KANSAS CITY SOUTHERN (Form: 10-K, Received: 04/07/2006 17:16:19)

/s/ Amanda E. Burger

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K


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

		FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005

OR
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 registrant as specified in its charter)


Delaware		44-0663509
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
427 West 12 ^th Street Kansas City, Missouri (Address of principal executive offices)		64105 (Zip Code)

(816) 983-1303

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered

Preferred Stock, Par Value $25 Per Share, 4%, Noncumulative		New York Stock Exchange
	Common Stock, $.01 Per Share Par Value	New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of June 30, 2005, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $1,650 million based on the closing sale price of $20.18 as reported on the New York Stock Exchange.

As of March 31, 2006 there were 75,273,618 shares of $.01 par common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Company’s Definitive Proxy Statement for the 2006 Annual Meeting of Stockholders which will be filed no later than 120 days after December 31, 2005 are incorporated by reference in Part I and III.

KANSAS CITY SOUTHERN

2005 FORM 10-K ANNUAL REPORT

Table of Contents


		Page

PART I
Item 1.	Business		3
Item 1A.	Risk Factors		11
Item 1B.	Unresolved Staff Comments		19
Item 2.	Properties		19
Item 3.	Legal Proceedings		21
Item 4.	Submission of Matters to a Vote of Security Holders		21
	Executive Officers of the Company		22

PART II
Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		23
Item 6.	Selected Financial Data		26
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		26
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		61
Item 8.	Financial Statements and Supplementary Data		63
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		132
Item 9A.	Controls and Procedures		132
Item 9B.	Other Information		133

PART III
Item 10.	Directors and Executive Officers of the Registrant		133
Item 11.	Executive Compensation		134
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		134
Item 13.	Certain Relationships and Related Transactions		134
Item 14.	Principal Accountant Fees and Services		134

PART IV
Item 15.	Exhibits, Financial Statement Schedules		135
Signatures			143
Employment Agreement
Transaction Agreement
Amendment No.1 to Transaction Agreement
Participation Agreement
Equipment and Lease Agreement
Commitment Letter
Computation of Ratio of Earnings to Fixed Charges
Subsidiaries of the Company
Consent of KPMG LLP
Consent of PricewaterhouseCoopers LLP
Certification
Certification
Section 1350 Certifications
Financial Statements

Part I


Item 1.	*Business*

COMPANY OVERVIEW

Kansas City Southern (“we”, “our”, “KCS”, “the Company” or “the Registrant”), a Delaware corporation, is a holding company with principal operations in rail transportation.

We are a holding company that owns and operates uniquely positioned domestic and international rail operations in North America that are strategically focused on the growing north/south freight corridor connecting key commercial and industrial markets in the central U.S. with major industrial cities in Mexico. The Kansas City Southern Railway Company (“KCSR”), which was founded in 1887, is one of seven Class I railroads. KCSR serves a ten-state region in the Midwest and southern parts of the U.S. and has the shortest north/south rail route between Kansas City, Missouri and several key ports along the Gulf of Mexico in Alabama, Louisiana, Mississippi and Texas.

We control and own all of the stock of Kansas City Southern de México, S.A. de C.V. (“KCSM”), formerly known as TFM, S.A. de C.V., through our wholly owned subsidiary, Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”). On December 2, 2005, the name of KCSM was formally changed to Kansas City Southern de México, S.A. de C.V. KCSM operates a primary commercial corridor of the Mexican railroad system and has as its core route a key portion of the shortest, most direct rail passageway between Mexico City and Laredo, Texas. KCSM serves most of Mexico’s principal industrial cities and three of its major shipping ports. KCSM’s rail lines are the only ones that serve Nuevo Laredo, Tamaulipas, the largest rail freight interchange point between the U.S. and Mexico. KCSM, through its concession with the Mexican government (the “Concession”), has the right to control and operate the southern half of the rail-bridge at Nuevo Laredo.

We own, directly and indirectly, through our wholly-owned subsidiaries, 100% of Mexrail, Inc. (“Mexrail”). Mexrail owns 100% of Texas Mexican Railway Company (“Tex-Mex”). Tex-Mex operates a 157-mile rail line extending from Laredo to the port city of Corpus Christi, Texas and connects the operations of KCSR with KCSM. Tex-Mex connects with KCSM at the U.S./ Mexico border at Laredo and connects to KCSR through trackage rights at Beaumont, Texas. Through our ownership in Mexrail, we own the northern half of the rail-bridge at Laredo, Texas, which spans the Rio Grande River between the U.S. and Mexico. Laredo is a principal international gateway through which more than 50% of all rail and truck traffic between the U.S. and Mexico crosses the border.

Our rail network (KCSR, KCSM and Tex-Mex) extends from the Midwest and Southeastern portions of the U.S. south into Mexico and connects with all other Class I railroads providing shippers with an effective alternative to other railroad routes and giving direct access to Mexico and the southeastern and southwestern U.S. through less congested interchange hubs.

We also own 50% of the stock of the Panama Canal Railway Company (“PCRC”), which holds the concession to operate a 47-mile coast-to -coast railroad located adjacent to the Panama Canal. The railroad handles containers in freight service across the isthmus. Panarail Tourism Company (“Panarail”), a wholly owned subsidiary of PCRC, operates commuter and tourist railway services over the lines of the PCRC.

Other subsidiaries and affiliates of KCS include the following:


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

	•	Transfin Insurance, Ltd., a wholly-owned and consolidated captive insurance company, providing property, general liability and certain other insurance coverage to KCS and its subsidiaries and affiliates;

	•	Trans-Serve, Inc., (d/b/a Superior Tie and Timber; “ST&T”), a wholly-owned and consolidated operator of a railroad wood tie treating facility; and


	•	PABTEX GP, LLC (“Pabtex”), a wholly-owned and consolidated owner of a bulk materials handling facility with deep-water access to the Gulf of Mexico at Port Arthur, Texas that stores and transfers petroleum coke and soda ash from trucks and rail cars to ships, primarily for export.

KCS was organized in 1962 as Kansas City Southern Industries, Inc., and in 2002 formally changed its name to Kansas City Southern. KCS, as the holding company, supplies its various subsidiaries with managerial, legal, tax, financial and accounting services, in addition to managing other minor “non-operating” investments.

Further discussion of the Company’s business, including equipment and business sectors, is incorporated by reference from Item 2, “Properties.”

The information set forth in response to Item 101 of Regulation S-K under Part II Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Form 10-K is incorporated by reference in partial response to this Item 1.

Available Information

Our Internet address is www.kcsi.com. Through this website, we make available, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after electronic filing or furnishing of these reports with the Securities and Exchange Commission. In addition, our corporate governance guidelines, ethics and legal compliance policy, and the charters of the Audit Committee, the Nominating and Corporate Governance Committee and the Compensation and Organization Committee of our Board of Directors are available on our Internet website. These guidelines, policies, and charters are available in print to any stockholder who requests them. Written requests may be made to the Corporate Secretary of KCS, P.O. Box 219335, Kansas City, Missouri 64121-9335 (or if by UPS or other form of express delivery to 427 West 12th Street, Kansas City, Missouri 64105).

OWNED RAIL NETWORK


	*KCSR*

KCSR has the shortest north/south rail route between Kansas City and several key ports along the Gulf of Mexico in Alabama, Louisiana, Mississippi and Texas. KCSR’s rail route includes the Meridian Speedway, linking Meridian, Mississippi and Dallas, Texas, and the east/west route linking Kansas City with East St. Louis, Illinois and Springfield, Illinois. In addition, KCSR has limited haulage rights between Springfield and Chicago that allow for originating or terminating shipments. The geographic reach of KCSR provides service to a diverse customer base that includes electric generating utilities, which use coal, and a wide range of companies in the chemical and petroleum, agricultural and mineral, forest products and metals, and automotive industries.

Eastern railroads and their customers can use our rail network to bypass the gateways at Chicago, Illinois; St. Louis, Missouri; and Memphis, Tennessee by interchanging with KCSR at Springfield and East St. Louis and at Meridian and Jackson, Mississippi. Other railroads connect with our rail network at Kansas City, Missouri; Birmingham, Alabama; and Shreveport, Louisiana; and Dallas, Beaumont and Laredo, Texas. KCSR revenues and net income are dependent on providing reliable service to customers at competitive rates, the general economic conditions in the geographic region served and the ability to effectively compete against other rail carriers and alternative modes of transportation, such as over-the -road truck transportation and barges. The ability of KCSR to maintain the roadway in order to provide safe and efficient transportation service is important to its ongoing viability as a rail carrier. Additionally, cost containment is important in maintaining a competitive market position, particularly with respect to employee costs, as approximately 82% of KCSR’s employees are covered under various collective bargaining agreements.


	*Mexrail*

On August 16, 2004, KCS entered into an agreement with KCSM to purchase Mexrail shares representing 51% ownership of Mexrail for approximately $32.7 million. Mexrail owns all of the shares of Tex-Mex. The Mexrail shares were placed in a voting trust pending regulatory approval by the Surface Transportation Board (“STB”) of KCS’s common control of Tex-Mex, KCSR and the Gateway Eastern Railway Company (“Gateway Eastern”). On November 29, 2004, the STB approved KCS’s application for authority to control Tex-Mex and the U.S. portion of the International Rail Bridge at Laredo. That authority became final on December 29, 2004. On January 1, 2005, the shares representing 51% of Mexrail were released from the voting trust to KCS, and KCS took control of Tex-Mex. Through its acquisition of KCSM, the Company controls 100% of the shares of Mexrail and Tex-Mex.

Tex-Mex connects to KCSR through trackage rights over the rail lines of the Union Pacific Railroad Company (“UP”) between Robstown and Beaumont, and Texas. These trackage rights were granted pursuant to a 1996 STB decision and have an initial term of 99 years.

KCSR is in the process of adopting the Tex-Mex stations on the Tex-Mex line. Effective April 1, 2006, Tex-Mex will cease engaging in the business of line haul freight operations. Rather, pursuant to the terms of a trackage agreement between KCSR and Tex-Mex, Tex-Mex will move KCSR freight trains over Tex-Mex’s rail lines using TexMex crews. As part of this change in Tex-Mex’s operations, Tex-Mex will assign its trackage agreements with UP and Houston Belt & Terminal to KCSR.

On March 12, 2001, Tex-Mex purchased from UP a line of railroad right-of -way extending 84.5 miles between Rosenberg, Texas and Victoria, Texas, and UP granted Tex-Mex trackage rights to access the line from the existing trackage rights. The line is not in service, but extensive reconstruction is being planned. Once reconstruction of the line is completed, Tex-Mex will be able to shorten its existing route between Corpus Christi and Houston, Texas by over 70 miles.


	*KCSM*

In December 1995, we entered into a joint venture agreement with Transportación Marítima Mexicana, S.A. de C.V., currently known as Grupo TMM, S.A. (“TMM”) to, among other things, provide for participation in the privatization of the Mexican national railway system and to promote the movement of rail traffic over Tex-Mex, KCSM and KCSR. Pursuant to written notice given by TMM, and in accordance with its terms, the joint venture agreement was terminated on December 1, 2003.

In 1997, we invested $298 million to obtain a 36.9% interest in Grupo TFM, the company formed by KCS and TMM under the joint venture agreement for the purpose of participating in the privatization of the Mexican national railway system. At the time that Grupo TFM purchased 80% of the shares of KCSM, TMM, the largest shareholder of Grupo TFM, owned 38.5% of Grupo TFM and the Mexican government owned the remaining 24.6% of Grupo TFM. As more fully described in “Note 3 — Investments and Acquisitions,” included under Part II Item 8, “Financial Statements and Supplementary Data” of this Form 10-K and incorporated herein by reference, in 2005, we acquired the remaining ownership interests of Grupo TFM from TMM and the Mexican government to result in our full ownership and consolidation of Grupo TFM.


	Acquisition of Grupo TFM.

April 1, 2005 — Acquisition Agreement. On December 15, 2004, the Company entered into the Amended and Restated Acquisition Agreement (the “Acquisition Agreement”). Under the terms of the Acquisition Agreement, KCS acquired all of TMM’s 48.5% effective interest in Grupo TFM on April 1, 2005 in exchange 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 $27.5 million in transaction costs for a total purchase price of $594.4 million. 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.

September 12, 2005 — Completion of VAT/ Put Settlement. On September 12, 2005, the Company and its subsidiaries, KCSM and Grupo TFM, along with TMM, entered into a settlement agreement with the Mexican government, resolving the controversies and disputes between the companies and the Mexican government concerning the payment of a value added tax (“VAT”) refund to KCSM and the obligation (“Put”) to purchase the remaining shares of KCSM owned by the Mexican government (the “VAT/ Put Settlement”). As a result of the VAT/ Put Settlement, KCS and its subsidiaries now own 100% of Grupo TFM and KCSM shares; the potential obligation of KCS, Grupo TFM and TMM to acquire the Mexican government’s remaining 20% ownership of KCSM has been eliminated; and the legal obligation of the Mexican government to issue the VAT refund to KCSM has been satisfied. There was no cash exchanged between the parties to the settlement agreement. In addition, the parties entered into mutual releases of all existing and potential claims relating to the VAT refund and the Put obligation, and entered into an agreement to dismiss all of the existing litigation between the parties. The VAT/ Put Settlement had two separate impacts — first, the resolution of a preacquisition contingency related to the April 1, 2005 transaction and second, KCSM’s acquisition of the minority interest in KCSM which was held by the Mexican government.

KCSM holds the Concession, which was awarded by the Mexican government in 1996, to operate Mexico’s Northeast Rail Lines (the Northeast Rail Lines are now known as “KCSM”) for 50 years ending in June 2047. Subject to certain conditions, KCSM has an option to extend the Concession for an additional 50 years. The Concession is subject to certain mandatory trackage rights and is exclusive until 2027. The Mexican government, however, may revoke KCSM’s exclusivity after 2017 if it determines that there is insufficient competition, and may terminate the Concession as a result of certain conditions or events, including (1) KCSM’s failure to meet its operating and financial obligations with regard to the Concession under applicable Mexican law, (2) a statutory appropriation by the Mexican government for reasons of public interest and (3) liquidation or bankruptcy of KCSM. KCSM’s assets and its rights under the Concession may, under certain circumstances such as natural disaster, war or other similar situations, also be seized temporarily by the Mexican government.

Under the Concession, KCSM operates a strategically significant corridor between Mexico and the U.S., and has as its core route a key portion of the shortest, most direct rail passageway between Mexico City and Laredo. KCSM’s rail lines are the only ones that serve Nuevo Laredo, the largest rail freight exchange point between the U.S. and Mexico. KCSM’s rail lines connect the most populated and industrialized regions of Mexico with Mexico’s principal U.S. border railway gateway at Laredo. In addition, KCSM serves three of Mexico’s primary seaports at Veracruz and Tampico on the Gulf of Mexico and Lazaro Cardenas on the Pacific Ocean. KCSM has the right to operate the rail lines through the Concession, but does not own the land, roadway or associated structures. Through KCSR, and its interchanges with other major U.S. railroads, KCSM provides its customers with access to an extensive rail network through which they may distribute their products throughout North America and overseas.

SIGNIFICANT INVESTMENTS


	*Panama Canal Railway Company*

In January 1998, the Republic of Panama awarded PCRC, a joint venture company formed by KCS and Mi-Jack Products, Inc., the concession to reconstruct and operate the Panama Canal Railway, a 47-mile railroad located adjacent to the Panama Canal that provides international shippers with a railway transportation option to complement the Panama Canal. The Panama Canal Railway, which traces its origins back to the late 1800s, is a north-south railroad traversing the Panama isthmus between the Pacific and Atlantic Oceans. The railroad has been reconstructed and resumed freight operations in December 2001. While only 47 miles long, management believes the Panama Canal Railway provides a unique opportunity to participate in transoceanic shipments as a complement to the existing Panama Canal traffic. Management believes the potential for this railroad is in the service of shipping customers who need to

reposition containers between the ports of Balboa and Colon without passing through the Canal. In addition, there is demand for passenger traffic for both commuter and pleasure/tourist travel. Panarail operates and promotes commuter and tourist passenger service over the Panama Canal Railway. Passenger service started during July 2001.

As of December 31, 2005, we have invested approximately $30.4 million toward the reconstruction and operations of the Panama Canal Railway. This investment is comprised of $12.9 million of equity and $17.5 million of subordinated loans. These loans carry a 10% interest rate and are payable on demand, subject to certain restrictions.

In November 1999, PCRC completed the financing for the reconstruction project with the International Finance Corporation (“IFC”), a member of the World Bank Group. The IFC’s investment of $5 million in PCRC was comprised of non-voting preferred shares, which paid a 10% cumulative dividend. On March 28, 2005, PCRC and the 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. At December 31, 2004, these shares had a recorded value of $5.0 million and approximately $2.6 million in accrued unpaid dividends. PCRC recorded an additional cost of approximately $2.9 million to reflect the premium paid to IFC and, 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.


	*Southern Capital*

In 1996, KCSR and GATX Capital Corporation (“GATX”) formed a 50-50 joint venture — Southern Capital — to perform certain leasing and financing activities. Southern Capital’s operations consist primarily of the acquisition of locomotives and other rail equipment and the leasing thereof to KCSR. Concurrent with the formation of this joint venture, KCSR entered into operating leases with Southern Capital for substantially all the locomotives and rolling stock that KCSR contributed or sold to Southern Capital at the time of formation of the joint venture. GATX contributed cash in the joint venture transaction formation.


	*Ferrocarril y Terminal Del Valle De México, S.A. De C.V. (The Mexico Valley Railway and Terminal or “FTVM”)*

FTVM was incorporated as a sociedad anonima de capital variable (variable capital corporation), under the laws of Mexico. The Corporate purpose of the company is to provide railroad services as well as ancillary services, including those related to interconnection, switching and haulage services. KCSM holds 25.0% of the share capital of FTVM. The other shareholders of FTVM, each holding a 25.0% interest, are Ferrocarril Mexicano, S.A. de C.V., Ferrocarril del Sureste, S.A. de C.V. and the Mexican Government.

HAULAGE RIGHTS

As a result of the 1988 acquisition of the Missouri-Kansas-Texas Railroad by UP, KCSR was granted (1) haulage rights between Kansas City and each of Council Bluffs, Iowa, Omaha and Lincoln, Nebraska and Atchison and Topeka, Kansas, and (2) a joint rate agreement for our grain traffic between Beaumont and each of Houston and Galveston, Texas. KCSR has the right to convert these haulage rights to trackage rights. KCSR’s haulage rights require UP to move KCSR traffic in UP trains; trackage rights would allow KCSR to operate its trains over UP tracks. These rights have a term of 199 years. In addition, KCSR has limited haulage rights between Springfield and Chicago for shipments that originate or terminate on the former Gateway Western rail lines.

MARKETS SERVED

Through its principal operating subsidiaries, KCSR and KCSM, KCS serves the following markets.


	Percentage of KCS
Commodity Group	Revenues in 2005

Chemical and petroleum		18.3	%
Forest products and metals		26.7	%
Agricultural and mineral		25.8	%
Intermodal and automotive		15.4	%
Coal		9.0	%
Other		4.8	%


	*Chemical and Petroleum*

KCS’s subsidiaries transport chemical and petroleum products via tank and hopper cars to markets in the southeast and northeast U.S. and throughout Mexico through interchanges with other rail carriers. Primary traffic includes plastics, petroleum and oils, petroleum coke, rubber, and miscellaneous chemicals.


	*Forest Products and Metals*

KCSR’s rail lines run through the heart of the southeastern U.S. timber-producing region. We believe that forest products made from trees in this region are generally less expensive than those from other regions due to lower production costs. As a result, southern yellow pine products from the southeast are increasingly being used at the expense of western producers that have experienced capacity reductions because of public policy considerations. KCSR serves paper mills directly and indirectly through short-line connections.

This product category includes metals, minerals and ores such as iron, steel, zinc and copper. The majority of metals, minerals and ores mined, and steel produced in Mexico are used for domestic consumption. The volume of Mexican steel exports fluctuates based on global market prices. Higher-end finished products such as steel coils used by Mexican manufacturers in automobiles, household appliances and other consumer goods are imported through Nuevo Laredo and through the seaports served by our rail lines. U.S. slab steel products are used primarily in the manufacture of drill pipe for the oil industry.


	*Agricultural and Mineral*

Agricultural products consist of grain, food and related products. Shipper demand for agricultural products is affected by competition among sources of grain and grain products, as well as price fluctuations in international markets for key commodities. In the U.S., KCSR’s rail lines receive and originate shipments of grain and grain products for delivery to feed mills serving the poultry industry. Through its marketing agreements, KCSR has access to sources of corn and other grain in Iowa and other Midwestern states. KCSR currently serves feed mills along its rail lines throughout Arkansas, Oklahoma, Texas, Louisiana, Mississippi and Alabama. U.S. export grain shipments and Mexico import grain shipments include primarily wheat, soybeans and corn transported to Mexico via Laredo and to the Gulf of Mexico for overseas destinations. Over the long term, U.S. export grain shipments are expected to increase as a result of Mexico’s reliance on grain imports. Food and related products consist mainly of soybean meal, grain meal, oils and canned goods, sugar and beer. Mineral shipments consist of a variety of products including ores, clay, stone and cement.


	*Intermodal and Automotive*

The intermodal freight business consists primarily of hauling freight containers or truck trailers by a combination of water, rail and motor carriers, with rail carriers serving as the link between the other modes of transportation. In 2005, KCS signed an agreement with Norfolk Southern Corporation

(NS) which, if implemented, will place part of the Meridian Speedway (KCSR’s rail line between Shreveport, LA and Meridian, MS) into a joint venture with NS and enable us to improve the Meridian Speedway. We anticipate that the improvements to the Meridian Speedway resulting from this agreement, if approved by the Surface Transportation Board and consummated by KCS and NS, will further our efforts to increase traffic between Lazaro Cardenas in Mexico and the eastern seaboard.


	*Coal*

KCS coal revenues are derived from traffic in the U.S., which is served by KCSR. KCSR, directly or indirectly, delivers coal to ten electric generating plants in the central U.S. Principally all the coal KCSR transports originates in the Powder River Basin in Wyoming and is transferred to KCSR’s rail lines at Kansas City.


	*Other*

Other rail-related revenues include a variety of miscellaneous services provided to customers and interconnecting carriers. Major items in this category include railcar switching services, demurrage (railcar retention charges) and drayage (local truck transportation services).

Government Regulation

In the U.S., the Company is subject to federal, state and local laws and regulations generally applicable to all businesses. Rail operations are subject to the regulatory jurisdiction of the Surface Transportation Board (“STB”) of the U.S. Department of Transportation (“DOT”), the Federal Railroad Administration of the DOT, the Occupational Safety and Health Administration (“OSHA”), as well as other federal and state regulatory agencies. The STB has jurisdiction over disputes and complaints involving certain rates, routes and services, the sale or abandonment of rail lines, applications for line extensions and construction, and consolidation or merger with, or acquisition of control of, rail common carriers.

DOT and OSHA each have jurisdiction under several federal statutes over a number of safety and health aspects of rail operations, including the transportation of hazardous materials. State agencies regulate some aspects of rail operations with respect to health and safety in areas not otherwise preempted by federal law.

KCSR rail operations, as well as those of our competitors, are subject to extensive federal, state and local environmental regulation. These laws cover discharges to water, air emissions, toxic substances, and the generation, handling, storage, transportation and disposal of waste and hazardous materials. This regulation has the effect of increasing the cost and liabilities associated with rail operations. Environmental risks are also inherent in rail operations, which frequently involve transporting chemicals and other hazardous materials.

The U.S. Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA” or “Superfund”) and similar state laws (known as “Superfund laws”) impose liability for the cost of remedial or removal actions, natural resources damages and related costs at certain sites identified as posing a threat to the environment or public health. CERCLA imposes joint, strict and several liabilities on the owners and operators of facilities in which hazardous waste and other hazardous substances are deposited or from which they are released or are likely to be released into the environment. Liability may be imposed, without regard to fault or the legality of the activity, on certain classes of persons, including the current and certain prior owners or operators of a site where hazardous substances have been released and persons that arranged for the disposal or treatment of hazardous substances. In addition, other potentially responsible parties, adjacent landowners or other third parties may initiate cost recovery actions or toxic tort litigation against sites subject to CERCLA or similar state laws. Given the nature of our business, we presently have environmental investigation and remediation obligations at certain sites, including a former foundry site in Alexandria, Louisiana, and will likely incur such obligations at additional sites in the future.

Although we have accrued for environmental liabilities, some of these accruals have been reduced for amounts we expect to recover from third party recoveries.

Our Mexican operations are subject to Mexican federal and state laws and regulations relating to the protection of the environment. The primary environmental law in Mexico is the General Law of Ecological Balance and Environmental Protection (the “Ecological Law”). The Mexican federal agency in charge of overseeing compliance with and enforcement of the federal environmental law is the Ministry of Environmental Protection and Natural Resources (“Semarnat”). The regulations issued under the Mexican Ecological Law and technical environmental requirements issued by Semarnat have promulgated standards for, among other things, water discharge, water supply, emissions, noise pollution, hazardous substances and transportation and handling of hazardous and solid waste. As part of its enforcement powers, Semarnat is empowered to bring administrative and criminal proceedings and impose economic sanctions against companies that violate environmental laws, and temporarily or even permanently close non-complying facilities. Under the Ecological Law, the Mexican government has implemented a program to protect the environment by promulgating rules concerning water, land, air and noise pollution, and transportation and handling of hazardous and solid waste materials. In addition, we are subject to the environmental laws and regulations issued by the Mexican governments of each of the states of Mexico where our facilities are located. The terms of the Concession also impose on us certain environmental law compliance obligations.

Noncompliance with applicable legal provisions may result in the imposition of fines, temporary or permanent shutdown of operations or other injunctive relief, criminal prosecution or the termination of our concession. We believe that all facilities that we operate are in substantial compliance with applicable environmental laws, regulations and agency agreements. There are currently no material legal or administrative proceedings pending against us with respect to any environmental matters and management does not believe that continued compliance with environmental laws will have any material adverse effect on our financial condition or results of operations. We cannot predict the effect, if any, that the adoption of additional or more stringent environmental laws and regulations would have on our results of operations, cash flows or financial condition.

Primary regulatory jurisdiction over KCSM is exercised by the Secretary of Communications and Transports (Secretaria de comunicaciones y Transportes or “Ministry of Transportation”). The Ministry of Transportation establishes regulations concerning railway safety and operations in Mexico, and it is the agency responsible in the first instance for resolving disputes between railways and between railways and customers. In addition, KCSM must register its maximum rates with the Ministry of Transportation and make regular reports to the Ministry of Transportation on investment and traffic volumes.

Competition

We compete against other railroads, many of which are much larger and have significantly greater financial and other resources. Since 1994, there has been significant consolidation among major North American rail carriers. As a result of this consolidation, the railroad industry is now dominated by a few “mega-carriers.” We regard the larger western railroads (BNSF Railway Company, or BNSF, and UP), in particular, as significant competitors to our operations and prospects because of their substantial resources. The ongoing impact of these mergers is uncertain. We believe that because of our investments and strategic alliances, we are positioned to attract additional rail traffic through our rail network.

Although it is still subject to approval by the Mexican Competition Commission (Comisión Federal de Competencia or “CFC”), Ferrocarril Mexicano, S.A. de C.V. (“Ferromex”) has acquired control of and merged with Ferrocarril del Sureste, S.A. de C.V. (“Ferrosur”), creating Mexico’s largest railway. Together Ferromex and Ferrosur are much larger than KCSM, and they serve most of the major ports and cities in Mexico and own a fifty percent interest in Ferrocarril y Terminal del Valle de México, S.A. de C.V. (the Mexico Valley Railway and Terminal or “FTVM”), which serves all of the industries located within Mexico City.

We are subject to competition from motor carriers, barge lines, and other maritime shipping, which compete across certain routes in operating areas. Truck carriers have eroded the railroad industry’s share of total transportation revenues. Intermodal traffic and certain other traffic face highly price sensitive competition, particularly from motor carriers. However, rail carriers, including KCSR and KCSM, have placed an emphasis on competing in the intermodal marketplace and working together with motor carriers and each other to provide end-to -end transportation of products.

While deregulation of freight rates has enhanced the ability of railroads to compete with each other and with alternative modes of transportation, this increased competition has resulted in downward pressure on freight rates. Competition with other railroads and other modes of transportation is generally based on the rates charged, the quality and reliability of the service provided and the quality of the carrier’s equipment for certain commodities.

Employees and Labor Relations

Labor relations in the U.S. railroad industry are subject to extensive governmental regulation under the Railway Labor Act (“RLA”). Under the RLA, national labor agreements are renegotiated when they become open for modification, but their terms remain in effect until new agreements are reached. Typically, neither management nor labor employees are permitted to take economic action until extended procedures are exhausted. Approximately 82% of KCSR’s employees are covered under various collective bargaining agreements with different labor organizations. Under the negotiating process for new collective bargaining agreements which began on November 1, 1999, all unions reached new labor agreements with KCSR in 2005. Wages, health and welfare benefits, work rules and other issues have been negotiated on an industry-wide scale. Previously, these negotiations, which can take place over significant periods of time, have not resulted in any extended work interruptions. The existing agreements will remain in effect until new agreements are reached or the RLA’s procedures are exhausted. Until new agreements are reached, the current agreements provide for periodic wage adjustments.

Approximately 71% of KCSM’s employees are covered by a labor agreement, which was renewed in 2005 and is effective for a two-year term ending in July 2007. The compensation terms of the labor agreement are subject to renegotiation on an annual basis and all other terms are renegotiated every two years. These negotiations have not resulted in any strikes, boycotts or other significant disruptions of KCSM’s operations.

Insurance

KCS’s subsidiaries are subject to a number of risks, including: (i) mechanical failure, (ii) collision, (iii) personal injury and property loss, (iv) cargo loss or damage, and (v) business interruption due to natural disasters, political circumstances, hostilities and labor strikes. In addition, the operation of any railroad is subject to the inherent possibility of catastrophic disaster, including chemical spills and other environmental mishaps.

Our present insurance coverage insures against the accident-related risks involved in the conduct of our business, and is consistent with industry practice and, for KCSM, the requirements of the Concession. For KCSM, Mexican railroad services law and regulations provide that, if we receive insurance proceeds in respect of any damage to our rail lines, those proceeds shall be applied to the repair or remediation of such damage or, in the event that we elect not to undertake such repairs, these proceeds must be paid to the Mexican government.


Item 1A.	*Risk Factors*


	*We compete against other railroads and other transportation providers.*

Our domestic and international operations are subject to competition from other railroads, many of which are much larger and have significantly greater financial and other resources. In addition, we are subject to competition from truck carriers and from barge lines and other maritime shipping. Increased

competition has resulted in downward pressure on freight rates. Competition with other railroads and other modes of transportation is generally based on the rates charged, the quality and reliability of the service provided and the quality of the carrier’s equipment for certain commodities. While we must build or acquire and maintain our infrastructure, truck carriers and maritime shippers and barges are able to use public rights-of -way. Continuing competitive pressures and declining margins, future improvements that increase the quality of alternative modes of transportation in the locations in which we operate, or legislation that provides motor carriers with additional advantages, such as increased size of vehicles and less weight restrictions, could have a material adverse effect on our results of operations, financial condition and liquidity.

If the railroad industry in general, and our Mexican operations in particular, are unable to preserve their competitive advantages vis-à-vis the trucking industry, our projected revenues could be adversely affected. Additionally, the revenue growth attributable to our Mexican operations could be affected by, among other factors, its inability to grow its existing customer base, negative macroeconomic developments impacting the U.S. and Mexican economies, and failure to capture additional cargo transport market share from the shipping industry and other railroads.

NAFTA called for Mexican trucks to have unrestricted access to highways in U.S. Border States by 1995 and full access to all U.S. highways by January 2000. However, the U.S. has not followed the timetable because of concerns over Mexico’s trucking safety standards. In February 2001, a NAFTA tribunal ruled in arbitration between the U.S. and Mexico that the U.S. must allow Mexican trucks to cross the border and operate on U.S. highways. On March 14, 2002, as part of its agreement under NAFTA, the U.S. Department of Transportation issued safety rules that allow Mexican truckers to apply for operating authority to transport goods beyond the 20-mile commercial zones along the Unites States-Mexico border. These safety rules require Mexican carriers seeking to operate in the U.S. to pass, among other things, safety inspections; to obtain valid insurance with a U.S. registered insurance company, to conduct alcohol and drug testing for drivers and to obtain a U.S. Department of Transportation identification number. Mexican commercial vehicles with authority to operate beyond the commercial zones will be permitted to enter the U.S. only at commercial border crossings and only when a certified motor carrier safety inspector is on duty. Given these recent developments, there can be no assurance that truck transport between Mexico and the U.S. will not increase substantially in the future. Such an increase could affect our ability to continue converting traffic to rail from truck transport because it may result in an expansion of the availability, or an improvement of the quality, of the trucking services offered in Mexico.

Through the Concession with the Mexican government, KCSM has the right to control and operate the southern half of the rail-bridge at Nuevo Laredo, Mexico. Under the Concession, KCSM must grant to Ferromex the right to operate over a north-south portion of its rail lines between Ramos Arizpe near Monterrey and the city of Queretaro that constitutes over 600 kilometers of KCSM’s main track. Using these trackage rights, Ferromex may be able to compete with KCSM over its rail lines for traffic between Mexico City and the U.S. The Concession also requires KCSM to grant rights to use certain portions of its tracks to Ferrosur and FTVM, thereby providing Ferrosur with more efficient access to certain Mexico City industries. As a result of having to grant trackage rights to other railroads, we incur additional maintenance costs and lose the flexibility of using a portion of our tracks at all times.

In recent years, there has been significant consolidation among major North American rail carriers. The resulting merged railroads could attempt to use their size and pricing power to block other railroads’ access to efficient gateways and routing options that are currently and have been historically available. There can be no assurance that further consolidation will not have an adverse effect on our operations.


	*Our business strategy, operations and growth rely significantly on joint ventures and other strategic alliances.*

Operation of our integrated rail network and our plans for growth and expansion rely significantly on joint ventures and other strategic alliances. Our operations are dependent on interchange, trackage rights,

haulage rights and marketing agreements with other railroads and third parties that enable us to exchange traffic and utilize trackage we do not own. Our ability to provide comprehensive rail service to our customers depends in large part upon our ability to maintain these agreements with other railroads and third parties. The termination of, or the failure to renew, these agreements could adversely affect our business, financial condition and results of operations. We are also dependent in part upon the financial health and efficient performance of other railroads. For example, much of Tex-Mex’s traffic moves over the UP’s lines via trackage rights, a significant portion of our grain shipments originate with IC&E pursuant to our marketing agreement with it, and BNSF is our largest partner in the interchange of rail traffic. There can be no assurance that we will not be materially adversely affected by operational or financial difficulties of other railroads.

Pursuant to the Concession, KCSM is required to grant rights to use portions of its tracks to Ferromex, Ferrosur and the FTVM. Applicable law stipulates that Ferromex, Ferrosur and the FTVM are required to grant to KCSM rights to use portions of their tracks. Applicable law provides that the Ministry of Transportation is entitled to set the rates in the event that KCSM and the party to whom it is granting the rights cannot agree on a rate. KCSM and Ferromex have not been able to agree upon the rates each of them is required to pay the other for interline services and haulage and trackage rights. In February 2001, KCSM initiated an administrative proceeding requesting a determination of such rates by the Ministry of Transportation, which subsequently issued a ruling establishing rates using certain criteria. KCSM and Ferromex appealed the rulings before the Mexican Federal Courts due to, among other things, a disagreement with the methodology employed by the Ministry of Transportation in calculating the trackage rights and interline rates. KCSM and Ferromex also requested and obtained a suspension of the effectiveness of the ruling pending resolution of the litigation. In February 2006, the Mexican Supreme Court issued a favorable decision upholding KCSM’s position concerning the methodology for establishing rates for trackage rights. This decision is not subject to further appeal. The Ministry of Transportation now has the responsibility to establish rates for trackage rights consistent with the court decision. The litigation concerning the methodology for establishing rates for interline services is still pending.


	*Our leverage could adversely affect our ability to fulfill obligations under various debt instruments and operate our business.*

Our level of debt could make it more difficult for us to borrow money in the future, will reduce the amount of money available to finance our operations and other business activities, including capital expenditures, exposes us to the risk of increased interest rates, makes us more vulnerable to general economic downturns and adverse industry conditions, could reduce our flexibility in planning for, or responding to, changing business and economic conditions, and may prevent us from raising the funds necessary to repurchase all of certain senior notes that could be tendered upon the occurrence of a change of control, which would constitute an event of default under the terms of the indentures for such senior notes. Our failure to comply with the financial and other restrictive covenants in our debt instruments, which, among other things, require us to maintain specified financial ratios and limit our ability to incur debt and sell assets, could result in an event of default that, if not cured or waived, could have a material adverse effect on our business or prospects. If we do not have enough cash to service our debt, meet other obligations and fund other liquidity needs, we may be required to take actions such as reducing or delaying capital expenditures, selling assets, restructuring or refinancing all or part of our existing debt, or seeking additional equity capital. We cannot assure that any of these remedies, including obtaining appropriate waivers from our lenders or new facilities, can be effected on commercially reasonable terms or at all. In addition, the terms of existing or future debt agreements may restrict us from adopting any of these alternatives.

The indebtedness of KCSM exposes us to risks in exchange rate fluctuations, because any devaluation of the peso would cause the cost of KCSM’s dollar-denominated debt to increase; and place us at a competitive disadvantage in Mexico compared to our Mexican competitors that have less debt and greater operating and financing flexibility than KCSM does.

Our business is capital intensive and requires substantial ongoing expenditures for, among other things, improvements to roadway, structures and technology, acquisitions, leases and repair of equipment, and maintenance of our rail system. Our failure to make necessary capital expenditures to maintain our operations could impair our ability to accommodate increases in traffic volumes or service existing customers.

In addition, the Concession requires us to make investments and undertake capital projects, including capital projects described in a business plan filed by KCSM every five years with the Mexican government. We may defer capital expenditures with respect to KCSM’s five-year business plan with the permission of the Ministry of Transportation. However, the Ministry of Transportation may not grant this permission, and KCSM’s failure to comply with the commitments in its business plan could result in the Mexican government revoking the Concession.


	*Our business may be adversely affected by changes in general economic, weather or other conditions.*

Our operations may be adversely affected by changes in the economic conditions of the industries and geographic areas that produce and consume the freight that we transport.

PCRC and Panarail Tourism Company are directly affected by its local economy. Our investment in PCRC has risks associated with operating in Panama, including, among others, cultural differences, varying labor and operating practices, political risk and differences between the U.S. and Panamanian economies. Historically, a stronger economy has resulted in improved results for our rail transportation operations. Conversely, when the economy has slowed, results have been less favorable. Our revenues may be affected by prevailing economic conditions and, if an economic slowdown or recession occurs in our key markets, the volume of rail shipments is likely to be reduced.

Our operations also may be affected by adverse weather conditions. We operate in and along the Gulf Coast of the U.S., and our facilities may be adversely affected by hurricanes and other extreme weather conditions. For example, recent hurricanes have adversely affected some of our shippers located along the Gulf Coast and caused interruptions in the flow of traffic within the Southern U.S. and between the U.S. and Mexico. As another example, a weak harvest in the Midwest may substantially reduce the volume of business handled for agricultural products customers. Many of the goods and commodities we transport experience cyclical demand. Our results of operations can be expected to reflect this cyclical demand because of the significant fixed costs inherent in railroad operations. Our operations may also be affected by natural disasters or terrorist acts. Significant reductions in our volume of rail shipments due to economic, weather or other conditions could have a material adverse effect on our business, financial condition, results of operations and cash flows.

The transportation industry is highly cyclical, generally tracking the cycles of the world economy. Although transportation markets are affected by general economic conditions, there are numerous specific factors within each particular market segment that may influence operating results. Some of our customers do business in industries that are highly cyclical, including the oil and gas, automotive and agricultural sectors. Any downturn in these sectors could have a material adverse effect on our operating results. Also, some of the products we transport have had a historical pattern of price cyclicality, which has typically been influenced by the general economic environment and by industry capacity and demand. For example, global steel and petrochemical prices have decreased in the past. We cannot assure you that prices and demand for these products will not decline in the future, adversely affecting those industries and, in turn, our financial results.


	Our business is subject to regulation by international, federal, state and local regulatory agencies. Our failure to comply with various federal, state and local regulations could have a material adverse effect on our operations.

We are subject to governmental regulation by international, federal, state and local regulatory agencies with respect to our railroad operations, as well as a variety of health, safety, labor, environmental, and other matters. Government regulation of the railroad industry is a significant determinant of the

competitiveness and profitability of railroads. Our failure to comply with applicable laws and regulations could have a material adverse effect on our operations, including limitations on our operating activities until compliance with applicable requirements is completed. These government agencies may change the legislative or regulatory framework within which we operate without providing any recourse for any adverse effects on our business that occurs as a result of this change. Additionally, some of the regulations require us to obtain and maintain various licenses, permits and other authorizations, and we cannot assure you that we will continue to be able to do so.


	Our business is subject to environmental, health and safety laws and regulations that could require us to incur material costs or liabilities relating to environmental, health or safety compliance or remediation.

Our operations are subject to extensive international, federal, state and local environmental, health and safety laws and regulations concerning, among other things, emissions to the air, discharges to waters, the handling, storage, transportation and disposal of waste and other materials, the cleanup of hazardous material or petroleum releases, decommissioning of underground storage tanks and noise pollution. Violations of these laws and regulations can result in substantial penalties, permit revocations, facility shutdowns and other civil and criminal sanctions. From time to time, our facilities have not been in compliance with environmental, health and safety laws and regulations and there can be no assurances that we will always be in compliance with such laws and regulations in the future. We incur, and expect to continue to incur, environmental compliance costs, including, in particular, costs necessary to maintain compliance with requirements governing chemical and hazardous material shipping operations, refueling operations and repair facilities. New laws and regulations, stricter enforcement of existing requirements, new spills, releases or violations or the discovery of previously unknown contamination could require us to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on our business, results of operations, financial condition and cash flows.

In the operation of a railroad, it is possible that derailments, explosions or other accidents may occur that could cause harm to the environment or to human health. As a result, we may incur costs in the future, which may be material, to address any such harm, including costs relating to the performance of clean-ups, natural resources damages and compensatory or punitive damages relating to harm to property or individuals.

standards for, among other things, water discharge, water supply, emissions, noise pollution, hazardous substances and transportation and handling of hazardous and solid waste. As part of its enforcement powers, Semarnat is empowered to bring administrative and criminal proceedings and impose economic sanctions against companies that violate environmental laws, and temporarily or even permanently close non-complying facilities. Under the Ecological Law, the Mexican government has implemented a program to protect the environment by promulgating rules concerning water, land, air and noise pollution, and hazardous substances. We are also subject to the laws of various jurisdictions and international conferences with respect to the discharge of materials into the environment. We cannot predict the effect, if any, that the adoption of additional or more stringent environmental laws and regulations would have on KCSM’s results of operations, cash flows or financial condition.


	Our business is vulnerable to rising fuel costs and disruptions in fuel supplies. Any significant increase in the cost of fuel, or severe disruption of fuel supplies, would have a material adverse effect on our business, results of operations and financial condition.

We incur substantial fuel costs in our railroad operations and these costs represent a significant portion of our transportation expenses. Fuel expense has increased from approximately 12% of our consolidated operating costs for the full year 2004 to its current level representing approximately 16% of our consolidated operating costs for 2005. This increase has been, in part, offset by fuel surcharges applied to our customer billings. If we are unable to continue the existing fuel surcharge program at KCSR and expand the fuel surcharge program for KCSM, our operating results could be materially adversely affected.

Fuel costs are affected by traffic levels, efficiency of operations and equipment, and petroleum market conditions. The supply and cost of fuel is subject to market conditions and is influenced by numerous factors beyond our control, including general economic conditions, world markets, government programs and regulations and competition. In addition, instability in the Middle East and interruptions in domestic production and refining due to hurricane damage may result in an increase in fuel prices. Significant price increases for fuel may have a material adverse effect on our operating results. Additionally, fuel prices and supplies could also be affected by any limitation in the fuel supply or by any imposition of mandatory allocation or rationing regulations. In the event of a severe disruption of fuel supplies resulting from supply shortages, political unrest, a disruption of oil imports, weather events, war or otherwise, the resulting impact on fuel prices and subsequent price increases could materially adversely affect our operating results, financial condition and cash flows.

We currently meet, and expect to continue to meet, fuel requirements for our Mexican operations almost exclusively through purchases at market prices from Petroleos Mexicanos, the national oil company of Mexico (“PEMEX”), a government-owned entity exclusively responsible for the distribution and sale of diesel fuel in Mexico. KCSM is party to a fuel supply contract with PEMEX of indefinite duration. Either party may terminate the contract upon 30 days written notice to the other at any time. If the fuel contract is terminated and we are unable to acquire diesel fuel from alternate sources on acceptable terms, our Mexican operations could be materially adversely affected.


	*A majority of our employees belong to labor unions. Strikes or work stoppages could adversely affect our operations.*

We are a party to collective bargaining agreements with various labor unions in the U.S. Approximately 82% of KCSR employees are covered under these agreements. Similarly, approximately 71% of KCSM employees are subject to collective labor contracts. We may be subject to, among other things, strikes, work stoppages or work slowdowns as a result of disputes with regard to the terms of these collective bargaining agreements and labor contracts or our potential inability to negotiate acceptable contracts with these unions. In the U.S., because such agreements are generally negotiated on an industry-wide basis, determination of the terms and conditions of future labor agreements could be beyond our control and, as a result, we may be subject to terms and conditions in amended or future labor agreements that could have a material adverse affect on our results of operations, financial position and cash flows. If the unionized workers in the U.S. or Mexico were to engage in a strike, work stoppage or

other slowdown, or other employees were to become unionized or the terms and conditions in future labor agreements were renegotiated, we could experience a significant disruption of our operations and higher ongoing labor costs.


	*Our business may be subject to various claims and lawsuits.*

The nature of the railroad business exposes us to the potential for various claims and litigation related to labor and employment, personal injury and property damage, environmental and other matters. We maintain insurance (including self-insurance) consistent with the industry practice against accident-related risks involved in the operation of the railroad. However, there can be no assurance that such insurance would be sufficient to cover the cost of damages suffered or that such insurance will continue to be available at commercially reasonable rates. Any material changes to current litigation trends could have a material adverse effect on our results of operations, financial condition and cash flows.

Due to the nature of railroad operations, claims related to personal injuries and third party liabilities resulting from crossing collisions and derailments, as well as claims related to personal property damage and other casualties is a substantial expense to KCS. Personal injury and casualty claims are subject to a significant degree of uncertainty, especially estimates related to personal injuries which have occurred but not yet been reported, therefore, the degree to which injuries have been incurred and the related costs have not yet been determined. Further, the cost of casualty claims is related to numerous factors, including the severity of the injury, the age of the claimant, and the legal jurisdiction. In determining the provision for casualty claims, management must make estimates regarding future costs related to substantially uncertain matters. Changes in these estimates could have a material effect on the results of operations in future periods.


	*Our business may be affected by future acts of terrorism or war.*

Terrorist attacks, such as those that occurred on September 11, 2001, any government response thereto and war or risk of war may adversely affect our results of operations, financial condition, and cash flows. These acts may also impact our ability to raise capital or our future business opportunities. Our rail lines and facilities could be direct targets or indirect casualties of an act or acts of terror, which could cause significant business interruption and result in increased costs and liabilities and decreased revenues. These acts could have a material adverse effect on our results of operations, financial condition, and cash flows. In addition, insurance premiums charged for some or all of the coverage currently maintained by us could increase dramatically or certain coverage may not be available in the future.

Additional Risk Factors Relating to Our Operations in Mexico


	*The Concession is subject to revocation or termination in certain circumstances.*

The Mexican government may terminate the Concession granted to KCSM as a result of KCSM’s surrender of its rights under the Concession, or for reasons of public interest, by revocation or upon KCSM’s liquidation or bankruptcy. The Mexican government may also temporarily seize KCSM’s assets and its rights under the Concession. The Mexican railroad services law and regulations provide that the Ministry of Communications and Transports (“Ministry of Transportation”) may revoke the Concession upon the occurrence of specified events, some of which will trigger automatic revocation. Revocation or termination of the Concession would prevent KCSM from operating its railroad and would materially adversely affect our Mexican operations and ability to make payments on our debt. In the event that the Concession is revoked by the Ministry of Transportation, KCSM will receive no compensation, and its interest in its rail lines and all other fixtures covered by the Concession, as well as all improvements made by it, will revert to the Mexican government.


	*Our ownership of KCSM and operations in Mexico subject us to political and economic risks.*

The Mexican government has exercised, and continues to exercise, significant influence over the Mexican economy. Accordingly, Mexican governmental actions concerning the economy and state-owned

enterprises could have a significant impact on Mexican private sector entities in general and on our Mexican operations in particular, as well as on market conditions, prices and returns on Mexican securities, including KCSM’s outstanding notes. The national elections held on July 2, 2000 ended 71 years of rule by the Institutional Revolutionary Party with the election of President Vicente Fox Quesada, a member of the National Action Party, and resulted in the increased representation of opposition parties in the Mexican Congress and in mayoral and gubernatorial positions. National elections will be held again on July 2, 2006. Although there have not yet been any material adverse repercussions resulting from this political change, multiparty rule is still relatively new in Mexico and could result in economic or political conditions that could materially and adversely affect our Mexican operations. We cannot predict the impact that this new political landscape will have on the Mexican economy. Furthermore, our financial condition, results of operations and prospects and, consequently, the market price for KCSM’s outstanding notes, may be affected by currency fluctuations, inflation, interest rates, regulation, taxation, social instability and other political, social and economic developments in or affecting Mexico.

The Mexican economy in the past has suffered balance of payment deficits and shortages in foreign exchange reserves. There are currently no exchange controls in Mexico. However, Mexico has imposed foreign exchange controls in the past. Pursuant to the provisions of NAFTA, if Mexico experiences serious balance of payment difficulties or the threat thereof in the future, Mexico would have the right to impose foreign exchange controls on investments made in Mexico, including those made by U.S. and Canadian investors. Any restrictive exchange control policy could adversely affect our ability to obtain dollars or to convert pesos into dollars for purposes of making interest and principal payments due on indebtedness, to the extent that it may have to effect those conversions. This could have a material adverse effect on our business and financial condition.

Securities of companies in emerging market countries tend to be influenced by economic and market conditions in other emerging market countries. Emerging market countries, including Argentina and Brazil, have recently been experiencing significant economic downturns and market volatility. These events have had an adverse effect on the economic conditions and securities markets of emerging market countries, including Mexico.

Our Mexican operations may also be adversely affected by currency fluctuations, price instability, inflation, interest rates, regulations, taxation, cultural differences, social instability, labor disputes and other political, social and economic developments in or affecting Mexico.


	Downturns in the U.S. economy or in trade between the U.S. and Mexico and fluctuations in the peso-dollar exchange rate would likely have adverse effects on our business and results of operations.

The level and timing of our Mexican business activity is heavily dependent upon the level of U.S.-Mexican trade and the effects of NAFTA on such trade. Downturns in the U.S. or Mexican economy or in trade between the U.S. and Mexico would likely have adverse effects on our business and results of operations. Our Mexican operations depend on the U.S. and Mexican markets for the products KCSM transports, the relative position of Mexico and the U.S. in these markets at any given time, and tariffs or other barriers to trade. Any future downturn in the U.S. economy could have a material adverse effect on KCSM’s results of operations and its ability to meet its debt service obligations as described above.

Also, fluctuations in the peso-dollar exchange rate could lead to shifts in the types and volumes of Mexican imports and exports. Although a decrease in the level of exports of some of the commodities that KCSM transports to the U.S. may be offset by a subsequent increase in imports of other commodities KCSM hauls into Mexico and vice versa, any offsetting increase might not occur on a timely basis, if at all. Future developments in U.S.-Mexican trade beyond our control may result in a reduction of freight volumes or in an unfavorable shift in the mix of products and commodities KCSM carries.

Any devaluation of the peso would cause the peso cost of KCSM’S dollar-denominated debt to increase, adversely affecting its ability to make payments on its indebtedness. Severe devaluation or

depreciation of the peso may result in disruption of the international foreign exchange markets and may limit our ability to transfer or to convert pesos into U.S. dollars for the purpose of making timely payments of interest and principal on our non-peso denominated indebtedness. Although the Mexican government currently does not restrict, and for many years has not restricted, the right or ability of Mexican or foreign persons or entities to convert pesos into U.S. dollars or transfer foreign currencies out of Mexico, the Mexican government could, as in the past, institute restrictive exchange rate policies that could limit our ability to transfer or convert pesos into U.S. dollars or other currencies for the purpose of making timely payments of our U.S. dollar-denominated debt and contractual commitments. Devaluation or depreciation of the peso against the U.S. dollar may also adversely affect U.S. dollar prices for our securities. Currency fluctuations are likely to continue to have an effect on our financial condition in future periods.


	*Mexico may experience high levels of inflation in the future which could adversely affect our results of operations.*

Mexico has a history of high levels of inflation, and may experience high inflation in the future. During most of the 1980s and during the mid- and late-1990s, Mexico experienced periods of high levels of inflation. The annual rates of inflation for the last five years, as measured by changes in the National Consumer Price Index, as provided by Banco de Mexico ranged from 4% to 5.7%. A substantial increase in the Mexican inflation rate would have the effect of increasing some of KCSM’s costs, which could adversely affect its results of operations and financial condition. High levels of inflation may also affect the balance of trade between Mexico and the U.S., and other countries, which could adversely affect KCSM’s results of operations.


Item 1B.	*Unresolved Staff Comments*

None.


Item 2.	*Properties*


	*U.S. Segment*

Certain KCSR property statistics follow:


	2005			2004			2003

Route miles — main and branch line		3,226			3,108			3,108
Total track miles		4,372			4,353			4,351
Miles of welded rail in service		2,320			2,322			2,309
Main line welded rail(%)		72	%		61	%		61	%
Cross ties replaced		340,033			292,843			280,226


Average Age (In Years):	2005		2004		2003

Wood ties in service		16.7		16.4		16.7
Rail in main and branch line		33.0		31.9		31.0
Road locomotives		25.2		26.0		25.5
All locomotives		26.1		26.9		26.5

Mexrail had 157 route miles in the main and branch line as of December 31, 2005.

KCSR and Mexrail’s fleet of locomotives and rolling stock consisted of the following at December 31:


		2005				2004(i)				2003(i)

		Leased		Owned		Leased		Owned		Leased		Owned

Locomotives:
	Total		331		315		279		239		354		133

Rolling Stock:
	Box Cars		5,401		1,323		5,204		1,307		5,252		1,354
	Gondolas		1,093		185		720		83		761		61
	Hopper Cars		4,323		989		3,084		802		2,746		805
	Flat Cars (Intermodal and Other)		844		531		1,288		533		1,366		552
	Tank Cars		24		28		28		30		41		40
	Auto Racks		198		—		198		—		200		—

	Total		11,883		3,056		10,522		2,755		10,366		2,812


(i)	Includes KCSR only.

KCSR, in support of its transportation operations, owns and operates repair shops, depots and office buildings along its right-of -way. A major facility, the Deramus Yard, is located in Shreveport, Louisiana and includes a general office building, locomotive repair shop, car repair shops, customer service center, material warehouses and fueling facilities totaling approximately 227,000 square feet. Other facilities owned by KCSR include a 21,000 square foot freight car repair shop in Kansas City, Missouri and approximately 15,000 square feet of office space in Baton Rouge, Louisiana. KCSR also has the support of a locomotive repair facility in Kansas City. This facility is owned and operated by General Electric Company (“GE”) and is used to maintain and repair AC 4400 locomotives that were manufactured by GE and are leased by KCSR.

KCSR owns 16.6% of the Kansas City Terminal Railway Company, which owns and operates approximately 80 miles of track, and operates an additional eight miles of track under trackage rights in greater Kansas City, Missouri. KCSR also leases for operating purposes certain short sections of trackage owned by various other railroad companies and jointly owns certain other facilities with these railroads.


	*KCSM*

Certain KCSM property statistics as of December 31, 2005 follow:


		Under		Track Usage
		Concession		Rights		Total

		(In miles)
Main track			2,639		541		3,180
Sidings under centralized traffic control			117		—		117
Spurs, yard tracks and other sidings			510		—		510

	Total		3,266		541		3,807

All of KCSM’s track is standard gauge (56.5 inches) and is generally in good condition. Of KCSM’s 2,639 miles of main track, 100.0% has 100 to 136-lbs. rail and approximately 78.0% is continuously welded rail. The portion of the Mexico City — Nuevo Laredo core route between Mexico City and Querétaro (approximately 143 miles) has double track. Installations along KCSM’s rail lines include supply centers, locomotive inspection centers, car inspection areas, repair shops, warehouses, freight yards and intermodal terminals.

The following table sets forth certain information with respect to KCSM’s track as of December 31, 2005:


		Main Line —
		Mexico City to
		Nuevo Laredo		All Lines

		(In miles)
Concrete ties installed			828		1,559
Wood ties installed			106		1,080

	Total		934		2,639

KCSM’s fleet of locomotives and rolling stock consisted of the following at December 31:


		2005

		Leased		Owned

Locomotives:
	Total		75		323

Rolling Stock:
	Box Cars		1,278		1,187
	Gondolas		2,922		1,824
	Hopper Cars		2,518		580
	Flat Cars (Intermodal and Other)		261		557
	Tank Cars		611		71
	Auto Racks		1,556		—
	Other		—		55

	Total		9,146		4,274

Under its Concession from the Mexican government, KCSM has the right to operate the rail lines, but does not own the land, roadway or associated structures. The Concession requires us to make investments and undertake capital projects, including capital projects described in a business plan filed every five years with the Mexican government. We may defer capital expenditures with respect to KCSM’s five-year business plan with the permission of the Ministry of Transportation. However, the Ministry of Transportation may not grant this permission, and KCSM’s failure to comply with the commitments in its business plan could result in the Mexican government revoking the Concession.


	*Other*

The information set forth in response to Item 102 of Regulation S-K under Item 1, “Business”, of this Form 10-K and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” is incorporated by reference in partial response to this Item 2.


Item 3.	*Legal Proceedings*

The information set forth in response to Item 103 of Regulation S-K under Part II Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other — Litigation” and “— Other — Environmental Matters” of this Form 10-K is incorporated by reference in response to this Item 3. In addition, see the discussion in Part II Item 8, “Financial Statements and Supplementary Data — Note 9 — Commitments and Contingencies” of this Form 10-K.


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

No matters were submitted to a vote of security holders during the three-month period ended December 31, 2005.

Executive Officers of KCS and Subsidiaries

All executive officers are elected annually and serve at the discretion of the Board of Directors. All of the executive officers have employment agreements with KCS and/or its subsidiaries. The mailing address of the principal executive officers is 427 W. 12 ^th Street, Kansas City, Missouri 64105.


Name	Age		Position(s)

Michael R. Haverty		61	Chairman of the Board, President and Chief Executive Officer
Arthur L. Shoener		59	Executive Vice President and Chief Operating Officer
Ronald G. Russ		51	Executive Vice President and Chief Financial Officer
Warren K. Erdman		47	Senior Vice President — Corporate Affairs
Jerry W. Heavin		54	Senior Vice President — International Engineering of KCSR
Larry M. Lawrence		43	Senior Vice President and Assistant to the Chairman
Robert B. Terry		49	Senior Vice President and General Counsel
Paul J. Weyandt		53	Senior Vice President — Finance and Treasurer
Richard M. Zuza		52	Senior Vice President — International Purchasing and Materials
James S. Brook		55	Vice President and Comptroller
Jay M. Nadlman		45	Vice President and Corporate Secretary

The information set forth in our Definitive Proxy Statement under the heading “Proposal 1 — Election of Directors — Nominees for Director to Serve Until the Annual Meeting of Stockholders in 2009” with respect to Mr. Haverty is incorporated herein by reference.

Arthur L. Shoener joined KCS in January 2005 as the Executive Vice President and Chief Operating Officer. Mr. Shoener also serves as the President and Chief Executive Officer of KCSR and Tex-Mex. Prior to joining KCS, Mr. Shoener served as the Executive Vice President of Operations for UP from 1991 through 1997. After leaving UP in 1997, Mr. Shoener established a transportation consulting firm with domestic and international clients.

Ronald G. Russ has served as Executive Vice President and Chief Financial Officer since January 16, 2003. Mr. Russ served as Senior Vice President and Chief Financial Officer from July 1, 2002 to January 15, 2003. Mr. Russ served as Executive Vice President and Chief Financial Officer of Wisconsin Central Transportation Corporation from 2000 to 2002. Mr. Russ served as a Vice President of Wisconsin Central Transportation Corporation from 1999 to 2000. He served as Treasurer of Wisconsin Central Transportation Corporation from 1987 to 1993. From 1993 to 1999 he was Executive Manager and Chief Financial Officer for Tranz Rail Holdings Limited, an affiliate of Wisconsin Central in Wellington, New Zealand. Over the course of his career, he also served in various capacities with Soo Line Railroad and The Chicago, Milwaukee, St. Paul and Pacific Railroad Company

Warren K. Erdman has served as Senior Vice President-Corporate Affairs of KCS and KCSR since January 1, 2006. Mr. Erdman served as Vice President — Corporate Affairs of KCS from April 15, 1997 to December 31, 2005 and as Vice President — Corporate Affairs of KCSR from May 1997 to December 31, 2005. Prior to joining KCS, Mr. Erdman served as Chief of Staff to U.S. Senator Kit Bond of Missouri from 1987 to 1997.

Jerry W. Heavin has served as Senior Vice President-International Engineering of KCSR since January 1, 2005 and a director of KCSR since July 9, 2002. Mr. Heavin served as Senior Vice President of Operations from July 9, 2002 to December 31, 2004. Mr. Heavin joined KCSR on September 1, 2001 and served as Vice President of Engineering of KCSR until July 8, 2002. Prior to joining KCSR,

Mr. Heavin served as an independent engineering consultant from 1997 through August 2001. Mr. Heavin began his railroad career in 1970 with UP, serving in various capacities, including general superintendent transportation and chief engineer of facilities.

Larry M. Lawrence has served as Senior Vice President and Assistant to Chairman-Strategies and Staff Studies of KCS since January 1, 2006. Mr. Lawrence served as Assistant to CEO-Staff Studies and Planning of KCS from November 2001 until December 2005. Prior to joining KCS in 2001, Mr. Lawrence was a strategy consultant for 15 years with McKinsey, A. T. Kearney and KPMG.

Robert B. Terry has served as Senior Vice President and General Counsel since October 1, 2004. Mr. Terry served as President and Chief Executive Officer of Farmland Industries, Inc. (“Farmland”) from 2002 to 2004. He served as Executive Vice President, General Counsel and Corporate Secretary of Farmland from 2000 to 2002 and as Vice President and General Counsel from 1993 to 2000. From 1990 through 1993, Mr. Terry served in various capacities in the legal department, environmental health and safety and communications with Farmland.

