Waiver and Amendment allowed TFM to issue $460.0 million principal amount of its 9 3/8% Senior Notes due 2012, (the “9 3/8% Notes”), in a principal amount in excess of the principal amount of 2009 Debentures outstanding and to use the amount of proceeds from the private placement of the 9 3/8% Notes in excess of the principal amount of the 2009 Debentures outstanding to pay accrued and unpaid interest on the 2009 Debentures repurchased or redeemed, to pay the fees of the underwriter associated with the issuance of the 9 3/8% Notes as well as the tender offer for the 2009 Debentures, to pay the premium related to the tender offer and to pay certain other expenses relating to the tender offer and issuance of the 9 3/8% Notes. The Waiver and Amendment also amends the amended and restated credit agreement to allow TFM to borrow up to $25 million from KCS on a fully subordinated basis.

Loss of Foreign Private Issuer Status for Grupo TFM. KCS acquired a controlling interest in Grupo TFM effective April 1, 2005. As a consequence of this change in control, Grupo TFM has ceased to qualify as a foreign private issuer for purposes of our reporting obligations to the Securities and Exchange Commission, or SEC. Accordingly, Grupo TFM has begun filing current reports on From 8-K, and will begin filing quarterly reports on Form 10-Q (beginning with respect to the second fiscal quarter of 2005) and annual reports on Form 10-K (beginning with respect to fiscal year 2005).

RESULTS OF OPERATIONS

Net Income. Consolidated net income for the quarter ended June 30, 2005 decreased $34.3 million compared to the quarter ended June 30, 2004. This decrease was due to several factors. Domestic operating income decreased $1.7 million compared to the quarter ended June 30, 2004. The international operating segment experienced an operating loss of $26.1 million for the quarter ended June 30, 2005. Both international and consolidated results benefited from a $17.8 million allocation of the net loss to the minority shareholder. Additionally, consolidated net income, increased due to a reduction in provision for income taxes of $2.2 million.

The following table summarizes the income statement components of KCS for the quarters ended June 30, 2005 and 2004 respectively, (in millions):


	Three Months
	Ended June 30,						Change
	2005			2004			In Dollars			Percentage
Revenues	$	381.1		$	153.9		$	227.2			147.6	%
Operating expenses		389.4			134.4			255.0			189.7	%


Operating income		(8.3	)		19.5			(27.8	)		(142.6	%)
Equity in net earnings (losses) of unconsolidated affiliates		1.5			3.2			(1.7	)		(53.1	%)
Interest expense		(38.7	)		(10.9	)		(27.8	)		255.0	%
Debt retirement costs		(3.9	)		—			(3.9	)	nm		%
Foreign exchange gains (losses)		4.3			—			4.3		nm		%
Other income		3.8			1.7			2.1			123.5	%


Income before income taxes and minority interest		(41.3	)		13.5			(54.8	)		(405.9	%)
Income tax provision		1.6			4.3			(2.7	)		(62.8	%)


Income before minority interest		(42.9	)		9.2			(52.1	)	nm		%
Minority interest		(17.8	)		—			(17.8	)	nm		%

Net income	$	(25.1	)	$	9.2		$	(34.3	)		(372.8	%)

nm – not meaningful percentage change in excess of 500%

Consolidated net income for year to date ended June 30, 2005 decreased $29.6 million compared to the same period in 2004. Domestic operating income for year to date ended June 30, 2005 increased $5.7 million compared to the same period in 2004, while the international segment operating loss was $26.1 million. Other non-operating income and expenses had a net decrease of $22.6 million for the international segment. These impacts were reduced by a $17.8 million allocation of the net loss that was made to a minority shareholder.

The following table summarizes the consolidated income statement components of KCS for the year to date periods ended June 30, 2005 and 2004 respectively, (in millions):


	Six Months
	Ended June 30,						Change
	2005			2004			In Dollars			Percentage
Revenues	$	579.3		$	301.7		$	277.6			92.0	%
Operating expenses		562.8			264.8			298.0			112.5	%


Operating income		16.5			36.9			(20.4	)		(55.3	%)
Equity in net earnings (losses) of unconsolidated affiliates		(0.6	)		4.6			(5.2	)		(113.0	%)
Interest expense		(51.0	)		(21.7	)		(29.3	)		135.0	%
Debt retirement costs		(3.9	)		(4.2	)		0.3			(7.1	%)
Foreign exchange gains (losses)		4.3			—			4.3		Nm		%
Other income		7.1			3.2			3.9			121.9	%


Income before income taxes and minority interest		(27.6	)		18.8			(46.4	)		(246.8	%)
Income tax provision		7.2			6.2			1.0			16.1	%


Income before minority interest		(34.8	)		12.6			(47.4	)		(376.2	%)
Minority interest		(17.8	)		—			(17.8	)	nm		%

Net income	$	(17.0	)	$	12.6		$	(29.6	)		(234.9	%)

nm – not meaningful percentage change in excess of 500%

Domestic Results. Revenue for our domestic segment constituted approximately 51.7% and 100% of KCS’s consolidated revenue for the quarter ended June 30, 2005 and 2004, respectively and 68.2% and 100.0% of KCS’s consolidated revenue for the year to date ended June 30, 2005 and 2004, respectively.

The following table summarizes domestic KCS revenues, including the revenues and carload statistics of KCSR and Mexrail, for the quarters ended June 30, 2005 and 2004. Certain prior year amounts have been reclassified to conform to the current year presentation.


											Carloads and
	Revenues										Intermodal Units
	(in millions)										(in thousands)
	Three Months										Three Months
	Ended June 30,				Change						Ended June 30,				Change
	2005		2004		In Dollars			Percentage			2005		2004		In Units		Percentage
General commodities:
Chemical and petroleum	$	38.8	$	33.8	$	5.0			14.8	%		43.1		37.6		5.5		14.6	%
Forest products and metals		54.9		38.3		16.6			43.6	%		58.9		46.5		12.4		26.7	%
Agricultural and mineral		44.2		30.0		14.2			47.3	%		52.7		36.6		16.1		44.0	%

Total general commodities		137.9		102.1		35.8			35.1	%		154.7		120.7		34.0		28.2	%
Intermodal and automotive		19.9		16.5		3.4			20.1	%		90.4		87.0		3.4		3.9	%
Coal		27.0		23.2		3.8			16.1	%		51.8		47.7		4.1		8.6	%

Carload revenues and carload and intermodal units		184.8		141.8		43.0			30.3	%		296.9		255.4		41.5		16.2	%

Other freight revenues		0.3		2.7		(2.4	)		(87.3	%)
Other revenues		11.9		9.4		2.5			26.6	%

Domestic revenues	$	197.0	$	153.9	$	43.1			28.0	%

The following table summarizes domestic KCS revenues, including the revenues and carload statistics of KCSR and Mexrail, for the year to date periods ended June 30, 2005 and 2004. Certain prior year amounts have been reclassified to conform to the current year presentation.


											Carloads and
	Revenues										Intermodal Units
	(in millions)										(in thousands)
	Six Months										Six Months
	Ended June 30,				Change						Ended June 30,				Change
	2005		2004		In Dollars			Percentage			2005		2004		In Units		Percentage
General commodities:
Chemical and petroleum	$	78.0	$	65.7	$	12.3			18.7	%		85.5		73.3		12.2		16.7	%
Forest products and metals		106.5		75.0		31.5			42.0	%		116.7		92.7		24.0		25.8	%
Agricultural and mineral		89.7		60.7		29.0			47.7	%		107.0		74.6		32.4		43.5	%

Total general commodities		274.2		201.4		72.8			36.1	%		309.2		240.6		68.6		28.5	%
Intermodal and automotive		37.7		31.2		6.5			21.0	%		173.3		167.7		5.6		3.4	%
Coal		57.7		45.2		12.5			27.8	%		112.2		96.2		16.0		16.6	%

Carload revenues and carload And intermodal units		369.6		277.8		91.8			33.0	%		594.7		504.5		90.2		17.9	%

Other freight revenues		0.7		5.3		(4.6	)		(86.7	%)
Other revenues		24.9		18.6		6.3			33.8	%

Domestic revenues	$	395.2	$	301.7	$	93.5			31.0	%

Domestic Revenues. For the quarter and year to date periods ended June 30, 2005, domestic revenues increased $43.1 million and $93.5 million, respectively. The Mexrail acquisition accounted for $18.0 million and $34.6 million of the increase in revenues for the quarter and year to date periods ended June 30, 2005, respectively. KCSR experienced revenue increases in all commodity groups due to a combination of higher carloadings, targeted price improvements and increased fuel surcharge revenue. Fuel surcharges accounted for $7.2 million and $15.1 million of the increase in revenues for the quarter and year to date periods ended June 30, 2005, respectively, compared to the same periods in 2004. The following discussion provides an analysis of our revenues by commodity group.

Chemical and petroleum products. For the quarter ended June 30, 2005, domestic chemical and petroleum products experienced increases in revenues as a result of increased volumes attributed to higher production and service improvements, certain targeted rate increases and fuel surcharges. Revenues in all commodities in the chemical and petroleum product business unit also increased for the year to date period ended June 30, 2005 compared to the same period in 2004. These increases were the result of higher traffic volume from both new and existing customers, fuel surcharges, and certain targeted rate increases. The impact of the Mexrail consolidation increased revenues by $2.8 million and $5.7 million in the chemical and petroleum product commodities for the quarter and year to date ended June 30, 2005, respectively.

Forest products and metals. Domestic forest products and metals experienced growth in all commodities within the commodity group for the quarter and year to date ended June 30, 2005 compared to the same periods in 2004. These increases were the result of improvements in traffic volume, certain targeted rate increases and fuel surcharges. For the quarter and year to date ended June 30, 2005, the consolidation of Mexrail contributed $4.4 million and $8.4 million, respectively, to forest products and metals revenue.

Agricultural and mineral products. Domestic revenues in all commodities in the agricultural business unit increased in the quarter and year to date ended June 30, 2005. For both periods, these increases were primarily the result of targeted rate increases and fuel surcharges. Additionally, ores and minerals revenues and stone, clay and glass revenues increased in the quarter and year to date ended June 30, 2005 as a result of higher production by certain customers. Domestic grain carloads decreased, primarily due to a slowdown in equipment cycle times resulting in less equipment available for utilization. Export grain carloads decreased primarily as a result of a decrease in gulf coast export traffic. For the quarter and year to date ended June 30, 2005, the consolidation of Mexrail contributed $7.8 million and $15.2 million to agricultural and mineral products revenue, respectively.

Intermodal and automotive . Domestic intermodal and automotive revenues for both the quarter and year to date periods ended June 30, 2005 increased compared to the same periods in 2004. Increases in intermodal revenues were primarily related to increased traffic resulting from a strengthening domestic market, as well as an expansion of traffic through additional gateways. Automotive traffic increased as a result of increased volumes from GM and Mazda. For the quarter and year to date ended June 30, 2005, the consolidation of Mexrail contributed $1.6 million and $2.8 million to intermodal and automotive products revenue, respectively.

Coal. Increases in domestic coal revenues for the quarter and year to date ended June 30, 2005 compared to the same periods in 2004 were due primarily to the addition of two new coal movements that had been served by other railroads,

certain targeted rate increases related to renegotiated contracts, as well as overall increases in carloadings and traffic volumes at certain electric generating stations as utilities increased stockpiles. Mexrail has no significant coal revenues.

The following table summarizes KCS’s domestic operating expenses for the quarters ended June 30, 2005 and 2004.


					Change
	2005		2004		In Dollars			Percentage
Compensation and benefits	$	62.1	$	52.2	$	9.9			19.0	%
Purchased services		22.9		15.4		7.5			48.7	%
Fuel		28.6		14.6		14.0			95.9	%
Equipment costs		14.6		11.6		3.0			25.9	%
Depreciation and amortization		14.6		13.1		1.5			11.5	%
Casualties and insurance		15.0		10.9		4.1			37.6	%
Other leases		2.7		3.0		(0.3	)		(10.0	%)
Other		18.7		13.6		5.1			37.5	%


Total domestic operating expenses	$	179.2	$	134.4	$	44.8			33.3	%

The following table summarizes KCS’s domestic operating expenses for the year to date periods ended June 30, 2005 and 2004.


					Change
	2005		2004		In Dollars		Percentage
Compensation and benefits	$	123.4	$	103.0	$	20.4		19.8	%
Purchased services		42.7		31.0		11.7		37.7	%
Fuel		55.0		29.4		25.6		87.1	%
Equipment costs		31.8		24.6		7.2		29.3	%
Depreciation and amortization		28.9		25.9		3.0		11.6	%
Casualties and insurance		27.7		16.6		11.1		66.9	%
Other leases		5.9		5.7		0.2		3.5	%
Other		37.2		28.6		8.6		30.1	%


Total domestic operating expenses	$	352.6	$	264.8	$	87.8		33.2	%

Domestic Operating Expenses. For the quarter and year to date ended June 30, 2005, domestic operating expenses increased $44.8 million (33.3%) and $87.8 million (33.2%), respectively, when compared to the same periods in 2004. Of this increase, $20.1 million and $38.6 million was attributable to the consolidation of Mexrail’s operations into KCS for the quarter and year to date ended June 30, 2005, respectively.

Compensation and Benefits . Increases in domestic compensation and benefits expense for the quarter and year to date ended June 30, 2005 compared to the same periods in 2004 were primarily the result of annual wage and salary rate increases which were effective July 1, 2004 and higher crew starts related to continued increases in traffic volume. For the quarter and year to date ended June 30, 2005, the consolidation of Mexrail added $5.1 million and $9.8 million, respectively, to compensation and benefits expense. The average headcount for the year to date period ended June 30, 2005 was approximately 3,000 compared to approximately 2,800 for the same period in 2004.

Purchased Services. Purchased services expense for the quarter and year to date ended June 30, 2005 increased compared to the same periods in 2004, primarily as a result of the consolidation of Mexrail’s operations into KCS. Mexrail has historically contracted for services in the maintenance of equipment and way and structures. Accordingly, Mexrail contributed $5.5 million and $10.1 million, respectively, to purchased services expense for the quarter and year to date ended June 30, 2005. Other factors leading to the increase in purchased services expense at KCSR were increased legal costs.

Fuel . Fuel expense increased for the quarter ended June 30, 2005 compared to the quarter ended June 30, 2004. This quarter to quarter increase was a result of 52.2% increase in average price per gallon and a 16.2% increase in consumption driven by volume increases. These increases were offset in part by fuel cost savings of $0.5 million as a result of our fuel hedging program, as well as improved fuel purchasing and distribution procedures implemented through our new Heavener, Oklahoma fueling facility. For the quarter ended June 30, 2005, the consolidation of Mexrail added $2.8 million to fuel expense.

Fuel expense increased for the year to date ended June 30, 2005 when compared to the same period in 2004. This year to date increase was the result of a 44.4% increase in the average price per gallon, as well as a 16.7% increase in consumption. These increases were partially offset by a savings of $0.9 million as a result of our fuel hedging program, along with improved fuel purchasing and distribution procedures implemented through our new Heavener, Oklahoma fueling facility. For the year to date ended June 30, 2005, the consolidation of Mexrail added $5.2 million to fuel expense.

Equipment Costs . Equipment costs for the quarter and year to date ended June 30, 2005 increased compared to the same periods in 2004. Of this increase, $3.1 million and $6.3 million was related to the Mexrail acquisition for the quarter and year to date ended June 30, 2005, respectively. Excluding the impact of the Mexrail acquisition, equipment costs decreased for both the quarter and year to date ended June 30, 2005 as the result of purchases from Southern Capital of equipment that was previously leased.

Depreciation and Amortization . Depreciation and amortization expense for the quarter and year to date ended June 30, 2005 increased compared to the same periods in 2004, primarily as a result of a higher asset base, partially offset by property retirements. For the quarter and year to date periods ended June 30, 2005, the consolidation of Mexrail added $0.9 million and $1.4 million, respectively, to depreciation and amortization expense.

Casualties and Insurance . Casualties and insurance expense for the second quarter of 2005 and year to date period ended June 30, 2005 increased compared to the same periods in 2004. These increases were the result of increased employee and third party personal injury claims and casualty expenses related to derailments. Additionally, $1.4 million and $3.1 million of this increase is related to the Mexrail acquisition for the quarter and year to date ended June 30, 2005, respectively.

Other Leases . Other lease expense for the quarter and year to date ended June 30, 2005 increased compared to the same periods in 2004, primarily related to pipeline rents for KCSR’s new fuel facility in Heavener, Oklahoma combined with normal rate increases in long-term leases.

International Results. KCS acquired a controlling interest in Grupo TFM effective April 1, 2005. Current quarter results reflect charges and costs associated with the Acquisition, as well as the effect of valuation adjustments as required by purchase accounting. Management evaluates the results of Grupo TFM based on its operating performance during the current quarter and comparison to plan.


	Three Months
	Ended June
	30,
	2005

Transportation revenues	$	184.1

Operating expenses		184.3
Depreciation and amortization		25.9

Total cost		210.2
Operating (loss) profit	$	(26.1	)

International Revenues. The following table summarizes consolidated Grupo TFM revenues, including the revenues and carloads statistics, for the three months ended June 30, 2005 and 2004. Although not consolidated in previous quarters, Grupo TFM’s revenue recognition policies were consistent with those of KCS in all material respects; therefore, commodity statistics are presented for purposes of comparison. During the second quarter of 2004 Mexrail was a consolidated subsidiary of Grupo TFM and has been excluded from this comparison.


											Carloads and
	Revenues										Intermodal Units
	(in millions)										(in thousands)
	Three Months										Three Months
	Ended June 30,				Change						Ended June 30,				Change
	2005		2004		In Dollars			Percentage			2005		2004		In Units			Percentage
Agro-industrial products	$	40.6	$	34.4	$	6.2			18.0	%		30.0		30.0		—			0.0	%
Cements, metals and minerals		35.9		34.8		1.1			3.2	%		45.4		42.8		2.6			6.1	%

Chemical and petrochemical products		29.9		34.1		(4.2	)		(12.3	%)		24.7		26.8		(2.1	)		(7.8	%)
Automotive products		32.0		29.9		2.1			6.7	%		31.0		29.9		1.1			3.7	%
Manufactured products, industrial products		25.8		20.4		5.4			26.5	%		29.2		25.9		3.3			12.7	%
Intermodal freight		15.9		13.1		2.8			21.4	%		58.5		51.4		7.1			13.8	%
Other		4.0		2.6		1.4			53.8	%		—		—		—			0.0	%


Grupo TFM	$	184.1	$	169.3	$	14.8			8.7	%		218.8		206.8		12.0			5.8	%

Revenues for the three months ended June 30, 2005 totaled $184.1 compared to $184.9 million for the same period in 2004. The increase was mainly attributable to the general recovery of the U.S. and Mexican economies, primarily in metal and mineral, industrial and agro-industrial products. For the three months ended June 30, 2005 freight revenues include fuel surcharges. Fuel surcharges are a function of the price billed by Pemex. Changes in this price will drive the amount of fuel surcharges we can apply in the future.

Agro-industrial Products. In the three months ended June 30, 2005, $40.6 million or 22.1% of Grupo TFM’s total transportation revenues was derived from the movement of agro-industrial products. Revenues of agro-industrial products increased 18% compared to the same period in 2004. Corn and sorghum revenues increased as a result of higher import volumes related to lower domestic harvest for the current period. Domestic revenues recorded a strong increase attributed to higher sugar volume. Price improvements also favorably impacted the period. This increase was offset by a reduction in import shipments of soybeans and wheat products during the three months ended June 30, 2005.

Cements, Metals and Minerals. In the three months ended June 30, 2005, $35.9 million or 19.5% of Grupo TFM’s total transportation revenues, was derived from the movement of cements, metals and minerals. These increases are the result of an increase in the production volumes of construction materials such as billets, bar and wire, cement and minerals as a result of a strong performance of the construction industry.

Steel slab and steel coils revenue increased as a result of higher international traffic, such as imports and exports, due to higher consumption by manufacturing industries as well as certain targeted rate increases during the period. Cement is one of the most widely used commodities in construction in Mexico and is produced throughout the country for both domestic use and export to the U.S. Two major companies in Mexico, which move their products with us, are CEMEX and Cementos Apasco, S.A. de C.V.

Chemical and Petrochemical Products. In the three months ended June 30, 2005, $29.9 million or 16.2% of Grupo TFM’s total transportation revenues, came from the movement of chemical and petrochemical products. For the three months ended June 30, 2005, Grupo TFM’s revenues decreased by 12.3% from the same period in 2004. The reduction in revenue from this segment was a direct consequence of the decrease in volume by PEMEX and CEMEX.

Automotive Products. Grupo TFM’s automotive revenues in the three months ended June 30, 2005 were $32.0 million or 17.4% of total transportation revenues. During the period, automotive revenues increased by 6.7% from the same period in 2004. This revenue increase was mainly a consequence of the efforts to capture traffic for domestic distribution.

Manufactured Products and Industrial Products. In the three months ended June 30, 2005, $25.8 million, or 14.0% of Grupo TFM’s total transportation revenues, were derived from the movement of manufactured products and industrial products. Grupo TFM’s revenues generated in this product category increased by 26.5% from the same period in 2004, mainly driven by the increase in rates of pulpwood movement and a recovery of traffic from barge movement, as well as new traffic. Additionally, export traffic of beer increased 41% due to higher production. Home appliances revenue increased, mainly driven by higher exports to the US market. Scrap paper revenue also increased due to a recovery of traffic that was lost in 2004 to barge shippers and to obtaining new traffic.

Intermodal Freight. In the three months ended June 30, 2005, $15.9 million, or 8.6% of Grupo TFM’s transportation revenues, was derived from intermodal freight, which entails hauling products in freight containers in combination with transport by water, rail and/or motor carriers, with rail carriers serving as the link between the other modes of transportation. During the three months ended June 30, 2005, our revenues in this product category increased by 21.4% from the same period in 2004. This increase was mainly attributable to the consolidation of steamship service at the port of Lázaro Cárdenas with the support of the port administration and Hutchinson Terminal, which also reflects the migration of international customers such as Maersk, APL & CP Ships from the port of Manzanillo to the port of Lázaro Cárdenas.

The opening of the port of Lázaro Cárdenas to containers represents an opportunity for further growth. The volume of intermodal traffic in Mexico has been increasing in recent years with several major international maritime companies,

including CP Ships, APL (American President Line), Maersk Sealand, Dicex, S.A., Navemar Internacional, S.A. de C.V. and Mediterranean Shipping Company. Increasing the quality and frequency of services to maritime ports has enabled us to convert some of this intermodal traffic from truck to rail transport.

International Operating expenses. Grupo TFM reported an operating loss of $26.1 million in the quarter ended June 30, 2005. Grupo TFM’s operating ratio for the quarter was 114.2%.

As a result of the Acquisition, assets and liabilities were revalued and adjusted to their fair value. The excess of purchase price over the historical book value of the assets resulted in a net increase in the basis of the assets of approximately $180 million and goodwill of $20 million was recognized.

In connection with the evaluation of the fair values of the assets and liabilities of Grupo TFM, certain assets were identified as having little or no value to KCS as the acquiring Company. Because KCS acquired only 48.5% of Grupo TFM (or 38.8% of TFM) in this transaction, the allocation of the excess purchase price over book value of net assets was limited to the acquired percentage. Accordingly, a reduction in the assets of Grupo TFM was limited to the acquired percentage and any residual was charged to expense. Grupo TFM operating expenses include $39.5 million relating to decreases in the basis of certain assets, the most significant of which was the write off of deferred employee profit sharing asset of approximately $35.6 million as a result of recent legal rulings in Mexico. A total of $15.9 million of these operating expenses were allocated to Grupo TFM’s minority interest. Grupo TFM also recognized $3.6 million in depreciation expense related to the increase in basis of tangible assets.

Consolidated Operating Income. Consolidated operating income for the quarter and year to date ended June 30, 2005 decreased $27.8 million to a consolidated operating loss of $8.3 million and decreased year to date by $20.4 million to consolidated operating income of $16.5 million, respectively when compared to the same periods in 2004. The quarter to quarter decrease was the result of a $227.2 million increase in revenues, offset by a corresponding $255.0 million increase in operating expenses. The acquisitions of TFM effectively increased revenues by $184.1 million and operating expenses by $210.2 million for the quarter and year to date ended June 30, 2005. Domestic revenues increased $43.1 million and $93.5 million for the quarter and year to date ended June 30, 2005, respectively. At the same time, for the quarter and year to date ended June 30, 2005, domestic operating expenses increased $44.8 million and $87.8 million, respectively.

Consolidated Interest Expense. Consolidated interest expense for the quarter ended June 30, 2005 increased $27.8 million compared to the quarter ended June 30, 2004, while consolidated interest expense increased $29.3 million for year to date ended June 30, 2005 when compared to year to dated ended June 30, 2004. This increase was the result of increased balances on our credit facility combined with increases in variable rates, and the addition of interest expense of $24.4 million through the Acquisition.

Consolidated Debt Retirement Costs. Consolidated debt retirement costs for the quarter ended June 30, 2005 increased $3.9 million due to the write-off of unamortized debt issuance costs associated with TFM senior discount debentures which were refinanced in the period and costs incurred in connection with obtaining the waiver. Consolidated debt retirement costs increased $0.3 million for the year ended June 30, 2005 when compared to the same period in 2004. During the year to date period ended June 30, 2004, KCS recorded $4.2 million of debt retirement costs resulting from the write-off of the unamortized balance of debt issuance costs associated with our previous credit facility.

Equity in Net Earnings (Losses) of Unconsolidated Affiliates. . For the quarter ended June 30, 2005, equity in income from other unconsolidated affiliates was $1.5 million compared to $3.2 million in the quarter ended June 30, 2004. For

year to date ended June 30, 2005, equity in loss from other unconsolidated affiliates was $0.6 million compared to equity in earnings from other unconsolidated affiliate of $4.6 million in the same period of 2004. Significant components of this change were as follows:

•		For the quarter and year to date periods ended June 30, 2005, equity in losses from the operations of PCRC were $0.3 million and $2.1 million, respectively, compared to $0.8 million and $1.6 million, respectively, for the same periods in 2004.

•		For the quarter and year to date periods ended June 30, 2005, equity in earnings of Southern Capital were $0.7 million and $1.4 million, respectively, compared to $1.1 million and $2.0 million, respectively, for the same periods in 2004.

•		Our investment in Mexico City Terminal Railway operation through Grupo TFM had $1.1 million in equity earnings for the quarter and year to date periods ended June 30, 2005.

Consolidated Income Tax Provision (Benefit). For the quarter ended June 30, 2005, KCS’s income tax provision was $1.6 million; a decrease of $2.7 million compared to a $4.3 million provision in the quarter ended June 30, 2004. This decrease was primarily due to the acquisition of TFM resulting in an effective income tax rate of (3.9%) and 31.9% for the quarters ended June 30, 2005 and 2004, respectively. The primary causes of the decrease in the consolidated effective rate were the utilization of U.S. tax credits enacted for the tax year 2005, a lower Mexican statutory tax rate of 29% as compared to U.S. statutory rate of 35%, foreign exchange rate fluctuations.

For year to date ended June 30, 2005, the consolidated tax provision increased $1.0 million compared to the same period in 2004. Due to the causes discussed above, the overall effective income tax rate was (26.1%) and 33.0% for year to date ended June 30, 2004 and 2005, respectively.