Paul J. Weyandt has served as Senior Vice President-Finance and Treasurer of KCS and KCSR since April 2005. He served as Vice President and Treasurer of KCS and of KCSR from September 2001 until March 2005. Before joining KCS, Mr. Weyandt was a consultant to the Structured Finance Group of GE Capital Corporation from May 2001 to September 2001. Prior to consulting, Mr. Weyandt spent 23 years with BNSF, most recently as Assistant Vice President Finance and Assistant Treasurer.

Richard M. Zuza joined KCS in November 2005 as the Senior Vice President-International Purchasing and Materials. Prior to joining KCS, Mr. Zuza served as Vice President of Procurement for Allstate Insurance Company from 1998 – 2005. He also served as Vice President of Purchasing for Gibson Greetings, Inc. for seven years and held a variety of purchasing positions with General Electric Company for 15 years.

James S. Brook has served as Vice President and Comptroller of KCS and KCSR since August, 2004. Prior to joining KCS, Mr. Brook served as Vice President of International Regulation for Aquila, Inc. from 1999 to 2004. From 1993 to 1999, he served as Vice President, Controller and Chief Accounting Officer for Aquila.

Jay M. Nadlman has served as Vice President and Corporate Secretary of KCS and KCSR since January 1, 2006. He served as Associate General Counsel and Corporate Secretary of KCS from April 1, 2001 until December 31, 2005. Mr. Nadlman joined KCS in December 1991 as a General Attorney, and was promoted to Assistant General Counsel in 1997, serving in that capacity until April 1, 2001. Mr. Nadlman served as Associate General Counsel and Secretary of KCSR since May 3, 2001 and as Assistant General Counsel and Assistant Secretary from August 1997 to May 3, 2001. Prior to joining KCS, Mr. Nadlman served as an attorney with the UP from 1985 to 1991.

There are no arrangements or understandings between the executive officers and any other person pursuant to which the executive officer was or is to be selected as an officer of KCS, except with respect to the executive officers who have entered into employment agreements. These employment agreements designate the position(s) to be held by the executive officer.

None of the above officers are related to one another, or to any of the directors of KCS, by family.

Part II


Item 5.	*Market for KCS’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities*

The information set forth in response to Item 201 of Regulation S-K on the cover (page i) under the heading “Company Stock,” and in Part II Item 8, “Financial Statements and Supplementary Data”, at Note 11 “Quarterly Financial Data (Unaudited)” of this Form 10-K is incorporated by reference in partial response to this Item 5.

We have not declared any cash dividends on our common stock during the last five fiscal years and we do not anticipate making any cash dividend payments to common stockholders in the foreseeable future. Pursuant to our credit agreement, we are prohibited from the payment of cash dividends on our common stock.

On May 5, 2003, KCS completed the sale of $200 million (400,000 shares) of 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C (“Convertible Preferred Stock”), with a liquidation preference of $500 per share in a private offering under Rule 144A to qualified institutional buyers. Net proceeds to KCS were $193 million after fees to the initial purchasers of $7 million and other expenses of the offering. Dividends on the Convertible Preferred Stock are cumulative and will be payable quarterly at an annual rate of 4.25% of the liquidation preference, when, and if declared by our Board of Directors. Accumulated unpaid dividends will accumulate dividends at the same 4.25% rate. Each share of the Convertible Preferred Stock will be convertible, under certain conditions, and subject to adjustment under certain conditions, into 33.4728 shares of our common stock. Conversion rights arise only upon the occurrence of the following: (i) the closing sale price of KCS’s common stock exceeds a specified level for a specified period; (ii) certain credit rating downgrades; (iii) the convertible preferred stock trading below a certain level for a specified period; (iv) notice of redemption; and (v) the occurrence of certain corporate transactions. On or after May 20, 2008, KCS will have the option to redeem any or all of the Convertible Preferred Stock, subject to certain conditions. Under certain circumstances, at the option of the holders of the Convertible Preferred Stock, KCS may be required to purchase shares of the Convertible Preferred Stock from the holders.

Following completion of the preparation of the 2005 financial statements of KCS, the Company determined that its Consolidated Coverage Ratio (as defined in the indentures for KCSR’s 7 ¹ / 2 % Senior Notes and 9 ¹ / 2 % Senior Notes) was less than 2.0:1. As a result, pursuant to the terms of each KCSR indenture, the Company is currently unable to pay cash dividends on its Series C Convertible Preferred Stock and dividends in cash or shares of KCS common stock on its Series D Convertible Preferred Stock (as defined below) and will be unable to pay such dividends until such ratio increases to at least 2.0:1. KCS anticipates that the ratio will increase by the end of the third quarter of 2006 such that it will again be permitted to pay cash dividends to these preferred stockholders although that cannot be assured. A special meeting of the holders of record of the Convertible Preferred Stock as of March 17, 2006 (the “Series C Stockholders”), was held on March 30, 2006 to vote on a proposed amendment to the terms of the Convertible Preferred Stock to allow the payment of dividends to the Series C Stockholders to be made, at the discretion of the Company, in cash, in shares of KCS common stock or in any combination thereof. As a quorum of the Series C Stockholders was not present in person or by proxy at the special meeting, the special meeting was adjourned indefinitely. Absent approval of such an amendment, the unpaid dividends for each of the Series C Convertible Preferred Stock and the Series D Convertible Preferred Stock (collectively, the “Preferred Stock”) will accumulate until such time that the Company may resume paying cash dividends to the holders of both classes of Preferred Stock. Whenever dividends on the Preferred Stock or another class or series of stock ranking on a parity with the Preferred Stock are in arrears for six consecutive quarters (or an equivalent number of days in the aggregate) holders of the Preferred Stock will be entitled to vote for the election of two of the authorized directors at the next Annual Shareholders’ Meeting and at each subsequent Shareholders’ Meeting until such time as all accumulated dividends are paid, set aside for payment or the Preferred Stock has been redeemed.

On March 23, 2006, Standard & Poor’s Rating Service (“S&P”) placed our preferred stock ratings on CreditWatch with negative implications. This rating action was taken after we announced that KCS failed to meet the consolidated coverage ratio threshold under the KCSR senior notes indentures that would allow us to pay cash dividends on our preferred stock.

On April 4, 2006, S&P placed its BB- ratings on KCS and KCSM on CreditWatch with negative implications and lowered the Company’s preferred stock ratings to CCC from B-. The preferred stock credit ratings remain on CreditWatch with negative implications. The rating actions followed recent negative developments, including the delay in filing our Annual Report on Form 10-K; and to reflect an increased risk of KCS failing to make the next dividend payment on its preferred stock as a result of the

special meeting being adjourned indefinitely. S&P has indicated that the preferred stock ratings would likely be lowered to ‘D’ if the May 15, 2006 dividend payment is missed. All ratings could be lowered if the Company fails to address liquidity concerns or fails to demonstrate the likelihood of improved financial results over the near to intermediate term.

On April 5, 2006 Moody’s Investors Service (“Moody’s”) placed all of KCS’, KCSR’s, and KCSM’s debt ratings under review for possible downgrade. Moody’s review was prompted by KCS’ inability to file our Annual Report on Form 10-K by March 31, 2006.

On December 9, 2005, Kansas City Southern (“KCS”) completed the sale and issuance of 210,000 shares of its 5 ¹ / 8 % Cumulative Convertible Perpetual Preferred Stock Series D (the “Series D Convertible Preferred Stock”), par value $1.00 per share. Each share of Series D Convertible Preferred Stock is convertible, at any time, into shares of KCS common stock at a conversion rate of 33.3333 shares of KCS common stock for each share of Series D Convertible Preferred Stock, subject to adjustments to the conversion rate as a result of dividends or distributions payable in shares of KCS common stock, subdivision or reclassification of shares of KCS common stock, and other events in which the KCS common stock may be diluted as provided in the Certificate of Designation of 5 ¹ / 8 % Cumulative Convertible Perpetual Preferred Stock of Kansas City Southern (“Certificate of Designation”). Dividends on the Series D Convertible Preferred Stock are payable at the discretion of the Company in cash, in KCS common stock or any combination thereof, when, as and if declared by the KCS board of directors, at the rate of 5.125% per annum of the liquidation preference of $1,000 quarterly in arrears. Dividends on the Series D Convertible Preferred Stock are cumulative from the date of issuance. Accumulated but unpaid dividends on the Series D Convertible Preferred Stock accumulate at the annual rate of 5.125%. The Series D Convertible Preferred Stock ranks senior to the common stock and to each class or series of KCS capital stock that has terms that provide that such class or series will rank junior to the Series D Convertible Preferred Stock and includes a liquidation preference that entitles the Series D Convertible Preferred Stock holders to payment of $1,000 per share of Series D Convertible Preferred Stock plus an amount equal to all dividends (whether or not declared) accumulated and unpaid on the Series D Convertible Preferred Stock to the date of a final distribution in the event of any liquidation, dissolution or winding-up of KCS, before any payment or distribution of the KCS’s assets shall be made to or set apart for the holders of any KCS capital stock ranking junior to the Series D Convertible Preferred Stock. Upon certain designated events, holders of the Series D Convertible Preferred Stock may, subject to legally available funds, require KCS to redeem any or all of their shares of Series D Convertible Preferred Stock at the liquidation preference, plus any accumulated and unpaid dividends to the date of redemption, which KCS may pay in either cash, in shares of KCS common stock, or any combination thereof at KCS’s option. Series D Convertible Preferred Stock holders will have no other right to require KCS to redeem the Series D Convertible Preferred Stock at any time. On or after February 20, 2011, KCS may, at its option, cause all, and not less than all, of the outstanding shares of Series D Convertible Preferred Stock to be automatically converted into shares of KCS common stock at the then prevailing conversion rate, but only if the closing sale price of the KCS common stock multiplied by the conversion rate then in effect equals or exceeds 130% of the liquidation preference for 20 trading days during any consecutive 30 trading day period, and if KCS has paid all accumulated and unpaid dividends on the dividend payment date immediately preceding the forced conversion date.

On December 12, 2005 the Company used substantially all of the proceeds from the Series D Convertible Preferred Stock offering to repurchase 9,000,000 shares of KCS Common Stock issued in April 2005 in connection with the acquisition of KCSM. All of the 9,000,000 shares were purchased at a price of $22.25 per share or $200.3 million. The Company does not have a formal program for the repurchase of any additional shares of our equity securities.

As of February 28, 2006, there were 4,806 record holders of our common stock.


Item 6.	*Selected Financial Data*

The selected financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included under Item 7 of this Form 10-K and the consolidated financial statements and the related notes thereto, and the Reports of Independent Accountants thereon, included herein and such data is qualified by reference thereto.


		2005(i)		2004			2003			2002		2001

		(In millions, except per share and ratio amounts)
Revenues		$	1,352.0	$	639.5		$	581.3		$	566.2	$	583.2
Equity in net earnings (losses) from unconsolidated affiliates		$	2.9	$	(4.5	)	$	11.0		$	43.4	$	27.1
Income before cumulative effect of accounting change and minority interest(ii)		$	83.1	$	24.4		$	3.3		$	57.2	$	31.1
Earnings per common share — Income (loss) before cumulative effect of accounting change(ii)
	Basic	$	1.21	$	0.25		$	(0.04	)	$	0.94	$	0.53
	Diluted		1.10		0.25			(0.04	)		0.91		0.51
Total assets		$	4,423.6	$	2,440.6		$	2,152.9		$	2,008.8	$	2,010.9
Total debt obligations(iii)		$	1,860.6	$	665.7		$	523.4		$	582.6	$	658.4
Cash dividends per common share		$	—	$	—		$	—		$	—	$	—


(i)	Amounts reflect the consolidation of Mexrail, effective January 1, 2005 and KCSM, effective April 1, 2005.

(ii)	Income from continuing operations before cumulative effect of accounting change and minority interest for the years ended December 31, 2005, 2004, 2003, 2002 and 2001 include certain unusual operating expenses and other income as further described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations.” These costs and other income include charges for casualty claims, costs related to the acquisitions of KCSM and Mexrail, hurricane related charges, costs related to the implementation of the Management Control System (“MCS”), benefits received from the settlement of certain legal and insurance claims, severance costs and expenses associated with legal verdicts against KCS, and gains recorded on the sale of operating property, among others. Other non-operating income includes gains recorded on sale of non-operating properties and investments.

(iii)	Includes current and long-term liability related to Grupo TFM acquisition.

The information set forth in response to Item 301 of Regulation S-K under Part II Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K is incorporated by reference in partial response to this Item 6.


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*

The following discussion is intended to clarify and focus on Kansas City Southern’s (“we”, “our”, “KCS” or “the Company”), results of operations, certain changes in its financial position, liquidity, capital structure and business developments for the periods covered by the consolidated financial statements included under Item 8 of this Form 10-K. This discussion should be read in conjunction with these consolidated financial statements, the related notes and the Reports of Independent Accountants thereon, and other information included in this report.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Cautionary Information” for cautionary statements concerning forward-looking comments.

CORPORATE OVERVIEW

KCS, a Delaware corporation, is a holding company with principal operations in rail transportation and its 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 subsidiary; Mexrail owns 100% of the Texas-Mexican Railway Company (“Tex-Mex”);

	•	Kansas City Southern de México, S.A. de C.V. (“KCSM”). On April 1, 2005 KCS completed its acquisition of control of KCSM and as of that date, KCSM became a consolidated subsidiary of KCS. On September 12, 2005, the Company and its subsidiaries, Grupo TFM and KCSM, along with the Mexican holding company Grupo TMM, S.A. (“TMM”), entered into a settlement agreement with the Mexican government resolving the controversies and disputes between the companies and the Mexican government concerning the payment of a VAT refund to KCSM and the purchase of the remaining shares of KCSM owned by the Mexican government. As a result of this settlement, KCS and its subsidiaries now own 100% of KCSM. For the first quarter of 2005, KCS accounted for its investment in KCSM on the equity basis of accounting.

	•	Southern Capital Corporation, LLC (“Southern Capital”), a 50% owned unconsolidated affiliate that leases locomotives and other 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 U.S. and Mexico. The U.S. segment consists primarily of KCSR and Mexrail, while Mexico includes primarily Grupo TFM and its operating subsidiary KCSM. In both the U.S. and the Mexico segments we generate our revenues and cash flows by providing our customers with freight delivery services both within our regions, and throughout North America 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 year ended December 31, 2005, consolidated capital expenditures were approximately $275.7 million. 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. On December 15, 2004, KCS entered into the Amended and Restated Acquisition Agreement (the “Acquisition Agreement”) with TMM, and other parties under which KCS acquired control of KCSM through the purchase of TMM’s shares of Grupo TFM (the “Acquisition”). Grupo TFM held an 80% economic interest in KCSM and all of the shares of stock with full voting rights of KCSM. The remaining 20% economic interest in KCSM was owned by the Mexican government in the form of shares with limited voting rights. The Mexican government had certain put rights with respect to its KCSM shares. 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.

On September 12, 2005, the Company and its subsidiaries, KCSM and Grupo TFM, along with the Mexican holding company TMM, entered into a settlement agreement with the Mexican government, resolving the controversies and disputes between the companies and the Mexican government concerning the payment of a value added tax (“VAT”) refund to KCSM and the obligation (“Put”) to purchase the remaining shares of KCSM owned by the Mexican government (the “VAT/ Put Settlement”). As a result of the VAT/ Put Settlement, KCS and its subsidiaries now own 100% of Grupo TFM and KCSM. The potential obligation of KCS, Grupo TFM and TMM to acquire the Mexican government’s remaining 20% ownership of KCSM has been eliminated; and the legal obligation of the Mexican government to issue the VAT refund to KCSM has been satisfied. There was no cash exchanged between the parties to the settlement agreement. In addition, the parties entered into mutual releases of all existing and potential claims relating to the VAT refund and the Put obligation, and entered into an agreement to dismiss all of the existing litigation between the parties.

As a result of the final resolution of the VAT claim and Put obligation, KCS was required to make a contingency payment of $110.0 million to TMM in accordance with the terms of the December 15, 2004 Amended and Restated Acquisition Agreement in a combination of stock, notes and cash. In addition, a contingent payment of $9.0 million to Jose F. Serrano International Business, S.A. de C.V. (“JSIB”) also became payable upon final resolution of the VAT claim and Put obligation. On March 13, 2006, in settlement of the $110.0 million obligation to TMM, KCS paid $35 million in cash, issued 1,494,469 shares of KCS Common Stock at the VWAP price of $23.4197, as determined in connection with the Acquisition Agreement, and issued a $40 million, five year note. Also on March 13, 2006, in settlement of the $9.0 million obligation to JSIB, KCS paid $9.0 million in cash to JSIB.

Effective January 1, 2005, the financial results of Mexrail were consolidated into KCS as a result of KCS taking possession from the trustee of 51% of the shares of Mexrail following the Surface Transportation Board’s approval of the Company’s application for authority to exercise common control over KCSR, the Gateway Eastern Railway Company and Tex-Mex. The remaining 49% of Mexrail is owned by KCSM. With the completion of the acquisition of 100% of KCSM, the Company has control of 100% of Mexrail.

OPERATING SEGMENTS

Operating units that are reported as segments include the U.S. and Mexico segments. Appropriate eliminations of revenue and reclassifications of operating revenues and expenses have been recorded in deriving consolidated data. The U.S. segment consists primarily of KCSR and Tex-Mex. Mexico consists of Grupo TFM, KCSM and Arrendadora TFM S.A. de C.V. (“Arrendadora”). Each of these segments is supported by separate executive management, operates and serves different geographical regions, and is subject to different customs, laws, and tax regulations.


	*2005 Analysis*

The Company completed the acquisition of Mexrail on January 1, 2005 and KCSM on April 1, 2005, doubling our size in terms of total revenue. Net income for the year ended December 31, 2005 increased by $76.5 million compared to the prior year. Operating income decreased by $21.2 million, interest expense increased by $89.1 million, and a net gain of $131.9 million was achieved in the Vat/ Put Settlement. In the second quarter, $17.8 million of the KCSM loss was allocated to the minority interest. The provision for income taxes decreased by $30.7 million and various other factors increased by $6.4 million.

Strong revenue growth continued in all major commodity and geographic markets, with increases of 25.8% in the United States, including 11.5% related to the acquisition of Mexrail, for the twelve months

ended December 31, 2005, and 7.3% in Mexico for the nine months ended December 31, 2004 compared to the nine months ended December 31, 2005. The growth resulted from a combination of targeted rate increases, variable fuel surcharges, and increased traffic volume across the system.

In the United States, revenue increased by $164.9 million. Operating expenses increased by $203.3 million, including a $57.4 million increase in fuel costs and a third quarter charge of $37.8 million charge to recognize additional costs related to occupational and personal injury claims. U.S. operations were adversely affected in the third and fourth quarter of 2005 by the severe weather and hurricanes in the Gulf Coast region. Operating income decreased by $38.4 million. The higher level of capital expenditures during 2005 achieved broad improvements to the system and will provide future capacity.

In Mexico, during the nine months of consolidated results following the April 1, 2005 acquisition, revenues were $547.6 million and operating income was $17.2 million marked by trends similar to the U.S. Segment regarding fuel costs which were approximately 15.2% of revenues. Mexico net income of $103.6 was also impacted by the VAT/Put Settlement which was reflected as non-operating income of $140.9 offset by interest expense of $71.6 million.

Consolidated net income available to common shareholders increased by $75.7 million to $91.4 million. Weighted average fully diluted common shares outstanding increased by 28.758 million due primarily to the April 1 issuance of 18 million common shares for the KCSM acquisition and to the increase in the number of potentially dilutive shares. Earnings per share increased by $0.85 to $1.10 fully diluted.


	*2006 Outlook*

The 2006 year should reflect the initial stage of the long term benefits that will result from these newly combined companies. Organizational realignments have largely been completed, and various initiatives are already underway to enhance customer service, improve operating efficiencies and velocity, and increase freight volumes. Several major capital projects are expected to be launched in 2006 by the recently announced joint venture with Norfolk Southern on the Meridian Speedway, and those will begin to facilitate significant increases in capacity and profitable volumes.

Revenue is expected to continue to grow with increasing volumes of freight traffic over the Company’s integrated system to and from Mexico. The transportation operating system that has been used successfully in the Company’s U.S. operations is being implemented in Mexico, and is expected to lead to gains in operating efficiencies there as well. Fuel costs are expected to continue to fluctuate at levels higher than historical experience.

High priority is being given to several key aspects of operations company-wide, and these are also expected to yield improved financial results. Initiatives have recently been launched to achieve aggressive new safety goals in 2006. Increased train velocity is the focus of a broad range of other initiatives, and expected to produce further improvements in customer service and revenue growth.

The completion of the acquisition of KCSM has resulted in the full inclusion of its financial performance in the financial statements of KCS on a consolidated basis. Factors unique to the Mexican economy and business climate, including exchange rates, tax laws, and inflation, are now impacting the Company’s financial reports and performance to a greater extent. We are not able to predict the impact of those factors on future results.

RECENT DEVELOPMENTS

On March 31, 2006 KCS failed to timely file our Annual Reports on Form 10-K with the Securities and Exchange Commission. As a result of this failure to timely file KCS and KCSR were unable to comply with certain reporting requirements contained in the Credit Agreement (as defined below). In addition KCSM failed to comply with certain reporting requirements and other terms of the 2005 KCSM Credit Agreement (as defined below). These failures constituted defaults under the terms of each of the credit agreements and limited the ability of KCSR and KCSM to access the revolving credit facility in

each of their respective credit agreements. On April 7, 2006 KCS and KCSR received a waiver from the lenders under the Credit Agreement and KCSM received an amendment and waiver from the lenders under the 2005 KCSM Credit Agreement. The waiver and the amendment and waiver, as more fully discussed below, waived the defaults and extended the timeframe for reporting requirements for 2005 fiscal year results from March 31, 2006 until April 30, 2006. Neither of KCS, KCSR or KCSM is currently in default under their respective credit agreements.

Following KCS’ failure to timely file our Annual Reports on Form 10-K, Standard & Poor’s Rating Service (“S&P”) placed its BB- rating on KCS and KCSM on CreditWatch with negative implications and Moody’s Investors Service (“Moody’s) placed all of KCS’, KCSR’s and KCSM’s debt ratings under review for possible downgrade.

KCS and KCSR Enter Into Agreement to Form Joint Venture with Norfolk Southern Corporation. On December 1, 2005, KCS and its wholly-owned subsidiary The Kansas City Southern Railway Company entered into a transaction agreement (the “Transaction Agreement”) with Norfolk Southern Corporation (“NS”) and its wholly-owned subsidiary The Alabama Great Southern Railroad Company providing for, among other things, the formation of a joint venture between the parties relating to the ownership and improvement of the rail line between Meridian, Mississippi and Shreveport, Louisiana (the “JV Line”), which is a portion of the rail line between Dallas, Texas and Meridian known as the “Meridian Speedway.”

Upon consummation of the transaction contemplated by the Transaction Agreement, the parties will form a new joint venture limited liability company (the “JV Company”) to which KCS will contribute the assets comprising the JV Line in exchange ultimately for a 70% equity interest and NS will contribute $300 million in cash in exchange ultimately for a 30% equity interest. Pursuant to the terms of the Transaction Agreement, NS’ $300 million investment in the JV Company will be used for mutually agreed-upon capital improvements to expand capacity, for capital maintenance projects and to reimburse KCS for certain previously-made expenditures on the JV line.

Pursuant to the terms of the Transaction Agreement, the JV Company and KCSR will enter into an operating agreement pursuant to which KCSR will perform all railroad services on behalf of the JV Company. The parties will also enter into a joint use agreement whereby NS will be the sole provider for certain intermodal traffic moving on the JV Line. KCS’ rail subsidiaries also will have certain trackage rights over the JV Line. In addition, the parties will enter into a joint marketing agreement with respect to the movement of certain domestic intermodal containers that move over the Meridian Speedway with a lift or drop at KCS’ Dallas Intermodal Terminal.

The transactions contemplated by the Transaction Agreement are subject to regulatory approvals, which could take six to twelve months, and other customary closing conditions.

KCS Completes Acquisition of KCSM. On April 1, 2005, KCS completed the acquisition of a controlling interest in KCSM from TMM. Under the terms of the acquisition agreement, KCS acquired all of TMM’s interest in KCSM for $200.0 million in cash, 18 million shares of KCS common stock, a $47.0 million two-year promissory note, and up to $110.0 million payable in a combination of cash and KCS common stock contingent upon the final resolution of the VAT lawsuit and the Mexican government’s Put claim, as described below.

Final Resolution of Value Added Tax (“VAT”) Lawsuit and Contingency Payment under the Acquisition Agreement. On September 12, 2005, the Company and its subsidiaries, KCSM and Grupo TFM, along with TMM, entered into a settlement agreement with the Mexican government, resolving the controversies and disputes between the companies and the Mexican government concerning the payment of a VAT refund to KCSM and the obligation (“Put”) to purchase the remaining shares of KCSM owned by the Mexican government. As a result of this settlement, KCS and its subsidiaries now own 100% of Grupo TFM and KCSM. The potential obligation of KCS, Grupo TFM and TMM to acquire the Mexican government’s remaining 20% ownership of KCSM has been eliminated, and the legal obligation of the Mexican government to issue the VAT refund to KCSM has been satisfied. There was no cash

exchanged between the parties to the settlement agreement. In addition, the parties entered into mutual releases of all existing and potential claims relating to the VAT refund and the Put obligation, and entered into an agreement to dismiss all of the existing litigation between the parties.

As a result of the VAT/ Put Settlement, KCS recorded a pretax gain of $131.9 million net of certain fees and expense paid to consultant and net of a $9.0 million contingency fee to Jose F. Serrano International Business, S.A. de C.V. (“JSIB”) payable on final resolution of the VAT claim and Put. Also as a result of the final resolution of the VAT claim and Put, KCS was required to make an additional payment of $110.0 million to TMM in accordance with the terms of the December 15, 2004 Amended and Restated Acquisition Agreement in a combination of cash, stock and notes. On March 13, 2006 in settlement of the $110.0 million obligation to TMM, KCS paid $35 million in cash, issued 1,494,469 shares of KCS Common Stock at the VWAP price of $23.4197, as determined in connection with the Acquisition Agreement, and issued a $40 million, five year note. As settlement of its $9.0 million obligation to JSIB, KCS paid $9 million in cash to JSIB.

KCS Completes Sale and Issuance of Preferred Stock. On December 9, 2005, KCS completed the sale and issuance of $210.0 million of its 5.125% Cumulative Convertible Preferred Stock Series D at its liquidation preference of $1,000 per share. KCS used substantially all of the net proceeds of the offering to repurchase 9.0 million shares of its common stock formerly owned by TMM which are currently held as treasury shares.

KCSR Credit Agreement Amendments and Waivers. On September 30, 2005, KCS, KCSR, and other KCS subsidiaries entered into a second amendment and waiver of its credit agreement dated March 30, 2004 (the “Credit Agreement”). The Credit Agreement was amended to increase the revolving credit facility commitment by $25.0 million to a total available line of credit of $125.0 million. The borrowing spread on the revolving credit facility was reduced by 50 basis points, while the borrowing spread on the term loan facility was reduced by 25 basis points (based on certain financial statement attributes). The revolving credit facility has a maturity date of March 20, 2007, while the term loan facility has a maturity date of March 20, 2008. Additionally, the capital expenditure limit was eliminated and certain other nonmaterial changes were made to the Credit Agreement as part of the amendment.

On November 4, 2005, KCS, KCSR and other KCS subsidiaries entered into a third amendment of the Credit Agreement. The Credit Agreement was amended to modify the definition of “EBITDA” in order to exclude from the definition certain non-cash charges not to exceed $35.7 million in the aggregate for the fiscal quarter ending on September 30, 2005, with respect to an increase in claim reserves.

On December 8, 2005, KCS, KCSR and other KCS subsidiaries entered into a third waiver of the Credit Agreement. The provisions of Section 5.02(g) of the Credit Agreement were waived in order to permit KCS to use substantially all of the net proceeds from the issuance of its 5.125% Cumulative Convertible Preferred Stock Series D to repurchase shares of its common stock.

On March 1, 2006, KCS, KCSR and other KCS subsidiaries entered into a fourth waiver of the Credit Agreement (the “Fourth Waiver”). Under the terms of the Fourth Waiver, which expires on April 30, 2006, the Lenders have agreed to waive the requirement that KCS, as defined in the Credit Agreement, maintain a leverage ratio of not more than 5.00:1 for the quarter ended December 31, 2005, provided that such ratio does not exceed 5.50:1.

On April 7, 2006, KCS, KCSR and other KCS subsidiaries entered into a fifth waiver of the Credit Agreement (the “Fifth Waiver”). Under the terms of the Fifth Waiver, which expires on April 30, 2006, the Lenders have agreed to waive the requirement of Section 5.03(b) that KCS furnish a copy of its 2005 annual audited financial statements by March 31, 2006 so long as KCS furnishes such audited financial statements by April 30, 2006.

contain terms and conditions substantially similar to the Credit Agreement, but will provide KCSR with additional financial flexibility. The closing on the new credit agreement is expected to occur before April 30, 2006. KCSR expects to be in compliance with all of the covenants of the new credit agreement, including the leverage ratio, throughout its term.

A further consequence of the late filing of our Annual report on Form 10-K is that the ability of KCS to access quickly the public equity markets has been reduced significantly, since KCS is no longer qualified as a “well-known seasoned issuer” and also cannot utilize the short-form registration statement on Form S-3. These restrictions will continue for 12 months following this filing.

KCSM New Credit Agreement. On October 24, 2005, KCSM entered into a new credit agreement (the “2005 KCSM Credit Agreement”) in an aggregate amount of up to $106 million with Bank of America, N.A., BBVA Bancomer, S.A., Institución de Banca Múltiple, Grupo Financiero BBVA Bancomer, and the other lenders named in the 2005 KCSM Credit Agreement. The 2005 KCSM Credit Agreement consists of a $30 million revolving credit facility and a $76 million term loan facility and is secured by the locomotives and rail cars owned by Arrendadora. Proceeds from the credit agreement were used by KCSM to pay all amounts outstanding under the Bridge Loan Agreement dated September 15, 2005, to pay all remaining amounts outstanding under the $186.4 million First Amended and Restated Credit Agreement dated as of June 24, 2004, and for other general corporate purposes. The maturity date for the credit facility is October 28, 2008. The 2005 KCSM Credit Agreement contains covenants that restrict or prohibit certain actions by KCSM, including, but not limited to, its ability to incur debt, create or suffer to exist liens, make prepayments of particular debt, pay dividends, make investments, engage in transactions with stockholders and affiliates, issue capital stock, sell certain assets, and engage in mergers and consolidations or in sale-leaseback transactions. Except for certain circumstances, KCSM’s capital expenditures may not exceed certain amounts for any period of four consecutive fiscal quarters. In addition, KCSM must meet certain consolidated interest coverage ratios, consolidated leverage ratios, and fixed charge coverage ratios. Failure to maintain compliance with covenants would constitute a default. Other events of default include, but are not limited to, certain payment defaults, certain bankruptcy and liquidation proceedings, a change of control, and certain adverse judgments or government actions. Any event of default could trigger acceleration of the time for payment of any amounts outstanding under the 2005 KCSM Credit Agreement.

On April 7, 2006 KCSM entered into an amendment and waiver (“Amendment and Waiver”) to the 2005 KCSM Credit Agreement. The 2005 KCSM Credit Agreement was amended to (i) exclude certain payment obligations accrued under two locomotive maintenance agreements and under a track maintenance rehabilitation agreement from the definition of Indebtedness, (ii) eliminate certain minimum and multiple borrowing thresholds for peso borrowings under the revolving credit facility and (iii) eliminate the reporting requirement to provide unaudited consolidated financial statements for the fourth fiscal quarter. The Amendment and Waiver also waived (x) certain reporting requirements, including the requirement of KCSM to provide audited consolidated financial statements within 90 days after the end of the 2005 fiscal year, provided such reports are delivered by April 30, 2006 and (v) compliance with the Consolidated Leverage Ratio obligations of Section 7.1(c) of the 2005 KCSM Credit Agreement for the four quarters ending December 31, 2005 if compliance therewith was calculated without giving effect to the amendment to the definition of “Indebtedness” in the Amendment and Waiver, provided that KCSM is in compliance therewith after giving effect to the Amendment and Waiver.

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 holders of the outstanding aggregate principal amount of each series of notes.

notes to permit KCS, Grupo TFM, and KCSM to effect a settlement of certain disputes among KCSM, Grupo TFM, and the Mexican government.

KCSM Completes Note Tender Offer and Consent Solicitation. On April 1, 2005, KCSM 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 KCSM’s Offer to Purchase and Consent Solicitation Statement dated April 1, 2005. KCSM 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, KCSM received the requisite consents to execute a supplemental indenture relating to the 2009 Debentures. As part of its tender offer for the 2009 Debentures, KCSM 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 KCSM and the Trustee under the indenture. KCSM 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, KCSM called for redemption all of its remaining outstanding 2009 Debentures that were not tendered in KCSM’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.

KCSM Issues New Senior Notes. On April 19, 2005, KCSM issued $460.0 million principal amount of 9 ³ / 8 % senior notes due 2012 (the “9 ³ / 8 % Senior Notes”). The 9 ³ / 8 % Senior Notes are denominated in U.S. Dollars, bear interest semiannually at a fixed rate of 9 ³ / 8 % and mature on May 1, 2012. The 9 ³ / 8 % Senior Notes are redeemable, at KCSM’s option, in whole at any time or in part from time to time, on and after May 1, 2009, upon not less than 30 nor more than 60 days notice. Subject to certain conditions, up to 35% of the principal amount of the 9 ³ / 8 % Senior Notes is redeemable prior to May 1, 2008. In addition, the 9 ³ / 8 % Senior Notes are redeemable, in whole but not in part, at KCSM’s option at 100% of their principal amount, together with accrued interest, in the event of certain changes in the Mexican withholding tax rate.

The 9 ³ / 8 % Senior Notes are unsecured, unsubordinated obligations of KCSM, rank pari passu in right of payment with all existing and future unsecured, unsubordinated obligations of KCSM, and are senior to all of its subordinated debt. The 9 ³ / 8 % Senior Notes effectively rank junior to all of KCSM’s secured indebtedness to the extent of the value of the assets securing such indebtedness. The 9 ³ / 8 % Senior Notes are not guaranteed by any of KCSM’s subsidiaries and are therefore effectively subordinated to all liabilities of KCSM’s subsidiaries. The 9 ³ / 8 % Senior Notes are not guaranteed by Grupo TFM.

In connection with the 9 ³ / 8 % Senior Notes, on April 19, 2005, KCSM entered into a registration rights agreement with the placement agents engaged in the offering of the 9 ³ / 8 % Senior Notes, or the Registration Rights Agreement. Pursuant to the terms of the Registration Rights Agreement, KCSM agreed, for the benefit of the holders of the 9 ³ / 8 % Senior Notes, at the cost to KCSM, to use its reasonable best efforts to:


	(i) file a registration statement with respect to a registered offer to exchange the 9 ³ / 8 % Senior Notes for new exchange notes having terms identical in all material respects to the 9 ³ / 8 % Senior Notes (except that the exchange notes will not contain transfer restrictions); and

	(ii) complete the registered exchange offer within 270 days after the closing date of the offering of the 9 ³ / 8 % Notes of April 19, 2005.

KCSM filed the registration statement and completed the registered exchange offer in accordance with the terms of the Registration Rights Agreement.

On April 18, 2005, KCSM entered into a first waiver and amendment (the “Waiver and Amendment”) to its First Amended and Restated Credit Agreement, dated as of June 24, 2004, with the banks which are a party thereto and J.P. Morgan Chase Bank, N.A., as administrative agent. The Waiver and Amendment allowed KCSM to issue the 9 ³ / 8 % Senior 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 % Senior 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 % Senior 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 % Senior Notes. The Waiver and Amendment also amended the First Amended and Restated Credit Agreement to allow KCSM to borrow up to $25 million from KCS on a fully subordinated basis.

As mentioned above, KCSM refinanced the first Amended and Restated Credit Agreement with proceeds from the 2005 KCSM Credit Agreement on October 24, 2005.

Stockholder Rights Plan. In connection with the expiration of the Rights Agreement, dated as of September 19, 1995, between the Company and Harris Trust & Savings Bank, as Rights Agent, which associated Rights (as defined therein) expired on October 12, 2005, the Board of Directors of the Company approved a plan to replace its rights plan. The Company entered into a Rights Agreement with UMB Bank, n.a., dated as of September 29, 2005 (the “Rights Agreement”). The Board of Directors of the Company declared a dividend distribution of one Right for each outstanding share of Company Common Stock to stockholders of record at the close of business on October 12, 2005 (the “Record Date”). Each Right entitles the registered holder to purchase from the Company ¹ / 1000 ths of a share of Series A Preferred Stock (“Preferred Stock”), or in some circumstances, shares of the Company’s Common Stock, other securities, cash or other assets, at a purchase price of $100 per share. Both shares and purchase rights are subject to adjustment as further described in Part II Item 8, “Financial Statements and Supplementary Data — Note 2 — Stockholder Rights Plan” to the Financial Statements.

The Rights, may have the effect of impeding a change in control of the Company without the prior consent of the Board, and the Rights could cause substantial dilution to a person that attempts to acquire the Company, without conditioning the offer on redemption of the Rights by the Board, or on the acquisition by such person of a substantial number of Rights. The Rights will not interfere with any Permitted Offer for all of the outstanding Common Stock that has the approval of a majority of the Independent Directors.

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 be used for infrastructure improvements. These improvements are expected to increase efficiency and capacity in order to accommodate growing freight rail traffic related to the NAFTA corridor. The interest rate under the loan agreement is 4.29% and the principal balance amortizes quarterly with a final maturity of July 13, 2030. At December 31, 2005, Tex-Mex had borrowed $21.7 million under the loan agreement. Tex-Mex expects to draw down the remaining available principal balance during 2006. The loan is being made under the Railroad Rehabilitation and Improvement Financing (“RRIF”) Program administered by the FRA. The loan is guaranteed by Mexrail, which 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.

Purchase of Locomotives. In September 1999, KCSM entered into a locomotive operating lease agreement covering 75 locomotives that was to expire in 20 years. The lease agreement contained standard provisions for this type of transaction, including the option to either purchase the assets or return the assets to the lessor at the end of the lease term. Because the lease agreement contained above market rates, in connection with the valuation of KCSM assets as part of the Acquisition and the principles of push down

accounting, KCSM recorded a valuation reserve that was being amortized over the remaining life of the lease.

On November 2, 2005, KCSR entered into an agreement with El-Mo-Mex, Inc. (“El-Mo”) to acquire El-Mo’s equity interest in the leased locomotives. KCSR and an affiliate paid cash in the amount of approximately $32.6 million and assumed approximately $95.9 million of debt and accrued interest to acquire the locomotives. KCSR subsequently purchased the locomotives from the affiliate. On December 20, 2005, KCSR entered into a leveraged lease arrangement, treated for financial reporting purposes as an operating lease, with an unaffiliated third party. Pursuant to the terms of this leveraged lease, KCSR was to sell the locomotives to a trust, which would then lease the locomotives to KCSR for a period of 18 years. The trust also would assume the debt assumed by KCSR in its purchase of the locomotives. Prior to year end, KCSR had completed the sale of 54 of the locomotives to the trust. The remaining 19 units (two of the original 75 were determined to be damaged beyond repair), valued at $32.5 million, were sold to the trust in January 2006 and are included in the December 31, 2005 financial statements as property.

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, Mississippi and Alabama to three subsidiary railroads of Watco, a short line 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 KCSR and the applicable Watco subsidiary. 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 bill the revenue on its traffic and pay a per car fee to Watco for the services provided. In addition, the lessee has agreed to pay KCSR annually, additional rent 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 KCSR for the annual period for which the lease amounts are due and Watco is required to provide certain limited capital expenditures on the branch lines as well as assume responsibility for the maintenance.

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

Calculation of Employee Statutory Profit Sharing. From 1997 until 2001, KCSM calculated the net taxable income that should be considered for employee statutory profit sharing under a judicial ruling that allowed it to deduct net operating losses, or NOLs, that had been carried forward from prior years. In 2002, the relevant legal provision was modified and KCSM sought another judicial ruling confirming its right to deduct NOLs from previous years. Due to a series of decisions in 2005 by the Mexican Supreme Court declaring that NOLs from previous years may not be deducted, KCSM changed the method of calculating its statutory profit sharing liability. KCSM no longer deducts NOLs from prior years when calculating employee statutory profit sharing. This change required KCSM to write off its deferred tax assets related to statutory profit sharing resulting in a charge to operating expenses of $35.6 million, after purchase accounting adjustments.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2005 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2004

Net Income. Consolidated net income for 2005 increased $76.5 million compared to 2004 primarily as a result of a $131.9 million gain resulting from the VAT/ Put Settlement, partially offset by a reduction

in operating income of $21.2 million. Additionally, consolidated net income increased due to a reduction in provision for income taxes of $30.7 million.

The reduction in consolidated operating income was driven primarily by an additional $37.8 million charge in 2005 to recognize additional costs related to occupational and personal injury claims determined as a result of our annual actuarial study, which was completed during the third quarter of 2005, and the write off of KCSM’s deferred tax asset related to statutory profit sharing. On a consolidated basis, both revenues and operating expenses were significantly impacted by the acquisitions completed during the year. In addition to the acquisitions, revenue growth for 2005 continued to be driven by increased volume, targeted rate increases and increased fuel surcharges to help offset rising fuel prices. Consolidated operating costs generally increased consistent with the volume increases, although price increases also impacted compensation and benefits and fuel expense.

The following table summarizes the consolidated income statement components of KCS (in millions). Certain prior period amounts have been reclassified to reflect changes to the current period presentation.


							Change

	2005			2004			In Dollars			Percentage

Revenues	$	1,352.0		$	639.5		$	712.5			111.4	%
Operating expenses		1289.7			556.0			733.7			132.0	%

Operating income		62.3			83.5			(21.2	)		(25.4	)%
Equity in net earnings (losses) of unconsolidated affiliates		2.9			(4.5	)		7.4			(164.4	)%
Interest expense		(133.5	)		(44.4	)		(89.1	)		200.7	%
VAT/ Put settlement gain, net		131.9			—			131.9			100.0	%
Other income		12.4			13.4			(1.0	)		(7.5	)%

Income before income taxes and minority interest		76.0			48.0			28.0			58.3	%
Income tax provision (benefit)		(7.1	)		23.6			(30.7	)		(130.1	)%

Income before minority interest		83.1			24.4			58.7			240.6	%
Minority interest		17.8			—			17.8			100.0	%

Net income	$	100.9		$	24.4		$	76.5			313.5	%


	*U.S. Results*

U.S. Revenues. The following table summarizes U.S. revenues, including the revenues and separate carload statistics of KCSR, and Mexrail, for the year ended December 31, 2005 (in millions). For the year ended December 31, 2004 the revenue and carload statistics are KCSR only. Certain prior period amounts have been reclassified to conform to the current period presentation.


	Revenues									Carloads and Intermodal Units

					Change									Change

	2005		2004		In Dollars		Percentage			2005		2004		In Units		Percentage

	(In millions)									(In thousands)
General commodities:
Chemical and petroleum	$	153.5	$	135.0	$	18.5		13.7	%		162.1		147.9		14.2		9.6	%
Forest products and metals		219.0		169.6		49.4		29.1	%		227.5		197.3		30.2		15.3	%
Agricultural and mineral		179.2		125.2		54.0		43.1	%		202.7		149.4		53.3		35.7	%

Total general commodities		551.7		429.8		121.9		28.4	%		592.3		494.6		97.7		19.8	%
Intermodal and automotive		76.6		66.8		9.8		14.7	%		346.5		342.8		3.7		1.1	%
Coal		122.3		92.1		30.2		32.8	%		233.4		194.7		38.7		19.9	%

Carload revenues and carload and intermodal units		750.6		588.7		161.9		27.5	%		1,172.2		1,032.1		140.1		13.6	%

Other revenue		53.8		50.8		3.0		5.9	%

U.S. revenues		804.4		639.5		164.9		25.8	%

For the year ended December 31, 2005, U.S. revenues increased $164.9 million. The Mexrail acquisition accounted for $73.3 million of the increase in revenues for the year ended December 31, 2005. U.S. revenue also experienced increases in all commodity groups due to a combination of higher carloadings, targeted price improvements and increased fuel surcharge revenue. Fuel surcharges increased to $52.0 million, which accounted for $35.3 million of the increase in revenues for the year ended December 31, 2005, compared to the same periods in 2004. Fuel surcharges will increase or decrease dependent on the price of West Texas Intermediate Crude Oil as published in the Wall Street Journal. The following discussion provides an analysis of our revenues by commodity group. Pending completion of the ongoing effort to change the TexMex mark and finalize its merger into KCS operations, carload data is presented based on the combination of the carloads for KCSR and Mexrail, without elimination for cars interchanged between the two roads.

Chemical and petroleum products. For the year ended December 31, 2005, U.S. chemical and petroleum products experienced increases in revenues in all commodity groups with the exception of inorganic chemicals. These increases were attributed to higher production, certain targeted rate increases and fuel surcharges. These revenue increases were partially offset by the effects of plant and production shutdowns resulting from the hurricanes during the second half of 2005. The impact of the Mexrail consolidation increased revenues $12.1 million in the chemical and petroleum product commodities for the year ended December 31, 2005.

Forest products and metals. For the year ended December 31, 2005, forest products and metals revenue for the U.S. segment experienced growth in all commodities compared to the same period in 2004. For the year to date period, these increases resulted primarily from certain targeted rate increases and fuel surcharges partially offset by the impact of hurricanes in the 3rd quarter of 2005. For the year ended December 31, 2005, the consolidation of Mexrail contributed $19.0 million, to forest products and metals revenue.

Agricultural and mineral products. U.S. revenues in the agricultural and mineral products business unit increased for the year ended December 31, 2005. The increases were primarily the result of targeted rate increases and fuel surcharges. Additionally, for the year ended December 31, 2005, all commodities, except grain, experienced increased traffic due to increased production. U.S. segment domestic grain

carloads decreased, primarily due to a slowdown in equipment cycle times resulting in lower equipment availability for the year while the impact of local harvests moving to local feed mills reduced traffic in the third quarter of 2005 compared to the same period in 2004. Export grain carloads decreased primarily as a result of a decrease in gulf coast export traffic including the effects of hurricane weather in the gulf coast region. For the year ended December 31, 2005, the consolidation of Mexrail contributed $30.7 million to agricultural and mineral products revenue.

Intermodal and automotive. Revenue for U.S. segment intermodal and automotive commodity group for the year ended December 31, 2005 increased compared to the same period in 2004. Excluding the impact of the acquisition of Mexrail, intermodal traffic declined for the year ended December 31, 2005. The declines were the result of changes in shipper traffic patterns as well as the effects of hurricane weather during the third quarter of 2005. Automotive traffic decreased as a result of decreased volumes from manufacturers for the year ended December 31, 2005. For the year ended December 31, 2005, the consolidation of Mexrail contributed $5.5 million to intermodal and automotive products revenue.

Coal. Increases in U.S. segment coal revenues for the year ended December 31, 2005 compared to the same period in 2004 were due primarily to the addition of two new coal customers that were previously served by other railroads, certain targeted rate increases related to renegotiated contracts and overall increases in carloadings and traffic volumes at certain electric generating stations in response to demand. Mexrail has no significant coal revenues.

U.S Operating Expenses. For the year ended December 31, 2005, U.S. operating expenses increased $203.3 million (36.6%), when compared to the same period in 2004. Of this increase, $83.3 million was attributable to the consolidation of Mexrail’s operations for the year ended December 31, 2005. The following table summarizes U.S. operating expenses of KCSR and Mexrail for the year ended December 31, 2005. For the year ended December 31, 2004 the operating expenses are KCSR only.


					Change

	2005		2004		In Dollars			Percentage

Compensation and benefits	$	244.8	$	213.0	$	31.8			14.9	%
Purchased services		84.6		62.3		22.3			35.8	%
Fuel		123.8		66.4		57.4			86.4	%
Equipment costs		68.9		50.4		18.5			36.7	%
Depreciation and amortization		60.0		53.5		6.5			12.1	%
Casualties and insurance		88.7		42.4		46.3			109.2	%
Other leases		11.5		11.8		(0.3	)		(2.5	)%
Other		77.0		56.2		20.8			37.0	%

Total U.S. operating expenses	$	759.3	$	556.0	$	203.3			36.6	%

Compensation and Benefits. Increases in compensation and benefits expense for the year ended December 31, 2005 compared to the same period in 2004 were primarily the result of annual wage and salary rate increases which were effective July 1, 2004 as well as higher employee counts. For the year ended December 31, 2005, the consolidation of Mexrail added $19.4 million to compensation and benefits expense. The average headcount for the year ended December 31, 2005 was approximately 3,060 compared to approximately 2,740 for the same period in 2004, including an increase of employees as a result of the consolidation of Mexrail.

Purchased Services. Purchased services expense for the year ended December 31, 2005 increased compared to the same period in 2004, primarily as a result of the consolidation of Mexrail’s operations. Mexrail has historically contracted for services in the maintenance of equipment and way and structures. Accordingly, Mexrail contributed $19.7 million, to purchased services expense for the year ended December 31, 2005.

Fuel. Fuel expense increased for the year ended December 31, 2005 compared to the same period in 2004. This increase was the result of a 50.5% increase in the average price per gallon, as well as a 26.0% increase in consumption. For the year ended December 31, 2005, the consolidation of Mexrail added $11.9 million to fuel expense.

Equipment Costs. Equipment costs for the year ended December 31, 2005 increased compared to the same period in 2004. Of this increase, $15.2 million was related to the Mexrail acquisition for the year ended December 31, 2005. Excluding the impact of the Mexrail acquisition, equipment costs increased for the year ended December 31, 2005 primarily as a result of increased equipment lease costs related to higher traffic levels and demand.

Depreciation and Amortization. Depreciation and amortization expense for the year ended December 31, 2005 increased compared to the same period in 2004, primarily as a result of a higher asset base, partially offset by property retirements. For the year ended December 31, 2005, the consolidation of Mexrail added $3.5 million to depreciation and amortization expense.

Casualties and Insurance. During the third quarter of 2005, the Company recorded a $37.8 million pre-tax charge reflecting changes in its estimates for the cost of personal injury claims and includes $7.5 million related to the Company’s first actuarial estimate of the cost of incurred but not reported occupational illness claims. The charge was recorded in “Casualties and Insurance” expense.

The majority of the increases for FELA and third party claims are attributable to adverse experience occurring since last year’s study, including an increase in the number of new claims and unforeseen adverse developments in the dollar amount of claims and potential settlements for many significant prior claims. The reserve for occupational illness claims resulted primarily from the first time actuarial study. The Company is continuing its practice of accruing monthly for estimated claim costs at levels recommended by the actuarial study, and those accruals have been increased accordingly.

Overhead Capitalization. KCS 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, 2005, operating expenses were reduced by approximately $1.8 million. Similarly, in the fourth quarter, the overhead allocation was reviewed to ensure that all appropriate current year costs were allocated which resulted in a reduction of operating expenses of approximately $3.0 million

Mexico Results.

KCS acquired a controlling interest in KCSM effective April 1, 2005. The nine month period ended December 31, 2005 results reflect charges and costs associated with the Acquisition and integration, as well as the effect of valuation adjustments as required by purchase accounting. Management evaluates the results of its Mexico operations based on its operating performance during the current year and comparison to plan.

Mexico Revenues. The following table summarizes consolidated Mexico revenues, including the revenues and carloads statistics, for the nine month periods ended December 31, 2005 and 2004. Although not consolidated in previous years, revenue recognition policies for our Mexico operations were consistent with those of U.S. operations in all material respects; therefore, commodity statistics are presented for purposes of comparison. Unaudited results for the nine months ended December 31, 2004 presented for comparative purposes.


	Revenues										Carloads and Intermodal Units

					Change										Change

	2005		2004		In Dollars			Percentage			2005		2004		In Units			Percentage

	(In millions)										(In thousands)
General commodities:
Chemical and petroleum	$	94.5	$	94.7	$	(0.2	)		(0.2	)%		71.4		76.5		(5.1	)		(6.7	)%
Forest products and metals		141.5		120.5		21.0			17.4	%		147.3		143.3		4.0			2.8	%
Agricultural and mineral		168.9		158.6		10.3			6.5	%		152.4		162.1		(9.7	)		(6.0	)%

Total general commodities		404.9		373.8		31.1			8.3	%		371.1		381.9		(10.8	)		(2.8	)%
Intermodal and automotive		131.9		130.3		1.6			1.2	%		250.2		253.0		(2.8	)		(1.1	)%

Carload revenues and carload and intermodal units		536.8		504.1		32.7			6.5	%		621.3		634.9		(13.6	)		(2.1	)%

Other revenues		10.8		6.4		4.4			68.8	%

Total revenues		547.6		510.5		37.1			7.3	%

Revenues for the nine months ended December 31, 2005 totaled $547.6 million compared to $510.5 million for the same period in 2004 resulting in an increase of $37.1 million. This increase was primarily attributable to the impact of fuel surcharges $23.9, million which increased $21.5 million over the nine months ended December 31, 2004, and increases in other factors of $15.6 million.

Chemical and Petrochemical Products. Revenues from chemical and petrochemical products during the nine months ended December 31, 2005, decreased from the same period in 2004 primarily due to disruptions related to the impact of hurricanes offset by increases in Mexican domestic revenues for the same period, related primarily to higher consumption of fuel products.

Forest products and metals. Domestic revenues increased during the nine months ended December 31, 2005 as a result of an increase in the production volumes of construction materials such as billets, bar and wire. Steel slab and steel coils revenue decreased as a result of lower international traffic, related to reduced consumption by manufacturing industries offset in part by certain targeted rate increases and fuel surcharges.

Agriculture and mineral. Revenues from agriculture products increased during the nine months ended December 31, 2005 compared to the same periods in 2004. The increases were primarily the result of targeted rate increases and fuel surcharges. Volume increases were seen in corn and sugar partially offset by reductions in import shipments of soybeans, sorghum and wheat products during the nine months ended December 31, 2005.

Intermodal and Automotive. Intermodal freight revenue increased $1.6 million for the nine month period ended December 31, 2005 compared to the same period in 2004. This increase was primarily attributable to the consolidation of steamship service at the port of Lázaro Cárdenas with the support of the port administration and Hutchinson Terminal. Automotive revenues for the nine month period ended December 31, 2005 decreased primarily as a consequence of lower domestic traffic offset by targeted increases in rates.

Mexico Operating Expenses. Mexico operations reported operating income of $17.2 million in the nine months ended December 31, 2005. The following table summarizes operating expenses of KCSM for the nine months ended December 31:


						Change

	2005		2004			In Dollars			Percentage

Compensation and benefits	$	95.6	$	87.2		$	8.4			9.6	%
Purchased services		108.7		120.5			(11.8	)		(9.8	)%
Fuel		83.1		65.3			17.8			27.3	%
Equipment costs		80.9		66.9			14.0			20.9	%
Depreciation and amortization		67.7		66.6			1.1			1.7	%
Casualties and insurance		14.7		9.7			5.0			51.5	%
Other leases		2.0		4.1			(2.1	)		(51.2	)%
KCSM employees’ statutory profit sharing		41.1		(2.1	)		43.2			2,057.1	%
Other		36.5		19.7			16.8			85.3	%

Total Mexico operating expenses	$	530.3	$	437.9		$	92.4			21.1	%

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 48.5% of Grupo TFM (or 38.8% of KCSM) 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 acquired percentage and any residual was charged to expense. Grupo TFM operating expenses include $41.1 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 shareowner.

As a result of the resolution of the VAT refund claim and Put obligation on September 12, 2005, KCS and its subsidiaries now own 100% of Grupo TFM; the potential obligation of KCS, Grupo TFM and TMM to acquire the Mexican government’s remaining 20% ownership of KCSM has been eliminated; and the legal obligation of the Mexican government to issue the VAT refund to KCSM has been satisfied. Resolution of the preacquisition contingency related to the April 1, 2005 transaction and KCSM’s exchange of the VAT for the book value of the minority interest resulted in an approximate $70.1 million decrease in the basis of the assets to reflect fair value.

Consolidated Interest Expense. Consolidated interest expense increased $89.1 million for year ended December 31, 2005 when compared to the twelve months ended December 31, 2004. This increase was the result of higher floating interest rates incurred under our Credit Agreement, increased borrowings under our revolving credit facility, interest associated with the debt assumed as part of the locomotive acquisition from El-Mo and the addition of interest expense of $71.4 million for the nine months ended December 31, 2005 due to the Acquisition of KCSM and $1.1 million for the twelve months ending December 31, 2005 due to the acquisition of Mexrail.

Consolidated Debt Retirement Costs. Consolidated debt retirement costs increased $0.2 million for the year ended December 31, 2005 when compared to the same period in 2004. For the year to date ended, December 31, 2005, $4.4 million in unamortized debt issuance costs were written off primarily in connection with the refinancing of KCSM’s 2009 Debentures and its First Amended and Restated Credit Agreement dated as of June 24, 2004. During the year to date period ended December 31, 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 year ended December 31, 2005, equity in earnings from other unconsolidated affiliates was $3.9 million compared to equity in losses

from other unconsolidated affiliate of $2.1 million for the same period of 2004. Significant components of this change were as follows:


	•	For the year ended December 31, 2005, equity in losses from the operations of PCRC was $1.7 million, compared to $2.1 million for the same period in 2004.

	•	For the year ended December 31, 2005, equity in earnings of Southern Capital was $2.8 million, compared to $2.7 million, for the same period in 2004.

	•	For the nine months ended December 31, 2005, KCSM’s equity in earnings of Ferrocarril y Terminal del Valle de México, S.A. de C.V. (“FTVM”) was $2.9 million.

For 2005, earnings for Southern Capital were $13.1 million compared to $11.8 million in 2004. This increase of $1.3 million was primarily the result of a gain recognized by Southern Capital for the sale of locomotives in 2005 of approximately $7.7 million as compared to $6.0 million in 2004. The sales of locomotives were to KCSR in the second quarters of 2005 and 2004 respectively. For purposes of recording its share of Southern Capital earnings, the Company has recorded its share of the gain as a reduction to the cost basis of the equipment acquired. As a result, the Company will recognize its equity in the gain over the remaining depreciable life of the locomotives as a reduction of depreciation expense.

Consolidated Income Tax Provision (Benefit). For the year ended December 31, 2005, KCS’s income tax benefit was $7.1 million, a change of $30.7 million as compared to a $23.6 million expense for the year ended December 31, 2004. This change was primarily due to the complexities relating to Mexico taxes resulting in an effective income tax rate of (9.3%) and 49.1% for the years ended December 31, 2005 and 2004, respectively. The primary causes of the decrease in the consolidated effective rate were the VAT/ Put Settlement, the utilization of U.S. tax credits enacted for the tax year 2005, a lower Mexican statutory tax rate of 30% as compared to U.S. statutory rate of 35%, and foreign exchange rate fluctuations and inflation. The VAT/ Put Settlement gain was not taxable in Mexico and is not expected to be taxable for U.S. income tax purposes. The Company believes, based upon opinions of outside legal counsel and other factors, that the VAT/ Put Settlement should not be taxable to KCS for U.S. income tax purposes. Such position has not been examined by taxing authorities and it is possible that this position could be challenged. The amount of such tax would be material; however the Company believes that it would have the right to indemnification under the terms of the Acquisition Agreement.

KCS intends to indefinitely reinvest the equity earnings from KCSM and accordingly, does not provide deferred income tax expense for the excess of its book basis over the tax basis of its investment in KCSM.

YEAR ENDED DECEMBER 31, 2004 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2003

Net Income. Net income for the year ended December 31, 2004 increased $12.2 million compared to the year ended December 31, 2003. The increase of $54.4 million in operating income was partially offset by a net decrease in other nonoperating income and expense items of $6.9 million, a $26.4 million increase in the provision for income taxes, and the impact of an $8.9 million cumulative effect of accounting change, net of income taxes in the first quarter of 2003.

The following table summarizes the income statement components of KCS (in millions):


							Change

	2004			2003			In Dollars			Percentage

Revenues	$	639.5		$	581.3		$	58.2			10.0	%
Operating expenses		556.0			552.2			3.8			0.7	%

Operating income		83.5			29.1			54.4			186.9	%
Equity in net earnings (losses) of unconsolidated affiliates		(4.5	)		11.0			(15.5	)		(140.9	)%
Interest expense		(44.4	)		(46.4	)		(2.0	)		4.3	%
Debt retirement costs		(4.2	)		—			(4.2	)		100.0	%
Other income		17.6			6.8			10.8			158.8	%

Income before income taxes and cumulative effect of accounting change		48.0			0.5			47.5			nm
Income tax provision (benefit)		23.6			(2.8	)		26.4			nm

Income (loss) before cumulative effect of accounting change		24.4			3.3			21.1			nm
Cumulative effect of accounting change, net of income taxes		—			8.9			(8.9	)		(100.0	)%

Net income (loss)	$	24.4		$	12.2		$	12.2			100.0	%

nm — not meaningful percentage change in excess of 500%

Revenues. The following table summarizes consolidated KCS revenues, including the revenues and carload statistics of KCSR, for the years ended December 31, 2004 and 2003. Certain prior period amounts have been reclassified to reflect changes in the business groups and to conform to the current period presentation.


	Revenues										Carloads and Intermodal Units

					Change										Change

	2004		2003		In Dollars			Percentage			2004		2003		In Units		Percentage

	(In millions)										(In thousands)
General commodities:
Chemical and petroleum	$	135.0	$	123.8	$	11.2			9.0	%		147.9		140.0		7.9		5.6	%
Forest products and metals		169.6		146.1		23.5			16.0	%		197.3		186.2		11.1		6.0	%
Agricultural and mineral		125.2		108.5		16.7			15.4	%		149.4		140.6		8.8		6.3	%

Total general commodities		429.8		378.4		51.4			13.6	%		494.6		466.8		27.8		6.0	%
Intermodal and automotive		66.8		59.1		7.7			13.0	%		342.8		310.5		32.3		10.4	%
Coal		92.1		92.7		(0.6	)		(0.6	)%		194.7		191.4		3.3		1.7	%

Carload revenues and carload and intermodal units		588.7		530.2		58.5			11.0	%		1,032.1		968.7		63.4		6.5	%

Other rail-related revenues		47.0		45.1		1.9			4.2	%

Total KCSR revenues		635.7		575.3		60.4			10.5	%
Other subsidiary revenues		3.8		6.0		(2.2	)		(36.7	)%

Consolidated revenues	$	639.5	$	581.3	$	58.2			10.0	%

For the year ended December 31, 2004, consolidated revenues increased $58.2 million. Freight revenues included fuel surcharges of $ 16.7 million compared with $4.4 million in the prior year. Fuel surcharges will increase or decrease dependent on the price of West Texas Intermediate Crude Oil as published in the Wall Street Journal. KCSR experienced revenue increases in the chemical and petroleum, forest products and metals, and agriculture and mineral products, and intermodal commodity groups while coal revenues were relatively flat. For most commodity groups, these increases in revenue resulted from higher carloadings and targeted price improvements. The following discussion provides an analysis of KCSR revenues by commodity group.