LIQUIDITY AND CAPITAL

Summary cash flow data for the Company is as follows (in millions):


	Six Months
	Ended June 30,
	2005			2004
Cash flows provided by (used for):

Operating activities	$	32.8		$	50.3
Investing activities		(74.3	)		(74.2	)
Financing activities		44.7			45.0

Cash and cash equivalents:
Net increase		3.2			21.1
At beginning of year		38.6			135.4

At end of period	$	41.8		$	156.5

During the year to date ended June 30, 2005, KCS’s consolidated cash position increased $3.2 million from December 31, 2004, as a result of operating cash inflows, cash acquired in the Grupo TFM and Mexrail acquisitions, proceeds from the issuance of long-term debt and the proceeds from employee stock plans. These increases were partially offset by property additions, investments in and loans to affiliates, and debt repayments. Net operating cash inflows were $32.8 million and $50.3 million for the year to date periods ended June 30, 2005 and 2004, respectively. The $17.5 million decrease in operating cash flows was primarily attributable to the year to date net loss, a $17.8 million change in minority interest related to the net loss, funding of restricted cash related to the acquisition of control of Grupo TFM, as well as the net changes in working capital balances, resulting mainly from the timing of certain payments and receipts. Operating cash flow for the year to date period ended June 30, 2005 also reflects the impact of changes in the timing on interest payments and lease accruals.

Net investing cash outflows were $74.3 million and $74.2 million for the year to date periods ended June 30, 2005 and 2004, respectively. Net cash outflows were impacted by a $0.8 million period to period increase in capital expenditures, $5.3 million in investments in and loans to affiliates and a $4.3 million increase in cash outlays related to the Acquisition. These factors, which resulted in investing cash outlays were partially offset by $8.5 million cash flow related to the cash acquired as part of the TFM and Mexrail acquisitions.

Cash flows for operating, investing and financing activities include the cash flow activities of Grupo TFM since the acquisition on April 1, 2005. Our consolidated ratio of debt to total capitalization was 54.9% and 39.4% at June 30, 2005 and December 31, 2004, respectively.

In addition to operating cash flows, KCS has financing available under the revolving credit facility (“2004 Revolving Credit Facility”) with a maximum borrowing amount of $100 million of which, $65.0 million was available as of June 30, 2005. The 2004 Revolving Credit Facility contains, among other provisions, various financial covenants which may restrict our access to the maximum borrowing amount. As a result of certain financial covenants contained in the 2004 Revolving Credit Facility, maximum utilization of the 2004 Revolving Credit Facility may be restricted. TFM has no credit lines, but does have an accounts receivable factoring program. As of June 30, 2005, no amounts were drawn.

Capital improvements for KCSR roadway track structures have historically been funded with cash flows from operations and external debt. KCS has historically used equipment trust certificates for major purchases of locomotives and rolling stock, while using internally generated cash flows or leasing for other equipment.

The following table summarizes the cash capital expenditures by type.


	Six Months
	Ended June 30,
Capital Expenditure Category (dollars in millions)	2005		2004
Track infrastructure	$	41.4	$	41.9
Locomotives, freight cars and other equipment		16.7		18.7
Information technology		2.6		1.3
Facilities and improvements		1.1		1.6
Other		5.3		2.8

Total capital expenditures	$	67.1	$	66.3

The Company has entered into an agreement to secure the transportation of locomotive diesel fuel via pipeline into the Company’s fuel facility in Heavener, Oklahoma. This pipeline was completed and placed in service in May 2004. The contract provides that the Company will pay to the supplier transportation fees based on published tariff rates per barrel. The contract further requires that for a period of ten years after the pipeline is placed in service, the fees will be at least $1.5 million per year.

KCS filed a Universal Shelf Registration Statement on Form S-3 (“Initial Shelf” — Registration No. 33-69648) in September 1993, as amended in April 1996, for the offering of up to $500.0 million in aggregate amount of securities. The SEC declared the Initial Shelf effective on April 22, 1996; however, no securities have been issued thereunder. KCS has carried forward $200 million aggregate amount of unsold securities from the Initial Shelf to a Shelf Registration Statement filed on Form S-3 (“Second Shelf” — Registration No. 333-61006) on May 16, 2001 for the offering of up to $450 million in aggregate amount of securities. The SEC declared the Second Shelf effective on June 5, 2001. Securities in the aggregate amount of $300 million remain available under the Initial Shelf and securities in the aggregate amount of $450 million remain available under the Second Shelf. To date, no securities have been issued under either the Initial Shelf or Second Shelf.

As discussed in our Annual Report on Form 10-K for the year ended December 31, 2004 — “Recent Developments – Mexican Government’s Put Rights with Respect to TFM Stock,” KCS could be required to purchase the Mexican government’s interest in TFM. If KCS had been required to purchase the Mexican government’s 20% interest in TFM, the total purchase price would have been approximately $520.0 million as of June 30, 2005. We are exploring various alternatives for financing this transaction. It is anticipated that this financing, if necessary, can be accomplished using our ability to access the capital markets. No commitments for such financing have been obtained at this time.

We believe, that our cash and other liquid assets, operating cash flows, access to capital markets, borrowing capacity, and other available financing resources are sufficient to fund anticipated operating, capital and debt service requirements and other commitments through 2005. Our operating cash flows and financing alternatives, however, can be impacted by various factors, some of which are outside of our control. Additionally, we are subject to economic factors surrounding capital markets, and our ability to obtain financing under reasonable terms is subject to market conditions. Further, our cost of debt can be impacted by independent rating agencies, which assign debt ratings based on certain credit measurements, such as interest coverage and leverage ratios.

Grupo TFM has the following commitments under long term debt and operating leases.

Locomotives operating leases. In May 1998 and September 1999, Grupo TFM entered into operating lease agreements for 75 locomotives each, which expire over the next 17 and 18 years, respectively. At the end of the contracts the locomotives will be returned to the lessor. As of June 30, 2005, Grupo TFM had received 150 locomotives. Rents under these agreements amounted to $7.3 million for the tree months ended on June 30, 2005.

Railcars operating leases. The Company lease certain railcars under agreements, which are classified as operating leases. The term of the contracts fluctuate between 3 and 15 years.

Maturities under long term debt and operating lease commitments are as follows:


	2005		2006		2007		2008		2009		2010		Thereafter
Car Leases	$	—	$	37.3	$	33.6	$	26.7	$	21.9	$	17.2	$	37.0
Locomotive Leases		—		29.1		29.1		29.1		29.1		29.1		256.9
Capital Leases		—		0.3		0.3		0.3		0.3		0.1		—
Debt Commitments		—		27.3		150.0		—		—		—		638.3

Total	$	—	$	94.0	$	213.0	$	56.1	$	51.3	$	46.4	$	932.2

In connection with the allocation of the purchase price adjustments of $8.4 million to reflect the fair value of a proportionate amount of Grupo TFM’s outstanding debt were recorded as an increase to the carrying value of debt. Such amounts will be amortized over the remaining term of the respective debt issues as a reduction of interest expense and have not been allocated to the various maturities.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Over the coming months, we will be working to integrate Grupo TFM into our business. This integration will be complex, involving the merger of systems and services over multiple U.S. and international locations. We may not be successful in integrating this business into our current structure, or in obtaining the anticipated cost savings or synergies from the Acquisition. To meet our quarterly certification requirements and in anticipation of incorporating Grupo TFM into our 2006 Sarbanes-Oxley compliance process, we will also be performing a detailed review of Grupo TFM’s internal control

structure to ensure that its controls over financial reporting are consistent with KCS’s policies and procedures. This review will take significant time and effort, similar to KCS’s Sarbanes-Oxley compliance efforts in 2004, and will involve significant cost. We may identify control deficiencies during this process. Our ability to realize the value of the assets acquired will depend on the future cash flows of the Grupo TFM business. If these future cash flows are below what we anticipated, we may incur future impairment losses associated with such assets which could have a material adverse effect on our results of operations. Our inability to successfully identify and complete acquisitions or successfully integrate any new or previous acquisitions could have a material adverse effect on our business.

Item 4. Controls and Procedures

As of the end of the fiscal quarter for which this Quarterly Report on Form 10-Q is filed, the Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have 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.

KCS management considers the acquisition of Grupo TFM on April 1, 2005 to be material to the results of operations, financial position and cash flows from the date of acquisition through June 30, 2005 and considers the internal controls and procedures of Grupo TFM to have a material affect on the Company’s internal control over financial reporting. Management is currently executing post merger integration plans which include converting accounting information systems and ongoing internal control evaluation. KCS intends to extend its Sarbanes-Oxley Act Section 404 compliance program to include Grupo TFM with an effective date no later than December 31, 2006.

Except as set forth above, there have not been any changes in the Company’s internal control over financial reporting that occurred during the fiscal quarter for which this Quarterly Report on Form 10-Q is filed that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Part I, Item 1. “Financial Statements”, Note 7 to the Consolidated Financial Statements of this Form 10-Q is hereby incorporated herein by reference.

Item 4. Submission of Matters to a Vote of Security Holders

Information required by this Item regarding the Company’s annual Meeting of Stockholders on May 5, 2005 was included in the Company’s Form 10-Q for the quarter ended march 31, 2005.

Item 5. Other Information

As previously reported in a Current Report on Form 8-K filed with the SEC on June 14, 2005, the Company announced the successful completion on June 10, 2005 of the previously announced solicitation of consents by KCSR to amend the indentures under which KCSR’s outstanding 9 ¹ / 2 % Senior Notes due 2008 and outstanding 71/2% Senior Notes due 2009 were issued. KCSR received the requisite consents from a majority of the outstanding aggregate principal amount of each series of Notes and, KCSR, KCS, the other note guarantors, and the trustee under each of the indentures, respectively, signed supplemental indentures with respect to each such series of Notes to permit TFM, an indirect subsidiary of KCS, to effect a settlement of certain disputes among TFM, Grupo TFM, and the Mexican government. KCS does not know when or if a settlement of these disputes will be consummated.

Item 6. Exhibits

a) Exhibits

10.1 Second Supplemental Indenture, dated as of June 10, 2005, between KCS, KCSR, and certain subsidiaries of KCS and The Bank of New York, as Trustee, relating to KCSR’s 9 ¹ / 2 % Senior Notes due 2008

10.2 Supplemental Indenture, dated as of June 10, 2005, between KCS, KCSR, and certain subsidiaries of KCS and U.S. Bank National Association, as Trustee, relating to KCSR’s 7 ¹ / 2 % Senior Notes due 2009

10.3 Financing Agreement between The Texas-Mexican Railway Company and the Federal Railroad Administration, dated June 28, 2005.

10.4 Pledge Agreement between Mexrail, Inc. and the Federal Railroad Administration, and Guaranty of Mexrail, Inc. in favor of the Federal Railroad Administration.

10.5 Lease Agreement between KCSR and Louisiana Southern Railroad, Inc. regarding certain land and track regarding certain land and track on the Sibley Branch and on the Hope Subdivision. Portions of this document have been redacted pursuant to a Request for Confidential Treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

10.6 Lease Agreement between KCSR and Alabama Southern Railroad, Inc. Portions of this document have been redacted pursuant to a Request for Confidential Treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

10.7 Lease Agreement between KCSR and Arkansas Southern Railroad, Inc. regarding certain land and track on the Nashville Branch. Portions of this document have been redacted pursuant to a Request for Confidential Treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

10.8 Lease Agreement between KCSR and Arkansas Southern Railroad, Inc. regarding certain land and track on the Waldron Branch. Portions of this document have been redacted pursuant to a Request for Confidential Treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

10.9 Lease Agreement between KCSR and Louisiana Southern Railroad, Inc. regarding certain land and track on the Hodge Subdivision and the Joyce Branch. Portions of this document have been redacted pursuant to a Request for Confidential Treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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 August 15, 2005.


	Kansas City Southern
	/s/ Ronald G. Russ
	Ronald G. Russ
	Executive Vice President and Chief Financial Officer (Principal Financial Officer)



	/s/ James S. Brook
	James S. Brook
	Vice President and Comptroller (Principal Accounting Officer)

Exhibit 10.1

SECOND SUPPLEMENTAL INDENTURE

SECOND SUPPLEMENTAL INDENTURE (this “Second Supplemental Indenture”) dated as of June 10, 2005, between THE KANSAS CITY SOUTHERN RAILWAY COMPANY, a corporation duly organized and existing under the laws of the State of Missouri, and the successor by merger to each of Gateway Western Railway Company, KCS Transportation Company, Mid-South Microwave, Inc., and Rice-Carden Corporation (the “Company”), KANSAS CITY SOUTHERN (formerly known as Kansas City Southern Industries, Inc., (the “Parent”), and GATEWAY EASTERN RAILWAY COMPANY, PABTEX, L.P., SOUTHERN DEVELOPMENT COMPANY, SOUTHERN INDUSTRIAL SERVICES, INC., and TRANS-SERVE, INC. (together with the Parent, the “Note Guarantors”), and THE BANK OF NEW YORK, a New York banking corporation, as trustee under the indenture referred to below (the “Trustee”).

W I T N E S S E T H :

WHEREAS, the Company and the Note Guarantors have heretofore executed and delivered to the Trustee an Indenture (the “Indenture”) dated as of September 27, 2000 and supplemented by a Supplemental Indenture (the “First Supplemental Indenture”) dated as of January 29, 2001, providing for the issuance of an aggregate principal amount of up to $300,000,000 of 9 ¹ / 2 % Senior Notes due 2008 (the “Securities”); and

WHEREAS, Section 9.02 of the Indenture provides that, with the written consent of the Holders of a majority in aggregate principal amount of the outstanding Securities (the “Requisite Consents”), the Company, the Note Guarantors and the Trustee may amend the Indenture;

WHEREAS, the Company has completed a consent solicitation (the “Consent Solicitation”) whereby the Company has obtained the Requisite Consents to amend certain sections of the Indenture (the “Amendments”);

WHEREAS, in connection with the Consent Solicitation, Holders that delivered a valid consent on a timely basis (the “Consenting Holders”) are entitled to receive a cash fee (the “Cash Fee”) with respect to the Securities in respect of which they have validly consented if the conditions to the Consent Solicitation are met;

WHEREAS, the Company, the Note Guarantors, and the Trustee are entering into this Second Supplemental Indenture in order to set forth the Amendments; and

WHEREAS, this Second Supplemental Indenture has been duly authorized by all necessary corporate action on the part of the Company, the Note Guarantors and the Trustee.

NOW THEREFORE, in consideration of the foregoing and for other good and valuable consideration, the receipt of which is hereby acknowledged, the Company, the Note Guarantors and the Trustee mutually covenant and agree for the equal and ratable benefit of the Holders of the Securities as follows:

ARTICLE 1

AMENDMENT OF THE INDENTURE

Section 1.01. Amendment to Section 1.01 of the Indenture. The Company, the Note Guarantors and the Trustee hereby agree to amend Section 1.01, and Section 1.01 is hereby amended by

(a) adding the following definitions to Section 1.01 in the appropriate alphabetical order:

“Mexico” means the Estadaos Unidos Mexicanos (the United Mexican States) and any branch of power, ministry, department, authority or statutory corporation or other entity (including a trust), owned or controlled directly or indirectly by the Estados Unidos Mexicanos or any of the foregoing created by law as a public entity; and

“VAT Claim” means TFM’s claim for a refund, credit or other payment of amounts of value added tax previously paid by TFM to Mexico.

(b) deleting the word “and” at the end of sub-section (c)(v) of the definition of “Asset Disposition” in Section 1.01 and adding the following paragraph to the end of such definition of “Asset Disposition”:

; and

(vii) sales or other dispositions of the VAT Claim if and to the extent (y) there are no cash proceeds thereof or (z) such cash proceeds are used to finance (or set aside in a reserve to finance) the repurchase of the Capital Stock of TFM from Mexico and the satisfaction of obligations relating to the settlement thereof.

Section 1.03 Amendment to Section 4.04 of the Indenture. The Company, the Note Guarantors and the Trustee hereby agree to amend Section 4.04, and Section 4.04 is hereby amended by deleting the word “or” at the end of sub-section (b)(vi) and adding the following paragraph following sub-section (b)(vii) thereof:

; or

(viii) the repurchase by TFM of, or the declaration and payment of dividends by TFM to Grupo TFM to allow Grupo TFM to repurchase, the Capital Stock of TFM from Mexico:

(y) if, after giving effect to such repurchase and any Indebtedness Incurred to fund such repurchase, the Consolidated Coverage Ratio would be greater than 2.0:1; or

(z) to the extent that the consideration paid to Mexico to repurchase the Capital Stock of TFM consists of a surrender or reduction of the

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VAT Claim or any portion thereof, or if and to the extent cash has been realized in respect to the VAT Claim, the consideration paid pursuant to this Section 4.04(b)(viii)(z) does not exceed the amount of such cash, or any combination of such surrender or reduction or such cash realized.

ARTICLE 2

MISCELLANEOUS

2.01. Ratification of Indenture, Supplemental Indentures Part of Indenture. Except as expressly amended hereby, the Indenture and the First Supplemental Indenture are in all respects ratified and confirmed and all the terms, conditions and provisions thereof shall remain in full force and effect. Upon the execution and delivery of this Second Supplemental Indenture by the Company, the Note Guarantors and the Trustee, the Indenture shall be supplemented in accordance herewith, this Second Supplemental Indenture shall form a part of the Indenture for all purposes, and every Holder of Securities heretofore or hereafter authenticated and delivered shall be bound hereby.

Notwithstanding the foregoing, the Amendments set forth herein will have no effect, and this Second Supplemental Indenture shall be null and void, if the Cash Fee is not paid to the Consenting Holders in accordance with the terms and conditions of the Consent Solicitation.

2.02. Governing Law. THIS SECOND SUPPLEMENTAL INDENTURE SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK BUT WITHOUT GIVING EFFECT TO APPLICABLE PRINCIPLES OF CONFLICTS OF LAW TO THE EXTENT THAT THE APPLICATION OF THE LAWS OF ANOTHER JURISDICTION WOULD BE REQUIRED THEREBY.

2.03. Trustee Makes No Representation. The Trustee makes no representation as to the validity or sufficiency of this Second Supplemental Indenture. The recitals and statements herein are deemed to be those of the Company and the Note Guarantors and not of the Trustee.

2.04. Severability Clause. In case any provision of this Second Supplemental Indenture shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby.

2.04. Counterparts. The parties may sign any number of copies of this Second Supplemental Indenture. Each signed copy shall be an original, but all of them together represent the same agreement.

2.05. Definitions, Effect of Headings. All capitalized terms not otherwise defined herein shall have the meanings ascribed to them in the Indenture. The section headings herein are for convenience only and shall not effect the construction thereof.

IN WITNESS WHEREOF, the parties hereto have caused this Second Supplemental Indenture to be duly executed as of the date first above written.

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THE KANSAS CITY SOUTHERN RAILWAY COMPANY

/s/ Ronald G. Russ
Executive Vice-President and Chief Financial Officer

KANSAS CITY SOUTHERN

/s/ Ronald G. Russ
Executive Vice-President and Chief Financial Officer

GATEWAY EASTERN RAILWAY COMPANY

/s/ Paul J. Weyandt
Vice-President and Treasurer

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PABTEX, L.P.

By:

	Southern Industrial Services, Inc., its general partner

		/s/ Ronald G. Russ Vice-President and Treasurer

SOUTHERN DEVELOPMENT COMPANY

/s/ Ronald G. Russ
Vice-President and Treasurer

SOUTHERN INDUSTRIAL SERVICES, INC.

/s/ Ronald G. Russ
Vice-President and Treasurer

TRANS-SERVE, INC.

/s/ Ronald G. Russ
Vice-President and Treasurer

THE BANK OF NEW YORK

/s/ Stanislav Pertsev
Assistant Treasurer

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Exhibit 10.2

SUPPLEMENTAL INDENTURE

SUPPLEMENTAL INDENTURE (this “Supplemental Indenture”) dated as of June 10, 2005, between THE KANSAS CITY SOUTHERN RAILWAY COMPANY, a corporation duly organized and existing under the laws of the State of Missouri, and the successor by merger to each of Mid-South Microwave, Inc., and Rice-Carden Corporation (the “Company”), KANSAS CITY SOUTHERN (the “Parent”), and GATEWAY EASTERN RAILWAY COMPANY, PABTEX GP, LLC, PABTEX, L.P., SIS BULK HOLDING, INC., SOUTHERN DEVELOPMENT COMPANY, SOUTHERN INDUSTRIAL SERVICES, INC., and TRANS-SERVE, INC. (together with the Parent, the “Note Guarantors”), and U.S. BANK NATIONAL ASSOCIATION, a national banking corporation, as trustee under the indenture referred to below (the “Trustee”).

W I T N E S S E T H :

WHEREAS, the Company and the Note Guarantors have heretofore executed and delivered to the Trustee an Indenture (the “Indenture”) dated as of June 12, 2002, providing for the issuance of an unlimited principal amount of 7 ¹ / 2 % Senior Notes due 2009 (the “Securities”); and

WHEREAS, the Company, the Note Guarantors, and the Trustee are entering into this Supplemental Indenture in order to set forth the Amendments; and

WHEREAS, this Supplemental Indenture has been duly authorized by all necessary corporate action on the part of the Company, the Note Guarantors and the Trustee.

ARTICLE 1
AMENDMENT OF THE INDENTURE

Section 1.01. Amendment to Section 1.01 of the Indenture. The Company, the Note Guarantors and the Trustee hereby agree to amend Section 1.01, and Section 1.01 is hereby amended by

(a) adding the following definitions to Section 1.01 in the appropriate alphabetical order:

“VAT Claim” means TFM’s claim for a refund, credit or other payment of amounts of value added tax previously paid by TFM to Mexico.

(b) deleting the word “and” at the end of sub-section (c)(iii) of the definition of “Asset Disposition” in Section 1.01 and adding the following paragraph to the end of such definition of “Asset Disposition”:

; and

(v) sales or other dispositions of the VAT Claim if and to the extent (y) there are no cash proceeds thereof or (z) such cash proceeds are used to finance (or set aside in a reserve to finance) the repurchase of the Capital Stock of TFM from Mexico and the satisfaction of obligations relating to the settlement thereof.

Section 1.03. Amendment to Section 4.04 of the Indenture. The Company, the Note Guarantors and the Trustee hereby agree to amend Section 4.04, and Section 4.04 is hereby amended by deleting the word “or” at the end of sub-section (b)(vi) and adding the following paragraph following sub-section (b)(vii) thereof:

; or

(viii) the repurchase by TFM of, or the declaration and payment of dividend by TFM to Grupo TFM to allow Grupo TFM to repurchase, the Capital Stock of TFM from Mexico:

(y) if, after giving effect to such repurchase and any Indebtedness Incurred to fund such repurchase, the Consolidated Coverage Ratio would be greater than 2.0:1; or

(z) to the extent that the consideration paid to Mexico to repurchase the Capital Stock of TFM consists of a surrender or reduction of the VAT Claim or any portion thereof, or if and to the extent cash has been realized in respect to the VAT Claim, the consideration paid pursuant to this Section 4.04(b)(viii)(z) does not exceed the amount of such cash, or any combination of such surrender or reduction or such cash realized.

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ARTICLE 2
MISCELLANEOUS

2.01. Ratification of Indenture, Supplemental Indentures Part of Indenture. Except as expressly amended hereby, the Indenture is in all respects ratified and confirmed and all the terms, conditions and provisions thereof shall remain in full force and effect. Upon the execution and delivery of this Supplemental Indenture by the Company, the Note Guarantors and the Trustee, the Indenture shall be supplemented in accordance herewith, this Supplemental Indenture shall form a part of the Indenture for all purposes, and every Holder of Securities heretofore or hereafter authenticated and delivered shall be bound hereby.

Notwithstanding the foregoing, the Amendments set forth herein will have no effect, and this Supplemental Indenture shall be null and void, if the Cash Fee is not paid to the Consenting Holders in accordance with the terms and conditions of the Consent Solicitation.

2.02. Governing Law. THIS SUPPLEMENTAL INDENTURE SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK BUT WITHOUT GIVING EFFECT TO APPLICABLE PRINCIPLES OF CONFLICTS OF LAW TO THE EXTENT THAT THE APPLICATION OF THE LAWS OF ANOTHER JURISDICTION WOULD BE REQUIRED THEREBY.

2.03. Trustee Makes No Representation. The Trustee makes no representation as to the validity or sufficiency of this Supplemental Indenture. The recitals and statements herein are deemed to be those of the Company and the Note Guarantors and not of the Trustee.

2.04. Severability Claus. In case any provision of this Supplemental Indenture shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby.

2.04. Counterparts. The parties may sign any number of copies of this Supplemental Indenture. Each signed copy shall be an original, but all of them together represent the same agreement.

IN WITNESS WHEREOF, the parties hereto have caused this Supplemental Indenture to be duly executed as of the date first above written.

THE KANSAS CITY SOUTHERN
RAILWAY COMPANY

/s/ Ronald G. Russ

Executive Vice-President and Chief Financial Officer

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KANSAS CITY SOUTHERN

/s/ Ronald G. Russ
Executive Vice-President and Chief Financial Officer

-4-

GATEWAY EASTERN RAILWAY COMPANY

/s/ Paul J. Weyandt
Vice-President and Treasurer

PABTEX GP, LLC

By:

Southern Industrial Services, Inc., its sole member

s/s Ronald G. Russ
Vice-President and Treasurer

PABTEX, L.P.

By:

Southern Industrial Services, Inc., its general partner

/s/ Ronald G. Russ
Vice-President and Treasurer

SIS BULK HOLDING, INC.

/s/ Ronald G. Russ
Vice-President and Treasurer

SOUTHERN DEVELOPMENT COMPANY

/s/ Ronald G. Russ
Vice-President and Treasurer

SOUTHERN INDUSTRIAL SERVICES, INC.

/s/ Ronald G. Russ
Vice-President and Treasurer

TRANS-SERVE, INC.