Chemical and petroleum products. For the year ended December 31, 2004, KCSR recorded higher revenues for all commodities within the chemical and petroleum products group. Revenue increases for petroleum, agricultural chemicals and industrial gases were primarily the result of targeted rate increases as well as increased traffic volumes. While some new business was added in 2004, increased volumes from existing customers driven by improvements in the economy accounts for the majority of the volume change. Excluding organic chemicals, revenue per carload (RPC) increased 6.6% over 2003. Organic chemical revenues increased primarily as a result of increased traffic, partially offset by lower RPC due to shorter hauls and changes in commodity mix.

Forest products and metals. For the year ended December 31, 2004, KCSR recorded higher revenues for all forest products and metal commodities compared to 2003. Revenue increases for all commodities in the group resulted from certain targeted rate increases, fuel surcharges, and increased volume attributed to higher production and service improvements. Volumes for lumber and plywood products experienced growth as a result of a robust housing industry and hurricane reconstruction in Florida. Wet weather in other areas of the country contributed to a rise in traffic for pulpwood, logs and chip. Military and other carloads increased due to strong traffic during the second half of 2004 as a result of increased movements for military installations serviced by KCSR.

Agricultural and mineral products. Revenues in all commodities in the agricultural business unit increased due to targeted rate increases and fuel surcharges resulting in an overall RPC increase of 8.5%.

Carload volumes increased in all commodities except for food and kindred. For the year ended December 31, 2004, increases in revenues for domestic grain were a direct result of increased production of feed mills on KCSR’s line. Export grain revenues for 2004 versus 2003 improved as a result of increased volumes related to the shipment of current year grain harvests to ports in the Gulf of Mexico, combined with strong increases in export volumes to Mexico. Ores and minerals revenue and stone, clay and glass revenues increased during 2004 as a result of higher production by certain customers, as well as certain targeted rate increases and fuel surcharges. Food and kindred product revenues increased primarily as a result of longer hauls to domestic destinations.

Intermodal and automotive. Intermodal revenues increased as a result of higher volumes from existing customers, as well as the generation of new intermodal business. Automotive traffic increased partially as a result of a temporary shift in traffic from Ford Motor Company and increased volumes from GM and Mazda. These increases were partially offset by a decrease in haulage revenue per car resulting from a change in the traffic mix.

Coal. Revenues for coal for the year ended December 31, 2004 decreased due primarily to lower traffic volumes at certain electric generating stations. These year-to -year decreases were partially offset by increased traffic in the fourth quarter of 2004 related to new business, as well increased production at other electric generating stations.

Operating Expenses. For the year ended December 31, 2004, consolidated operating expenses increased $3.8 million compared to the year ended December 31, 2003. The following table summarizes KCS’s consolidated operating expenses for the years ended December 31, 2004 and 2003. Certain prior period amounts have been reclassified to conform to the current year presentation.


					Change

	2004		2003		In Dollars			Percentage

Compensation and benefits	$	213.0	$	197.8	$	15.2			7.7	%
Purchased services		62.3		63.5		(1.2	)		(1.9	)%
Fuel		66.4		47.4		19.0			40.1	%
Equipment costs		50.4		57.4		(7.0	)		(12.2	)%
Depreciation and amortization		53.5		64.3		(10.8	)		(16.8	)%
Casualties and insurance		42.4		56.4		(14.0	)		(24.8	)%
Other leases		11.8		9.8		2.0			20.4	%
Other		56.2		55.6		0.6			1.1	%

Total consolidated operating expenses	$	556.0	$	552.2	$	3.8			0.7	%

Compensation and Benefits. Compensation and benefits expense increased $15.2 million for the year ended December 31, 2004 compared to the year ended December 31, 2003. This increase was primarily the result of annual wage and salary rate increases, higher crew starts related to higher traffic volume and increased incentive compensation. Average headcount for the year ended December 31, 2004 was 2,740 compared to 2,676 for the year ended December 31, 2003.

Purchased Services. Purchased services expense for the year ended December 31, 2004 decreased $1.2 million compared to the year ended December 31, 2003 resulting from lower levels of equipment repairs partially offset by increases in infrastructure repairs performed by outside parties and higher legal costs related to claim settlements.

Fuel. Fuel expense increased $19.0 million for the year ended December 31, 2004 compared to the year ended December 31, 2003. Increases of 30.2% in average price per gallon and 6.8% in consumption were offset in part by fuel cost savings of $3.0 million as a result of our fuel hedging program and improved fuel purchasing and distribution procedures implemented through our new Heavener, Oklahoma fueling facility. The 6.8% increase in consumption was a direct result of increased traffic, as gallons per gross ton mile remained unchanged from 2003 to 2004 at 1.37. Fuel cost represented approximately 11.9%

of operating expenses for the year ended December 31, 2004 compared to 8.6% of operating costs and expenses for the year ended December 31, 2003.

Equipment Costs. Equipment costs for the year ended December 31, 2004 decreased $7.0 million compared to the year ended December 31, 2003. This decrease was primarily due to continued efficiency gains in KCSR’s rail operations combined with an increase in car hire receivable for KCSR rolling stock on foreign lines and the 2004 acquisition of locomotives from Southern Capital, which were previously under lease.

Depreciation and Amortization. Depreciation and amortization expense for the year ended December 31, 2004 decreased $10.8 million compared to the year ended December 31, 2003 primarily as a result of changes in depreciable lives and salvage values approved by the STB and which took effect on January 1, 2004. These decreases were partially offset by increases in the property base as a result of capital expenditures.

Casualties and Insurance. Casualties and insurance expense for the year ended December 31, 2004 decreased $14.0 million compared to the year ended December 31, 2003. Casualties and insurance expense was significantly impacted in 2003 as a result of a $21.1 million provision in the fourth quarter of 2003. Excluding this provision, the $7.1 million increase in casualties and insurance was primarily the result of a $5.0 million derailment in Bolton, Mississippi in September 2004. Casualties and insurance expense for the year ended December 31, 2004 reflects the net effect of approximately $4.4 million in insurance settlements.

Other Leases. Other lease expense for the year ended December 31, 2004 increased $2.0 million compared to the year ended December 31, 2003, related to pipeline rents for KCSR’s new fuel facility in Heavener, Oklahoma. Additionally, KCSR experienced normal rate increases in long-term leases.

Operating Income. Consolidated operating income for the year ended December 31, 2004 increased $54.4 million to $83.5 million compared to $29.1 million for the year ended December 31, 2003. Accordingly, KCS experienced a reduction in its consolidated operating ratio (ratio of operating expenses to operating revenues) of 8.1 basis points to 86.9% in 2004 from 95.0% in 2003. This decrease was the result of a $58.2 million increase in revenue, partially offset by a corresponding $3.8 million increase in operating expenses.

Interest Expense. Consolidated interest expense for the year ended December 31, 2004 decreased $2.0 million compared to the year ended December 31, 2003. This reduction was primarily the result of decreased balances on higher fixed rate debt instruments and lower average interest rates related to the Credit Facility.

Debt Retirement Costs. During the year ended December 31, 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.

Other Income. Increases in KCS’s other income for the year ended December 31, 2004 were primarily the result of interest on tax refunds received in 2004 related to certain prior year tax returns as well as fluctuations in gains on sales of non-operating property.

Income Tax Provision (Benefit). For the year ended December 31, 2004, KCS’s income tax provision was $23.6 million, an increase of $26.4 million compared to a $2.8 million benefit for the year ended December 31, 2003. This increase was primarily due to a $47.5 million increase in income before income taxes, resulting in an effective income tax rate of 49.1% and (600.7)% for the years ended December 31, 2004 and 2003, respectively. The primary cause of the increase in the effective rate was the increase in KCS pre-tax earnings, excluding equity in earnings of unconsolidated subsidiaries, of $50.4 million in 2004 compared to a pre-tax loss of $11.8 million in 2003, resulting in a consolidated effective income tax rate of 46.8% for 2004 compared to 23.8% for 2003. KCS intends to indefinitely reinvest the equity earnings from KCSM and accordingly, does not provide deferred income tax expense for the excess of its book basis over the tax basis of its investment in KCSM.

Equity in Net Earnings (Losses) of Unconsolidated Affiliates. For the years ended December 31, 2004 and 2003, KCSM’s operating results and KCS’s corresponding equity in earnings under U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) were as follows (in millions):


	2004			2003

Revenue	$	699.2		$	698.5
Operating expenses		593.1			591.2

Net income (loss)	$	(8.3	)	$	27.3

KCS equity in earnings (losses) of KCSM	$	(2.4	)	$	12.3

The increase in KCSM operating expenses was driven primarily by increases in fuel costs of $19.2 million partially offset by decreases in other operating expenses. Net income of KCSM was significantly impacted by a $4.7 million income tax provision (U.S. GAAP) compared to a $51.5 million income tax benefit for 2003. This net increase in the tax provision was largely driven by tax legislation passed in the fourth quarter of 2004 that lowered future corporate income tax rates in Mexico. As a result of this legislation, the value of certain net deferred tax assets was adjusted to reflect lower values resulting in a charge to the tax provision of $23.7 million. KCSM’s principal deferred tax assets are the result of prior year net operating losses for income tax purposes. KCSM’s tax provision for 2004 was also impacted by changes in the peso/dollar exchange rate as well as adjustments for inflation within the Mexican economy.

Prior to 2005, KCSM reported its financial results under International Financial Reporting Standards (“IFRS”). Because we were required to report our equity in net earnings in KCSM under U.S. GAAP and KCSM reported under IFRS, differences in deferred income tax calculations and the classification of certain operating expense categories occurred. The deferred income tax calculations are significantly impacted by fluctuations in the relative value of the Mexican peso versus the U.S. dollar and the rate of Mexican inflation, and can result in significant variability in the amount of equity earnings reported by KCS. Additionally, in 2004, KCSM recognized a loss, net of tax and minority interest, of $4.2 million on the sale of its interest in Mexrail to KCS. For purposes of recording our equity in the net losses of KCSM, this loss was eliminated due to the sale being to KCS, a related party.

For the year ended December 31, 2004, equity in losses from other unconsolidated affiliates was $2.1 million compared to equity in losses from other unconsolidated affiliates of $1.3 million in 2003. Significant components of this change were as follows:


	•	For 2004, KCS recorded equity in losses of $2.1 million from PCRC compared to $3.1 million for 2003 as PCRC continued to operate below full capacity due to delays in the completion of port expansion in Balboa.

	•	Equity in losses of $2.7 million from KCS’s investment in Mexrail. For 2003 and the first half of 2004, Mexrail’s results were consolidated into the results of KCSM.

	•	Equity in earnings from Southern Capital of $2.7 million compared to $1.8 million in 2003.

For 2004, earnings for Southern Capital were $11.8 million compared to $4.1 million in 2003. This increase of $7.7 million was primarily the result of the recognition by Southern Capital of an approximate $6.0 million gain related to the sale of locomotives to KCSR in the second quarter of 2004. For purposes of recording its share of Southern Capital earnings, the Company has recorded its share of the gain as a reduction to the cost basis of the equipment acquired. As a result, the Company will recognize its equity in the gain over the remaining depreciable life of the locomotives as a reduction of depreciation expense.

Cumulative Effect of Accounting Change. The Company adopted the provisions of Statement of Financial Accounting Standards No. 143 “Accounting for Asset Retirement Obligations” (“SFAS 143”) effective January 1, 2003. As a result, the Company changed its method of accounting for removal costs of certain track structure assets and recorded a one-time benefit of $8.9 million (net of income taxes of

$5.6 million) during the first quarter of 2003. This change is reported as a cumulative effect of an accounting change in the accompanying consolidated statement of income.

LIQUIDITY AND CAPITAL RESOURCES

KCS is a highly leveraged company. Our primary sources of liquidity are cash flows generated from operations, borrowings under our revolving credit facilities and access to debt and equity capital markets. Although we have had excellent access to capital markets, as a highly leveraged company the financial terms under which we obtain funding often contain certain restrictive covenants. Our covenants restrict or prohibit certain actions, including, but not limited to, our ability to incur debt, create or suffer to exist liens, make prepayments of particular debt, pay dividends, make investments, engage in transactions with stockholders and affiliates, issue capital stock, sell certain assets, and engage in mergers and consolidations or in sale-leaseback transactions. These covenants restrict our financial flexibility. As of December 31, 2005, our total available liquidity, defined as the cash balance plus revolving credit facility availability, was approximately $68 million. On March 31, 2006 in settlement of our obligations to TMM and JSIB, KCS paid $44 million in cash and other considerations. These cash payments reduced our available liquidity.

As a result of KCS acquiring a controlling interest in Grupo TFM and KCSM, both companies became subject to the terms and conditions of the indentures governing KCSR’s two senior notes issues. The restrictive covenants of these indentures limit the ability of Grupo TFM and KCSM to incur additional debt. Grupo TFM and KCSM can only incur debt to refinance existing debt.

For the four quarters ended December 31, 2005, KCS’ consolidated coverage ratio (EBITDA/ interest expense), as defined and measured under the KCSR senior notes indentures, was less than 2.00:1. A ratio of less than 2.00:1 restricts KCS’ ability to incur additional indebtedness, with certain exceptions including borrowings under our revolving credit facility, and pay cash dividends under the terms of the indentures. We anticipate that our ability to incur additional indebtedness and pay cash dividends will remain restricted by the coverage ratio until the end of the third quarter of 2006.

For the twelve month period ended December 31, 2005, KCS did not meet the leverage ratio covenant (debt/ EBITDA) of 5.00:1 as defined and measured under the terms of its credit agreement dated March 30, 2004 (the “Credit Agreement”). On March 1, 2006 KCS, KCSR and other KCS subsidiaries entered into a fourth waiver of its Credit Agreement (the “Fourth Waiver”). Under the terms of the Fourth Waiver, which expires on April 30, 2006, the Lenders have agreed to waive the requirement that the KCS, as defined by the Credit Agreement, maintain a leverage ratio of not more than 5.00:1 for the quarter ended December 31, 2005, provided that such ratio does not exceed 5.50:1.

On March 31, 2006, KCS failed to meet certain reporting requirements under the Credit Agreement. This failure resulted in a default under the Credit Agreement and limited KCSR’s access to the revolving credit facility. On April 7, 2006, KCS, KCSR and other KCS subsidiaries entered into a fifth waiver of the Credit Agreement (the “Fifth Waiver”). Under the terms of the Fifth Waiver, which expires on April 30, 2006, the Lenders have agreed to waive the requirement of Section 5.03(b) that KCS furnish a copy of its 2005 annual audited financial statements by March 31, 2006 so long as KCS furnishes such audited financial statements by April 30, 2006. We are not currently in default of the Credit Agreement and currently have access to the revolving credit facility.

On March 17, 2006 KCSR entered into a commitment letter (the “Commitment Letter”) with The Bank of Nova Scotia (“Scotia”) under which Scotia has agreed to provide KCSR with a $371.2 million, fully underwritten, new credit agreement to refinance KCSR’s existing Credit Agreement. The new credit agreement will consist of a $246.2 million term loan facility and a $125 million revolving credit facility and contain terms and conditions substantially similar to the Credit Agreement, but will provide KCSR with additional financial flexibility. The closing on the new credit agreement is expected to occur before April 30, 2006. KCSR expects to be in compliance with all of the covenants of the new credit agreement throughout its term, including the leverage ratio.

For the twelve month period ended December 31, 2005, KCSM did not meet the leverage ratio covenant (debt/ EBITDA) of 4.50:1 as defined and measured under the terms of its credit agreement dated October 24, 2005 (the “2005 KCSM Credit Agreement”). In addition, on March 31, 2006, KCSM failed to meet certain reporting requirements under the 2005 KCSM Credit Agreement. These failures resulted in defaults under the 2005 KCSM Credit Agreement and limited KCSM’s access to the revolving credit facility. On April 7, 2006 KCSM entered into an amendment and waiver (“Amendment and Waiver”) to the 2005 KCSM Credit Agreement. The 2005 KCSM Credit Agreement was amended to (i) exclude certain payment obligations accrued under two locomotive maintenance agreements and under a track maintenance rehabilitation agreement from the definition of Indebtedness, (ii) eliminate certain minimum and multiple borrowing thresholds for peso borrowings under the revolving credit facility and (iii) eliminate the reporting requirement to provide unaudited consolidated financial statements for the fourth fiscal quarter. The Amendment and Waiver also waived (x) certain reporting requirements, including the requirement of KCSM to provide audited consolidated financial statements 90 days after the end of the 2005 fiscal year, provided such reports are delivered by April 30, 2006 and (y) compliance with the Consolidated Leverage Ratio obligations of Section 7.1(c) of the 2005 KCSM Credit Agreement for the four quarters ending December 31, 2005 if compliance therewith was calculated without giving effect to the amendment to the definition of “Indebtedness” in the Amendment and Waiver, provided that KCSM is in compliance therewith after giving effect to the Amendment and Waiver. KCSM is not currently in default of the 2005 KCSM Credit Agreement and currently has access to the revolving credit facility.

We believe, based on current expectations, that our cash and other liquid assets, operating cash flows, access to capital markets, and other available financing resources will be sufficient to fund anticipated operating, capital and debt service requirements and other commitments through 2006. A consequence of the late filing of our Annual report on Form 10-K is that the ability of KCS to access quickly the public equity markets has been reduced significantly, since KCS is no longer qualified as a “well-known seasoned issuer” and also cannot utilize the short-form registration statement on Form S-3. These restrictions will continue for 12 months following this filing. Our operating cash flow and financing alternatives, however, can be unexpectedly impacted by various factors, some of which are outside of our control. For example, if we were to experience a substantial reduction in revenues or a substantial increase in operating costs or other liabilities, our operating cash flows could be significantly reduced. 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.

During 2005, subsequent to the VAT/ Put Settlement, both Standard & Poor’s Rating Service (“S&P”) and Moody’s Investors Service (“Moody’s”) removed their negative outlook on our debt rating and moved our outlook to stable. On March 23, 2006, S&P Rating Service placed our preferred stock ratings on CreditWatch with negative implications. This rating action was taken after we announced that KCS failed to meet the consolidated coverage ratio threshold under the KCSR senior notes indentures that would allow us to pay cash dividends on our Preferred Stock. On April 4, 2006 S&P placed its BB- ratings on KCS and KCSM on CreditWatch with negative implications and lowered the Company’s preferred stock ratings to CCC from B-. The preferred stock credit ratings remain on CreditWatch with negative implications. The rating actions followed recent negative developments, including the delay in filing our Annual Reports on Form 10-K, and to reflect an increased risk of KCS failing to make the next dividend payment on its preferred stock as a result of the special meeting being adjourned indefinitely. S&P placed the corporate credit and other ratings on CreditWatch on concerns about the Company’s liquidity in the wake of these events. S&P has indicated that the preferred stock ratings would likely be lowered to ‘D’ if the May 15, 2006 dividend payment is missed. All ratings could be lowered if the Company fails to address liquidity concerns or fails to demonstrate the likelihood of improved financial results over the near to intermediate term.

On April 5, 2006 Moody’s Investors Service (“Moody’s”) placed all of KCS’, KCSR’s and KCSM’s debt ratings under review for possible downgrade. Moody’s review was prompted by KCS’ inability to file this 2005 Form 10-K by March 31, 2006.


	*Cash Flow Information and Contractual Obligations*

Summary cash flow data follows for the years ended December 31, 2005, 2004 and 2003, respectively: (dollars in millions)


		2005			2004			2003

Cash flows provided by (used for):
	Operating activities	$	178.8		$	142.7		$	68.0
	Investing activities		(289.5	)		(376.8	)		(86.0	)
	Financing activities		103.2			137.3			134.4

Net increase (decrease) in cash and cash equivalents			(7.5	)		(96.8	)		116.4
Cash and cash equivalents at beginning of year			38.6			135.4			19.0

Cash and cash equivalents at end of year		$	31.1		$	38.6		$	135.4

During the year ended December 31, 2005, our consolidated cash position decreased by $7.5 million from December 31, 2004. This resulted primarily from an increased level of capital expenditures. During the year ended December 31, 2004, our consolidated cash position decreased by $96.8 million from December 31, 2003. This resulted primarily from an increased level of investments in affiliates. The primary sources of cash were cash inflows from operating activities, the issuance and assumption of long-term debt, the issuance of preferred stock and borrowings under our revolving credit facilities. The primary uses of cash were for capital expenditures, investments in affiliates, repayment of long-term debt and the repurchase of our common stock.

KCS’s cash flow from operations has historically been positive and sufficient to fund operations, KCSR roadway capital expenditures, other capital improvements and debt service. During 2005, KCSR used borrowings under its revolving credit facility to fund an expanded capital expenditure program. External sources of cash (principally bank debt, public debt, preferred stock and leases) have been used to refinance existing indebtedness and to fund acquisitions, new investments and equipment additions.

Operating Cash Flows. The following table summarizes consolidated operating cash flow information for the years ended December 31, 2005, 2004, and 2003, respectively: (dollars in millions)


		2005			2004			2003

Net income		$	100.9		$	24.4		$	12.2
Depreciation and amortization			127.7			53.5			64.3
Equity in undistributed (earnings) losses of unconsolidated affiliates			(2.9	)		4.5			(11.0	)
VAT/ Put Settlement gain			(131.9	)		—			—
Funding of restricted cash			(9.0	)		—			—
Minority interest			(17.8	)		—			—
Distributions from unconsolidated affiliates			8.3			8.8			—
Deferred income taxes			(17.3	)		35.9			1.6
KCSM employees’ statutory profit sharing			41.1			—			—
Gains on sales of properties and investments			1.0			(3.8	)		(6.2	)
Tax benefit realized upon exercise of stock options			5.0			9.5			2.5
Cumulative effect of accounting change			—			—			(8.9	)
Change in working capital items			45.9			1.3			6.3
Other			27.8			8.6			7.2

	Net cash flow from operating activities	$	178.8		$	142.7		$	68.0

Net operating cash flows for 2005 increased $36.1 million to $178.8 million compared to $142.7 million in 2004. This increase in operating cash flows was primarily attributable to the consolidation of KCSM which was partially offset by changes in working capital balances relating to the timing of payments and receipts.

Net operating cash flows for 2004 increased $74.7 million to $142.7 million compared to $68.0 million in 2003. This increase in operating cash flows was primarily attributable to an increase in net income, distributions from unconsolidated affiliates, the increase in deferred tax expense recognized in 2004, the impact of certain tax benefits related to stock options and changes in working capital balances relating to the timing of payments and receipts, as well as the discharge of certain non-current liabilities.

Investing Cash Flows. Net investing cash outflows were $289.5 million and $376.8 million during the years ended December 31, 2005 and 2004, respectively. This $87.3 million decrease was related to the investments in Mexrail and Grupo TFM in 2004. During 2005, KCS capital expenditures increased by approximately $158.5 million, of which KCSM contributed $72.0 million and Mexrail contributed $28.6 million. KCS also incurred approximately $10.1 million of costs associated with the Acquisition of Grupo TFM in 2005 as compared to $9.5 million in 2004.

Net investing cash outflows were $376.8 million and $86.0 million during the years ended December 31, 2004 and 2003, respectively. This $290.8 million increase in investing cash outflows was primarily related to the $200 million of restricted cash placed in an escrow account for investment in Grupo TFM and the $32.7 million investment in Mexrail during 2004, as well as an increase of $33.2 million in capital expenditures. During 2003, in contemplation of the Acquisition, KCS repurchased a 51% interest in Mexrail for $32.7 million. In accordance with a demand from KCSM, KCS sold its interest in Mexrail back to KCSM on September 30, 2003 for $32.7 million. As a result of these two Mexrail transactions in 2003, there was no net impact to net investing cash outflows during 2003. Also impacting net investing cash outflows for 2004 and 2003 were approximately $9.5 million and $9.3 million, respectively, of costs associated with the Acquisition that were deferred and included in other investing activities.

Financing Cash Flows. Financing cash inflows were derived from the issuance of long-term debt, including borrowings under our revolving credit facilities, the issuance of preferred stock and proceeds from

the issuance of common stock under employee stock plans. Financing cash outflows were used for the repayment of debt, the repurchase of our common stock, the payment of dividends on our preferred stock and the payment of debt and preferred stock issuance costs. Financing cash flows for 2005, 2004, and 2003 were as follows:


	•	Financing cash flows for 2005 were $103.2 million, resulting primarily from borrowings under our revolving credit facilities. During 2005, KCS issued $210 million of preferred stock, assumed debt under a purchase agreement for 75 locomotives, of which $24.3 million was outstanding at December 31, 2005, borrowed $21.7 million under the Tex-Mex RRIF loan and had borrowings of $92 million outstanding at year end under KCSR’s revolving credit facility. Net proceeds from the issuance of the preferred stock were used to repurchase 9 million shares of KCS common stock. Also during 2005, KCSM issued $460 million of 9 3/8% senior unsecured notes and entered into a new $106 million credit facility. The proceeds from these two financings were used by KCSM to repay $443.5 million of senior discount debentures, $31 million under a bridge loan, the remaining balance of $67.5 million under its previous credit facility and the costs associated with the transactions.

	•	Financing cash flows for 2004 were $137.3 million, resulting primarily from borrowings under a new credit facility. In March, 2004 KCS entered into a new $250 credit agreement consisting of a $150 million term loan facility and a $100 million revolving credit facility. The term loan was fully drawn at closing. In December, 2004 KCS amended the new credit agreement to increase the term loan facility from $150 million to $250 million. The additional $100 million was used to fund a portion of the escrow account under the Acquisition. In March, 2004 KCS used cash on hand to pay off the term loan facility under its previous credit agreement. There were no borrowings outstanding at year end under the revolving credit facility.

	•	Financing cash flows for 2003 were $134.4 million, resulting primarily from the net proceed received from the issuance of $200 million of preferred stock which was partially offset by the repayment of $59.2 million of debt.

	•	Proceeds from the sale of KCS common stock pursuant to employee stock plans were $1.7 million, $7.4 million and $5.3 million in 2005, 2004 and 2003, respectively.

	•	Payment of cash dividends were $8.7 million, $8.7 million and $4.7 million in 2005, 2004 and 2003, respectively. Approximately $0.2 million of dividends were paid in each year on our Preferred Stock and approximately $8.5 million, $8.5 million and $4.5 million of dividends were paid in 2005, 2004 and 2003, respectively, on our 4.25% Cumulative Preferred Stock.

Contractual Obligations. The following table outlines our material obligations under long-term debt, operating lease and other contractual commitments at December 31, 2005. Typically, payments for operating leases, other contractual obligations and interest on long-term debt are funded through operating cash flows. Principal payment obligations on long-term debt are typically refinanced by issuing new long-term debt. If operating cash flows are not sufficient, funds received from other sources, including borrowings under credit facilities and proceeds from property and other asset dispositions might also be available. These obligations are customary transactions similar to those entered into by others in the transportation industry. We anticipate refinancing certain parts of our long-term debt prior to maturity.


			Payments Due by Period

			Less Than		1-3		More Than
	Total		1 Year		Years		3 Years

Contractual Obligations
Long-term debt (including capital lease obligations)(i)(ii)	$	1,860.6	$	116.3	$	871.2	$	873.1
Operating leases		915.7		133.2		227.5		555.0
Other contractual obligations(iii)		401.7		60.3		120.1		221.3

Total contractual obligations	$	3,178.0	$	309.8	$	1,218.8	$	1,649.4


(i)	Excludes amounts for interest

(ii)	Includes current and long-term liability related to Grupo TFM acquisition.

(iii)	Other contractual obligations include purchase commitments and certain maintenance agreements.


	*Off-Balance Sheet Arrangements*

As further described in Note 3 to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K, we hold a 50% interest in Southern Capital, a joint venture that provides us with access to equipment financing alternatives. Southern Capital’s principal operations are the acquisition of locomotives, rolling stock and other railroad equipment and the leasing thereof to KCSR. On June 25, 2002, Southern Capital refinanced the outstanding balance of certain debt through the issuance of 5.7% pass through trust certificates and proceeds from the sale of 50 locomotives. These pass through trust certificates are secured by all of the locomotives and rolling stock owned by Southern Capital and rental payments payable by KCSR under the operating leases of the equipment owned by Southern Capital. As Southern Capital is a 50% owned unconsolidated joint venture, this debt is not reflected in KCS’ Consolidated Balance Sheets, which are included in Item 8 of this Form 10-K.

Also, as described in Note 3 to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K, under the terms of the loan agreement with International Finance Corporation (“IFC”), we are a guarantor for up to $5.6 million of associated debt. Also, if PCRC terminates the concession contract without the IFC’s consent, we are a guarantor for up to 50% of the outstanding senior loans. Furthermore, we are a guarantor for up to $3.0 million of the equipment loans and approximately $100,000 relating to the other capital leases.

On March 28, 2005, PCRC and the IFC finalized an agreement whereby PCRC would redeem the shares subscribed and owned by the IFC pursuant to the IFC Subscription. Under the agreement, PCRC paid to the IFC $10.5 million. These shares had a recorded value of $5.0 million and approximately $2.6 million in accrued unpaid dividends. Upon completion of the transaction, PCRC recorded additional cost of approximately $2.9 million to reflect the premium paid to IFC and, as a result, KCS recorded its share of the transaction cost of approximately $1.5 million through its equity in earnings of PCRC in the first quarter of 2005.

As previously described, on November 2, 2005, KCSR entered into an agreement with El-Mo-Mex, Inc. (“El-Mo”) to acquire El-Mo’s equity interest in the leased locomotives. KCSR and an affiliate paid cash in the amount of approximately $32.6 million and assumed approximately $95.9 million of debt and

accrued interest to acquire the locomotives. KCSR subsequently purchased the locomotives from the affiliate. On December 20, 2005, KCSR entered into a leveraged lease arrangement, treated for financial reporting purposes as an operating lease, with an unaffiliated third party.


	*Capital Expenditures*

Capital improvements for KCSR roadway track structures have historically been funded with cash flows from operations. In 2005, we used proceeds from borrowings under our Revolving Credit Facility to finance an expanded capital program. We have historically used internally generated cash flows or leasing for equipment capital expenditures. Through our Southern Capital joint venture, we have the ability to finance railroad equipment, and therefore, have increasingly used lease-financing alternatives for our locomotives and rolling stock.

The following table summarizes the cash capital expenditures by type for KCSR and Mexrail for the year ended December 31, 2005 and KCSM for the nine months ended December 31, 2005. For the years ended December 31, 2004 and 2003 the cash capital expenditures are for KCSR only. (dollars in millions)


	*Capital Expenditure Category*


	2005		2004		2003

Track infrastructure	$	190.1	$	57.2	$	52.9
Locomotives, freight cars and other equipment		41.8		22.6		14.9
Facilities and capacity projects		1.7		27.4		6.8
Information technology		12.2		5.4		3.8
Other		29.9		4.6		5.6

Total capital expenditures	$	275.7	$	117.2	$	84.0

Internally generated cash flows and borrowings under our credit agreements are expected to be used to fund capital programs for 2006, currently estimated at approximately $80 million in the U.S. and $96 million in Mexico.


	*Maintenance & Repairs*

KCSR and KCSM, like other railroads, are required to maintain their own property infrastructure. Portions of roadway and equipment maintenance costs are capitalized and other portions are expensed (as components of material and supplies, purchased services and others), as appropriate. Maintenance and capital improvement programs are in conformity with the standards promulgated by the applicable regulatory agency and are accounted for in accordance with applicable regulatory accounting rules. We expect to continue funding roadway and equipment maintenance expenditures with internally generated cash flows.


	*Capital Structure*

Components of our capital structure are as follows (dollars in millions).


		2005			2004

Debt due within one year(i)		$	116.3		$	9.9
Long-term debt(ii)			1,744.3			655.8

	Total debt(iii)		1,860.6			665.7
Stockholders’ equity			1,426.2			1,016.5

Total debt plus equity		$	3,286.8		$	1,682.2

Total debt as a percent of Total debt plus equity (“debt ratio”)			56.6	%		39.6	%


(i)	Includes current liability related to Grupo TFM acquisition.

(ii)	Includes long-term liability related to Grupo TFM acquisition.

(iii)	Includes current and long-term liability related to Grupo TFM acquisition.

Our consolidated debt ratio as of December 31, 2005 increased 17.0 percentage points as compared to December 31, 2004. Total consolidated debt increased $1,194.9 million, primarily as a result of the Acquisition, $92 million of borrowings under our revolving credit facility outstanding at December 31, 2005, $24.3 million of assumed debt remaining outstanding under a purchase agreement for 75 locomotives and $21.7 million of borrowings under the Tex-Mex RRIF loan. KCSM debt of $891.7 million was outstanding as of December 31, 2005.


	*Shelf Registration Statements and Public Securities Offerings*

Kansas City Southern currently has three shelf registration statements on file with the SEC (“Initial Shelf” — Registration No. 33-69648; “Second Shelf” — Registration No. 333-61006; “Third Shelf” — Registration No. 333-130112). 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. The Third Shelf was filed in accordance with the securities offering reform rules of the SEC that allow well known seasoned issuers to register an unspecified amount of different types of securities on an immediately effective Form S-3 registration statement. On December 9, 2005, the Company completed the sale and issuance of 210,000 shares of its Convertible Preferred Stock Series D pursuant to the Third Shelf. See Item 5 “Market for KCS’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for a detailed discussion of the terms of the Convertible Preferred Stock Series D and the offering. There remains an unspecified amount of securities available under the Third Shelf. To date, no securities have been issued under either the Initial Shelf or Second Shelf. As a consequence of the late filing of this 2005 Form 10-K, KCS will be ineligible to use any of these shelf registration statements until it has timely filed all periodic reports required under Section 13(a) or Section 15(d) of the Exchange Act for twelve months from the date of filing this 2005 Form 10-K.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

KCS’s accounting and financial reporting policies are in conformity with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Management believes that the following accounting policies and estimates are critical to an understanding of KCS’s historical and future performance. Management has discussed the development and selection of the following critical accounting estimates with the Audit Committee of KCS’s Board of Directors and the Audit Committee has reviewed the selection, application and disclosure of our critical accounting policies and estimates.


	*Depreciation of Property, Plant and Equipment*

The railroad industry is extremely capital intensive. Maintenance and the depreciation of operating assets constitute a substantial operating expense for KCS, as well as the railroad industry as a whole. We capitalize costs relating to additions and replacements of property, plant and equipment, including certain overhead costs representing the indirect costs associated with construction and improvement projects. Overhead factors are periodically reviewed and adjusted to reflect current costs. All of these costs are depreciated using the group method consistent with industry standards and rules established by the STB. The cost of property, plant and equipment normally retired, less salvage value, is charged to depreciation expense over the estimated life of the operating assets using group straight-line rates for financial statement purposes. The STB approves the depreciation rates used by KCSR (excluding the amortization of computer software) but not for KCSM. Both KCSR and KCSM periodically conduct studies of depreciation rates for properties and equipment and implements approved changes, as necessary, to depreciation rates. These studies take into consideration the historical retirement experience of similar assets, the current condition of the assets, current operations and potential changes in technology, estimated salvage value of the assets, and industry regulations. For all other consolidated subsidiaries, depreciation is derived based upon the asset value in excess of estimated salvage value using the straight-line method over the estimated useful lives of the assets for financial reporting purposes. Depreciation is based upon estimates of the useful lives of assets as well as their net salvage value at the end of their useful lives. Estimation of the useful lives of assets that are long-lived as well as their salvage value requires significant management judgment. Accordingly, management believes that accounting estimates related to depreciation expense are critical.

Currently, KCSR and KCSM depreciate operating assets, including road and structures, rolling stock and equipment, and capitalized leases generally over a range of 3 to 50 years depending upon the estimated life of the particular asset. We amortize computer software over a range of 3 to 12 years depending upon the estimated useful life of the software. In addition to the adjustment to rates as a result of the depreciation studies, certain other events could occur that would materially affect the Company’s estimates and assumptions related to depreciation. Unforeseen changes in operations or technology could substantially alter our assumptions regarding our ability to realize the return of our investment in operating assets and, therefore, affect the amount of depreciation expense to charge against both current and future revenues. Because depreciation expense is a function of analytical studies made of property, plant and equipment, subsequent studies could result in different estimates of useful lives and net salvage values. If future depreciation studies yield results indicating that our assets have shorter lives as a result of obsolescence, physical condition, changes in technology or changes in net salvage values, the estimate of depreciation expense could increase. Likewise, if future studies indicate that assets have longer lives, the estimate of depreciation expense could decrease.

KCSR Depreciation Study. For the year ended December 31, 2004, changes were made to certain KCSR depreciation rates. As described above, depreciation is computed using group straight-line rates for financial statement purposes, which require approval of the STB. During the year ended December 31, 2003, the KCSR engaged a civil engineering firm with expertise in railway property usage to conduct a study to evaluate depreciation rates for properties and equipment. The study centered on evaluating actual historical replacement patterns to assess future lives and indicated that KCSR was depreciating its property over shorter periods than we actually utilize the assets, as estimated by the study. Specifically, the average rate applied to the Road and Structures Asset class (primarily rail, railroad ties and bridges) decreased approximately 0.7%, while the average rate applied to the Rolling Stock and Equipment Asset class (locomotives and railcars) decreased approximately 0.5%. The effect of this change in estimate on net income was approximately $8.0 million, net of tax of $5.0 million ($0.12 per share, on a diluted basis), for the year ended December 31, 2004.

KCSM Depreciation Review. For the year ended December 31, 2005, KCSM adopted the group depreciation method for consistency with KCSR. Accordingly, changes were made to certain historical depreciation rates. Unlike KCSR, KCSM depreciation rates are not subject to the approval of the STB, accordingly, the changes to the depreciation rates were applied in 2005. During the year ended

December 31, 2005, the KCSM engaged a civil engineering firm with expertise in railway property usage to conduct an analysis of depreciation rates for properties and equipment. The analysis centered on evaluating actual historical replacement patterns to assess future lives and indicated that KCSM was depreciating its property over shorter periods than we actually utilize the assets. As a result, depreciation expense recorded in the fourth quarter of 2005 reflected an adjustment totaling $5.5 million, to reduce depreciation expense as recorded in the second and third quarters of 2005. Concession rights and related assets are amortized over the shorter of their remaining useful life as determined by the KCSM depreciation review or the life of the concession.


	*Provision for Environmental Remediation*

Our operations are subject to extensive federal, state and local environmental laws and regulations. The major environmental laws to which we are subject include, among others, the Federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA,” also known as the Superfund law), the Toxic Substances Control Act, the Federal Water Pollution Control Act, and the Hazardous Materials Transportation Act. CERCLA can impose joint and several liabilities for cleanup and investigation costs, without regard to fault or legality of the original conduct, on current and predecessor owners and operators of a site, as well as those who generate, or arrange for the disposal of, hazardous substances. The risk of incurring environmental liability is inherent in the railroad industry. We own property that is, or has been, used for industrial purposes. Use of these properties may subject KCS to potentially material liabilities relating to the investigation and cleanup of contaminants, claims alleging personal injury, or property damage as the result of exposures to, or release of, hazardous substances.

KCS conducts studies, as well as site surveys, to determine the extent of environmental damage and the necessary requirements to remediate this damage. These studies incorporate the analysis of our internal environmental engineering staff and consultation with legal counsel. From these studies and surveys, a range of estimates of the costs involved is derived and a liability and related expense for environmental remediation is recorded within this range. Our recorded liabilities for these issues represent our best estimates (on an undiscounted basis) of remediation and restoration costs that may be required to comply with present laws and regulations. These estimates are based on forecasts of the total future direct costs related to environmental remediation. These estimates change periodically as additional or better information becomes available as to the extent of site remediation required, if any. In addition, advanced technologies related to the detection, appropriate remedial course of action and anticipated cost can influence these estimates. Certain changes could occur that would materially affect our estimates and assumptions related to costs for environmental remediation. If KCS becomes subject to more stringent environmental remediation costs at known sites, if we discover additional contamination, discover previously unknown sites, or become subject to related personal or property damage, KCS could incur material costs in connection with its environmental remediation. Accordingly, management believes that estimates related to the accrual of environmental remediation liabilities are critical to our results of operations.

For the year ended December 31, 2005, the expense related to environmental remediation was $2.1 million and is included as purchased services expense on the consolidated statements of income. Additionally, as of December 31, 2005, KCS has a total liability recorded for environmental remediation of $5.8 million including liabilities assumed in connection with the Mexrail acquisition of $2.8 million. This amount was derived from a range of reasonable estimates based upon the studies and site surveys described above and in accordance with SFAS 5. As of December 31, 2005 there were no accrued liabilities relating to environmental remediation at KCSM.


	*Provision for Casualty Claims*

Due to the nature of U.S. railroad operations, claims related to personal injuries and third party liabilities resulting from crossing collisions and derailments, as well as claims related to personal property damage and other casualties is a substantial expense to KCS. Claims are estimated and recorded for known reported occurrences as well as for incurred but not reported (“IBNR”) occurrences. Consistent

with the general practice within the railroad industry, our estimated liability for these casualty expenses is actuarially determined on an undiscounted basis. In estimating the liability for casualty claims, we obtain an estimate from an independent third party actuarial firm, which calculates an estimate using historical experience and estimates of claim costs as well as numerous assumptions regarding factors relevant to the derivation of an estimate of future claim costs. Employees are compensated for work related personal injury claims according to provisions contained within the Federal Employers’ Liability Act (“FELA”).

Reserves for occupational illness claims were previously established through an assessment made on a case-by-case basis, and a liability was established when management determined that it was probable and reasonably estimable. No provision was made for occupational illness claims that may have been incurred but not yet reported, since the Company believed the low end of the range of reasonably possible loss was not material. During 2005 the Company experienced a marked increase in the number of such claims. In light of these developments, the Company requested and obtained an actuarial study of these potential unasserted claims for the first time. The study indicated that existing reserves should be increased by $7.5 million.

Personal injury and casualty claims are subject to a significant degree of uncertainty, especially estimates related to IBNR personal injuries for which a party has yet to assert a claim and, therefore, the degree to which injuries have been incurred and the related costs have not yet been determined. In estimating costs related to casualty claims, management must make assumptions regarding future costs. The cost of casualty claims is related to numerous factors, including the severity of the injury, the age of the claimant, and the legal jurisdiction. In deriving an estimate of the provision for casualty claims, management must make assumptions related to substantially uncertain matters. Changes in the assumptions used for actuarial studies could have a material effect on the estimate of the provision for casualty claims. Management believes that the accounting estimate related to the liability for personal injuries and other casualty claims is critical to our results of operations.

For the year ended December 31, 2005, casualty expense was approximately $57.6 million and was included in casualties and insurance expense in the consolidated statements of income. Based on the methods described above and information available as of December 31, 2005, our liability for casualty claims was $103.9 million. For the year ended December 31, 2005, the provision for casualty expense represented 8.1% of consolidated operating expenses. For purposes of earnings sensitivity analysis, if the December 31, 2005 reserve were adjusted (increased or decreased) 10%, casualty expense would have changed $10.4 million.


	*Provision for Income Taxes*

Deferred income taxes represent a substantial liability of KCS. For financial reporting purposes, management determines our current tax liability, as well as deferred tax assets and liabilities, in accordance with the liability method of accounting for income taxes as specified in Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes.” The provision for income taxes is the sum of income taxes both currently payable and deferred into the future. Currently payable income taxes represent the liability related to KCS’s U.S., state and Mexican income tax returns for the current year and anticipated tax payments resulting from income tax audits while the net deferred tax expense or benefit represents the change in the balance of deferred tax assets or liabilities as reported on the balance sheet. The changes in deferred tax assets and liabilities are determined based upon the changes in differences between the basis of assets and liabilities for financial reporting purposes and the basis of assets and liabilities for tax purposes as measured using the enacted tax rates that management estimates will be in effect when these differences reverse. In addition, the tax provision for Mexico is further complicated by the impacts of inflation as well as the exchange rate, both of which can have a significant impact on the calculation. In addition to estimating the future tax rates applicable to the reversal of tax differences, management must also make certain assumptions regarding whether tax differences are permanent or temporary. If the differences are temporary, management must estimate the timing of their reversal, and whether taxable operating income in future periods will be sufficient to fully recognize any gross deferred

tax assets of KCS. Accordingly, management believes that the estimates related to the provision for income taxes is critical to our results of operations

OTHER

Derivative Instruments. KCS does not engage in the trading of derivatives. Our objective for using derivative instruments is to manage our fuel and interest rate risk to mitigate the impact of fluctuations in fuel prices and interest rates. We account for derivative transactions under Statement of Financial Accounting Standards 133 “Accounting for Derivative Instruments and Hedging Activities” as amended, as set forth in Note 2 to the Consolidated Financial Statements in Item 8 of this Form 10-K. In general, we enter 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 our various operations, and in so doing, may enter into such transactions more frequently as deemed appropriate.

Fuel Derivative Transactions. Fuel expense is a significant component of our operating expenses. Fuel costs are affected by (i) traffic levels, (ii) efficiency of operations and equipment, and (iii) fuel market conditions. To stabilize the price for future fuel purchases and protect our operating results against adverse fuel price fluctuations, from time to time, KCS enters into transactions, such as forward purchase commitments and commodity swap transactions. These derivative instruments hedge against fluctuations in the price of No. 2 Gulf Coast Heating Oil, the commodity on which KCSR’s diesel fuel prices are determined. Using certain risk management strategies, we are able to reduce our risk related to rising diesel fuel prices. At December 31, 2005 we had no outstanding fuel hedges.

Foreign Exchange Matters. In connection with our acquisition of KCSM, matters may arise with respect to financial accounting and reporting for foreign currency transactions and for translating foreign currency transactions into U.S. dollars. KCS follows the requirements outlined in Statement of Financial Accounting Standards No. 52 “Foreign Currency Translation” (“SFAS 52”), and related authoritative guidance. KCSM uses the U.S. dollar as its functional currency. Earnings (losses) from KCSM included in our results of operations reflect any such transaction gains and losses that KCSM records in the process of translating certain transactions from Mexican pesos to U.S. dollars. We continue to evaluate existing alternatives with respect to utilizing foreign currency instruments to hedge our U.S. dollar investment in KCSM as market conditions change or exchange rates fluctuate. At December 31, 2005 we had no outstanding foreign currency hedging instruments.

Litigation. The Company is a party to various legal proceedings and administrative actions, all of which are of an ordinary, routine nature and incidental to its operations. Included in these proceedings are various tort claims brought by current and former employees for job related injuries and by third parties for injuries related to railroad operations. We aggressively defend these matters and have established liability reserves that management believes are adequate to cover expected costs. Although it is not possible to predict the outcome of any legal proceeding, in the opinion of the Company’s management, other than those proceedings described in detail below, such proceedings and actions should not, individually, or in the aggregate, have a material adverse effect on the Company’s financial condition.

Reinsurance Litigation. The Company has established its personal injury and casualty reserves based on an assumption that it will have the benefit of insurance under existing policies. Several reinsurers of the Company’s captive insurer have filed a declaratory judgment action in federal court in Vermont seeking a declaration that based on a claimed lack of notice, they have no obligation to provide coverage for a set of lawsuits currently pending against a subsidiary of the Company. The Company’s captive insurer has answered and filed a counterclaim to establish its right to coverage. The Company presently believes that it has a strong basis to establish that notice was properly delivered and that it has a right to coverage. In the event the Company is unsuccessful in the litigation with the reinsurance carriers and the damages in the underlying litigation exceed the self insured retention, the Company would not have reinsurance to cover such excess. While the Company is not presently able to reliably estimate such amounts, those additional amounts could be material. In the event the Company is unsuccessful in the reinsurance

litigation, the Company believes it would have a strong claim against third parties responsible for providing notice to the reinsurers for any damages caused by the loss of the insurance coverage. The accompanying financial statements do not include any accruals related to the possible lack of insurance coverage from the reinsurers.

Recent Accounting Pronouncements. See Note 2 in the Notes to KCS’s Consolidated Financial Statements in Item 8 of this Form 10-K for information relative to recent accounting pronouncements.

CAUTIONARY INFORMATION

The discussions set forth in this Annual Report on Form 10-K contain statements concerning potential future events. Such forward-looking statements are based upon assumptions by KCS’s management, as of the date of this Annual Report, including assumptions about risks and uncertainties faced by KCS. In addition, management may make forward-looking statements orally or in other writings, including, but not limited to, in press releases, in the annual report to shareholders and in KCS’s other filings with the Securities and Exchange Commission. 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. These statements involve a number of risks and uncertainties. Actual results could materially differ from those anticipated by such forward-looking statements. Such differences could be caused by a number of factors or combination of factors including, but not limited to, the factors identified below and the factors discussed above under the heading “Risk Factors.” Readers are strongly encouraged to consider these factors when evaluating any forward-looking statements concerning KCS.


	•	whether we are fully successful in executing our business strategy, including capitalizing on NAFTA trade to generate traffic and increase revenues, exploiting our domestic opportunities, establishing new and expanding existing strategic alliances and marketing agreements and providing superior customer service;

	•	whether KCS is successful in retaining and attracting qualified management personnel;

	•	whether KCS is able to generate cash that will be sufficient to allow us to pay principal and interest on our debt and meet our obligations and to fund our other liquidity needs;

	•	whether KCS will be able to meet the covenants as defined by its various debt agreements, or in the alternative to obtain the necessary waivers and amendments to maintain compliance;

	•	material adverse changes in economic and industry conditions, both within the U.S. and globally;

	•	the effects of adverse general economic conditions affecting customer demand and the industries and geographic areas that produce and consume commodities carried;

	•	industry competition, conditions, performance and consolidation;

	•	general legislative and regulatory developments, including possible enactment of initiatives to re-regulate the rail industry;

	•	legislative, regulatory, or legal developments involving taxation, including enactment of new federal or state income tax rates, revisions of controlling authority, and the outcome of tax claims and litigation;

	•	changes in securities and capital markets;

	•	natural events such as severe weather, fire, floods, hurricanes, earthquakes or other disruptions of our operating systems, structures and equipment;

	•	any adverse economic or operational repercussions from terrorist activities and any governmental response thereto;

	•	war or risk of war;

	•	changes in fuel prices;


	•	changes in labor costs and labor difficulties, including stoppages affecting either our operations or our customers’ abilities to deliver goods to us for shipment; and

	•	outcome of claims and litigation, including those related to environmental contamination, personal injuries and occupational illness from hearing loss, repetitive motion and exposure to asbestos and diesel fumes.

We caution against placing undue reliance on forward-looking statements, which reflect our current beliefs and are based on information currently available to us as of the date a forward-looking statement is made. We undertake no obligation to revise forward-looking statements to reflect future events, changes in circumstances, or changes in beliefs. In the event we do update any forward-looking statement, no inference should be made that we will make additional updates with respect to that statement, related matters, or any other forward-looking statements. Any corrections or revisions may appear in our public filings with the Securities and Exchange Commission, which are accessible at www.sec.gov, and on our website at www.kcsi.com and which investors are advised to consult.


Item 7A.	*Quantitative and Qualitative Disclosures About Market Risk*

KCS utilizes various financial instruments that have certain inherent market risks. Generally, these instruments have not been entered into for trading purposes. The following information, together with information included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K and Note 10 of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K, which are hereby incorporated by reference, describe the key aspects of certain financial instruments that have market risk to KCS.

Interest Rate Sensitivity

Our floating-rate indebtedness totaled $440.9 million and $249.2 million at December 31, 2005 and 2004, respectively. Our two credit agreements, each comprised of a revolving credit facility and a term loan facility, contain variable rate debt which accrues interest based on target interest indexes (e.g., London Interbank Offered Rate — “LIBOR,” federal funds rate, etc.) plus an applicable spread, as set forth in each credit agreement. Given the balance of $440.9 million variable rate debt at December 31, 2005, we are sensitive to fluctuations in interest rates. For example, a hypothetical 100 basis points increase in each of the respective target interest indexes would result in additional interest expense of approximately $4.4 million on an annualized basis for the floating-rate instruments held by KCS as of December 31, 2005.

Based upon the borrowing rates available to KCS and its subsidiaries for indebtedness with similar terms and average maturities, the fair value of our long-term debt was approximately $1,938.6 million at December 31, 2005 and $704 million at December 31, 2004.

Commodity Price Sensitivity

As described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other — Derivative Instruments” of this Form 10-K, KCS periodically participates in diesel fuel purchase commitment and swap transactions. At December 31, 2005, KCS was not a party to any fuel swap agreements. Subsequent to December 31, 2005 KCS entered into fuel swap agreements for 3.2 million gallons. We also hold fuel inventories for use in operations. These inventories are not material to our overall financial position. With the exception of the fuel currently hedged under fuel swap transactions for 2006, fuel costs are expected to mirror market conditions in 2005. Assuming annual consumption of 140 million gallons, a $0.10 change in the price of fuel would result in an increase in operating expenses of $14 million.

Foreign Exchange Sensitivity

In connection with our acquisition of KCSM, matters arise with respect to financial accounting and reporting for foreign currency transactions and for translating foreign currency transactions into U.S. dollars. KCSM uses the U.S. dollar as its functional currency. Earnings (losses) from KCSM included in our results of operations reflect any such translation gains and losses that KCSM records in the process of translating certain transactions from Mexican pesos to U.S. dollars. Therefore, we have exposure to fluctuations in the value of the Mexican peso. While not currently utilizing foreign currency instruments to hedge our U.S. dollar investment in KCSM, we continue to evaluate existing alternatives as market conditions and exchange rates fluctuate.


Item 8.	*Financial Statements and Supplementary Data*

Index to Financial Statements


		Page

Management’s Report on Internal Control Over Financial Reporting			64
Report of Independent Registered Public Accounting Firm			65
Financial Statements:
	Report of Independent Registered Public Accounting Firm		67
	Consolidated Statements of Income for the three years ended December 31, 2005		68
	Consolidated Balance Sheets at December 31, 2005 and 2004		69
	Consolidated Statements of Cash Flows for the three years ended December 31, 2005		70
	Consolidated Statements of Changes in Stockholders’ Equity for the three years ended December 31, 2005		71
	Notes to Consolidated Financial Statements		72

Introductory Comments

The Consolidated Financial Statements included herein have been prepared by Kansas City Southern (the “Company” or “KCS”), pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Beginning with the year ended December 31, 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. Results for the year ended December 31, 2005 are not indicative of the expected results for future periods.

Financial Statement Schedules:


	All schedules are omitted because they are not applicable, are insignificant or the required information is shown in the consolidated financial statements or notes thereto. The combined and consolidated financial statements of Grupo TFM as of December 31, 2005 and 2004 and for years ended December 31, 2005, 2004 and 2003 are attached to this Form 10-K as Exhibit 99.1.

Management’s Report on Internal Control Over Financial Reporting

The management of Kansas City Southern (“KCS” or “the Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). KCS’s internal control over financial reporting was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

Under the supervision and participation of the Company’s Chief Executive Officer and Chief Financial Officer, KCS management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 based on the framework established by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework (commonly referred to as the COSO framework). Management’s assessment identified the following material weakness in the Company’s internal control related to the accounting for income taxes as of December 31, 2005:

The Company lacked sufficient personnel with adequate expertise in accounting for income taxes, effective reconciliation procedures related to income tax accounts, and sufficient oversight of the income tax accounting function by management. As a result, the Company is restating the opening retained earnings balance for the year ended December 31, 2003 in connection with issuing the 2005 consolidated financial statements to reflect the correction of errors in the accounting for income taxes. Additionally, a material misstatement was identified in the income tax provision in the Company’s 2005 consolidated financial statements that was corrected prior to the issuance of such financial statements.

Because of the material weakness described above, KCS management concluded that the Company’s internal control over financial reporting was not effective as of December 31, 2005.

The Company acquired Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”) and its subsidiary, Kansas City Southern de Mexico, S.A. de C.V. (“KCSM”) on April 1, 2005. Management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 Grupo TFM’s and KCSM’s internal control over financial reporting, which represents 53% of the Company’s consolidated total assets and 41% of the Company’s consolidated total revenues included in the consolidated financial statements of the Company and its subsidiaries as of and for the year ended December 31, 2005.

KPMG LLP, an independent registered public accounting firm, has issued an audit report on management’s assessment of the Company’s internal control over financial reporting as of December 31, 2005, on page 62 (Item 8) of this Annual Report on Form 10-K.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of

Kansas City Southern:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 8) , that Kansas City Southern and subsidiaries (the “Company”) did not maintain effective internal control over financial reporting as of December 31, 2005, because of the effect of the material weakness identified in management’s assessment that the Company’s controls and procedures over accounting for income taxes were ineffective based on criteria established in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Kansas City Southern’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (U.S.). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

The following material weakness has been identified and included in management’s assessment:

The Company lacked sufficient personnel with adequate expertise in accounting for income taxes, effective reconciliation procedures related to income tax accounts and sufficient oversight of the income tax accounting function by management. As a result, the Company is restating the opening retained earnings balance for the year ended December 31, 2003 in connection with issuing the 2005 consolidated financial statements to reflect the correction of errors in the accounting for income taxes. Additionally, a material misstatement was identified in the income tax provision in the 2005 consolidated financial statements.

Because of this material weakness, there is more than a remote likelihood that a material misstatement in the Company’s annual or interim financial statements due to errors in accounting for income taxes could occur and not be prevented or detected by its internal control over financial reporting.

The Company acquired control of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”) and its subsidiary, Kansas City Southern de Mexico, S.A. de C.V. (“KCSM”) on April 1, 2005. Management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 Grupo TFM’s and KCSM’s internal control over financial reporting which represents 53% of the Company’s consolidated total assets and 41% of the Company’s consolidated total revenues included in the consolidated financial statements of the Company and its subsidiaries as of and for the year ended December 31, 2005. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Grupo TFM and KCSM.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), the consolidated balance sheets of Kansas City Southern and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005. The aforementioned material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 consolidated financial statements, and this report does not affect our report dated April 7, 2006, which expressed an unqualified opinion on those consolidated financial statements.

In our opinion, management’s assessment that the Company did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in “Internal Control — Integrated Framework” issued by COSO. Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in “Internal Control — Integrated Framework” issued by COSO.


	/s/ KPMG LLP

Kansas City, Missouri

April 7, 2006

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of

Kansas City Southern:

We have audited the accompanying consolidated balance sheets of Kansas City Southern and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the financial statements of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (Grupo TFM), a 46.6% owned investee company, as of December 31, 2004 and for the years ended December 31, 2004 and 2003. The Company’s investment in Grupo TFM at December 31, 2004 was $389.6 million, and its equity in earnings (loss) of Grupo TFM was $(2.4) million and $12.3 million for the years ended December 31, 2004 and 2003, respectively. The financial statements of Grupo TFM as of December 31, 2004 and for the years ended December 31, 2004 and 2003 were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Grupo TFM as of December 31, 2004 and for the years ended December 31, 2004 and 2003, is based solely on the reports of other auditors.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (U.S.). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, based on our audits, and the reports of other auditors for 2004 and 2003, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kansas City Southern and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, effective January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations.”

As discussed in Note 13 to the consolidated financial statements, the Company restated its balance sheet as of December 31, 2004 and its statements of changes in stockholders’ equity for the years ended December 31, 2004 and 2003.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), the effectiveness of Kansas City Southern’s and subsidiaries internal control over financial reporting as of December 31, 2005, based on criteria established in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated April 7, 2006 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.