/s/ Ronald G. Russ
Vice-President and Treasurer

U.S. BANK NATIONAL ASSOCIATION

/s/ Richard Prokosch
Vice President

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EXHIBIT 10.3

June 28, 2005

FINANCING AGREEMENT

BETWEEN

TEXAS MEXICAN RAILWAY COMPANY

AND

The UNITED STATES OF AMERICA, represented by the SECRETARY OF
TRANSPORTATION acting through ADMINISTRATOR of the
FEDERAL RAILROAD ADMINISTRATION

TABLE OF CONTENTS


		Page
ARTICLE I TERM			1
Section 1.1.	Definitions		1
Section 1.2.	Interpretation		3
Section 1.3.	Term		3

ARTICLE II ISSUANCE OF NOTES			4
Section 2.1.	Issuance of Notes		4
Section 2.2.	Disbursement Conditions		4
Section 2.3.	Outstanding Loan Balance		5
Section 2.4.	Repayment		5
Section 2.5.	Prepayment		5
Section 2.6.	Transfer and Related Representations		5
Section 2.7.	Obligations Surviving Transfer		6

ARTICLE III REPRESENTATIONS AND WARRANTIES OF BORROWER			6
Section 3.1.	Organization and Good Standing		6
Section 3.2.	Validity of Agreement		7
Section 3.3.	No Bankruptcy of Current Officers and Directors; No Felony Conviction or Securities Law Violation		7
Section 3.4.	No Changes Since Most Recent Balance Sheet		8
Section 3.5.	Distribution		8
Section 3.6.	Material Contracts, Judgments, Decrees, Obligations or Liabilities		8
Section 3.7.	Litigation		8
Section 3.8.	Defaults Under Existing Agreements		8
Section 3.9.	Completeness of Information		9
Section 3.10.	Tax Returns		9
Section 3.11.	Related Persons		9

ARTICLE IV AFFIRMATIVE COVENANTS OF BORROWER			9
Section 4.1.	Further Documentation		9
Section 4.2.	Use of Proceeds		10
Section 4.3.	Pay Taxes and Other Claims		10
Section 4.4.	Maintenance of Insurance		10
Section 4.5.	Rehabilitation, Operation and Maintenance of Rail Properties		11
Section 4.6.	Financial and Project Reports		11
Section 4.7.	Financial Test		11
Section 4.8.	Compliance with Applicable Laws		12
Section 4.9.	Legal Process		13
Section 4.10.	Information on Borrower’s Performance		13
Section 4.11.	Audit and Inspection Rights		13
Section 4.12.	Budgets		13
Section 4.13.	Minutes of Meeting		14

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		Page
Section 4.14.	Notification of Events		14
Section 4.15.	Employee Protection		14

ARTICLE V NEGATIVE COVENANTS OF BORROWER			15
Section 5.1.	Guarantees, Indebtedness		15
Section 5.2.	Purchase of Investment Securities, Lending or Advancing Funds		15
Section 5.3.	Purchase or Lease of Assets		15
Section 5.4.	Deployment of Assets		15
Section 5.5.	Prohibited Interest		15
Section 5.6.	Dividends		16
Section 5.7.	Merger, Acquisition, or Sale of Assets		16
Section 5.8.	Encumbrances		17
Section 5.9.	Discontinuance or Abandonment of Business		17
Section 5.10.	Abandonment of Rail Line		17

ARTICLE VI EVENTS OF DEFAULT AND REMEDIES			17
Section 6.1.	Events of Default		17
Section 6.2.	Remedies		18

ARTICLE VII MISCELLANEOUS PROVISIONS			19
Section 7.1.	Incorporation of Exhibits, Schedules and Documents		19
Section 7.2.	Entire Agreement		19
Section 7.3.	Parties Bound; Right to Assign		19
Section 7.4.	Table of Contents and Headings		20
Section 7.5.	Notices; Action to be Taken		20
Section 7.6.	Release of Information		20
Section 7.7.	No Waiver by Administrator or Holder		20
Section 7.8.	Governing Law		21
Section 7.9.	Indemnification		21
Section 7.10.	Representatives		21
Section 7.11.	Counterparts		21
Section 7.12.	Severability		21
Section 7.13.	Amendments and Waivers		21
Section 7.14.	No Third Party Rights		22
Section 7.15.	Remedies Not Exclusive		22

EXHIBITS

Exhibit A Application

Exhibit B Project Description

Exhibit C Sample Note

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FINANCING AGREEMENT

THIS AGREEMENT is made and entered into on this ___day of June, 2005, in Washington, D.C., by and between the UNITED STATES OF AMERICA, represented by the SECRETARY OF TRANSPORTATION acting through Administrator of the FEDERAL RAILROAD ADMINISTRATION (“Administrator” or “Lender”), and TEXAS MEXICAN RAILWAY COMPANY, a corporation organized and existing under the laws of Texas (“Borrower”).

RECITALS

WHEREAS, the Secretary is authorized, pursuant to the Act, to provide financial assistance for purposes consistent with the Act as may be approved by the Secretary and the Secretary has duly delegated the Secretary’s authority under the Act to Administrator;

WHEREAS, under the Act, Borrower has submitted the Application to Administrator requesting loans in the aggregate amount of Fifty Million Dollars ($50,000,000) for the Project, as described in Exhibit B hereto;

WHEREAS, Allowable Costs of the Project as detailed in Exhibit B are to be funded by Administrator through the purchase from Borrower of one or more Notes, a specimen copy of which is attached hereto as Exhibit C, each bearing interest at a rate of 4.29 percent per annum, with a maximum aggregate principal amount of Fifty Million Dollars ($50,000,000) due and payable in full twenty-five (25) years after the date of the first Note issued hereunder;

WHEREAS, Borrower has executed and delivered to Administrator a Deed of Trust, Security Agreement and Fixture Filing to secure the Indebtedness (as defined below);

WHEREAS, Mexrail, Inc., a Delaware corporation (“Mexrail”), the owner of all the capital stock of Borrower has executed and delivered to Administrator a limited Guaranty of the Indebtedness (the “Guaranty”) and a Pledge Agreement (the “Pledge Agreement”) securing such Guaranty; and

WHEREAS, Administrator is willing to execute this Agreement and provide loans pursuant to the Act in accordance with the terms and conditions hereof.

NOW, THEREFORE, in consideration of the premises and the mutual undertakings hereinafter set forth, the parties hereto agree as follows:

ARTICLE I

TERM

Section 1.1. Definitions .

(a) “Act” means Title V of the Railroad Revitalization and Regulatory Reform Act of 1976, as amended, 45 U.S.C. 821 et seq .

(b) “Affiliate” means with respect to any entity (i) any entity that directly or indirectly controls such entity, (ii) any entity which is controlled by or is under common control with such controlling entity, (iii) each of such entity’s officers or directors (or persons functioning in substantially similar roles) and the spouses, parents, descendants and siblings of such officers, directors or other persons. For purposes hereof, the term “entity” shall include natural persons.

(c) “Allowable Costs” means those costs associated with the Project, as defined in Exhibit B, which may be paid with funds made available under this Agreement.

(d) “Administrator” means Administrator of the Federal Railroad Administration or Administrator’s designee.

(e) “Application” means the application that Borrower submitted to Administrator to support Borrower’s loan request, including all exhibits and attachments and supplementary materials, which is attached hereto as Exhibit A.

(f) “Business” means the following business conducted by Borrower: railroad transportation freight;

(g) “Change in Control” means any person or group of persons (within the meaning of Section 13(d) of the Securities Exchange Act of 1934, as amended), obtaining ownership or control in one or more series of transactions of more than 50% of the outstanding shares of common stock of Borrower.

(h) “Deed of Trust” shall mean the Deed of Trust, Security Agreement and Fixture Filing entered into by Borrower in favor of Administrator, dated the date hereof, pursuant to which Borrower has, subject to the terms thereof, mortgaged the real properties and granted a security interest in the assets described therein as security for the Indebtedness.

(i) “Event of Default” shall have the meaning assigned in Section 6.1.

(j) “Fixed Charge Coverage Ratio” means the ratio of earnings before interest, cash taxes, depreciation, and capital leases to total current income taxes, total debt service including current principal and interest and operating lese payments.

(k) “Holder” means any entity to which Administrator transfers the Indebtedness or a subsequent transferee of the Indebtedness.

(l) “Indebtedness” means the obligations of Borrower as of the date hereof, or which may arise hereafter, to Administrator under this Agreement, the Note or the Notes, the Deed of Trust, and any other documents contemplated by or entered into in connection with the transaction described in this Agreement.

(m) “Loan Amortization Schedule” means each Loan Amortization Schedule attached as Appendix One to a Note delivered pursuant to Section 2.1, as adjusted from time to time in accordance with the provisions of Section 2.3.

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(n) “Maximum Aggregate Principal Amount” means the maximum total principal amount of the Notes, not to exceed Fifty Million Dollars ($50,000,000).

(o) “Mortgaged Property” means that property of Borrower pledged to Administrator under the Deed of Trust.

(p) “Note” or “Notes” mean a note or notes in the form of note attached hereto as Exhibit C, issued by Borrower pursuant to this Agreement to evidence each disbursement of the funds by Administrator to pay for Allowable Costs, which may be replaced by a Final Note for the full amount of such disbursements after all such disbursements have been made.

(q) “Officer” means the Chairman, the Chief Executive Officer, any Vice Chairman, the President, the Treasurer and the Secretary of Borrower.

(r) “Outstanding Loan Balance” means the aggregate principal amount drawn by the Borrower and then outstanding, as determined in accordance with Section 2.3.

(s) “Project” means the project as defined in Exhibit B.

(t) “Rail Line” means that segment of Borrower’s railroad which is part of the Project, as described in more detail in Exhibit B.

(u) “Secretary” means the Secretary of the Department of Transportation.

Section 1.2. Interpretation .

Unless the context shall otherwise require, the words “hereto”, “herein”, “hereof’ and other words of similar import refer to this Agreement as a whole. Words of the masculine gender shall be deemed and construed to include correlative words of the feminine and neuter genders and vice versa. Words importing the singular number shall include the plural number and vice versa unless the context shall otherwise require. Unless the context shall otherwise require, references to sections, subsections and provisions are to the applicable sections, subsections and provisions of this Agreement. The headings or titles of this Agreement and its sections, schedules or exhibits, as well as any table of contents, are for convenience of reference only and shall not define or limit its provisions. Unless the context shall otherwise require, all references to any resolution, contract, agreement or other document shall be deemed to include any amendments to, or modifications or restatements of, such documents that are approved in accordance with the terms thereof and hereof. Every request, order, demand, application, appointment, notice, statement, certificate, consent or similar communication or action hereunder by any party shall, unless otherwise specifically provided, be delivered in writing in accordance with Section 7.5 and signed by a duly authorized representative of such party.

Section 1.3. Term .

This Agreement shall terminate upon the satisfaction of all the Indebtedness in accordance with the provisions hereof and thereof.

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ARTICLE II

ISSUANCE OF NOTES

Section 2.1. Issuance of Notes .

(a) Borrower hereby agrees to issue and sell to Administrator and, subject to the provisions of the Act and this Agreement, Administrator agrees to purchase and receive from Borrower, Notes in the aggregate principal amount not exceeding the Maximum Aggregate Principal Amount, said amount constituting the maximum aggregate consideration. Each Note shall bear interest at a rate of 4.29 percent per annum, such interest and principal to be paid in equal quarterly payments on March 15, June 15, September 15 and December 15 of each year until the Note is paid in full. The first payment of a Note shall be due on the first such date after the issue date of such Note, and the last payment shall be due on the date twenty-five (25) years after the earliest issue date of any Note issued hereunder; provided that the initial payment of the Note shall be in an amount equal only to interest accrued on the Note since the issue date, and provided further that each payment thereafter shall be in an amount equal to principal payable on the date of such payment in accordance with the Loan Amortization Schedule for such Note plus interest accrued thereon and each such payment shall be applied first to pay the interest having accrued on the Note and then to principal. The Note may be prepaid in part or in full prior to the payment date without penalty.

(b) The total Allowable Costs to be funded by Administrator, for the performance of the Project shall be not more than the Maximum Aggregate Principal Amount.

(d) After the last Note is issued, at Administrator’s request, all the Notes issued hereunder will be replaced by a Final Note with a principal amount equal to the aggregate outstanding Loan Amount Balance of all the individual outstanding Notes. Such a final Note shall bear interest at a rate equal to the interest rate on each Note, such interest and principal to be paid in equal quarterly payments on March 15, June 15, September 15, and December 15 of each year until the final Note is paid in full. The first payment of the Final Note shall be due on the first such date after its issue, and the last payment shall be due on the date twenty-five (25) years after the earliest issue date of any Note.

Section 2.2. Disbursement Conditions .

Proceeds of the Notes shall be disbursed solely to pay directly for, or to reimburse Borrower for its prior payment of, Allowable Costs incurred in connection with the Project. Such disbursements shall be made pursuant to requisitions in the form set forth in Appendix One to Exhibit B submitted by Borrower to, and approved by, Lender, all in accordance with the procedures set forth in Exhibit B.

In no event shall disbursements be made more than once each month, nor shall at the time of any disbursement the sum of all prior disbursements proceeds and the disbursement then to be made exceed the cumulative disbursements through the end of the then-current year set forth in

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the Anticipated Secured Loan Disbursement Schedule contained in Exhibit B, as the same may be amended from time to time pursuant to Section 7.13.

Section 2.3. Outstanding Loan Balance .

The Outstanding Loan Balance of each loan shall be as set forth on the Loan Amortization Schedule originally delivered with the Note corresponding to and evidencing such loan. Such Outstanding Loan Balance will be recalculated as of each date on which principal with respect to such Note is prepaid by Borrower in accordance with Section 2.5

Any Lender’s recalculation of an Outstanding Loan Balance shall be deemed conclusive absent manifest error. Upon any recalculation of an Outstanding Loan Balance, Lender shall make applicable revisions to the related Loan Amortization Schedule and provide Borrower with a copy of such revised Loan Amortization Schedule. Revisions to a Loan Amortization Schedule as a result of partial prepayments of principal of the related Note shall be made by applying such prepayments in the inverse order of maturity, such that the latest principal installment or installments of the related Loan Amortization Schedule are thereby satisfied in whole or in part.

Section 2.4. Repayment .

Borrower shall repay the Outstanding Loan Balance plus all interest which shall have accrued as set forth in the related Loan Amortization Schedule; provided, however, that in the event that any portion of the principal amount of a Note is prepaid in accordance with Section 2.5, the Borrower shall thereafter make payments in accordance with the new Loan Amortization Schedule, as revised pursuant to Section 2.3 to reflect such reduced principal amount after the prepayments. Payments under this Agreement and a Note shall be made on or before each payment date specified in such Note, by wire transfer in immediately available funds in accordance with payment instructions to be provided by Lender.

Section 2.5. Prepayment .

Borrower may prepay any Note in whole or in part (and, if in part, the principal installments and amounts thereof to be prepaid shall be determined by Borrower except prepayments required by Section 4.4), at any time or from time to time, without penalty or premium, by paying to Lender such principal amount of the Note to be prepaid, together with the unpaid interest accrued on the amount of principal so prepaid to the date of such prepayment. Each prepayment shall be specified by Borrower in a written notice delivered to Lender not less than ten (10) days prior to the date set for prepayment.

All such partial prepayments of principal shall be applied to future installments due on such Note in the inverse order of maturity, such that the latest principal installment or installments of the pre-existing Loan Amortization Schedule are thereby satisfied in whole or in part.

Section 2.6. Transfer and Related Representations .

(a) The United States represents that it is acquiring the Notes not with a view to, or in connection with, any distribution thereof. The Notes have not been registered under the

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Securities Act of 1933, as amended, or any other State or Federal securities laws. All Holders of the Notes at any time acknowledge that they may be restricted in the resale, transfer or other disposition of such Notes by Federal or state statutes or rules and regulations thereunder. Borrower shall have no obligation to pay for any steps which might be necessary to accomplish a transfer of Notes under such laws. However, upon the request of any Holder, Borrower shall, within a reasonable amount of time, make available adequate current public information concerning Borrower, to enable any such Holder to sell a Note or the Notes in compliance with any such Federal or state statutes or rules and regulations thereunder, whether or not a Note or the Notes are in fact to be offered for sale.

(b) Before transferring any Note, each and every Holder of the Note shall give written notice to Borrower of such Holder’s intention to so transfer, describing briefly the manner of such proposed transfer.

Section 2.7. Obligations Surviving Transfer .

In the event that Administrator shall transfer the entire amount of, or any part of, one or more of the Notes to another Holder or Holders:

(a) The following shall remain obligations of Borrower to Administrator, and shall not be obligations to any other Holder or Holders, pursuant to this Agreement until the termination of this Agreement, unless sooner terminated by Administrator:

(1) Section 2.7; and

(2) Sections 4.5 and 4.10.

(b) The rights and remedies under this Section shall be solely those of Administrator. Nothing contained in this Section shall confer upon any Holder or Holders, other than Administrator, any rights or remedies under this Section or the right to enforce any of said rights or remedies under this Agreement.

ARTICLE III

REPRESENTATIONS AND WARRANTIES OF BORROWER

Borrower hereby makes the following representations and warranties to Administrator:

Section 3.1. Organization and Good Standing .

(a) Borrower is duly organized and in good standing under the laws of the State of Texas, has full legal right, power and authority to enter into this Agreement, to issue the Notes and to carry out and consummate all transactions contemplated by this Agreement and has duly authorized the execution, delivery and performance of this Agreement and the Notes.

(b) The officers of Borrower executing this Agreement and the Notes are duly and properly in office and fully authorized to execute the same on behalf of Borrower.

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(c) Borrower has full power and authority to own, lease, hold, and operate its property, and to conduct its business (as now operated and conducted or presently proposed to be operated and conducted) in conformity with all applicable Federal, state, and local laws, statutes, and regulations. No new or additional authorization from any governmental agency or body is required to permit Borrower to operate its business as now conducted or presently proposed to be conducted.

Section 3.2. Validity of Agreement .

Borrower represents that in connection with its execution, delivery and performance of this Agreement, the Deed of Trust, any other document executed by Borrower in connection with the transaction contemplated herein, and the issuance, sale and delivery of the Notes:

(a) have been duly authorized by all necessary corporate action and applicable governmental authority;

(b) do not conflict with, violate, or contravene any rights of shareholders or creditors of Borrower, any statute, law, rule, regulation, order, writ, injunction or decree or other order of any court or governmental authority, or any mortgage, lien, lease or agreement of Borrower, nor is Borrower subject to any provision of any constitution, statute, regulation, Borrower’s articles or certificate of incorporation and by-laws, mortgage, lien, lease, agreement, order, judgment or decree, or any other restriction of any kind or character, which would prevent Borrower from executing and performing the obligations of the Indebtedness;

(c) will constitute valid and legally binding obligations of Borrower enforceable against Borrower in accordance therewith, except as enforceability may be affected by any applicable laws affecting creditors’ rights generally and the application of equitable principles.

(d) no consent or approval of any trustee, holder of any indebtedness of Borrower or any other person, and no consent, permission, authorization, order or license of, or filing or registration with, any governmental entity is necessary in connection with the execution and delivery of this Agreement, the Notes or the Deed of Trust, the consummation of any transaction herein described, or the fulfillment of or compliance with the terms and conditions hereof, except as have been obtained or made and as are in full force and effect and except filing and/or recordation requirements imposed by this Agreement.

Section 3.3. No Bankruptcy of Current Officers and Directors; No Felony Conviction or Securities Law Violation .

For the period commencing ten (10) years prior to the date hereof and ending on the date hereof:

(a) no current Officer or director of Borrower has been involved (either in his personal capacity or, to the knowledge of the Officers and directors of Borrower, in the capacity of a corporate officer, director or stockholder owning in excess of ten (10) percent of issued and outstanding shares of any class of such corporation’s stock) in a bankruptcy or similar type proceeding; and

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(b) no current Officer or director of Borrower has been convicted of a felony or violation of securities laws.

Section 3.4. No Changes Since Most Recent Balance Sheet .

The Borrower has kept and maintains its records of account, and will issue its financial statements, in accordance with generally accepted accounting principals consistently applied. There has been no significant change in the capital structure or the condition (financial, business, labor or otherwise) of Borrower, taken as a whole, since the most recent financial statements delivered to Administrator prior to the date hereof.

Section 3.5. Distribution .

As of the date hereof, no distributions to Borrower’s stockholders, as dividends or as other payments of profit, surplus or reserves, or of capital, are presently due or payable, nor have any been declared and remain unpaid.

Section 3.6. Material Contracts , Judgments , Decrees , Obligations or Liabilities .

Borrower is not a party or subject to any existing or contingent contract, agreement, debt, mortgage, indenture, instrument, judgment, decree, obligation or other liability (other than transactions in the ordinary course of business which do not, individually or in the aggregate, materially adversely affect the condition or operations of Borrower) which has a material adverse effect on the financial condition of Borrower, including asset values, business, labor or otherwise or operations of Borrower.

Section 3.7. Litigation .

There is no litigation, legal or administrative proceeding, investigation or other action of any nature pending, or to the knowledge of Borrower threatened against or affecting Borrower, which involves the reasonable probability of a judgment or liability not fully covered by insurance or which would materially adversely affect the assets of Borrower or Borrower’s ability or right to carry on its business as now conducted or presently proposed to be conducted, and Borrower has not been cited, enjoined, or in any way restricted by any local, state, or Federal court or agency in the conduct of any material aspect of its business.

Section 3.8. Defaults Under Existing Agreements .

Borrower is not:

(a) in default under any written indenture, contract, mortgage, franchise, lease, agreement, permit, or any other instrument to which it is a party and which is, or may become, material to the Business as it is presently conducted;

(b) in violation of any applicable law;

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(d) in default under or cited for noncompliance with any order, license, or regulation of any Federal, state, municipal or other government agency, which defaults, citations, violations or noncompliance individually or in the aggregate would have consequences which materially adversely affect the assets of Borrower or its right to carry on its business which it now conducts or presently proposes to conduct.

Section 3.9. Completeness of Information .

To the best of the knowledge and belief of Borrower, the information set forth in the Application, and all subsequent submissions to Administrator, is true and complete in all material respects as of the date of this Agreement.

Section 3.10. Tax Returns .

All Federal, state, and other tax returns and reports of Borrower required by law or regulation to be filed have been duly filed except those for which the filing date has been duly extended; and other governmental charges (other than those presently payable without penalty) imposed upon Borrower with respect to any of their properties, assets or income which are due and payable have been duly paid, except those governmental charges for which payment is being contested in good faith by Borrower.

Section 3.11. Related Persons .

No stockholder (owning in excess of ten (10) percent of the issued and outstanding shares of any class of Borrower’s stock), director, or Officer of Borrower, nor, to the knowledge of any such individual, any relative thereof (i.e., parent, spouse or child) (a) is retained or employed, directly or indirectly in a material position for, or is a director or officer of any supplier, customer (other than by bill of lading or transportation contract), contractor or any other entity with which Borrower does business, or which is financially involved with Borrower in any manner, other than Affiliates of Borrower; or (b) is a stockholder owning in excess of ten (10) percent of the issued and outstanding shares of any supplier, customer (other than by bill of lading or transportation contract), contractor or any other entity with which Borrower does business, or which is financially involved with Borrower in any manner, other than Affiliates of Borrower.

ARTICLE IV

AFFIRMATIVE COVENANTS OF BORROWER

The Borrower hereby makes the following covenants to Administrator:

Section 4.1. Further Documentation.

Borrower shall execute and cause to be delivered to Administrator such other certificates, documents, statements, agreements, or opinions as may be reasonably requested by Administrator in furtherance of the transactions contemplated herein.

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Section 4.2. Use of Proceeds .

(a) Borrower shall use the proceeds from the purchase of the Notes by Administrator solely to fund Allowable Costs in accordance with the terms of this Agreement and Exhibit B hereof.

(b) Borrower shall complete the Project and perform each of the other obligations pertaining to the Indebtedness. Administrator shall be obligated to reimburse Borrower in the performance of the Project only for Allowable Costs and not for costs that are not Allowable Costs or for costs that are Allowable Costs but incurred in excess of the Maximum Aggregate Principal Amount.

Section 4.3. Pay Taxes and Other Claims .

Borrower shall file all Federal, state, and other tax returns and reports of Borrower required by law or regulation to be filed and pay and discharge or cause to be paid and discharged all taxes, assessments, fees and other governmental charges lawfully levied or imposed upon its property before the date on which penalties attach thereto. Borrower shall pay, when due all lawful claims for labor, materials, supplies, and rents, and pay all other debts and liabilities, any of which, if unpaid, would by law be a lien or charge upon its Mortgaged Properties; provided , that , nothing herein shall require any payment referred to in this Section 4.3 so long as (a) such nonpayment is in good faith and by appropriate proceedings being diligently contested, (b) a reserve as shall be required by generally accepted accounting principles shall have been made therefore; and (c) failure to pay when due would not result in the forfeiture or loss of property of Borrower having a material adverse effect on Borrower.

Section 4.4. Maintenance of Insurance .

(a) Borrower shall insure, or cause to be insured, its assets against claims for losses from fire, casualty, liability and property damage consistent with normal industry practice, or as part of an integrated system with its rail Affiliates. Borrower will promptly notify Administrator of any material change in its insurance coverage that departs from normal industry standards. In the event Borrower sustains a loss to all or any part of the Mortgaged Property and Borrower determines that it will not repair, rebuild or replace such damaged property, then any insurance proceeds received for such damage shall be paid to Administrator and applied as a prepayment to the Notes in accordance with Section 2.5.

(b) Borrower shall not use the proceeds received from any third party including an insurance carrier (except for service interruption insurance) in partial or full satisfaction of any claim for damage or loss to the Mortgaged Property for any purpose other than the restoration or like replacement of the damaged or lost property which resulted in such claim or the satisfaction of other claims against Borrower arising from such claim or loss unless Borrower determines that such restoration, replacement or satisfaction is not in its best interest and such proceeds are paid to Administrator in accordance with Section 4.4(a), nor will it hereafter enter into any agreement which would provide for the disbursement of such insurance proceeds in a manner contrary to the provisions of this Section, without the prior written consent of Administrator.

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Section 4.5. Rehabilitation, Operation and Maintenance of Rail Properties .

(a) Borrower shall complete the Project in accordance with Exhibit B hereto.

(b) During the term of this Agreement, Borrower shall:

(i) operate common or contract carrier rail services over the Rail Line; and

(ii) maintain the Rail Line in accordance with the maintenance standards described in Exhibit B, except during periods of force majeure as defined therein.

Section 4.6. Financial and Project Reports .

Borrower shall at its own cost and expense continue to keep full, complete and current books and records of its business and financial affairs in accordance with generally accepted accounting principals consistently applied and:

(a) deliver to Administrator as soon as practicable but in any event within one hundred and twenty (120) days after the end of each fiscal year:

(i) a profit and loss statement, balance sheet, and statement of cash flows of Borrower as of the end of such calendar year, audited and certified (whether or not unqualified, except that it shall not be qualified as to scope) by Borrower’s independent certified public accounting firm, detailing the results of operations and financial condition;

(ii) all Federal regulatory year-end financial statements filed by Borrower with any other Federal agency;

(b) during the course of the Project, deliver to Administrator within twenty (20) days after the end of each month and within thirty (30) days after completion of the Project, a progress report of work completed and actual expenditures compared to the budgets contained in Exhibit B, in a form as prescribed by Administrator; and

(c) deliver to Administrator within forty-five (45) days after the end of each quarter (other than the fourth quarter), financial statements, including balance sheet, income statement and statement of cash flows of Borrower.

Section 4.7. Financial Test.

Commencing with the first anniversary of the completion of the Project until the Indebtedness is paid, Borrower shall maintain a Fixed Charge Coverage Ratio of not less than 1.05 at the end of each fiscal quarter. The Fixed Charge Coverage Ratio shall be calculated each quarter and submitted to Administrator along with the quarterly financial statements required under Section 4.6 hereof.

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Section 4.8. Compliance with Applicable Laws .

Borrower shall own and hold the Mortgaged Properties and conduct its business in conformity in all material respects with all Federal, state, and local laws, statutes, ordinances, regulations and orders of governmental authorities and all requirements of such foreign jurisdictions as may be applicable and will promptly comply with any such laws, statutes, ordinances, regulations and orders.

The following list of Federal laws is illustrative of the type of requirements generally applicable to transportation projects. It is not intended to be exhaustive.

(a) The Americans With Disabilities Act of 1990 and implementing regulations (42 U.S.C. 12101 et seq.; 28 C.F.R. Part 35; 29 C.F.R. Part 1630).

(b) Title VI of the Civil Rights, Act of 1964, as amended (42 U.S.C. 2000d et seq.; 42 U.S.C. 5332) and United States Department of Transportation regulations, 49 C.F.R. Parts 21 and 23.

(c) Section 504 of the Rehabilitation Act of 1973 (29 U.S.C. 794) and United States Department of Transportation regulations, 49 C.F.R. Part 27.