	KPMG LLP

Kansas City, Missouri

April 7, 2006

KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31


			2005			2004			2003

			Dollars in millions, except share
			and per share amounts
Revenues			$	1,352.0		$	639.5		$	581.3
Operating expenses
	Compensation and benefits			340.4			213.0			197.8
	Depreciation and amortization			127.7			53.5			64.3
	Purchased services			195.1			62.3			63.5
	Casualties and insurance			103.4			42.4			56.4
	Fuel			206.9			66.4			47.4
	Equipment costs			149.8			50.4			57.4
	KCSM employees’ statutory profit sharing			41.1			—			—
	Other			125.3			68.0			65.4

Total operating expenses				1289.7			556.0			552.2

Operating income				62.3			83.5			29.1
Equity in net earnings (losses) of unconsolidated affiliates:
		Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V.		(1.0	)		(2.4	)		12.3
		Other		3.9			(2.1	)		(1.3	)
Interest expense				(133.5	)		(44.4	)		(46.4	)
Debt retirement costs				(4.4	)		(4.2	)		—
Foreign exchange gain				3.5			—			—
VAT/ Put settlement gain, net				131.9			—			—
Other income				13.3			17.6			6.8

Income before income taxes, minority interest and cumulative effect of accounting change				76.0			48.0			0.5
Income tax provision (benefit) (Note 6)				(7.1	)		23.6			(2.8	)

Income before minority interest and cumulative effect of accounting change				83.1			24.4			3.3
Minority interest				17.8			—			—

Income before cumulative effect of accounting change				100.9			24.4			3.3
Cumulative effect of accounting change, net of income taxes				—			—			8.9

Net income				100.9			24.4			12.2
Preferred stock dividends				9.5			8.7			5.9

Net income available to common shareholders			$	91.4		$	15.7		$	6.3

Per Share Data
Basic earnings (loss) per common share
	Income (loss) before cumulative effect of accounting change		$	1.21		$	0.25		$	(0.04	)
	Cumulative effect of accounting change, net of income taxes			—			—			0.14

		Total basic earnings per common share	$	1.21		$	0.25		$	0.10

Diluted earnings (loss) per common share
	Income (loss) before cumulative effect of accounting change		$	1.10		$	0.25		$	(0.04	)
	Cumulative effect of accounting change, net of income taxes			—			—			0.14

		Total diluted earnings per common share	$	1.10		$	0.25		$	0.10

Weighted average common shares outstanding (in thousands)
		Basic		75,527			62,715			61,725
		Potential dilutive common shares		17,220			1,268			—

		Diluted		92,747			63,983			61,725

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

CONSOLIDATED BALANCE SHEETS

at December 31


			2005			2004,

						Restated
			Dollars in millions,
			except share and per
			share amounts
ASSETS
Current Assets:
	Cash and cash equivalents		$	31.1		$	38.6
	Accounts receivable, net (Note 4)			315.7			131.4
	Accounts receivable from related parties			—			8.2
	Inventories			73.9			48.2
	Other current assets (Note 4)			46.1			27.2

		Total current assets		466.8			253.6

Investments (Note 3)				60.3			484.9
Properties, net (Note 4)				2,298.3			1,424.0
Concession rights (net of $41.2 accumulated amortization as of December 31, 2005)				1,360.4			—
Goodwill				10.6			10.6
Restricted funds — escrow accounts related to Grupo TFM acquisition				9.0			200.0
Deferred tax income				152.2			—
Other assets				66.0			67.5

	Total assets		$	4,423.6		$	2,440.6


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
	Debt due within one year (Note 5)		$	38.0		$	9.9
	Accounts and wages payable			215.4			52.8
	Payable to related parties			0.3			34.7
	Current liability related to Grupo TFM acquisition			78.3			—
	Accrued liabilities (Note 4)			241.7			148.4

		Total current liabilities		573.7			245.8

Other Liabilities
	Long-term debt (Note 5)			1,663.9			655.8
	Long-term liability related to Grupo TFM acquisition			80.4			—
	Deferred income taxes (Note 6)			409.2			438.9
	Other noncurrent liabilities and deferred credits (Note 4)			270.2			83.6

		Total other liabilities		2,423.7			1,178.3

Commitments and contingencies				—			—
Stockholders’ Equity (Notes 2,7):
	$25 par, 4% noncumulative, Preferred stock, 840,000 shares authorized, 649,736 shares issued, 242,170 shares outstanding at December 31, 2005 and 2004			6.1			6.1
	Series C — Cumulative Convertible Preferred stock, $1 par, 4.25%, 400,000 shares authorized, issued and outstanding at December 31, 2005 and 2004			0.4			0.4
	Series D — Cumulative Convertible Preferred stock, $1 par, 5.125%, 210,000 share authorized, issued and outstanding at December 31, 2005			0.2			—
	$.01 par, Common stock, 400,000,000 shares authorized; 91,369,116 shares issued; 73,412,081 and 63,270,204 shares outstanding at December 31, 2005 and 2004, respectively			0.7			0.6
	Paid in capital			480.5			155.3
	Retained earnings			946.1			853.9
	Unearned restricted stock compensation			(7.4	)		—
	Accumulated other comprehensive income (loss)			(0.4	)		0.2

		Total stockholders’ equity		1,426.2			1,016.5

	Total liabilities and stockholders’ equity		$	4,423.6		$	2,440.6

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31


			2005			2004			2003

			Dollars in millions
CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
	Net income		$	100.9		$	24.4		$	12.2
	Adjustments to reconcile net income to net cash Provided by operating activities
		Depreciation and amortization		127.7			53.5			64.3
		Deferred income taxes		(17.3	)		35.9			1.6
		KCSM employees’ statutory profit sharing		41.1			—			—
		Equity in undistributed earnings (losses) of unconsolidated affiliates		(2.9	)		4.5			(11.0	)
		VAT/ Put Settlement gain		(131.9	)		—			—
		Funding of restricted cash		(9.0	)		—			—
		Minority interest		(17.8	)		—			—
		Distributions from unconsolidated affiliates		8.3			8.8			—
		Loss (gain) on sale of assets		1.0			(3.8	)		(6.2	)
		Cumulative effect of accounting change		—			—			(8.9	)
	Tax benefit realized upon exercise of stock options			5.0			9.5			2.5
	Changes in working capital items
		Accounts receivable		5.8			(25.0	)		4.0
		Inventories		(0.8	)		(11.4	)		(2.5	)
		Other current assets		15.7			(2.2	)		15.3
		Accounts and wages payable		10.5			10.2			(2.4	)
		Accrued liabilities		14.7			29.7			(8.1	)
	Other, net			27.8			8.6			7.2

		Net		178.8			142.7			68.0

INVESTING ACTIVITIES:
	Property acquisitions			(275.7	)		(117.2	)		(84.0	)
	Proceeds from disposal of property			6.3			4.9			15.0
	Funding of restricted escrow account			—			(200.0	)		—
	Investments in and loans to affiliates			(10.5	)		(55.0	)		(40.4	)
	Proceeds from sale of investments, net			(8.0	)		0.5			32.7
	Acquisition costs			(10.1	)		(9.5	)		(9.3	)
	Cash of Mexrail at date of acquisition			3.0			—			—
	Cash of KCSM at date of acquisition			5.5			—			—
	Other, net			—			(0.5	)		—

		Net		(289.5	)		(376.8	)		(86.0	)

FINANCING ACTIVITIES:
	Proceeds from issuance of long-term debt			644.7			250.0			—
	Repayment of long-term debt			(521.5	)		(107.6	)		(59.2	)
	Net proceeds from issuance of preferred stock			203.9			—			193.0
	Debt issuance costs			(16.5	)		(3.8	)		—
	Proceeds from stock plans			1.7			7.4			5.3
	Repurchase of common stock			(200.4	)		—			—
	Cash dividends paid			(8.7	)		(8.7	)		(4.7	)

		Net		103.2			137.3			134.4

CASH AND CASH EQUIVALENTS:
	Net increase (decrease) in cash and cash equivalents			(7.5	)		(96.8	)		116.4
	At beginning of year			38.6			135.4			19.0

	At end of period		$	31.1		$	38.6		$	135.4

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash payments (refunds)
	Interest		$	132.8		$	42.1		$	42.4
	Income tax payments (refunds)		$	(1.6	)	$	(21.2	)	$	(23.6	)

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY


				$1 Par
				Cumulative
				Preferred Stock													Unearned			Accumulated
		$25 Par						$.01 Par									Compensation			Other
		Preferred		Series C		Series D		Common			Paid in			Retained			from Restricted			Comprehensive
		Stock		4.25%		5.125%		Stock			Capital			Earnings			Stock			Income (Loss)			Total

Balance at December 31, 2002, as previously reported		$	6.1	$	—	$	—	$	0.6		$	—		$	748.5		$	—		$	(2.3	)	$	752.9

Prior period adjustment (Note 13)															(8.0	)								(8.0	)

Balance at December 31, 2002, as restated		$	6.1	$	—	$	—	$	0.6		$	—		$	740.5		$	—		$	(2.3	)	$	744.9

Comprehensive income:
	Net income														12.2
	Change in fair value of cash flow hedges																				0.6
	Amortization of loss related to interest rate swaps																				1.2
Comprehensive income																								14.0
Issuance of Series C preferred stock					0.4							110.9			81.7									193.0
Dividends on $25 Par Preferred Stock ($1.00/share)															(0.2	)								(0.2	)
Dividends on Series C Cumulative Preferred Stock ($11.22/share)															(4.5	)								(4.5	)
Options exercised and stock subscribed															5.2									5.2
Stock plan shares issued from treasury															3.3									3.3

Balance at December 31, 2003, as restated		$	6.1	$	0.4	$	—	$	0.6		$	110.9		$	838.2		$	—		$	(0.5	)	$	955.7

Comprehensive income:
	Net income														24.4
	Change in fair value of cash flow hedges																				0.2
	Amortization of loss related to interest rate swaps																				0.5
Comprehensive income																								25.1
Dividends on $25 Par Preferred Stock ($1.00/share)															(0.2	)								(0.2	)
Dividends on Series C Cumulative Preferred Stock ($21.25/share)															(8.5	)								(8.5	)
Options exercised and stock subscribed												42.0												42.0
Stock plan shares issued from treasury												2.4												2.4

Balance at December 31, 2004, as restated		$	6.1	$	0.4	$	—	$	0.6		$	155.3		$	853.9		$	—		$	0.2		$	1,016.5

Comprehensive income
	Net income														100.9
	Change in fair value of cash flow hedges																				(1.1	)
	Amortization of loss related to interest rate swaps																				.5
Comprehensive income																								100.3
Dividends on $25 Par Preferred Stock ($1.00/share)															(0.2	)								(0.2	)
Dividends on Series C Cumulative Preferred Stock ($21.25/share)															(8.5	)								(8.5	)
Options exercised and stock subscribed												8.3												8.3
Stock plan shares issued from treasury												2.3												2.3
Issuance of restricted stock awards												8.9						(8.9	)					—
Amortization of unearned compensation																		1.5						1.5
Stock issued in acquisition of Grupo TFM									0.2			304.2												304.4
Issuance of Series D Cumulative Preferred Stock							0.2					201.8												202.0
Repurchase of $.01 Par Common Stock									(0.1	)		(200.3	)											(200.4	)

Balance at December 31, 2005		$	6.1	$	0.4	$	0.2	$	0.7		$	480.5		$	946.1		$	(7.4	)	$	(0.4	)	$	1,426.2

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 1.	Description of the Business

Kansas City Southern (“KCS” or the “Company”) is a Delaware corporation that was initially organized in 1962 as Kansas City Southern Industries, Inc. In 2002, the Company formally changed its name to Kansas City Southern. KCS is a holding company with principal operations in rail transportation.

Until the second 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 U.S. and Mexico. In both the U.S. and the Mexico segments, we generate our revenues and cash flows by providing our customers with freight delivery services both within our regions, and throughout North America 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.

KCS’s principal geographic business segments include the following:


	*U.S. Segment*


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

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

	•	Combined with equity investments in:

	•	Southern Capital Corporation, LLC (“Southern Capital”), a 50% owned unconsolidated affiliate that leases locomotives and other 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”).


	*Mexico Segment*


	•	Grupo Transportacion Ferroviaria Mexicana,, S.A. de C.V. (“Grupo TFM”), a wholly-owned subsidiary, our Mexican holding company which owns all but one share of Kansas City Southern de México, S.A. de C.V. (“KCSM”).

	•	KCSM which is the principal operating subsidiary of Grupo TFM operates under the rights granted by the concession acquired from the Mexican government in 1997 (the KCSM Concession) as described below.

	•	Arrendadora TFM, S.A. de C.V. (“Arrendadora”), is wholly-owned by Grupo TFM and KCSM and has as its only operation, the leasing to KCSM of the locomotives and freight cars acquired through the privatization and subsequently sold to Arrendadora by KCSM.

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. On September 12, 2005, the Company and its subsidiaries, Grupo TFM and KCSM, along with the Mexican holding company Grupo TMM, S.A. (“TMM”), entered into a settlement agreement with the Mexican government resolving the controversies and disputes between the companies and the Mexican government concerning the payment of a VAT refund to KCSM and the purchase of the remaining shares of KCSM owned by the Mexican government. As a result of this settlement, KCS and its subsidiaries now own 100% of Grupo TFM and KCSM. For

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the first quarter of 2005, KCS accounted for its investment in Grupo TFM on the equity basis of accounting. Grupo TFM and KCSM constituted 53% of the Company’s consolidated assets at December 31, 2005 and 41% of the Company’s consolidated revenues for the fiscal year then ended.

The KCSM Concession

We hold a 50-year concession, which took effect in June 1997 and is renewable under certain conditions for additional periods of up to 50 years, to provide freight transportation services over our rail lines. Our concession is exclusive for the first 30 years of our operations, subject to certain trackage rights of Ferromex, Ferrosur, two short line railroads and Ferrocarril y Terminal del Valle de México , S.A de C.V. (Mexico Valley Railroad and Terminal) (“FTVM”). In conjunction with our concession, KCSM has the right to use, during the full term of the concession, all track and buildings that are necessary for our rail lines’ operation. Under the terms of the concession, KCSM is required to pay the Mexican government a concession duty equal to 0.5% of our gross revenues during the first 15 years of the concession period and 1.25% of such revenues during the remainder of the period.

Under the concession and the Mexican railroad services law and regulations, we may freely set our rates unless the Ministry of Transportation, in consultation with the Mexican Antitrust Commission, determines that there is no effective competition in Mexico’s rail industry, taking into account alternative rail routes and modes of transportation. We are required to provide railroad services to all users on a fair and non-discriminatory basis and in accordance with efficiency and safety standards approved periodically by the Ministry of Transportation. In the event that we collect from customers rates higher than the registered rates, we must reimburse those customers with interest, and risk the revocation of the concession.

Mexican railroad services law and regulations and the concession establish several circumstances under which the concession will terminate, including among others, revocation by the Ministry of Transportation, voluntary surrender of our rights under the concession, statutory appropriation or our liquidation or bankruptcy. Specifically, as it relates to liquidity of the railroad, the concession requires us to make investments and undertake capital projects, including capital projects described in a business plan filed every five years with the Mexican government. We filed our second business plan with the Mexican government in 2003. Under the terms of the plan, we have committed to certain minimal investment and capital improvement goals, which may be waived by the Secretaría de Comunicaciones y Transportes (Mexican Communication and Transportation Ministry (“SCT”) upon our application for relief for good cause.

In the event that the concession is revoked by the Ministry of Transportation, we will receive no compensation, and our rail lines and all other fixtures covered by the concession, as well as all improvements made by us, will revert to the Mexican government. All other property not covered by the concession, including movable railroad property we purchased from the Mexican government, as well as all locomotives and railcars we otherwise acquired, will remain our property. However, if we attempt to sell more than 15.0% of our equipment to a third party within 90 days of termination or revocation of our concession, the Mexican government will have a right of first refusal to purchase the equipment on the same terms offered by the third party if no other concessionaire is likely to provide rail services over our rail lines and the equipment being sold is indispensable to the continuation of our rail services. After the Mexican government receives notice from us of our intention to sell the equipment, it will have 30 days to exercise its right of first refusal. In addition, the Mexican government will have the right to cause us to lease all of our service-related assets to the Ministry of Transportation for a term of at least one year, automatically renewable for additional one-year terms up to five years. The Mexican government must exercise this right within four months after revocation of the concession.

If the Mexican government legally terminates the concession, public domain assets used in the operation of our rail lines would be owned, controlled and managed by the Mexican government. The

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Mexican government may also temporarily seize our rail lines and our assets used in operating our rail lines in the event of a natural disaster, war, significant public disturbances, or imminent danger to the domestic peace or economy. In such events, the Ministry of Transportation may restrict our ability to exploit the concession fully for such time and in such manner as the Ministry of Transportation deems necessary under the circumstances but only for the duration of any of the foregoing events. Further, Mexican law requires that the Mexican government pay us compensation if it effects a statutory appropriation for reasons of the public interest. With respect to a temporary seizure due to any cause other than international war, the Mexican railroad services law and regulations provides that the Mexican government will indemnify an affected concessionaire for an amount equal to damages caused and losses suffered. These payments may not be sufficient to compensate us for our losses and may not be timely made.

Employees and Labor Relations. Labor relations in the U.S. railroad industry are subject to extensive governmental regulation under the Railway Labor Act (“RLA”). Under the RLA, national labor agreements are renegotiated when they become open for modification, but their terms remain in effect until new agreements are reached. Typically, neither management nor labor employees are permitted to take economic action until extended procedures are exhausted. Approximately 82% of KCSR’s employees are covered under various collective bargaining agreements with different labor organizations. Under the negotiating process for new collective bargaining agreements which began on November 1, 1999, all unions reached new labor agreements with KCSR in 2005. Wages, health and welfare benefits, work rules and other issues have been negotiated on an industry-wide scale. Previously, these negotiations, which can take place over significant periods of time, have not resulted in any extended work interruptions. The existing agreements will remain in effect until new agreements are reached or the RLA’s procedures are exhausted. Until new agreements are reached, the current agreements provide for periodic wage adjustments.

Approximately 71% of KCSM’s total employees are covered by a labor agreement, which was renewed in 2005 and is effective for a two-year term ending in July 2007. The compensation terms of the labor agreement are subject to renegotiation on an annual basis and all other terms are renegotiated every two years. These negotiations have not resulted in any strikes, boycotts or other material disruptions at KCSM.


Note 2.	Significant Accounting Policies

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 the year ended December 31, 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 the effective date of the acquisition of control on January 1, 2005 for Mexrail and April 1, 2005 for Grupo TFM, the investments were accounted for under the equity method.

KCSM Seniority premiums. KCSM employees are entitled to a seniority premium upon termination of employment after 15 years of service. Seniority premiums are expensed in the years in which the services are rendered. Other compensation based on length of service to which employees may be entitled

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

in the event of dismissal, in accordance with the Mexican Federal Law, is charged to expense in the year in which it becomes payable.

Use of Estimates. The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the U.S. of America (“U.S. GAAP”). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Management reviews its estimates, including those related to the recoverability and useful lives of assets, as well as liabilities for litigation, environmental remediation, casualty claims, and income taxes. Changes in facts and circumstances may result in revised estimates. Actual results could differ from those estimates.

Revenue Recognition. The Company recognizes freight revenue based upon the percentage of completion of a commodity movement. Other revenues, in general, are recognized when the product is shipped, as services are performed or contractual obligations fulfilled.

Cash Equivalents. Short-term liquid investments with an initial maturity of generally three months or less are considered cash equivalents. Cash equivalents at December 31, 2004 also included a $10 million deposit in connection with the litigation under the Original Acquisition Agreement which was refunded on completion of the Acquisition.

Restricted Cash. In connection with KCS’s acquisition of the controlling interest in Grupo TFM (the “Acquisition”), KCS 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 José F. Serrano Segovia, Chairman of the Board of 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, in connection with the Acquisition, $200 million was held in an escrow account. Such amounts were restricted for the purpose of that transaction and could only be released to the Company if the transaction was terminated. The funds were distributed at closing of the transaction on April 1, 2005.

Accounts Receivable, net. Accounts receivable, net includes accounts receivable reduced by an allowance for uncollectible accounts as determined based on historical experience and may be adjusted for economic uncertainties or known trends. Accounts are charged to the allowance for bad debts when a customer enters bankruptcy, when an account has been transferred to a collection agent or submitted for legal action and in certain other cases, when a customer is significantly past due and all available means of collection have been exhausted.

Inventories. Inventories, primarily diesel fuel, items to be used in the maintenance of rolling stock and items to be used in the maintenance or construction of road property, are valued at the lower of average cost or market.

Mexican Peso to U.S. Dollar Translation. For tax purposes, Grupo TFM and its subsidiaries are required to maintain their books and records in Mexican pesos (“Ps”). For financial reporting purposes,

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Grupo TFM and subsidiaries keep records and use the U.S. dollar as their functional and reporting currency. The U.S. 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 U.S. 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 other income.

Liabilities related to the KCSM Acquisition. In connection with the acquisition of Grupo TFM and the settlement of the VAT/ Put, the Company has recorded certain liabilities payable to TMM, as summarized below.


	•	The $47.0 million Escrow Notes (see description of the “Escrow Notes” in Note 3) are subject to reduction 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. The $47.0 amount is payable on or before April 1, 2007 and accrues interest at a stated rate of 5.0%. The $47.0 million and related interest, is payable in cash or in stock (shares to be determined based on the volume weighted average price (the “VWAP”) 20 days prior to the settlement) at the Company’s discretion. Accordingly, as of December 31, 2005, the Company has included $48.8 million for this liability and the related accrued interest in other noncurrent liabilities on the balance sheet.

	•	A contingent payment of $110.0 million payable to TMM as a result of the final resolution of the VAT Claim and Put (described in Note 3) which will be settled in three parts: (i) $35.0 million in stock (shares to be determined based on the VWAP 20 days prior to the final resolution of the VAT Claim and Put, as defined in the Acquisition Agreement); (ii) $35.0 million in cash upon final resolution of the VAT Claim and Put, as defined in the Acquisition Agreement; and (iii) up to an additional $40.0 million in cash or stock (shares to be determined based on the VWAP in accordance with the terms of the Acquisition Agreement) payable no more than five years from the final closing date. The liability is non-interest bearing; therefore, it has been recorded at its present value based on a 5.0% discount rate, consistent with the stated rate of similar interest bearing notes in the Acquisition Agreement. Accordingly, at December 31, 2005 the Company has recorded as a current liability of $69.3 million to be settled upon final resolution of the VAT Claim and Put, as defined in the Acquisition Agreement, and $31.6 million as a non-current liability to be settled in 5 years.

	•	A contingent payment of $9.0 million payable to JSIB, which became payable upon final resolution of the VAT Claim and Put. The $9.0 million is payable in cash or in stock (shares to be determined based on the VWAP 20 days prior to the final resolution of the VAT Claim and Put) at the Company’s discretion. Accordingly, at December 31, 2005 the Company has recorded the $9.0 million as a current liability to be settled upon final resolution of the VAT Claim and Put, as defined in the Acquisition Agreement.

On March 13, 2006, in settlement of the $110.0 million obligation to TMM, KCS paid $35 million in cash, issued 1,494,469 shares of KCS Common Stock at the VWAP price of $23.4197, as determined in connection with the Acquisition Agreement, and issued a $40 million, five year note. Also on March 13, 2006, in settlement of the $9.0 million obligation to JSIB, KCS paid $9.0 million to JSIB.

Payable to Related Parties. As of December 31, 2004, substantially all of the Payable to related parties relates to the acquisition of Grupo TFM’s interest in Mexrail under the terms of the Mexrail Stock Purchase Agreement. Under the terms of that agreement, KCS had an option to purchase the remaining shares of Mexrail owned by KCSM at a price of $31.4 million. Among other conditions, the agreement

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

provided that if KCS did not exercise the purchase option, or otherwise acquire direct or indirect ownership of the remaining 49% interest, KCS would be obligated to purchase KCSM’s 49% interest in Mexrail on October 31, 2005 (the “KCSM Put”). With the completion of the acquisition of Grupo TFM, the Company acquired indirect ownership of KCSM’s remaining 49% interest in Mexrail, which effectively extinguished the KCSM Put. At December 31, 2005, the results of Grupo TFM and Mexrail are presented on a consolidated basis.

Properties, Concession Assets and Depreciation. Properties are stated at cost. Additions and renewals, including those on leased assets that increase the life or utility of the asset are capitalized and all properties are depreciated over the estimated remaining life or lease term of such assets, whichever is shorter. The Company 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. Depreciation for railway operating assets is derived using the group-life method. This method classifies similar assets by equipment or road type and depreciates these assets as a whole. Repairs and maintenance costs are charged to expense as incurred.

As further described in “Note 3 — Investments and Acquisitions”, during the current year the Company completed the acquisitions Mexrail and Grupo TFM. In conjunction with these acquisitions and as a result of the allocation of the purchase price, adjustments have been made to the carrying value of both the owned properties owned and the Concession rights and related assets. The fair values assigned to assets acquired and liabilities assumed were based on valuations prepared by independent third party appraisal firms, published market prices and management estimates.

Concession assets acquired and liabilities assumed pursuant to the Asset Purchase Agreement, dated December 1996, entered into among FNE (now known as KCSM), the Secretary of Communications and the Mexican National Railway, include:


	(i) The tangible assets acquired consisting of locomotives, freight cars and materials and supplies;

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

	(iii) The 25% equity interest in the company established to operate the Mexico City rail terminal facilities — Ferrocarril y Terminal del Valle de México, S.A. de C.V. (“FTVM”); and

	(iv) Finance lease obligations assumed.

KCSR Depreciation Study. For the year ended December 31, 2004, changes were made to certain KCSR depreciation rates. As described above, depreciation is computed using group straight-line rates for financial statement purposes, which require approval of the STB. During the year ended December 31, 2003, the KCSR engaged a civil engineering firm with expertise in railway property usage to conduct a study to evaluate depreciation rates for properties and equipment. The study centered on evaluating actual historical replacement patterns to assess future lives and indicated that KCSR was depreciating its property over shorter periods than we actually utilize the assets, as estimated by the study. Specifically, the average rate applied to the Road and Structures Asset class (primarily rail, railroad ties and bridges) decreased approximately 0.7%, while the average rate applied to the Rolling Stock and Equipment Asset class (locomotives and railcars) decreased approximately 0.6%. The effect of this change in estimate on net income was approximately $8.0 million, net of tax of $5.0 million ($0.12 per share, on a diluted basis), for the year ended December 31, 2004.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

accordingly, the changes to the depreciation rates were applied in 2005. During the year ended December 31, 2005, the KCSM engaged a civil engineering firm with expertise in railway property usage to conduct an analysis of depreciation rates for properties and equipment. The analysis centered on evaluating actual historical replacement patterns to assess future lives and indicated that KCSM was depreciating its property over shorter periods than we actually utilize the assets. As a result, depreciation expense recorded in the fourth quarter of 2005 reflected an adjustment totaling $5.5 million, to reduce relating to depreciation expense as recorded in the second and third quarters of 2005. Concession rights and related assets are amortized over the shorter of their remaining useful life as determined by the KCSM depreciation review or the life of the concession.

The ranges of annual depreciation rates for financial statement purposes are:


Road and structures		2%-14%
Rolling stock and equipment		2%-22%
Computer software		8%-14%
Capitalized leases		3%- 7%

Accelerated depreciation is used for income tax purposes.

The cost of transportation equipment and road property normally retired, less salvage value, is charged to accumulated depreciation. The cost of industrial and other property retired, and the cost of transportation property abnormally retired, together with accumulated depreciation thereon, are eliminated from the property accounts and the related gains or losses are reflected in net income. Gains or losses recognized on the sale of non-operating property reflected in other income are not material for the periods presented.

Concession rights and related assets. Costs incurred by the Company to acquire the concession rights and related assets were capitalized and are amortized over the estimated useful lives of the related assets and rights acquired. Concession replacements and improvements are stated at cost. Major repairs and track rehabilitation are capitalized. Amortization is calculated using the straight-line method based on the estimated useful lives of the respective improvements or, the term of the concession, if shorter.

Long-lived assets. The Company evaluates the recoverability of its operating properties when there is an indication that an asset value has been impaired. The measurement of possible impairment is based primarily on the ability to recover the carrying value of the asset from expected future operating cash flows related to the assets on an undiscounted basis. At December 31, 2005, there were no assets which required an impairment adjustment.

Casualty Claims. Casualty claims in excess of self-insurance levels are insured up to certain coverage amounts, depending on the type of claim and year of occurrence. The Company’s casualty liability reserve is based on a study by an independent third party actuarial firm performed on an undiscounted basis. The reserve is based on claims filed and an estimate of claims incurred but not yet reported. While the ultimate amount of claims incurred is dependent on various factors, it is management’s opinion that the recorded liability is a reasonable estimate of aggregate future claims. Adjustments to the liability will be reflected as operating expenses in the period in which the adjustments are known. Legal fees related to casualty claims are recorded in operating expense in the period in which they are incurred.

As more fully described in Note 9 “Commitments and Contingencies” reserves for occupational illness claims were previously established through an assessment made on a case-by-case basis, and a liability was established when management determined that it was probable and reasonably estimable. Prior to 2005, no provision was made for occupational illness claims that may have been incurred but not yet reported, since the Company believed the low end of the range of reasonably possible loss was not material. During 2005 the company experienced a marked increase in the number of such claims,

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

accordingly the Company requested and obtained an actuarial study of these potential unasserted claims for the first time. The study indicated that existing reserves should be increased by $7.5 million.

Computer Software Costs. Costs incurred in conjunction with the purchase or development of computer software for internal use are capitalized. Costs incurred in the preliminary project stage, as well as training and maintenance costs, are expensed as incurred. Direct and indirect costs associated with the application development stage of internal use software are capitalized until such time that the software is substantially complete and ready for its intended use. Capitalized costs are amortized on a straight-line basis over the useful life of the software.

Fair Value of Financial Instruments. The Company’s financial instruments include cash and cash equivalents, accounts receivable, lease and contract receivables, accounts payable and long-term debt as described in Note 5.

The financial statement carrying value of the Company’s cash equivalents approximates fair value due to their short-term nature. Carrying value approximates fair value for all financial instruments with six months or less to re-pricing or maturity and for financial instruments with variable interest rates. The Company estimates the fair value of long-term debt based upon borrowing rates available at the reporting date for indebtedness with similar terms and average maturities. Based upon the borrowing rates currently available to the Company and its subsidiaries for indebtedness with similar terms and average maturities, the fair value of long-term debt was approximately $1,938.6 million and $704 million at December 31, 2005 and 2004, respectively. The financial statement carrying value was $1,860.6 million and $665 million at December 31, 2005 and 2004, respectively.

Derivative Instruments. Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended, requires that derivatives be recorded on the balance sheet as either assets or liabilities measured at fair value. Changes in the fair value of derivatives are recorded either through current earnings or as other comprehensive income, depending on the type of hedge transaction. Gains and losses on the derivative instrument reported in other comprehensive income are reclassified into earnings in the periods in which earnings are impacted by the variability of the cash flow of the hedged item. The ineffective portion of all hedge transactions is recognized in current period earnings.

Income Taxes. Deferred income tax effects of transactions reported in different periods for financial reporting and income tax return purposes are recorded under the liability method of accounting for income taxes. This method gives consideration to the future tax consequences of the deferred income tax items and immediately recognizes changes in income tax laws upon enactment.

Prior to the acquisition of a controlling interest in Grupo TFM on April 1, 2005, Grupo TFM provided deferred income taxes for the difference between the financial reporting and income tax bases of its assets and liabilities. KCS recorded its proportionate share of these income taxes through its equity in Grupo TFM’s earnings. Since April 1, 2005, Grupo TFM income taxes are reflected in the consolidated results. Although KCSM has generated book profits, it has incurred tax losses due primarily to the accelerated tax amortization of the concession rights. We have recognized a deferred income tax asset for the resulting net operating loss carryforwards and may continue to recognize additional amounts in the next few years. Management anticipates that such net operating loss carryforwards will be realized given the long carryforward period (through the year 2046) for amortization of the concession, as well as the fact that we expect to generate taxable income in the future. Our tax projections take into consideration certain assumptions, some of which are under our control and others which are not. Key assumptions include inflation rates, currency fluctuations and future revenue growth. If our assumptions are not correct, we would have to recognize a valuation allowance on our deferred tax asset.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Prior to 2005, the Company did not provide U.S. Federal income taxes for the temporary difference between the financial reporting basis and income tax basis of its investment in Grupo TFM because Grupo TFM was a foreign corporate joint venture that was considered permanent in duration, and the Company did not expect the reversal of the temporary difference to occur in the foreseeable future. Following the acquisition of control of Grupo TFM in 2005, the Company has not provided U.S. Federal income taxes on the undistributed earnings of Grupo TFM since the Company intends to reinvest such earnings indefinitely outside of the United States.

KCSM employees’ statutory profit sharing. KCSM is subject to employee statutory profit sharing requirements under Mexican law and calculates profit sharing liability as 10% of KCSM net taxable income, adjusted as prescribed by the Mexican Income Tax law. In calculating its net taxable income for statutory profit sharing purposes, KCSM previously deducted NOL carryforwards. The application of NOL carryforwards can result in a deferred profit sharing asset for a given period instead of a profit sharing liability. The Mexican tax authorities had challenged KCSM’s calculation of statutory profit sharing liabilities in the late 1990s, but KCSM prevailed with a Mexican Fiscal Court ruling in 1999 followed by a Tax Authority Release acknowledging its ability to continue to calculate statutory profit sharing the way it had been, including the deduction of NOL carryforwards in the calculation of net taxable income for statutory profit sharing purposes. However, since a technical amendment to the Mexican tax law in 2002, the Mexican tax authorities have objected to KCSM’s deduction of NOL carryforwards in the calculation of net taxable income for statutory profit sharing purposes following such amendment, which objection KCSM has challenged in court. Under U.S. GAAP, employee statutory profit sharing is an operating expense.

Due to a series of decisions in 2005 by the Mexican Supreme Court declaring that NOLs from previous years may not be deducted, KCSM changed the method of calculating its statutory profit sharing liability. KCSM no longer deducts NOLs from prior years when calculating employee statutory profit sharing. This change required KCSM to write off its deferred tax assets related to statutory profit sharing resulting in a charge to operating expenses of $35.6 million, after purchase accounting adjustments.

Changes of Interest in Subsidiaries and Equity Investees. A change of the Company’s interest in a subsidiary or equity investee resulting from the sale of the subsidiary’s or equity investee’s stock is generally recorded as a gain or loss in the Company’s net income in the period that the change of interest occurs. If an issuance of stock by the subsidiary or affiliate is from treasury shares on which gains have been previously recognized, however, KCS will record the gain directly to its equity and not include the gain in net income. A change of interest in a subsidiary or equity investee resulting from a subsidiary’s or equity investee’s purchase of its stock increases the Company’s ownership percentage of the subsidiary or equity investee. The Company records this type of transaction under the purchase method of accounting, whereby any excess of fair market value over the net tangible and identifiable intangible assets is recorded as goodwill.

Treasury Stock. The excess of par over cost of the preferred shares held in Treasury is credited to paid in capital. Common shares held in Treasury are accounted for as if they were retired and the excess of cost over par value of such shares is charged to paid in capital.

Stock Plans. Proceeds received from the exercise of stock options or subscriptions are credited to the appropriate stockholders’ equity accounts in the year exercised.

Pursuant to Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), compensation expense is recognized ratably over the option vesting period to the extent that an option exercise price is less than the market price of the stock at the date of grant. KCS’s practice is to set the option exercise price equal to the market price of the stock at date of grant; therefore, no compensation expense is recognized for financial reporting purposes.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”) in October 1995. This statement allows companies to continue under the approach set forth in APB 25 for recognizing stock-based compensation expense in the financial statements, but encourages companies to adopt the fair value method of accounting for employee stock options. 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 KCS employee stock purchase plan, under the fair value based method prescribed by SFAS 123 (see additional information regarding SFAS 123R under “New Accounting Pronouncements”), net income and earnings per share would have been as follows:


		2005			2004			2003

Net income (In millions):
	As reported	$	100.9		$	24.4		$	12.2
	Additional stock-based compensation expense determined under fair value method, net of income taxes		(0.8	)		(1.6	)		(1.8	)

	Pro forma	$	100.1		$	22.8		$	10.4
Earnings per Basic share:
	As reported	$	1.21		$	0.25		$	0.10
	Pro forma		1.20			0.22			0.07
Earnings per Diluted share:
	As reported	$	1.10		$	0.25		$	0.10
	Pro forma		1.07			0.22			0.07

All shares held in the Employee Stock Ownership Plan (“ESOP”) are treated as outstanding for purposes of computing the Company’s earnings per share. See additional information in “Note 8 — Profit Sharing and Other Postretirement Benefits.”

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Earnings Per Share. 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 each of the years ended December 31, 2005, 2004 and 2003 (in thousands) :


		Years Ended December 31,

		2005		2004		2003

Basic shares			75,527		62,715		61,725
Additional weighted average shares attributable to convertible securities and stock options:
	$9.0 million VAT/ Put settlement payment due to JSIB		110		—		—
	$47.0 million escrow note		1,439		—		—
	$110.0 million VAT/ Put settlement contingency payment		918		—		—
	Convertible preferred stock		13,389		—		—
	Stock options		1,358		1,268		—
	Restricted shares		6		—		—

Diluted shares			92,747		63,983		61,725

Potentially dilutive shares excluded from the calculation (in thousands):


	Years Ended December 31,

	2005		2004		2003

Stock options where the exercise price is greater than the average market price of common shares		1		361		261

Stock options which are anti-dilutive		—		—		1,357

Convertible preferred stock Series C which are anti-dilutive		—		13,389		8,926

Convertible preferred stock Series D which are anti-dilutive		486		—		—

The following is a reconciliation from net income available to common shareholders for purposes of basic earnings per share to net income available to common shareholders for purposes of diluted earnings per share for each of the years ended December 31, 2005, 2004 and 2003 (in millions):


	Years Ended December 31,

	2005		2004		2003

Net income available to common shareholders for purposes of computing basic earnings per share	$	91.4	$	15.7	$	6.3
Effect of dividends on conversion of convertible preferred stock		8.5		—		—
Effect of interest expense on conversion of $47.0 million escrow note		1.1		—		—
Effect of interest expense on conversion of note payable to TMM for VAT/ Put settlement		0.6		—		—

Net income available to common shareholders for purposes of computing diluted earnings per share	$	101.6	$	15.7	$	6.3

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Postretirement benefits. The Company provides certain medical, life and other postretirement benefits to certain retirees. The costs of such benefits are expensed over the estimated period of employment.

Environmental liabilities. The Company records liabilities for remediation and restoration costs related to past activities when the Company’s obligation is probable and the costs can be reasonably estimated. Costs of future expenditures for environmental remediation are not discounted to their present value. Recoveries of environmental remediation costs from other parties are recorded as assets when their receipt is deemed probable. Costs of ongoing compliance activities related to current operations are expensed as incurred.

New Accounting Pronouncements.


	*SFAS 123R*

In December 2004, the FASB issued Statement of Financial Accounting Standard No. 123 (Revised), “Share-Based Payments” (“SFAS 123R”), which is effective in the first annual period beginning 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. Previously, the Company recognized compensation expense to the extent that an option price was less than the market price of the stock at the date of the grant (the “Intrinsic Value”). Because KCS’s practice was to set the option exercise price equal to the market price of the stock as of the date of the grant, no compensation expense was 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. The Company intends to use the Modified Prospective Application, which would require that all new awards and modified awards after the effective date and any unvested awards at the effective date can be recognized as compensation cost ratably over the option vesting period.

As described above under “Stock Plans,” using the Black-Scholes method, the after-tax expense related to share based compensation would have been $0.8 million, $1.6 million and $1.8 million for the years ended December 31, 2005, December 31, 2004 and December 31, 2003, respectively. The impact on future operating results will be dependent on the type and extent of stock-based compensation to be issued as determined by the Company’s Compensation Committee and cannot be determined at this time.


	*SFAS 143*

KCS adopted Statement of Financial Accounting Standard No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”) effective for the year ended December 31, 2003. Under SFAS 143, the fair value of a liability for an asset retirement obligation must be recognized in the period in which it is incurred if a reasonable estimate of the fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. KCSR, along with other Class I railroads, depreciates track structure (rail, ties, and other track material) in accordance with regulations promulgated by the STB. These regulations require KCSR to depreciate track structure to a net salvage value (gross estimated salvage value less estimated costs to remove the track structure at the end of its useful life). For certain track structure such as ties, with little or no gross salvage value, this practice ultimately results in depreciating an asset below a value of zero, and thus, in effect, results in recording a liability. Under the requirements of SFAS 143, in the absence of a legal obligation to remove the track structure, such accounting practice is prohibited. The Company adopted the provisions of SFAS 143 in the first quarter of 2003, and, as a result, reviewed its depreciation of track structures to determine instances where the depreciation of removal costs has resulted or would be expected (based on the current depreciation rate) to result in the depreciation of an asset below zero when considering net

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

salvage value. As a result of this review, the Company estimated the excess depreciation recorded on such assets and recorded this amount as a reduction in accumulated depreciation of $14.5 million and as a cumulative effect of an accounting change of $8.9 million (net of taxes of $5.6 million) as required by SFAS 143 in the first quarter of 2003.

A summary of the pro forma net income and earnings per share had SFAS 143 been applied retroactively is as follows:


	2005		2004		2003

Net income (in millions)
As reported	$	100.9	$	24.4	$	12.2
Pro forma	$	100.9	$	24.4	$	3.3
Earnings per Basic share:
As reported	$	1.21	$	0.25	$	0.10
Pro forma	$	1.21	$	0.25	$	(0.04	)
Earnings per Diluted share:
As reported	$	1.10	$	0.25	$	0.10
Pro forma	$	1.10	$	0.25	$	(0.04	)


	*FIN 46 (revised)*

In December 2003, the FASB issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”). The Company adopted FIN 46R effective for the year ended December 31, 2003. FIN 46R clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain variable interest entities by providing guidance on how a business entity should evaluate whether it has controlling financial interest in an entity through means other than voting rights and how the entity should be consolidated. FIN 46R replaces Interpretation No. 46 “Consolidation of Variable Interest Entities,” which was issued in January 2003. The Company performed an assessment of its equity method investments in Southern Capital and PCRC for any potential impact this interpretation may have on its accounting for these entities as equity investments. The adoption of FIN 46R had no material impact on the Company’s accounting for its investment in Southern Capital or PCRC since, at inception, these entities had sufficient funding and capital.


Note 3.	Investments and Acquisitions

Investments, including investments in unconsolidated affiliates, are as follows (in millions):


	Percentage			Carrying Value
	Ownership as of
Company Name	December 31, 2005			2005		2004

KCSM(i)		100.0	%	$	—	$	389.6
Southern Capital		50.0	%		27.9		29.1
PCRC		50.0	%		0.6		2.4
Mexrail(ii)		100.0	%		—		30.0
FTVM		25.0	%		10.9		—
Other					20.9		33.8

				$	60.3	$	484.9


(i)		46.6% ownership through first quarter 2005 only

(ii)		51.0% ownership at the end of 2004

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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. The excess of the purchase price over the fair value was recorded as goodwill. The fair values assigned to assets acquired and liabilities assumed were 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.

April 1, 2005 — Acquisition Agreement. 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 KCSM through the purchase of shares of common stock of Grupo TFM. At the time, Grupo TFM held an 80% interest in KCSM and all of the shares of stock with full voting rights of KCSM. The remaining 20% economic interest in KCSM was 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 in exchange 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 $27.5 million in transaction costs for a total purchase price of $594.4 million. 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 $594.4 million, KCS acquired 48.5% of Grupo TFM (or 38.8% of KCSM). On a preliminary basis, 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 $199.6 million. As a result of the ongoing valuation of certain assets and liabilities, during the fourth quarter of 2005, Grupo TFM and KCSM, recognized changes to the preliminary allocation of purchase price, which was pushed down by KCS. In addition, the KCS purchase price was increased by $4.4 million, relating primarily to an increase in the estimates for severance and relocation costs.

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 KCSM) 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 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.

September 12, 2005 Completion of VAT/ Put Settlement. On September 12, 2005, the Company and its subsidiaries, KCSM and Grupo TFM, along with TMM, entered into a settlement agreement with the Mexican government, resolving the controversies and disputes between the companies and the Mexican

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

government concerning the payment of a value added tax (“VAT”) refund to KCSM and the obligation (“Put”) to purchase the remaining shares of KCSM owned by the Mexican government (the “VAT/ Put Settlement”). As a result of the VAT/ Put Settlement, KCS and its subsidiaries now own 100% of Grupo TFM and KCSM; the potential obligation of KCS, Grupo TFM and TMM to acquire the Mexican government’s remaining 20% ownership of KCSM has been eliminated; and the legal obligation of the Mexican government to issue the VAT refund to KCSM has been satisfied. There was no cash exchanged between the parties to the settlement agreement. In addition, the parties entered into mutual releases of all existing and potential claims relating to the VAT refund and the Put obligation, and entered into an agreement to dismiss all of the existing litigation between the parties.

The VAT/ Put Settlement had two separate impacts — first, the resolution of a preacquisition contingency related to the April 1, 2005 transaction and second, KCSM’s acquisition of the minority interest held by the Mexican government.


	*Resolution of pre-acquisition contingencies.*

Both the VAT refund claim and the Mexican government’s put rights were pre-acquisition contingencies. Accordingly, the impact of the acquired asset and the resulting liability has been reflected as adjustments to the preliminary purchase accounting described above. Because there is no market for Grupo TFM stock, management assessed the fair value of the government’s shares acquired in the settlement to be properly estimated as the pro rata equivalent of the fair value of Grupo TFM stock paid to TMM under the Acquisition Agreement. Based on this assessment, the fair value of the Mexican government’s shares was determined to be $305.5 million.

Under the terms of the Acquisition Agreement, KCS acquired TMM’s 51% interest in the VAT refund claim as settled. Accordingly, the preliminary purchase accounting for the Grupo TFM acquisition has been adjusted to reflect as an asset the fair value of the acquisition of TMM’s proportionate share of the VAT refund claim of $155.8 million.

In accordance with the Acquisition Agreement, a contingent payment of additional purchase price of $110.0 million became payable to TMM as a result of the final resolution of the VAT Claim and Put, which will be settled in three parts: (i) $35.0 million in stock (shares to be determined based on the VWAP 20 days prior to the final resolution of the VAT Claim and Put, as defined in the Acquisition Agreement); (ii) $35.0 million in cash at time of final resolution of the VAT Claim and Put, as defined in the Acquisition Agreement; and (iii) up to an additional $40.0 million in cash or stock (shares to be determined in accordance with the provisions of the Acquisition Agreement) payable no more than five years from the final closing date (April 1, 2005). The liability is non-interest bearing, therefore it has been recorded at its present value based on a 5.0% discount rate, consistent with the stated rate of similar interest bearing notes in the Acquisition Agreement.

The remaining fair value of the Mexican government’s shares obtained in the VAT/ Put Settlement, approximately $149.7 million, is attributable to the previously existing 49% KCS interest in Grupo TFM and has been recorded as nonoperating income and is presented net of applicable legal, consulting and other fees of approximately $17.8 million including, $9.0 million payable to JSIB, which became payable on final resolution of the VAT Claim and Put. The VAT/ Put settlement gain was not taxable in Mexico. The Company believes, based upon opinions of outside legal counsel and other factors, that the VAT/ Put Settlement should not be taxable to KCS for U.S. income tax purposes. Such position has not been examined by the taxing authority and it is possible that this position could be challenged. The amount of such tax would be material; however the Company believes that it would have the right to indemnification under the terms of the Acquisition Agreement.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	*KCSM Acquisition of Mexican government Shares.*

In connection with the VAT/ Put Settlement, the acquisition of the Mexican government’s interest was accounted for as a purchase. The aggregate carrying value of $375.6 million for the Mexican government shares (23.9% effective ownership — consisting of minority interest of $256.9 million and the Association in Participation Agreement with a book value of $118.7 million) exceeded the estimated fair value of this interest of $305.5 million representing the purchase price.


	*Purchase Price Allocation*

Significant components of the allocation of the excess of the purchase price over the carrying value of the net assets acquired, including both the April 1, 2005 and the September 12, 2005 acquisitions, are as follows:


Increase in current assets		$	11.0
Decrease in property and equipment			(36.9	)
Increase in concession assets			268.2
Increase in deferred income taxes			(81.4	)
Increase in non-current assets			83.6
Increase in current liabilities			(15.3	)
Increase in non-current liabilities			(95.9	)

	Total	$	133.3

The allocation of the purchase price above reflects preliminary estimates to various amounts that are subject to change as the Company obtains additional information relating to the fair values of certain property and equipment. The preliminary purchase price allocation reflects $15.3 million relating to estimated severance and relocation costs. During the nine months ended December 31, 2005 the Company has expended $5.4 million, with $9.9 million left to disburse.

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 property, plant and equipment, and concession assets.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the dates of acquisition as adjusted for the above impacts (dollars in millions):


Current assets		$	269.2
Property, plant and equipment			524.7
Concession rights			1,380.0
Other assets			219.5

	Total assets acquired	$	2,393.4

Current liabilities		$	288.3
Long-term debt acquired			802.6
Other liabilities			112.6
Minority Interest			—

	Total liabilities acquired	$	1,203.5


	*Deferred Assets and Liabilities.*

In connection with the Acquisition, we assessed the fair value of KCSM’s long term contractual relationships including, debt, locomotive and railcar leases and maintenance contracts for locomotives. As a result of the amortization of the deferred credits and deferred charges, for the nine months ended December 31, 2005 KCSM recognized an increase in equipment costs of $5.6 million and reductions of purchased services expense and interest costs of $4.8 million and $2.3 million, respectively. Fair value was determined based on current market rates and other management estimates. Accordingly, we have recorded necessary valuation reserves for the related contracts which are reflected in the December 31, 2005 consolidated financial statements.

Acquisition of Mexrail.

On August 16, 2004, KCS, TMM and KCSM entered into a new Stock Purchase Agreement. Pursuant to the terms of that agreement, KCS purchased from KCSM 51% of the outstanding shares of Mexrail, a wholly-owned subsidiary of KCSM, for $32.7 million and placed those shares into trust pending approval of the Surface Transportation Board (“STB”) to exercise common control over 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. 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 physically to KCSM. 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.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition as of December 31, 2005:

Mexrail, Inc.

As of January 1, 2005


		(Dollars in millions)
Current assets		$	37.8
Property, plant and equipment			108.2
Other assets			0.3

	Total assets acquired	$	146.3

Current liabilities		$	59.7
Long-term debt			—
Other liabilities			29.31

	Total liabilities acquired	$	89.0

The allocation of the purchase price above reflects the final adjustments to the fair values of assets and liabilities of Mexrail. All severance reserves recorded for the Mexrail acquisition were expended prior to December 31, 2005.

Pro Forma Earnings. The following table reflects the pro forma financial results for the twelve months ended December 31, 2005 as though the Grupo TFM Acquisition had occurred on January 1, 2005: (unaudited, in millions except for shares outstanding, which are in thousands, and the per share amounts.)


	KCS and Mexrail		Grupo TFM for
	Historical and		the Period
	Grupo TFM		January 1, 2005
	Since April 1,		Through March 31,		Pro Forma
	2005		2005		Adjustments			Pro Forma

Revenues	$	1,352.0	$	170.1	$	—		$	1,522.1
Net income (loss)		100.9		0.1		(150.1	)		(49.1	)
Income (loss) from continuing operations available to common shareholders		91.4		0.1	$	(150.1	)		(58.6	)

Basic earnings (loss) per common share	$	1.21						$	(0.74	)

Basic weighted average common shares outstanding		75,527				3,750			79,277

Diluted earnings (loss) per common share	$	1.10						$	(0.74	)

Diluted weighted average common shares outstanding		92,747				(13,470	)		79,277

For purposes of comparison, pro forma earnings have been reduced by the $131.9 million non-recurring, non-cash gain on the VAT/ Put settlement.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table reflects the pro forma financial results for the twelve months ended December 31, 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, and the per share amounts.)


								Pro Forma
	KCS		Mexrail			Grupo TFM		Adjustments			Pro Forma

Revenues	$	639.5	$	60.3		$	664.2	$	—		$	1,364.0
Net Income (loss)		24.4		(6.4	)		2.6		(16.6	)		4.0
Income (loss) from continuing operations available to common shareholders	$	15.7	$	(6.4	)	$	4.2	$	(14.0	)	$	(0.5	)

Basic earnings per common share	$	0.25									$	(0.01	)

Basic weighted average common shares outstanding		62,715							18,000			80,715

Diluted earnings per common share	$	0.25									$	(0.01	)

Diluted weighted average common shares outstanding		63,983							16,732			80,715

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.

SOUTHERN CAPITAL CORPORATION, LLC

In 1996, the Company and GATX Capital Corporation (“GATX”) completed a transaction for the formation and financing of a joint venture, Southern Capital Corporation, LLC (“Southern Capital”), to perform certain leasing and financing activities. Southern Capital’s principal operations are the acquisition of locomotives, rolling stock and other railroad equipment and the leasing thereof to KCSR. The Company holds a 50% interest in Southern Capital, which it accounts for using the equity method of accounting.

Concurrent with the formation of this joint venture, the KCSR entered into operating leases with Southern Capital for substantially all the locomotives and rolling stock contributed or sold to Southern Capital at rental rates that management believes reflected market conditions at that time. Southern Capital has acquired additional equipment since its inception, all of which is leased to KCSR. KCSR paid Southern Capital $30.1 million, $32.5 million and $35.3 million under these operating leases in 2005, 2004 and 2003, respectively. In connection with the formation of Southern Capital, the Company received cash that exceeded the net book value of assets contributed to the joint venture by approximately $44.1 million. Accordingly, this excess fair value over book value is being recognized as a reduction in lease rental expense over the terms of the leases (approximately $3.6 million, $4.4 million and $4.5 million in 2005, 2004 and 2003, respectively). During 2005 and 2004, the Company received cash dividends of $8.3 million and $8.8 million respectively from Southern Capital. No dividends were received from Southern Capital during 2003.

During 2005 and 2004, Southern Capital recorded a gain of approximately $7.7 and $6.0 million, respectively related to the sale of locomotives to KCSR. For purposes of recording its share of Southern Capital earnings, the Company has recorded its share of the gain as a reduction to the cost basis of the equipment acquired. As a result, the Company will recognize its equity in the gain over the remaining depreciable life of the locomotives as a reduction of depreciation expense.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During 2001, Southern Capital refinanced its five-year credit facility, which was scheduled to mature on October 19, 2001, with a one-year bridge loan for $201 million. On June 25, 2002, Southern Capital refinanced the outstanding balance of this bridge loan through the issuance of approximately $167.6 million of 5.7% pass through trust certificates and proceeds from the sale of 50 locomotives. Of this amount, $104.0 million is secured by all of the locomotives and rolling stock owned by Southern Capital (other than the 50 locomotives, which were sold, as discussed below) and rental payments payable by KCSR under the operating and financing leases of the equipment owned by Southern Capital. Payments of interest and principal of the pass through trust certificates, which are due semi-annually on June 30 and December 30 commencing on December 30, 2002 and ending on June 30, 2022, are insured under a financial guarantee insurance policy by MBIA Insurance Corporation (“MBIA”). KCSR leases or subleases all of the equipment securing the pass through certificates.

The remaining amount of pass through trust certificates, approximately $63.6 million was assigned to General Electric Corporation (“GE”), the buyer of the 50 locomotives, and is secured by the sold locomotives and rental payments payable by KCSR under the sublease. Southern Capital does not have the option, nor is it obligated to repurchase or redeem the lease receivable or related equipment on or prior to the expiration of the lease agreement entered into with KCSR at the time of the sale. Southern Capital does not guarantee the lease payments of KCSR and has no obligation to make such payments if KCSR should fail to do so. In the event of a default by KCSR, a third party insurance company, MBIA, guarantees the outstanding debt and may seize the collateralized assets, or find a third party lessee to continue making the rental payments to satisfy the debt requirements.

PANAMA CANAL RAILWAY COMPANY

In January 1998, the Republic of Panama awarded PCRC, a joint venture company owed equally by KCS and Mi-Jack Products, Inc., the concession to reconstruct and operate the Panama Canal Railway, a 47-mile railroad located adjacent to the Panama Canal that provides international shippers with a railway transportation option to complement the Panama Canal. The Panama Canal Railway, which traces its origins back to the late 1800’s, is a north-south railroad traversing the Panama isthmus between the Pacific and Atlantic Oceans. The railroad has been reconstructed and resumed freight operations on December 1, 2001. Panarail operates and promotes commuter and tourist passenger service over the Panama Canal Railway. Passenger service started during July 2001.

As of December 31, 2005, the Company has invested approximately $30.4 million toward the reconstruction and operations of the Panama Canal Railway. This investment is comprised of $12.9 million of equity and $17.5 million of subordinated loans. These loans carry a 10% interest rate and are payable on demand, subject to certain restrictions.

In November 1999, PCRC completed the financing for the reconstruction project with the International Finance Corporation (“IFC”), a member of the World Bank Group. The IFC’s investment of $5 million in PCRC is comprised of non-voting preferred shares, which paid a 10% cumulative dividend. On March 28, 2005, PCRC and the 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. At December 31, 2004, these shares had a recorded value of $5.0 million and approximately $2.6 million in accrued unpaid dividends. PCRC recorded an additional cost of approximately $2.9 million to reflect the premium paid to IFC and, 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.

Under the terms of the loan agreement with IFC, the Company is a guarantor for up to $5.6 million of the associated debt. Also if PCRC terminates the concession contract without IFC’s consent, the Company is a guarantor for up to 50% of the outstanding senior loans. The Company is also a guarantor for up to $1.4 million of the equipment loans and approximately $100,000 relating to the other capital

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

leases, and has issued an irrevocable letter of credit in the amount of $1.5 million to fulfill the Company’s 50% guarantee of a $2.9 million equipment loan. The cost of the reconstruction totaled approximately $80 million.

THE MEXICO VALLEY RAILWAY AND TERMINAL (FERROCARRIL Y TERMINAL DEL VALLE DE MÉXICO, S.A. DE C.V. “FTVM”)

FTVM was incorporated as a sociedad anonima de capital variable (variable capital corporation), under the laws of Mexico. The Corporate purpose of the company is to provide railroad services as well as ancillary services, including those related to interconnection, switching and haulage services. KCSM holds 25.0% of the share capital of FTVM. The other shareholders of FTVM, each holding a 25.0% interest, are Ferrocarril Mexicano, S.A. de C.V. (“Ferromex”), Ferrocarril del Sureste, S.A. de C.V. (“Ferrosur”) and the Mexican Government.

Pursuant to the Concession, KCSM, is required to grant rights to use portions of its track to Ferromex, Ferrosur and FTVM. The Concession also stipulates that Ferromex, Ferrosur and FTVM are required to grant KCSM the rights to use portions of their tracks.

Financial Information. Financial information of unconsolidated affiliates that the Company accounted for under the equity method is presented in the following table. Amounts, including those for KCSM, are presented under U.S. GAAP. Certain prior year amounts have been reclassified to reflect amounts from applicable audited financial statements ( in millions).


		As of and for the		As of and for the
		Nine Months		Twelve Months
		Ended		Ended
		December 31, 2005		December 31, 2005

				Southern
		FTVM		Capital		PCRC

Investment in unconsolidated affiliates		$	10.9	$	27.9	$	.6
Equity in net assets of unconsolidated affiliates			9.6		27.9		.6
Financial Condition:
Current assets		$	35.4	$	5.2	$	5.2
Non-current assets			28.1		92.8		81.5

	Assets	$	63.5	$	98.0	$	86.7

Current liabilities		$	9.3	$	1.0	$	13.9
Non-current liabilities			15.8		41.2		71.5
Minority interest			—		—		—
Equity of stockholders and partners			38.4		55.8		1.3

	Liabilities and equity	$	63.5	$	98.0	$	86.7

Operating results:
Revenues		$	55.3	$	27.4	$	17.5

Costs and expenses		$	45.9	$	14.3	$	21.0

Net income (loss)		$	9.4	$	13.1	$	(3.5	)

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


		As of and for the Twelve Months Ended
		December 31, 2004

					Grupo			Southern
		Mexrail			TFM			Capital		PCRC

Investment in unconsolidated affiliates		$	30.0		$	389.6		$	29.1	$	2.4
Equity in net assets of unconsolidated affiliates			27.1			375.0			29.1		2.4
Financial Condition:
Current assets		$	29.8		$	252.7		$	2.3	$	4.2
Non-current assets			71.2			1,982.3			113.5		83.4

	Assets	$	101.0		$	2,235.0		$	115.8	$	87.6

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

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

Operating results:
Revenues		$	60.1		$	699.2		$	22.7	$	10.1

Costs and expenses		$	73.8		$	593.1		$	17.2	$	9.2

Net income (loss)		$	(7.9	)	$	(8.3	)	$	11.8	$	(4.2	)


	As of and for the Twelve
	Months Ended
	December 31, 2003

	Grupo		Southern
	TFM		Capital		PCRC

Operating results:
Revenues	$	698.5	$	31.3	$	7.8

Costs and expenses	$	591.0	$	27.6	$	9.1

Net income (loss)	$	27.3	$	3.6	$	(6.1	)

On March 27, 2002 KCSM purchased all of the shares of Mexrail from TMM and KCS. Accordingly for the period from January 1, 2004 through July 31, 2004, and for the year ended December 31, 2003, the results of Mexrail are consolidated into the results of Grupo TFM.

The effects of foreign currency transactions and capitalized interest prior to June 23, 1997, which are not recorded on Grupo TFM’s books, result in the difference between the carrying amount of the Company’s investment in Grupo TFM and the underlying equity in net assets. Additionally, the purchase by Grupo TFM of the Mexican government’s former 24.6% interest in Grupo TFM resulted in a reduction of Grupo TFM’s stockholder’s equity as the purchased shares from the Mexican government were recorded as treasury shares at Grupo TFM. The Company invested no funds in this transaction, however, and, therefore, it did not have an impact on the Company’s investment in Grupo TFM. As a result, the difference between the Company’s equity in net assets of Grupo TFM and its underlying investment arising as a result of this transaction is being amortized against the Company’s equity in earnings from Grupo TFM over a 33 year period, which was the estimate of the average remaining useful life of Grupo TFM’s concession assets.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The deferred income tax calculations for Grupo TFM are significantly impacted by fluctuations in the relative value of the Mexican peso versus the U.S. dollar and the rate of Mexican inflation, and can result in significant variability in the amount of equity earnings (losses) reported by the Company.


Note 4.	Other Balance Sheet Captions

Accounts Receivable. Accounts receivable include the following items (in millions):


	2005			2004

Accounts receivable	$	339.8		$	149.2
Allowance for doubtful accounts		(24.1	)		(9.6	)

Accounts receivable, net	$	315.7		$	139.6

Bad debt expense	$	15.2		$	2.7

Other Current Assets. Other current assets include the following items (in millions):


		2005		2004

Deferred income taxes		$	10.0	$	13.8
Prepaid expenses			10.1		3.8
Deferred charge related to favorable railcar leases (net of $6.7 million amortization)			11.3		—
Other			14.7		9.6

	Total	$	46.1	$	27.2

Properties. Properties and related accumulated depreciation and amortization are summarized below (in millions):


		2005		2004

Properties
	Road properties	$	1,982.5	$	1,735.2
	Equipment		388.0		293.8
	Locomotives sale-leaseback		32.5		—
	Computer software		71.8		68.3
	Equipment under capital leases		5.4		4.1
	Concession improvements		296.1		—
	Other		161.3		9.1

	Total		2,937.6		2,110.5
Accumulated depreciation and amortization			820.4		755.3

	Total		2,117.2		1,355.2
Construction in progress			181.1		68.8

	Net Properties	$	2,298.3	$	1,424.0

Sale-leaseback of locomotives. In September 1999, KCSM entered into a locomotive operating lease agreement covering 75 locomotives that was to expire in 20 years. The lease agreement contained standard provisions for this type of transaction, including the option to either purchase the assets or return the assets to the lessor at the end of the lease term. Because the lease agreement contained above market rates, in

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

connection with the valuation of KCSM assets as part of the Acquisition and the principles of push down accounting, KCSM recorded a valuation reserve that was being amortized over the remaining life of the lease.

On November 2, 2005, KCSR entered into an agreement with El-Mo-Mex, Inc. (“El-Mo”) to acquire El-Mo’s equity interest in the leased locomotives. KCSR and an affiliate paid cash in the amount of approximately $32.6 million and assumed approximately $95.9 million of debt and accrued interest to acquire the locomotives. KCSR subsequently purchased the locomotives from the affiliate. On December 20, 2005, KCSR entered into a leveraged lease arrangement, treated for financial reporting purposes as an operating lease, with an unaffiliated third party. Pursuant to the terms of this leveraged lease, KCSR was to sell the locomotives to a trust, which would then lease the locomotives to KCSR for a period of 18 years. The trust also would assume the debt assumed by KCSR in its purchase of the locomotives. Prior to year end, KCSR had completed the sale of 54 of the locomotives to the trust. The remaining 19 units (two of the original 75 were determined to be damaged beyond repair) valued at $32.5 million were sold to the trust in January 2006 and are included in the December 31, 2005 financial statements as property.

Overhead Capitalization. KCS 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, 2005, operating expenses were reduced by approximately $1.8 million. Similarly, in the fourth quarter, the overhead allocation was reviewed to ensure that all appropriate current year cost was allocated which resulted in a reduction of operating expenses of approximately $3.0 million.

Concession Assets. As discussed in Note 1, in December 1996, the Mexican Government (the “Government”) granted KCSM the Concession (the “Concession”) to operate the northeast rail lines for an initial period of fifty years, exclusive for thirty years, renewable, subject to certain conditions, for a second period of equal length. Under the terms of the Concession, the Company has the right to use and is obligated to maintain the right of way, track structure, buildings and related maintenance facilities to the operational standards specified in the concession agreement and to return the assets in that condition at the end of the concession period.