(d) The Uniform Relocation Assistance and Real Property Acquisition Policies Act of 1970, as amended (42 U.S.C. 4601 et seq.), with the understanding that the requirements of said Act are not applicable with respect to utility relocations except with respect to acquisitions by Borrower of easements or other real property rights for the relocated facilities.

(e) Equal Employment Opportunity requirements under Executive Order 11246 dated September 24, 1965 (30 F.R. 12319), any Executive Order amending such order, and implementing regulations (41 C.F.R. Part 60).

(f) Restrictions governing the use of Federal appropriated funds for lobbying (31 U.S.C. 1352; 49 C.F.R. Part 20).

(g) The Clean Air Act, as amended (42 U.S.C. 1857 et seq., as amended by Pub.L. 91-604).

(h) The National Environmental Policy Act of 1969 (42 U.S.C. 4321 et seq.).

(i) The Federal Water Pollution Control Act, as amended (33 U.S.C. 1251 et seq., as amended by Pub.L. 92-500).

(j) The applicable requirements of 49 C.F.R. Part 26 relating to the Disadvantaged Business Enterprise program.

(k) The environmental mitigation requirements and commitments made by Borrower that result in Lender’s approval of the Final Environmental Impact Statement (issued pursuant to 42 U.S.C. 4332(2)(C)), Environmental Assessment, or Categorical Exclusion Determination.

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(l) The Buy America requirements set forth in Section 165 of the Surface Transportation Assistance Act of 1982 and implementing regulations (23 C.F.R. 635.410).

(m) The Endangered Species Act (16 U.S.C. 1531, et seq.)

Section 4.9. Legal Process .

Borrower shall promptly give written notice to Administrator of all legal proceedings materially and adversely relating to Borrower’s ability to perform the obligations in respect of the Indebtedness.

Section 4.10. Information on Borrower’s Performance .

On request of Administrator, Borrower shall furnish promptly to Administrator such information as may be reasonably necessary to determine whether (a) Borrower is fulfilling its warranties, covenants and agreements contained in this Agreement, or (b) an Event of Default has occurred under this Agreement.

Section 4.11. Audit and Inspection Rights .

(a) Borrower shall give representatives of Administrator and the Comptroller General of the United States free access at reasonable times during normal business hours and upon reasonable advance notice to examine and inspect all books, accounts, records, reports, files, inventories, and other papers and things and equipment, facilities and property relating to this Agreement (but, in respect of inspections of equipment, facilities and property, at their sole risk and expense and subject to reasonable security precautions). Such access shall be granted to the extent deemed necessary (as reasonably determined by such representatives) to facilitate any audit to determine compliance by Borrower with this Agreement, or to inspect any equipment or facilities relating to Borrower’s obligations under this Agreement.

(b) Borrower agrees to cooperate with such representatives in connection with any audits and/or inspections pursuant to Section 4.11(a).

(c) Such representatives shall have the right to discuss with the Officers of Borrower the business and affairs of Borrower, and Borrower shall use its best efforts to obtain for such representatives the right with respect to its contractors and subcontractors to discuss their business and affairs relating in any way to the Agreement and the Act.

Section 4.12. Budgets .

During the term of the Project, not more than sixty (60) days after the beginning of each fiscal year, Borrower shall prepare and submit to its Board of Directors, and obtain approval of the Board with respect thereto, capital and operating expense budgets (reporting separately maintenance of way, maintenance of equipment, transportation, and other expenses), annual profit and loss projections, a projected cash flow statement and a projected year-end balance sheet, all itemized in reasonable detail, for the calendar year. A copy of such documents, as approved by the Board, and any change in such documents as is required to be approved by the Board or its designee shall be provided to Administrator within thirty (30) days after such Board

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or designee approval and shall include, if available, a narrative statement reconciling the information furnished thereunder with Borrower’s obligations in respect of the Indebtedness.

Section 4.13. Minutes of Meeting .

Borrower shall provide Administrator copies of minutes, or portions thereof, of the meetings of its Board of Directors, or portions thereof, as they relate in any way to the Indebtedness, solely upon Administrator’s request therefore.

Section 4.14. Notification of Events .

(a) Borrower shall, within five (5) business days after Borrower learns of its occurrence, give Administrator notice of any Event of Default.

(b) Borrower shall, within 5 business days after Borrower learns of its occurrence, give Administrator notice of any of the following events, setting forth details of such event:

(1) Events of Default — any event which, given notice or the passage of time or both, would constitute an Event of Default by Borrower;

(2) Litigation — the filing of any actual litigation, suit or action, or the delivery to Borrower of any written claim, which could reasonably be expected to have a material adverse effect upon the Project or its revenues and expenses, or upon Borrower or its performance hereunder or under the Notes; and

(3) Other Adverse Events — the occurrence of any other event or condition which could reasonably be expected to have a material and adverse effect upon the Project or its revenues or expenses or upon Borrower or its performance hereunder or under the Notes.

(c) Within 30 days after an event specified in subsection (a) above, Borrower shall provide a statement setting forth the actions Borrower proposes to take with respect thereto.

Section 4.15. Employee Protection

Borrower shall make fair and equitable arrangements, in accordance with 45 U.S.C. 836, to protect the interests of any employees not otherwise protected under Title V of the Regional Rail Reorganization Act of 1973 (45 U.S.C. 771 et seq.) who may be adversely affected by actions taken pursuant to, or as a consequence of, this Agreement.

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ARTICLE V

NEGATIVE COVENANTS OF BORROWER

As long as this Agreement remains in effect, Borrower shall not take any of the following actions without the prior written consent of Administrator:

Section 5.1. Guarantees, Indebtedness.

Borrower shall not incur, create, assume, guarantee or in any manner become liable for any indebtedness for borrowed money (not including accounts payable and interline payables) except (a) any indebtedness incurred simultaneously to and for the purpose of the repayment in full of the Indebtedness; (b) indebtedness in the ordinary course of its operations, which do not exceed $150,000,000, outstanding at any one time; or (c) indebtedness incurred in connection with the purchase of assets permitted under Section 5.3 of this Agreement.

Section 5.2. Purchase of Investment Securities, Lending or Advancing Funds .

Borrower shall not purchase investment securities other than (a) investment grade debt issuances of municipal, Federal or state agencies, (b) certificates of deposit of $1,000,000 or less in FDIC or FSLIC-insured financial institutions with less than $50 million in capitalization, (c) certificates of deposit or money market instruments with financial institutions with at least $50 million in capitalization, and (d) overnight investments of excess cash in checking accounts in financial institutions of more than $50 million in capitalization. In addition, Borrower shall not lend or advance any funds generated in the operation of the Business, to any person, corporation, firm or other entity, except in the ordinary course of business.

Section 5.3. Purchase or Lease of Assets .

Borrower shall not use any funds generated in the operation of the Business to purchase or lease any item of chattel asset, real estate or capital asset unless such asset will be used in the operation of the Business as presently conducted and is in the ordinary course of business which shall include, without limitation, the construction and/or reconstruction of tracks and other track-related material on Borrower’s right of way..

Section 5.4. Deployment of Assets .

Borrower shall not at any time appropriate, use or retain assets generated in the operation of the Business, for any purpose not directly related to the Business.

Section 5.5. Prohibited Interest .

Except as between Borrower and its Affiliates:

(a) Borrower shall not, after the date of this Agreement, enter into any contract, subcontract, or arrangement in excess of $50,000 (other than for personal employment) in connection with the financing of, or the carrying out of, work to be performed under this Agreement in which any director or Officer of Borrower during his or her subsequent tenure or

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more recently than two years before the date of such contract (if his or her tenure is continuing) shall have or shall have had any personal interest, direct or indirect, in the other party to such contract, subcontract or arrangement unless such contract is entered into on a publicly advertised, sealed-bid basis, the recipient is the lowest qualified bidder on such basis, such Officer or director recuses himself or herself from further dealings with respect to such contract, subcontract or arrangement, and written records of the entire transactions are sufficient to satisfy Administrator upon inspection, except that Borrower may enter into transactions with any of its Affiliates; provided such transactions are undertaken at competitive rates.

(b) Borrower shall not knowingly allow any contractor or subcontractor of Borrower to enter into any contract, subcontract, or other arrangement in excess of $50,000 (other than for personal employment) related to the Project if any of its Officers, directors, or any members of the immediate family or one of the foregoing has any material interest in the contract, subcontract or arrangement, unless the other party (or parties) to such contract, subcontract or arrangement is the lowest qualified bidder on a publicly advertised, sealed-bid basis and written records of the entire transaction are sufficient to satisfy Administrator upon inspection.

(c) Borrower shall not allow any member of or delegate to Congress to share any benefit that may arise from this Agreement; but this provision shall not restrict the making of any contract with a publicly held entity for the general benefit of such entity.

(d) Borrower shall not pay any full-time employee of the Federal government any consulting fees, salaries, or travel expenses (unless on leave without pay) from any Federal funds provided under this Agreement except where specifically authorized by statute.

Section 5.6. Dividends .

Borrower will not make any distributions to its stockholders as dividends or as other payments of profit, surplus or reserves, or of capital; provided, however, (i) that Borrower shall be permitted to make such distributions in an amount no greater than 50% of cumulative net income from the date hereof provided that such distributions do not exceed 50% of Borrower’s available cash, and (ii) nothing in this Section 5.6 shall prohibit Borrower from making such distributions with respect to full proceeds received by Borrower from issuance of Borrower’s capital stock or capital contributions. Borrower will not make any payment on loans made to it, or for its benefit, by its stockholders, parent or any other company controlled by its parent prior to the date of this Agreement.

Section 5.7. Merger, Acquisition, or Sale of Assets .

Borrower will not consolidate, merge with, transfer, permit or take any action to facilitate the transfer of substantially all of its assets (except for intra company transactions (mergers, consolidations or transfers in which the survivor is Borrower or an Affiliate of Borrower’s parent) among Borrower and Affiliates in which the survivor or transferee assumes the Indebtedness and transactions pursuant to, and under the terms of, a consent of Administrator), or control of itself or use any funds generated in the operation of the Business to purchase any assets or stock of any corporation, firm, association or enterprise or otherwise invest in any

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assets not related to Business, or sell, lease or otherwise transfer any of its assets except in the ordinary course of its business. Borrower shall not approve, permit or consent to the sale or transfer of its stock if such sale or transfer would result in a Change in Control of Borrower.

Section 5.8. Encumbrances .

Borrower shall not place, create, incur, assume or permit to exist any mortgage, pledge, lien or encumbrance on the Mortgaged Properties superior to the lien created by the Deed of Trust; provided that (a) Borrower may create, grant or permit purchase money security interests in connection with its purchases of equipment, and (b) as long as no enforcement, collection, levy or foreclosure proceeding shall have been commenced, liens imposed by law such as materialmen’s, mechanics, carriers’, workmen’s and repairmen’s liens and other similar liens arising in the ordinary course of business securing obligations that are not overdue for a period of more than 30 days shall be permitted.

Section 5.9. Discontinuance or Abandonment of Business .

Borrower shall not, except when a transaction permitted by Sections 5.7 or 7.3 of this Agreement gives rise to a discontinuance or abandonment by Borrower or during periods of force majeure, discontinue or abandon its entire business or any substantial part of its business which would adversely affect its ability to perform its obligations under the Indebtedness.

Section 5.10. Abandonment of Rail Line .

Borrower shall not abandon or file an application with the Surface Transportation Board for the abandonment of the Rail Line, except with the prior written consent of Administrator.

ARTICLE VI

EVENTS OF DEFAULT AND REMEDIES

Section 6.1. Events of Default .

The following shall be Events of Default:

(a) A failure to pay any interest or principal of the Note(s) after the same becomes due and payable; provided, however, that if once during a twelve (12) month period Borrower makes such payment within five (5) days after the same becomes due and payable, no Event of Default with respect to such payment shall have occurred.

(b) Borrower’s breach in the due observance or performance of any covenant or condition contained in Section 5.7, 5.9, 5.10.

(c) Borrower’s breach in the due observance or performance of any other covenant or condition contained in this Agreement to be kept or performed by Borrower if such breach shall continue uncured by Borrower for a period of thirty (30) days following Borrower’s receipt of notice thereof or knowledge by an officer of Borrower or an event of default pursuant the Deed of Trust, provided that if such breach or event of default does not have a material

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adverse effect on the Business or Borrower’s assets and if Borrower shall have commenced and is diligently pursuing a cure of any such breach or event of default, Borrower shall have up to an additional period not in excess of one hundred eighty (180) days to complete such cure.

(d) Any representation or warranty made by Borrower herein proving to be untrue or incomplete in any material respect as of the date hereof, or any statement, certificate or information furnished by or on behalf of Borrower hereunder proving to be untrue or incomplete in any material respect, as of the date on which the matters therein set forth were stated or certified.

(e) Borrower’s: (i) making a general assignment for the benefit of creditors, or (ii) applying for or consenting to the appointment of a receiver, trustee or liquidator of all or a substantial part of its assets, or (iii) being adjudicated a bankrupt or insolvent, or (iv) filing a voluntary petition in bankruptcy or filing a petition or answer seeking reorganization or an arrangement with creditors who are seeking to take advantage of any other law (whether Federal or state) relating to relief of debtors, or admitting by answer (by default or otherwise) the material allegations of a petition filed against it in any bankruptcy, reorganization, arrangement, insolvency or other proceeding (whether Federal or state) relating to relief of debtors, or (v) suffering or permitting to continue unstayed and in effect for sixty (60) days or more any judgment, decree or order, entered by a court of competent jurisdiction, which approved a petition seeking reorganization of Borrower or appoints a receiver, trustee or liquidator of all or a substantial part of its assets.

(f) The occurrence of any default or event of default under any term, condition or covenant of any bond, note, debenture, guaranty, trust agreement, mortgage or similar instrument to which Borrower is a party or by which Borrower is bound (a “Debt Instrument”) if the outstanding indebtedness or obligations of Borrower under such Debt Instrument (i) exceeds $1,000,000 in aggregate principal amount and (ii) such indebtedness or obligations is declared to be due and payable by reason of such default or event of default prior to the date on which such indebtedness or obligations would otherwise become due and payable.

(g) Failure by Mexrail to perform or observe any covenant or agreement under the Guaranty, or a misrepresentation by Mexrail under the Guaranty.

Section 6.2. Remedies .

(a) Upon the occurrence of an Event of Default specified in Section 6.1(a), (c), (d), (f) or (g) hereof, Administrator may send a written demand to Borrower which may, in addition to invoking any other remedy available to Administrator: (1) require an immediate payment to Administrator by Borrower, of any amount specified by Administrator not to exceed in the aggregate that would be paid if Borrower immediately repaid the Indebtedness in full; and/or (2) suspend or terminate any further borrowing of funds hereunder.

(b) Upon the occurrence of an Event of Default specified in Section 6.1(b) or (e) hereof, Borrower shall immediately pay to Administrator the Indebtedness in full, and further borrowing of funds by Borrower hereunder shall immediately be terminated;

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(c) Upon the occurrence of any Event of Default specified in Section 6.1 hereof, if Borrower shall fail to make such payment as is required pursuant to subsection 6.2(a) or (b) hereof, Administrator may exercise all rights and remedies of Administrator, whether specified herein or provided for or inherent in law or equity, which shall not be exclusive and shall be cumulative, including enforcement through an order for specific performance of each of Borrower’s obligations underlying any Event of Default, and Borrower agrees not to contest the applicability of specific performance as a remedy, notwithstanding that an action at law for damages may be available.

(d) Borrower shall be liable for all Lender’s legally assessed or reasonably incurred expenses of its counsel and court costs in connection with any proceeding brought to enforce payment or performance under the Indebtedness and Borrower shall promptly pay such charge upon the request of Administrator.

(e) Administrator shall be entitled to any remedy specified in Exhibit B, which remedy will not in any manner limit the remedies otherwise available to Administrator hereunder.

ARTICLE VII

MISCELLANEOUS PROVISIONS

Section 7.1. Incorporation of Exhibits, Schedules and Documents .

All references herein to this Agreement shall be deemed also to refer to the exhibits and schedules attached hereto and be a part hereof as if the provisions thereof had been set forth in their entirety herein.

Section 7.2. Entire Agreement .

This Agreement embodies the entire agreement and understanding between Borrower and Administrator and supersedes all prior agreements and understandings relative to the subject matter hereof.

Section 7.3. Parties Bound; Right to Assign .

All the terms and conditions of this Agreement shall be binding upon, inure to the benefit of, and be enforceable by and against, each of the parties hereto and their legal representatives and assigns (including subsequent Holders) to the extent of their respective interests and obligations hereunder; provided, however, that this Agreement may not be transferred or assigned by Borrower without the prior written consent of Administrator which, in the case of a consolidation, merger or transfer of assets permitted pursuant to Section 5.7 hereof, such assignment will be pursuant to, and under the terms of, such consent of Administrator.

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Section 7.4. Table of Contents and Headings .

The table of contents and headings of the articles and sections of this Agreement are inserted for convenience only and shall not be deemed to constitute a part hereof or in any manner limit or define the terms of this Agreement.

Section 7.5. Notices; Action to be Taken .

Any notice required or submitted hereunder shall be deemed given if delivered in person or mailed by registered or certified mail, return receipt requested and postage prepaid, to the following addresses of the parties hereto or at such addresses as either Borrower or Administrator shall from time to time designate by written notice:


		Borrower:		Texas Mexican Railway Company
				427 West 12 ^th Street
				Kansas City, MO 64105
				Attn: Senior Vice President and General Counsel

		Administrator:		Federal Railroad Administration
				400 Seventh Street, S.W.
				Washington, D.C. 20590
				Attn: Associate Administrator for Railroad Development

				with a copy to the Chief Counsel
				at the same address as above

All notices mailed shall be deemed given on the date received at the office of the party to whom notice is to be given as evidenced by a personal delivery receipt or the registered or certified mail return receipt.

Section 7.6. Release of Information .

Administrator shall not disclose any Confidential Information (as defined below) to any person without the consent of the Borrower, other than (a) to Administrator’s officers, directors, employees, agents and advisors and to actual or prospective assignees and then only on a confidential basis, (b) as required by any law (including the Freedom of Information Act (FOIA) (5 U.S.C. 552)), rule or regulation or judicial process, and (c) as requested or required by any state, Federal or foreign authority or examiner regulating Administrator. “Confidential Information” means any information that Borrower furnishes to Administrator, but does not include any such information that is or becomes generally available to the public. For purposes of the FOIA, confidential shall have the meaning applied through FOIA exception 4 (5 U.S.C. 552(b)(4)).

Section 7.7. No Waiver by Administrator or Holder .

No course of dealing on the part of Administrator, nor any failure or delay by Administrator with respect to exercising any right, power, or privilege under the Indebtedness shall operate as a waiver thereof, or of any other right, power or privilege, nor shall

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Administrator’s failure to exercise any rights granted in the Indebtedness in the event of breach or default by Borrower, or Administrator’s exercise of any single or partial exercise of any such right, power or privilege hereunder, operate as a waiver thereof, or of any other right, power or privilege.

Section 7.8. Governing Law .

This Agreement has been executed and delivered in the District of Columbia and shall be construed in accordance with and governed by Federal law where applicable and otherwise by the laws of the District of Columbia.

Section 7.9. Indemnification .

(a) Borrower shall promptly upon demand indemnify and hold the United States harmless from and against any claim, demand, cause of action, damage, liability, cost or expense (including reasonable attorneys’ fees and court costs) incurred by the United States and arising out of, or in any way resulting from this Agreement, the Project, or the Indebtedness, including, but not limited to, the use, operation or condition of any equipment or facilities to which the proceeds of financial assistance have been applied hereunder (except if the claim, demand, cause of action, damage, liability, cost or expense is asserted against the United States in its governmental capacity or results from the willful act or negligence of the United States).

(b) The provisions of this section shall survive the issuance, execution, delivery and termination of the other provisions of the Indebtedness.

Section 7.10. Representatives .

References to Administrator or the Comptroller General of the United States include their subordinates, employees, agents and servants. Administrator and the Officers and directors of Borrower act hereunder in their official and not personal capacities.

Section 7.11. Counterparts .

This Agreement and any amendments, waivers, consents or supplements hereto or in connection herewith, may be executed in any number of counterparts. All such counterparts shall be deemed to be originals and shall constitute but one and the same instrument.

Section 7.12. Severability .

If any provision of this Agreement shall be invalid, illegal, or unenforceable, the validity, legality, or enforceability of the remaining provisions shall not be affected or impaired in any way thereby. A provision held to be unenforceable as applied to any party or circumstance remains applicable to other parties and circumstances.

Section 7.13. Amendments and Waivers .

No amendment, modification, termination or waiver of any provision of this Agreement shall in any event be effective without the written consent of the parties hereto.

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Section 7.14. No Third Party Rights .

The parties hereby agree that this Agreement creates no third party rights against the United States or Administrator, solely by virtue of the Indebtedness and that no third party creditor or creditors of the Borrower shall have any right against Administrator with respect to the Indebtedness made pursuant to this Agreement.

Section 7.15. Remedies Not Exclusive .

No remedy conferred herein or reserved to Lender is intended to be exclusive of any other available remedy or remedies, but each and every such remedy shall be cumulative and shall be in addition to every other remedy given hereunder or now or hereafter existing at law or in equity or by statute.

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IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first entered above.


ATTEST:		FEDERAL RAILROAD ADMINISTRATOR

UNREADABLE
		By:
		Name: JOSEPH H. BOARDMAN
		Title: Administrator of the Federal Railroad Administration

ATTEST:		TEXAS MEXICAN RAILWAY COMPANY

JAMES D. STANDEN
		By: /s/ Ronald G. Russ
		Name: Ronald G. Russ
		Title: Vice President and
		Chief Financial Officer
Date: June 30, 2005

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EXHIBIT B


LOAN AMOUNT:		$50,000,000

PURPOSE OF LOAN:		The loan proceeds will be expended to upgrade Borrower’s main line track and to refinance a bridge loan incurred in connection with the first portion of that work; to build two new sidings, to extend an existing siding and to rehabilitate Borrower’s yards.

PROJECT DESCRIPTION

1.		Debt Refinancing: Refinancing of bridge loan from The Kansas City Southern Railway Company to Borrower for payment of expenses incurred for emergency portions of the main line rehabilitation work evidenced by receipts provided to the Federal Railroad Administration on March 16, 2004.

2.		Tie Replacement & Surfacing: Purchase and installation of approximately 75,000 new ties and surfacing distributed over 145 miles of main line. The tie replacement includes 73,580 9-ft ties and 1,420 10-ft ties. The surfacing includes 87,600 tons of ballast.

3.		Rail Replacement: Purchase and installation of approximately 46 track miles of 115, 133, and 136 lb. rail, complete with tie plates, anchors, welds, and spikes.


Rail Upgrade			Rail	Rail
	Track Miles		Unit Cost	Total Cost
SH 115# Rail		7.1	$530.50/TN	$	764,003
New 136# Rail		15.7	$758/TN	$	2,844,498
New 133# Rail		15.5	$760/TN	$	2,757,450
SH Relay 115# or >		7.7	$630/TN	$	1,109,331

ALLOWABLE COSTS SUMMARY

SEE ATTACHED COST ESTIMATE – EXHIBIT “X”

CHANGE PROCEDURES

A projected cost variance of 10% or more after bids will require Borrower to notify Lender within 30 days.

WORK SCHEDULED COMPLETION DATES DATE OF FUNDING

SEE ATTACHED CASH FLOW SPREADSHEET – EXHIBIT “Y”

The anticipated funding date will follow the cash flow schedule by 30 days.

CHANGE PROCEDURES

A schedule work variance of 60 days or more will require the Borrower notify Lender in a timely fashion.

BUDGET OF EXPENDITURES THROUGH COMPLETION


1.	Debt Refinancing			$	10,000,000
2.	Tie Replacement & Surfacing
	Tie Replacement Labor	$	1,237,501
	Surfacing	$	672,188
	Ballast	$	2,233,800
	Material (not including ballast)	$	2,604,935
	sub-total			$	6,748,424
3.	Rail Replacement
	Rail Relay Labor	$	4,935,479
	Welds	$	2,472,087
	Material	$	13,334,240
	sub-total			$	20,741,806
4.	Road Crossing Rehab.			$	659,800
5.	Corpus Christi Yard			$	911,302
6.	Laredo Yard			$	1,741,324
7.	Siding Construction
	New Agua Dulce Siding	$	955,290
	New Benevidas Siding	$	1,345,775
	Killiam Siding Extension	$	461,193
	Sub-total			$	2,762,259
8.	Mobilization			$	460,000
9.	Contractor Fee			$	5,580,000
10.	Track Material Salvage			($	2,760,300	)
11.	Bridges			$	1,400,000
12.	Road Crossing Elimination			$	200,000
13.	Flagging			$	643,500
14.	Work Train			$	66,000
15.	Brandt Truck			$	629,000
16.	Track Equipment			$	509,000
17.	KCS Labor/Supervision			$	100,000
	Contingency (5%)			$	2,019,606
	Design & Construction Services			$	2,000,000
	TOTAL			$	54,411,718

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MAINTENANCE STANDARDS AFTER PROJECT COMPLETION

1.		Debt Refinancing – see below

2.		Tie & Surfacing — will replace ties as needed and continue year round track maintenance to ensure that the track remains at the level to which it was rehabilitated.

3.		Rail Replacement — will replace rail as needed and continue year round track maintenance to ensure that the track remains at the level to which it was rehabilitated.

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EXHIBIT 10.4

MEXRAIL, INC.
as Pledgor

AND

THE UNITED STATES OF AMERICA,
REPRESENTED BY
THE SECRETARY OF TRANSPORTATION
ACTING THROUGH
THE ADMINISTRATOR OF THE FEDERAL RAILROAD ADMINISTRATION
as Secured Party

PLEDGE AGREEMENT

Dated as of June 28, 2005

TABLE OF CONTENTS


		Page
Section 1.	DEFINITIONS		1
1.01.	Definition of Terms Used Herein Generally		1
1.02.	Definition of Certain Terms Used Herein		1
1.03.	Rules of Interpretation		2

Section 2.	PLEDGE		2
2.01.	Grant of Security Interest		2
2.02.	Description of Pledged Collateral		2
2.03.	Authorization to File Financing Statements		2

Section 3.	REPRESENTATIONS AND WARRANTIES OF PLEDGOR		3
3.01.	Pledgor’s Legal Status		3
3.02.	Pledgor’s Legal Name		3
3.03.	Pledgor’s Locations		3
3.04.	Authority; Binding Obligation; No Conflict		3
3.05.	Title to Collateral		3
3.06.	Required Consents		3
3.07.	Nature of Security Interest		4

Section 4.	COVENANTS OF PLEDGOR		4
4.01.	Pledgor’s Legal Status		4
4.02.	Pledgor’s Name		4
4.03.	Pledgor’s Organizational Number		4
4.04.	Locations		4
4.05.	Title to Collateral		4
4.06.	Taxes		4
4.07.	Further Assurances		5

Section 5.	CERTAIN PAYMENTS and RIGHTS PRIOR TO EVENT OF DEFAULT		5
5.01.	Payments Prior to an Event of Default		5
5.02.	Rights and Payments after an Event of Default		5

Section 6.	ALL PAYMENTS IN TRUST		5

Section 7.	EXPENSES		5

Section 8.	REMEDIES		6
8.01.	Disposition Upon Default and Related Provisions		6
8.02.	Secured Party Appointed Attorney-In-Fact		6
8.03.	Secured Party’s Duties of Reasonable Care		7


		Page
8.04.	Indemnification		8
8.05.	Prior Recourse		8
8.06.	Secured Party May Perform		8
Section 9.	SURETYSHIP WAIVERS BY PLEDGOR; OBLIGATIONS ABSOLUTE		8

Section 10.	MARSHALLING		9

Section 11.	PROCEEDS OF DISPOSITIONS		9

Section 12.	REINSTATEMENT		10

Section 13.	MISCELLANEOUS		10
13.01.	Notices		10
13.02.	Governing Law; Consent to Jurisdiction		10
13.03.	WAIVER OF JURY TRIAL, ETC		10
13.04.	Counterparts		10
13.05.	Headings		10
13.06.	Severability		10
13.07.	Survival of Agreement		11
13.08.	Binding Effect; Several Agreement		11
13.09.	Waivers; Amendment		11

PLEDGE AGREEMENT (this “ Pledge Agreement ”), dated June ___, 2005, between MEXRAIL, INC. , a Delaware corporation (“ Pledgor ”), and the UNITED STATES OF AMERICA, represented by the SECRETARY OF TRANSPORTATION acting through the ADMINISTRATOR OF THE FEDERAL RAILROAD ADMINISTRATION (“ Secured Party ”).