Concession assets and related amortization are summarized below (in millions):


		2005

Concession Assets
	Road properties	$	1,241.2
	Land		111.8
	Other		48.6

	Total		1,401.6
Accumulated amortization			41.2

	Net Properties	$	1,360.4

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Accrued Liabilities. Accrued liabilities include the following items (in millions):


		2005		2004

Claims reserves		$	40.1	$	35.1
Prepaid freight charges due other railroads			32.2		30.5
Car hire per diem			10.7		9.2
Vacation accrual			11.3		9.9
Property and other taxes			20.7		7.2
Interest payable			17.9		5.9
Deferred credits related to unfavorable locomotive leases and maintenance contracts			9.7		—
Other			99.1		50.6

	Total	$	241.7	$	148.4

Other Noncurrent Liabilities and Deferred Credits. Other noncurrent liabilities and deferred credits include the following items (in millions):


		2005		2004

Claims reserves		$	90.9	$	39.9
Accrued employee benefits			10.0		8.4
Deferred gain on sale of equipment to Southern Capital			5.1		8.7
Deferred gain on sale of Mexrail			—		5.9
KCSM employees’ statutory profit sharing			29.0		—
Deferred credits related to unfavorable locomotive leases and maintenance contracts			54.2		—
Other			81.0		20.7

	Total	$	270.2	$	83.6

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Note 5.	Long-Term Debt

Indebtedness Outstanding. Long-term debt and pertinent provisions follow (in millions):


		2005		2004

KCS		$	.2	$	1.3
Liability related to Grupo TFM Acquisition			158.7		—
KCSR
Borrowings pursuant to Amended 2004 Senior Secured Credit Facility Revolving Credit Facility, variable interest rate at December 31, 2005 — 6.04%, due March 2007			92.0		—
	Term Loans, variable interest rate at December 31,2005 — 5.80%, due March 2008		246.8		249.2
7 ¹ / 2 % Senior Notes, due June 15, 2009			200.0		200.0
9 ¹ / 2 % Senior Notes, due October 1, 2008			200.0		200.0
Equipment Trust Certificates, 8.56% due serially to December 15, 2006			5.4		10.8
Equipment Secured Debt, 8.84% due serially to November 11, 2006			24.3		—
Capital Lease Obligations, 7.15% to 8.00%, due serially to September 30, 2009			1.1		1.5
Term Loans with State of Illinois, 3% to 5% due serially to 2018			2.3		2.2
Other			—		.7
Tex-Mex
RRIF loan, 4.29%, due July 13, 2030			21.7		—
KCSM
10 ¹ / 4 % Senior Notes, due June 15, 2007			150.0		—
12 ¹ / 2 % Senior Notes, due June 15, 2012			178.3		—
9 ³ / 8 % Senior Notes, due May 01, 2012			460.0		—
Revolving Credit Facility, variable interest rate at December 31, 2005 — 11.12%, due October 28, 2008			6.6		—
Revolving Credit Facility, variable interest rate at December 31, 2005 — 6.98%, due October 28, 2008			19.5		—
Term Loans, variable interest rate at December 31,2005 — 7.17%, due October 28, 2008			76.0		—
Capital Lease Obligations, due in 2010 and 2011			1.3		—
Fair market adjustment related to purchase accounting			16.4		—

Total			1860.6		665.7
Less: debt due within one year(i)(ii)			116.3		9.9

Long-term debt		$	1744.3	$	655.8


(i)		Includes $4.2 million of adjustments to reflect the fair value of the liabilities assumed

(ii)		Includes current liability related to Grupo TFM acquisition.

Amended 2004 Senior Secured Credit Facility. On March 30, 2004, the Company entered into a credit agreement (“Credit Agreement”) consisting of a $100 million revolving credit facility (“Revolving Credit Facility”) maturing on March 30, 2007 and a $150 million Term B loan facility (“Term Loan Facility”) maturing on March 30, 2008. The Term Loan Facility was fully funded on the closing

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

date and the proceeds were used to pay transaction costs and for other general corporate purposes, including additional investments in the Company’s Mexican affiliates. Up to $25.0 million of the Revolving Credit Facility is available for letters of credit and up to $15 million is available for swing line loans. The proceeds from borrowings under the Revolving Credit Facility may be used for working capital and for general corporate purposes, including additional investments in the Company’s Mexican affiliates. The letters of credit may be used for general corporate purposes. Borrowings under the Credit Agreement are secured by substantially all of the Company’s domestic assets and are guaranteed by the majority of its domestic subsidiaries.

The Term Loan Facility and the Revolving Credit Facility bear interest at the London Interbank Offered Rate (“LIBOR”) plus an applicable margin or at an alternative base rate plus an applicable margin. The applicable margin for the Term Loan Facility was 200 basis points over LIBOR for LIBOR borrowings. The applicable margin for the Revolving Credit Facility was set at 2.25% for LIBOR borrowings for the first six months and thereafter is based on the Company’s leverage ratio (defined as the ratio of the Company’s total debt to consolidated EBITDA (earnings before interest, taxes, depreciation and amortization, excluding the undistributed earnings of unconsolidated affiliates and certain other non-cash charges) for the prior twelve months).

The Credit Agreement requires the payment of a commitment fee to the lenders on the average daily, unused amount of the Revolving Credit Facility. Additionally, a fee equal to the applicable margin for LIBOR priced borrowings under the Revolving Credit Facility will be paid on any letter of credit issued under the Revolving Credit Facility. As of December 31, 2005, the KSCR revolver had an available balance of approximately $33.0 million and the KCSM revolver had an available balance of approximately $4.0 million.

The Credit Agreement contains certain provisions, covenants and restrictions customary for this type of debt and for borrowers with a similar credit rating. These provisions include, among others, restrictions on the Company’s ability and its subsidiaries ability to 1) incur additional debt or liens; 2) enter into sale and leaseback transactions; 3) merge or consolidate with another entity; 4) sell assets; 5) enter into certain transactions with affiliates; 6) make investments, loans, advances, guarantees or acquisitions; 7) make certain restricted payments, including dividends, or make certain payments on other indebtedness; or 8) make capital expenditures in excess of allowed amounts. In addition, the Company is required to comply with certain financial ratios, including minimum interest expense coverage and leverage ratios. The Credit Agreement also contains certain customary events of default. These covenants, along with other provisions, could restrict maximum utilization of the Revolving Credit Facility.

On December 22, 2004, KCS, KCSR, and other KCS its subsidiaries entered into an amendment and waiver of the Credit Agreement. The Credit Agreement was amended to, among other things, increase the Term Loan Facility by $100,000,000 and decrease the borrowing spread by 25 basis points to 175 basis points for LIBOR borrowings. In addition, a waiver was granted that would allow KCSR to make an additional $55 million of capital expenditures during 2004 and 2005.

On September 30, 2005, KCS, KCSR, and other KCS subsidiaries entered into a second amendment and waiver of the Credit Agreement. The Credit Agreement was amended to increase the Revolving Credit Facility commitment by $25.0 million to a total available line of credit of $125.0 million. The borrowing spread on the Revolving Credit Facility was reduced by 50 basis points, while the borrowing spread on the Term Loan Facility was reduced by 25 basis points (based on certain financial statement attributes). Additionally, the capital expenditure limit was eliminated and certain other nonmaterial changes were made to the Credit Agreement as part of the amendment.

On November 4, 2005, KCS, KCSR and other KCS subsidiaries entered into a third amendment of the Credit Agreement. The Credit Agreement was amended to modify the definition of “EBITDA” in

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

order to exclude from the definition certain non-cash charges not to exceed $35.7 million in the aggregate for the fiscal quarter ending on September 30, 2005, with respect to an increase in claim reserves.

On December 8, 2005, KCS, KCSR and other KCS subsidiaries entered into a third waiver of the Credit Agreement. The provisions of Section 5.02(g) of the Credit Agreement were waived in order to permit KCS to use substantially all of the net proceeds from the issuance of its 5.125% Cumulative Convertible Series D Preferred Stock to repurchase shares of its common stock.

On March 1, 2006 KCS, KCSR and other KCS subsidiaries entered into a fourth waiver of the 2004 Credit Agreement (the “Fourth Waiver”). Under the terms of the Fourth Waiver, which expires on April 30, 2006, the Lenders have agreed to waive the requirement that KCS, as defined in the Credit Agreement maintain a leverage ratio of not more than 5.00:1 for the quarter ended December 31, 2005, provided that such ratio does not exceed 5.50:1.

On March 17, 2006, KCSR entered into a commitment letter (the “Commitment Letter”) with The Bank of Nova Scotia (“Scotia”) under which Scotia has agreed to provide KCSR with a $371.2 million, fully underwritten, new credit agreement to refinance KCSR’s existing Credit Agreement. The new credit agreement will consist of a $246.2 million term loan facility and a $125 million revolving credit facility and contain terms and conditions substantially similar to the Credit Agreement, but will provide KCSR with additional financial flexibility. The closing on the new credit agreement is expected to occur before April 30, 2006. KCSR expects to be in compliance with all of the covenants of the new credit agreement, including the leverage ratio, throughout its term.

7 ¹ / 2 % Senior Notes. In June 2002, KCSR issued $200 million of 7 ¹ / 2 % senior notes due June 15, 2009 (“7 ¹ / 2 % Senior Notes”). Net proceeds from the offering of $195.8 million, together with cash, were used to repay term debt under a previous KCSR credit facility and certain other secured indebtedness of the Company. The 7 ¹ / 2 % Senior Notes were subsequently exchanged for registered notes with substantially identical terms. These registered notes bear a fixed annual interest rate to be paid semi-annually on June 15 and December 15 and are due June 15, 2009. These registered notes are general unsecured obligations of KCSR, are guaranteed by the Company and certain of its domestic subsidiaries, and contain certain covenants and restrictions customary for this type of debt instrument and for borrowers with similar credit ratings.

9 ¹ / 2 % Senior Notes. During the third quarter of 2000, KCSR issued $200 million of 9 ¹ / 2 % senior notes due October 1, 2008 (“9 ¹ / 2 % Senior Notes”). Net proceeds from the offering of $196.5 million were used to refinance term debt and reduce commitments under a previous KCSR credit facility. The 9 ¹ / 2 % Senior Notes were subsequently exchanged for registered notes with substantially identical terms. These registered notes bear a fixed annual interest rate to be paid semi-annually on April 1 and November 1 and are due on October 1, 2008. These registered notes are general unsecured obligations of KCSR, are guaranteed by the Company and certain of its domestic subsidiaries, and contain certain covenants and restrictions customary for this type of debt instrument and for borrowers with similar credit ratings.

Consent Solicitation regarding the 7 ¹ / 2 % and 9 ¹ / 2 % Senior Notes. On June 10, 2005, KCSR completed the successful solicitation of consents to amend the indentures, as supplemented where applicable, under which KCSR’s outstanding 7 ¹ / 2 % Senior Notes and outstanding 9 ¹ / 2 % Senior Notes were

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

issued. KCSR received the requisite consents from a majority of the holders 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, Grupo TFM, and KCSM to effect a settlement of certain disputes among KCSM, Grupo TFM, and the Mexican government.

Equipment Trust and Capital Lease Indebtedness. KCSR has purchased certain locomotives and rolling stock under equipment trust certificates and capitalized lease obligations.

On November 2, 2005, KCSR entered into an agreement with El-Mo-Mex, Inc. (“El-Mo”) to acquire El-Mo’s equity interest in certain leased locomotives. KCSR and an affiliate paid cash in the amount of approximately $32.6 million and assumed approximately $95.9 million of debt and accrued interest to acquire the locomotives. KCSR subsequently purchased the locomotives from the affiliate. On December 20, 2005, KCSR entered into a leveraged lease arrangement, treated for financial reporting purposes as an operating lease, with an unaffiliated third party. Pursuant to the terms of this leveraged lease, KCSR was to sell the locomotives to a trust, which would then lease the locomotives to KCSR for a period of 18 years. The trust also would assume the debt assumed by KCSR in its purchase of the locomotives. Prior to year end, KCSR had completed the sale of 54 of the locomotives to the trust. The remaining 19 units (two of the original 75 were determined to be damaged beyond repair) valued at $32.5 million were sold to the trust in January 2006. As of December 31, 2005 there was $24.3 million of debt associated with the 19 unsold locomotives recorded on our balance sheet.

RRIF 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 infrastructure improvements. These improvements are expected to increase efficiency and capacity in order to accommodate growing freight rail traffic related to the NAFTA corridor. The interest rate under the loan agreement is 4.29% and the principal balance amortizes quarterly with a final maturity of July 13, 2030. At December 31, 2005, Tex-Mex had borrowed $21.7 million under the loan agreement. Tex-Mex expects to draw down the remaining available principal balance during 2006. The loan is being made under the Railroad Rehabilitation and Improvement Financing (“RRIF”) Program administered by the FRA. The loan is guaranteed by Mexrail, which 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.

10 ¹ / 4 % Senior Notes. KCSM issued the 2007 Senior Notes in June 1997. The 2007 Senior Notes are denominated in dollars, bear interest semiannually at a fixed rate of 10 ¹ / 4 % and mature on June 15, 2007. The 2007 Senior Notes are not redeemable at KCSM’s option except, subject to certain limitations, in the event of certain changes in Mexican law. The 2007 Senior Notes are unsecured, unsubordinated obligations of KCSM, rank pari passu in right of payment with all existing and future unsecured, unsubordinated obligations of KCSM and are senior in right of payment to all future subordinated indebtedness of KCSM. The 2007 Senior Notes are unconditionally guaranteed on an unsecured unsubordinated basis by Grupo TFM.

12 ¹ / 2 % Senior Notes. KCSM issued the 2012 Senior Notes in June 2002. The 2012 Senior Notes are denominated in dollars, bear interest semiannually at a fixed rate of 12 ¹ / 2 % and mature on June 15, 2012. The 2012 Senior Notes are unsecured, unsubordinated obligations of KCSM, rank pari passu in right of payment with all existing and future unsecured, unsubordinated obligations of KCSM, and are senior in right of payment to all future subordinated indebtedness of KCSM. The 12 ¹ / 2 % Senior Notes are not guaranteed by Grupo TFM. The 2012 Senior Notes are redeemable at any time in the event of certain

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

changes in Mexican tax law and at KCSM’s option, in whole or in part, on or after June 15, 2007, subject to certain limitations, at the following redemption prices (expressed in percentages of principal amount at maturity), plus accrued and unpaid interest, if any:


	Redemption
Year	Price

2007		106.250	%
2008		104.167	%
2009		102.083	%
2010 and thereafter		100.000	%

9 ³ / 8 % Senior Notes. On April 1, 2005, KCSM 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 KCSM’s Offer to Purchase and Consent Solicitation Statement dated April 1, 2005. KCSM 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, representing approximately 87% 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. As a result of such consents and early tenders, KCSM received the requisite consents to execute a supplemental indenture relating to the 2009 Debentures. As part of its tender offer for the 2009 Debentures, KCSM 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 KCSM and the Trustee under the indenture. KCSM 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, KCSM called for redemption of all its remaining outstanding 2009 Debentures that were not tendered in KCSM’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 19, 2005, KCSM issued $460.0 million principal amount of 9 ³ / 8 % senior notes due 2012 (the “9 ³ / 8 % Senior Notes”). The 9 ³ / 8 % Senior Notes are denominated in U.S. Dollars, bear interest semiannually at a fixed rate of 9 ³ / 8 % and mature on May 1, 2012. The 9 ³ / 8 % Senior Notes are redeemable, at KCSM’s option, in whole at any time or in part from time to time, on and after May 1, 2009, upon not less than 30 nor more than 60 days notice. Subject to certain conditions, up to 35% of the principal amount of the 9 ³ / 8 % Senior Notes is redeemable prior to May 1, 2008. In addition, the 9 ³ / 8 % Senior Notes are redeemable, in whole but not in part, at KCSM’s option at 100% of their principal amount, together with accrued interest, in the event of certain changes in the Mexican withholding tax rate.

The 9 ³ / 8 % Senior Notes are unsecured, unsubordinated obligations of KCSM, rank pari passu in right of payment with all existing and future unsecured, unsubordinated obligations of KCSM, and are senior to all of KCSM’s subordinated debt. The 9 ³ / 8 % Senior Notes effectively rank junior to all of KCSM’s secured indebtedness to the extent of the value of the assets securing such indebtedness. The 9 ³ / 8 % Senior Notes are not guaranteed by any of KCSM’s subsidiaries and are therefore effectively subordinated to all liabilities of KCSM’s subsidiaries. The 9 ³ / 8 % Senior Notes are not guaranteed by Grupo TFM.

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In connection with the issuance of the 9 ³ / 8 % Senior Notes, on April 19, 2005, KCSM entered into a registration rights agreement with the placement agents engaged in the offering of the 9 ³ / 8 % Senior Notes, or the Registration Rights Agreement. Pursuant to the terms of the Registration Rights Agreement, KCSM agreed, for the benefit of the holders of the 9 ³ / 8 % Senior Notes, at the cost to KCSM, to use its reasonable best efforts to:


	(i) file a registration statement with respect to a registered offer to exchange the 9 ³ / 8 % Senior Notes for new exchange notes having terms identical in all material respects to the 9 ³ / 8 % Senior Notes (except that the exchange notes will not contain transfer restrictions); and

	(ii) complete the registered exchange offer within 270 days after the closing date of the offering of the 9 ³ / 8 % Senior Notes of April 19, 2005.

KCSM filed the registration statement and completed the registered exchange offer in accordance with the terms of the Registration Rights Agreement.

KCSM New Credit Agreement. On October 24, 2005, KCSM entered into a new credit agreement (the “2005 KCSM Credit Agreement”) in an aggregate amount of up to $106 million with Bank of America, N.A., BBVA Bancomer, S.A., Institución de Banca Múltiple, Grupo Financiero BBVA Bancomer, and the other lenders named in the 2005 KCSM Credit Agreement. The 2005 KCSM Credit Agreement consists of a $30 million revolving credit facility and a $76 million term loan facility and is secured by the locomotives and rail cars owned by KCSM’s subsidiary, Arrendadora. Proceeds from the credit agreement were used by KCSM to pay all amounts outstanding under the Bridge Loan Agreement dated September 15, 2005, to pay all remaining amounts outstanding under the $186.4 million First Amended and Restated Credit Agreement dated as of June 24, 2004, and for other general corporate purposes. The maturity date for the credit facility is October 28, 2008. The 2005 KCSM Credit Agreement contains covenants that restrict or prohibit certain actions by KCSM, including, but not limited to, its ability to incur debt, create or suffer to exist liens, make prepayments of particular debt, pay dividends, make investments, engage in transactions with stockholders and affiliates, issue capital stock, sell certain assets, and engage in mergers and consolidations or in sale-leaseback transactions. Except for certain circumstances, KCSM’s capital expenditures may not exceed certain amounts for any period of four consecutive fiscal quarters. In addition, KCSM must meet certain consolidated interest coverage ratios, consolidated leverage ratios, and fixed charge coverage ratios. Failure to maintain compliance with covenants would constitute a default. Other events of default include, but are not limited to, certain payment defaults, certain bankruptcy and liquidation proceedings, a change of control, and certain adverse judgments or government actions. Any event of default could trigger acceleration of the time for payment of any amounts outstanding under the 2005 KCSM Credit Agreement.

102

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

On April 7, 2006 KCSM entered into an amendment and waiver (“Amendment and Waiver”) to the 2005 KCSM Credit Agreement. The 2005 KCSM Credit Agreement was amended to (i) exclude certain payment obligations accrued under two locomotive maintenance agreements and under a track maintenance rehabilitation agreement from the definition of Indebtedness, (ii) eliminate certain minimum and multiple borrowing thresholds for peso borrowings under the revolving credit facility and (iii) eliminate the reporting requirement to provide unaudited consolidated financial statements for the fourth fiscal quarter. The Amendment and Waiver also waived (x) certain reporting requirements, including the requirement of KCSM to provide audited consolidated financial statements 90 days after the end of the 2005 fiscal year, provided such reports are delivered by April 30, 2006 and (y) compliance with the Consolidated Leverage Ratio obligations of Section 7.1(c) of the 2005 KCSM Credit Agreement for the four quarters ending December 31, 2005 if compliance therewith was calculated without giving effect to the amendment to the definition of “Indebtedness” in the Amendment and Waiver, provided that KCSM is in compliance therewith after giving effect to the Amendment and Waiver.

Leases and Debt Maturities. The Company and its subsidiaries lease transportation equipment, as well as office and other operating facilities under various capital and operating leases. Rental expenses under operating leases were $103.0 million and $57.7 million for the years ended December 31, 2005 and 2004, respectively. Contingent rentals and sublease rentals were not significant. Minimum annual payments and present value thereof under existing capital leases, other debt maturities, and minimum annual rental commitments under non-cancelable operating leases are as follows (dollars in millions):


			Capital Leases
											Operating Leases
	Long-		Minimum				Net
	Term		Lease		Less		Present		Total		Southern		Third
	Debt		Payments		Interest		Value		Debt		Capital		Party		Total

2006(i)		115.7		0.7		0.1		0.6		116.3		24.4		108.8		133.2
2007(ii)		539.4		0.7		0.1		0.6		540.0		18.9		100.6		119.5
2008		330.6		0.6		—		0.6		331.2		19.3		88.7		108.0
2009		200.9		0.5		—		0.5		201.4		17.2		72.0		89.2
Later years		671.5		0.2		—		0.2		671.7		126.2		339.6		465.8

Total(iii)	$	1858.1	$	2.7	$	0.2	$	2.5	$	1860.6	$	206.0	$	709.7	$	915.7


(i)	Includes current liability related to Grupo TFM acquisition.

(ii)	Includes long-term liability related to Grupo TFM acquisition.

(iii)	Includes current and long-term liability related to Grupo TFM acquisition.

Other Agreements, Guarantees, Provisions and Restrictions. The Company has debt agreements containing restrictions on subsidiary indebtedness, advances and transfers of assets, and sale and leaseback transactions, as well as requiring compliance with various financial covenants. Because of certain financial covenants contained in the debt agreements, however, maximum utilization of the Company’s available line of credit may be restricted.

Change in Control Provisions. Certain loan agreements and debt instruments entered into or guaranteed by the Company and its subsidiaries provide for default in the event of a specified change in control of the Company or particular subsidiaries of the Company.


Note 6.	Income Taxes

Current income tax expense represents the amounts expected to be reported on the Company’s income tax return, and deferred tax expense or benefit represents the change in net deferred tax assets and

103

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

liabilities. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse. Valuation allowances are used to reduce deferred tax assets to the amount considered likely to be realized.

Tax Expense. Income tax provision (benefit) consists of the following components (in millions):


			2005			2004			2003

Current
	Federal		$	11.2		$	(12.4	)	$	(4.7	)
	State and local			(1.3	)		0.1			0.3
	Foreign			.3			—			—

		Total current		10.2			(12.3	)		(4.4	)

Deferred
	Federal			(17.8	)		33.8			0.6
	State and local			1.4			2.1			1.0
	Foreign			(.9	)		—			—

		Total deferred		(17.3	)		35.9			1.6

Total income tax provision (benefit)			$	(7.1	)	$	23.6		$	(2.8	)

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows (in millions):


				2005			2004

							Restated
Liabilities:
	Depreciation			$	565.2		$	463.2
	Investments				16.2			7.3
	Concession rights				277.5			—
	Other, net				5.6			5.2

		Gross deferred tax liabilities			864.5			475.7

Assets:
	Loss carryovers				(491.3	)		(16.5	)
	Book reserves not currently deductible for tax				(57.4	)		(36.5	)
	Inventories and Provisions				(70.9	)		—
	Vacation accrual				(3.5	)		(2.4	)
	Other, net				(3.9	)		(4.0	)

		Gross deferred tax assets before valuation allowance			(627.0	)		(59.4	)
	Valuation allowance on loss carryovers				9.5			8.8

			Gross deferred tax assets		(617.5	)		(50.6	)

Net deferred tax liability				$	247.0		$	425.1

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Tax Rates. Differences between the Company’s effective income tax rates and the U.S. federal income tax statutory rates of 35% are as follows (in millions):


		2005			2004			2003

Income tax provision using the Statutory rate in effect		$	26.7		$	16.8		$	0.2
Tax effect of:
	Earnings of equity investees		.3			1.8			(4.3	)
	State and local income tax provision		.1			2.8			0.8
	Tax Credits		(2.4	)		—			—
	Foreign exchange, tax rate and indexation adjustments		4.3			—			—
	Write off of deferred profit sharing		10.1			—			—
	VAT Settlement		(42.3	)		—			—
	Difference between U.S. and foreign tax rate		(3.9	)		—			—
	Foreign asset tax		.3			—			—
	Other, net		(0.3	)		2.2			0.5

Income tax provision (benefit)		$	(7.1	)	$	23.6		$	(2.8	)

Effective tax rate			(9.3	)%		49.1	%		(600.7	)%

Other, net for 2004 includes certain adjustments of prior year provision estimates resulting in a $1.1 million increase in tax expense.

Difference Attributable to KCSM Investment. At December 31, 2005, the Company’s book basis exceeded the tax basis of its investment in KCSM by $496.9 million. The Company has not provided a deferred income tax liability for the income taxes, if any, which might become payable on the realization of this basis difference because the Company intends to indefinitely reinvest in KCSM the financial accounting earnings which gave rise to the basis differential. Moreover, the Company has no other plans to realize this basis differential by a sale of its investment in KCSM. If the Company were to realize this basis difference in the future by a receipt of dividends or the sale of its interest in KCSM, as of December 31, 2005 the Company would incur gross federal income taxes of $173.9 million, which might be partially offset by Mexican income taxes.

Prior to the acquisition of a controlling interest in Grupo TFM on April 1, 2005, Grupo TFM provided deferred income taxes for the difference between the financial reporting and income tax bases of its assets and liabilities. KCS recorded its proportionate share of these income taxes through its equity in Grupo TFM’s earnings. Since April 1, 2005, Grupo TFM income taxes are reflected in the consolidated results. Although KCSM has generated book profits, it has incurred tax losses due primarily to the accelerated tax amortization of the concession rights. We have recognized a deferred income tax asset for the resulting net operating loss carryforwards and may continue to recognize additional amounts in the next few years. Management anticipates that such net operating loss carryforwards will be realized given the expiration dates (through the year 2046) of the loss carryforwards, as well as the fact that we expect to generate taxable income in the future. Our tax projections take into consideration certain assumptions, some of which are under our control and others which are not. Key assumptions include inflation rates, currency fluctuations and future revenue growth. If our assumptions are not correct, we may have to recognize a valuation allowance on our deferred tax asset.

As described in Note 3, on September 12, 2005, the Company and its subsidiaries, KCSM and Grupo TFM, along with TMM, entered into a settlement agreement with the Mexican government, resolving the controversies and disputes between the companies and the Mexican government concerning the payment of

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KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

a value added tax (“VAT”) refund to KCSM and the obligation (“Put”) to purchase the remaining shares of KCSM owned by the Mexican government (the “VAT/ Put Settlement”). All Mexican income taxes on the VAT were paid as part of the VAT/ Put Settlement. The Company believes, based upon opinions of outside legal counsel and other factors, that the VAT/ Put Settlement should not be taxable to KCS for U.S. income tax purposes. Such position has not been examined by the taxing authority and it is possible that this position could be challenged. The amount of such tax would be material; however the Company believes that it would have the right to indemnification under the terms of the Acquisition Agreement.

Tax Carryovers. In the years ended December 31, 2004 and 2003, the Company generated both U.S. federal and state net operating losses. The losses are carried forward 20 years for federal and from 5 to 20 years for state.

Both the federal and state loss carryovers are analyzed each year to determine the likelihood of realization. The U.S. federal loss carryover at December 31, 2005 is approximately $117.6 million and will expire beginning in 2023. The Company believes the Federal loss carryover will be realized.

The state loss carryovers arise from both combined and separately filed tax filings from as early as 1991. The loss carryovers may expire as early as December 31, 2006 and as late as December 31, 2025. The state loss carryover at December 31, 2005 is $497.9 million (approximately $16.2 million of tax), of which it is expected that $291.8 million (approximately $9.5 million of tax) will expire without utilization, leaving $206.1 million (approximately $6.7 million of tax) expected to be realized. Management believes that deferred tax assets, net of the valuation allowance, will be ultimately realized.

The Mexico federal loss carryovers at December 31, 2005 are approximately $1.5 billion (Mexican pesos of approximately 15.7 billion) and will expire as early as 2007 and as late as 2046. The Company believes the Mexican loss carryovers will be realized.

Internal Revenue Service reviews. The IRS is currently in the process of reviewing the consolidated federal income tax returns for the years 1997 through 1999. The examination is expected to be completed during 2006 so a current income tax liability has been accrued for the anticipated outcome. In addition, other tax authorities are currently reviewing the years 2000 through 2004. The Company believes that adequate provision has been made for any adjustment (taxes and interest) that may be assessed for all open years.

In 2004, the IRS concluded reviews of the 1990-1996 tax years. The Company received $21.6 million in tax refunds ($37.6 million including interest) from adjustments arising in those years. The Company recognized interest income in the financial statements as an increase of $10.3 million to other income, an increase in deferred taxes of $21.5 million and an increase of $6.0 million in other liabilities (primarily interest and amounts due to former affiliates) offset by an increase in current tax expense of $0.2 million. The federal statute of limitations has closed for years prior to 1997.

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Note 7.	Stockholders’ Equity

Stockholders’ Equity. Information regarding the Company’s capital stock at December 31, 2005 and 2004 follows:


	Shares		Shares
	Authorized		Issued

$25 Par, 4% noncumulative, Preferred stock		840,000		649,736
$1 Par, Preferred stock		2,000,000		None
$1 Par, Series A, Preferred stock		150,000		None
$1 Par, Series B convertible, Preferred stock		1,000,000		None
$1 Par, Redeemable Cumulative Convertible Perpetual Preferred Stock Series C		400,000		400,000
$1 Par, Cumulative Convertible Perpetual Preferred Stock Series D		210,000		210,000
$.01 Par, Common stock		400,000,000		91,369,116

Shares outstanding at December 31:


	2005		2004

$25 Par, 4% noncumulative, Preferred stock		242,170		242,170
$1 Par, Redeemable Cumulative Convertible Perpetual Preferred Stock Series C		400,000		400,000
$1 Par, Cumulative Convertible Perpetual Preferred Stock Series D		210,000		—
$.01 Par, Common stock		73,412,081		63,270,204

Stock Option Plans. The Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan (as amended and restated effective May 5, 2004) provides for the granting of options to purchase up to 16.0 million shares of the Company’s common stock by officers and other designated employees. Options have been granted under this plan at 100% of the average market price of the Company’s stock on the date of grant and generally may not be exercised sooner than one year or longer than ten years following the date of the grant, except that options outstanding with limited rights (“LRs”) or limited stock appreciation rights (“LSARs”), become immediately exercisable upon certain defined circumstances constituting a change in control of the Company. The plan includes provisions for stock appreciation rights, LRs and LSARs. All outstanding options include LSARs, except for options granted to non-employee Directors prior to 1999.

For purposes of computing the pro forma effects of option grants under the fair value accounting method prescribed by SFAS 123, the fair value of each option grant is estimated on the date of grant using a version of the Black-Scholes option pricing model. The following assumptions were used for the various grants depending on the date of grant, nature of vesting and term of option:

2005

2004

2003

Dividend Yield

Expected Volatility

26% to 27%

26% to 32%

33% to 41%

Risk-free Interest Rate

3.27% to 3.71%

2.17% to 3.91%

1.68% to 2.30%

Expected Life

3 years

3-7 years

For the three years ended December 31, 2005, changes in these assumptions have resulted from changes in the risk free rate due to changing market conditions and changes in expected volatility that reflect an average of the most recent three years volatility of KCS common stock.

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Summary of Company’s Stock Option Plans. A summary of the status of the Company’s stock option plans as of December 31, 2005, 2004 and 2003 and changes during the years then ended is presented below.


	2005					2004					2003

				Weighted-					Weighted-					Weighted-
				Average					Average					Average
				Exercise					Exercise					Exercise
	Shares			Price		Shares			Price		Shares			Price

Outstanding at January 1		4,192,742		$	8.62		4,612,863		$	7.36		4,845,226		$	6.35
Exercised		(554,869	)		6.88		(894,832	)		5.64		(769,782	)		4.60
Canceled/ Expired		(34,680	)		10.54		(115,536	)		12.27		(114,582	)		10.67
Granted		104,200			17.51		590,247			14.67		652,001			12.15

Outstanding at December 31		3,707,393		$	9.11		4,192,742		$	8.62		4,612,863		$	7.36

Exercisable at December 31		3,081,063		$	8.21		3,140,786		$	6.93		3,807,886		$	6.30
Weighted — average fair value of options granted during the period				$	3.98				$	3.64				$	4.86

The following table summarizes information about stock options outstanding at December 31, 2005:


	Outstanding
							Exercisable
			Weighted-
			Average		Weighted-				Weighted-
			Remaining		Average				Average
	Shares		Contractual Life		Exercise		Shares		Exercise
Range of Exercise Prices	Outstanding		(years)		Price		Exercisable		Price

$ 0 - 5		135,468		2.3	$	1.98		135,468	$	1.98
5 - 10		1,980,259		4.6		5.80		1,980,259		5.80
10 - 15		1,262,466		7.9		13.14		745,336		13.40
15 - 20		329,200		8.0		16.55		220,000		16.11

$ 0 - 20		3,707,393		6.9	$	9.11		3,081,063	$	8.21

At December 31, 2005, shares available for future grants under the stock option plan were 2,834,705.

Stock Purchase Plan. The Employee Stock Purchase Plan (“ESPP”), established in 1977, provides substantially all full-time employees of the Company, certain subsidiaries and certain other affiliated entities, with the right to subscribe to an aggregate of 11.4 million shares of common stock. For offerings under the Fifteenth Offering of the ESPP, the purchase price for shares were 85% of the average market price on either the exercise date or the offering date, whichever was lower, but in no event less than the par value of the shares. For offerings under the Seventeenth and Sixteenth Offerings, the purchase prices for shares was 90% of the average market price on either the exercise date or the offering date, whichever

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was lower, but in no event less than the par value of the shares. The following table summarizes activity related to the various ESPP offerings:


	Date		Shares				Shares				Received from
	Initiated		Subscribed		Price		Issued		Date Issued		Employees*

											(In millions)
Seventeenth Offering		2005		140,867	$	20.10		—		—	$	—
Sixteenth Offering		2004		119,384	$	15.14		109,062		2005/2006	$	1.7
Fifteenth Offering		2003		242,589	$	11.08-$11.28		206,123		2004/2005	$	2.3


*	Represents amounts received from employees through payroll deductions for share purchases under applicable offering.

At December 31, 2005, there were approximately 4.2 million shares available for future ESPP offerings.

For purposes of computing the pro forma effects of employees’ purchase rights under the fair value accounting method prescribed by SFAS 123, the fair value of the offerings under the ESPP is estimated on the date of grant using a version of the Black-Scholes option pricing model. The following weighted-average assumptions were used for the Seventeenth, Sixteenth, and Fifteenth Offerings, respectively: i) dividend yield of 0.00%, 0.00% and 0.00%; ii) expected volatility of 27%, 27% and 35%; iii) risk-free interest rate of 3.41%, 2.85% and 1.26%; and iv) expected life of one year. The weighted-average fair value of purchase rights granted under the Seventeenth, Sixteenth, and Fifteenth Offerings of the ESPP were $3.98, $2.96 and $2.95, respectively.

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 year cliff vesting for employees and one year for directors. For the year ended December 31, 2005 399,591 restricted shares were granted at a weighted-average fair value of $20.53 per share. The value of restricted shares is amortized to expense over the vesting period. For the year ended December 31, 2005 the Company expensed $8.2 million related to restricted stock compensation earned.

Treasury Stock. Shares of common stock in Treasury and related activity were as follows at December 31:


	2005			2004			2003

Balance at beginning of year		10,098,912			11,193,495			12,266,101
Shares purchased		9,000,000			—			—
Shares issued to fund stock option exercises		(528,758	)		(889,803	)		(1,072,606	)
Employee stock purchase plan shares issued		(205,928	)		(197,780	)		—
Restricted shares issued		(442,632	)		(7,000	)		—
Restricted shares forfeited		35,441			—			—

Balance at end of year		17,957,035			10,098,912			11,193,495

Redeemable Cumulative Convertible Perpetual Preferred Stock — Series C. On May 5, 2003, the Company completed the sale of $200 million of Redeemable Cumulative Convertible Perpetual Preferred Stock (“Convertible Preferred Stock”) with a liquidation preference of $500 per share in a private offering. Dividends on the Convertible Preferred Stock are cumulative and are payable quarterly at an annual rate of 4.25% of the liquidation preference, when, as and if declared by the Company’s board of

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directors. Accumulated unpaid dividends will accumulate dividends at the same rate as dividends accumulate on the Convertible Preferred Stock. Each share of the Convertible Preferred Stock will be convertible, under certain conditions, and subject to adjustment under certain conditions, into 33.4728 shares of the Company’s common stock. On or after May 20, 2008, the Company will have the option to redeem any or all of the Convertible Preferred Stock, subject to certain conditions. Under certain circumstances, at the option of the holders of the Convertible Preferred Stock, the Company may be required to purchase shares of the Convertible Preferred Stock from the holders. The Convertible Preferred Stock is redeemable at the option of a holder only in the event of a “fundamental change,” which is defined as “any transaction or event (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) in connection with which all or substantially all of the Company’s common stock is exchanged for, converted into, acquired for or constitutes solely the right to receive common stock that is not listed on a U.S. national securities exchange or approved for quotation on the NASDAQ National Market or similar system. The practical effect of this provision is to limit the Company’s ability to eliminate a holder’s ability to convert the Convertible Preferred Stock into common shares of a publicly traded security through a merger or consolidation transaction. In no other circumstances is the Company potentially obligated to redeem the Convertible Preferred Stock for cash. Accordingly, since the Company is in a position to control whether the Company experiences a “fundamental change,” the Convertible Preferred Stock is classified as permanent equity capital.

Cumulative Convertible Perpetual Preferred Stock — Series D. On December 9, 2005, KCS completed the sale and issuance of 210,000 shares of its 5 ¹ / 8 % Series D Convertible Preferred Stock, par value $1.00 per share (the “Series D Convertible Preferred Stock”). Each share of Series D Convertible Preferred Stock is convertible, at any time, into shares of KCS common stock at a conversion rate of 33.3333 shares of KCS common stock for each share of Series D Convertible Preferred Stock subject to adjustments to the conversion rate as a result of dividends or distributions payable in shares of KCS common stock, subdivision or reclassification of shares of KCS common stock, and other events in which the KCS common stock may be diluted as provided in the Certificate of Designations of 5 ¹ / 8 % Cumulative Convertible Perpetual Preferred Stock of Kansas City Southern (“Certificate of Designations”). Dividends on the Series D Convertible Preferred Stock are payable, quarterly in arrears, at the discretion of the Company in cash, in KCS common stock or any combination thereof, when, as and if declared by the KCS board of directors, at the rate of 5.125% per annum of the liquidation preference of $1,000. Dividends on the Series D Convertible Preferred Stock will be cumulative from the date of issuance. Accumulated but unpaid dividends on the Series D Convertible Preferred Stock accumulate at the annual rate of 5.125%. The Series D Convertible Preferred Stock ranks senior to the common stock and to each class or series of KCS capital stock that has terms that provide that such class or series will rank junior to the Series D Convertible Preferred Stock and includes a liquidation preference that entitles the Series D Convertible Preferred Stock holders to payment of $1,000 per share of Series D Convertible Preferred Stock plus an amount equal to all dividends (whether or not declared) accumulated and unpaid on the Series D Convertible Preferred Stock to the date of a final distribution in the event of any liquidation, dissolution or winding-up of KCS, before any payment or distribution of the KCS’s assets shall be made to or set apart for the holders of any KCS capital stock ranking junior to the Series D Convertible Preferred Stock. On or after February 20, 2011, KCS may, at its option, cause all, and not less than all, of the outstanding shares of Series D Convertible Preferred Stock to be automatically converted into shares of KCS common stock at the then prevailing conversion rate, but only if the closing sale price of the KCS common stock multiplied by the conversion rate then in effect equals or exceeds 130% of the liquidation preference for 20 trading days during any consecutive 30 trading day period, and if KCS has paid all accumulated and unpaid dividends on the dividend payment date immediately preceding the forced conversion date.

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Upon certain designated events (a “fundamental change” as defined by the Certificate of Designation), holders of the Series D Convertible Preferred Stock may, subject to legally available funds, require KCS to redeem any or all of their shares of Series D Convertible Preferred Stock at the liquidation preference, plus any accumulated and unpaid dividends to the date of redemption, which KCS may pay in either cash, in shares of KCS common stock, or any combination thereof at KCS’s option. The Series D Convertible Preferred Stock is redeemable at the option of a holder only in the event of a “fundamental change,” which is defined as “any transaction or event (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) in connection with which 50% or more of the Common Stock of the Corporation is exchanged for, converted into, acquired for or constitutes solely the right to receive consideration which is not at least 90% shares of common stock that (i) are listed on, or immediately after the transaction or event will be listed on, a United States national securities exchange, or (ii) are approved, or immediately after the transaction or event will be approved, for quotation thereof in an inter-dealer quotation system of any registered United States national securities association. Prior to February 20, 2016 and within ten days of notice of a fundamental change, if the holder of the Series D Convertible Preferred Stock tenders the stock for conversion, the holder will be entitled to additional shares in the form of a “make whole payment” as specified by the agreement. Since KCS has the ability, in the event of a fundamental change, to pay the redemption price in shares of KCS common stock (which are not required to be registered shares), the Series D Convertible Preferred Stock is classified as permanent equity capital. The number of shares to be issued would be based upon the value of KCS common stock at that time. In no event will the number of shares issued on the occurrence of a fundamental change exceed 52.5 million shares.

On December 12, 2005 the Company used substantially all of the proceeds from the Series D Convertible Preferred Stock offering to repurchase 9,000,000 shares of KCS Common Stock issued to TMM in April 2005 in connection with the acquisition of KCSM. All of the 9,000,000 shares were purchased at a price of $22.25 per share or $200.3 million. The Company does not have a formal program for the repurchase of any additional shares of our equity securities.

Dividend Restrictions. Following completion of the preparation of the 2005 financial statements of KCS, the Company determined that its Consolidated Coverage Ratio (as defined in the indentures for KCSR’s 7 ¹ / 2 % Senior Notes and 9 ¹ / 2 % Senior Notes) was less than 2.0:1. As a result, pursuant to the terms of each KCSR indenture, the Company is currently unable to pay cash dividends on its Series C Convertible Preferred Stock and dividends in cash or shares of KCS common stock on its Series D Convertible Preferred Stock (as described below) and will be unable to pay such dividends until such ratio increases to at least 2.0:1. KCS anticipates that the ratio will increase by the end of the third quarter of 2006 such that it will again be permitted to pay cash dividends to these preferred stockholders although that cannot be assured. A special meeting of the holders of record of the Convertible Preferred Stock as of March 17, 2006 (the “Series C Stockholders”), was held on March 30, 2006 to vote on a proposed amendment to the terms of the Convertible Preferred Stock to allow the payment of dividends to the Series C Stockholders to be made, at the discretion of the Company, in cash, in shares of KCS common stock or in any combination thereof. As a quorum of the Series C Stockholders was not present in person or by proxy at the special meeting, the special meeting was adjourned indefinitely. Absent approval of such an amendment, the dividends for each of the Series C Convertible Preferred Stock and the Series D Convertible Preferred Stock (collectively, the “Preferred Stock”) will accumulate until such time that the Company may resume paying cash dividends to the holders of both classes of Preferred Stock. Whenever dividends on the Preferred Stock or another class or series of stock ranking on a parity with the Preferred Stock are in arrears for six consecutive quarters (or an equivalent number of days in the aggregate) holders of the Preferred Stock will be entitled to vote for the election of two of the authorized directors at the next Annual Shareholders’ Meeting and at each subsequent Shareholders’ Meeting until such time as all accumulated dividends are paid, set aside for payment or the Preferred Stock has been redeemed.

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Stockholder Rights Plan. On September 27, 2005, the Board of Directors of the Company declared a dividend distribution of one Right for each outstanding share of the Company’s Common Stock, $0.01 par value per share to the stockholders of record as of the close of business on October 12, 2005 pursuant to a Rights Agreement (the “Rights Agreement”) with UMB Bank, n.a. replacing KCS’s previous Rights Agreement that expired on October 12, 2005. Each Right entitles the registered holder thereof to purchase from the Company ¹ / 1000 ths of a share of Series A Preferred Stock, par value $1.00 per share, or in some circumstances, Common Stock, other securities, cash or other assets, at a price of $100 per share (both shares and price are subject to adjustment as described below).

As of December 31, 2005, the Company had a total of 400,000,000 shares of Common Stock authorized, of which 73,412,081 shares were issued and outstanding. The Rights were attached to all Common Stock certificates representing shares then outstanding, and no separate Rights Certificates will be distributed. Subject to certain exceptions specified in the Rights Agreement, the Rights will separate from the Common Stock and a Distribution Date will occur upon the earlier of (i) ten (10) business days following a public announcement that a person or group of affiliated or associated persons has acquired beneficial ownership of fifteen percent (15%) or more of the then outstanding shares of Common Stock (or thirteen percent (13%) in the case the Independent Directors determine such Person is an “Adverse Person”) (each such person or group of affiliated or associated persons referred to herein and in the Rights Agreement as an “Acquiring Person”), or (ii) ten (10) business days following the commencement of a tender offer or exchange offer that would result in a person or group becoming an Acquiring Person. Pursuant to exceptions set forth in the Rights Agreement, TMM and certain of its affiliates and stockholders have been exempted under certain circumstances from the definition of an “Acquiring Person.”

Until the Distribution Date, (i) the Rights will be evidenced by the Common Stock certificates and will be transferred with and only with such Common Stock certificates, (ii) new Common Stock certificates issued after the Record Date will contain a notation incorporating the Rights Agreement by reference and (iii) the surrender for transfer of any certificates for Common Stock outstanding will also constitute the transfer of the Rights associated with the Common Stock represented by such certificate. As soon as practicable after the Distribution Date, Rights Certificates will be mailed to holders of record of the Common Stock as of the close of business of the Distribution Date, and thereafter the separate Rights Certificates alone will represent the Rights. Following the Distribution Date, shares of Common Stock issued will be accompanied by Rights only in certain instances.

The Rights are not exercisable until the Distribution Date and will expire at the close of business on October 11, 2010, unless the Rights are earlier redeemed by the Company as described below.

In the event that a Person becomes an Acquiring Person, except pursuant to a tender or exchange offer for all outstanding shares of Common Stock that a majority of the Independent Directors determines to be adequate and otherwise in the best interests of the Company’s stockholders, taking into consideration all factors that such directors deem relevant (a “Permitted Offer”), each holder of a Right will thereafter have the right to receive, upon exercise of the Right at the then current Purchase Price, that number of shares of the Preferred Stock (or in certain circumstances, Common Stock or assets or other securities of the Company) having a market value of two times the Purchase Price. Notwithstanding the foregoing, following the occurrence of the event set forth in this paragraph, all Rights that are or were beneficially owned by any Acquiring Person or Adverse Person will be null and void.

In the event that, at any time following the Share Acquisition Date, (i) the Company engages in a merger or other business combination transaction in which the Company is not the surviving corporation, (ii) the Company engages in a merger or other business combination transaction in which the Company is the surviving corporation and the Common Stock of the Company is changed or exchanged, or (iii) fifty percent (50%) or more of the Company’s assets, cash flow or earning power is sold or transferred (in each

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case other than with an entity which acquired the shares pursuant to a Permitted Offer), each holder of a Right shall thereafter have the right to receive, upon exercise of the Right at the then current Purchase Price, that number of shares of the common stock of the acquiring company (or certain of its affiliates) that at the time of such transaction would have a market value of two times the exercise price of the Right. If the Rights are exercised to acquire the Preferred Stock, then the Rights will not thereafter be exercisable to acquire the securities of any Acquiring Person. The events set forth in this paragraph and in the second preceding paragraph are referred to in the Rights Agreement as “Triggering Events.”

At any time until the Share Acquisition Date or the Final Expiration Date, the Company may redeem the Rights in whole, but not in part, at a price of $0.0025 per Right (the “Redemption Price”). Following the Share Acquisition Date, but prior to an event listed in Section 13(a) of the Rights Agreement (i.e. a merger, consolidation or sale of more than fifty percent (50%) of the assets or earnings power of the Company and its subsidiaries), the Company may redeem the Rights in connection with any event specified in Section 13(a) in which all stockholders are treated alike and which does not include the Acquiring Person or its Affiliates or Associates. In addition, the Company’s right of redemption may be reinstated following an inadvertent trigger of the Rights (as determined by the Board) if an Acquiring Person reduces its beneficial ownership to 10% or less of the outstanding shares of Common Stock of the Company in a transaction or series of transactions not involving the Company. Immediately upon the action of the Board electing to redeem the Rights, the Company shall make announcement thereof, and upon such election, the right to exercise the Rights will terminate and the only right of the holders of Rights will be to receive the Redemption Price.

Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Company, including, without limitation, the right to vote or to receive dividends. While the distribution of the Rights will not be taxable to stockholders or to the Company, stockholders may, depending on the circumstances, recognize taxable income in the event that the Rights become exercisable for the Preferred Stock (or other securities, as the case may be) of the Company or for common stock of an acquiring company or in the event of the redemption of the Rights as set forth above.

The Purchase Price payable, and the number of shares of Preferred Stock (or Common Stock, other securities, cash or other assets, as the case may be) issuable upon exercise of the Rights are subject to adjustment from time to time to prevent dilution (i) in the event of a stock dividend on, or a subdivision, combination or reclassification of the Preferred Stock, (ii) upon the grant to holders of the Preferred Stock of certain rights or warrants to subscribe for shares of the Preferred Stock or convertible securities at less than the current market price of the Preferred Stock or (iii) upon the distribution to holders of the Preferred Stock of evidences of indebtedness or assets (excluding regular periodic cash dividends out of earnings or retained earnings or dividends payable in the Preferred Stock) or of subscription rights or warrants (other than those referred to above).

With certain exceptions, no adjustment in the Purchase Price will be required until cumulative adjustments require an adjustment of at least one percent (1%) in such Purchase Price. No fractional shares will be issued (other than fractional shares which are integral multiples of ¹ / 1000 ths of a share of Preferred Stock) and, in lieu thereof, an adjustment in cash will be made based on the market price of the Preferred Stock on the last Trading Date prior to the date of exercise.

Prior to the Distribution Date, the Board may amend or supplement any provision of the Rights Agreement without the consent of the holders of the Rights. Following the Distribution Date, the Board of Directors may amend the provisions of the Rights Agreement in order to cure any ambiguity, to correct any defect or inconsistency or to make changes deemed necessary or desirable, so long as such changes do not adversely affect the interests of the holders of the Rights (excluding the interests of any Acquiring Person and its affiliates and associates). In any case, however, the Board of Directors may not amend or

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supplement the Rights Agreement to change or supplement the Redemption Price, Final Expiration Date, the Purchase Price or the number of ¹ / 1000 ths of a share of Preferred Stock for which a Right is exercisable.

The Rights may have the effect of impeding a change in control of the Company without the prior consent of the Board, and the Rights could cause substantial dilution to a person that attempts to acquire the Company without conditioning the offer on redemption of the Rights by the Board or on the acquisition by such person of a substantial number of Rights. The Rights will not interfere with any Permitted Offer for all of the outstanding Common Stock that has the approval of the Independent Directors.

Change in Control Provisions. The Company and certain of its subsidiaries have entered into agreements with employees whereby, upon defined circumstances constituting a change in control of the Company or subsidiary, certain stock options become exercisable, certain benefit entitlements are automatically funded and such employees are entitled to specified cash payments upon termination of employment.

The Company and certain of its subsidiaries have established trusts to provide for the funding of corporate commitments and entitlements of officers, directors, employees and others in the event of a specified change in control of the Company or subsidiary. Assets held in such trusts at December 31, 2005 were not material. Depending upon the circumstances at the time of any such change in control, the most significant factor of which would be the highest price paid for KCS common stock by a party seeking to control the Company, funding of the Company’s trusts could be substantial.


Note 8.	Profit Sharing and Other Postretirement Benefits

The Company maintains various plans for the benefit of its employees as described below. For the years ended December 31, 2005, 2004 and 2003, the Company expensed $1.4 million, $1.2 million and $0.9 million, respectively, related to the KCS 401(k) and Profit Sharing Plan (the “401(k) Plan”). During 2005, 2004 and 2003, the Company did not recognize any expense relative to profit sharing or the ESOP.

401(k) and Profit Sharing Plan. The 401(k) Plan permits participants to make contributions by salary reduction pursuant to section 401(k) of the Internal Revenue Code and also allows employees to direct their profit sharing accounts into selected investments. The Company matched employee 401(k) contributions up to a maximum of 5% of compensation in 2005, 2004 and 2003. Qualified profit sharing plans are maintained for most employees not included in collective bargaining agreements. Contributions by the Company and its subsidiaries are made at the discretion of the Board of Directors of KCS in amounts not to exceed the maximum allowable for federal income tax purposes.

Employee Stock Ownership Plan. KCS established the ESOP for employees not covered by collective bargaining agreements. KCS contributions to the ESOP are based on a percentage of wages earned by eligible employees. Contributions and percentages are determined by the Compensation and Organization Committee of the Board of Directors.

Other Postretirement Benefits. The Company provides certain medical, life and other postretirement 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. Certain management employees also maintain their status under a collective bargaining agreement, which permits them access to postretirement medical under the multiemployer plan

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described below. Assumptions related to medical postretirement benefits plan were adjusted in 2004 to reflect the expected participation of these individuals in the multiemployer plan. 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 in 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.

For the KCS Plan, during 2005, the Company revised its postretirement medical plan to exclude prescription drug coverage where it is available under Medicare Part D. As a result of this negative plan amendment, the actuarial valuation of the accumulated pension benefit obligation includes unrecognized prior service cost benefit of $2.3 million which will be amortized over the estimated remaining life of the affected participants of 9.5 years.

The Gateway Western benefit plans are slightly different from those of the Company and other subsidiaries. Gateway Western provides contributory health, dental and life insurance benefits to these remaining employees and retirees. Based upon current regulations, the Gateway Western’s 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.

The Company uses December 31 as the measurement date for its postretirement benefit obligations.


	*Assumptions*

Weighted-average assumptions used to determine benefit obligations were as follows for the years ended December 31:


	2005			2004

Discount rate		5.40	%		5.65	%

Weighted-average assumptions used to determine the net benefit cost were as follows for the years ended December 31:


	2005			2004

Discount rate		5.65	%		6.00	%
Expected long-term rate of return on life insurance plan assets		6.25			6.50

The Company’s health care costs, excluding former Gateway Western employees and certain former employees of the MidSouth, 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. The expected rate of return on life insurance plan assets is the return, over the period that benefits are expected to be paid. In determining the expected long-term rate of return, the Company considered forward looking information and historical returns for similar investments.

The assumed annual rate of increase in health care costs for Gateway Western employees and retirees under the Gateway Western plan is as follows:


	2005			2004

Health care cost trend assumed for next year		10.00	%		10.00	%
Ultimate trend rate		5.00			5.00
Year that rate reaches the ultimate trend rate		2010			2009

115

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

An increase or decrease in the assumed health care cost trend rates by one percent in 2005, 2004 and 2003 would not have a significant impact on the accumulated postretirement benefit obligation or on the aggregate of the service and interest components of the net periodic postretirement benefit cost.


	*Obligations, Funded Status and Components of Net Periodic Benefit Cost*

A reconciliation of the accumulated postretirement benefit obligation, change in plan assets and funded status, respectively, at December 31 follows (in millions):


	2005			2004

Accumulated postretirement benefit obligation at beginning of year	$	9.1		$	10.2
Benefit obligation from acquisition of Mexrail		2.0			—
Negative plan adjustment		(2.3	)		—
Service cost		0.1			0.2
Interest cost		0.5			0.6
Actuarial (gain) loss		0.1			(1.0	)
Benefits paid, net of retiree contributions(i)		(0.9	)		(0.9	)

Accumulated postretirement benefit obligation at end of year		8.6			9.1

Fair value of plan assets at beginning of year		.8			1.0
Actual return on plan assets		.1			—
Benefits paid, net of retiree contributions(i)		(0.2	)		(0.2	)

Fair value of plan assets at end of year		0.7			0.8
Funded status		(7.9	)		(8.3	)
Unrecognized prior service cost		(2.3	)		(0.1	)

Accrued benefit cost	$	(10.2	)	$	(8.4	)


(i)	Benefits paid for the reconciliation of accumulated postretirement benefit obligation include both medical and life insurance benefits; whereas benefits paid for the fair value of plan assets reconciliation include only life insurance benefits. Plan assets relate only to the life insurance benefits. Medical benefits are funded as obligations become due.

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


	2005		2004		2003

Service cost	$	0.1	$	0.2	$	0.3
Interest cost		0.5		0.6		0.6
Expected return on plan assets		—		—		(0.1	)

Net periodic postretirement benefit cost	$	0.6	$	0.8	$	0.8

The net periodic postretirement benefit costs outlined above do not include a component for the amortization of actuarial gains or losses as the Company has consistently recognized these gains and losses immediately. Actuarial (gains) losses recognized by the Company were $0.1 million, ($1.0) million and $0.2 million for 2005, 2004 and 2003, respectively. The amortization of unrecognized prior service cost was not material for the years ended December 31, 2005, 2004 and 2003, respectively.

116

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	*Cash Flows*

During 2006, the Company expects to contribute approximately $0.8 million to its other post retirement benefit plans in the form of benefit payments.

The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid (in millions):


	Expected Future
Years	Benefits Payments

2006	$	0.8
2007		0.7
2008		0.7
2009		0.7
2010		0.7
2011 — 2015	$	4.0


	*Multi-employer Plan*

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 $2.6 million, $1.9 million and $1.7 million for 2005, 2004 and 2003, respectively. Based on existing rates, premium amounts are not expected to change substantially in 2006 compared to 2005.


Note 9.	Commitments and Contingencies

Litigation. The Company is a party to various legal proceedings and administrative actions, all of which are of an ordinary, routine nature and incidental to its operations. Included in these proceedings are various tort claims brought by current and former employees for job related injuries and by third parties for injuries related to railroad operations. We aggressively defend these matters and have established liability reserves which management believes are adequate to cover expected costs. Although it is not possible to predict the outcome of any legal proceeding, in the opinion of the Company’s management, other than those proceedings described in detail below, such proceedings and actions should not, individually, or in the aggregate, have a material adverse effect on the Company’s financial condition.

Reinsurance Litigation. The Company has established its personal injury and casualty reserves based on an assumption that it and its other insured or reinsured subsidiaries would have the benefit of insurance under existing policies. Several reinsurers of the Company’s captive insurer have filed a declaratory judgment action in federal court in Vermont seeking a declaration that, based on a claimed lack of notice, they have no obligation to provide coverage for a set of lawsuits currently pending against a subsidiary of the Company. The Company’s captive insurer has answered and filed a counterclaim to establish its right to coverage. The Company presently believes that it has a strong basis to establish that notice was properly delivered and that it has a right to coverage. In the event the Company is unsuccessful in the litigation with the reinsurance carriers and the damages in the underlying litigation exceed the self insured retention, the Company would not have reinsurance to cover such excess. While the Company is not presently able to reliably estimate such amounts, those additional amounts could be material. In the event the Company is unsuccessful in the reinsurance litigation, the Company believes it would have a strong claim against third parties responsible for providing notice to the reinsurers for any damages caused by the loss of the insurance coverage. The accompanying financial statements do not include any accruals related to the possible lack of insurance coverage from the reinsurers.

117

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stilwell Tax Dispute. On October 15, 2004, KCS and Janus Capital Group Inc. (“Janus”), formerly Stilwell Financial Inc. (“Stilwell”), finalized a settlement agreement (“Release”), effecting settlement of all disputes which arose on or before August 13, 2004 relating to the spin-off of Stilwell from KCS on July 12, 2000 (the “Spin-off”). As part of the settlement, all arbitration claims filed by the parties with the American Arbitration Association were dismissed. This claim involved the entitlement to compensation expense deductions for federal income tax purposes, associated with the exercise of certain stock options issued by Stilwell (the “Substituted Options”) in connection with the Spin-off. Prior to the settlement, amounts related to the tax benefits of exercises of the Substituted Options were recorded as a noncurrent liability in the consolidated financial statements pending resolution of this dispute. As a result of this settlement, the Company reclassified approximately $27.1 million in tax benefits from previous exercises of the Substituted Options to additional paid in capital on the balance sheet. As previously disclosed, the settlement had no adverse consequences to the Company.

Environmental Liabilities. The Company’s operations are subject to extensive federal, state and local environmental laws and regulations. The major environmental laws, to which the Company is subject, include, among others, the Federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA,” also known as the Superfund law), the Toxic Substances Control Act, the Federal Water Pollution Control Act, and the Hazardous Materials Transportation Act. CERCLA can impose joint and several liabilities for cleanup and investigation costs, without regard to fault or legality of the original conduct, on current and predecessor owners and operators of a site, as well as those who generate, or arrange for the disposal of, hazardous substances. The Company does not foresee that compliance with the requirements imposed by the environmental legislation will impair its competitive capability or result in any material additional capital expenditures, operating or maintenance costs.

The risk of incurring environmental liability is inherent in the railroad industry. As part of serving the petroleum and chemicals industry, KCSR transports hazardous materials and has a professional team available to respond and handle environmental issues that might occur in the transport of such materials. Additionally, the Company is a partner in the Responsible Care ^® program and, as a result, has initiated certain additional environmental, health and safety programs. KCSR performs ongoing reviews and evaluations of the various environmental programs and issues within the Company’s operations, and, as necessary, takes actions to limit the Company’s exposure to potential liability.

The Company owns property that is, or has been, used for industrial purposes. Use of these properties may subject the Company to potentially material liabilities relating to the investigation and cleanup of contaminants, claims alleging personal injury, or property damage as the result of exposures to, or release of, hazardous substances. Although the Company is responsible for investigating and remediating contamination at several locations, based on currently available information, the Company does not expect any related liabilities, individually or collectively, to have a material impact on its results of operations, financial position or cash flows. In the event that the Company becomes subject to more stringent cleanup requirements at these sites, discovers additional contamination, or becomes subject to related personal or property damage claims, the Company could incur material costs in connection with these sites.

The Company records liabilities for remediation and restoration costs related to past activities when the Company’s obligation is probable and the costs can be reasonably estimated. Costs of ongoing compliance activities to current operations are expensed as incurred. The Company’s recorded liabilities for these issues represent its best estimates (on an undiscounted basis) of remediation and restoration costs that may be required to comply with present laws and regulations. Although these costs cannot be predicted with certainty, management believes that the ultimate outcome of identified matters will not have a material adverse effect on the Company’s consolidated results of operations, financial condition or cash flows.

118

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Casualty Claim Reserves. The Company’s casualty and liability reserve for its U.S. business segment is based on a study by an independent third party actuarial firm performed on an undiscounted basis. The reserve is based on claims filed and an estimate of claims incurred but not yet reported. While the ultimate amount of claims incurred is dependent on various factors, it is management’s opinion that the recorded liability is a reasonable estimate of aggregate future claims. Adjustments to the liability are reflected as operating expenses in the period in which the adjustments are known. Casualty claims in excess of self-insurance levels are insured up to certain coverage amounts, depending on the type of claim and year of occurrence. The activity in the reserve for the years ended December 31, 2005 and 2004 is as follows (in millions):


	2005			2004

Balance as of January 1	$	52.8		$	49.5
Liability acquired in connection with Mexrail Acquisition		13.9			—
Additions to reserves (including impacts of recent actuarial study)		57.6			17.4
Payments		(20.4	)		(14.1	)

Balances as of December 31	$	103.9		$	52.8

During the third quarter, the Company initiated a new comprehensive actuarial study of all of its casualty reserves. Based on that study, the reserves for FELA, third-party, and occupational illness claims were increased, resulting in a charge to third quarter operating income of $37.8 million. The charge reflects the impact of higher settlements for major FELA and third-party claims and significant increases in the frequency of these claims in 2004 and 2005. In addition, the charge includes reserves for occupational illness including asbestos-related claims that were established on an actuarial basis for the first time.

Reserves for occupational illness claims were previously established through an assessment made on a case-by-case basis, and a liability was established when management determined that it was probable and reasonably estimable. No provision was made for occupational illness claims that may have been incurred but not yet reported, since the Company believed the low end of the range of reasonably possible loss was not material. During 2005 the Company experienced a marked increase in the number of such claims. Accordingly, the Company requested and obtained an actuarial study of these potential unasserted claims for the first time. The study indicated that existing reserves should be increased by $7.5 million.

Based on the results of the actuarial study, reserves for FELA and third-party claims were increased by $30.3 million. The majority of these increases are attributable to adverse experience occurring since last year’s study, including an increase in the number of new claims and adverse development in the dollar amount of potential settlements for many significant prior claims.

Management believes that its previous reserve estimates for those prior claims were reasonable based on the information available at the time. The Company is continuing its practice of accruing monthly for estimated claim costs at levels recommended by the actuarial study and evaluation of recent known trends, and those accruals have been increased accordingly.

Disputes Relating to Payments for the use of Trackage and Haulage Rights and Interline Services. KCSM and Ferrocarril Mexicano, S.A. de C.V. (“Ferromex”) both initiated administrative proceedings seeking a determination by the Secretaria de Communicaciones y Transportes (“Secretariat of Communications and Transports” or “SCT”) of the rates that we should pay each other in connection with the use of trackage and haulage rights and interline and terminal services. The SCT, on March 13, 2002, issued a ruling setting the rates for trackage and haulage rights. On August 5, 2002, the SCT issued a ruling setting the rates for interline and terminal services. KCSM and Ferromex appealed both rulings and, following trial and appellate court decisions, the Mexican Supreme Court on February 24, 2006, in a

119

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

ruling from the bench, sustained KCSM’s appeal of the SCT’s trackage and haulage rights ruling, vacating the ruling and ordering the SCT to issue a new ruling consistent with the Court’s opinion. KCSM has not yet received the written opinion of the Mexican Supreme Court relating to the decision announced on February 24, 2006 decision, nor has the Mexican Supreme Court decided the interline and terminal services appeal. We believe that even if the rates set in 2002 become effective, there will be no material adverse effect on our results of operations.

Disputes Relating to the Exercise of Trackage Rights. KCSM and Ferromex are also parties to various civil cases involving disputes over the application and proper interpretation of the mandatory trackage rights, none of which we believe to be material individually or in the aggregate.

Disputes Relating to the Scope of the Mandatory Trackage Rights. In August 2002, the SCT issued rulings determining Ferromex’s trackage rights in Monterrey and KCSM’s trackage rights in Altamira. KCSM and Ferromex both appealed the SCT’s rulings. At the administrative federal court level, KCSM obtained favorable rulings in both cases. Ferromex appealed these rulings. In connection with the Altamira proceedings, on August 10, 2005, an appellate court granted Ferromex’s appeal and ordered the Administrative Federal Court determined to vacate its prior resolution and issue a new resolution declaring as null and void the SCT’s determination that KCSM’s trackage rights should include access to the Port of Altamira. In connection with the Monterrey proceedings, the case was remanded to the Administrative Federal Court with the instructions to consider additional arguments before issuing its ruling. KCSM is still awaiting that ruling.

Track maintenance and rehabilitation agreement. In May 2000, KCSM entered into a track maintenance and rehabilitation agreement with a Mexican subsidiary of Alstom. The agreement expires in 2012. Under this agreement, the contractor performed a major rehabilitation of the line and provides routine maintenance between Celaya and Lázaro Cárdenas, approximately 350 miles. Maintenance and rehabilitation expense amounted to $3.4 million in 2005.

Panama Canal Railway Company. Under certain limited conditions, the Company is a guarantor for up to $5.6 million of cash deficiencies associated with the operations of PCRC. In addition, the Company is a guarantor for up to $3.0 million of equipment loans. Further, if the Company or its partner terminates the concession contract without the consent of IFC, the Company is a guarantor for up to 50% of the outstanding senior loans. See Note 3.

Heavener Fueling Facility and Pipeline. The Company has entered into an agreement to transport locomotive diesel fuel via pipeline into the Company’s fuel facility in Heavener, Oklahoma. The 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.


Note 10.	Derivative Instruments and Purchase Commitments

The Company does not engage in the trading of derivatives. The Company’s objective for using derivative instruments is to manage its fuel price risk and mitigate the impact of fluctuations in fuel prices. 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.

120

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	*Fuel Derivative Transactions*

At December 31, 2005, the Company was not a party to any fuel swap agreements. Fuel hedging transactions, including fuel swaps as well as forward purchase commitments, resulted in a decrease in fuel expense of $2.4 million, $3.0 million, and $1.1 million in 2005, 2004 and 2003, respectively. Subsequent to December 31, 2005 KCS entered into fuel swap agreements for 3.2 million gallons.

Foreign exchange contracts. The purpose of KCSM’s foreign exchange contracts is to limit the risks arising from exchange rate fluctuations in its Mexican peso-denominated monetary assets and liabilities. The nature and quantity of any hedging transactions will be determined by management based upon net asset exposure and market conditions.

As of December 31, 2005, KCSM had two Mexican peso call options outstanding in the notional amount of $1.2 million and $1.7 million, respectively, based on the average exchange rate of 13.00 pesos per dollar and 12.50 pesos per dollar. These options expire on September 6 and May 30, 2006, respectively. The premiums paid were $16 and $34, respectively, and were expensed since these contracts did not qualify for hedge accounting. As of December 31, 2005, KCSM did not have any outstanding forward contracts.

Foreign currency balances. At December 31, 2005 and 2004, KCSM had monetary assets and liabilities denominated in Mexican pesos of Ps1,088 million and Ps549 million and of Ps1,057 million and Ps290 million, respectively. At December 31, 2005 and 2004, the exchange rate was 11.14 pesos per dollar and 10.73 pesos per dollar, respectively.


	*Southern Capital*

The Company records adjustments to its stockholders’ equity (accumulated other comprehensive income (loss)) for its portion of the adjustment to the fair value of derivative transactions to which Southern Capital was a participant. The Company also adjusts its investment in Southern Capital by the change in the fair value of these derivative instruments. For the year ended December 31, 2002, the Company recorded a reduction to its stockholders equity (accumulated other comprehensive loss) of approximately $0.3 million for its portion of the amount recorded by Southern Capital for the adjustment to the fair value of its interest rate swap transactions. The Company also reduced its investment in Southern Capital by the same amount.

During 2002, in conjunction with the refinancing of its debt, Southern Capital terminated these interest rate swap transactions. As a result, Southern Capital is amortizing the balance of accumulated other comprehensive income (loss) into interest expense over the former remaining life of the interest rate swap transactions. The Company is recording the impact of this charge through a related reduction in equity earnings from Southern Capital and is amortizing the related accumulated other comprehensive income (loss) balance to its investment in Southern Capital. During the years ended December 31, 2005, 2004 and 2003, the Company recorded related amortization of $0.5 million, $0.5 million and $1.2 million, respectively.

121

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Note 11.	Quarterly Financial Data (Unaudited)


				2005

				Fourth			Third			Second			First
				Quarter(ii)			Quarter			Quarter			Quarter

				(In millions, except per share amounts)
Revenues				$	388.1		$	384.6		$	381.1		$	198.2
Operating expenses					307.9			346.0			349.0			159.1
Depreciation and amortization					32.5			40.5			40.4			14.3

		Operating income			47.7			(1.9	)		(8.3	)		24.8
Equity in net earnings (losses) of unconsolidated affiliates KCSM					—			—			—			(1.0	)
		Other			2.1			1.3			1.5			(1.0	)
Interest expense					(42.8	)		(39.5	)		(38.7	)		(12.4	)
Debt retirement costs					(.5	)		—			(3.9	)		—
Foreign exchange gain					.7			(1.5	)		4.3			—
VAT/ Put settlement gain, net					—			131.9			—			—
Other income					3.5			2.7			3.8			3.3

Income (loss) before income taxes					10.7			92.9			(41.3	)		13.7
Income tax provision					5.5			(19.8	)		1.6			5.6
Minority interest					—			—			17.8			—

Net income				$	5.2		$	112.7		$	(25.1	)	$	8.1

Per Share Data
	Total basic earnings (loss) per common share			$	0.03		$	1.35		$	(0.33	)	$	0.09

	Total diluted earnings (loss) per common share			$	0.03		$	1.14		$	(0.33	)	$	0.09

Dividends per share: $25 par preferred stock				$	0.25		$	0.25		$	0.25		$	0.25
Dividends per share: $1 Par Convertible Preferred Stock Series C(i)				$	5.31		$	5.31		$	5.31		$	5.31
Dividends per share: $1 Par Convertible Preferred Stock Series D				$	—		$	—		$	—		$	—
Stock Price Ranges:
		$25 Par Preferred — High		$	23.50		$	23.50		$	23.50		$	24.00
			— Low	$	22.00		$	22.60		$	22.00		$	21.45
		Common — High		$	25.71		$	23.44		$	21.00		$	20.34
			— Low	$	20.55		$	19.47		$	18.45		$	16.05


(i)		The accumulation of 2005’s four quarters of dividends on the $1 Par Convertible Preferred Stock Series C does not total the annual amount of $21.25 for the year ended December 31, 2005 due to rounding.

(ii)		The fourth quarter 2005 results include the following significant adjustments which could affect comparability.

As described in Note 2, in the fourth quarter of 2005, TFM completed its depreciation study which resulted in a pretax adjustment to depreciation expense of $5.5 million which relates to the second and third quarters of 2005.

122

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As described in Note 4, KCS finalized its calculation of overhead to be allocated to construction projects. As result, the fourth quarter includes an adjustment of approximately $3.0 million reduction in operating expenses to finalize the overhead allocation.


				2004

				Fourth			Third			Second			First
				Quarter			Quarter			Quarter			Quarter

Revenues				$	174.6		$	163.2		$	153.9		$	147.8
Operating expenses					133.0			130.6			121.3			117.6
Depreciation and amortization					14.2			13.4			13.1			12.8

		Operating income (loss)			27.4			19.2			19.5			17.4
Equity in net earnings (losses) of unconsolidated affiliates KCSM					(8.5	)		1.9			2.9			1.3
		Other			(1.7	)		(0.8	)		0.3			0.1
Interest expense					(11.4	)		(11.3	)		(10.9	)		(10.8	)
Debt retirement costs					—			—			—			(4.2	)
Other income					5.8			8.6			1.7			1.5

Income (loss) before income taxes					11.6			17.6			13.5			5.3
Income tax provision (benefit)					10.9			6.5			4.3			1.9

Net income				$	0.7		$	11.1		$	9.2		$	3.4

Per Share Data(i)
	Total basic earnings (loss) per common share			$	(0.02	)	$	0.14		$	0.11		$	0.02

	Total diluted earnings (loss) per common share			$	(0.02	)	$	0.14		$	0.11		$	0.02

Dividends per share: $25 par preferred stock				$	0.25		$	0.25		$	0.25		$	0.25
Dividends per share: $1 Par Convertible Preferred Stock — Series C				$	5.31		$	5.31		$	5.31		$	5.31
Stock Price Ranges:
		$25 Par Preferred — High		$	21.75		$	21.35		$	21.30		$	21.50
			— Low	$	20.50		$	19.95		$	19.52		$	19.45
		Common — High		$	18.08		$	15.53		$	15.53		$	15.35
			— Low	$	15.22		$	13.27		$	12.60		$	13.39


(i)		The accumulation of 2004’s four quarters of dividends on the $1 Par Convertible Preferred Stock Series C does not total the annual amount of $21.25 for the year ended December 31, 2004 due to rounding.


Note 12.	Condensed Consolidating Financial Information

As discussed in Note 5, KCSR has outstanding $200 million of 9 ¹ / 2 % Notes due 2008 and $200 million of 7 ¹ / 2 % 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 its domestic subsidiaries (all of which are wholly-owned) within the KCS consolidated group. For each of these note issues, KCSR registered exchange notes with the SEC that have substantially identical terms and associated guarantees and all of the initial senior notes for each issue have been exchanged for $200 million of registered exchange notes for each respective note issue.

123

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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 affiliates whose securities collateralize an issue registered or being registered.” This condensed 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


		December 31, 2005

											Non-
								Guarantor			Guarantor			Consolidating			Consolidated
		Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

		(Dollars in millions)
Revenues		$	—		$	725.9		$	21.9		$	637.1		$	(32.9	)	$	1,352.0
Operating expenses			19.1			650.7			22.9			629.9			(32.9	)		1,289.7

	Operating income (loss)		(19.1	)		75.2			(1.0	)		7.2			—			62.3
Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries			127.1			1.6			—			(4.1	)		(121.7	)		2.9
Interest expense			(5.7	)		(58.5	)		2.4			(73.3	)		1.6			(133.5	)
Debt retirement costs			—			—			—			(4.4	)		—			(4.4	)
Foreign exchange gains			—			—			—			3.5			—			3.5
VAT/ Put settlement gain, net			(9.0	)		—			—			140.9			—			131.9
Other income			2.2			6.3			.1			6.3			(1.6	)		13.3

	Income (loss) before income taxes		95.5			24.6			1.5			76.1			(121.7	)		76.0
Income tax provision (benefit)			(5.4	)		1.7			.2			(3.6	)		—			(7.1	)
Minority Interest			—			—			—			17.8			—			17.8

Net income		$	100.9		$	22.9		$	1.3		$	97.5		$	(121.7	)	$	100.9

124

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


		December 31, 2004

											Non-
								Guarantor			Guarantor			Consolidating			Consolidated
		Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

		(Dollars in millions)
Revenues		$	—		$	635.2		$	20.5		$	14.1		$	(30.3	)	$	639.5
Operating expenses			14.7			529.0			19.1			23.5			(30.3	)		556.0

	Operating income (loss)		(14.7	)		106.2			1.4			(9.4	)		—			83.5
Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries			35.1			(0.8	)		—			(3.9	)		(34.9	)		(4.5	)
Interest expense			(0.8	)		(43.6	)		(0.4	)		—			0.4			(44.4	)
Other income			0.3			16.3			—			1.4			(0.4	)		17.6
Debt retirement costs			—			(4.2	)		—			—			—			(4.2	)

	Income (loss) before income taxes		19.9			73.9			1.0			(11.9	)		(34.9	)		48.0
Income tax provision (benefit)			(4.5	)		31.0			0.4			(3.3	)		—			23.6

Net income		$	24.4		$	42.9		$	0.6		$	(8.6	)	$	(34.9	)	$	24.4


		December 31, 2003

											Non-
								Guarantor			Guarantor			Consolidating			Consolidated
		Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

		(Dollars in millions)
Revenues		$	—		$	575.0		$	21.5		$	15.4		$	(30.6	)	$	581.3
Operating expenses			13.5			517.7			20.9			30.7			(30.6	)		552.2

	Operating income (loss)		(13.5	)		57.3			0.6			(15.3	)		—			29.1
Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries			12.5			11.7			—			11.1			(24.3	)		11.0
Interest expense			(0.6	)		(45.8	)		(0.5	)		—			0.5			(46.4	)
Other income			0.1			5.9			0.1			1.2			(0.5	)		6.8

	Income (loss) before income taxes		(1.5	)		29.1			0.2			(3.0	)		(24.3	)		.5
Income tax provision (benefit)			(4.8	)		7.2			0.1			(5.3	)		—			(2.8	)

Income before cumulative effect of accounting change			3.3			21.9			0.1			2.3			(24.3	)		3.3
Cumulative effect of accounting change, net of tax			8.9			8.9			—			—			(8.9	)		8.9

Net income		$	12.2		$	30.8		$	0.1		$	2.3		$	(33.2	)	$	12.2

125

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Balance Sheets


		As of December 31, 2005

										Non-
							Guarantor			Guarantor		Consolidating			Consolidated
		Parent			KCSR		Subsidiaries			Subsidiaries		Adjustments			KCS

		(Dollars in millions)
ASSETS
Current assets		$	2.4		$	476.1	$	20.3		$	233.3	$	(265.3	)	$	466.8
Investments held for operating purposes and investments in subsidiaries			1,715.4			435.8		—			464.2		(2,555.1	)		60.3
Properties, net			0.1			1,301.5		239.3			724.9		—			2,265.8
Concession rights			—			—		—			1,360.4		—			1,360.4
Other assets			10.9			52.1		5.3			218.0		(16.0	)		270.3

	Total assets	$	1,728.8		$	2,265.5	$	264.9		$	3,000.8	$	(2,836.4	)	$	4,423.6


LIABILITIES AND EQUITY
Current liabilities		$	202.2		$	141.0	$	240.2		$	257.8	$	(267.5	)	$	573.7
Long-term debt			0.2			738.1		0.6			925.0		—			1,663.9
Payable to affiliates			17.7			—		0.7			26.6		(45.0	)		—
Deferred income taxes			(3.5	)		424.6		(0.5	)		4.5		(15.9	)		409.2
Other liabilities			86.0			110.5		14.6			139.5		—			350.6
Stockholders’ equity			1,426.2			851.3		9.3			1,647.4		(2,508.0	)		1,426.2

	Total liabilities and equity	$	1,728.8		$	2,265.5	$	264.9		$	3,000.8	$	(2,836.4	)	$	4,423.6

126

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


		As of December 31, 2004

								Non-
						Guarantor		Guarantor		Consolidating			Consolidated
		Parent		KCSR		Subsidiaries		Subsidiaries		Adjustments			KCS

		(Dollars in millions)
ASSETS
Current assets		$	13.7	$	231.9	$	12.5	$	13.2	$	(17.7	)	$	253.6
Investments held for operating purposes and investments in subsidiaries			870.6		436.5		—		420.1		(1,242.3	)		484.9
Properties, net			0.2		1,420.0		3.8		—		—			1424.0
Restricted escrow account for KCSM acquisition			200.0		—		—		—		—			200.0
Goodwill and other assets			51.9		26.2		1.7		11.0		(12.7	)		78.1

	Total assets	$	1,136.4	$	2,114.6	$	18.0	$	444.3	$	(1,272.7	)	$	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, as restated			19.7		430.3		0.2		1.4		(12.7	)		438.9
Other liabilities			3.9		57.8		6.5		15.4		—			83.6
Stockholders’ equity, as restated			1,016.5		828.5		8.1		387.9		(1,224.5	)		1,016.5

	Total liabilities and equity	$	1,136.4	$	2,114.6	$	18.0	$	444.3	$	(1,272.7	)	$	2,440.6

127

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Statements of Cash Flows


			December 31, 2005

												Non-
									Guarantor			Guarantor			Consolidating			Consolidated
			Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

			(Dollars in millions)
Net cash flows provided by (used for) operating activities:
	Excluding intercompany activity		$	(1.1	)	$	107.4		$	11.3		$	61.2		$	—		$	178.8
	Intercompany activity			17.3			(14.9	)		(8.9	)		6.5			—			—

		Net cash flows provided by (used for) operating activities:	$	16.2		$	92.5		$	2.4		$	67.7		$	—		$	178.8
Investing activities:
	Property acquisitions			—			(170.9	)		(3.5	)		(101.3	)		—			(275.7	)
	Proceeds from disposal of property			—			5.7			—			0.6			—			6.3
	Proceeds from sale of investments, net			—			(8.0	)		—			—			—			(8.0	)
	Investments in and loans to affiliates			(9.9	)		(16.3	)		—			8.0			7.7			(10.5	)
	Acquisition Costs			(10.1	)		—			—			—			—			(10.1	)
	Consolidation of Mexrail			—			—			—			3.0			—			3.0
	Consolidation of TFM			—			—			—			5.5			—			5.5
	Repayment of loans to affiliates			—			10.1			—			4.2			(14.3	)		—
	Other, net			—			—			—			—			—			—

		Net		(20.0	)		(179.4	)		(3.5	)		(80.0	)		(6.6	)		(289.5	)

Financing activities:
	Proceeds from issuance of long-term debt			—			20.3			—			624.4			—			644.7
	Repayment of long-term debt			(1.0	)		62.7			—			(583.2	)		—			(521.5	)
	Capital contribution			—			—			—			5.5			(5.5	)		—
	Proceeds of loans from affiliates			5.2			—			—			—			(5.2	)		—
	Repayment of loans from affiliates			(6.7	)		—			—			(10.6	)		17.3			—
	Issuance of preferred stock, net			—			—			—			—			—			—
	Debt issuance costs			—			(2.9	)		—			(13.6	)		—			(16.5	)
	Proceeds from stock plans			1.7			—			—			—			—			1.7
	Repurchase of common stock			(200.4	)		—			—			—			—			(200.4	)
	Net proceeds from issuance of preferred stock			203.9			—			—			—			—			203.9
	Cash dividends paid			(8.7	)		—			—			—			—			(8.7	)

		Net		(6.0	)		80.1			—			22.5			6.6			103.2

Cash and cash equivalents:
	Net increase (decrease)			(9.8	)		(6.8	)		(1.1	)		10.2			—			(7.5	)
	At beginning of period			10.5			27.5			0.2			.4			—			38.6

	At end of period		$	0.7		$	20.7		$	(0.9	)	$	10.6		$	—		$	31.1

128

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


			December 31, 2004

												Non-
									Guarantor			Guarantor			Consolidating			Consolidated
			Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

			(Dollars in millions)
Net cash flows provided by (used for) operating activities:
	Excluding intercompany activity		$	(11.5	)	$	156.2		$	1.9		$	(3.9	)	$	—		$	142.7
	Intercompany activity			236.6			(239.7	)		(0.2	)		3.3			—			—

		Net cash flows provided by (used for) operating activities:	$	225.1		$	(83.5	)	$	1.7		$	(0.6	)	$	—		$	142.7
Investing activities:
	Property acquisitions			—			(116.7	)		(0.5	)		—			—			(117.2	)
	Proceeds from disposal of property			—			4.9			—			—			—			4.9
	Funding of restricted escrow account			(200.0	)		—			—			—			—			(200.0	)
	Investments in and loans to affiliates			(41.7	)		(10.5	)		—			(9.3	)		6.5			(55.0	)
	Proceeds from sale of investments			0.4			—			—			0.1			—			0.5
	Repayment of loans to affiliates			—			—			—			8.8			(8.8	)		—
	Other, net			(9.6	)		(0.4	)		—			—			—			(10.0	)

		Net		(250.9	)		(122.7	)		(0.5	)		(0.4	)		(2.3	)		(376.8	)

Financing activities:
	Proceeds from issuance of long-term debt			—			250.0			—			—			—			250.0
	Repayment of long-term debt			—			(106.6	)		(1.0	)		—			—			(107.6	)
	Proceeds of loans from affiliates			6.5			—			—			—			(6.5	)		—
	Repayment of loans from affiliates			(8.8	)		—			—			—			8.8			—
	Debt issuance costs			—			(3.8	)		—			—			—			(3.8	)
	Proceeds from stock plans			7.4			—			—			—			—			7.4
	Cash dividends paid			(8.7	)		—			—			—			—			(8.7	)

		Net		(3.6	)		139.6			(1.0	)		—			2.3			137.3

Cash and cash equivalents:
	Net increase (decrease)			(29.4	)		(66.6	)		0.2			(1.0	)		—			(96.8	)
	At beginning of period			39.9			94.0			0.1			1.4			—			135.4

	At end of period		$	10.5		$	27.4		$	0.3		$	0.4		$	—		$	38.6

129

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


			December 31, 2003

												Non-
									Guarantor			Guarantor			Consolidating			Consolidated
			Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

			(Dollars in millions)
Net cash flows provided by (used for) operating activities:			$	(130.9	)	$	209.2		$	(10.4	)	$	—		$	0.1		$	68.0

Investing activities:
	Property acquisitions			—			(83.6	)		(0.4	)		—			—			(84.0	)
	Proceeds from disposal of property			—			15.0			—			—			—			15.0
	Investments in and loans to affiliates			(41.8	)		(6.1	)		—			(28.6	)		36.1			(40.4	)
	Proceeds from sale of investments			32.7			—			—			—			—			32.7
	Repayment of loans to affiliates			—			—			—			20.7			(20.7	)		—
	Other, net			(9.3	)		—			—			—			—			(9.3	)

		Net		(18.4	)		(74.7	)		(0.4	)		(7.9	)		15.4			(86.0	)

Financing activities:
	Proceeds from issuance of long-term debt			—			—			—			—			—			—
	Repayment of long-term debt			—			(58.2	)		(1.0	)		—			—			(59.2	)
	Proceeds of loans from affiliates			27.4			—			—			—			(27.4	)		—
	Repayment of loans from affiliates			(20.7	)		—			—			—			20.7			—
	Issuance of preferred stock, net			193.0			—			—			—			—			193.0
	Proceeds from stock plans			5.1			0.2			—			—			—			5.3
	Cash dividends paid			(4.7	)		—			—			—			—			(4.7	)
	Other, net			—			—			—			8.8			(8.8	)		—

		Net		200.1			(58.0	)		(1.0	)		8.8			(15.5	)		134.4

Cash and cash equivalents:
	Net increase (decrease)			50.8			76.5			(11.8	)		0.9			—			116.4
	At beginning of period			(10.8	)		17.5			11.8			0.5			—			19.0

	At end of period		$	40.0		$	94.0		$	—		$	1.4		$	—		$	135.4


Note 13.	Restatement of Prior Periods

During the preparation of its year-end financial reports for 2005 certain errors were identified in the calculation of the Company’s deferred income tax balances which arose in the years prior to 2003. The Company has determined that its deferred tax liability balance at December 31, 2002 and subsequent dates was understated by approximately $8 million. The Company has also determined that the errors had no material impact on earnings as reported in the annual periods ended December 31, 2003, 2004 and 2005. Accordingly, the consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2005 include an adjustment to previously presented consolidated balance sheets to reflect reductions of retained earnings at December 31, 2002 and subsequent periods of approximately $8.0 million, with corresponding increases in deferred income taxes payable. The

130

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

restatement did not affect net cash provided by operations, net cash used in investing activities or net cash provided by financing activities.


	December 31, 2004 As		December 31, 2004 As
	Previously Reported		Restated

Deferred Taxes	$	430.9	$	438.9
Retained earnings		861.9		853.9


Note 14.	Segment Reporting

The accompanying segment reporting information has been prepared and presented pursuant to Statement of Financial Accounting Standards no. 131, “Disclosures about Segments of an Enterprise and Related Information.” Operating units that are reported as segments include the U.S. and Mexico segments. Appropriate eliminations of revenue and reclassifications of operating revenues and expenses have been recorded in deriving consolidated data. The U.S. segment consists primarily of KCSR and Tex-Mex. The Mexico segment consists of Grupo TFM, KCSM and Arrendadora TFM S.A. de C.V. (“Arrendadora”). Each of these segments is supported by separate executive management, operates and serves different geographical regions, and are subject to different customs, laws, and tax regulations.


		US		Mexico		Elimination			Consolidated

Revenue		$	804.4	$	547.6	$	—		$	1,352.0
Operating expenses:
	Compensation and benefits		244.8		95.6		—			340.4
	Purchased services		84.6		108.7		1.8			195.1
	Fuel		123.8		83.1		—			206.9
	Equipment costs		68.9		80.9		—			149.8
	Depreciation and amortization		60.0		67.7		—			127.7
Casualties and insurance			88.7		14.7		—			103.4
KCSM employees’ statutory profit sharing			—		41.2		—			41.2
Other			88.5		38.5		(1.8	)		125.2

Total operating expenses			759.3		530.4		—			1,289.7

Operating income			45.1		17.2		—			62.3


Total Assets			3,271.2		2,418.3		(1,265.9	)		4,423.6
Total Liabilities			1,849.4		1,215.5		(67.5	)		2,997.4
Capital Expenditures		$	203.7	$	72.0	$	—		$	275.7

131


Item 9.	*Changes in and Disagreements with Accountants on Accounting and Financial Disclosure*

There were no disagreements with accountants on accounting and financial disclosure matters.


Item 9A.	*Controls and Procedures*

(a) Disclosure Controls and Procedures

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 Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the fiscal year for which this annual report on Form 10-K is filed. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s current disclosure controls and procedures are not 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 due to the material weakness described in “Management’s Report on Internal Control Over Financial Reporting” in Item 8 of this Form 10-K.

(b) Changes in Internal Control over Financial Reporting

KCS management considers the acquisition of Grupo TFM and KCSM on April 1, 2005 to be material to the results of operations, financial position and cash flows from the date of acquisition through December 31, 2005 and considers the internal controls and procedures of Grupo TFM and KCSM 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 and KCSM 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 our last fiscal quarter (our fourth quarter in the case of an annual report) that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The report of management on the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) is included as “Management’s Report on Internal Control Over Financial Reporting” in Item 8. During its closing process for the 2005 fiscal year, the Company concluded that a reduction of approximately $8 million in the amount of its retained earnings account was necessary to correct an error in the amounts recorded for deferred income taxes payable in the year ended December 31, 2002. The Company has determined that its deferred tax liability was understated by approximately $8 million and that its retained earnings were overstated by that amount as of December 31, 2002. Additionally, a material misstatement was identified in the income tax provision in the 2005 consolidated financial statements that was corrected prior to the issuance of such financial statements.

As stated in “Management’s Report on Internal Control Over Financial Reporting” in Item 8 of this Form 10-K, the Company’s management has concluded that there is a material weakness in the Company’s existing internal control over financial reporting.

The Company’s tax department, in conjunction with the Company’s management and Audit Committee, has developed a plan of remedial action to improve the internal controls with respect to the analysis of the deferred tax asset and liability balances to discover and correct such errors in the future. The remedial action includes (i) the timely preparation of rollforwards of fixed asset balances from book

132

cost to tax basis to produce tax basis fixed asset amounts that are appropriately reconciled to tax provisions and tax returns, (ii) increased tax department staffing and financial management oversight to ensure an adequate level of review of the deferred tax balances, (iii) conversion of a spreadsheet based tax fixed asset system to the Company’s enterprise account system used to maintain the financial books of the Company, and (iv) additional training of the tax department staff in the use of the accounting tools.


Item 9B.	*Other Information*

None.

Part III

The Company has incorporated by reference certain responses to the Items of this Part III pursuant to Rule 12b-23 under the Exchange Act and General Instruction G(3) to Form 10-K. The Company’s definitive proxy statement for the annual meeting of stockholders scheduled for May 4, 2006 (“Proxy Statement”) will be filed no later than 120 days after December 31, 2005.


Item 10.	*Directors and Executive Officers of the Company*

(a) Directors of the Company

The information set forth in response to Item 401 of Regulation S-K under the heading “Proposal 1 — Election of Two Directors” and “The Board of Directors” in the Company’s Proxy Statement is incorporated herein by reference in partial response to this Item 10.

(b) Executive Officers of the Company

The information set forth in response to Item 401 of Regulation S-K under “Executive Officers of the Company,” an unnumbered Item in Part I (immediately following Item 4, Submission of Matters to a Vote of Security Holders), of this Form 10-K, is incorporated herein by reference in partial response to this Item 10.

The information set forth in response to Item 405 of Regulation S-K under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Definitive Proxy Statement is incorporated herein by reference in partial response to this Item 10.

(d) Code of Ethics

The Company has adopted a Code of Business Conduct and Ethics (the “Code of Ethics”) that applies to directors, officers (including, among others, the Company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions) and employees. The Company has posted its Code of Ethics on its Internet website at www.kcsi.com. The Company will also post on this Internet website any amendments to, or waivers from, a provision of its Code of Ethics that applies to the Company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions as required by applicable rules and regulations. The Code of Ethics is available, in print, free of charge, upon request. Written requests may be made to the Corporate Secretary of KCS, P.O. Box 219335, Kansas City, Missouri 64121-9335

(e) Annual Certification to the New York Stock Exchange

KCS’s common stock is listed on the New York Stock Exchange (“NYSE”). As a result, KCS’s Chief Executive Officer is required to make annually, and he has made on June 2, 2005, a CEO’s Annual Certification to the New York Stock Exchange in accordance with Section 303A.12 of the NYSE Listed Company Manual stating that he was not aware of any violations by KCS of the NYSE corporate governance listing standards.

133


Item 11.	*Executive Compensation*

The information set forth in response to Item 402 of Regulation S-K under “Management Compensation” and “The Board of Directors — Compensation of Directors” in the Company’s Definitive Proxy Statement, (other than the Compensation and Organization Committee Report on Executive Compensation and the Stock Performance Graph), is incorporated herein by reference in response to this Item 11.


Item 12.	*Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters*

The information set forth in response to Item 403 of Regulation S-K under the heading “Principal Stockholders and Stock Owned Beneficially by Directors and Certain Executive Officers” in the Company’s Definitive Proxy Statement is incorporated herein by reference in partial response to this Item 12.

Equity Compensation Plan Information

The following table provides information as of December 31, 2005 about our common stock that may be issued upon the exercise of options, warrants and rights, as well as shares remaining available for future issuance under our existing equity compensation plans.

Weighted-

Number of Securities

Average Exercise

Remaining Available for

Price of

Future Issuance Under

Number of Securities to be

Outstanding

Equity Compensation

Issued Upon Exercise of

Options,

Plans (Excluding

Outstanding Options,

Warrants and

Securities Reflected in

Warrants and Rights

Rights

Column (a)(1)

Plan Category

(a)

(b)

(c)

Equity compensation plans approved by security holders

3,707,393

9.11

7,012,821

Equity compensation plans not approved by security holders

Total

3,707,393

9.11

7,012,821

(1)

Includes 4,178,116 shares available for issuance under the Employee Stock Purchase Plan. In addition, includes 2,834,705 shares available for issuance under the 1991 Plan as awards in the form of Restricted Shares, Bonus Shares, Performance Units or Performance Shares or issued upon the exercise of Options (including ISOs), stock appreciation rights or limited stock appreciation rights awarded under the 1991 Plan.

The Company has no knowledge of any arrangement the operation of which may at a subsequent date result in a change of control of the Company.


Item 13.	*Certain Relationships and Related Transactions*

The information set forth in response to Item 404 of Regulation S-K under the heading “Compensation Committee Interlocks and Insider Participation; Certain Relationships and Related Transactions” in the Company’s Definitive Proxy Statement is incorporated herein by reference in response to this Item 13.


Item 14.	*Principal Accountant Fees and Services*

Information concerning principal accounting fees and services under the heading “Audit Matters — Principal Accounting Firm Fees” and “The Board of Directors — The Audit Committee” in the Company’s Definitive Proxy Statement is hereby incorporated by reference in response to this Item 14.

134

Part IV


Item 15.	*Exhibits, Financial Statement Schedules and Reports on Form 8-K*

(a) List of Documents filed as part of this Report

(1) Financial Statements

The financial statements and related notes, together with the report of KPMG LLP appear in Part II Item 8, Financial Statements and Supplementary Data, of this Form 10-K.

(2) Financial Statement Schedules

The schedules and exhibits for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission appear in Part II Item 8, “Financial Statements and Supplementary Data”, under the “Index to Financial Statements” of this Form 10-K.

(3) List of Exhibits

(a) Exhibits

The Company has attached or incorporated by reference herein certain exhibits as specified below pursuant to Rule 12b-32 under the Exchange Act.

(2) Plan of acquisition, reorganization, arrangement, liquidation or succession


2	.1	Amended and Restated Acquisition Agreement, dated as of December 15, 2004, by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., KCS Acquisition Subsidiary, Inc., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (the “Amended Acquisition Agreement”), filed as Exhibit 10.1 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (File No. 1-4717), is incorporated herein by reference as Exhibit 2.1.
2	.2	Stockholders’ Agreement by and among KCS, Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and certain stockholders of Grupo TMM, S.A (the “Stockholders’ Agreement”), filed as Exhibit 10.3 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (File No. 1-4717), is incorporated herein by reference as Exhibit 2.2.
2	.3	Registration Rights Agreement by and among KCS, Grupo TMM, S.A., TMM Multimodal, S.A. de C.V. and certain stockholders of Grupo TMM, S.A. (the “Acquisition Registration Rights Agreement”), filed as Exhibit 10.4 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (File No. 1-4717), is incorporated herein by reference as Exhibit 2.3.
2	.4	Consulting Agreement by and between KCS and José F. Serrano International Business, S.A. de C.V. (the “Consulting Agreement”), filed as Exhibit 10.5 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (File No. 1-4717), is incorporated herein by reference as Exhibit 2.4.
2	.6	Marketing and Services Agreement by and among KCSR, TMM Logistics, S.A. de C.V. and TFM, S.A. de C.V. (the “Marketing and Services Agreement”), filed as Exhibit 10.6 to KCS’s Current Report on Form 8-K filed on December 21, 2004 (File No. 1-4717), is incorporated herein by reference as Exhibit 2.5.
2	.7	Rights Agreement, dated as of September 29, 2005, by and between KCS and UMB Bank, n.a., filed as Exhibit 10.1 to KCS’s Current Report on Form 8-K filed on October 3, 2005 (File No. 1-4717), is incorporated herein by reference as Exhibit 2.7.

135

(3) Articles of Incorporation and Bylaws

Articles of Incorporation


	3	.1		Exhibit 3.1 to the Company’s Registration Statement on Form S-4 originally filed July 12, 2002 (Registration No. 333-92360), as amended and declared effective on July 30, 2002 (the “2002 S-4 Registration Statement”), Restated Certificate of Incorporation, is hereby incorporated by reference as Exhibit 3.1.

Bylaws


	3	.2		The By-Laws of Kansas City Southern, as amended and restated to March 8 , 2004, filed as Exhibit 3.2 to the Company’s Form 10-K for the year ended December 31, 2003 (File No. 1-4717), is incorporated herein by reference as Exhibit 3.2.

(4) Instruments Defining the Right of Security Holders, Including Indentures


4	.1	The Fourth, Seventh, Eighth, Eleventh, Twelfth, Thirteenth, Fourteenth, Fifteenth and Sixteenth paragraphs of the Company’s Restated Certificate of Incorporation (See Exhibit 3.1).
4	.2	Article I, Sections 1, 3 and 11 of Article II, Article V and Article VIII of KCS’s Bylaws (See Exhibit 3.2).
4	.3	The Indenture, dated July 1, 1992 between the Company and The Chase Manhattan Bank (the “1992 Indenture”) attached as Exhibit 4 to the Company’s Shelf Registration of $300 million of Debt Securities on Form S-3 filed June 19, 1992 (Registration No. 33-47198) and as Exhibit 4(a) to the Company’s Form S-3 filed March 29, 1993 (Registration No. 33-60192) registering $200 million of Debt Securities, is hereby incorporated by reference as Exhibit 4.3.
4	.3.1	Exhibit 4.5.2 to the Company’s Form 10-K for the fiscal year ended December 31, 1999 (File No. 1-4717), Supplemental Indenture dated December 17, 1999 to the 1992 Indenture with respect to the 6.625% Notes Due March 1, 2005 issued pursuant to the 1992 Indenture, is hereby incorporated by reference as Exhibit 4.3.1.
4	.3.2	Exhibit 4.5.4 to the Company’s Form 10-K for the fiscal year ended December 31, 1999 (File No. 1-4717), Supplemental Indenture dated December 17, 1999 to the 1992 Indenture with respect to the 7% Debentures Due December 15, 2025 issued pursuant to the 1992 Indenture, is hereby incorporated by reference as Exhibit 4.3.2.
4	.4	Exhibit 99 to the Company’s Form 8-A dated October 24, 1995 (File No. 1-4717), the Stockholder Rights Agreement by and between the Company and Harris Trust and Savings Bank dated as of September 19, 1995, is hereby incorporated by reference as Exhibit 4.4.
4	.5	Exhibit 4.1 to the Company’s S-4 Registration Statement on Form S-4 originally filed on January 25, 2001 (Registration No. 333-54262), as amended and declared effective on March 15, 2001 (the “2001 S-4 Registration Statement”), the Indenture, dated as of September 27, 2000, among the Company, The Kansas City Southern Railway Company (“KCSR”), certain other subsidiaries of the Company and The Bank of New York, as Trustee (the “2000 Indenture”), is hereby incorporated by reference as Exhibit 4.5.
4	.5.1	Exhibit 4.1.1 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Supplemental Indenture, dated as of January 29, 2001, to the 2000 Indenture, among the Company, KCSR, certain other subsidiaries of the Company and The Bank of New York, as trustee, is hereby incorporated by reference as Exhibit 4.5.1.
4	.5.2	Second Supplemental Indenture, dated as of June 10, 2005, to the 2000 Indenture, among the Company, KCSR, and certain other subsidiaries of the Company and the Bank of New York, as Trustee, filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2005, is hereby incorporated by reference as Exhibit 4.5.2.
4	.6	Form of Exchange Note (included as Exhibit B to Exhibit 4.5 hereto).
4	.7	Exhibit 4.3 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), the Exchange and Registration Rights Agreement, dated as of September 27, 2000, among the Company, KCSR, certain other subsidiaries of the Company, is hereby incorporated by reference as Exhibit 4.7.

136


4	.8	The Indenture, dated June 12, 2002, among KCSR, the Company and certain subsidiaries of the Company, and U.S. Bank National Association, as Trustee (the “2002 Indenture”), attached as Exhibit 4.1 to the 2002 S-4 Registration Statement (Registration No. 333-92360) is hereby incorporated by reference as Exhibit 4.8.
4	.8.1	Form of Face of Exchange Note, included as Exhibit B to Exhibit 4.8 and filed as Exhibit 4.2 to the 2002 S-4 Registration Statement (Registration No. 333-92360) is hereby incorporated by reference as Exhibit 4.8.1.
4	.8.2	Supplemental Indenture, dated June 10, 2005, to the 2002 Indenture among the Company, KCSR, and certain other subsidiaries of the Company, and U.S. Bank National Association, as Trustee, filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2005, is hereby incorporated by reference as Exhibit 4.8.2.
4	.9	Certificate of Designations of 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C, filed as Exhibit 3.1(b) to KCS’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 (File No. 1-4717), is hereby incorporated by reference as Exhibit 4.9.
4	.10	Exhibit 4.5 to the Company’s Registration Statement on Form S-3 originally filed on August 1, 2003 (Registration No. 333-107573), as amended and declared effective on October 24, 2003 (the “2003 S-3 Registration Statement”), Registration Rights Agreement dated May 5, 2003 among KCS, Morgan Stanley & Co. Incorporated and Deutsche Bank Securities Inc., is hereby incorporated by reference as Exhibit 4.10.
4	.11	Certificate of Designations of 5.125% Cumulative Convertible Perpetual Preferred Stock, Series D, filed as Exhibit 4.1 to KCS’s Current Report on Form 8-K, filed on December 15, 2005, is hereby incorporated by reference as Exhibit 4.11.

(9) Voting Trust Agreement (Inapplicable)

(10) Material Contracts


10	.1*	Form of Officer Indemnification Agreement attached as Exhibit 10.1 to the Company’s Form 10-K for the year ended December 31, 2001 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.1.
10	.2 *	Form of Director Indemnification Agreement attached as Exhibit 10.2 to the Company’s Form 10-K for the year ended December 31, 2001 (Commission File No. 1-4717), is hereby incorporated by reference as Exhibit 10.2.
10	.3	The 1992 Indenture. (See Exhibit 4.3)
10	.4.1	Supplemental Indenture dated December 17, 1999 to the 1992 Indenture with respect to the 6.625% Notes Due March 1, 2005 issued pursuant to the 1992 Indenture. (See Exhibit 4.3.1)
10	.4.2	Supplemental Indenture dated December 17, 1999 to the 1992 Indenture with respect to the 7% Debentures Due December 15, 2025 issued pursuant to the 1992 Indenture. (See Exhibit 4.3.2)
10	.5*	Exhibit 10.1 to the Company’s Form 10-Q for the period ended March 31, 1997 (File No. 1-4717), The Kansas City Southern Railway Company Directors’ Deferred Fee Plan as adopted August 20, 1982 and the amendment thereto effective March 19, 1997 to such plan, is hereby incorporated by reference as Exhibit 10.5.
10	.6*	Exhibit 10.4 to the Company’s Form 10-K for the fiscal year ended December 31, 1990 (File No. 1-4717), Description of the Company’s 1991 incentive compensation plan, is hereby incorporated by reference as Exhibit 10.6.
10	.7 *	Exhibit 10.7 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 (File No. 1-4717), Directors Deferred Fee Plan, adopted August 20, 1982, as amended and restated effective January 1, 2005, is hereby incorporated by reference as Exhibit 10.7.
10	.8.1*	Exhibit 10.8.1 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 (File No. 1-4717), Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan, as amended and restated effective as of March 14, 2005 is hereby incorporated by reference as Exhibit 10.8.1.

137


10	.8.2 *	Exhibit 10.8.2 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 (File No. 1-4717), Form of Non-Qualified Stock Option Award Agreement for employees under the 1991 Amended and Restated Stock Option and Performance Award Plan, is hereby incorporated by reference as Exhibit 10.8.2.
10	.8.3 *	Exhibit 10.8.3 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 (File No. 1-4717), Form of Non-Qualified Stock Option Award Agreement for Directors under the 1991 Amended and Restated Stock Option and Performance Award Plan, is hereby incorporated by reference as Exhibit 10.8.3.
10	.8.4*	Exhibit 10.8.4 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 (File No. 1-4717), Form of Non-Qualified Stock Option Award agreement for employees under the 1991 Amended and Restated Stock Option and Performance Award Plan (referencing threshold dates), is hereby incorporated by reference as Exhibit 10.8.4.
10	.8.5*	Exhibit 10.8.5 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 (File No. 1-4717), Form of Restricted Shares Award Agreement (graded vesting) under the 1991 Amended and Restated Stock Option and Performance Award Plan, is hereby incorporated by reference as Exhibit 10.8.5.
10	.8.6*	Form of Restricted Shares Award Agreement (cliff vesting) under the 1991 Amended and Restated Stock Option and Performance Award Plan, attached as Exhibit 10.1 to the Company’s Form 8-K filed on March 18, 2005 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.8.6.
10	.8.7*	Exhibit 10.8.7 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 (File No. 1-4717), Form of Restricted Shares Award Agreement under the 1991 Amended and Restated Stock Option and Performance Award Plan (applicable to restricted shares to be purchased), is hereby incorporated by reference as Exhibit 10.8.7.
10	.9.1*	Kansas City Southern 401(k) and Profit Sharing Plan (Amended and Restated Effective April 1, 2002), attached as Exhibit 10.10.1 to the Company’s Form 10-K for the year ended December 31, 2002 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.9.1.
10	.9.2*	First Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), effective January 1, 2003, attached as Exhibit 10.10.2 to the Company’s Form 10-K for the year ended December 31, 2002 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.9.2.
10	.9.3*	Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), dated June 30, 2003 and effective as of January 1, 2001, attached as Exhibit 10.10.3 to the Company’s Form 10-K for the year ended December 31, 2003 (File No. 1- 4717), is hereby incorporated by reference as Exhibit 10.9.3.
10	.9.4*	Amendment to the Kansas City Southern 401(k) and Profit Sharing Plan (As Amended and Restated Effective April 1, 2002), dated December 3, 2003 and effective as of January 1, 2003, attached as Exhibit 10.10.4 to the Company’s Form 10-K for the year ended December 31, 2003 (File No. 1- 4717), is hereby incorporated by reference as Exhibit 10.9.4.
10	.10	Exhibit 10.10 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), the Assignment, Consent and Acceptance Agreement, dated August 10, 1999, by and among the Company, DST Systems, Inc. and Stilwell Financial Inc., is hereby incorporated by reference as Exhibit 10.10.
10	.11*	Employment Agreement, as amended and restated January 1, 2001, by and among the Company, KCSR and Michael R. Haverty, attached as Exhibit 10.12 to the Company’s Form 10-K for the year ended December 31, 2001 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.11.
10	.12*	Employment Agreement, dated June 1, 2002 by and among the Company, KCSR and Ronald G. Russ, attached as Exhibit 10.17 to the Company’s 2002 S-4 Registration Statement (Registration No. 333-92360) is hereby incorporated by reference as Exhibit 10.12.
10	.12.1*	First Amendment to Employment Agreement, dated March 14, 2003, by and among the Company, KCSR, and Ronald G. Russ, attached as Exhibit 10.14.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.12.1.

138


10	.13*	Employment Agreement, dated January 1, 2005, between KCS and Arthur L. Shoener, attached as Exhibit 10.1 to the Company’s Current Report on Form 8-K/A filed on February 14, 2005 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.13.
10	.14*	Employment Agreement, dated October 1, 2004, between KCS and Robert B. Terry, is attached hereto as Exhibit 10.14.
10	.15*	Labor Agreement, dated as from July 5, 2005, between KCSM and Francisco Javier Rion Del Olmo, filed as Exhibit 10.1 to KCSM’s Current Report on Form 8-K, filed on July 7, 2005 is hereby incorporated by reference as Exhibit 10.15.
10	.16*	Kansas City Southern Executive Plan, as amended and restated January 1, 2005, filed as Exhibit 10.17 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.16.
10	.17*	The Kansas City Southern Annual Incentive Plan, attached as Exhibit 10.20 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.17.
10	.18	Credit Agreement dated as of March 30, 2004 among KCSR, KCS, the subsidiary guarantors, the lenders party thereto, The Bank of Nova Scotia (“BNS”), Morgan Stanley Senior Funding, Inc. (“Morgan Stanley”) and Harris Trust and Savings Bank, attached as Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended March 31, 2004 (File No. 1-4717), is incorporated herein by reference as Exhibit 10.18.
10	.19.1	Security Agreement dated March 30, 2004 from KCS, KCSR and certain other subsidiaries of KCS to The Bank of Nova Scotia as Collateral Agent, filed as Exhibit 10.19.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.19.1.
10	.19.2	Amendment and Waiver No. 1 to the Credit Agreement and Amendment No. 1 to the Security Agreement among KCSR, KCS, the subsidiary guarantors, the lenders party thereto and The Bank of Nova Scotia, dated as of December 22, 2004, attached as Exhibit 10.1 to the Company’s Form 8-K filed on December 29, 2004 (File No. 1-4717), is incorporated herein by reference as Exhibit 10.19.2.
10	.20	The 2000 Indenture. (See Exhibit 4.5)
10	.21	Supplemental Indenture, dated as of January 29, 2001, to the 2000 Indenture (See Exhibit 4.5.1).
10	.22	Second Supplemental Indenture, dated as of June 10, 2005, to the 2000 Indenture. (See Exhibit 4.5.2)
10	.23	Exhibit 10.23 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Intercompany Agreement, dated as of August 16, 1999, between the Company and Stilwell Financial Inc., is hereby incorporated by reference as Exhibit 10.23.
10	.24	Exhibit 10.24 to the Company’s 2001 S-4 Registration Statement (Registration No. 333-54262), Tax Disaffiliation Agreement, dated as of August 16, 1999, between the Company and Stilwell Financial Inc., is hereby incorporated by reference as Exhibit 10.24.
10	.25	Lease Agreement, as amended, between The Kansas City Southern Railway Company and Broadway Square Partners LLP dated June 26, 2001, attached as Exhibit 10.34 to the Company’s Form 10-K for the year ended December 31, 2001 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.25.
10	.26	The 2002 Indenture. (See Exhibit 4.8)
10	.27	Supplemental Indenture, dated as of June 10, 2005, to the 2002 Indenture. (See Exhibit 4.8.2)
10	.28	Agreement to Forego Compensation between A. Edward Allinson and the Company, fully executed on March 30, 2001; Loan Agreement between A. Edward Allinson and the Company fully executed on September 18, 2001; and the Promissory Note executed by the Trustees of The A. Edward Allinson Irrevocable Trust Agreement dated, June 4, 2001, Courtney Ann Arnot, A. Edward Allinson III and Bradford J. Allinson, Trustees, as Maker, and the Company, as Holder, attached as Exhibit 10.36 to the Company’s Form 10-K for the year ended December 31, 2002 (File No. 1-4717), are hereby incorporated by reference as Exhibit 10.28.

139


10	.29	Agreement to Forego Compensation between Michael G. Fitt and the Company, fully executed on March 30, 2001; Loan Agreement between Michael G. Fitt and the Company, fully executed on September 7, 2001; and the Promissory Note executed by the Trustees of The Michael G. and Doreen E. Fitt Irrevocable Insurance Trust, Anne E. Skyes, Colin M-D. Fitt and Ian D.G. Fitt, Trustees, as Maker, and the Company, as Holder, attached as Exhibit 10.37 to the Company’s Form 10-K for the year ended December 31, 2002 (File No. 1-4717), are hereby incorporated by reference as Exhibit 10.29.
10	.30.1	Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), attached as Exhibit 10.38 to the Company’s Form 10-K for the year ended December 31, 2002 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.30.1.
10	.30.2	Amendment to the Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), dated June 30, 2003 and effective as of January 1, 2001, attached as Exhibit 10.38.2 to the Company’s Form 10-K for the year ended December 31, 2003 (File No. 1- 4717), is hereby incorporated by reference as Exhibit 10.30.2.
10	.30.3	Amendment to the Kansas City Southern Employee Stock Ownership Plan (As Amended and Restated Effective April 1, 2002), dated December 3, 2003 and effective as of January 1, 2003, attached as Exhibit 10.38.3 to the Company’s Form 10-K for the year ended December 31, 2003 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.30.3.
10	.31	Placement Agreement dated April 29, 2003 by and among the Company, Morgan Stanley & Co. Incorporated and Deutsche Bank Securities Inc., attached as Exhibit 10 to the Company’s Form 10-Q for the quarter ended June 30, 2003 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.31.
10	.32	The Amended Acquisition Agreement. (See Exhibit 2.1)
10	.33	The Stockholders’ Agreement. (See Exhibit 2.3)
10	.34	The Acquisition Registration Rights Agreement. (See Exhibit 2.4)
10	.35	The Consulting Agreement. (See Exhibit 2.5)
10	.36	The Marketing and Services Agreement. (See Exhibit 2.6)
10	.37	Form of Indemnity Escrow Note (as defined in the Amended Acquisition Agreement), filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed December 21, 2004. (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.37.
10	.38	Form of VAT Escrow Note (as defined in the Amended Acquisition Agreement), filed as Exhibit 10.7 to the Company’s Current Report on Form 8-K filed December 21, 2004. (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.38.
10	.39	Closing Escrow Agreement by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., KCS Acquisition Subsidiary, Inc., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.8 to the Company’s Current Report on Form 8-K filed December 21, 2004. (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.39.
10	.40	Indemnity Escrow Agreement by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Multimodal, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.9 to the Company’s Current Report on Form 8-K filed December 21, 2004 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.40.
10	.41	VAT Escrow Agreement by and among KCS, KARA Sub, Inc., KCS Investment I, Ltd., KCS Acquisition Subsidiary, Inc., Caymex Transportation, Inc., Grupo TMM, S.A., TMM Holdings, S.A. de C.V., TMM Multimodal, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.10 to the Company’s Current Report on Form 8-K filed December 21, 2004 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.41.
10	.42	Consulting Compensation Escrow Agreement by and among KCS, Jose F. Serrano International Business, S.A. de C.V. and The Bank of Nova Scotia Trust Company of New York, filed as Exhibit 10.11 to the Company’s Current Report on Form 8-K filed December 21, 2004 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.42.

140


10	.43	Agreement of Assignment and Assumption of Rights, and Agency Agreement with Undisclosed Principal, Duties and Obligations, filed as Exhibit 10.12 to the Company’s Current Report on Form 8-K filed December 21, 2004 (File No. 1-4717), is hereby incorporated by reference as Exhibit 10.43.
10	.44	Underwriting Agreement, dated December 5, 2005, among the Company and Morgan Stanley & Co. Incorporated, filed as Exhibit 99.2 to the Company’s Current Report on Form 8-K, filed December 5, 2005, is hereby incorporated by reference as Exhibit 10.44.
10	.45	Underwriting Agreement, dated December 5, 2005, among the Company, Grupo TMM, S.A. and Morgan Stanley & Co. Incorporated, filed as Exhibit 99.3 to the Company’s Current Report on Form 8-K, filed December 5, 2005, is hereby incorporated by reference as Exhibit 10.45.
10	.46	Transaction Agreement, dated December 1, 2005, by and between the Company, KCSR, Norfolk Southern Corporation and The Alabama Great Southern Railroad Company is attached hereto as Exhibit 10.46.
10	.47	Amendment No. 1 to Transaction Agreement dated as of January 17, 2006, by and between the Company, KCSR, Norfolk Southern Corporation and The Alabama Great Southern Railroad Company is attached hereto as Exhibit 10.47.
10	.48	Participation Agreement, dated as of December 20, 2005, among KCSR, KCSR Trust 2005-1 (acting through Wilmington Trust Company, as owner trustee) (“Trust”), GS Leasing (KCSR 2005-1) LLC, Wells Fargo Bank Northwest, National Association, Export Development Canada, and KfW, is attached hereto as Exhibit 10.48.
10	.49	Equipment and Lease Agreement, dated as of December 20, 2005, by and between KCSR and the Trust, is attached hereto as Exhibit 10.49.
10	.50	Commitment Letter by and between KCS and Bank of Nova Scotia, dated March 17, 2006, is attached hereto as Exhibit 10.50.

(11) Statement Re Computation of Per Share Earnings (Inapplicable)

(12) Statements Re Computation of Ratios


	12	.1		The Computation of Ratio of Earnings to Fixed Charges prepared pursuant to Item 601(b)(12) of Regulation S-K is attached to this Form 10-K as Exhibit 12.1.

(13) Annual Report to Security Holders, Form 10-Q or Quarterly Report to Security Holders (Inapplicable)

(16) Letter Re Change in Certifying Accountant (Inapplicable)

(18) Letter Re: Change in Accounting Principles (Inapplicable)

(21) Subsidiaries of the Company


	21	.1		The list of the Subsidiaries of the Company prepared pursuant to Item 601(b)(21) of Regulation S-K is attached to this Form 10-K as Exhibit 21.1.

(22) Published Report Regarding Matters Submitted to Vote of Security Holders (Inapplicable)

(23) Consents of Experts and Counsel


23	.1	Consent of KPMG LLP is attached to this Form 10-K as Exhibit 23.1.
23	.2	Consent of PricewaterhouseCoopers is attached to this Form 10-K as Exhibit 23.2.

(24) Power of Attorney (Inapplicable)

141

(31) Rule 13a-14(a)/15d-14(a) Certifications


31	.1	Certification of Michael R. Haverty, Chief Executive Officer of the Company, is attached hereto as Exhibit 31.1.
31	.2	Certification of Ronald G. Russ, Chief Financial Officer of the Company, is attached hereto as Exhibit 31.2.

(32) Section 1350 Certifications


	32	.1		Certification Pursuant to 18 U.S.C. Section 1350 of Michael R. Haverty, Chief Executive Officer of the Company, and Ronald G. Russ, Chief Financial Officer of the Company, is attached hereto as Exhibit 32.1.

(99) Additional Exhibits


	99	.1		The combined and consolidated financial statements of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (including the notes thereto and the Report of Independent Accountants thereon) as of December 31, 2005 and 2004 and for each of the three years in the period ended December 31, 2005 as listed under Item 15(a)(2) herein, are included in this Form 10-K as Exhibit 99.1.


*	Represents a management contract or a compensatory plan or arrangement

142

SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) 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.


	Kansas City Southern


	By:	/s/ M. R. Haverty



	M. R. Haverty
	Chairman, President, Chief Executive
	Officer and Director

April 7, 2006

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated on March 31, 2006.


Signature				Capacity


/s/ M. R. Haverty M. R. Haverty				Chairman, President, Chief Executive Officer and Director

/s/ Arthur L. Shoener Arthur L. Shoener				Executive Vice President and Chief Operating Officer

/s/ R. G. Russ R. 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)

/s/ A.E. Allinson A.E. Allinson				Director

/s/ Robert J. Druten Robert J. Druten				Director

/s/ M.G. Fitt M.G. Fitt				Director

/s/ J.R. Jones J.R. Jones				Director

/s/ T. A. McDonnell T. A. McDonnell				Director

143


Signature				Capacity


/s/ K. L. Pletz K. L. Pletz				Director

/s/ R.E. Slater R.E. Slater				Director

144

KANSAS CITY SOUTHERN

2005 FORM 10-K ANNUAL REPORT

INDEX TO EXHIBITS


				Regulation S-K
Exhibit				Item 601(b)
No.			Document	Exhibit No.

	10	.14*	Employment Agreement, dated October 1,2004, between KCS and Robert B. Terry		10

	10	.46	Transaction Agreement, dated December 1, 2005, by and between the Company, KCSR, Norfolk Southern Corporation and The Alabama Great Southern Railroad Company		10

	10	.47	Amendment No. 1 to Transaction Agreement, dated as of January 17, 2006, by and between the Company, KCSR, Norfolk Southern Corporation and The Alabama Great Southern Railroad Company		10

	10	.48	Participation Agreement, dated as of December 20, 2005, among KCSR, KCSR Trust 2005-1 (acting through Wilmington Trust Company, as owner trustee) (“Trust”), GS Leasing (KCSR 2005-1) LLC, Wells Fargo Bank Northwest, National Association, Export Development Canada, and KfW		10

	10	.49	Equipment and Lease Agreement, dated as of December 20, 2005, by and between KCSR and the Trust		10

	10	.50	Commitment Letter by and between KCS and Bank of Nova Scotia, dated March 17, 2006		10

	12	.1	Computation of Ratio of Earnings to Fixed Charges		12

	21	.1	Subsidiaries of the Company		21

	23	.1	Consent of KPMG LLP		23

	23	.2	Consent of PricewaterhouseCoopers		23

	31	.1	Certification of Michael R. Haverty		31

	31	.2	Certification of Ronald G. Russ		31

	32	.1	Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 — Michael R. Haverty and Ronald G. Russ		32

	99	.1	Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. combined and consolidated financial statements as of December 31, 2005 and 2004 and for each of the three years in the period ended December 31, 2005		99


*	Represents a management contract or a compensatory plan or arrangement

The above exhibits are not included in this Form 10-K, but are

on file with the Securities and Exchange Commission

145

Exhibit 10.14

EMPLOYMENT AGREEMENT

THIS AGREEMENT , made and entered into as of this 1st day of October, 2004 , by and between Kansas City Southern, a Delaware corporation (“KCS”) and Robert B. Terry , an individual (“Executive”).

WHEREAS , Executive has been offered employment by KCS and Executive desire for KCS to continue to employ Executive on the terms and conditions set forth in this Agreement and to provide an incentive to Executive to remain in the employ of KCS hereafter, particularly in the event of any change in control (as herein defined) of KCS, or Railway, thereby establishing and preserving continuity of management of KCS.

NOW, THEREFORE , in consideration of the mutual covenants and agreements herein contained, it is agreed by and between KCS and Executive as follows:

1. Employment . KCS hereby employs Executive as its Senior Vice President and General Counsel to serve at the pleasure of the Board of Directors of KCS (the “KCS Board”) and to have such duties, powers and responsibilities as may be prescribed or delegated from time to time by the President or other officer to whom Executive reports, subject to the powers vested in the KCS Board and in the stockholders of KCS. Executive shall faithfully perform his duties under this Agreement to the best of his ability and shall devote substantially all of his working time and efforts to the business and affairs of KCS and its affiliates.

2. Compensation .

(a) Base Compensation . KCS shall pay Executive as compensation for his services hereunder an annual base salary at the rate approved by the KCS Compensation Committee. Such rate shall not be reduced except as agreed by the parties or except as part of a general salary reduction program imposed by KCS for non-union employees and applicable to all officers of KCS, not related to a Change of Control.