WHEREAS, TEXAS MEXICAN RAILWAY COMPANY, a wholly-owned subsidiary of Pledgor ( “Borrower ”) has entered into a Financing Agreement dated of even date herewith (as amended, supplemented, restated or otherwise modified and in effect from time to time, the “ Financing Agreement ”), with Secured Party, pursuant to which, among other things, Secured Party has agreed to make loans to Borrower upon the terms and subject to the conditions specified in the Financing Agreement;

WHEREAS, Pledgor has entered into a Guaranty and dated of even date herewith (as amended, supplemented, restated or otherwise modified and in effect from time to time, the “ Guaranty ”), in favor of Secured Party, pursuant to which, among other things, Pledgor has guaranteed all obligations of Borrower pursuant to the Financing Agreement; and

WHEREAS, in order to secure all Secured Obligations (as defined below), Pledgor has agreed to execute and deliver to Secured Party a pledge agreement in substantially the form hereof,

NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:

Section 1. DEFINITIONS.

1.01. Definition of Terms Used Herein Generally . All capitalized terms used but not defined herein shall have the meanings set forth in the Financing Agreement. All terms used herein and defined in the DELUCC shall have the same definitions herein as specified therein; provided, however, that if a term is defined in Article 9 of the DELUCC differently than in another Article of the DELUCC, the term has the meaning specified in Article 9 of the DELUCC.

1.02. Definition of Certain Terms Used Herein . As used herein, the following terms shall have the following meanings:

“ Bridge Net Revenues ” shall have the meaning ascribed to such term in Section 2.02.

“ DELUCC ” shall mean the Uniform Commercial Code as in effect in the State of Delaware from time to time.

“ Indemnified Party ” shall have the meaning assigned to such term in Section 8 . 04.

“ Lien ” shall mean any security interest, mortgage, lien, encumbrance or adverse claim, and any financing statement or similar document filed in respect of same.

“ Pledged Collateral ” shall have the meaning assigned to such term in Section 2.01.

“ Secured Obligations ” shall mean the Guaranteed Obligations as such terms is defined in the Guaranty.

“ Security Interests ” shall mean the security interest granted pursuant to Section 2.01, as well as all other security interests created or assigned as additional security for the Secured Obligations pursuant to the provisions of this Pledge Agreement.

“ UCC ” means the Uniform Commercial Code as in effect in Delaware.

1.03. Rules of Interpretation . The rules of interpretation specified in subsections 8(ii) and 8(iii) of the Guaranty shall be applicable to this Pledge Agreement. References to “sections”, “Exhibits” and “Schedules” shall be to Sections, Exhibits and Schedules, respectively, of this Pledge Agreement unless otherwise specifically provided. Any of the terms defined in this Section I may, unless the context otherwise requires, be used in the singular or the plural depending on the reference. All references to statutes and related regulations shall include (unless otherwise specifically provided herein) any amendments of same and any successor statutes and regulations.

Section 2. PLEDGE.

2.01. Grant of Security Interest . To secure the payment or performance, as the case may be, in full of the Secured Obligations, whether at stated maturity, by acceleration or otherwise, Pledgor hereby pledges to Secured Party, and grants to Secured Party a first priority Security Interest in, the collateral described in Section 2.02 (collectively, the “ Pledged Collateral ”).

2.02. Description of Pledged Collateral . The Pledged Collateral is all right, title and interest of Pledgor (whether now or in the future) in the Bridge Net Revenues. For purposes hereof, “ Bridge Net Revenues ” shall mean gross revenues earned from time to time by per-car fees charged by Pledgor to Union Pacific Railroad Company and Borrower for each car crossing the International Rail Bridge located in Laredo, Texas, less the operating costs of Borrower in providing haulage for equipment and maintenance of such Bridge.

2.03. Authorization to File Financing Statements . Pledgor hereby irrevocably authorizes Secured Party at any time and from time to time to file in Delaware and any jurisdiction in which the Uniform Commercial Code has been adopted and are applicable to the pledge hereunder any initial financing statements and amendments thereto that (a) describe the Pledged Collateral, and (b) contain any other information required by part 5 of Article 9 of the UCC for the sufficiency or filing office acceptance of any initial financing statement or amendment, including (i) whether Pledgor is an organization, the type of organization and any organization identification number issued to Pledgor. Pledgor agrees to furnish any such information to Secured Party promptly upon request. Pledgor also ratifies its authorization for Secured Party to have filed in any Uniform Commercial Code jurisdiction any like initial financing statements or amendments thereto if filed prior to the date hereof.

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Section 3. REPRESENTATIONS AND WARRANTIES OF PLEDGOR.

Pledgor hereby represents and warrants to Secured Party that:

3.01. Pledgor’s Legal Status . Pledgor is a corporation organized under the laws of Delaware.

3.02. Pledgor’s Legal Name . Pledgor’s exact legal name is that set forth in the initial paragraph hereof and on the signature page hereof.

3.03. Pledgor’s Locations . Pledgor’s place of business or (if it has more than one place of business) its chief executive office is at Laredo, Texas.

3.04. Authority; Binding Obligation; No Conflict . Pledgor has full power and authority to execute, deliver and perform its obligations in accordance with the terms of this Pledge Agreement and to grant to Secured Party the Security Interest in the Pledged Collateral pursuant hereto, without the consent or approval of any other person or entity other than any consent or approval which has been obtained and is in full force and effect. This Pledge Agreement has been duly authorized, executed and delivered by Pledgor and is the legally valid and binding obligation of Pledgor, enforceable against Pledgor in accordance with its terms, except as enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium, or similar laws or equitable principles relating to or limiting creditor’s rights generally. The granting to Secured Party of the Security Interest in the Pledged Collateral hereunder, the execution by Pledgor of this Pledge Agreement and the performance by Pledgor of its obligations hereunder do not and will not (a) result in the existence or imposition of any lien nor obligate Pledgor to create any lien (other than such Security Interest) in favor of any person or entity over all or any of its assets; (b) conflict with any agreement, mortgage, bond or other instrument to which Pledgor is a party or which is binding upon Pledgor or any of its assets; (c) conflict with Pledgor’s certificate of incorporation, by-laws, or other organizational or charter documents; or (d) conflict with any law, regulation or judicial order binding on Pledgor or any of the Pledged Collateral.

3.05. Title to Collateral . The Pledged Collateral is owned by the Pledgor free and clear of any lien. The Pledgor has not filed or consented to the filing of (a) any financing statement or analogous document under the UCC or any other applicable laws covering any Pledged Collateral, (b) any assignment in which the Pledgor assigns any Pledged Collateral or any security agreement or similar instrument covering any Pledged Collateral with any foreign governmental, municipal or other office, which financing statement or analogous document, assignment, security agreement or similar instrument is still in effect.

3.06. Required Consents . No consent of any person (including, without limitation, partners, shareholders or creditors of Pledgor or of any subsidiary of Pledgor) and no license, permit, approval or authorization of, exemption by, notice or report to, or registration, filing or declaration with, any governmental instrumentality is required in connection with (i) the execution, delivery, performance, validity or enforceability of this Pledge Agreement, (ii) the

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perfection or maintenance of the Security Interest created hereby (including the first priority nature of such Security Interest), or (iii) the exercise by Secured Party of the rights provided for in this Pledge Agreement.

3.07. Nature of Security Interest . Upon the filing of appropriate UCC Financing Statements, the pledge of the Pledged Collateral pursuant to this Pledge Agreement creates a valid and perfected first priority Security Interest in the Pledged Collateral, securing the prompt and complete payment, performance and observance of the Secured Obligations.

Section 4. COVENANTS OF PLEDGOR.

The Pledgor covenants and agrees with the Secured Party, in each case of the Pledgor’s own cost and expense, as follows.

4.01. Pledgor’s Legal Status . Pledgor shall not change its type of organization, jurisdiction of organization or other legal structure, except as permitted under the Financing Agreement.

4.02. Pledgor’s Name . Without providing at least 30 days prior written notice to Secured Party, Pledgor shall not change its name.

4.03. Pledgor’s Organizational Number . Without providing at least 30 days prior written notice to Secured Party, Pledgor shall not change its organizational identification number if it has one. If Pledgor does not have an organizational identification number and later obtains one, Pledgor shall forthwith notify Secured Party of such organizational identification number.

4.04. Locations . Without providing at least 30 days prior written notice to Secured Party, Pledgor shall not change its place of business or (if it has more than one place of business) its chief executive office or its mailing address.

4.05. Title to Collateral . (a) Except for the Security Interest herein granted, Pledgor shall be the owner of the Pledged Collateral free from any Lien, and Pledgor, at its sole cost and expense, shall defend the same against all claims and demands of all persons at any time claiming the same or any interests therein adverse to Secured Party; and (b) Pledgor shall not sell or otherwise dispose of, or pledge, mortgage or create, or suffer to exist a lien on, the Pledged Collateral in favor of any person other than Secured Party and the inclusion of “proceeds” of the Pledged Collateral under the Security Interest granted herein shall not be deemed a consent by Secured Party to any sale or other disposition of any Pledged Collateral.

4.06. Taxes . Pledgor shall pay promptly when due all taxes, assessments, governmental charges and levies upon the Pledged Collateral or incurred in connection with the Pledged Collateral or incurred in connection with this Pledge Agreement; provided, however, that Pledgor shall have the right to contest such taxes, assessments, governmental charges and levies that it reasonably believes to be incurred in error.

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4.07. Further Assurances . Pledgor will, from time to time, at its expense, promptly execute and deliver all further instruments and documents and take all further action that may be necessary, or that Secured Party may reasonably request, in order to perfect and protect any Security Interest granted or purported to be granted hereby or to enable Secured Party to exercise and enforce its rights and remedies hereunder with respect to any Pledged Collateral.

Section 5. CERTAIN PAYMENTS and RIGHTS PRIOR TO EVENT OF DEFAULT.

5.01. Payments Prior to an Event of Default . So long as no Event of Default shall have occurred and be continuing, Pledgor shall be entitled:

(a) to exercise, as it shall think fit, but in a manner not inconsistent with the terms hereof, all rights of control, ownership and otherwise with respect to the Pledged Collateral of Pledgor; and

(b) to receive and retain for its own account any and all payments, proceeds, monies, compensation, property, assets, instruments or rights paid, from time to time, in respect of the Pledged Collateral.

5.02. Rights and Payments after an Event of Default . Upon the occurrence and during the continuance of any Event of Default, all rights of Pledgor to exercise or refrain from exercising the rights that it would otherwise be entitled to exercise pursuant to Section 5.01(a) hereof and to receive the payments, proceeds, monies, compensation, property, assets, instruments or rights that Pledgor would otherwise be authorized to receive and retain pursuant to Section 5.01(b) hereof shall cease, and thereupon Secured Party shall be entitled to exercise all powers with respect to the Pledged Collateral and to receive and retain, as additional collateral hereunder, any and all payments, proceeds, monies, compensation, property, assets, instruments or rights at any time paid upon any of the Pledged Collateral during such an Event of Default.

Section 6. ALL PAYMENTS IN TRUST.

Upon the provisions of Section 5.02 becoming effective upon the occurrence and during the continuance of an Event of Default, all payments, proceeds, monies, compensation, property, assets, instruments or rights that are received by Pledgor contrary to the provisions of Section 5 hereof shall be received and held in trust by Pledgor for the benefit of Secured Party, shall be segregated by Pledgor from other funds of Pledgor and shall be forthwith paid over to Secured Party as Pledged Collateral in the same form as so received (with any necessary endorsement).

Section 7. EXPENSES.

Pledgor shall pay all reasonable expenses incurred by Secured Party in connection with any amendment, waiver, enforcement or collection of this Pledge Agreement or the exercise of remedies hereunder, including, without limitation, reasonable attorneys’ fees and expenses and advertising costs. If Pledgor fails promptly to pay any portion of the above expenses when due

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or to perform any other obligation of Pledgor under this Pledge Agreement, Secured Party may, at its option, but shall not be required to, pay or perform the same and charge Pledgor for all costs and expenses incurred therefor, and Pledgor agrees to reimburse Secured Party therefor on demand. All sums so paid or incurred by Secured Party for any of the foregoing, any and all other sums for which Pledgor may become liable hereunder and all such costs and expenses incurred by Secured Party in enforcing or protecting the Security Interests or any of its rights or remedies under this Pledge Agreement shall be payable by Pledgor on demand, shall constitute Secured Obligations, shall bear interest until paid at a rate per annum agreed to the rate requested under the Financing Agreement.

Section 8.REMEDIES.

8.01. Disposition Upon Default and Related Provisions .

(a) Upon the occurrence and during the continuance of any Event of Default, Secured Party may exercise in respect of the Pledged Collateral, in addition to other rights and remedies provided for herein or otherwise available to it, all rights and remedies of a secured party on default under the DELUCC at that time (whether or not applicable to the affected Pledged Collateral) and may also, without obligation to resort to other security, at any time and from time to time sell, resell assign and deliver in its sole discretion, all or any of the Pledged Collateral, at the same or different times, and all right, title and interest, claim and demand therein and right of redemption thereof, on any securities exchange on which any Pledged Collateral may be listed, or at public or private sale, for cash, upon credit or for future delivery, and in connection therewith Secured Party may grant options.

(b) The remedies provided herein in favor of Secured Party shall not be deemed exclusive, but shall be cumulative, and shall be in addition to all other remedies in favor of Secured Party existing at law or in equity.

8.02. Secured Party Appointed Attorney-In-Fact .

(a) To effectuate the terms and provisions hereof, Pledgor hereby appoints Secured Party as Pledgor’s attorney-in-fact for the purpose, from and after the occurrence and during the continuance of an Event of Default, of carrying out the provisions of this Pledge Agreement and taking any action and executing any instrument that Secured Party from time to time in Secured Party’s reasonable discretion may deem necessary or advisable to accomplish the purposes of this Pledge Agreement. Without limiting the generality of the foregoing, Secured Party shall, from and after the occurrence and during the continuance of an Event of Default, have the right and power to:

(i) receive, endorse and collect all checks and other orders for the payment of money made payable to Pledgor representing any interest or dividend or other distribution or amount payable in respect of the Pledged Collateral or any part thereof and to give full discharge for the same;

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(ii) execute endorsements, assignments or other instruments of conveyance or transfer with respect to all or any of the Pledged Collateral;

(iii) exercise all rights of Pledgor as owner of the Pledged Collateral including, without limitation, the right to sign any and all amendments, instruments, certificates, proxies, and other writings necessary or advisable to exercise all rights and privileges of (or on behalf of) the owner of the Pledged Collateral;

(iv) ask, demand, collect, sue for, recover, compound, receive and give acquaintance and receipts for moneys due and to become due under or in respect of any of the Pledged Collateral;

(v) file any claims or take any action or institute any proceedings that Secured Party may deem necessary or desirable for the collection of any of the Pledged Collateral or otherwise to enforce the rights of Secured Party with respect to any of the Pledged Collateral; and

(vi) generally to sell, transfer, pledge, make any agreement with respect to or otherwise deal with any of the Pledged Collateral as fully and completely as though Secured Party were the absolute owner thereof for all purposes, and to do, at Secured Party’s option and Pledgor’s expense, at any time or from time to time, all acts and things that Secured Party deems reasonably necessary to protect, preserve or realize upon the Pledged Collateral.

(b) Pledgor hereby ratifies and approves all acts of Secured Party made or taken pursuant to this Section 8.02 ( provided that Pledgor does not, by virtue of such ratification, release any claim that Pledgor may otherwise have against Secured Party for any such acts made or taken by Secured Party through gross negligence or willful misconduct). Neither Secured Party nor any person designated by Secured Party shall be liable for any acts or omissions or for any error of judgment or mistake of fact or law, except such as may result from Secured Party’s gross negligence or willful misconduct. This power, being coupled with an interest, is irrevocable so long as this Pledge Agreement shall remain in force.

8.03. Secured Party’s Duties of Reasonable Care .

(a) Secured Party shall have the duty to exercise reasonable care in the custody and preservation of any Pledged Collateral in its possession, which duty shall be fully satisfied if such Pledged Collateral is accorded treatment substantially equal to that which Secured Party accords its own property and, with respect to any calls, conversions, exchanges, redemptions, offers, tenders or similar matters relating to any such Pledged Collateral (herein called “ events ”).

(i) Secured Party endeavors to take such action with respect to any of the events as Pledgor may reasonably and specifically request in writing in sufficient time for such action to be evaluated and taken or, if Secured Party reasonably believes that the action requested would adversely affect the value of the Pledged Collateral as collateral or the collection of the Secured Obligations, or would otherwise prejudice the interests of Secured

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Party, Secured Party gives reasonable notice to Pledgor that any such requested action will not be taken and, if Secured Party makes such determination or if Pledgor fails to make such timely request, Secured Party takes such other action as it deems advisable in the circumstances.

(ii) Except as hereinabove specifically set forth, Secured Party shall have no further obligation to ascertain the occurrence of, or to notify Pledgor with respect to, any events and shall not be deemed to assume any such further obligation as a result of the establishment by Secured Party of any internal procedures with respect to any Pledged Collateral in its possession, nor shall Secured Party be deemed to assume any other responsibility for, or obligation or duty with respect to, any Pledged Collateral or its use of any nature or kind, or any matter or proceedings arising out of or relating thereto, including, without limitation, any obligation or duty to take any action to collect, preserve or protect its or Pledgor’s rights in the Pledged Collateral or against any prior parties thereto, but the same shall be at Pledgor’s sole risk and responsibility at all times.

(iii) Pledgor waives any restriction or obligation imposed on Secured Party under Sections 9-207(c)(1) and 9-207(c)(2) of the DELUCC.

8.04. Indemnification . Pledgor hereby releases Secured Party, and the respective officers, shareholders, directors, employees and agents of each thereof (each, an “ Indemnified Party ”) from any claims, causes of action and demands at any time arising out of or with respect to this Pledge Agreement, the Secured Obligations, the Pledged Collateral and its use and/or any actions taken or omitted to be taken by such Indemnified Party with respect thereto (except such claims, causes of action and demands arising from the bad faith, gross negligence or willful misconduct of such Indemnified Party) and Pledgor hereby agrees to hold each Indemnified Party harmless from and with respect to any and all such claims, causes of action and demands (except such claims, causes of action and demands arising from the gross negligence or willful misconduct of such Indemnified Party).

8.05. Prior Recourse . Secured Party’s prior recourse to any Pledged Collateral shall not constitute a condition of any demand, suit or proceeding for payment or collection of the Secured Obligations.

8.06. Secured Party May Perform . If Pledgor fails to perform any agreement contained herein, Secured Party may itself perform or cause performance of such agreement, and the expenses of Secured Party incurred in connection therewith shall be treated as provided in Section 7 hereof.

Section 9. SURETYSHIP WAIVERS BY PLEDGOR; OBLIGATIONS ABSOLUTE.

(a) The Pledgor waives demand, notice, protest, notice of acceptance of this Pledge Agreement, notice of loans made, credit extended, collateral received or delivered or other action taken in reliance hereon and all other demands and notices of any description, thereof, all in such manner and at such time or times as the Secured Party may deem advisable

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the Secured Party shall have no duty as to the collection or protection of the Pledged Collateral or any income thereon, nor as to the preservation of rights against prior parties, nor as to the preservation of any rights pertaining thereto beyond the safe custody thereof as set forth in Section 8.03.

(b) All rights of the Secured Party hereunder, the Security Interests and all obligations of the Pledgor hereunder shall be absolute and unconditional irrespective of (a) any lack of validity or enforceability of the Guaranty , the Financing Agreement any agreement with respect to any of the Secured Obligations or any other agreement or instrument relating to any of the foregoing, (b) any change in the time, manner or place of payment of, or in any other term of, all or any of the Secured Obligations, or any other amendment or waiver of or any consent to any departure from the Guaranty, the Financing Agreement or any other agreement or instrument, (c) any exchange, release or non-perfection of any lien on other collateral, or any release or amendment or waiver of or consent under or departure from or any acceptance of partial payment thereon and or settlement, compromise or adjustment of any Secured Obligation or of any guarantee, securing or guaranteeing all or any of the Secured Obligations, or (d) any other circumstance that might otherwise constitute a defense available to, or a discharge of, the Pledgor in respect of the Secured Obligations or this Pledge Agreement.

Section 10. MARSHALLING.

Secured Party shall not be required to marshal any present or future collateral security (including but not limited to this Pledge Agreement and the Pledged Collateral) for, or other assurances of payment of, the Secured Obligations or any of them or to resort to such collateral security or other assurances of payment in any particular order, and all of its rights hereunder and in respect of such collateral security and other assurances of payment shall be cumulative and in addition to all other rights, however existing or arising. To the extent that it lawfully may, Pledgor hereby agrees that it shall not invoke any law relating to the marshalling of collateral which might cause delay in or impede the enforcement of Secured Party’s rights under this Pledge Agreement or under any other instrument creating or evidencing any of the Secured Obligations or under which any of the Secured Obligations is outstanding or by which any of the Secured Obligations is secured or payment thereof is otherwise assured, and, to the extent that it lawfully may, Pledgor hereby irrevocably waives the benefits of all such laws.

Section 11. PROCEEDS OF DISPOSITIONS.

After deducting all expenses payable to Secured Party, including, without limitation, pursuant to Section 7, the residue of any proceeds of collection or sale of the Secured Obligations or Pledged Collateral shall, to the extent actually received in cash, be applied to the payment of the remaining Secured Obligations in such order or preference as is provided in the Guaranty, proper allowance and provision being made for any Secured Obligations not then due or held as additional collateral. Upon the final payment and satisfaction in full of all of the Secured Obligations and the termination of all commitments under the Guaranty and after making any payments required by Sections 9-608(a)(1)(C) or 9-615(a)(3) of the DELUCC, any

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excess shall be returned to Pledgor, and in any event Pledgor shall remain liable for any deficiency in the payment of the Secured Obligations.

Section 12. REINSTATEMENT.

The obligations of Pledgor pursuant to this Pledge Agreement shall continue to be effective or automatically be reinstated, as the case may be, if at any time payment of any of the Secured Obligations is rescinded or otherwise must be restored or returned by Secured Party upon the insolvency, bankruptcy, dissolution, liquidation or reorganization of Pledgor or any other obligor or otherwise, all as though such payment had not been made.

Section 13. MISCELLANEOUS.

13.01. Notices . Except as otherwise provided herein, whenever it is provided herein that any notice, demand, request, consent, approval, declaration or other communication shall or may be given to or served upon any of the parties by any other party, or whenever any of the parties desires to give and serve upon any other party any communication with respect to this Pledge Agreement, each such notice, demand, request, consent, approval, declaration or other communication shall be in writing and shall be given in the manner and to the address, and deemed received, as provided for in the Financing Agreement.

13.02. Governing Law; Consent to Jurisdiction . THIS PLEDGE AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE DISTRICT OF COLUMBIA.

13.03. WAIVER OF JURY TRIAL, ETC . PLEDGOR WAIVES ITS RIGHT TO A JURY TRIAL WITH RESPECT TO ANY ACTION OR CLAIM ARISING OUT OF ANY LITIGATION OR DISPUTE DIRECTLY OR INDIRECTLY ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS PLEDGE AGREEMENT, ANY RIGHTS OR OBLIGATIONS HEREUNDER OR THE PERFORMANCE OF ANY SUCH RIGHTS OR OBLIGATIONS. EXCEPT AS PROHIBITED BY LAW, PLEDGOR WAIVES ANY RIGHT WHICH IT MAY HAVE TO CLAIM OR RECOVER IN ANY LITIGATION OR DISPUTE REFERRED TO IN THE PRECEDING SENTENCE ANY SPECIAL, EXEMPLARY, PUNITIVE OR CONSEQUENTIAL DAMAGES OR ANY DAMAGES OTHER THAN, OR IN ADDITION TO, ACTUAL DAMAGES.

13.04. Counterparts . This Pledge Agreement may be executed in two or more separate counterparts, each of which shall constitute an original and all of which shall collectively and separately constitute one and the same agreement.

13.05. Headings . The headings of each section of this Pledge Agreement are for convenience only and shall not define or limit the provisions thereof.

13.06. Severability . In the event any one or more of the provisions contained in this Pledge Agreement should be held invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not in any

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way be affected or impaired thereby (it being understood that the invalidity of a particular provision in a particular jurisdiction shall not in and of itself affect the validity of such provision in any other jurisdiction).

13.07. Survival of Agreement . All covenants, agreements, representations and warranties made by the Pledgor herein and in the certificates or other instruments prepared or delivered in connection with or pursuant to this Pledge Agreement shall be considered to have been relied upon by the Secured Party and shall survive the execution and delivery of the Guaranty and the advance of all extensions of credit contemplated thereby, regardless of any investigation made by the Secured Party, and shall continue in full force and effect until this Pledge Agreement shall terminate (or thereafter to the extent provided herein).

13.08. Binding Effect; Several Agreement . This Pledge Agreement is binding upon the Pledgor and the Secured Party and their respective successors and assigns, and shall inure to the benefit of the Pledgor, the Secured Party and their respective successors and assigns, except that the Pledgor shall have no right to assign or transfer its rights or obligations hereunder or any interest herein (and any such assignment or transfer shall be void) except as expressly contemplated by this Pledge Agreement.

13.09. Waivers; Amendment .

(a) No failure or delay of the Secured Party in exercising any power or right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such a right or power, preclude any other or further exercise thereof or the exercise of any other right or power. The rights and remedies of the Secured Party hereunder and under the Guaranty are cumulative and are not exclusive of an y rights or remedies that it would otherwise have. No waiver of any provisions of this Pledge Agreement or consent to any departure by the Pledgor therefrom shall in any event be effective unless the same shall be permitted by paragraph (b) below, and then such waiver or consent shall be effective only in the specific instance and for the purpose for which given. No notice to or demand on the Pledgor in any case shall entitle the Pledgor to any other or further notice or demand in similar or other circumstances.

(b) Neither this Pledge Agreement nor an y provision hereof may be waived, amended or modified except pursuant to an agreement or agreements in writing entered into by the Secured Party and the Pledgor.

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IN WITNESS WHEREOF, intending to he legally bound, Pledgor has caused this Pledge Agreement to be duly executed as of the date first above written.


	MEXRAIL, INC.

	By:	/s/ Ronald G. Russ

		Name:	Ronald G. Russ
		Title:	Executive Vice President and
			Chief Financial Officer

Address:			427 West 12 ^th Street
			Kansas City, MO 64105
			Senior Vice President
			and General Counsel
			816-983-1702

	Attention:
	Telecopier No.:

	Accepted and Agreed:

	THE UNITED STATES OF AMERICA, REPRESENTED BY THE SECRETARY OF TRANSPORTATION ACTING THROUGH THE ADMINISTRATOR OF THE FEDERAL RAILROAD ADMINISTRATION

	as Secured Party

	By:	/s/ Joseph H. Boardman

		Name:
		Title: Administrator of the Federal Railroad Administration

Address:			400 7 ^th St. SW
			Washington, DC 20590
			Attn: Assoc. Administrator for Railroad Development

	Attention:
	Telecopier No.:

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EXHIBIT 10.5

LEASE AGREEMENT

Between

THE KANSAS CITY SOUTHERN RAILWAY COMPANY

and

LOUISIANA SOUTHERN RAILROAD, INC.

Covering Certain Land and Track

Between Milepost 83.5 and Milepost 78.8 on the Sibley Branch.
Between Milepost 49.6 and Milepost 78.8 and Between Milepost 78.8
and Milepost B-102 on the Hope Subdivision

Effective as of September 25, 2005

Portions of this document have been redacted pursuant to a Request for Confidential Treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended. Redacted portions are indicated with the notation [**].

CONTENTS


Section		Page No.
1.	Lease Premises		1

2.	Lease Term		5

3.	Rail Service		6

4.	Rent		7

5.	Conditions — Precedent		8

6.	Maintenance		9

7.	Accounting and Reporting		12

8.	Representations and Warranties		12

9.	Obligations of the Parties		13

10.	Eminent Domain		16

11.	Insurance and Indemnification		17

12.	Taxes		19

13.	Easements, Leases and Licenses		19

14.	Termination		19

15.	Force Majeure		21

16.	Defeasance		21

17	Events of Default		21

18.	Arbitration		22

19.	Compensation for Services		24

20.	Allocation of Income and Expenses		24

21.	Liens		24


Section		Page No.
22.	Reserved Rights		24

23.	Confidentiality		25

24.	Miscellaneous		26

EXHIBITS


Exhibit A		Map

Exhibit B		Contracts / Agreements

Exhibit C		Interchange Agreement

Exhibit D		Divisions Agreement

LEASE AGREEMENT
HOPE SUBDIVISION AND SIBLEY BRANCH

THIS LEASE AGREEMENT , dated as of this 20th day of July, 2005, by and between THE KANSAS CITY SOUTHERN RAILWAY COMPANY , a Missouri corporation, (“KCS”) and LOUISIANA SOUTHERN RAILROAD, INC, a Kansas corporation (“LESSEE”).

RECITALS

A. LESSEE intends to lease from KCS, that certain line of railroad in the State of Louisiana, on the Sibley Branch Hope Subdivision extending between Milepost 83.5 and Milepost 78.8, and Between Milepost 49.6 and Milepost 78.8 and Between Milepost 78.8 and Milepost B-102 on the Hope subdivision, a distance of approximately 57.3 miles. The Hope Subdivision and Sibley Branch are hereinafter referred to as the “Leased Premises”), and are shown in solid green lines on attached Exhibit “A”.

B. The parties desire to enter into this Lease setting forth terms and conditions for the use, management and operation of the Leased Premises described above.

NOW, THEREFORE , in consideration of the foregoing and other good and valuable consideration, intending to be legally bound, the parties do hereby agree as follows:

SECTION I. LEASED PREMISES

SECTION 1.1 KCS does hereby lease to LESSEE and LESSEE does hereby lease from KCS the Leased Premises described in the Recitals above and the property described in Section 1.2.

SECTION 1.2 The Leased Premises shall include, without limitation, the right to use the right of way for railroad operations, tracks, rails, ties, ballast, other track materials, switches, crossings, bridges, culverts, buildings, crossing, warning devices and any and all improvements or fixtures affixed to the right-of-way, but specifically exclude any and all items of personal property not owned by KCS or not affixed to the land, including, without limitation, railroad rolling stock, locomotives, equipment, machinery, tools, inventories, materials and supplies. Within ninety (90) days after the Effective Date, as defined in Section 2.1. KCS shall remove all its personal property from the Leased Premises. Items not so removed shall be deemed included in the Leased Premises. LESSEE expressly acknowledges that KCS has previously leased and/or licensed portions of the Leased Premises. This Lease is made subject to those leases and/or licenses. To the extent that there exists, on the Leased Premises, property included in or owned by said prior Lessees, said property may remain on the property

to the extent permitted by the terms of the lease under which it was placed on the property.

KCS shall retain the ownership of all AEI readers currently on the Leased Premises. KCS and LESSEE will mutually agree on locations where AEI readers are required to record interchange of cars under this Agreement. LESSEE will relocate or pay for the relocation, operation and maintenance of any AEI readers relocated from their current location to record interchange of cars under this Agreement. KCS will remove, at its cost, from the Leased Premises all AEI readers not required for recording interchange of cars under this Agreement.

LESSEE may, at its expense obtain and locate on the Leased Premises, AEI readers at other locations of its choice on the Leased Premise. Any AEI readers obtained and placed at the expense of LESSEE shall remain the property of LESSEE and LESSEE shall have the right to remove such readers for the Leased Premises upon expiration of termination of this Agreement.

SECTION 1.3 LESSEE shall take the Leased Premises in an “AS IS, WHERE IS” CONDITION AND WITHOUT ANY EXPRESS OR IMPLIED WARRANTIES, INCLUDING BUT NOT LIMITED TO ANY WARRANTIES OF TITLE, MERCHANTABILITY, HABITABILITY, OR FITNESS FOR A PARTICULAR PURPOSE and subject to: (a) reservations or exceptions of record of minerals or mineral rights, including but not limited to all coal, oil, gas, casing head gasoline and minerals of any nature and character whatsoever underlying the Leased Premises together with the sole, exclusive and perpetual right to explore for, remove, and dispose of said minerals by any means or methods suitable to KCS, (b) all easements, public utility easements and rights-of-way, howsoever created, for crossings, pipelines, wire lines, fiber optic facilities, roads, streets, highways and other legal purposes; (c) existing and future building zoning, subdivision and other applicable federal, state, county, municipal and local laws, ordinances and regulations; (d) encroachments or other conditions that may be revealed by a survey, title search or inspection of the property; (e) all existing ways, alleys, privileges, rights, appurtenances and servitudes, howsoever created; (f) any liens of mortgage or deeds of trust encumbering said property; (g) the KCS’s exclusive right to grant any and all easements, leases, licenses or rights of occupancy in, on, under, through, above, across or along the Leased Premises, or any portion thereof, for the purpose of construction, of these rights shall include but not be limited to, the installation, operation, use, maintenance, repair, replacement, relocation and reconstruction of any fiber optic facilities, signboards or coal slurry pipeline PROVIDED, HOWEVER, that the exercise not materially interfere with LESSEE’s railroad operations.

SECTION II. LEASE TERM

SECTION 2.1 Unless this Agreement is terminated earlier in accordance with Section XV, LESSEE shall have and hold the Leased Premises unto itself, its successors and assigns, for a term of ten (10) years, beginning no later than November 15, 2005, or at such earlier date as is mutually agreed to by both parties in writing: and continuing in effect until August 31, 2015. The “Effective Date” shall be the date five

(5) days after KCS has notified LESSEE in writing that KCS has satisfactory evidence of compliance with the conditions precedent provided in Section V unless such notice period is waived by mutual agreement. Promptly following execution of this Agreement, Lessee, at its sole expense, shall prepare and file such documents as may be required (if any) to secure approval, or exemption from approval of this transaction by the Surface Transportation Board of the United States Department of Transportation (“STB”), if such approval or exemption from approval is necessary or appropriate. LESSEE shall permit KCS to review prior to filing all documents proposed by LESSEE to be filed with the STB, or any court, to secure legal approval or exemption of this transaction.

At least six month prior to the end of the initial ten (10) year term of this Agreement, either party may provide the other party with written notice of a request to renew the term of this Agreement. In the event either party provides such notice, the parties will meet to discuss whether it would be mutually beneficial to extend the term of this Agreement for an additional ten year term, upon such terms as may be agreed to by the parties. without obligation on either party to enter into an extension.

SECTION 2.2 If, subject to the right of KCS to evict or remove LESSEE from the Leased Premises by all available legal means, LESSEE holds over and remains in possession of the Leased Premises following expiration of the then current term, original or extended, or following an early termination of this Lease pursuant to Section XIV, such holding over will create a month-to-month tenancy only. During any such hold over period, LESSEE agrees to pay to KCS as monthly rent, a sum [**], as adjusted pursuant to Section 4.4. Such monthly payments shall be due each month on the same day of the month as the Anniversary Date of this Lease. Any profits or losses from LESSEE’s operations during any holdover period shall inure and accrue to the LESSEE.

SECTION III. RAIL SERVICE

SECTION 3.1 Beginning on the Effective Date and throughout the term of this Lease, LESSEE shall be entitled to use of the Leased Premises for the operation of common carrier rail service. KCS further warrants that as of the date of this Lease, there is no other rail carrier to which KCS has granted rights to use the Leased Premises other than pursuant to joint facility agreements or arrangements that are superior to those granted herein to LESSEE. During the term of this Lease, LESSEE shall not grant to any third party the right to operate over the Leased Premises, nor shall it enter into any commercial or other agreement to move the traffic of any third party, other than to perform its common carrier obligations under the Interstate Commerce Commission Termination Act.

SECTION 3.2 During the term of this Lease, LESSEE:

3.2.1 will not suspend or discontinue its operation as a common carrier by rail over all or any part of the Leased Premises without first applying for and obtaining from the Surface Transportation Board (“STB”), and any other regulatory agency with jurisdiction, any necessary certificate of public convenience and necessity or other approvals or exemptions from regulation for such discontinuance of operations over the Leased Premises; provided, however, that LESSEE will not seek such regulatory authority, or if no regulatory authority is needed, take any action to suspend or discontinue its operations on the Leased Premises, without first giving KCS six (6) months’ advance written notice of LESSEE’s intent to do so.

3.2.2 agrees to offer freight transportation services on the Leased Premises, to all shippers on the Leased Premises as least at the levels in place on the Effective Date of this Lease Agreement and sufficient to comply with all current contracts with shippers located on the Leased Premises.

3.2.3 agrees to fulfill all service requirements of existing transportation contracts to the extent such services involve services formerly provided on Leased Premises. LESSEE agrees to comply with the terms of all existing agreements related to the use of the Leased Premises including but not limited to: car cleaning contracts, crossing agreements, interlocker agreements and joint facility agreements, as shown on Exhibit “B”.

3.2.4 [**]

SECTION 3.3 Upon suspension or discontinuance of LESSEE’s operations as a rail carrier of freight over all or any part of the Leased Premises during the term of this Lease or any extended term hereof, for reasons other than events of force majeure, or a lawful embargo, whether or not pursuant to necessary and proper regulatory authority as required by Section 3.2 of this Section III, LESSEE will promptly relinquish to KCS possession of the Leased Premises and this Lease Agreement will terminate as provided by Section XIV of this Lease; PROVIDED, HOWEVER, any discontinuance of service or abandonment of any portion(s) of the Leased Premises which are inconsequential to rail freight service over the Leased Premises generally will be permitted and will not result in a termination of this Lease or require relinquishment of possession of the Leased Premises by LESSEE.

SECTION IV. RENT

this section, [**]. As additional consideration, Lessee agrees to enter into and fulfill the obligations of the Divisions Agreement attached hereto and incorporated herein as Exhibit “D”.

SECTION 4.2 LESSEE shall pay all due rent payments, and all other payments required by this Lease, to KCS at 427 West 12 ^th Street, P.O.Box 219335, Kansas City, Missouri 64121-9335, or at such other location or individual as may be designated by KCS in writing from time to time.

SECTION 4.3 Acceptance by KCS, its successors, assigns or designees of rent or other payments shall not be deemed to constitute a waiver of any other provision of this Lease.

SECTION 4.4 As additional security for the payment by LESSEE to KCS of any sums of money required hereunder to be paid by LESSEE, it is agreed that in the event LESSEE fails, neglects or refuses to timely pay any sums due and owing to KCS hereunder, KCS may use any and all sums which it may collect from any third party and which may, in whole or in part, be payable to LESSEE, as an offset against any and all payments for which LESSEE is delinquent. In addition, any sums at any time due and payable to LESSEE by KCS may also be used by KCS and credited to KCS’s account to the extent of any delinquent payment owed by LESSEE to KCS.

SECTION V. CONDITIONS-PRECEDENT

SECTION 5.1 Prior to the Effective Date and as conditions precedent to either party’s obligations hereunder:

5.1.1 There shall not be a work stoppage imminent or in effect on the lines of KCS or any of its affiliated companies as a result of the execution and/or implementation of this Lease.

5.1.2 LESSEE shall have acquired, at LESSEE’s cost, the right to conduct rail freight service over the Leased Premises from the Surface Transportation Board (“STB”) through an application or exemption under 10901 49 U.S.C., and shall have obtained such judicial, administrative agency or other regulatory approvals, authorizations or exemptions as may be necessary to enable it to undertake its obligations hereunder.

5.1.3 KCS and LESSEE shall not be prevented from fulfilling their respective obligations under this Lease as a result of legislative, judicial or administrative action.

5.1.4 KCS and LESSEE shall execute an interchange agreement in the form attached as Exhibit “C” whereby KCS and LESSEE will interchange

traffic destined to or originating at Industries located on or served from the Leased Premises..

5.1.5 Upon execution hereof, KCS shall make available for LESSEE’s inspection and review all contracts, deeds, agreements and documents pertaining to or affecting the Leased Premises.

SECTION 5.2 Each party to this Lease shall be responsible for all costs of protection of its respective employees arising out of STB approval or exemption of this transaction under 49 U.S.C. § 10901 and implementation of the transaction, the exercise or performance by KCS or LESSEE of any rights or obligations hereunder, the termination of this Lease, or LESSEE’s abandonment or discontinuance of operations on the Lease Premises, whether such costs are attributable to protective conditions or benefits imposed by any judicial, regulatory or governmental body or are required to be paid pursuant to collective bargaining or other agreements. LESSEE shall consider for employment any of KCS’s employees on the Leased Premises who, in LESSEE’s sole judgment, are qualified for the positions for which they apply and make proper application therefor. LESSEE shall give priority-hiring consideration to employees of KCS who work on the Leased Premises. LESSEE promptly shall notify KCS of the name of each of KCS’s current employees who LESSEE offers to hire, and also the name of each of these employees who LESSEE actually hires.

SECTION VI. MAINTENANCE, MODIFICATIONS AND IMPROVEMENTS

SECTION 6.1 During the term of this Lease, LESSEE shall:

6.1.1. Maintain the Leased Premises in compliance with all state and federal statues, rules and regulations and except for track that is classified as excepted track pursuant to 49 C.F.R. Section 213.9 (“Excepted Track”) on the Effective Date, maintain the track on Leased Premises to at least Class I standards, as defined by the Federal Railroad Administration (“FRA”) and capable of operating speeds of at least 10 miles an hour, at LESSEE’s own cost and expense and to a standard that is sufficient to continue rail freight service commensurate with the needs of the rail users located thereon, provided that if on the Effective Date the condition of any portion of the Leased Premises is better than Class I standards, that portion of the Leased Premises shall be maintained at no worse condition than exists on the Effective Date.

6.1.2. Maintain Excepted Track on the Leased Premises in a condition that operations can be safely conducted over it at the speed specified in the timetable or track bulletins as of the Effective Date and that is sufficient to continue rail freight service commensurate with the needs of the rail users located thereon.

6.1.3. LESSEE shall protect the Leased Premises against all encroachments or unauthorized uses. LESSEE will within one hundred eighty (180) days from the

6.1.4. Effective Date, construct at its own expense interchange tracks and other connections or tracks (wyes, turnouts, etc., including but not limited to building a north to west wye connection at Sibley, LA, and two sixty (60) car interchange tracks with yard air in the vicinity of Sibley, pursuant to the terms and conditions of the Capital Improvement Agreement executed contemporaneously with this agreement.

6.1.4 The parties agree that to the extent that traffic volumes decrease on any segment of the Leased Premises to a level that LESSEE [**].

SECTION 6.2 In the event KCS shall notifies LESSEE in writing that Lessee has failed to perform any of its maintenance obligations under this agreement LESSEE shall, within thirty (30) days of its receipt of such notice, commence necessary repairs and maintenance and shall proceed to complete same with reasonable diligence. LESSEE may relocate switches and industrial tracks from one location on the Leased Premises to another location on the Leased Premises upon receiving any necessary and proper regulatory authority and after ten (10) days’ written notice to KCS. Any rehabilitation or reconstruction, including but not limited to that necessitated by an Act of God, will be the sole responsibility of LESSEE. Such maintenance shall include any function which KCS, but for this Lease, would be required to perform pursuant to any applicable federal, state or municipal laws ordinances or regulations.

SECTION 6.3 Nothing herein shall preclude LESSEE, at its sole cost and expense, from maintaining the Leased Premises to a standard higher than the minimum herein provided, but LESSEE shall not be required hereunder to do so.

SECTION 6.4 Except for Reserved Rights, LESSEE’s maintenance obligations hereunder shall include, but shall not be limited to, buildings, highway grade crossings, grade crossing signal protection devices, bridges, culverts and other structures, sub-roadbed and all other improvements on the Leased Premises. [**]

provided that any such net proceeds not reinvested in the Leased Premises shall be paid to KCS. Such requirement shall also apply to all other facilities leased hereunder. Any repair or replacement of welded rail shall also be welded. LESSEE may make any replacement and substitute with any material having the same or higher weight and quality as the materials being replaced, without the prior written consent of the KCS, All maintenance, renewal, retirements, additions and betterments shall progressively become a part of the Leased Premises and the sole ownership of KCS.

On or before June 1st of 2006 and June 1 of each calendar year thereafter, during the term of this Agreement, LESSEE shall provide KCS with a written summary of all salvage or other materials removed from the Leased Premises, the proceeds received therefor and the manner in which the proceeds were reinvested. Failure to either reinvest such proceeds or pay any unreinvested proceeds to KCS within six (6) months following such reporting date shall, at KCS’s sole discretion, constitute a Default hereunder.

SECTION 6.6 LESSEE may from time to time establish or relocate sidetracks or industrial spur tracks on the Leased Premises. KCS shall have no obligation to bear any cost of materials, construction or maintenance of said sidetracks or industrial spur tracks outside the leased right of way. That portion of any such spur track that is constructed upon the Leased Premises shall become part of the Leased Premises and, upon termination of this Lease, the property of KCS. Prior to execution of any industry track agreement by LESSEE, Lessee shall obtain KCS’s written approval. For any industry or Customer track built on the Leased Premises after the effective date, which is constructed or financed by LESSEE, LESSEE shall be entitled to any and all track rentals derived therefrom during the term of this Lease. All industry track agreements, regardless of duration, shall contain provisions indemnifying KCS and holding it harmless from all liability in connection with the construction, maintenance or operation thereof.

SECTION 6.7 In the event of a dispute between KCS and LESSEE with respect to LESSEE’s fulfillment of its duties under this Section VI, it is agreed between the parties that an inspection by a qualified representative of the FRA shall be arranged by KCS and such representative shall inspect those segments or portions of track in dispute and his findings in this regard shall be binding upon the parties.

SECTION 6.8 LESSEE shall not allow any liens to be placed on the Leased Premises or encumbrances against the Leased Premises or any portion thereof, and will pay, satisfy, and discharge all claims or liens for material and labor or either of them used, contracted for, or employed by LESSEE during the term of this Lease in any construction, repair, maintenance, or removal on the Leased Premises and any improvements located thereon, whether said improvements are the property of KCS or of LESSEE, within thirty (30) days of receiving notice of such lien. LESSEE WILL INDEMNIFY AND SAVE HARMLESS KCS FROM ALL SUCH CLAIMS, LIENS, OR DEMANDS WHATSOEVER . In the event the Lease is terminated or expires, LESSEE shall return the Leased Premises to KCS free and clear of any such liens claims and demands.

SECTION 6.9 During the term of this Agreement, [**]

SECTION VII. ACCOUNTING AND REPORTING

SECTION 7.1 LESSEE agrees to furnish to KCS audited copies of the financial reports of Watco Companies, Inc. or any company which directly or indirectly owns a majority interest in LESSEE audited by an independent accounting firm on an annual basis on or before May 1 of each year for the term of this lease. Copies of unaudited financial reports pertaining to LESSEE and the Leased Premises prepared in the normal course of LESSEE’s business shall be provided to Lessor on a quarterly basis. KCS shall take the same precautions to protect the confidentiality of non-public financial information provided under this Section that it uses to protect its own confidential non-public financial information.

SECTION VIII. REPRESENTATIONS AND WARRANTIES

SECTION 8.1 KCS represents and warrants that:

8.1.1 It has full statutory power and authority to enter into this Lease and to carry out the obligations of KCS hereunder.

8.1.2 Its execution of and performance under this Lease do not violate any statute, rule, regulation, order, writ, injunction or decree of any court, administrative agency or governmental body.

SECTION 8.2 LESSEE represents and warrants that:

8.2.1 It is a corporation duly organized, validly existing, and in good standing under the laws of the State of Kansas and by the effective date shall be qualified to do business in the State of Louisiana.

8.2.3 It has full power and authority to enter into this Lease, and, subject to necessary judicial and regulatory authority, to carry out its obligations hereunder.

8.2.3 Upon expiration of the original or any extended term of this Lease or upon termination hereof by KCS pursuant to Section XIV, LESSEE will bear any and all costs of protection of its current or future employees, including former employees of KCS that may be employed by LESSEE, arising from any labor protective conditions imposed by the STB, any other regulatory agency or statute as a result of LESSEE’s lease or operation of the Leased Premises and any related agreements or arrangements, or arising as a result of the termination of this Lease. Nothing contained herein is intended to be for the benefit of any such employee nor should any employee be considered a third party beneficiary hereunder. Nothing in this Lease shall be construed as an assumption by LESSEE of any obligations to KCS’s current or former

employees under collective bargaining or other agreements that may exist or have existed between KCS and its employees, or any of them.

SECTION IX. OBLIGATIONS OF THE PARTIES

SECTION 9.1 During the term of this Lease, LESSEE will initiate, contract for and obtain in its sole name all utility services required for its use of or operations on the Leased Premises. LESSEE shall pay all bills for water, sewer, gas, telephone and electric service to the Leased Premises. If KCS is required to, or does pay, any such bills, LESSEE will promptly reimburse KCS upon receipt of a bill or bills therefor. If the Leased Premises are not billed separately but as a part of a larger tract or parcel, LESSEE shall pay that portion of such bills as is attributable to usage on or in connection with the Leased Premises.

SECTION 9.2 During the term of this Lease, LESSEE will comply with all applicable federal, state and municipal laws, ordinances, and regulations, and LESSEE will not knowingly do, or permit to be done, upon or about the Leased Premises, anything forbidden by law, ordinance or regulation. LESSEE further agrees to use its best efforts to secure all necessary governmental authority for it to commence operations under this Lease and discontinue operation on the Leased Premises at the expiration or termination of this Lease, as applicable.

SECTION 9.3 During the term of this Lease, LESSEE will comply with all federal, state, and local laws, rules, regulations, and ordinances controlling air, water, noise, hazardous waste, solid waste, and other pollution or relating to the storage, transport, release, or disposal of hazardous materials, substances, waste, or other pollutants. LESSEE at its own expense will make all modifications, repairs, or additions to the Leased Premises, install and bear the expense of any and all structures, devices, or equipment, and implement and bear the expense of any remedial action which may be required under any such laws, rules, regulations, ordinances, or judgments related to actions occurring during the term of this Lease. During the term of this Lease, LESSEE will not dispose of any wastes of any kind, whether hazardous or not, on the Leased Premises.

SECTION 9.4

PRIOR TO THE EFFECTIVE DATE KCS AND LESSEE HAVE CONDUCTED A JOINT INSPECTION OF THE LEASED PREMISES AND HAVE ESTABLISHED AND AGREED UPON THE CURRENT CONDITIONS AT THE TIME OF THIS LEASE AND THAT THE LEASED PREMISES ARE SUITABLE FOR SAFELY CONDUCTING THE OPERATIONS CONTEMPLATED BY THE LEASE. [**]]

[**]

SECTION 9.5 LESSEE will promptly notify by telephone, the KCS official responsible for environmental matters and furnish KCS written notice of any and all (i) releases of hazardous wastes or substances of which it becomes aware which occur during the term of this Lease whenever such releases are required to be reported to any federal, state, or local authority, and (ii) alleged water or air permit condition violations, and (iii) any notification received by LESSEE alleging any violation of any state, federal or local statute, ordinance, ruling, order or regulation pertaining to environmental protection and or hazardous material, handling transportation or storage. To the extent practicable, such written notice will identify the substance releases, the amount released, and the measures undertaken to clean up and remove the released material and any contaminated soil or water, will identify the nature and extent of the alleged violation and the measures taken to eliminate the violation, and will certify that LESSEE has complied with all applicable regulations, orders, judgments or decrees in connection therewith, or the date by which such compliance is expected. LESSEE will also provide KCS with copies of any and all reports made to any governmental agency that relate to such releases or such alleged violations during the term of this Lease.

SECTION 9.6 During the term of this Lease, KCS will have the right, upon five (5) days prior notice, to enter the Leased Premises for the purpose of inspecting the Leased Premises to ensure compliance with the requirements of this Lease. If KCS detects any violation, including but not limited to any contamination of the Leased Premises, which is the responsibility of LESSEE under this Agreement, KCS will notify LESSEE of the violation. Upon receipt of such notice LESSEE will take immediate steps to eliminate the violation or remove the contamination to the satisfaction of any governmental agency with Jurisdiction over the subject matter of the violation. Should LESSEE inadequately remedy or fail to eliminate the violation, KCS or its representative will have the right, but not the obligation, to enter the Leased Premises and to take whatever corrective action KCS reasonably deems necessary to eliminate the violation, at the sole expense of LESSEE. The above provision shall in no way limit or restrict LESSEE’s right to challenge or otherwise object to the legitimacy of the interpretation or applicability of any governmental requirement.

SECTION 9.7 Regardless of any acquiescence by KCS, LESSEE will:

9.7.1 [**]

9.7.2 Reimburse KCS and its officers, agents, employees, KCS’s parent corporation, subsidiaries, affiliates, successors, and assigns for all costs and expenses incurred by KCS or its officers, agents, employees, KCS’s, parent corporation, subsidiaries, affiliates, successors, and assigns in eliminating or remedying such violations, pollution, or contamination by Lessee as set forth in Section 9.7.1 above.

9.8 KCS will provide LESSEE, at no cost to LESSEE, access to KCS’ radio towers and local and base radios as needed to support communications on the Leased Premises. LESSEE, at LESSEE’s expense, shall be responsible for delivery and implementation of connections between Leased Premises and other LESSEE related properties.

SECTION X. EMINENT DOMAIN

SECTION 10.1 In the event that at any time during the term of this Lease the whole or any part of the Leased Premises shall be taken by any lawful power by the exercise of the right of eminent domain for any public or quasi-public purpose the following provisions shall be applicable: To the extent any compensation received by KCS is for improvements paid for by LESSEE, a percentage of the amount received by KCS for such improvements paid for by LESSEE equal to the amount received by KCS for such improvement multiplied by percentage which has numerator equal to the number of years remaining in the then current term of the Agreement and a denominator equal to ten (10).