3. Benefits . During the period of his employment hereunder, KCS shall provide Executive with coverage under such benefit plans and programs as are made generally available to similarly situated employees of KCS, provided (a) KCS shall have no obligation with respect to any plan or program if Executive is not eligible for coverage thereunder, and (b) Executive acknowledges that stock options and other stock and equity participation awards are granted in the discretion of the KCS Board or the Compensation Committee of the KCS Board and that Executive has no right to receive stock options or other equity participation awards or any particular number or level of stock options or other awards. In determining contributions, coverage and benefits under any disability insurance policy and under any cash compensation-based plan provided to Executive by KCS, it shall be assumed that the value of Executive’s annual compensation, pursuant to this Agreement, is 160% of Executive’s annual base salary. Executive acknowledges that all rights and benefits under benefit plans and programs shall be governed by the official text of each plan or program and not by any summary or description thereof or any provision of this Agreement (except to the extent that this Agreement expressly

modifies such benefit plans or programs) and that KCS is not under any obligation to continue in effect or to fund any such plan or program, except as provided in Paragraph 7 hereof.

4. Term and Termination .

The “Term” of this Agreement shall begin on the date first written above and continue until terminated as provided in (a) through (d) of this Section 4.

(a) Termination by Executive . Executive may terminate this Agreement and his employment hereunder by providing at least thirty (30) days advance written notice to KCS, except that in the event of any material breach of this Agreement by KCS, Executive may terminate this Agreement and his employment hereunder immediately upon notice to KCS.

(b) Death or Disability . This Agreement and Executive’s employment hereunder shall terminate automatically on the death or disability of Executive, except to the extent employment is continued under KCS’s disability plan. For purposes of this Agreement, Executive shall be deemed to be disabled if he qualifies for disability benefits under KCS’s long-term disability plan.

(c) Termination by KCS For Cause . KCS may terminate this Agreement and Executive’s employment “for cause” immediately upon notice to Executive. For purposes of this Agreement (except for Paragraph 7), termination “for cause” shall mean termination based upon any one or more of the following:

(i) Any material breach of this Agreement by Executive;

(ii) Executive’s dishonesty involving Railway, KCS, or any subsidiary of Railway or KCS;

(iii) Gross negligence or willful misconduct in the performance of Executive’s duties as determined in good faith by the KCS Board;

(iv) Executive’s failure to substantially perform his duties and responsibilities hereunder, including without limitation Executive’s willful failure to follow reasonable instructions of the President or other officer to whom Executive reports;

(v) Executive’s breach of an express employment policy of KCS or its affiliates;

(vi) Executive’s fraud or criminal activity;

(vii) Embezzlement or misappropriation by Executive.; or

(viii) Executive’s breach of his fiduciary duty to Railway, or KCS, or their affiliates.

(d) Termination by KCS Other Than For Cause .

(i) KCS may terminate this Agreement and Executive’s employment other than for cause immediately upon notice to Executive, and in such event, KCS shall provide severance benefits to Executive in accordance with Paragraph 4(d)(ii) below. Executive acknowledges and agrees that such severance benefits constitute the exclusive remedy of Executive upon termination of employment other than for cause. Notwithstanding any other provision of this Agreement, as a condition to receiving such severance benefits, Executive shall execute a full release of claims in favor of KCS and Railway and their affiliates in the form Attached hereto as Appendix A.

(ii) Unless the provisions of Paragraph 7 of this Agreement are applicable, if Executive’s employment is terminated under Paragraph 4(d)(i), KCS shall continue, for a period of one (1) year following such termination, (a) to pay to Executive as severance pay a monthly amount equal to one-twelfth (1/12th) of the annual base salary referenced in Paragraph 2(a) above, at the rate in effect immediately prior to termination, and, (b) to reimburse Executive for the cost (including state and federal income taxes payable with respect to this reimbursement) of continuing the health insurance coverage provided pursuant to this Agreement or obtaining health insurance coverage comparable to the health insurance provided pursuant to this Agreement, and obtaining coverage comparable to the life insurance provided pursuant to this Agreement, unless Executive is provided comparable health or life insurance coverage in connection with other employment. The foregoing obligations of KCS shall continue until the end of such one (1) year period notwithstanding the death or disability of Executive during said period (except, in the event of death, the obligation to reimburse Executive for the cost of life insurance shall not continue). In the year in which termination of employment occurs, Executive shall be eligible to receive benefits under the KCS Incentive Compensation Plan and any Executive Plan in which Executive participates (the “Executive Plan”) (if such Plans then are in existence and Executive was entitled to participate immediately prior to termination) in accordance with the provisions of such plans then applicable, and severance pay received in such year shall be taken into account for the purpose of determining benefits, if any, under the KCS Incentive Compensation Plan but not under the Executive Plan. After the year in which termination occurs, Executive shall not be entitled to accrue or receive benefits under the KCS Incentive Compensation Plan or the Executive Plan with respect to the severance pay provided herein, notwithstanding that benefits under such plan there are still generally available to executive employees of KCS. After termination of employment, Executive shall not be entitled to accrue or receive benefits under any other employee benefit plan or program, except that Executive shall be entitled to participate in the KCS Section 401(k) and Profit Sharing Plan and the KCS Employee Stock Ownership Plan (if KCS employees then still participate in such plans) in the year of termination of employment only if Executive meets all requirements of such plans for participation in such year.

5. Confidentiality and Non-Disclosure .

(a) Executive understands and agrees that he will be given Confidential Information (as defined below) during his employment with KCS relating to the business of

KCS, Railway, and/or their affiliates, in exchange for his agreement herein. Executive hereby expressly agrees to maintain in strictest confidence and not to use in any way (including without limitation in any future business relationship of Executive), publish, disclose or authorize anyone else to use, publish or disclose in any way, any Confidential Information relating in any manner to the business or affairs of KCS, Railway, and/or their affiliates. Executive agrees further not to remove or retain any figures, calculations, letters, documents, lists, papers, or copies thereof, which embody Confidential Information of KCS, Railway, and/or their affiliates, and to return, prior to Executive’s termination of employment for any reason, any such information in Executive’s possession. If Executive discovers, or comes into possession of, any such information after his termination he shall promptly return it to KCS. Executive acknowledges that the provisions of this paragraph are consistent with KCS’s policies and procedures to which Executive, as an employee of KCS, is bound.

(b) For purposes of this Agreement, “Confidential Information” includes, but is not limited to, information in the possession of, prepared by, obtained by, compiled by, or that is used by KCS, Railway, or their affiliates or customers and (i) is proprietary to, about, or created by KCS, Railway, or their affiliates or customers; (ii) gives KCS, Railway, or their affiliates or customers some competitive business advantage, the opportunity of obtaining such advantage, or disclosure of which might be detrimental to the interest of KCS, Railway, or their affiliates or customers; and (iii) is not typically disclosed by KCS, Railway, or their affiliates or customers, or known by persons who are not employed by KCS, Railway, or their affiliates or customers. Without in any way limiting the foregoing and by way of example, Confidential Information shall include: information pertaining to KCS’s, Railway’s, or their affiliates’ business operations such as financial and operational information and data, operational plans and strategies, business and marketing strategies, pricing information, plans for various products and services, and acquisition and divestiture planning.

(c) In the event of any breach of this Paragraph 5 by Executive, Railway shall be entitled to terminate any and all remaining severance benefits under Paragraph 4(d)(ii) and shall be entitled to pursue such other legal and equitable remedies as may be available. Executive acknowledges, understands and agrees that KCS, Railway, and/or their affiliates will suffer immediate and irreparable harm if Executive fails to comply with any of his obligations under Paragraph 5 of this Agreement, and that monetary damages alone will be inadequate to compensate KCS, Railway, or their affiliates for such breach. Accordingly, Executive agrees that KCS, Railway, and/or their affiliates shall, in addition to any other remedies available to it at law or in equity, be entitled to temporary, preliminary, and permanent injunctive relief and specific performance to enforce the terms of Paragraph 5 without the necessity of proving inadequacy of legal remedies or irreparable harm or posting bond.

6. Duties Upon Termination; Survival .

(a) Duties . Upon termination of this Agreement by KCS or Executive for any reason, Executive shall immediately sign such written resignations from all positions as an officer, director or member of any committee or board of KCS, and Railway and all direct and indirect subsidiaries and affiliates of KCS and Railway as may be requested by KCS and shall sign such other documents and papers relating to Executive’s employment, benefits and benefit plans as KCS may reasonably request.

(b) Survival . The provisions of Paragraphs 5, 6(a) and 7 of this Agreement shall survive any termination of this Agreement by KCS, Railway or Executive, and the provisions of Paragraph 4(d)(ii) shall survive any termination of this Agreement by KCS under Paragraph 4(d)(i).

7. Continuation of Employment Upon Change in Control .

(a) Continuation of Employment . Subject to the terms and conditions of this Paragraph 7, in the event of a Change in Control (as defined in Paragraph 7(d)) at any time during the term of this Agreement, Executive agrees to remain in the employ of KCS for a period of three years (the “Three Year Period”) from the date of such Change in Control (the “Control Change Date”). KCS agrees to continue to employ Executive for the Three Year Period. During the Three Year Period, (i) the Executive’s position (including offices, titles, reporting requirements and responsibilities), authority and duties shall be at least commensurate in all material respects with the most significant of those held, exercised and assigned at any time during the 12 month period immediately before the Control Change Date and (B) the Executive’s services shall be performed at the location where Executive was employed immediately before the Control Change Date or at any other location less than 40 miles from such former location. During the Three Year Period, KCS shall continue to pay to Executive an annual base salary on the same basis and at the same intervals as in effect prior to the Control Change Date at a rate not less than 12 times the highest monthly base salary paid or payable to the Executive by KCS in respect of the 12-month period immediately before the Control Change Date.

(b) Benefits . During the Three-Year Period, Executive shall be entitled to participate, on the basis of his executive position, in each of the following KCS plans (together, the “Specified Benefits”) in existence, and in accordance with the terms thereof, at the Control Change Date:

(i) any benefit plan, and trust fund associated therewith, related to: (A) life, health, dental, disability, accidental death and dismemberment insurance or accrued but unpaid vacation time; (B) profit sharing, thrift or deferred savings (including deferred compensation, such as under Sec. 401(k) plans); (C) retirement or pension benefits; (D) ERISA excess benefits and similar plans and (E) tax favored employee stock ownership (such as under ESOP, and Employee Stock Purchase programs); and

(ii) any other benefit plans hereafter made generally available to executives of Executive’s level or to the employees of KCS generally.

In addition, KCS shall use its best efforts to cause all outstanding options held by Executive under any stock option plan of KCS or its affiliates to become immediately exercisable on the Control Change Date and to the extent that such options are not vested and are subsequently forfeited, the Executive shall receive a lump-sum cash payment within 5 days after the options are forfeited equal to the difference between the fair market value of the shares of stock subject to the non-vested, forfeited options determined as of the date such options are forfeited and the exercise price for such options. During the Three Year Period Executive shall be entitled to participate, on the basis of his executive position, in any incentive compensation plan of KCS, in accordance with the terms thereof at the Control Change Date; provided that if

under KCS’s programs or Executive’s Employment Agreement in existence immediately prior to the Control Change Date, there are written limitations on participation for a designated time period in any incentive compensation plan, such limitations shall continue after the Control Change Date to the extent so provided for prior to the Control Change Date.

If the amount of contributions or benefits with respect to the Specified Benefits or any incentive compensation is determined on a discretionary basis under the terms of the Specified Benefits or any incentive compensation plan immediately prior to the Control Change Date, the amount of such contributions or benefits during the Three-Year Period for each of the Specified Benefits shall not be less than the average annual contributions or benefits for each Specified Benefit for the three plan years ending prior to the Control Change Date and, in the case of any incentive compensation plan, the amount of the incentive compensation during the Three Year Period shall not be less than 75% of the maximum that could have been paid to the Executive under the terms of the incentive compensation plan.

(c) Payment . With respect to any plan or agreement under which Executive would be entitled at the Control Change Date to receive Specified Benefits or incentive compensation as a general obligation of KCS which has not been separately funded (including specifically, but not limited to, those referred to under Paragraph 7(b)(i)(D) above), Executive shall receive within five (5) days after such date full payment in cash of all amounts to which he is then entitled thereunder.

(d) Change in Control . For purposes of this Agreement, a “Change in Control” shall be deemed to have occurred if:

(i) for any reason at any time less than seventy-five percent (75%) of the members of the KCS Board shall be individuals who fall into any of the following categories: (A) individuals who were members of the KCS Board on the date of the Agreement; or (B) individuals whose election, or nomination for election by KCS’s stockholders, was approved by a vote of at least seventy-five percent (75%) of the members of the KCS Board then still in office who were members of the KCS Board on the date of the Agreement; or (C) individuals whose election, or nomination for election, by KCS’s stockholders, was approved by a vote of at least seventy-five percent (75%) of the members of the KCS Board then still in office who were elected in the manner described in (A) or (B) above, or

(ii) any “person” (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934 (the “Exchange Act”)) other than KCS shall have become after September 18, 1997, according to a public announcement or filing, the “beneficial owner” (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of KCS, or Railway representing thirty percent (30%) (or, with respect to Paragraph 7(c) hereof, 40%) or more (calculated in accordance with Rule 13d-3) of the combined voting power of KCS’s or Railway’s or then outstanding voting securities; or

(iii) the stockholders of Railway or KCS shall have approved a merger, consolidation or dissolution of Railway or KCS or a sale, lease, exchange or disposition

of all or substantially all of Railway’s or KCS’s assets, if persons who were the beneficial owners of the combined voting power of Railway’s or KCS’s voting securities immediately before any such merger, consolidation, dissolution, sale, lease, exchange or disposition do not immediately thereafter, beneficially own, directly or indirectly, in substantially the same proportions, more than 60% of the combined voting power of any corporation or other entity resulting from any such transaction.

(e) Termination After Control Change Date . Notwithstanding any other provision of this Paragraph 7, at any time after the Control Change Date, KCS may terminate the employment of Executive (the “Termination”), but unless such Termination is for Cause as defined in subparagraph (g) or for disability, within five (5) days of the Termination KCS shall pay to Executive his full base salary through the Termination, to the extent not theretofore paid, plus a lump sum amount (the “Special Severance Payment”) equal to the product of: (i) 175% of his annual base salary specified in Paragraph 7(a) multiplied by (ii) Three ; and Specified Benefits (excluding any incentive compensation) to which Executive was entitled immediately prior to Termination shall continue until the end of the 3-year period (“Benefits Period”) beginning on the date of Termination. If any plan pursuant to which Specified Benefits are provided immediately prior to Termination would not permit continued participation by Executive after Termination, then KCS shall pay to Executive within five (5) days after Termination a lump sum payment equal to the amount of Specified Benefits Executive would have received under such plan if Executive had been fully vested in the average annual contributions or benefits in effect for the three plan years ending prior to the Control Change Date (regardless of any limitations based on the earnings or performance of KCS, or Railway) and a continuing participant in such plan to the end of the Benefits Period. Following the end of the Benefits Period, KCS shall continue to provide to the Executive and the Executive’s family the following benefits (“Post-Period Benefits”): (1) prior to the Executive’s attainment of age sixty (60), health, prescription and dental benefits equivalent to those then applicable to active peer executives of KCS) and their families, as the same may be modified from time to time, and (2) following the Executive’s attainment of age sixty (60) (and without regard to the Executive’s period of service with KCS) health and prescription benefits equivalent to those then applicable to retired peer executives of KCS and their families immediately prior to the Change of Control. The cost to the Executive of such Post-Period Benefits shall not exceed the cost of such benefits to active or retired (as applicable) peer executives immediately prior to the Change of Control. Notwithstanding the preceding two sentences of this Paragraph 7(e), if the Executive is covered under any health, prescription or dental plan provided by a subsequent employer, then the corresponding type of plan coverage (i.e., health, prescription or dental), required to be provided as Post-Period Benefits under this Paragraph 7(e) shall cease. The Executive’s rights under this Paragraph 7(e) shall be in addition to, and not in lieu of, any post-termination continuation coverage or conversion rights the Executive may have pursuant to applicable law, including without limitation continuation coverage required by Section 4980 of the Code. Nothing in this Paragraph 7(e) shall be deemed to limit in any manner the reserved right of KCS, in its sole and absolute discretion, to at any time amend, modify or terminate health, prescription or dental benefits for active or retired employees generally.

(f) Resignation After Control Change Date . In the event of a Change in Control as defined in Paragraph 7(d), thereafter, upon good reason (as defined below), Executive may, at any time during the three-year period following the Change in Control, in his sole

discretion, on not less than thirty (30) days’ written notice (the “Notice of Resignation”) to the Secretary of KCS and effective at the end of such notice period, resign his employment with KCS (the “Resignation”). Within five (5) days of such a Resignation, KCS shall pay to Executive his full base salary through the effective date of such Resignation, to the extent not theretofore paid, plus a lump sum amount equal to the Special Severance Payment (computed as provided in the first sentence of Paragraph 7(e), except that for purposes of such computation all references to “Termination” shall be deemed to be references to “Resignation”). Upon Resignation of Executive, Specified Benefits to which Executive was entitled immediately prior to Resignation shall continue on the same terms and conditions as provided in Paragraph 7(e) in the case of Termination (including equivalent payments provided for therein), and Post-Period Benefits shall be provided on the same terms and conditions as provided in Paragraph 7(e) in the case of Termination. For purposes of this Agreement, “good reason” means any of the following:

(i) the assignment of the Executive of any duties inconsistent in any respect with the Executive’s position (including offices, titles, reporting requirements or responsibilities), authority or duties as contemplated by Section 7(a)(i), or any other action by KCS which results in a diminution or other material adverse change in such position, authority or duties;

(ii) any failure by KCS to comply with any of the provisions of Paragraph 7;

(iii) KCS’s requiring the Executive to be based at any office or location other than the location described in Section 7(a)(ii);

(iv) any other material adverse change to the terms and conditions of the Executive’s employment; or

(v) any purported termination by KCS of the Executive’s employment other than as expressly permitted by this Agreement (any such purported termination shall not be effective for any other purpose under this Agreement).

A passage of time prior to delivery of the Notice of Resignation or a failure by the Executive to include in the Notice of Resignation any fact or circumstance which contributes to a showing of Good Reason shall not waive any right of the Executive under this Agreement or preclude the Executive from asserting such fact or circumstance in enforcing rights under this Agreement.

(g) Termination for Cause After Control Change Date . Notwithstanding any other provision of this Paragraph 7, at any time after the Control Change Date, Executive may be terminated by KCS “for cause.” Cause means commission by the Executive of any felony or willful breach of duty by the Executive in the course of the Executive’s employment; except that Cause shall not mean:

(i) bad judgment or negligence;

(ii) any act or omission believed by the Executive in good faith to have been in or not opposed to the interest of KCS or Railway (without intent of the Executive to gain, directly or indirectly, a profit to which the Executive was not legally entitled);

(iii) any act or omission with respect to which a determination could properly have been made by the KCS Board that the Executive met the applicable standard of conduct for indemnification or reimbursement under KCS’s by-laws, any applicable indemnification agreement, or applicable law, in each case in effect at the time of such act or omission; or

(iv) any act or omission with respect to which Notice of Termination of the Executive is given, more than 12 months after the earliest date on which any member of the KCS Board, not a party to the act or omission, knew or should have known of such act or omission.

Any Termination of the Executive’s employment by KCS for Cause shall be communicated to the Executive by Notice of Termination.

(h) Gross-up for Certain Taxes . If it is determined (by the reasonable computation of KCS’s independent auditors, which determinations shall be certified to by such auditors and set forth in a written certificate (“Certificate”) delivered to the Executive) that any benefit received or deemed received by the Executive from Railway, or KCS pursuant to this Agreement or otherwise (collectively, the “Payments”) is or will become subject to any excise tax under Section 4999 of the Code or any similar tax payable under any United States federal, state, local or other law (such excise tax and all such similar taxes collectively, “Excise Taxes”), then KCS shall, immediately after such determination, pay the Executive an amount (the “Gross-up Payment”) equal to the product of:

(i) the amount of such Excise Taxes; multiplied by

(ii) the Gross-up Multiple (as defined in Paragraph 7(k)).

The Gross-up Payment is intended to compensate the Executive for the Excise Taxes and any federal, state, local or other income or excise taxes or other taxes payable by the Executive with respect to the Gross-up Payment.

KCS shall cause the preparation and delivery to the Executive of a Certificate upon request at any time. KCS shall, in addition to complying with this Paragraph 7(h), cause all determinations and certifications under Paragraphs 7(h)-(o) to be made as soon as reasonably possible and in adequate time to permit the Executive to prepare and file the Executive’s individual tax returns on a timely basis.

(i) Determination by the Executive .

(i) If KCS shall fail (A) to deliver a Certificate to the Executive or (B) to pay to the Executive the amount of the Gross-up Payment, if any, within 14 days after receipt from the Executive of a written request for a Certificate, or if at any time following receipt of a Certificate the Executive disputes the amount of the Gross-up

Payment set forth therein, the Executive may elect to demand the payment of the amount which the Executive, in accordance with an opinion of counsel to the Executive (“Executive Counsel Opinion”), determines to be the Gross-up Payment. Any such demand by the Executive shall be made by delivery to KCS of a written notice which specifies the Gross-up Payment determined by the Executive and an Executive Counsel Opinion regarding such Gross-up Payment (such written notice and opinion collectively, the “Executive’s Determination”). Within 14 days after delivery of the Executive’s Determination to KCS, KCS shall either: (A) pay the Executive the Gross-up Payment set forth in the Executive’s Determination (less the portion of such amount, if any, previously paid to the Executive by KCS) or (B) deliver to the Executive a Certificate specifying the Gross-up Payment determined by KCS’s independent auditors, together with an opinion of KCS’s counsel (“KCS Counsel Opinion”), and pay the Executive the Gross-up Payment specified in such Certificate. If for any reason KCS fails to comply with clause (B) of the preceding sentence, the Gross-up Payment specified in the Executive’s Determination shall be controlling for all purposes.

(ii) If the Executive does not make a request for, and KCS does not deliver to the Executive, a Certificate, KCS shall, for purposes of Paragraph 7(j), be deemed to have determined that no Gross-up Payment is due.

(j) Additional Gross-up Amounts . If, despite the initial conclusion of KCS and/or the Executive that certain Payments are neither subject to Excise Taxes nor to be counted in determining whether other Payments are subject to Excise Taxes (any such item, a “Non-Parachute Item”), it is later determined (pursuant to subsequently-enacted provisions of the Code, final regulations or published rulings of the IRS, final IRS determination or judgment of a court of competent jurisdiction or KCS’s independent auditors) that any of the Non-Parachute Items are subject to Excise Taxes, or are to be counted in determining whether any Payments are subject to Excise Taxes, with the result that the amount of Excise Taxes payable by the Executive is greater than the amount determined by KCS or the Executive pursuant to Paragraph 7(h) or Paragraph 7(i), as applicable, then KCS shall pay the Executive an amount (which shall also be deemed a Gross-up Payment) equal to the product of:

(i) the sum of (A) such additional Excise Taxes and (B) any interest, fines, penalties, expenses or other costs incurred by the Executive as a result of having taken a position in accordance with a determination made pursuant to Paragraph 7(h); multiplied by

(ii) the Gross-up Multiple.

(k) Gross-up Multiple . The Gross-up Multiple shall equal a fraction, the numerator of which is one (1.0), and the denominator of which is one (1.0) minus the sum, expressed as a decimal fraction, of the rates of all federal, state, local and other income and other taxes and any Excise Taxes applicable to the Gross-up Payment; provided that, if such sum exceeds 0.8, it shall be deemed equal to 0.8 for purposes of this computation. (If different rates of tax are applicable to various portions of a Gross-up Payment, the weighted average of such rates shall be used.)

(l) Opinion of Counsel . “Executive Counsel Opinion” means a legal opinion of nationally recognized executive compensation counsel that there is a reasonable basis to support a conclusion that the Gross-up Payment determined by the Executive has been calculated in accord with this Paragraph 7 and applicable law. “Company Counsel Opinion” means a legal opinion of nationally recognized executive compensation counsel that (i) there is a reasonable basis to support a conclusion that the Gross-up Payment set forth in the Certificate of KCS’s independent auditors has been calculated in accord with this Paragraph 7 and applicable law, and (ii) there is no reasonable basis for the calculation of the Gross-up Payment determined by the Executive.

(m) Amount Increased or Contested . The Executive shall notify KCS in writing of any claim by the IRS or other taxing authority that, if successful, would require the payment by KCS of a Gross-up Payment. Such notice shall include the nature of such claim and the date on which such claim is due to be paid. The Executive shall give such notice as soon as practicable, but no later than 10 business days, after the Executive first obtains actual knowledge of such claim; provided, however, that any failure to give or delay in giving such notice shall affect KCS’s obligations under this Paragraph 7 only if and to the extent that such failure results in actual prejudice to KCS. The Executive shall not pay such claim less than 30 days after the Executive gives such notice to KCS (or, if sooner, the date on which payment of such claim is due). If KCS notifies the Executive in writing before the expiration of such period that it desires to contest such claim, the Executive shall:

(i) give KCS any information that it reasonably requests relating to such claim;

(ii) take such action in connection with contesting such claim as KCS reasonably requests in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by KCS;

(iii) cooperate with KCS in good faith to contest such claim; and

(iv) permit KCS to participate in any proceedings relating to such claim; provided, however, that KCS shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including related interest and penalties, imposed as a result of such representation and payment of costs and expenses. Without limiting the foregoing, KCS shall control all proceedings in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner. The Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as KCS shall determine; provided, however, that if KCS directs the Executive to pay such claim and sue for a refund, KCS shall advance the amount of such payment to the Executive, on are interest-free basis and shall indemnify

the Executive, on an after-tax basis, for any Excise Tax or income tax, including related interest or penalties, imposed with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. KCS’s control of the contest shall be limited to issues with respect to which a Gross-up Payment would be payable. The Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the IRS or other taxing authority.

(n) Refunds . If, after the receipt by the Executive of an amount advanced by KCS pursuant to Paragraph 7(m), the Executive receives any refund with respect to such claim, the Executive shall (subject to KCS’s complying with the requirements of Paragraph 7(m)) promptly pay KCS the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by KCS pursuant to Paragraph 7(m), a determination is made that the Executive shall not be entitled to a full refund with respect to such claim and KCS does not notify the Executive in writing of its intent to contest such determination before the expiration of 30 days after such determination, then the applicable part of such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-up Payment required to be paid. Any contest of a denial of refund shall be controlled by Paragraph 7(m).

(o) Expenses . If any dispute should arise under this Agreement after the Control Change Date involving an effort by Executive to protect, enforce or secure rights or benefits claimed by Executive hereunder, KCS shall pay (promptly upon demand by Executive accompanied by reasonable evidence of incurrence) all reasonable expenses (including attorneys’ fees) incurred by Executive in connection with such dispute, without regard to whether Executive prevails in such dispute except that Executive shall repay KCS any amounts so received if a court having jurisdiction shall make a final, non-appealable determination that Executive acted frivolously or in bad faith by such dispute. To assure Executive that adequate funds will be made available to discharge KCS’s obligations set forth in the preceding sentence, KCS has established a trust and upon the occurrence of a Change in Control shall promptly deliver to the trustee of such trust to hold in accordance with the terms and conditions thereof that sum which the KCS Board shall have determined is reasonably sufficient for such purpose.

(p) Prevailing Provisions . On and after the Control Change Date, the provisions of this Paragraph 7 shall control and take precedence over any other provisions of this Agreement which are in conflict with or address the same or a similar subject matter as the provisions of this Paragraph 7.

8. Mitigation and Other Employment . After a termination of Executive’s employment pursuant to Paragraph 4(d)(i) or a Change in Control as defined in Paragraph 7(d), Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise, and except as otherwise specifically provided in Paragraph 4(d)(ii) with respect to health and life insurance and in Paragraph 7(e) with respect to health, prescription and dental benefits, no such other employment, if obtained, or compensation or benefits payable in connection therewith shall reduce any amounts or benefits

to which Executive is entitled hereunder. Such amounts or benefits payable to Executive under this Agreement shall not be treated as damages but as severance compensation to which Executive is entitled because Executive’s employment has been terminated.

9. Notice . Notices and all other communications to either party pursuant to this Agreement shall be in writing and shall be deemed to have been given when personally delivered, delivered by facsimile or deposited in the United States mail by certified or registered mail, postage prepaid, addressed to KCS at P.O. Box 219335, Kansas City, Missouri 64121-9335, Attention: Secretary, or, in the case of the Executive, to him at 4952 West 132 ^nd Terrace, Leawood, Kansas 66209 , or to such other address as a party shall designate by notice to the other party.

10. Amendment . No provision of this Agreement may be amended, modified, waived or discharged unless such amendment, waiver, modification or discharge is agreed to in writing signed by Executive, and the President of KCS. No waiver by any party hereto at any time of any breach by another party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the time or at any prior or subsequent time.

11. Successors in Interest . The rights and obligations of KCS under this Agreement shall inure to the benefit of and be binding in each and every respect upon the direct and indirect successors and assigns of KCS, regardless of the manner in which such successors or assigns shall succeed to the interest of KCS hereunder, and this Agreement shall not be terminated by the voluntary or involuntary dissolution of KCS or Railway or by any merger or consolidation or acquisition involving KCS or Railway, or upon any transfer of all or substantially all of KCS’s or Railway’s assets, or terminated otherwise than in accordance with its terms. In the event of any such merger or consolidation or transfer of assets, the provisions of this Agreement shall be binding upon and shall inure to the benefit of the surviving corporation or the corporation or other person to which such assets shall be transferred. Neither this Agreement nor any of the payments or benefits hereunder may be pledged, assigned or transferred by Executive either in whole or in part in any manner, without the prior written consent of KCS.

12. Severability . The invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions hereof, and this Agreement shall be construed in all respects as if such invalid or unenforceable provisions were omitted.

13. Controlling Law and Jurisdiction . The validity, interpretation and performance of this Agreement shall be subject to and construed under the laws of the State of Missouri, without regard to principles of conflicts of law.

14. Entire Agreement . This Agreement constitutes the entire agreement among the parties with respect to the subject matter hereof and terminates and supersedes all other prior agreements and understandings, both written and oral, between the parties with respect to the terms of Executive’s employment or severance arrangements.

IN WITNESS WHEREOF , the parties hereto have executed this Amended and Restated Agreement as of the 1st day of October, 2004.


		KANSAS CITY SOUTHERN

		By:		/s/ Michael R. Haverty


		Michael R. Haverty, Chairman, President, and CEO


		EXECUTIVE

		/s/ Robert B. Terry


						Robert B. Terry

Appendix A

WAIVER AND RELEASE

In consideration of the benefits described in the Employment Agreement, I do hereby fully waive all claims and release Kansas City Southern (KCS), and its affiliates, parents, subsidiaries, successors, assigns, directors and officers, fiduciaries, employees and agents, as well as any employee benefit plans from liability and damages related in any way to any claim I may have against or KCS. This waiver and release includes, but is not limited to all claims, causes of action and rights under Title VII of the Civil Rights Act of 1964, as amended; the Civil Rights Act of 1991; the Age Discrimination in Employment Act of 1967, as amended; the Civil Rights Act of 1866; the American with Disabilities Act of 1990; the Rehabilitation Act of 1973; the Older Workers Benefit Protection Act of 1990; the Employee Retirement Income Security Act of 1974, as amended; the Worker Adjustment and Retraining Notification Act; the Family and Medical Leave Act; the Federal Employers Liability Act; the Railway Labor Act, including bumping rights, rights to file a grievance, rights to a hearing (whether before any company official, any system, group, regional or special adjustment board, the National Railroad Adjustment Board, or any other entity), and any rights to arbitration thereunder; the Missouri Human Rights Act, the Kansas Act Against Discrimination, the Kansas and Missouri Workers’ Compensation acts, and all local state and federal statutes and regulations; all claims arising from labor protective conditions imposed by the Interstate Commerce Commission or the Surface Transportation Board; all any KCSR incentive or benefit plan or program, and any rights under any collective bargaining agreement, including seniority rights, bumping rights and reinstatement rights, rights to file or assert a grievance or other complaint, rights to a hearing, or rights to arbitration under such agreement; and all rights under common law such as breach of contract, tort or personal injury of any sort.

I understand that this Agreement and Release also precludes me from recovering any relief as a result of any lawsuit, grievance or claims brought on my behalf and arising out of my employment or resignation of, or separation from employment, provided that nothing in this Agreement and this Release may affect my entitlement, if any, to workers’ compensation or unemployment compensation. Additionally, nothing in this Agreement and Release prohibits me from communications with, filing a complaint with, or full cooperation in the investigations of, any governmental agency on matters within their jurisdictions. However, as stated above, this Agreement and Release does prohibit me from recovering any relief, including monetary relief, as a result of such activities.

If any term, provision, covenant, or restriction of this Agreement and Release is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of this Agreement and Release and the other terms, provisions, covenants and restrictions hereof shall remain in full force and effect and shall in no way be affected, impaired or invalidated. I understand and agree that, in the event of breach by me of any of the terms and conditions of this Agreement and Release, the Railway will be entitled to recover all costs and expenses as a result of my breach, including but not limited to, reasonable attorneys’ fees and costs.

I have read this Agreement and Release and I understand all of its terms. I enter into and sign this Agreement and Release knowingly and voluntarily, with full knowledge of what it means.


/s/ Robert B. Terry		October 1, 2004

Employee Signature		Date

Robert B. Terry		(Contained within original)

Employee Name(Please Print)		Social Security Number

Exhibit 10.46

EXECUTION COPY

TRANSACTION AGREEMENT

BY AND AMONG

KANSAS CITY SOUTHERN,

THE KANSAS CITY SOUTHERN RAILWAY COMPANY,

NORFOLK SOUTHERN CORPORATION,

AND

THE ALABAMA GREAT SOUTHERN RAILROAD
COMPANY

DATED AS OF

DECEMBER 1, 2005

TABLE OF CONTENTS


			Page
1.	Definitions			2
	1.1	Certain Definitions		2
	1.2	Construction of Certain Terms and Phrases		12

2.	Purchase and Sale of Membership Interest			12
	2.1	Purchase and Sale of Membership Interest		12
	2.2	Use of Proceeds		13

3.	Contribution of Assets and Assumption of Liabilities			13
	3.1	Contribution of Assets		13
	3.2	Transfer of Liabilities		15

4.	Partner Financing			15

5.	Intentionally Omitted			16

6.	The Closing			16
	6.1	The Closing		16

7.	Deliveries at the Closing			16
	7.1	Deliveries at the Closing		16
	7.2	Further Assurances		17

8.	Representations and Warranties of KCS and KCSR			17
	8.1	Organization, Standing and Power		17
	8.2	Authority; Enforceability; Noncontravention		17
	8.3	Assets		18
	8.4	Material Contracts		18
	8.5	Absence of Certain Changes and Events		20
	8.6	Litigation and Proceedings		20
	8.7	Environmental Matters		21
	8.8	Compliance With Laws and Other Matters		21
	8.9	Labor Relations		22
	8.10	Taxes		23
	8.11	Insurance		23
	8.12	Books and Records		24
	8.13	Transactions with Affiliates		24
	8.14	Real Property		24
	8.15	Brokers		26

9.	Representations and Warranties of NS			26
	9.1	Organization, Standing and Power		26


			Page
	9.2	Authority; Enforceability; Noncontravention		26
	9.3	Brokers		27
	9.4	Sufficient Funds		27

10.	Covenants			27
	10.1	Operation of the Line by KCS and KCSR		27
	10.2	Inspection of Records; Environmental Audits		28
	10.3	Alternative Proposals		29
	10.4	Confer with NS		30
	10.5	Commercially Reasonable Efforts		30
	10.6	Real Estate Matters		31
	10.7	Publicity		31
	10.8	Standstill		31
	10.9	Encumbrance and Transfer of Assets; Indentures		32
	10.10	Option to Acquire the Line		32
	10.11	Determination and Payment of Real Property Taxes		35
	10.12	NS Automotive Traffic		36
	10.13	Vicksburg Bridge Lease Dispute		36

11.	Conditions to the Closing			36
	11.1	Mutual Conditions		36
	11.2	Additional Conditions of NS		36
	11.3	Additional Conditions of KCS		37

12.	Survival of Representations and Warranties; Indemnity			38
	12.1	Survival of Representations and Warranties		38
	12.2	Indemnification by KCS		39
	12.3	Indemnification by NS		40
	12.4	Notification of Claims		40
	12.5	Matters Involving Third Parties		41
	12.6	Taxes		42
	12.7	Other Limits on Indemnification		42

13.	Termination			43
	13.1	Termination by Mutual Consent		43
	13.2	Termination by Final Order		43
	13.3	Termination by NS		43
	13.4	Termination by KCS		44
	13.5	Effect of Termination		45

14.	Miscellaneous			45
	14.1	Notices		45
	14.2	Entire Agreement		46
	14.3	Assignment		46
	14.4	Extension, Waiver and Amendment		46
	14.5	Governing Law; Submission to Jurisdiction		46
	14.6	Specific Performance; Injunctive Relief		47


		Page
14.7	Severability		47
14.8	Captions		47
14.9	Counterparts		47
14.10	Costs and Attorneys' Fees		47
14.11	Judicial Interpretation		47
14.12	No Third Party Beneficiaries		48
14.13	Dispute Resolution		48

iii

TRANSACTION AGREEMENT

THIS TRANSACTION AGREEMENT (this “Agreement”) is made and entered into as of December 1, 2005, by and among KANSAS CITY SOUTHERN, a Delaware corporation (“KCS”), THE KANSAS CITY SOUTHERN RAILWAY COMPANY, a Missouri corporation and Subsidiary of KCS (“KCSR”), NORFOLK SOUTHERN CORPORATION, a Virginia corporation (“NS”), and THE ALABAMA GREAT SOUTHERN RAILROAD COMPANY, an Alabama corporation and Subsidiary of NS (“AGS”), with reference to the following facts:

	A.		KCS, through KCSR, currently owns or operates certain properties, trackage rights, signals, equipment, and other rights, Permits, claims, contracts and assets related thereto, in each case, as set forth on Annex A hereto (collectively, the “Assets”), constituting the rail line between Meridian, Mississippi and Shreveport, Louisiana identified on Annex B (the “Line”).

	B.		KCS and NS have determined that it is advisable to form a joint venture which will own such Assets, and, at the Closing, KCS and NS, through AGS, will form a limited liability company (the “Company”) for the purpose of effecting the joint venture contemplated hereby and enter into a Limited Liability Company Agreement substantially in the form attached hereto as Exhibit A (the “Company Agreement”) setting forth their rights and obligations as members of the Company.

	C.		On the terms and subject to the conditions contained herein, KCS desires to, and desires to cause KCSR to, contribute the Assets to the Company in exchange for a 70% membership interest in the Company, (as contemplated by the Company Agreement), and NS desires to cause AGS to contribute the amounts contemplated by Schedule 2.1(a) to the Company in exchange for a 30% membership interest in the Company.

	D.		In connection with the transactions contemplated by this Agreement and the Company Agreement, at the Closing, the parties will enter into, or will cause the Company or their respective Affiliates to enter into, as applicable: (i) an Operating Agreement substantially in the form attached hereto as Exhibit B (the “Operating Agreement”), (ii) an NSR Joint Use Agreement substantially in the form attached hereto as Exhibit C (the “NSR Joint Use Agreement”), (iii) a KCSR Joint Use Agreement substantially in the form attached hereto as Exhibit D (the “KCSR Joint Use Agreement”), (iv) a Western Haulage Agreement substantially in the form attached hereto as Exhibit E, (v) a KCSR Master Interchange Agreement substantially in the form attached hereto as Exhibit F, (vi) a Unified Assignment and Assumption

Agreement substantially in the form attached hereto as Exhibit G, (vii) the Vicksburg Assignment Agreement (as defined in Section 3.1(b)), (viii) the Jackson Assignment Agreement (as defined in Section 3.1(c)), (ix) one or more Notes (as defined in Section 4), (x) the Omnibus Bill of Sale attached hereto as Exhibit H, (xi) the Unified Liability Agreement attached hereto as Exhibit I, (xii) the Dallas Terminal Marketing Agreement attached hereto as Exhibit J, (xiii) the NSR – KCSR Haulage Agreement (as defined in Section 3.1(c)) and (xiv) the Access Agreement (as defined in Section 10.2(c)) (collectively, the “Ancillary Agreements”).

NOW, THEREFORE, with reference to the foregoing facts and in consideration of the mutual agreements and understandings set forth herein, the parties hereto, intending to be legally bound, hereby agree as follows:

Definitions .

1.1 Certain Definitions . All terms defined in this Agreement shall have the defined meanings when used in this Agreement or in any agreement, note, certificate, report or other document made or delivered pursuant to this Agreement, unless otherwise defined or the context otherwise requires. The following terms shall have the following meanings:

“AAA” shall have the meaning given to that term in Section 14.13.

“Access Agreement” shall have the meaning given to that term in Section 10.2(c).

“Action” means any litigation, action, suit, proceeding, investigation, arbitration, claim or other dispute by or before any court or other Governmental Authority, or any other alternative dispute resolution proceedings, such as arbitration or mediation.

“Affiliate” shall mean, with respect to any specified Person, (i) any other Person who, directly or indirectly, controls, is under common control with, or is controlled by, such specified Person, (ii) any other Person who is a director, officer, manager, member, partner or trustee of the specified Person or a Person described in clause (i) of this definition or any spouse of the specified Person or any such other Person or (iii) any Person of which the specified Person and/or any one or more of the Persons specified in clause (i) or (ii) of this definition, individually or in the aggregate, beneficially own 10% or more of any class of voting securities.

“Aggregate NS Consideration” shall have the meaning given to that term in Schedule 2.1(a).

“Agreement” shall have the meaning given to that term in the Recitals.

“AGS” shall have the meaning given to that term in the Recitals.

“Alternative Proposal” shall have the meaning given to that term in Section 10.3.

“Ancillary Agreements” shall have the meaning given to that term in the Recitals.

“Anniversary Date” shall have the meaning given to that term in Section 2.1(b).

“Appraiser” shall have the meaning given to that term in Section 10.10(d).

“Appraisal Report” shall have the meaning given to that term in Section 10.10(e).

“Assets” shall have the meaning given to that term in the Recitals.

“Assumed Liabilities” shall have the meaning given to that term in Section 3.2(a).

“Business Combination” shall have the meaning given to that term in Section 10.8.

“Business Day” shall mean any day other than a Saturday or Sunday or any day banks in the State of New York are authorized or required to be closed.

“Canadian National” shall mean the Canadian National Railway Company.

“Capital Contribution Amount” shall mean, on any given date, the total of the KCSR Borrowing Capacity and the Company Capital Amount.

“Capital Proceeds” shall have the meaning given to that term in Section 2.2.

“Charter Documents” shall mean the certificate of incorporation or articles of incorporation and the by-laws, with respect to a corporation; the partnership agreement, with respect to a general partnership; or the certificate of formation and operating or company agreement, with respect to a limited liability company.

“Cleanup” shall mean all actions, including investigations, required by Law to: (1) cleanup, remove, treat or remediate Hazardous Materials in the environment; (2) prevent the Release of Hazardous Materials so that they do not migrate, endanger or threaten to endanger public health or welfare or the environment; (3) perform pre-remedial studies and investigations and post-remedial monitoring and care; or (4) respond to any government requests for information or documents in any way relating to cleanup, removal, treatment or remediation or potential cleanup, removal, treatment or remediation of Hazardous Materials in the environment.

“Closing” shall mean the closing of the purchase and sale of the NS Interest on the Closing Date as contemplated by Section 2.1(a) and the contribution of the Assets in exchange for the KCS Interest.

“Closing Date” shall have the meaning given to that term in Section 6.1.

“Company” shall have the meaning given to that term in the Recitals.

“Company Agreement” shall have the meaning given to that term in the Recitals.

“Company Capital Amount” shall mean, as of any determination date, the total amount that the Company will be able to expend for capital improvements on the Line within one-hundred eighty (180) days of such date in accordance with Section 4.06(iii) of the Indentures which improvements were not the subject of any prior calculation of the Company Capital Amount.

“Company Indemnified Parties” shall have the meaning given to that term in Section 12.2(a).

“Company Line Assets” shall have the meaning given to that term in Section 10.10(a)(ii).

“Confidentiality Agreement” shall have the meaning given to that term in Section 10.2(a).

“Contract” shall mean any note, bond, debenture, mortgage, license, agreement, commitment, contract, obligation, promise or understanding.

“Conveying Party ” shall have the meaning given to that them in Section 3.1(c).

“Damages” shall have the meaning given to that term in Section 12.2(a).

“Delaware Courts” shall have the meaning given to that term in Section 14.5(b).

“Dispute” shall have the meaning given to that term in Section 14.13.

“Dispute Notice” shall have the meaning given to that term in Section 14.13.

“Disclosure Schedule” shall have the meaning given to that term in Article 8.

“Environmental Claim” means any fine, claim, action, lien, cause of action, investigation or notice by any Person alleging potential liability (including potential liability for Cleanup costs, governmental response costs, natural resources

damages, property damages, personal injuries, or penalties) arising out of, based on or resulting from (a) the presence, Release or threatened Release of any Hazardous Materials, or (b) circumstances forming the basis of any violation of any Environmental Law.

“Environmental Laws” means all Laws relating to pollution or protection of human health or the environment, including all Laws relating to Releases or threatened Releases of Hazardous Materials or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, Release, disposal, transport or handling of Hazardous Materials, all Laws relating to record keeping, notification, disclosure and reporting requirements respecting Hazardous Materials and all Laws relating to endangered or threatened species of fish, wildlife and plants and natural resources.

“Environmental Reports” shall have the meaning given to that term in Section 8.7(d).

“Excess Capital” shall have the meaning given to that term in Section 2.2.

“Excess Proceeds” shall have the meaning given to that term in Section 2.2.

“Excluded Assets” shall have the meaning given to that term in Section 8.3.

“Governmental Authority” shall mean any nation or government, any state or other political subdivision thereof, and any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government or any mediation body or arbitral tribunal, including the STB.

“Hazardous Materials” shall mean all substances defined as Hazardous Substances, Oils, Pollutants or Contaminants in the National Oil and Hazardous Substances Pollution Contingency Plan, 40 C.F.R. § 300.5, or defined as such by, or regulated as such under, any Environmental Law.

“Indebtedness” means, with respect to any Person, (i) any liability, contingent or otherwise, (a) for borrowed money, capitalized lease obligations, purchase money obligations or other obligations relating to the deferred purchase price of assets or property or (b) evidenced by a note, bond, debenture, letter of credit or similar instrument given in connection with the acquisition, other than in the ordinary course of business consistent with past practice, of any property, assets, securities or otherwise, including indebtedness created or arising under conditional sale or other title retention agreements (even though the rights and remedies of the seller or lender under the agreements in the event of default are limited to repossession or sale of the property), (ii) any liability of others described in the preceding clause (i) which such Person has guaranteed or which otherwise is its legal liability, (iii) all indebtedness referred to above secured by (or for which the holder of the indebtedness has an existing right, contingent or otherwise, to be secured by), any Lien upon the property of such Person, whether or not the obligations secured thereby have been assumed, and (iv) any amendment, renewal, extension or

refunding of any liability referred to in clauses (i), (ii) and (iii) above; provided , however , that Indebtedness does not include any trade payables of any Person incurred in the ordinary course of business consistent with past practice. The amount of Indebtedness of any Person at any date shall be the outstanding balance at the date of all unconditional obligations as described above and the maximum amount of any contingent obligations at the date.

“Indemnified Party” shall have the meaning given to that term in Section 12.4.

“Indemnifying Party” shall have the meaning given to that term in Section 12.4.

“Indentures” shall mean, collectively, the Indenture, dated as of September 27, 2000, among KCSR, KCS, certain Subsidiaries of KCS and The Bank of New York, as trustee, governing the terms of KCS’ 9 ¹ / 2 % Senior Notes due 2008 and the Indenture, dated as of June 12, 2002, among KCSR, KCS, certain Subsidiaries of KCS and U.S. Bank National Association, as trustee, governing the terms of KCS’ 7 ¹ / 2 % Senior Notes due 2009, as they may be amended from time to time.

“Issuance Date” shall have the meaning given to that term in Schedule 2.1(a).

“Jackson Assignment Agreement” shall have the meaning given to that term in Section 3.1(c).

“Jackson Flyover” shall mean a bridge to carry the Company’s tracks over the real property and tracks of Canadian National Railway Company (or its Subsidiaries) located at Jackson, Mississippi which establishes a continuous line of rail between Meridian, Mississippi and Shreveport, Louisiana.

“KCS” shall have the meaning given to that term in the Recitals.

“KCSR Borrowing Capacity” shall mean, as of any determination date, the total amount of previously unborrowed funds that KCSR (or any other Subsidiary of KCS which is on such date a party to the Company Agreement) is permitted to borrow from the Company pursuant to a Note on such date without violating in any respect the KCS Credit Agreement, the Indentures or any other Contract evidencing more than $100,000 of Indebtedness to which it is a party on such date; it being understood that, in no event shall the KCSR Borrowing Capacity, together with all funds previously borrowed pursuant to any Note (including any Note evidencing the borrowing of the Excess Proceeds contemplated by Section 4), exceed $300,000,000.

“KCS Credit Agreement” shall mean the Credit Agreement dated as of March 30, 2004 among KCSR, KCS, certain subsidiaries of KCS and Lenders (as defined therein), as amended through the date hereof.

“KCS Credit Agreement Amendment No. 2” shall mean Amendment No. 2 to the Credit Agreement, dated as of September 30, 2005, among KCSR, KCS, the subsidiary guarantors listed on the signature page thereto, the Lender Parties (as defined therein) thereto and The Bank of Nova Scotia.

“KCS Interest” shall have the meaning given to that term in Section 3.1.

“KCSR Joint Use Agreement” shall have the meaning given to that term in the Recitals.

“KCS Line Assets” shall have the meaning given to that term in Section 10.10(a).

“KCS Membership Interests” shall have the meaning given to that term in Section 10.10(a)(i).

“KCSR” shall have the meaning given to that term in the Recitals.

“Knowledge” with respect to KCS shall mean the actual knowledge, after due inquiry into the matter in question, of any of the Persons listed on Schedule 1.1(a) hereto.

“Law” shall mean any U.S. federal, state or local or foreign statute, law, rule, regulation, ordinance, order, code, policy or rule of common law, now or hereafter in effect and, in each case, as amended, any binding judicial or administrative interpretation thereof by a Governmental Authority or otherwise, including any judicial or administrative order, consent, decree or judgment; provided that, each reference to “Law” in Sections 8 and 9 of this Agreement shall mean only a Law in effect as of the date of this Agreement.

“Lease” shall have the meaning given to that term in Section 8.4(b)(viii).

“Leased Personal Property” shall mean all personal property leased by KCS and its Affiliates which is included in the Assets.

“Leased Property” shall have the meaning given to that term in Section 8.14(b).

“Lien” shall mean any mortgage, deed of trust, pledge, security interest, hypothecation, assignment, deposit arrangement, encumbrance, lien (statutory or other), or preference, purchase option, right of first offer, right of first refusal, priority or other security agreement (including any conditional sale or other title retention agreement, any financing lease having substantially the same economic effect as any of the foregoing, and the filing of any financing statement under the Uniform Commercial Code or comparable Law of any jurisdiction to evidence any of the foregoing).

“Line” shall have the meaning given to that term in the Recitals.

“Line Assets” shall have the meaning given to that term in Section 10.10(a).

“Line FMV” shall have the meaning given to that term in Section 10.10(d)(i).

“Line Option” shall have the meaning given to that term in Section 10.10(a).

“Line Option Exercise Notice” shall have the meaning given to that term in Section 10.10(g).

“Line Option Notice” shall have the meaning given to that term in Section 10.10(a).

“Line Option Valuation Notice” shall have the meaning given to that term in Section 10.10(d).

“Material Adverse Effect” shall mean, with respect to any party, any change, circumstance, event or effect which, individually or when considered in conjunction with other changes, circumstances or effects, has had or would reasonably be likely to have a material adverse effect on (a) with respect to a Material Adverse Effect on KCS and KCSR, the Assets, taken as a whole, or the financial condition or results of operations of the business of the Company to be conducted with the Assets after the Closing, taken as a whole, or (b) any party, the ability of such party to consummate the transactions contemplated by this Agreement, the Ancillary Agreements or the Company Agreement or to perform its obligations hereunder or thereunder; provided , that none of the following shall be deemed to constitute, and none of the following shall be taken into account in determining whether there has been, a Material Adverse Effect: (x) any adverse change, event, development, or effect arising from or relating to (1) general business or economic conditions, including conditions related to the prospective business of the party and including changes in energy prices or availability, except to the extent that such conditions disproportionately affect such party’s business relative to the effect of such factors on other Persons operating in such party’s industry, (2) national or international political or social conditions, including the engagement by the United States in hostilities, whether or not pursuant to the declaration of a national emergency or war, or the occurrence of any military or terrorist attack upon the United States, or any of its territories, possessions, or diplomatic or consular offices or upon any military installation, equipment or personnel of the United States, except to the extent that such conditions disproportionately affect such party’s business relative to the effect of such factors on other Persons operating in such party’s industry, (3) financial, banking, or securities markets (including any disruption thereof and any decline in the price of any security or any market index), (4) changes in United States generally accepted accounting principles, (5) changes in Law or (6) the taking of any action contemplated by this Agreement and the other agreements contemplated hereby, (y) any of the events, occurrences, or circumstances set forth in Schedule 1.1(b) and (z) any change, occurrence, event or effect, which shall have been cured without a Material Adverse Effect (excluding this clause (z)),

on the Assets, before the earlier of the Closing Date or the date on which this Agreement is terminated pursuant to Section 13.

“Material Contracts” shall have the meaning given to that term in Section 8.4(b).

“Membership Interest FMV” shall have the meaning given to that term in Section 10.10(d)(ii).

“MSR Jackson Trackage Rights” shall mean that certain trackage rights agreement, as supplemented and amended from time to time, dated March 26, 1986, between Midsouth Rail Corporation and Illinois Central Gulf Railroad Corporation, and the underlying right of movement, pursuant to which KCSR (as successor to Midsouth Rail Corporation) operates over an approximately four-tenths (0.4) of a mile section of track in Jackson, Mississippi that is controlled by Canadian National (as successor to Illinois Central Gulf Railroad Corporation).

“Notes” shall have the meaning given to that term in Section 4.

“Notices” shall have the meaning given to that term in Section 14.1.

“NS” shall have the meaning given to that term in the Recitals.

“NS Closing Cash Purchase Price” shall mean the NS Consideration payable by NS on the Closing Date as determined in accordance with Schedule 2.1(a).

“NS Consideration” shall have the meaning given to that term in Schedule 2.1(a).

“NS Indemnified Parties” shall have the meaning given to that term in Section 12.2(a).

“NS Interest” shall have the meaning given to that term in Section 2.1(a).

“NSR” shall mean Norfolk Southern Railway Company, a Virginia corporation and Subsidiary of NS.

“NSR Joint Use Agreement” shall have the meaning given to that term in the Recitals.

“Officer’s Certificate” shall have the meaning given to that term in Section 2.1(b).

“Operating Agreement” shall have the meaning given to that term in the Recitals.

“Owned Property” shall have the meaning given to that term in Section 8.14(a).

“Partner Financing” shall have the meaning given to that term in Article 4.

“Permitted Liens” shall mean collectively, (i) Liens for Taxes not yet due and payable or which are being contested in good faith by appropriate proceedings and for which adequate reserves have been made; (ii) such imperfections of title, easements and other similar encumbrances, if any, as do not, individually or in the aggregate, interfere in any material respect with the use of any Owned Property as such Owned Property is used on the date of this Agreement; (iii) mechanics’, materialmen’s, workmen’s, repairmen’s, warehousemen’s, carrier’s and other similar Liens arising in the ordinary course of business consistent with past practice, all of which shall be released at or prior to the Closing; (iv) Liens arising under the Indentures; or (v) those Liens set forth on Schedule 1.1(c) hereto.

“Permits” shall have the meaning given to that term in Section 8.8(b).

“Person” shall mean an individual or a partnership, corporation, trust, association, limited liability company, Governmental Authority or other entity.

“Preferred Return” shall have the meaning given to that term in the Company Agreement.

“Preferred Return Amount” shall have the meaning given to that term in the Company Agreement.

“Property” shall have the meaning given to that term in Section 8.14(c).

“Release” means any release, spill, emission, discharge, leaking, pumping, injection, deposit, disposal, or leaching into the environment (including ambient air, surface water, groundwater and surface or subsurface strata) or into or out of any property, including the movement of Hazardous Materials through or in the air, soil, surface water, groundwater or property.

“Required Governmental Consents” shall have the meaning given to that term in Section 10.5.

“Restricted Subsidiary” shall have the meaning given to that term in the Indentures.

“Retained Interests” shall have the meaning given to that term in Section 3.1(d).

“Rules” shall have the meaning given to that term in Section 14.13.

“Standstill Period” shall have the meaning given to that term in Section 10.8.

“STB” shall mean the Surface Transportation Board or any successor entity thereto.

“Subsidiary” of any Person shall mean any entity of which such Person owns, directly or indirectly, securities or other ownership interests having the power to elect a majority of the board of directors or other persons performing similar functions, or otherwise having the power to direct, manage or control the conduct of business of such entity.

“Tax Return” shall mean any report, return, document, declaration or other information or filing (including any amendment thereto) with respect to Taxes required by Law to be supplied to any Governmental Authority (foreign or domestic) or to be collected or maintained, including information returns, any documents accompanying payments of estimated Taxes, or requests for the extension of time in which to file any such report, return, document, declaration or other information or filing.

“Taxes” shall mean all federal, state, local, foreign and other taxes, customs, duties, fees, levies, assessments or charges of any kind whatsoever, including all net income, gross income, gross receipts, sales, use, ad valorem, transfer, franchise, profits, license, withholding, payroll, employment, excise, estimated, severance, stamp, occupation, real or personal property, business, documentary, registration, filing, recordation, unemployment, worker’s compensation, commercial rent, premium, windfall profits, deemed profits, lease, capital, production, corporation, value added, bulk sale or other taxes, customs, duties, fees, levies, assessments or charges of any kind whatsoever, together with any interest and any penalties, additions to tax or additional amounts imposed by any Governmental Authority (domestic or foreign) regardless of whether disputed or whether related to the filing of a Tax Return (or the failure to file a Tax Return).

“Terminal” shall have the meaning given to that term in Section 8.14(a).

“Third Party Claim” shall have the meaning given to that term in Section 12.5(a).

“Third Party Leases” shall have the meaning given to that term in Section 8.4(b)(ix).

“Title Company” shall have the meaning given to that term in Section 10.6(b).

“Transfer” shall mean sell, assign, transfer, pledge, grant a security interest in, or otherwise dispose of, with or without consideration, and “Transferred” shall have a correlative meaning.

“Vicksburg Assignment Agreement” shall have the meaning given to that term in Section 3.1(b).

“Vicksburg Bridge Lease” shall mean that certain lease, as supplemented, amended and/or replaced from time to time, dated February 11, 1928 between Vicksburg Bridge and Terminal Company and The Yazoo and Mississippi Valley Railroad Company, pursuant to which KCSR leases that certain railroad bridge over the Mississippi River at Vicksburg, MS.

1.2 Construction of Certain Terms and Phrases . Unless the context otherwise requires, (a) words of any gender include each other gender; (b) words using the singular or plural number also include the plural or singular number, respectively; (c) the terms “hereof,” “herein,” “hereby” and derivative or similar words refer to this entire Agreement; (d) the terms “Article” or “Section” refers to the specified Article or Section of this Agreement; (e) the terms “and” and “or” include the term “and/or” when the context is appropriate; (f) the terms “include” or “including” also include the words “without limitation” when the context is appropriate; and (g) the phrases “ordinary course of business” and “ordinary course of business consistent with past practice” refer to the business and practice of the Person specified or, in the case of the operation of the Line, the business and practice of KCS, KCSR and their respective Subsidiaries with respect to the Assets. Whenever this Agreement refers to a number of days, such number shall refer to calendar days unless Business Days are specified. All accounting terms used herein and not expressly defined herein shall have the meanings given to them under generally accepted accounting principles, as in effect in the United States of America. Whenever this Agreement refers to an Exhibit or Schedule attached hereto, the Exhibit or Schedule shall be deemed to be incorporated by reference.

2. Purchase and Sale of Membership Interest .

2.1 Purchase and Sale of Membership Interest .

(a) KCS shall prepare and deliver to NS at least ten (10) Business Days prior to the Closing Date a certificate duly executed by the chief financial officer of KCS certifying as of such date the Capital Contribution Amount (each such certificate, an “Officer’s Certificate”). Subject to the terms and conditions of this Agreement, at the Closing, KCS and NS shall cause the Company to issue and sell to AGS, and NS shall cause AGS to purchase from the Company, up to a 30% membership interest in the Company (as adjusted pursuant to Section 2.1(b), the “NS Interest”) in exchange for cash consideration, in each case, as determined in accordance with Schedule 2.1(a).

(b) Within ten (10) Business Days prior to each six-month anniversary of the Closing Date (each, an “Anniversary Date”) until the NS Interest represents a 30% membership interest in the Company, KCS shall prepare and deliver to NS an Officer’s Certificate. Subject to the terms and conditions of this Agreement, on each Anniversary Date, KCS and NS shall cause the Company to issue and sell to AGS, and NS shall cause AGS to purchase from the Company, in exchange for cash consideration determined in accordance with Schedule 2.1(a), an additional membership interest in the Company such that, upon the issuance thereof, AGS and KCS will hold the

respective percentage membership interests in the Company, in each case, determined in accordance with Schedule 2.1(a).

2.2 Use of Proceeds . KCS and NS shall cause the Company to use $260,000,000 of the proceeds from the sale of the NS Interest plus any interest earned thereon from time to time (the “Capital Proceeds”) for the capital expenditures anticipated to be made in accordance with the Company Agreement and the Budgets (including any Rollover Budgets) and Business Plans (as each such term is defined in the Company Agreement) for the Company contemplated thereby. KCS and NS shall cause at Closing up to $40,000,000 of the proceeds from the sale of the NS Interest to be paid to reimburse KCS for capital expenditures made by KCS on the Line within the two-year period ending on the Closing Date (none of which shall have been made in anticipation of this Agreement) as presented on a schedule delivered to NS prior to the Closing Date, which schedule shall be final and binding on NS if it accurately sets forth expenditures made in accordance with the principles expressed in this sentence (the difference between $40,000,000 and such reimbursement shall be the “Excess Proceeds”), and (b) the Excess Proceeds and any portion of the Capital Proceeds not allocated at such time for capital expenditures in accordance with the then current Budget or any Rollover Budget, as the case may be, and Business Plan (in the aggregate, the “Excess Capital”) to be made available by the Company to provide the Partner Financing pursuant to Article 4 below. KCS and NS shall cause the Company to pay KCS a Preferred Return Amount on and, at KCS’ election, a Preferred Return of, the Excess Proceeds, as contemplated in the Company Agreement.