10.1.1 If such proceedings shall result in the taking of the whole or a portion of the Leased Premises that materially interferes with LESSEE’s use of the Leased Premises for railroad purposes, LESSEE shall have the right, upon written notice to KCS, to terminate this Lease in its entirety. In that event, and subject to any necessary regulatory approvals or exemptions, this Lease shall terminate and expire on the date title to the Leased Premises vests in the condemning authority, and the rent and other sums or charges provided in this Lease shall be adjusted as of the date of such vesting.

10.1.2 If such proceeding shall result in the taking of less than all of the Leased Premises which does not materially interfere with LESSEE’s use of the Leased Premises for railroad purposes, then the Lease shall continue for the balance of its term as to the part of the Leased Premises remaining, without any reduction, abatement or effect upon the rent or any other sum or charge to be paid by the LESSEE under the provisions of this Lease.

10.1.3 Except as otherwise expressly provided in this Section, KCS shall be entitled to any and all funds payable for the total or partial taking of the Leased Premises without any participation by LESSEE; provided, however, that nothing contained herein shall be construed to preclude LESSEE from prosecuting any claim directly against the condemning authority for loss of its business or for the value of its leasehold estate.

10.1.4 Each party shall provide prompt notice to the other party of any eminent domain proceeding involving the Leased Premises. Each party shall be entitled to participate in any such proceeding, at its own expense, and to consult with the other party, its attorneys, and experts. LESSEE and KCS shall make-all reasonable efforts to cooperate with each other in the defense of such proceedings and to use their best efforts to ensure LESSEE’s continued ability to use the Leased Premises for the conduct of freight railroad operations.

SECTION XI. [**]

SECTION 11.1 [**]

SECTION 11.2 IN THE PERFORMANCE OF THIS LEASE, LESSEE SHALL COMPLY WITH ALL APPLICABLE FEDERAL, STATE AND LOCAL GOVERNMENTAL STATUTES, ORDINANCES, ORDERS AND REGULATIONS. NO PENALTIES, COSTS OR ADDITIONAL EXPENSE RESULTING FROM FAILURE TO COMPLY WITH ANY SUCH REQUIREMENT SHALL BE ADDED TO OR FORM THE BASIS FOR ANY PART OF THE LEASE PRICES HEREIN PROVIDED. LESSEE SHALL DEFEND, INDEMNIFY, SAVE HARMLESS KCS FROM AND AGAINST ALL CLAIMS, ACTIONS OR LEGAL PROCEEDINGS ARISING FROM THE VIOLATION OR ALLEGED VIOLATION OF ANY LAWS, ORDINANCES, ORDERS OR REGULATIONS TO THE EXTENT CAUSED OR PERMITTED BY LESSEE.

SECTION 11.3 LESSEE shall, at its own sole cost and expense, procure the following kinds of insurance for the term of this agreement commencing as of the date of the Effective Date and promptly pay when due all premiums for that insurance. Upon the failure of LESSEE to maintain insurance as provided herein, KCS shall have the right, after giving LESSEE ten days written notice, to obtain such insurance and LESSEE shall promptly reimburse KCS for that expense. The following minimum insurance coverage shall be kept in force during the term of this Lease:

[**]

SECTION 11.4 LESSEE warrants that this Lease has been reviewed with its insurance agent(s)/broker(s) and the agent(s)/broker(s) has been instructed to procure the insurance coverage required herein and name KCS as additional insured with respect to all liabilities assumed by LESSEE hereunder.

SECTION 11.5 [**]

SECTION 11.6 The insurance policy (ies) shall be written by a reputable insurance company or companies acceptable to KCS or with a current Best’s Insurance Guide Rating of B and Class X or better. Such insurance company shall be authorized to transact business in the State of Louisiana.

SECTION 11.7 Insurance coverage provided in the amounts set forth herein shall not be construed to otherwise relieve LESSEE from liability hereunder in excess of such coverage, nor shall it preclude LESSEE from taking such other action as is available to it under any other provision of this Agreement or otherwise in law.

SECTION XII. TAXES

SECTION 12.1 [**]

SECTION XIII. EASEMENTS, LEASES AND LICENSES

SECTION 13.1 Except to the extent specifically provided in other sections of this Agreement, LESSEE shall not be entitled to receive any revenue from any Reserved Rights as defined in Section 23.1 of this Agreement or renewals thereof, or attributable to any agreements entered into by KCS for Reserved Rights following the Effective Date. KCS reserves the exclusive right to grant easements, licenses, agreements and leases affecting the Leased Premises which do not materially interfere with the LESSEE’s use of the Leased Premises, KCS shall be responsible for all duties, maintenance, costs, fencing, insurance, taxes (income, ad valorem, or otherwise), special assessments and liabilities owed to, on or for said revenues, easements, lease, licenses, or other agreements.

SECTION 13.2 Nothing in this Lease shall prevent KCS from selling any portion of the Leased Premises that are located beyond fifty (50) feet of the centerline of any branch or mainline track, including areas of any station grounds provided such areas are not being used in connection with LESSEE’s rail freight operations. All proceeds from such real estate sales shall accrue solely to KCS and LESSEE shall execute a lease amendment deleting any such sale property from the description and terms hereof or any other document reasonably necessary to remove the encumbrance of this Lease from such property. KCS agree to provide LESSEE sixty (60) days notice before is sells any real property located on or adjacent to the Leased Premises.

SECTION 13.3 LESSEE shall not execute any encumbrance, lease, easement or any agreement affecting the Leased Premises, except for new Customer tracks as described in this agreement

SECTION XIV. TERMINATION

SECTION 14.1 This Lease may be terminated: as follows:

14.1.1 By LESSEE or KCS on or at any time prior to the Effective Date if any substantive condition unacceptable to LESSEE or to KCS is imposed upon the regulatory approvals or exemptions contemplated by Section V of this Lease for LESSEE’s lease and operation of the Leased Premises;

14.1.2. Pursuant to Section XVIII upon the occurrence of an Event of Default as provided in Section XVII;

14.1.3. By KCS upon five (5) days’ notice to LESSEE, as a consequence of an uninterrupted abandonment or discontinuance of operations, as the case may be, by LESSEE over any line segment of the Leased Premises (other than an inconsequential abandonment or discontinuance not affecting rail service generally over the Line) lasting more than seven (7) days, other than by reason of an event of force majeure , a lawful embargo, or changes in the demand for service; or

14.1.4. By LESSEE or KCS upon the effective date of regulatory approvals or exemptions to permit LESSEE to abandon or discontinue rail operations, provided LESSEE shall give KCS contemporaneous notice of initiation or receipt of documents relating to any such application, exemption or proceeding;

14.1.5 The termination or expiration of this Agreement will not affect or impair the rights or obligations of either party arising under this Agreement prior to such termination or expiration.

SECTION 14.2 In the event that within 180 days after the Effective Date any of KCS’s labor organizations cause a work stoppage as a result of this Lease and KCS is unable to obtain an injunction against such work stoppage or negotiate a satisfactory resolution with the organization within 48 hours, KCS shall have the right, anytime within such 180 day period, to terminate this Lease by giving five (5) days’ written notice to LESSEE. In such event LESSEE shall deliver possession of the Leased Premises to KCS on such 5th day, subject to all necessary prior regulatory approvals or exemptions, and LESSEE shall comply with the provisions of Sections 14.4 and 14.5, within such five (5) day period rather than the times stated therein.

SECTION 14.3 In the event of termination of this Lease, LESSEE shall vacate the Leased Premises in an orderly manner. Upon any termination resulting from an Event of Default by LESSEE, KCS, at any time thereafter and subject to all necessary prior regulatory approvals or exemptions, may re-enter and take possession of the Leased Premises by affording sixty (60) days’ written notice to LESSEE specifying such Event or Events of Default and that this Lease has terminated.

SECTION 14.4 At least 60 days prior to the expiration of this Lease, or promptly upon the earlier termination of this Lease, LESSEE shall submit all necessary applications, petitions and/or notices to the STB or any successor agency, and shall make when and where due all related ancillary submissions (including but not limited environmental reports) required to effectuate a termination of this Lease and a discontinuance of LESSEE’s operations hereunder. In the event that LESSEE fails to make such filings, KCS may make such filings as may be appropriate to effectuate discontinuance of LESSEE’s operations of the Leased Premises, with LESSEE being responsible for all costs (including but not limited to filing fees and attorney fees) incurred by KCS in making such filings. In the event KCS makes such filings,

LESSEE will not oppose the relief requested in KCS’s filings. Upon expiration or earlier termination of this Lease, KCS shall have the right to enter onto and operate the Leased Premises.

SECTION XV. FORCE MAJEURE

SECTION 15.1 The prompt and timely performance of all obligations and covenants under this Lease, including the obligation to make prompt and timely payment of each installment of rent or any other payment of any nature, is and shall be of the essence of this Lease.

SECTION 15.2 Either party shall be excused from its obligations under this Lease, other than payment of rent, to the extent its performance is prevented by an event of Force Majeure. For purposes of this Lease an event of Force Majeure shall include: strikes, lockouts, labor disputes, casualties, acts of God, war, terrorist acts, court orders, work stoppages, nuclear incidents, riots, public disorder, acts of a public enemy, criminal acts or acts or omissions of other parties or entities, floods, storms, earthquakes, hurricanes, tornadoes, or other sever weather or climactic conditions, blockade, insurrection, vandalism or sabotage, fire, accident, wreck, derailment, washout or explosion, embargoes, Association of American Railroads, STB or FRA orders, other governmental laws, orders or regulations or other such causes beyond the reasonable control of said party (each a “Force Majeure”). In the event either party is prevented from performing its obligations under this Lease by a Force Majeure, the party so prevented shall be excused from its obligations under this Lease, other than payment of rent, to the extent such performance was prevented by such Force Majeure, The party experiencing Force Majeure shall take prompt action to remove such causes of Force Majeure insofar as practicable with all reasonable dispatch, and its obligation to perform the provisions of this Lease shall resume immediately after such causes have been removed.

SECTION XVI. DEFEASANCE.

SECTION 16.1 LESSEE shall not make any use of the Leased Premises inconsistent with KCS’s right, title and interest therein and which may cause the right to use and occupy the Leased Premises to revert to any party other than KCS. KCS and LESSEE shall make all reasonable efforts to defend KCS’s title to the Leased Premises against any adverse claims.

SECTION XVII. EVENTS OF DEFAULT AND BREACH

SECTION 17.1 The following shall be Events of Default:

17.1.1 Failure by LESSEE to make payments of rent when due.

17.1.2 The filing of any involuntary bankruptcy, receivership or arrangement proceeding by KCS, LESSEE or any holding company having an interest in LESSEE, which filing is not dismissed within sixty (60) days.

17.2 Upon the occurrence of a default included in 17.1; or any breach of any material term of this Agreement not considered a default under Section 17.1 the injured party shall notify the breaching party in writing and specify the breach and what corrective action is desired to cure the breach.

17.3 If, upon the expiration of ten (10) days from the receipt of said notice or time specified in 17.2, the breach has not been cured (or, if such breach cannot be cured within 10 days, steps have not been taken to effect such cure and pursued with all due diligence within said period), the injured party shall have the right, at its sole option, to cure the breach if possible and be reimbursed by the breaching party for the cost thereof, including any and all reasonable attorney’s fees, and for any reasonably foreseeable consequential damages.

17.4 Nothing herein shall prevent the injured party from resorting to any other remedy permitted under this Lease or at law or equity, including seeking damages and/or specific performance, as shall be necessary or appropriate to make the injured party whole in the premises. Failure of the injured party to demand or enforce a cure for breach in one instance shall not be deemed a waiver of its right to do so for any subsequent breach by the breaching party.

SECTION 17.5 The failure of either party hereto to enforce at any time any of the provisions of this Lease or to exercise any right or option which is herein provided shall in no way be construed to be a waiver of such provisions as to the future, nor in any way to affect the validity of this Lease or any part hereof or the right of either party to thereafter enforce each and every such provision and to exercise any such right or option. No waiver of any breach of this Lease shall be held to be a waiver of any other or subsequent breach.

SECTION XVIII. ARBITRATION

SECTION 18.1 If at any time a question or controversy involving an amount less than [**] shall arise between the parties hereto in connection with the Agreement upon which the parties cannot agree, the parties will follow the dispute resolution procedures set forth in this Section 19. No arbitrator shall have authority to change the terms or provisions of this Agreement.

hereunder. The arbitrator shall be jointly selected by the parties, but, if they do not agree on an arbitrator within thirty (30) days after demand for arbitration is made by a party, they shall request that the arbitrator be designated by the American Arbitration Association.

SECTION 18.3 Until any award is made upon questions submitted to arbitration, the business, settlements and payments to be transacted and made and other performance under the Agreement shall continue to be transacted and made in the manner and form existing prior to the time such questions arose. Any such damages in such an award shall earn interest from the date the damages were initially incurred until paid at the corporate “prime rate” as reported in The Wall Street Journal on the date of the Award.

SECTION 18.4 The arbitrator shall have the power to require the performance of acts found to be required by this Agreement and to require the cessation or nonperformance of acts found to be prohibited by this Agreement. The arbitrator shall not have the power to award consequential or punitive damages. No award under this Section may change the terms of this Agreement.

SECTION 18.5 The arbitrator shall make an award in writing, shall be final, binding and conclusive on all parties to the arbitration when delivered to them.

SECTION 18.6 Any party may, within ten (10) days of delivery of the award, seek clarification or reconsideration of the award from the arbitrator. The other party or parties shall be provided an opportunity for a response thereto within twenty (20) days of receipt thereof. The arbitrator shall make the decision granting or denying such clarification or reconsideration in writing, within sixty (60) days of receipt of a petition for such clarification or reconsideration, which shall then be final, binding and conclusive on all parties to the arbitration when delivered to them.

SECTION 18.7 Each party to the arbitration shall pay the fees and expenses of its own witnesses, exhibits and counsel. The compensation, costs, and expenses of the arbitrator shall be paid in equal shares by the parties to the arbitration.

SECTION 18.8 The parties may conduct such reasonable discovery as will facilitate a prompt and efficient resolution of the issues in dispute; provided that the arbitrator may provide for and place such limitations on the conduct of such discovery as the arbitrator may deem appropriate. The books and papers of the parties, as far as they relate to the matter submitted for arbitration, shall be open to the examination of the arbitrator.

SECTION 18.9 All proceedings relating to any such arbitration, and all testimony, written submissions and award of the arbitrator therein, shall be private and confidential as among the parties, and shall not be disclosed to any other person, except as required by law and except as reasonably necessary to prosecute or defend any judicial action to enforce, vacate or modify such arbitration award.

SECTION 18.10 The location of any arbitration proceeding held hereunder shall be agreed upon by the parties, or, if they are unable to agree, in Kansas City, Missouri.

SECTION XIX. COMPENSATION FOR SERVICES ON LEASED PREMISES

For the term of this Lease, LESSEE agrees to comply with and be legally bound by the terms and provisions of the Association of American Railroads’ practices, rules, agreements, and circulars such as OT-5, claim handling, as it applies to lading and equipment damage occurring while in LESSEE’s possession, etc.

SECTION XX. ALLOCATION OF INCOME AND EXPENSES

This is an absolute, pure net lease; and, except as otherwise expressly provided in this Lease, LESSEE shall have and hereby assumes all duties and obligations with relation to the repair, maintenance, existence and operation of the Leased Premises and all other improvements or fixtures now or hereafter located during the Term of this Lease, irrespective of law or custom.

SECTION XXI. (INTENTIONALLY OMITTED)

SECTION XXII RESERVED RIGHTS

SECTION 22.1 KCS reserves unto itself, its affiliates, subsidiaries, parents, successors and/or assigns, the following property rights hereinafter collectively referred to as the “Reserved Rights” the following:

22.1.1 All existing agreements, leases, or licenses with third parties, including any affiliates of KCS, whether recorded or not, except those assigned to LESSEE under this Lease if any; and

22.1.2 The exclusive right to prepare and enter into future agreements, leases, licenses or occupations with third parties; and

22.1.3 The right, by any commercially reasonable means, to install, construct, operate, maintain, repair, renew, replace, and remove utility systems and their associated and appurtenant equipment and facilities as well as the right to attach the utility systems and related facilities to existing bridges, and to install them in existing tunnels, and the right of ingress and egress for access purposes; and

22.1.4 The right, by any commercially reasonable means, to install, construct, operate, maintain, repair, renew, replace, and remove commercial poster panels and towers and their associated and appurtenant equipment and facilities as well as the right to attach the commercial poster panels and towers and related

facilities to existing bridges and to install them in existing tunnels, and the right of ingress and egress for access purposes; and

22.1.5 The right to amend this Lease at any time, in its sole discretion, to exclude from the Lease Premises any portion of the land for the purpose of conveying such properties to third parties, provided that the same does not materially interfere with LESSEE’s continuing freight operations or the safety thereof, does not require LESSEE to incur or expend any incremental costs, and does not substantially increase LESSEE’s risk (i.e. insurance and indemnity will be required for LESSEE’s benefit); and

22.1.6 All rights to and the right to convey all minerals, mineral rights, and air rights in, on or under the Leased Premises.

SECTION 22.2 KCS shall retain any rentals, fees or other payments associated with the Reserved Rights. KCS shall be responsible for any duties required to be performed pursuant to the Reserved Rights including but not limited to all maintenance, costs, fencing, insurance, taxes (income, ad valorem, or otherwise) , special assessments, and liabilities owed to, on, or for said reserved rights.

SECTION 22.3 KCS’s exercise of the Reserved Rights in this Section 23 shall not unreasonably interfere with LESSEE’s present or reasonably contemplated freight operations under this Lease.

SECTION XXIII. CONFIDENTIALITY

SECTION 23.1 Each party hereto covenants that all information and documents concerning the other party known to, or received or reviewed by, the first party, its employees, agents or representatives, in connection with this Lease and the transactions contemplated hereby shall be maintained in confidence and not disclosed or utilized (other than in connection with the transactions contemplated hereby) by the first party, its employees, agents or representatives, without the other party’s prior written consent, unless (i) such information and documents were, are now, or become generally available to the public (but not as a result of a breach of any duty of confidentiality by which the first party, or any of its employees, agents and representatives, is bound), (ii) such information and documents were known to first party prior to their disclosure to the first party by the other party in connection with this Lease, as demonstrated by the first party’s written records, (iii) such information and documents are disclosed by a third party, or (iv) such items are required to be disclosed pursuant to a judicial order or applicable law, rule or regulation or to the parties’ insurers. Notwithstanding anything herein to the contrary, each party may disclose (without prior notification to, or approval or consent by, the other party), to taxing authorities and/or to such party’s representatives, outside counsel and advisors, any confidential information that is required to be disclosed in connection with such party’s tax filings, reports, claims, audits, and litigation.

SECTION 23.2 In the event that either party hereto, or any of its employees, agents, representatives, becomes legally compelled to disclose any such information or documents, the disclosing party shall provide the other party with prompt notice before such disclosure so that the other party may seek a protective order or other appropriate remedy or waive compliance with the provisions of this Lease, or both. In the event that such protective order or other remedy is not obtained, or that the other party waives compliance with the provisions of this Lease, the disclosing party shall furnish only that portion of the information or documents that it is advised by written opinion of counsel is legally required.

SECTION 23.3 It is agreed that money damages would not be a sufficient remedy or any breach of this Section 24 and that either party hereto shall be entitled to specific performance as a remedy for any such breach. Such remedy shall not be deemed to be the exclusive remedy for breach of this Section 24 but shall be in addition to all other remedies available at law or in equity. Each party hereto further agrees and covenants that it shall not use any information or document that it obtains or has obtained in connection with this Lease in any judicial or administrative proceeding brought against the other party, except in a proceeding brought hereunder. With respect to any judicial or administrative proceeding brought by a third party challenging any provision of this Lease or relating to any action or inaction required by this Lease, the party against whom such proceeding is brought may use for purposes of defending such proceeding information or documents that it obtains or has obtained in connection with this Lease; provided, however, that the party against whom such proceeding is brought shall consult with and obtain the written consent of the other party prior to such use of information or documents.

SECTION XXIV. MISCELLANEOUS

SECTION 24.1 Entire Agreement . This Lease expresses the entire agreement between the parties and supersedes all prior oral or written agreements, commitments, or understandings with respect to the matters provided for herein, and no modification of this Lease shall be binding upon the party affected unless set forth in writing and duly executed by the affected party.

SECTION 24.2 Notices . All notices, demands, requests or other communications which may be or are required to be given, served or sent by either party to the other pursuant to this Lease shall be in writing and shall be deemed to have been properly given or sent:

24.2.1 If intended for KCS, by mailing by registered or certified mail, return receipt requested, with postage prepaid, addressed to KCS at:


		President
		The Kansas City Southern Railway Company
		Cathedral Square Headquarters Building
		427 West 12 ^th Street
		Kansas City, Missouri 64105

24.2.2 If intended for LESSEE by mailing by registered or certified mail, return receipt requested with postage prepaid, addressed to LESSEE at:


		Executive Vice President
		Louisiana Southern Railroad, Inc.
		315 W. Third Street
		Pittsburg, KS 66762

24.2.3 Each notice, demand, request or communication which shall be mailed by registered or certified mail to either party in the manner aforesaid shall be deemed sufficiently given, served or sent for all purposes at the time such notice, demand, request or communication shall be either received by the addressee or refused by the addressee upon presentation. Either party may change the name of the recipient of any notice, or his or her address, at any time by complying with the foregoing procedure.

SECTION 24.3 Employee Claims. LESSEE agrees to defend, indemnify and hold harmless KCS from any claims of LSLESSEE employees alleging they are employees of KCS.

SECTION 24.4 Binding Effect . This Lease shall be binding upon and inure to the benefit of KCS and LESSEE, and shall be binding upon the successors and assigns of LESSEE, subject to the limitations hereinafter set forth. LESSEE may not assign its rights under this Lease or any interest therein, or attempt to have any other person assume its obligations under this Lease through merger or otherwise, without the prior written consent of KCS.

SECTION 24.5 Severability . If fulfillment of any provision hereof or any transaction related hereto shall involve transcending the limit of validity prescribed by law, then the obligation to be fulfilled shall be reduced to the limit of such validity; and if any clause or provision herein contained operates or would prospectively operate to invalidate this Lease in whole or in part, then such clause or provision only shall be held ineffective, as though not herein contained, and the remainder of this Lease shall remain operative and in full force and effect.

SECTION 24.6 Headings . Article headings used in this Lease are inserted for convenience of reference only and shall not be deemed to be a part of this Lease for any purpose.

SECTION 24.7 Governing Law . This Lease shall be governed and construed in accordance with the laws of the State of Missouri

SECTION 24.8 Amendment . No modification, addition, deletion, change, or amendments to this Lease or any of the Appendices shall be effective unless and until such modification, addition or amendment is in writing and signed by the parties.

SECTION 24.9 Counterparts . This Lease may be executed in any number of counterparts, each of which shall be deemed to be an original and all of which together shall be deemed to be one and the same instrument.

IN WITNESS WHEREOF , the parties hereto have caused this Agreement to be duly executed on their behalf, as of the 20 ^th day of July, 2005.


		THE KANSAS CITY SOUTHERN RAILWAY COMPANY

		By:		/s/ Michael R. Haverty


		Title:		Chairman of the Board


		By:		/s/ Arthur L. Shoener


		Title:		President


		LOUISIANA SOUTHERN RAILROAD, INC.

		By:		/s/ Edward McKechnie


		Title:		Executive V.P. and Assistant Secretary


		By:		/s/ Craig Richey


		Title:		General Counsel and Assistant Secretary

EXHIBIT 10.6

LEASE AGREEMENT

Between

THE KANSAS CITY SOUTHERN RAILWAY COMPANY

and

ALABAMA SOUTHERN RAILROAD, INC.

Covering Certain Land and Track

Between Milepost 17 and End of Line at Milepost 78.9 on the
Tuscaloosa Subdivision, and
Between Tuscaloosa at Milepost 0 and End of Line at Milepost 9.3
near Fox, Ala. on the Warrior Branch,
and Between Brookwood Jct. at Milepost 443.5 and Milepost 429.1 at
Brookwood, Ala., on the Brookwood Branch

Effective as of September 25, 2005

CONTENTS


Section		Page No.
1.	Lease Premises	1

2.	Lease Term	5

3.	Rail Service	6

4.	Rent	7

5.	Conditions — Precedent	8

6.	Maintenance	9

7.	Accounting and Reporting	12

8.	Representations and Warranties	12

9.	Obligations of the Parties	13

10.	Eminent Domain	16

11.	Insurance and Indemnification	17

12.	Taxes	19

13.	Easements, Leases and Licenses	19

14.	Termination	19

15.	Force Majeure	21

16.	Defeasance	21

17	Events of Default	21

18.	Arbitration	22

19.	Compensation for Services	24

20.	Allocation of Income and Expenses	24

21.	Liens	24


Section		Page No.
22.	Reserved Rights	24

23.	Confidentiality	25

24.	Miscellaneous	26


Exhibit A		EXHIBITS

Exhibit A		Map

Exhibit B		Contracts / Agreements

Exhibit C		Interchange Agreement

Exhibit D		Divisions Agreement

LEASE AGREEMENT
TUSCALOOSA SUBDIVISION, BROOKWOOD AND WARRIOR BRANCHES

THIS LEASE AGREEMENT , dated as of this 20th day of July, 2005, by and between THE KANSAS CITY SOUTHERN RAILWAY COMPANY , a Missouri corporation, (“KCS”) and ALABAMA SOUTHERN RAILROAD, INC, a Kansas corporation (“LESSEE”).

RECITALS

LESSEE intends to lease from KCS, that certain line of railroad in the State of Alabama, Between Milepost 17 and End of Line at Milepost 78.9 on the Tuscaloosa Subdivision, and Between Tuscaloosa at Milepost 0 and End of Line at Milepost 9.3 near Fox, Ala. on the Warrior Branch, and Between Brookwood Jct. at Milepost 443.5 and Milepost 429.1 at Brookwood, Ala., on the Brookwood Branchon, a distance of approximately 85.6 miles. The Tuscaloosa Subdivision, Warrior Branch, and Brookwood Branch are hereinafter referred to as the “Leased Premises”), and are shown in solid green lines on attached Exhibit “A”.

B. The parties desire to enter into this Lease setting forth terms and conditions for the use, management and operation of the Leased Premises described above.

NOW, THEREFORE , in consideration of the foregoing and other good and valuable consideration, intending to be legally bound, the parties do hereby agree as follows:

SECTION I. LEASED PREMISES

SECTION 1.1 KCS does hereby lease to LESSEE and LESSEE does hereby lease from KCS the Leased Premises described in the Recitals above and the property described in Section 1.2.

included in or owned by said prior Lessees, said property may remain on the property to the extent permitted by the terms of the lease under which it was placed on the property.

SECTION II. LEASE TERM

continuing in effect until August 31, 2015. The “Effective Date” shall be the date five (5) days after KCS has notified LESSEE in writing that KCS has satisfactory evidence of compliance with the conditions precedent provided in Section V unless such notice period is waived by mutual agreement. Promptly following execution of this Agreement, Lessee, at its sole expense, shall prepare and file such documents as may be required (if any) to secure approval, or exemption from approval of this transaction by the Surface Transportation Board of the United States Department of Transportation (“STB”), if such approval or exemption from approval is necessary or appropriate. LESSEE shall permit KCS to review prior to filing all documents proposed by LESSEE to be filed with the STB, or any court, to secure legal approval or exemption of this transaction.

SECTION 2.2 If, subject to the right of KCS to evict or remove LESSEE from the Leased Premises by all available legal means, LESSEE holds over and remains in possession of the Leased Premises following expiration of the then current term, original or extended, or following an early termination of this Lease pursuant to Section XIV, such holding over will create a month-to-month tenancy only. During any such hold over period, LESSEE agrees to pay to KCS as monthly rent, a sum of [**] as adjusted pursuant to Section 4.4. Such monthly payments shall be due each month on the same day of the month as the Anniversary Date of this Lease. Any profits or losses from LESSEE’s operations during any holdover period shall inure and accrue to the LESSEE.

SECTION III. RAIL SERVICE

SECTION 3.2 During the term of this Lease, LESSEE:

3.2.4 [**]

SECTION IV. RENT

derived from traffic interchanged to carriers other than KCS, for purposes of this section, [**]. As additional consideration, Lessee agrees to enter into and fulfill the obligations of the Divisions Agreement attached hereto and incorporated herein as Exhibit “D”.

SECTION 4.3 Acceptance by KCS, its successors, assigns or designees of rent or other payments shall not be deemed to constitute a waiver of any other provision of this Lease.

SECTION V. CONDITIONS-PRECEDENT

SECTION 5.1 Prior to the Effective Date and as conditions precedent to either party’s obligations hereunder:

5.1.1 There shall not be a work stoppage imminent or in effect on the lines of KCS or any of its affiliated companies as a result of the execution and/or implementation of this Lease.

5.1.3 KCS and LESSEE shall not be prevented from fulfilling their respective obligations under this Lease as a result of legislative, judicial or administrative action.

5.1.4 KCS and LESSEE shall execute an interchange agreement in the form attached as Exhibit “C” whereby KCS and LESSEE will interchange traffic destined to or originating at Industries located on or served from the Leased Premises.

5.1.5 Upon execution hereof, KCS shall make available for LESSEE’s inspection and review all contracts, deeds, agreements and documents pertaining to or affecting the Leased Premises.

SECTION VI. MAINTENANCE, MODIFICATIONS AND IMPROVEMENTS

SECTION 6.1 During the term of this Lease, LESSEE shall:

6.1.3. LESSEE shall protect the Leased Premises against all encroachments or unauthorized uses. LESSEE will within one hundred eighty (180) days from the Effective Date, construct at its own expense interchange tracks and other connections or tracks (wyes, turnouts, etc., including but not limited to building two seventy five (75) car interchange tracks with yard air in the vicinity of Columbus, Ms., pursuant to the terms and conditions of the Capital Improvement Agreement executed contemporaneously with this agreement.

6.1.4 The parties agree that to the extent that traffic volumes decrease on any segment of the Leased Premises to a level that LESSEE [**]

to KCS. Such requirement shall also apply to all other facilities leased hereunder. Any repair or replacement of welded rail shall also be welded. LESSEE may make any replacement and substitute with any material having the same or higher weight and quality as the materials being replaced, without the prior written consent of the KCS, All maintenance, renewal, retirements, additions and betterments shall progressively become a part of the Leased Premises and the sole ownership of KCS.

SECTION 6.9 During the term of this Agreement, [**]

SECTION VII. ACCOUNTING AND REPORTING

SECTION VIII. REPRESENTATIONS AND WARRANTIES

SECTION 8.1 KCS represents and warrants that:

8.1.1 It has full statutory power and authority to enter into this Lease and to carry out the obligations of KCS hereunder.

8.1.2 Its execution of and performance under this Lease do not violate any statute, rule, regulation, order, writ, injunction or decree of any court, administrative agency or governmental body.

SECTION 8.2 LESSEE represents and warrants that:

8.2.3 It has full power and authority to enter into this Lease, and, subject to necessary judicial and regulatory authority, to carry out its obligations hereunder.

construed as an assumption by LESSEE of any obligations to KCS’s current or former employees under collective bargaining or other agreements that may exist or have existed between KCS and its employees, or any of them.

SECTION IX. OBLIGATIONS OF THE PARTIES

SECTION 9.4

[**]

SECTION 9.7 Regardless of any acquiescence by KCS, LESSEE will:

9.7.1 [**]

remedying such violations, pollution, or contamination by Lessee as set forth in Section 9.7.1 above.

SECTION X. EMINENT DOMAIN

cooperate with each other in the defense of such proceedings and to use their best efforts to ensure LESSEE’s continued ability to use the Leased Premises for the conduct of freight railroad operations.

SECTION XI. [**]

SECTION 11.1 [**]

[**]

SECTION 11.5 [**]

SECTION XII. TAXES

SECTION 12.1 [**]

SECTION XIII. EASEMENTS, LEASES AND LICENSES

SECTION 13.3 LESSEE shall not execute any encumbrance, lease, easement or any agreement affecting the Leased Premises, except for new Customer tracks as described in this agreement

SECTION XIV. TERMINATION

SECTION 14.1 This Lease may be terminated: as follows:

14.1.2. Pursuant to Section XVIII upon the occurrence of an Event of Default as provided in Section XVII;

14.1.5 The termination or expiration of this Agreement will not affect or impair the rights or obligations of either party arising under this Agreement prior to such termination or expiration.

discontinuance of LESSEE’s operations hereunder. In the event that LESSEE fails to make such filings, KCS may make such filings as may be appropriate to effectuate discontinuance of LESSEE’s operations of the Leased Premises, with LESSEE being responsible for all costs (including but not limited to filing fees and attorney fees) incurred by KCS in making such filings. In the event KCS makes such filings, LESSEE will not oppose the relief requested in KCS’s filings. Upon expiration or earlier termination of this Lease, KCS shall have the right to enter onto and operate the Leased Premises.

SECTION XV. FORCE MAJEURE

SECTION XVI. DEFEASANCE.

SECTION XVII. EVENTS OF DEFAULT AND BREACH

SECTION 17.1 The following shall be Events of Default:

17.1.1 Failure by LESSEE to make payments of rent when due.

SECTION XVIII. ARBITRATION

SECTION 18.1 If at any time a question or controversy involving an amount less than [**]shall arise between the parties hereto in connection with the Agreement upon which the parties cannot agree, the parties will follow the dispute resolution procedures set forth in this Section 19. No arbitrator shall have authority to change the terms or provisions of this Agreement.

SECTION 18.2 Any dispute arising out of or relating in any way to this Agreement shall be subject to arbitration under this Section in accordance with the Commercial Arbitration Rules of the American Arbitration Association. Any party may, upon 10 days’ prior notice to the other party or parties, refer the matter to arbitration hereunder. The arbitrator shall be jointly selected by the parties, but, if they do not agree on an arbitrator within thirty (30) days after demand for arbitration is made by a party, they shall request that the arbitrator be designated by the American Arbitration Association.

SECTION 18.5 The arbitrator shall make an award in writing, shall be final, binding and conclusive on all parties to the arbitration when delivered to them.

SECTION 18.9 All proceedings relating to any such arbitration, and all testimony, written submissions and award of the arbitrator therein, shall be private and

confidential as among the parties, and shall not be disclosed to any other person, except as required by law and except as reasonably necessary to prosecute or defend any judicial action to enforce, vacate or modify such arbitration award.

SECTION 18.10 The location of any arbitration proceeding held hereunder shall be agreed upon by the parties, or, if they are unable to agree, in Kansas City, Missouri.

SECTION XIX. COMPENSATION FOR SERVICES ON LEASED PREMISES

SECTION XX. ALLOCATION OF INCOME AND EXPENSES

SECTION XXI. (INTENTIONALLY OMITTED)

SECTION XXII RESERVED RIGHTS

22.1.1 All existing agreements, leases, or licenses with third parties, including any affiliates of KCS, whether recorded or not, except those assigned to LESSEE under this Lease if any; and

22.1.2 The exclusive right to prepare and enter into future agreements, leases, licenses or occupations with third parties; and

22.1.6 All rights to and the right to convey all minerals, mineral rights, and air rights in, on or under the Leased Premises.

SECTION 22.3 KCS’s exercise of the Reserved Rights in this Section 23 shall not unreasonably interfere with LESSEE’s present or reasonably contemplated freight operations under this Lease.

SECTION XXIII. CONFIDENTIALITY

confidential information that is required to be disclosed in connection with such party’s tax filings, reports, claims, audits, and litigation.

SECTION XXIV. MISCELLANEOUS

24.2.1 If intended for KCS, by mailing by registered or certified mail, return receipt requested, with postage prepaid, addressed to KCS at:

President
The Kansas City Southern Railway Company

Cathedral Square Headquarters Building
427 West 12 ^th Street
Kansas City, Missouri 64105

24.2.2 If intended for LESSEE by mailing by registered or certified mail, return receipt requested with postage prepaid, addressed to LESSEE at:

Executive Vice President Strategic Development
Alabama Southern Railroad, Inc.
315 W. Third Street
Pittsburg, KS 66762

SECTION 24.3 Employee Claims. LESSEE agrees to defend, indemnify and hold harmless KCS from any claims of LSLESSEE employees alleging they are employees of KCS.

SECTION 24.6 Headings . Article headings used in this Lease are inserted for convenience of reference only and shall not be deemed to be a part of this Lease for any purpose.

SECTION 24.7 Governing Law . This Lease shall be governed and construed in accordance with the laws of the State of Missouri

IN WITNESS WHEREOF , the parties hereto have caused this Agreement to be duly executed on their behalf, as of the ___day of ___, 2005.


		THE KANSAS CITY SOUTHERN RAILWAY
				COMPANY

		By:		/s/ Michael R. Haverty


		Title:		Chairman of the Board


		By:		/s/ Arthur L. Shoener


		Title:		President


		Alabama Southern Railroad, Inc.

		By:		/s/ Edward McKechnie


		Title:		Executive V.P. and Assistant Secretary


		By:		/s/ Craig Richey


		Title:		General Counsel and Assistant Secretary

EXHIBIT 10.7

LEASE AGREEMENT

Between

THE KANSAS CITY SOUTHERN RAILWAY COMPANY

and

ARKANSAS SOUTHERN RAILROAD, INC.

Covering Certain Land and Track

Between a point not including the 601 track switch at Ashdown, Ark.,
approximately Milepost 32 and End of Line at Milepost 0 near
Nashville, Ark., on the Nashville Branch

Effective as of September 25, 2005

CONTENTS


Section		Page No.
1.	Lease Premises		1

2.	Lease Term		5

3.	Rail Service		6

4.	Rent		7

5.	Conditions – Precedent		8

6.	Maintenance		9

7.	Accounting and Reporting		12

8.	Representations and Warranties		12

9.	Obligations of the Parties		13

10.	Eminent Domain		16

11.	Insurance and Indemnification		17

12.	Taxes		19

13.	Easements, Leases and Licenses		19

14.	Termination		19

15.	Force Majeure		21

16.	Defeasance		21

17	Events of Default		21

18.	Arbitration		22

19.	Compensation for Services		24

20.	Allocation of Income and Expenses		24

21.	Liens		24


Section		Page No.
22.	Reserved Rights		24

23.	Confidentiality		25

24.	Miscellaneous		26

EXHIBITS


Exhibit A		Map

Exhibit B		Contracts / Agreements

Exhibit C		Interchange Agreement

Exhibit D		Divisions Agreement

LEASE AGREEMENT

NASHVILLE BRANCH

THIS LEASE AGREEMENT , dated as of this 20th day of July, 2005, by and between THE KANSAS CITY SOUTHERN RAILWAY COMPANY , a Missouri corporation, (“KCS”) and ARKANSAS SOUTHERN RAILROAD, INC, a Kansas corporation (“LESSEE”).

RECITALS

A. LESSEE intends to lease from KCS, that certain line of railroad in the State of Arkansas, on the Nashville Branch extending between a point between a point not including the 601 track switch at Ashdown, Ark., approximately Milepost 32 and End of Line at Milepost 0 near Nashville, Ark. a distance of approximately 32 miles. The Nashville Branch is hereinafter referred to as the “Leased Premises”), and are shown in solid green lines on attached Exhibit “A”.

B. The parties desire to enter into this Lease setting forth terms and conditions for the use, management and operation of the Leased Premises described above.

NOW, THEREFORE , in consideration of the foregoing and other good and valuable consideration, intending to be legally bound, the parties do hereby agree as follows:

SECTION I. LEASED PREMISES

SECTION 1.1 KCS does hereby lease to LESSEE and LESSEE does hereby lease from KCS the Leased Premises described in the Recitals above and the property described in Section 1.2.

SECTION II. LEASE TERM

period is waived by mutual agreement. Promptly following execution of this Agreement, Lessee, at its sole expense, shall prepare and file such documents as may be required (if any) to secure approval, or exemption from approval of this transaction by the Surface Transportation Board of the United States Department of Transportation (“STB”), if such approval or exemption from approval is necessary or appropriate. LESSEE shall permit KCS to review prior to filing all documents proposed by LESSEE to be filed with the STB, or any court, to secure legal approval or exemption of this transaction.

SECTION 2.2 If, subject to the right of KCS to evict or remove LESSEE from the Leased Premises by all available legal means, LESSEE holds over and remains in possession of the Leased Premises following expiration of the then current term, original or extended, or following an early termination of this Lease pursuant to Section XIV, such holding over will create a month-to-month tenancy only. During any such hold over period, LESSEE agrees to pay to KCS as monthly rent, a sum [**] as adjusted pursuant to Section 4.4. Such monthly payments shall be due each month on the same day of the month as the Anniversary Date of this Lease. Any profits or losses from LESSEE’s operations during any holdover period shall inure and accrue to the LESSEE.

SECTION III. RAIL SERVICE

SECTION 3.2 During the term of this Lease, LESSEE:

3.2.1 will not suspend or discontinue its operation as a common carrier by rail over all or any part of the Leased Premises without first applying for and

3.2.2 obtaining from the Surface Transportation Board (“STB”), and any other regulatory agency with jurisdiction, any necessary certificate of public convenience and necessity or other approvals or exemptions from regulation for such discontinuance of operations over the Leased Premises; provided, however, that LESSEE will not seek such regulatory authority, or if no regulatory authority is needed, take any action to suspend or discontinue its operations on the Leased Premises, without first giving KCS six (6) months’ advance written notice of LESSEE’s intent to do so.

3.2.3 agrees to offer freight transportation services on the Leased Premises, to all shippers on the Leased Premises as least at the levels in place on the Effective Date of this Lease Agreement and sufficient to comply with all current contracts with shippers located on the Leased Premises.

3.2.4 agrees to fulfill all service requirements of existing transportation contracts to the extent such services involve services formerly provided on Leased Premises. LESSEE agrees to comply with the terms of all existing agreements related to the use of the Leased Premises including but not limited to: car cleaning contracts, crossing agreements, interlocker agreements and joint facility agreements, as shown on Exhibit “B”.

3.2.4 [**]

SECTION IV. RENT

SECTION 4.1 LESSEE agrees to pay KCS rent for the Leased Premises, payable annually in advance on the 1st day of September, the amount of [**] for the annual period for which the rent is due. In calculating the percentage of revenue derived from traffic interchanged to carriers other than KCS, for purposes of this section, [**]. As additional consideration, Lessee agrees to enter into and fulfill the

obligations of the Divisions Agreement attached hereto and incorporated herein as Exhibit “D”.

SECTION 4.3 Acceptance by KCS, its successors, assigns or designees of rent or other payments shall not be deemed to constitute a waiver of any other provision of this Lease.

SECTION V. CONDITIONS-PRECEDENT

SECTION 5.1 Prior to the Effective Date and as conditions precedent to either party’s obligations hereunder:

5.1.1 There shall not be a work stoppage imminent or in effect on the lines of KCS or any of its affiliated companies as a result of the execution and/or implementation of this Lease.

5.1.3 KCS and LESSEE shall not be prevented from fulfilling their respective obligations under this Lease as a result of legislative, judicial or administrative action.

5.1.5 Upon execution hereof, KCS shall make available for LESSEE’s inspection and review all contracts, deeds, agreements and documents pertaining to or affecting the Leased Premises.

SECTION VI. MAINTENANCE, MODIFICATIONS AND IMPROVEMENTS

SECTION 6.1 During the term of this Lease, LESSEE shall:

6.1.3. LESSEE shall protect the Leased Premises against all encroachments or unauthorized uses.

6.1.4 The parties agree that to the extent that traffic volumes decrease on any segment of the Leased Premises to a level that [**].

SECTION 6.5 In connection with its use of the Leased Premises, LESSEE shall have the right to replace, add to or relay elements of the Leased Premises in the interest of cost or operating efficiency provided that, a continuous and usable line of railroad between the termini in effect on the Effective Date is maintained and that all items removed are replaced with similar items of the same or higher quality, greater weight and higher value and provided that the work being performed by the LESSEE and the materials being provided by the LESSEE are sufficient to maintain the trackage to the standards set forth in Section 6.1 and any modifications conform with KCS’s then current engineering standards. LESSEE shall have the right to apply the net proceeds from salvaged materials to maintenance or improvement of the Leased Premises; provided that any such net proceeds not reinvested in the Leased Premises shall be paid to KCS. Such requirement shall also apply to all other facilities leased hereunder. Any repair or replacement of welded rail shall also be welded. LESSEE may make any replacement and substitute with any material having the same or higher weight and quality as the materials being replaced, without the prior written consent of the KCS, All maintenance, renewal, retirements, additions and betterments shall progressively become a part of the Leased Premises and the sole ownership of KCS.

SECTION 6.9 During the term of this Agreement, LESSEE shall be[**].

SECTION VII. ACCOUNTING AND REPORTING

annual basis on or before May 1 of each year for the term of this lease. Copies of unaudited financial reports pertaining to LESSEE and the Leased Premises prepared in the normal course of LESSEE’s business shall be provided to Lessor on a quarterly basis. KCS shall take the same precautions to protect the confidentiality of non-public financial information provided under this Section that it uses to protect its own confidential non-public financial information.

SECTION VIII. REPRESENTATIONS AND WARRANTIES

SECTION 8.1 KCS represents and warrants that:

8.1.1 It has full statutory power and authority to enter into this Lease and to carry out the obligations of KCS hereunder.

8.1.2 Its execution of and performance under this Lease do not violate any statute, rule, regulation, order, writ, injunction or decree of any court, administrative agency or governmental body.

SECTION 8.2 LESSEE represents and warrants that:

8.2.1 It is a corporation duly organized, validly existing, and in good standing under the laws of the State of Kansas and by the effective date shall be is qualified to do business in the State of Arkansas.

8.2.3 It has full power and authority to enter into this Lease, and, subject to necessary judicial and regulatory authority, to carry out its obligations hereunder.

SECTION IX. OBLIGATIONS OF THE PARTIES

pay, any such bills, LESSEE will promptly reimburse KCS upon receipt of a bill or bills therefor. If the Leased Premises are not billed separately but as a part of a larger tract or parcel, LESSEE shall pay that portion of such bills as is attributable to usage on or in connection with the Leased Premises.

SECTION 9.4

[**]

To the extent practicable, such written notice will identify the substance releases, the amount released, and the measures undertaken to clean up and remove the released material and any contaminated soil or water, will identify the nature and extent of the alleged violation and the measures taken to eliminate the violation, and will certify that LESSEE has complied with all applicable regulations, orders, judgments or decrees in connection therewith, or the date by which such compliance is expected. LESSEE will also provide KCS with copies of any and all reports made to any governmental agency that relate to such releases or such alleged violations during the term of this Lease.

SECTION 9.7 Regardless of any acquiescence by KCS, LESSEE will:

9.7.1 [**]

SECTION X. EMINENT DOMAIN

SECTION XI. [**]

SECTION 11.1 [**]

[**]

SECTION 11.5 [**]

SECTION XII. TAXES

SECTION 12.1 [**]

SECTION XIII. EASEMENTS, LEASES AND LICENSES

SECTION 13.3 LESSEE shall not execute any encumbrance, lease, easement or any agreement affecting the Leased Premises, except for new Customer tracks as described in this agreement

SECTION XIV. TERMINATION

SECTION 14.1 This Lease may be terminated: as follows:

14.1.2. Pursuant to Section XVIII upon the occurrence of an Event of Default as provided in Section XVII;

14.1.5 The termination or expiration of this Agreement will not affect or impair the rights or obligations of either party arising under this Agreement prior to such termination or expiration.

SECTION XV. FORCE MAJEURE

SECTION XVI. DEFEASANCE.

SECTION XVII. EVENTS OF DEFAULT AND BREACH

SECTION 17.1 The following shall be Events of Default:

17.1.1 Failure by LESSEE to make payments of rent when due.

SECTION XVIII. ARBITRATION

they shall request that the arbitrator be designated by the American Arbitration Association.

SECTION 18.5 The arbitrator shall make an award in writing, shall be final, binding and conclusive on all parties to the arbitration when delivered to them.

SECTION 18.10 The location of any arbitration proceeding held hereunder shall be agreed upon by the parties, or, if they are unable to agree, in Kansas City, Missouri.

SECTION XIX. COMPENSATION FOR SERVICES ON LEASED PREMISES

SECTION XX. ALLOCATION OF INCOME AND EXPENSES

SECTION XXI. (INTENTIONALLY OMITTED)

SECTION XXII RESERVED RIGHTS

22.1.1 All existing agreements, leases, or licenses with third parties, including any affiliates of KCS, whether recorded or not, except those assigned to LESSEE under this Lease if any; and

22.1.2 The exclusive right to prepare and enter into future agreements, leases, licenses or occupations with third parties; and

facilities to existing bridges and to install them in existing tunnels, and the right of ingress and egress for access purposes; and

22.1.6 All rights to and the right to convey all minerals, mineral rights, and air rights in, on or under the Leased Premises.

SECTION 22.3 KCS’s exercise of the Reserved Rights in this Section 23 shall not unreasonably interfere with LESSEE’s present or reasonably contemplated freight operations under this Lease.

SECTION XXIII. CONFIDENTIALITY

SECTION XXIV. MISCELLANEOUS

24.2.1 If intended for KCS, by mailing by registered or certified mail, return receipt requested, with postage prepaid, addressed to KCS at:

President
The Kansas City Southern Railway Company
Cathedral Square Headquarters Building
427 West 12 ^th Street
Kansas City, Missouri 64105

24.2.2 If intended for LESSEE by mailing by registered or certified mail, return receipt requested with postage prepaid, addressed to LESSEE at:

Executive Vice President Strategic Development
Arkansas Southern Railroad, Inc.
315 W. Third Street
Pittsburg, KS 66762

SECTION 24.3 Employee Claims. LESSEE agrees to defend, indemnify and hold harmless KCS from any claims of LSLESSEE employees alleging they are employees of KCS.

SECTION 24.6 Headings . Article headings used in this Lease are inserted for convenience of reference only and shall not be deemed to be a part of this Lease for any purpose.

SECTION 24.7 Governing Law . This Lease shall be governed and construed in accordance with the laws of the State of Missouri

IN WITNESS WHEREOF , the parties hereto have caused this Agreement to be duly executed on their behalf, as of the 20 ^th day of July, 2005.


		THE KANSAS CITY SOUTHERN RAILWAY
		COMPANY

		By:		/s/ Michael R. Haverty

		Title:		Chairman of the Board


		By:		/s/ Arthur L. Shoener

		Title:		President


		Arkansas Southern Railroad, Inc.

		By:		/s/ Edward McKechnie

		Title:		Executive V.P. and Assistant Secretary


		By:		/s/ Craig Richey

		Title:		General Counsel and Assistant Secretary

EXHIBIT 10.8

LEASE AGREEMENT

Between

THE KANSAS CITY SOUTHERN RAILWAY COMPANY

and

ARKANSAS SOUTHERN RAILROAD, INC.

Covering Certain Land and Track

Between Milepost 4 near Heavener, Ok., and End of Line at Milepost
33 on the Waldron Branch

Effective as of September 25, 2005

CONTENTS


Section		Page No.
1.	Lease Premises		1

2.	Lease Term		5

3.	Rail Service		6

4.	Rent		7

5.	Conditions – Precedent		8

6.	Maintenance		9

7.	Accounting and Reporting		12

8.	Representations and Warranties		12

9.	Obligations of the Parties		13

10.	Eminent Domain		16

11.	Insurance and Indemnification		17

12.	Taxes		19

13.	Easements, Leases and Licenses		19

14.	Termination		19

15.	Force Majeure		21

16.	Defeasance		21

17	Events of Default		21

18.	Arbitration		22

19.	Compensation for Services		24

20.	Allocation of Income and Expenses		24

21.	Liens		24


Section		Page No.
22.	Reserved Rights		24

23.	Confidentiality		25

24.	Miscellaneous		26

EXHIBITS


Exhibit A		Map

Exhibit B		Contracts / Agreements

Exhibit C		Interchange Agreement

Exhibit D		Divisions Agreement

LEASE AGREEMENT

WALDRON BRANCH

RECITALS

A. LESSEE intends to lease from KCS, that certain line of railroad in the State of Arkansas, on the Waldron Branch extending between Milepost 4 near Heavener, Ok., and End of Line at Milepost 33, a distance of approximately 29 miles. The Waldron Branch is hereinafter referred to as the “Leased Premises”), and are shown in solid green lines on attached Exhibit “A”.

B. The parties desire to enter into this Lease setting forth terms and conditions for the use, management and operation of the Leased Premises described above.

NOW, THEREFORE , in consideration of the foregoing and other good and valuable consideration, intending to be legally bound, the parties do hereby agree as follows:

SECTION I. LEASED PREMISES

SECTION 1.1 KCS does hereby lease to LESSEE and LESSEE does hereby lease from KCS the Leased Premises described in the Recitals above and the property described in Section 1.2.

SECTION II. LEASE TERM

V unless such notice period is waived by mutual agreement. Promptly following execution of this Agreement, Lessee, at its sole expense, shall prepare and file such documents as may be required (if any) to secure approval, or exemption from approval of this transaction by the Surface Transportation Board of the United States Department of Transportation (“STB”), if such approval or exemption from approval is necessary or appropriate. LESSEE shall permit KCS to review prior to filing all documents proposed by LESSEE to be filed with the STB, or any court, to secure legal approval or exemption of this transaction.

SECTION 2.2 If, subject to the right of KCS to evict or remove LESSEE from the Leased Premises by all available legal means, LESSEE holds over and remains in possession of the Leased Premises following expiration of the then current term, original or extended, or following an early termination of this Lease pursuant to Section XIV, such holding over will create a month-to-month tenancy only. During any such hold over period, LESSEE agrees to pay to KCS as monthly rent, a sum of [**], as adjusted pursuant to Section 4.4. Such monthly payments shall be due each month on the same day of the month as the Anniversary Date of this Lease. Any profits or losses from LESSEE’s operations during any holdover period shall inure and accrue to the LESSEE.

SECTION III. RAIL SERVICE

SECTION 3.2 During the term of this Lease, LESSEE:

3.2.1 will not suspend or discontinue its operation as a common carrier by rail over all or any part of the Leased Premises without first applying for and

3.2.4 [**]

SECTION IV. RENT

SECTION 4.1 LESSEE agrees to pay KCS rent for the Leased Premises, payable annually in advance on the 1st day of September, the amount of [**] for the annual period for which the rent is due. In calculating the percentage of revenue derived from traffic interchanged to carriers other than KCS, for purposes of this section,[**] As additional consideration, Lessee agrees to enter into and fulfill the obligations of the Divisions Agreement attached hereto and incorporated herein as Exhibit “D”.