3. Contribution of Assets and Assumption of Liabilities .

3.1 Contribution of Assets .

(a) Subject to the terms and conditions of this Agreement, at the Closing, KCS and KCSR shall, and shall cause their respective Subsidiaries, as applicable, to, transfer, convey, assign and deliver to the Company, all of their respective right, title and interest in the Assets, free and clear of all Liens other than Permitted Liens, and in exchange for the Assets, KCS and NS shall cause the Company to issue to KCS a 71.4286% membership interest in the Company (as adjusted pursuant to Section 2.1(b) and together with the Preferred Return, the “KCS Interest”). The parties acknowledge that KCS’ initial capital account in the Company will be as set forth in Exhibit 2.2 to the Company Agreement and that the Company shall be a Restricted Subsidiary prior to the transfer of the Assets to the Company and shall remain a Restricted Subsidiary so long as the Indentures remain in effect.

(b) Prior to the Closing, KCSR shall use its commercially reasonable efforts to obtain the consent of the Warren County Bridge Commission to an assignment of the Vicksburg Bridge Lease to the Company. Should KCSR obtain said consent prior to the Closing, at the Closing, KCSR shall assign the Vicksburg Bridge Lease to the Company pursuant to an assignment agreement substantially in the form attached hereto as Exhibit K (the “Vicksburg Assignment Agreement”). Should KCSR fail to obtain said consent prior to the Closing, at the Closing, KCSR shall sublease, at the

same rate as paid by KCSR , the Vicksburg Bridge Lease to the Company pursuant to a customary sublease agreement, and thereafter shall continue to use its commercially reasonable efforts to obtain the consent of the Warren County Bridge Commission to an assignment of the Vicksburg Bridge Lease to the Company and, upon receipt of such consent, shall assign the Vicksburg Bridge Lease to the Company pursuant to an assignment agreement substantially in the form of the Vicksburg Assignment Agreement. Notwithstanding anything herein to the contrary, for purposes of this Agreement, the Vicksburg Assignment Agreement shall only be considered an Ancillary Agreement if the consent of the Warren County Bridge Commission to an assignment of the Vicksburg Bridge Lease to the Company is obtained by KCSR prior to Closing. Any material amendment, and any termination or renewal, of the Vicksburg Bridge Lease prior to any assignment pursuant to the Vicksburg Assignment Agreement shall be made only with the written consent of NS, provided that the consent of NS shall not be required for KCS to resolve the current dispute with the Warren County Bridge Commission regarding the Vicksburg Bridge Lease described in Section 8.4(a)(i) of the Disclosure Schedule if such resolution does not prevent or materially impair the assignment to the Company of such lease as contemplated by this Section 3.1(b) or materially, adversely affect the access to or enjoyment of the Vicksburg Bridge as contemplated by the NSR Joint Use Agreement.

(c) Prior to the Closing, KCSR shall use its commercially reasonable efforts to obtain the consent of Canadian National to an assignment of the MSR Jackson Trackage Rights to the Company. KCS and NS shall seek an order of the STB permitting said assignment, should such consent be obtained, or overriding any provision of said MSR Jackson Trackage Rights preventing such assignment without the consent of Canadian National, should such consent not be obtained. Any assignment by KCSR of the MSR Jackson Trackage Rights to the Company shall be pursuant to an assignment agreement substantially in the form attached hereto as Exhibit L (the “Jackson Assignment Agreement”). Following the Closing Date and until the earlier of assignment to the Company of the MSR Jackson Trackage Rights or commencement of railroad operations over the Jackson Flyover, as provided in Section 5.13 of the Company Agreement, KCSR shall provide the Company and NSR with haulage rights over the portion of the Line subject to the MSR Jackson Trackage Rights pursuant to an NSR – KCSR Haulage Agreement substantially in the form attached as Exhibit M hereto (the “NSR – KCSR Haulage Agreement”).

(d) Schedule 3.1(d) sets forth certain interests of KCS and its Subsidiaries (the “Retained Interests”) in the Assets to be conveyed to the Company pursuant to Section 3.1(a) which interests shall be retained following the Closing by the party conveying the relevant Assets to the Company (the “Conveying Party”). The Retained Interests may be exercised only at the sole risk and expense of the Conveying Party, in a manner that shall not unreasonably interfere with the operation of the Assets as contemplated by the Operating Agreement, the NSR Joint Use Agreement and the KCSR Joint Use Agreement, and shall be subject to execution of a reasonable access agreement between the relevant Conveying Party and the Company. KCS shall cause any Conveying Party seeking to exercise Retained Interests to provide reasonable advance notice to the Company before said party may enter any relevant Assets consisting of Property for purposes of exercising a Retained Interest, and said party’s actions on such

Property shall at all times be subject to the reasonable direction and control of the operating officer in charge of the Property and to applicable provisions of the Company’s safety and operating rules.

(e) The parties hereto acknowledge that some of the Owned Properties include adjoining land, buildings, structures and other improvements that are not included in the Assets and that, accordingly, must be subdivided into separate lots. Accordingly, as to each such Owned Property, KCS shall promptly, and at KCS’ sole expense, take all steps necessary (including, without limitation, recording all required deeds, performing all required surveys and obtaining all necessary planning and zoning approvals) to subdivide and obtain a separate tax lot/parcel for the portion of each such Owned Property that is included in the Assets, distinct from any adjoining land, buildings, structures or other improvements that are not included in the Assets.

3.2 Transfer of Liabilities .

(a) Subject to the terms and conditions of this Agreement, at the Closing, KCS and NS shall cause the Company to assume the liabilities and obligations of KCS, KCSR and their respective Affiliates relating to the operation of the Assets set forth on Schedule 3.2 hereto (the “Assumed Liabilities”). Except as and to the extent otherwise expressly provided in this Agreement, the Company has not agreed to pay, shall not be required to assume and shall not have any obligation in respect of, any liability or obligation, direct or indirect, absolute or contingent, of KCS, KCSR, NS or any other Person, the assumption of which by the Company is not expressly provided for in this Agreement.

(b) Notwithstanding anything in Section 3.2(a) to the contrary, any assignment agreement or sublease entered into pursuant to Section 3.1(b) shall provide that all liabilities and obligations under the Vicksburg Bridge Lease relating to or arising from events or omissions occurring prior to the Closing shall be the liabilities and obligations of KCSR, and any liabilities and obligations under the Vicksburg Bridge Lease relating to or arising from events or omissions occurring after the Closing shall be the liabilities and obligations of the Company, except to the extent that any such liabilities or obligations arise from the exercise by the Conveying Parties of the Retained Interests.

4. Partner Financing . Promptly following the Closing, KCS and NS shall cause the Company to loan to KCS an amount not to exceed the Excess Proceeds and thereafter to KCS and NS from time to time upon such party’s request up to an amount equal to the Excess Capital less the aggregate amount of any outstanding loans made pursuant to this Section 4 (such loans, the “Partner Financing”) to be evidenced by one or more notes substantially in the form attached hereto as Exhibit N (collectively, the “Notes”). All such Partner Financing shall first be made available to KCS and, if KCS elects not to borrow such amounts, subsequently to NS and shall in each case be structured so as to not violate, in the reasonable opinion of counsel to KCS, any provision of the Indentures.

5. Intentionally Omitted

6. The Closing .

6.1 The Closing . The Closing shall take place at the offices of Sonnenschein Nath & Rosenthal LLP, 1221 Avenue of the Americas, 25th Floor, New York, New York 10020 at 10:00 A.M., local time on a date to be agreed to by NS and KCS, which date shall be no later than three Business Days following the date on which all of the conditions set forth in Article 11 shall have been satisfied or waived (other than those conditions that by their nature are to be satisfied at the Closing, but subject to the fulfillment or waiver of those conditions), or at such other time and place as KCS and NS mutually agree upon in writing. The date of the Closing is referred to in this Agreement as the “Closing Date.”

7. Deliveries at the Closing .

7.1 Deliveries at the Closing . At the Closing:

(a) NS shall, or shall cause AGS and its other Subsidiaries to, deliver (i) the NS Closing Cash Purchase Price by wire transfer of immediately available funds to the account(s) designated by KCS and NS on behalf of the Company in writing at least one Business Day prior to the Closing Date; (ii) duly executed counterpart originals of each Ancillary Agreement to which NS, AGS or any of their respective Subsidiaries is a party to KCS or the Company, as applicable; (iii) a duly executed counterpart original of the Company Agreement to KCS; (iv) the certificate required to be delivered to KCS pursuant to Section 11.3(c) of this Agreement; (v) the opinions required pursuant to Section 11.3(e) of the Agreement to KCS; and (vi) such documents and instruments as KCS may reasonably request to evidence the satisfaction of all conditions precedent set forth in Article 11 of this Agreement or which are required to be delivered by NS at or prior to the Closing Date pursuant to this Agreement.

(b) KCS and KCSR shall, or shall cause their respective Subsidiaries to, deliver: (i) a duly executed counterpart original of the Company Agreement to NS; (ii) duly executed counterpart originals of each Ancillary Agreement to which KCS, KCSR or their respective Subsidiaries is a party to NS or the Company, as applicable; (iii) the certificate required to be delivered to NS pursuant to Section 11.2(c) of this Agreement; (iv) the consents required, if any, pursuant to Section 11.2(d) of this Agreement to NS; (v) quitclaim deeds with respect to each of the Owned Properties to the Company; (vi) the consent to assignment or sublease, as the case may be, provided for in Section 3.1(b) of this Agreement to the Company; (vii) all such other deeds, endorsements, assignments and other instruments as are necessary to transfer to the Company KCS’ and its Subsidiaries’ interest in the Assets in accordance with the terms hereof; (viii) the opinions required pursuant to Section 11.2(f) of the Agreement to NS; and (ix) such documents and instruments to NS as NS may reasonably request to evidence the satisfaction of all conditions precedent set forth in Article 11 of this Agreement or which are required to be delivered by KCS at or prior to the Closing Date pursuant to this Agreement.

(c) KCS and NS shall cause the Company to deliver (i) duly executed counterpart originals of each Ancillary Agreement to which the Company is a party to NS or KCS, as applicable and (ii) certificates representing the NS Initial Interest and the KCS Interest to AGS and KCS, respectively.

7.2 Further Assurances . At and following the Closing, each party to this Agreement shall deliver or cause to be delivered, as appropriate, such further certificates, consents and other documents as may be necessary to carry out the terms of this Agreement.

8. Representations and Warranties of KCS and KCSR . Except as set forth in the disclosure schedule (the “Disclosure Schedule”) prepared by KCS and delivered to NS concurrently with the execution of this Agreement (in each case making reference to the particular subsection of this Agreement to which the relevant disclosure or exception is being made), KCS and KCSR jointly represent and warrant to NS as of the date hereof and, to the extent provided in Section 11.2(a), as of the Closing, as follows:

8.1 Organization, Standing and Power . Each of KCS and KCSR is a corporation duly organized, validly existing and in good standing under the Laws of the jurisdiction of its incorporation and has all requisite power and authority to own, lease and operate its properties and assets and to carry on its business as now being conducted. Each of KCS and KCSR is duly qualified or licensed as a foreign entity and is in good standing in each jurisdiction where the nature of its properties owned or held under lease or the nature of the business conducted by it make such qualification necessary, except for any failure to be so qualified, licensed and in good standing as would not, individually or in the aggregate, have a Material Adverse Effect on KCS or KCSR.

8.2 Authority; Enforceability; Noncontravention .

(a) Each of KCS, KCSR and their respective Subsidiaries, as the case may be, has full power and authority to enter into, execute and deliver this Agreement, each of the Ancillary Agreements and the Company Agreement to which it is a party and perform its obligations hereunder and thereunder. This Agreement has been, and each of the Ancillary Agreements and the Company Agreement will be, duly authorized by all necessary action of each of KCS, KCSR and their respective Subsidiaries, as the case may be. This Agreement has been, and each of the Ancillary Agreements and the Company Agreement will be, duly executed and delivered by each of KCS, KCSR and their respective Subsidiaries, as the case may be, and, assuming their due execution and delivery by the other party or parties hereto or thereto, constitutes or will constitute a valid and legally binding obligation of each of KCS, KCSR and their respective Subsidiaries, as the case may be, respectively, enforceable against them in accordance with its terms, subject to the effect of bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other similar Laws relating to or affecting creditors’ rights generally, and to the availability of equitable remedies.

(b) The execution and delivery of this Agreement, each of the Ancillary Agreements and the Company Agreement by each of KCS, KCSR and their respective Subsidiaries, as the case may be, does not and will not, and compliance by KCS and KCSR, as applicable, with the provisions of this Agreement, each of the Ancillary Agreements and the Company Agreement will not, (i) conflict with or result in a breach or default under the Charter Documents of KCS, KCSR or their respective Subsidiaries; (ii) constitute or result in a material breach or violation of, or a material default under, or the acceleration of (with or without the giving of notice, the lapse of time or both) any obligation pursuant to, any provision of any Material Contract to which KCS, KCSR or their respective Subsidiaries is a party or otherwise bound, or to which any property or asset of KCS, KCSR or their respective Subsidiaries is subject; (iii) subject to the filings with Governmental Authorities and other matters referred to in Section 8.2(c) below, violate any Law applicable to KCS, KCSR or their respective Subsidiaries; (iv) result in the creation or imposition of any material Lien on the Assets; or (v) constitute or result in any material change in the rights or obligations of any party under any of the Material Contracts.

(c) Except (i) for the applicable requirements of the STB and (ii) as set forth on Section 8.2(c) of the Disclosure Schedule, there are no approvals, authorizations, consents, orders or other actions of, or filings with, any Person, including any Governmental Authority, that are required to be obtained or made by KCS, KCSR, or their respective Subsidiaries or the Company in connection with the execution of, and the consummation of the transactions contemplated under, this Agreement, the Ancillary Agreements or the Company Agreement, except in each case as will not, individually or in the aggregate, impair in any material respect the performance by KCS, KCSR or their respective Subsidiaries of their respective obligations hereunder.

8.3 Assets . The Assets constitute all properties, assets and rights (real, personal and mixed, tangible and intangible) currently utilized in the operation of the Line, other than operating equipment such as locomotives, rail cars and maintenance vehicles, and other than maintenance of way machinery and tools (the “Excluded Assets”) and, except for the Excluded Assets, the Assets are sufficient to operate the Line (i) in substantially the same manner as operated by KCS and its Affiliates prior to the Closing and (ii) as contemplated by the NSR Joint Use Agreement, the KCSR Joint Use Agreement, and the Operating Agreement. KCS or one of its wholly owned Subsidiaries has, and upon consummation of the transactions contemplated hereby the Company will acquire, good and marketable title to all of the non-real estate owned Assets free and clear of all Liens except for Permitted Liens.

8.4 Material Contracts .

(a) (i) True and correct copies of each Material Contract, including all amendments and modifications thereof and waivers thereunder, have been made available to NS and its counsel; (ii) except as set forth in Section 8.4(a)(ii) of the Disclosure Schedule, each Material Contract is in full force and effect, and is the valid and binding obligation of KCS, KCSR or their respective Subsidiaries and, to the Knowledge of KCS, each other party to the Material Contract, and upon consummation

of the transactions contemplated hereby each Material Contract will remain in full force and effect, and will be the valid and binding obligation of the Company and, to the Knowledge of KCS, each other party to the Material Contract; (iii) except as set forth in Section 8.4(a)(iii) of the Disclosure Schedule, KCS, KCSR or their respective Subsidiaries has performed all of its respective material obligations required to be performed by it to date under each Material Contract, and is not in material breach of or material default under any Material Contract, and no event has occurred or circumstance exists which, with notice or lapse of time or both, would constitute a material breach of or material default by KCS, KCSR or their respective Subsidiaries under any Material Contract; (iv) except as set forth in Section 8.4(a)(iv) of the Disclosure Schedule, to the Knowledge of KCS, each party to each Material Contract other than KCS, KCSR or their respective Subsidiaries has performed all of the material obligations required to be performed by it to date under the Material Contract, and is not in material breach of or in material default under the Material Contract, and no event has occurred or circumstance exists which, with notice or lapse of time or both, would constitute a material breach of or material default by such other party under any Material Contract; and (v) no Material Contract will be affected adversely in any material way by the execution, delivery or performance of this Agreement, the Ancillary Agreements or the Company Agreement, each in accordance with its terms, and no Material Contract contains any change in control provision, restriction on assignment or other terms that will become applicable or inapplicable as a result of the consummation of the transactions contemplated by this Agreement, the Ancillary Agreements or the Company Agreement.

(b) For purposes of this Agreement, “Material Contracts” shall mean the following Contracts of KCS, KCSR or their respective Subsidiaries, each of which contracts is listed in Section 8.4(b) of the Disclosure Schedule, (X) relating to or affecting in any material way the Assets or the Assumed Liabilities or (Y) to be assigned to the Company pursuant to the terms hereof which are in effect on the date hereof:

(i) Each Contract which is to be performed in whole or in part at or after the date of this Agreement and which (1) cannot be canceled upon 60 days’ notice without payment or penalty and involves aggregate annual payments of more than $100,000; (2) involves material nonmonetary obligations to be performed later than one year from the date hereof; (3) otherwise materially affects the Assets or the operation of the Line; or (4) was not entered into in the ordinary course of business consistent with past practice;

(ii) Each Contract providing for the indemnification of any third party;

(iii) Each Contract providing for any future payments that are conditioned, in whole or in part, on any Transfer or assignment of any of the Assets;

(iv) Each Contract for the Transfer of any of the Assets or for the grant of any preferential right to purchase any of the Assets or which requires the consent of any third party to the Transfer of any of the Assets;

(v) Each Contract evidencing more than $100,000 of Indebtedness of KCS or its Subsidiaries (including the Indentures);

(vi) Each Contract involving aggregate consideration in excess of $100,000 (1) under which the benefits cannot be retained or there will be a default as a result of the consummation of the transactions contemplated by this Agreement without the written consent or approval of other parties or (2) which would require the making of any material payment, other than payments as contemplated by this Agreement, to any employee of KCS or to any other Person as a result of the consummation of the transactions contemplated herein;

(vii) Each Contract pursuant to which any material Leased Personal Property is used or leased in the operation of the Line;

(viii) Each lease, sublease or other occupancy agreement pursuant to which KCS or any of its Subsidiaries leases, subleases or otherwise occupies any real property included or related to the Line (such leases, subleases and other occupancy agreements, together with any amendments, modifications and other supplements thereto, each a “Lease” and collectively, the “Leases”);

(ix) Each lease, sublease or other occupancy agreement pursuant to which KCS or any of its Subsidiaries leases or subleases any Property to a third party or one of its Affiliates (each such lease, sublease and other occupancy agreement, together with any amendments, modifications and other supplements thereto, a “Third Party Lease” and collectively, the “Third Party Leases”);

(x) Each Contract involving a guarantee of any Indebtedness or imposing a Lien on any of the Assets which serve as collateral for Indebtedness; and

(xi) Each Contract granting haulage, trackage or other access or operating rights with respect to the Line.

8.5 Absence of Certain Changes and Events . Except as set forth in Section 8.5 of the Disclosure Schedule, since December 31, 2004 and prior to the date hereof, except for this Agreement and changes contemplated by this Agreement, (i) neither KCS nor any of its Subsidiaries has taken any action which would be in violation of Section 10.1 had such action been taken after the date hereof and (ii) there has not been any change or development or combination of changes or developments which, individually or in the aggregate, has resulted in, or is reasonably likely to result in, a Material Adverse Effect on KCS or KCSR.

8.6 Litigation and Proceedings . Except as set forth in Section 8.6 of the Disclosure Schedule, there is no pending or, to the Knowledge of KCS, threatened Action to which KCS, KCSR or any of their respective Subsidiaries is a party involving the Assets or the operation of the Line in any material way, and neither KCS nor any of its Subsidiaries is subject to any material judgment, order, writ, injunction, decree or regulatory directive or agreement with respect to the Assets or the operation of the Line.

None of the Assets is subject to any judgment, order or decree entered in any Action which would be reasonably likely to have a Material Adverse Effect on KCS or KCSR.

8.7 Environmental Matters .

(a) KCS, KCSR and their respective Subsidiaries, with respect to the Properties and the operation of the Line, are in compliance in all material respects with all applicable Environmental Laws (which compliance includes, but is not limited to, the possession by KCS, KCSR and their respective Subsidiaries of all material permits and other governmental authorizations required under applicable Environmental Laws, and compliance with the terms and conditions thereof). None of KCS, KCSR or any of their respective Subsidiaries has received in writing any notice, action, inquiry, investigation or claim alleging that KCS, KCSR or any of their respective Subsidiaries, with respect to the Properties or the operation of the Line, are not in such compliance.

(b) There is no Environmental Claim relating to the Properties or the operation of the Line pending or, to the Knowledge of KCS, threatened against KCS, KCSR or any of their respective Subsidiaries or, to the Knowledge of KCS, against any Person whose liability for any such Environmental Claim KCS, KCSR or any of their respective Subsidiaries has retained or assumed either contractually or by operation of Law which would, individually or in the aggregate, be material.

(c) To the Knowledge of KCS, no event has occurred and no condition exists including, without limitation, the Release, threatened Release or presence of any Hazardous Material, which could reasonably be expected to form the basis of any Environmental Claim relating to the Properties or the operation of the Line which would, individually or in the aggregate, be material.

(d) KCS has delivered or otherwise made available for inspection to NS true and correct copies and results of any reports, studies, analyses, tests or other monitoring reports or related substantive correspondence with any Governmental Authority possessed or initiated by or on behalf of KCS, KCSR or any of their respective Subsidiaries pertaining to Hazardous Materials in, on, beneath or adjacent to the Properties, or regarding KCS’ and its Subsidiaries’ compliance with applicable Environmental Laws with respect to the Properties and the operation of the Line (any of the foregoing, “Environmental Reports”).

8.8 Compliance With Laws and Other Matters . KCS, KCSR and each of their respective Subsidiaries:

(a) is, and since January 1, 2003 has been, in compliance in all material respects, in the operation of the Line, with all applicable Laws (it being understood that, solely for purposes of this Section 8.8, the term “Laws” shall not include any Environmental Laws) and the regulations, ordinances, rules, judgments, orders or decrees of any Governmental Authority applicable thereto or to the employees involved in the operation of the Line;

(b) has, and upon the consummation of the transactions contemplated hereby the Company will have, all material permits, licenses, franchises, certificates of authority, orders, and approvals of, and has made all material filings, applications, and registrations with, Governmental Authorities that are required in order to permit it to operate the Line (the “Permits”); and since January 1, 2003 has been, in compliance in all material respects with the terms of the Permits; and all the Permits are, and will be, in full force and effect and a complete and accurate list of the Permits is set forth in Section 8.8(b) of the Disclosure Schedule;

(c) has, since January 1, 2003, received no notification or communication from any Governmental Authority (i) asserting that it is not in compliance with any Laws (or indicating, in the absence of any such assertion, a possible investigation or inquiry with respect to any of the foregoing) with respect to the operation of the Line or (ii) threatening to suspend, materially modify or revoke any Permit; and

(d) is not a party to or subject to any material order, decree, agreement, memorandum of understanding or similar arrangement with, or a commitment letter, supervisory letter or similar submission to, any Governmental Authority with respect to the Assets or the operation of the Line, and none of KCS, KCSR or any of their respective Subsidiaries has been advised by any such Governmental Authority that such Governmental Authority is contemplating issuing or requesting (or is considering the appropriateness of issuing or requesting) any such material order, decree, agreement, memorandum of understanding, commitment letter, supervisory letter or similar submission.

8.9 Labor Relations . Except as set forth in Section 8.9 of the Disclosure Schedule:

(a) There is no strike, lockout, slowdown or stoppage pending or, to the Knowledge of KCS, threatened against or directly affecting the operation of the Line.

(b) Neither KCS nor any of its Subsidiaries is delinquent in payments in any material respect: (i) to any of its employees involved in the operation of the Line for any wages, salaries, commissions, bonuses or other direct compensation for any services performed by them, (ii) to any of its employees involved in the operation of the Line for amounts required to be reimbursed to such employees or (iii) to any benefit plans with respect to amounts owed on behalf of any of its employees involved in the operation of the Line.

(c) There is no unfair labor practice, charge or complaint against KCS, KCSR or their respective Subsidiaries with respect to the operation of the Line, pending or, to the knowledge of KCS, threatened, before any Governmental Authority; and there is no grievance that would be reasonably likely to have a Material Adverse Effect on KCS or KCSR nor any arbitration proceeding arising out of or under any collective bargaining agreement pending against KCS, KCSR or their respective Subsidiaries with respect to the operation of the Line.

(d) Each of KCS and any of its Subsidiaries who are or have been (i) required to comply with Executive Order 11246 or any other requirements applicable to a “contractor” or “subcontractor” (as defined by Executive Order 11246) or (ii) required to maintain an affirmative action plan have complied with such requirements in all material respects.

8.10 Taxes . (a) All Tax Returns required to be filed by KCS, KCSR or any of their respective Subsidiaries with respect to the Assets and the operation of the Line have been filed on a timely basis and all such returns are true, complete, and correct in all material respects, (b) all Taxes (whether or not shown on any Tax Return) that are due or claimed to be due from KCS, KCSR or any of their respective Subsidiaries with respect to the Assets and the operation of the Line have been paid, (c) no notice has been received of any deficiencies for Taxes claimed, proposed or assessed by any Government Authority with respect to the Assets or the operation of the Line for which KCS, KCSR or any of their respective Subsidiaries may be liable, (d) there are no pending, current or proposed audits, examinations, suits, proceedings, investigations, claims or administrative proceedings for or relating to any liability in respect of any Taxes with respect to the Assets or the operation of the Line for which KCS, KCSR or any of their respective Subsidiaries may be liable, (e) each of KCS, KCSR and their respective Subsidiaries has withheld and paid to the relevant Governmental Authority all Taxes required to have been withheld and paid in accordance with applicable Law with respect to the Assets and the operation of the Line, including in connection with any amounts paid or owing to any employee, independent contractor, creditor, equity holder or other Person, (f) there is, to the Knowledge of KCS, no outstanding material claim by any Governmental Authority in a jurisdiction where KCS, KCSR or any of their respective Subsidiaries does not file Tax Returns that KCS, KCSR or any of such Subsidiaries may be subject to Tax in such jurisdiction with respect to the Assets or and the operation of the Line, (g) there are no Liens on any of the Assets that arose in connection with any failure (or alleged failure) to pay any Tax, and (h) none of KCS, KCSR or any of their respective Subsidiaries with respect to the Assets or the operation of the Line will be required to include any item of income in, or exclude any item of deduction from, income for any Tax period (or portion thereof) ending after the Closing Date as a result of any (1) change in method of accounting for a Tax period ending on or prior to the Closing Date, (2) agreement with a Governmental Authority executed on or prior to the Closing Date, (3) deferred gains, (4) installment sale or open transaction disposition made on or prior to the Closing Date, or (5) prepaid amount received on or prior to the Closing Date, in each case under this Section 8.10(h), to the extent that the Tax liability of the Company or any Member (as defined in the Company Agreement) could be materially affected.

8.11 Insurance . The Assets are insured with reputable insurers and Section 8.11 of the Disclosure Schedule contains a true and correct list of such insurance policies maintained by KCS, copies of which have been made available to NS. With respect to all insurance policies that are individually or in the aggregate material to the Assets and the operation of the Line: (i) such policies are in full force and effect on the date hereof and KCS, KCSR and their respective Subsidiaries shall use their commercially reasonable efforts to continue such policies in full force and effect through the Closing Date, (ii) all premiums currently payable or previously due and payable with

respect to all periods up to and including the Closing Date have been paid to the extent such premiums are due and payable on or prior to the date hereof and, with respect to premiums not due or payable at or prior to the date hereof, all premiums due and payable prior to the Closing Date, will have been paid prior to the Closing Date and (iii) no notice of cancellation or termination has been received with respect to any such policy.

8.12 Books and Records . The books and records of KCS, KCSR and their respective Subsidiaries relating to the Assets and the operation of the Line have been fully, properly and accurately maintained in all material respects.

8.13 Transactions with Affiliates . With respect to the Assets and the operation of the Line, there are no outstanding amounts payable to or receivable from, or advances by KCS, KCSR or any of their respective Subsidiaries to, and none of KCS, KCSR or any of their respective Subsidiaries is otherwise a creditor or debtor to, any member or stockholder, director, employee or Affiliate of KCS, KCSR or any of their respective Subsidiaries. With respect to the Assets and the operation of the Line, neither KCS, KCSR nor any Subsidiary of KCS nor KCSR is a party to any transaction or agreement with any Affiliate, member or stockholder, director or executive officer of KCS, KCSR or any of their respective Subsidiaries or any material transaction or agreement with any employee other than executive officers.

8.14 Real Property .

(a) Section 8.14(a) of the Disclosure Schedule sets forth a true, correct and complete list of each parcel of real property owned by KCS, KCSR or their respective Subsidiaries included in the Assets (each such parcel and, for solely the purposes of this Section 8.14, the Dallas Intermodal Terminal described on Annex C hereto (the “Terminal”), individually, an “Owned Property” and collectively, the “Owned Properties”) showing the common address, or other means of identification, and record title holder thereof and, to the Knowledge of KCS, all Liens thereon. Each of KCS, KCSR and their respective Subsidiaries, as applicable, owns, and upon the consummation of the transactions contemplated hereby will transfer to the Company all of their respective rights, titles and interests in and to the Owned Properties and to all buildings, structures and other improvements thereon, free and clear of all Liens, except for Permitted Liens, and subject to the Retained Interests, sufficient for the operation of the Line in the ordinary course of business (i) in substantially the same manner as operated by KCS and its Affiliates prior to the Closing and (ii) as contemplated by the NSR Joint Use Agreement, the KCSR Joint Use Agreement, and the Operating Agreement.

(b) Section 8.14(b) of the Disclosure Schedule sets forth the common address of each parcel of real property leased or subleased by KCS, KCSR or their applicable Subsidiary pursuant to each Lease (each a “Leased Property” and collectively, the “Leased Properties”). True, correct and complete copies of all work letters, side agreements, consents, subordination agreements, guarantees and other similar arrangements or agreements with respect to each Lease and to which KCS or any of its Subsidiaries is a party (or that are otherwise in the possession of KCS, KCSR or their respective Subsidiaries) has heretofore been made available to NS and its counsel. KCS

(either directly or through KCSR or another Subsidiary) holds, and after the consummation of the transactions contemplated hereby the Company will hold, a valid and existing leasehold or subleasehold interest, as applicable, in each Leased Property pursuant to the applicable Lease, free and clear of all Liens, other than Permitted Liens, and subject to the Retained Interests. There are no oral agreements in effect as to any Lease to which KCS or any of its Subsidiaries is a party. The terms of the Leases have not been modified in any respect, except to the extent that such modifications are set forth in the documents previously delivered or made available to NS and its counsel, and none of KCS, KCSR or any of their respective Subsidiaries is in negotiations with any landlord to cancel or terminate any Lease prior to the stated maturity date of such Lease. Except for Permitted Liens, none of KCS, KCSR or their applicable Subsidiaries has assigned, transferred, conveyed, mortgaged, deeded in trust or encumbered its leasehold interest in any Lease. Neither KCS nor any Subsidiary has received a notice of default or termination with respect to any Lease. No material damage or destruction (i.e., damage or destruction that would permit either party to the applicable Lease to terminate such Lease or cause the abatement of rent thereunder) has occurred with respect to any of the Leased Properties which has not been repaired prior to the date hereof.

(c) The Owned Properties and the Leased Properties (each a “Property” and collectively, the “Properties”) constitute all of the real estate, other than rail yards and similar facilities, within which KCS and its Subsidiaries operate the Line. The Properties are in compliance with all requirements of applicable Law in all material respects, and none of KCS, KCSR or any of their respective Subsidiaries has received notice of, and KCS has no Knowledge of, any condemnation, eminent domain, zoning, land use proceedings or other claims, causes of action, lawsuits or legal proceedings pending, threatened or contemplated regarding the ownership, use or possession of the Properties or any part thereof or of any sale or other disposition of the Owned Properties or any part thereof in lieu of condemnation, except for those matters that are set forth in Section 8.14(c) of the Disclosure Schedule.

(d) Section 8.14(d) of the Disclosure Schedule sets forth the common address of, or other means of identifying, each parcel of real property leased or subleased by KCS, KCSR or their applicable Subsidiary pursuant to each Third Party Lease and the property (or portion thereof) subject to such Third Party Lease. True, correct and complete copies of all work letters, side agreements, consents, subordination agreements, guarantees and other similar arrangements or agreements with respect to the Third Party Leases and to which KCS, KCSR or any of their respective Subsidiaries is a party (or that are otherwise in the possession of KCS, KCSR or any of their respective Subsidiaries) has heretofore been made available to NS. There are no oral agreements in effect as to any Third Party Lease to which KCS or any Subsidiary of KCS is a party. The terms of the Third Party Leases have not been modified in any respect, except to the extent that such modifications are set forth in the documents previously delivered or made available to NS and its counsel, and neither KCS, KCSR or any of their respective Subsidiaries is in negotiations with any tenant or subtenant to cancel or terminate any Third Party Lease prior to the stated maturity date of such Third Party Lease.

8.15 Brokers . Neither KCS nor any of its Affiliates has retained or otherwise engaged or employed, or paid or agreed to pay any fee or commission, to any agent, broker, finder or other Person, for or on account of acting as a finder or broker in connection with this Agreement, the Ancillary Agreements or the Company Agreement or the transactions contemplated hereby and thereby.

9. Representations and Warranties of NS . NS hereby represents and warrants as of the date hereof and, to the extent provided in Section 11.3(a), as of the Closing, as follows:

9.1 Organization, Standing and Power . NS is a corporation duly organized, validly existing and in good standing under the Laws of the jurisdiction of its incorporation and has all requisite power and authority to own, lease and operate its properties and assets and to carry on its business as now being conducted.

9.2 Authority; Enforceability; Noncontravention .

(a) Each of NS, AGS and their respective Subsidiaries, as the case may be, has full power and authority to enter into, execute and deliver this Agreement, each of the Ancillary Agreements and the Company Agreement to which it is a party and perform its obligations hereunder and thereunder. This Agreement has been, and each of the Ancillary Agreements and the Company Agreement will be, duly authorized by all necessary action of each of NS, AGS and their respective Subsidiaries, as the case may be. This Agreement has been and each of the Ancillary Agreements and the Company Agreement will be, duly executed and delivered by each of NS, NSR and AGS, as the case may be, and, assuming it is duly executed and delivered by KCS and the Company, as applicable, constitutes or will constitute a valid and legally binding obligation of each of NS, AGS and their respective Subsidiaries, as the case may be, enforceable against them in accordance with its terms, subject to the effect of bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other similar Laws relating to or affecting creditors’ rights generally, and to the availability of equitable remedies.

(b) The execution and delivery by each of NS, NSR and AGS, as the case may be, of this Agreement, each of the Ancillary Agreements and the Company Agreement do not and will not, and compliance by each of NS, NSR or AGS, as the case may be, with the provisions of this Agreement, each of the Ancillary Agreements and the Company Agreement will not, (i) conflict with or result in a breach or default under the Charter Documents of NS, NSR or AGS or any of the terms, conditions or provisions of any Contract to which NS is a party or otherwise bound, or to which any property or asset of NS, NSR or AGS is subject; (ii) subject to the filings with Governmental Authorities and other matters referred to in Section 9.2(c) below, violate any Law applicable to NS, NSR or AGS; or (iii) result in the creation or imposition of any Lien on any asset of NS, NSR or AGS, except in each case as will not, individually or in the aggregate, impair in any material respect NS’ performance of its obligations hereunder.

(c) Except (i) for the applicable requirements of the STB and (ii) as set forth on Schedule 9.2(c), there are no approvals, authorizations, consents, orders or other actions of, or filings with, any Person that are required to be obtained or made by NS, NSR, AGS or the Company in connection with the execution of, and the consummation of the transactions contemplated under, this Agreement, the Ancillary Agreements or the Company Agreement, except for any matters as will not, individually or in the aggregate, impair in any material respect NS’ performance of its obligations hereunder.

9.3 Brokers . Neither NS nor any of its Affiliates has retained or otherwise engaged or employed, or paid or agreed to pay any fee or commission, to any agent, broker, finder or other Person, for or on account of acting as a finder or broker in connection with this Agreement, the Ancillary Agreements or the Company Agreement or the transactions contemplated hereby and thereby.

9.4 Sufficient Funds . NS has, and will have as of the Closing, sufficient funds available to pay the NS Closing Cash Purchase Price.

10. Covenants .

10.1 Operation of the Line by KCS and KCSR . Between the date of this Agreement and the earlier of the Closing or termination pursuant to Section 13, except (a) as contemplated by this Agreement, (b) as may be required by applicable Law, (c) as set forth in Schedule 10.1 or (d) with the prior written consent of NS, KCS and KCSR will, and will cause their respective Subsidiaries to (X) operate the Line according to the ordinary course of business consistent with past practice, (Y) use all commercially reasonable efforts to preserve intact the Assets and maintain the rights, franchises and existing relations with suppliers and employees relating thereto and (Z) without limiting the generality of the clauses (X) and (Y) above:

(i) not transfer any of the Assets or any interest of KCS, KCSR or any of their respective Subsidiaries therein other than in the ordinary course of business consistent with past practice or to KCS or any Restricted Subsidiary;

(ii) not change the general nature of operation of the Assets or conduct any new line of business with the rail operating Assets not consistent with past practice;

(iii) not mortgage, encumber or pledge any of the Assets or permit or allow any of the Assets to be subjected to any Lien other than Permitted Liens;

(iv) not terminate prior to the scheduled expiration of, make any material modifications to, transfer or materially amend any Material Contract;

(v) not dispose of any books, records and accounts relating to the Assets, and to maintain such books records or accounts in the usual, regular and ordinary manner, on a basis consistent with prior periods;

(vi) not enter into any lease for real property with respect to any portion of the Assets;

(vii) not enter into any Contract of any kind or nature with any Affiliate (other than KCS or any Restricted Subsidiary), or make any payment or other asset Transfer to or for the benefit of any Affiliate (other than KCS or any Restricted Subsidiary), in each case, relating to the Assets or the operation of the Line;

(viii) not permit any waste of any of the Assets;

(ix) not pay, discharge or satisfy any material claim, liability or obligation (absolute, accrued, contingent or otherwise) related to the Assets other than in the ordinary course of business consistent with past practice;

(x) not cancel or compromise any material debt or material claim or waive or release any material rights relating to the Assets or the operation of the Line;

(xi) not grant any haulage, trackage or other access or operating rights with respect to the Line, except as required by Law;

(xii) not take any action that would cause a breach of any representation or warranty set forth in Article 8 hereof; or

(xiii) not authorize or enter into any agreement to otherwise take any of the foregoing actions.

10.2 Inspection of Records; Environmental Audits .

(a) Between the date of this Agreement and the Closing, KCS and KCSR shall, and shall cause their respective Subsidiaries to, allow, to the extent not prohibited by applicable Law, the officers, attorneys, accountants and other duly authorized representatives of NS reasonable access during regular business hours to the records and files, correspondence, audits, properties and personnel, as well as to all information, in each case, relating to the Assets. Any information regarding the Assets so obtained, and any information obtained by either party pursuant to the provisions of this Agreement, the Company Agreement and the Ancillary Agreements, shall be subject to the Agreement Regarding Confidentiality and Related Matters between KCS and NS, dated as of April 11, 2005, as extended to date (the “Confidentiality Agreement”), and such information shall be held by the recipient in accordance with the terms of the Confidentiality Agreement; it being understood that, for purposes of this provision, the term of the Confidentiality Agreement shall be deemed to have been extended for a period of one (1) year immediately following the Closing Date. No investigation by NS or its representatives shall affect the representations and warranties of KCS and KCSR set forth herein or preclude reliance thereon.

(b) Between the date of this Agreement and the Closing, KCS shall continue to make available for inspection by NS true, correct and complete copies

of the Environmental Reports, and shall promptly deliver to NS true, correct and complete copies of any Environmental Reports that are prepared after the date hereof or that have not been previously disclosed to NS.

(c) If reasonably necessary (as determined solely by NS), NS and/or its appointed agents shall be entitled to perform at the expense of NS Phase I and Phase II environmental audits of the Properties in a manner which shall not unreasonably interfere with the operation of the Line in the ordinary course of business consistent with past practice. With respect to any Property for which NS determines a Phase I and/or Phase II audit is warranted, KCS, KCSR and their respective Subsidiaries shall provide NS and its appointed agents reasonable access to any such Property to conduct the Phase I and/or Phase II audit. Additionally, KCS, KCSR and their respective Subsidiaries shall fully cooperate with all reasonable requests made by NS and its appointed agents in connection with the Phase I and Phase II audits in accordance with the terms of the access agreement set forth in Exhibit O (the “Access Agreement”) and shall cooperate in good faith with reasonable requests made by NS and its appointed agents in connection with the Phase I and Phase II audits.

10.3 Alternative Proposals . During the period from the date of this Agreement and extending through the earlier of the termination of this Agreement in accordance with its terms or the Closing, KCS agrees that (a) it shall not, and shall use its commercially reasonable efforts to direct and cause its officers, directors, employees, agents and representatives (including any investment banker, attorney or accountant), as applicable, not to, directly or indirectly, (i) initiate, solicit or encourage, directly or indirectly, or accept the submission of any proposal or offer by any third party with respect to any joint venture, merger, acquisition, sale, consolidation or similar transaction involving the Line or any haulage, trackage or marketing arrangement involving the Line, in each case, other than the transactions contemplated by this Agreement (any such proposal or offer being hereinafter referred to as an “Alternative Proposal”) or initiate or participate in any negotiations or discussions concerning an Alternative Proposal, (ii) enter into any agreement, agreement in principle, letter of intent or similar arrangement (whether or not legally binding) with any third party relating to an Alternative Proposal or (iii) provide any confidential information or data to any third party relating to an Alternative Proposal, and (b) it shall notify NS promptly if any Alternative Proposal is received by it or any negotiations or discussions relating to a potential Alternative Proposal are sought to be initiated or continued with KCS, including the material terms of such Alternative Proposal and the identity of the Person making such Alternative Proposal or seeking such negotiations or discussions; provided , that nothing in this Section 10.3 shall prevent KCS from taking any action with respect to any proposal or offer not initiated, solicited or encouraged in violation of this Section 10.3 or participating in negotiations or discussions with respect to such a proposal or offer if it is advised by outside legal counsel that it is required to take such action to satisfy the fiduciary duties of the Board of Directors of KCS under Delaware law; provided , however , that KCS shall not be permitted to terminate this Agreement other than as provided in Article 13 hereof.

10.4 Confer with NS . Prior to the Closing, to the extent practicable and not prohibited by applicable Law, KCS shall confer with NS on all operational matters that might reasonably be expected to materially affect the Assets or, after the Closing Date, the operation of the Line, including, but not limited to material transactions and material expenditures.

10.5 Commercially Reasonable Efforts . Between the date of this Agreement and the Closing, each of the parties to this Agreement will use its commercially reasonable efforts to cause the conditions to the obligations of the other parties set forth in Article 11 of this Agreement, as the case may be, to be satisfied; provided , that, except as agreed in writing by the parties hereto, in no event shall any of the parties hereto be obligated to accept, or cause the Company to accept, in connection with obtaining any Required Governmental Consents required by Section 11.1(c) or any consent, approval or agreement required by Section 11.2(d), any condition or requirement that is not acceptable to such party in its reasonable judgment. In addition, the parties hereto shall (i) cooperate and use their commercially reasonable efforts to obtain all consents, approvals, authorizations and agreements (or exemptions therefrom) of all Governmental Authorities necessary to authorize, approve or permit the consummation of the transactions contemplated by this Agreement, the Company Agreement and the Ancillary Agreements (the “Required Governmental Consents”) at the earliest possible time hereafter, (ii) as promptly as practicable hereafter, file or submit, or cause to be filed or submitted, to all Governmental Authorities all notices, applications, documents and other materials necessary in connection with obtaining the Required Governmental Consents and (iii) use their respective commercially reasonable efforts to respond as promptly as practicable to all inquiries received from all Governmental Authorities for additional information or documentation in connection with obtaining such Required Governmental Consents. Each of the parties hereto shall promptly advise each other party hereto upon receiving any communication (written or oral) from any Governmental Authority whose consent, approval or authorization is required, or to whom notice must be submitted, for consummation of the transactions contemplated by this Agreement, the Company Agreement and the Ancillary Agreements which constitutes a reasonable likelihood that any requisite regulatory consent, approval or authorization will not be obtained or that receipt of any such consent, approval or authorization will be materially delayed. Each of the parties hereto shall furnish to the other party hereto such necessary information and reasonable assistance as the other may reasonably request in connection with its preparation of any filings or submissions to any Governmental Authority necessary to obtain any of the Required Governmental Consents. Each of the parties hereto shall provide the other party hereto with draft copies and as-filed copies of all filings and submissions with Governmental Authorities in respect of the Required Governmental Consents and shall provide the other with a reasonable opportunity to comment upon all such draft copies. Each of the parties hereto and its respective representatives shall promptly inform the other party hereto regarding the substance of all communications and contacts received from any Governmental Authority with respect to this Agreement, the Company Agreement, the Ancillary Agreements or the transactions contemplated hereby and thereby, and neither of the parties hereto shall initiate any contact or communications with any Governmental Authority regarding this Agreement, the Ancillary Agreements or the transactions contemplated hereby and thereby without

giving reasonable prior notice to the other party hereto and offering the other party hereto the opportunity to have a representative of such party participate in the contact or communication. For the avoidance of doubt, either party hereto shall be free to discuss regulatory matters with any Governmental Authority without the participation of the other party hereto to the extent such discussions do not directly relate to the transaction contemplated by this Agreement, the Company Agreement and the Ancillary Agreements.

10.6 Real Estate Matters .

(a) KCS and KCSR shall use their commercially reasonable efforts to obtain an estoppel certificate from each landlord under the Leases certifying that each lease is in full force and effect and that there are no defaults thereunder or any conditions that with the passage of time would constitute a default thereunder, or an estoppel certificate in the form so provided for under any such Lease or Third Party Lease. In the event that KCS is unable to deliver an estoppel certificate for any of the Leases or Third Party Leases to NS at the Closing, KCS shall indemnify NS against any loss, cost, liability or expense which NS may incur as a result of the failure of KCS to deliver such estoppel certificate.

(b) KCS and KCSR shall cause (i) title to the Owned Properties, at Closing, to be free and clear of all Liens and without exceptions, disclaimers of liability or objections except for Permitted Liens and any matters which the Title Company has committed to insure over or omit, and (ii) the First American Title Insurance Company of New York or another reputable title insurance company selected by NS (the “Title Company”) to insure the Owned Properties under the terms described above.

(c) Between the date of this Agreement and the Closing, KCS shall disclose to NS any newly identified Liens on the Owned Properties that have not been previously disclosed to NS.

10.7 Publicity . The initial public disclosure relating hereto, if any, will be a joint press release and thereafter, except as otherwise required by Law, the applicable rules of the stock exchanges on which KCS’ and NS’ shares are listed or any other self-regulatory organization, the parties shall coordinate with each other, including the provision of drafts and the opportunity to comment thereon, prior to issuing any press releases or otherwise making public statements with respect to the transactions contemplated hereby.

10.8 Standstill . For a ten (10) year period commencing on the date hereof (such period, the “Standstill Period”), neither KCS nor NS shall, jointly with any third Person, directly or indirectly, (i) purchase or offer or agree to purchase any material assets or any voting securities of the other party (other than purchases of up to 1% of the other party’s common stock) other than in the ordinary course of business consistent with past practice or (ii) propose any merger or other business combination involving the other party (any such purchase, offer to purchase or proposal, a “Business Combination”), except, in each case, if specifically invited in writing to do so by the other party. In

addition, during the Standstill Period, neither KCS nor NS nor any of their respective Subsidiaries shall, jointly with any third Person, without the prior written consent of the other party: (i) make, or in any way participate, directly or indirectly, in any solicitation of proxies to vote or seek to advise or influence any Person with respect to the voting of any voting securities of the other party; (ii) form, join, or in any way participate in a “group” within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934 with respect to any voting securities of the other party; or (iii) otherwise act, alone or in concert with others, to seek to control the management, Board of Directors, or policies of the other party. Notwithstanding the foregoing, the provisions of this Section 10.8 shall not apply to either party if during such Standstill Period (i) the other party publicly proposes to enter into a Business Combination with another Person, (ii) either NS or KCS (or their respective Affiliates) ceases to be a member of the Company or (iii) this Agreement is terminated pursuant to Article 13 hereof.

10.9 Encumbrance and Transfer of Assets; Indentures .

(a) From and after the date hereof, KCS shall not, and shall cause its Subsidiaries not to, without the prior written consent of NS: (i) enter into, amend or extend any Contract (including the Indentures or the notes governed thereby) in any manner which would encumber any of the assets or properties of the Company or prohibit, limit or defer in any way any of NS’ management rights set forth in the Company Agreement (including any rights in respect of Major Decisions (as such term is defined in the Company Agreement) that become or may become with the passage of time effective and/or that are modified after the Closing Date); or (ii) with respect to any assets transferred from the Company to KCS or its Restricted Subsidiaries as permitted by the Company Agreement, except as contemplated by Section 10.10, enter into any Contract with respect to or consummate any (x) acquisition, divestiture, spin-off, merger, consolidation, business combination or similar transaction in which such assets would cease to be held by KCS or a Restricted Subsidiary or their respective successors, (y) sale, transfer, lease, sublease, license or other disposition of such assets (except by a Restricted Subsidiary to another Restricted Subsidiary or KCS) or (z) formation of or other participation in, any joint venture or partnership with respect to such assets.

(b) From and after the date hereof, KCS shall, and from and after the Closing Date NS shall, cause the Company to comply with the provisions of the Indentures and shall not, and shall cause the Company not to, incur any additional Indebtedness other than as and to the extent permitted by the Company Agreement and the Indentures and, in any event, subject to Section 10.9(a).

10.10 Option to Acquire the Line .

(a) In the event of a Permitted Asset Transfer (as such term is defined in the Company Agreement) to which NS has not previously consented in writing, KCS shall, at least twenty (20) Business Days before such transfer, provide Notice thereof (each such Notice, a “Line Option Notice”) to NS in accordance with the provisions of Section 14.1 and NS shall have the option (the “Line Option”) to acquire, or cause one or more of its Subsidiaries to acquire, in accordance with the procedures set

forth in this Section 10.10, (1) from the relevant transferee or transferees, all right, title and interest in the Line, as it then exists, but subject to Permitted Liens, that is owned by such transferee(s) together with, at the option of NS in its sole discretion, all right, title and interest of such transferee(s) or KCS and its Subsidiaries (other than the Company) in and to the rail yards at or near Monroe, Louisiana, Bossier City, Louisiana and Pearson, Mississippi (the Line and such rail yards collectively, the “Line Assets”) that are owned by such transferee or KCS or any of its Subsidiaries (other than the Company) at the time of such Permitted Asset Transfer (the “KCS Line Assets”) and (2) either:

(i) from KCS and its Subsidiaries, the Membership Interests of the KCS Member (as such terms are defined in the Company Agreement) (the “KCS Membership Interests”); or

(ii) from the Company, the remaining Line Assets (if any) owned by the Company following such Permitted Asset Transfer (the “Company Line Assets”).

(b) Notwithstanding anything to the contrary herein, in the case of a Permitted Asset Transfer involving one or more assets of the Company that are not material, individually or in the aggregate, to the operation of the Line, the Line Option will not be available to NS if, within twenty (20) days after such transfer, the asset(s) subject to such Permitted Asset Transfer are transferred back to the Company on terms which have the same effect as if such Permitted Asset Transfer had not occurred.

(c) From and after the date of a Line Option Notice, KCS shall allow, to the extent not prohibited by applicable Law, the officers, attorneys, accountants and other duly authorized representatives of NS access during regular business hours to any books, records, files, correspondence, audits, properties, personnel and other information of KCS or its Subsidiaries relating to the Line Assets owned by KCS or its Subsidiaries (other than the Company) that is reasonably requested by NS or its representatives.

(d) At any time during the thirty (30) day period commencing on receipt of a Line Option Notice, NS may give Notice to KCS in accordance with the provisions of Section 14.1 (each such Notice, a “Line Option Valuation Notice”) of its desire to commence the valuation of the Line Assets and the KCS Membership Interests in accordance with the procedures set forth in this Section 10.10(d). Upon the delivery of a Line Option Valuation Notice, NS and KCS shall each select and engage a reputable, independent M.A.I. designated appraiser with at least ten (10) years of experience in valuing real property and rail improvements for rail line and yard property or, at their respective option, an independent investment banking firm of national reputation and such appraisers or investment banking firms shall be instructed to meet within thirty (30) days following their selection and at such meeting to mutually agree upon the selection of an appraiser, appropriately qualified in their judgment (the “Appraiser”) to determine:

(i) the fair market value of the Line Assets on a stand-alone rail operation basis (the “Line FMV”), as well as the portion of the Line FMV

attributable to the KCS Line Assets, in the aggregate, and the Company Line Assets, in the aggregate; and

(ii) the fair market value of the KCS Membership Interests (with the Line FMV determined as provided in Section 10.10(d)(i)) (the “Membership Interest FMV”).

For purposes of this Section 10.10(d), “fair market value” shall mean, with respect to any asset or property, the price that could be negotiated in an arm’s-length, free market transaction, for cash, between a willing seller and a willing and able buyer, neither of whom is under undue pressure or compulsion to complete the transaction.

(e) Within ninety (90) days of the date of its appointment, the Appraiser shall provide to both NS and KCS a report (the “Appraisal Report”), which report shall include the Appraiser’s determination of the Line FMV, as well as the portion of the Line FMV attributable to the KCS Line Assets, in the aggregate, and the Company Line Assets, in the aggregate, and the Appraiser’s determination of the Membership Interest FMV.

(f) Each of NS and KCS shall, and shall cause the Company and their respective Subsidiaries to, cooperate with the Appraiser and promptly provide all documents and other information and access during regular business hours to the Line Assets reasonably requested by the Appraiser in connection with its appraisal. The determination of the Line FMV and the Membership Interest FMV set forth in the Appraisal Report shall be final and binding on NS and KCS for purposes of this Section 10.10. KCS and NS shall bear equally all expenses of the Appraiser.

(g) Within sixty (60) days after the determination of the Line FMV and the Membership Interest FMV, either by mutual agreement of the parties (without any obligation to negotiate toward or reach such agreement) or by the issuance of the Appraisal Report, NS shall give Notice to KCS of whether it wishes to exercise the Line Option (the “Line Option Exercise Notice”) at the Line FMV or the portion thereof attributable to the KCS Line Assets and Membership Interest FMV, as the case may be, as finally determined pursuant to subsections (e) and (f) above, which Notice shall indicate whether NS wishes to acquire the KCS Membership Interests pursuant to Section 10.10(a)(i) or the Company Line Assets pursuant to Section 10.10(a)(ii). In the event that NS has elected to acquire the KCS Membership Interests pursuant to the Line Option, the transfer of such interests shall be governed by the procedure set forth in Article 10 of the Company Agreement. If NS delivers a Line Option Exercise Notice to KCS, NS (or its designated Subsidiar(ies)), KCS and its Subsidiaries shall effect the transfer of the KCS Line Assets, and (in the case that NS has elected to acquire the Company Line Assets pursuant to the Line Option) cause the Company to effect the transfer of the Company Line Assets, to NS (or its designated Subsidiar(ies)) pursuant to customary documentation reasonably acceptable to the parties, including any agreements, documents and other instruments necessary or reasonably requested by NS (or its designated Subsidiar(ies)) to effect such transfer. Such documentation shall call for KCS and its Subsidiaries and, if NS elects to acquire the Company Line Assets pursuant to

Section 10.10(a)(ii), the Company to provide representations, warranties, covenants and indemnities with respect to the KCS Line Assets and Company Line Assets, respectively, with terms at least as favorable to NS and its Subsidiaries as are set forth in this Agreement with respect to the Line and the Assets. Notwithstanding anything to the contrary contained herein, the completion of the sale of the KCS Line Assets and/or Company Line Assets, as the case may be, pursuant to the Line Option and in accordance with the terms of such documentation shall each occur, and the NS Member shall pay the portion of the Line FMV attributable to the assets so acquired to the transferring party, on a date to be mutually agreed by KCS and NS, but in no event later than the later of (i) ninety (90) days after the delivery date of the Line Option Exercise Notice and (ii) five Business Days after the date on which the last of any required regulatory approvals in connection with such transaction is received. The KCS Line Assets and, if applicable, Company Line Assets, shall be conveyed to NS (or its designated Subsidiar(ies)) subject only to Permitted Liens and KCS shall be responsible for the payment of all transfer, filing and recording taxes in connection with the exercise of the Line Option with respect to such assets and the conveyance of the KCS Line Assets and, if applicable, Company Line Assets. All payments of the Line FMV attributable to the assets acquired shall be made by wire transfer of immediately available funds to an account or accounts specified by the intended recipients.

(h) In the event that NS elects not to exercise the Line Option, it shall be entitled to exercise the contingent trackage rights described in Section 3 of the NSR Joint Use Agreement. For the avoidance of doubt, nothing in this Section 10.10 nor any decision of NS not to exercise the Line Option shall in any way limit the rights of NS and its Affiliates under the NSR Joint Use Agreement, the Western Haulage Agreement, the Contingent Haulage Agreement or any other Ancillary Agreement.

(i) Notwithstanding anything in this Section 10.10 to the contrary, the Line Option shall be exercised, and title to the Line Assets shall vest, if at all, on or prior to the date on which the last of the living descendents of Joseph P. Kennedy shall die, plus twenty one (21) years.

(j) In the event that no Appraiser is appointed pursuant to and in compliance with Section 10.10(d) an Appraiser will be appointed by arbitration in accordance with Section 14.13.

10.11 Determination and Payment of Real Property Taxes . KCSR is contributing the Assets to the Company through one deed that excludes certain property. Because the Assets will be included in KCSR’s Form R1 that is filed annually with the STB, Mississippi, Louisiana, and their local governments will assess property tax against KCSR (not the Company) that includes the Assets. Therefore, in connection with each annual property tax assessment, KCSR and NS will determine jointly and in good faith a reasonable and fair allocation of KCSR’s property tax liability that is attributable to the Assets and that should be paid by the Company, and KCSR and NS will certify in writing that the determined amount is reasonable and fair. Thereafter, KCSR will bill the Company for, and the Company shall promptly pay to KCSR, the jointly determined share of the property tax.

10.12 NS Automotive Traffic . From and after the date hereof, NS and KCS shall negotiate in good faith the terms of an agreement with respect to NS’ rights to move automotive traffic over the Line or to interchange such traffic.

10.13 Vicksburg Bridge Lease Dispute . KCS shall use its commercially reasonable efforts to resolve the Vicksburg Bridge Lease dispute referred to in, and in the manner contemplated by, Section 3.1(b).

11. Conditions to the Closing .

11.1 Mutual Conditions . The respective obligations of the parties to complete the purchase/sale of the NS Interest on the Closing Date as contemplated by Section 2.1(a), the contribution of the Assets in exchange for the KCS Interest and to take the other actions required to be taken by each of the parties at the Closing is subject to the satisfaction, at or prior to the Closing, of each of the following conditions (any of which may be waived jointly by NS and KCS in writing, in whole or in part):

(a) Company Agreement . KCS and NS or their respective Affiliates shall have entered into the Company Agreement.

(b) Ancillary Agreements . KCS, KCSR, NS, the Company and their respective Affiliates, as applicable, shall have entered into each of Ancillary Agreements.

(c) Regulatory Approvals . All Required Governmental Consents (including from the STB) shall have been obtained and shall be in full force and effect, and not subject to conditions that any party deems unacceptable in its reasonable judgment, and shall not be subject to a pending petition for review before a U.S. Court of Appeals.

(d) No Order or Action . No Law shall have been enacted, entered, promulgated or enforced by any Governmental Authority which prohibits, restricts or makes illegal the consummation of the Closing or any of the material transactions contemplated thereby, or by the Company Agreement or any of the Ancillary Agreements, and no Action shall be pending or threatened that questions the validity of this Agreement, the Company Agreement or any of the Ancillary Agreements or declares or proposes to declare the same unlawful or seeks to enjoin the consummation of any of the material transactions contemplated hereby or thereby.

11.2 Additional Conditions of NS . The obligation of NS to complete the purchase of the NS Interest on the Closing Date as contemplated by Section 2.1(a), and to take the other actions required to be taken by NS at the Closing is subject to the satisfaction, at or prior to the Closing, of each of the following additional conditions (any of which may be waived by NS in writing, in whole or in part):

(a) Representations and Warranties . The representations and warranties contained in Article 8 hereof and in all certificates delivered by KCS and KCSR to NS pursuant hereto or in connection with the transactions contemplated hereby

shall be true and accurate in all respects (in the case of representations and warranties qualified by “materiality,” “in all material respects,” “Material Adverse Effect” or similar terms or phrases, and in the case of the representations and warranties set forth in Sections 8.1 and 8.2) or in all material respects (in the case of all other representations and warranties) as of the date of this Agreement and as of the Closing as though made at and as of the Closing (except for changes contemplated by this Agreement and except for representations and warranties that by their terms speak specifically as of the date of this Agreement or some other date, in which case as of such date).

(b) Performance . KCS and KCSR shall have performed all obligations and complied with in all material respects all covenants required by this Agreement to be performed or complied with by KCS or KCSR on or prior to the Closing Date.

(c) Certificate . KCS shall have delivered to NS a certificate, dated the Closing Date, signed on behalf of KCS by an officer of KCS, certifying that the conditions specified in Sections 11.2(a) and (b) of this Agreement have been satisfied.

(d) Consents . At the Closing, KCS shall have delivered to NS all consents, approvals and agreements of any third Persons required by the terms of any Material Contract in order that the rights of KCS or any of its Subsidiaries or the prospective rights of the Company under such Material Contract, in each case, as they relate to the Assets or the Assumed Liabilities, will not be impaired by the consummation of the transactions contemplated by this Agreement, the Company Agreement and the Ancillary Agreements, and such consents, approvals and agreements shall be in full force and effect.

(e) No Material Adverse Effect . There shall have been no Material Adverse Effect on KCS or KCSR.

(f) Opinions of Counsel . NS shall have received an opinion of Sonnenschein Nath & Rosenthal LLP, dated as of the Closing Date, substantially in the form attached as Exhibit P hereto, and an opinion of the Senior Vice President and General Counsel of KCS, dated as of the Closing Date, substantially in the form attached as Exhibit Q hereto.

(g) Bank Approval of Transaction Agreements . KCS shall have delivered to NS written confirmation by the Required Lenders (as such term is defined in KCS Credit Agreement Amendment No. 2) that the form and substance of this Agreement and the Ancillary Agreements are satisfactory to the Required Lenders as contemplated by Section 1(a)(xiv) of KCS Credit Agreement Amendment No. 2.

11.3 Additional Conditions of KCS . The obligation of KCS and KCSR to complete the contribution of the Assets in exchange for the KCS Interest, and to take the other actions required to be taken by KCS and KCSR at the Closing is subject to the satisfaction, at or prior to the Closing, of each of the following additional conditions (any of which may be waived by KCS in writing, in whole or in part):

(a) Representations and Warranties . The representations and warranties contained in Article 9 hereof and in all certificates delivered by NS to KCS pursuant hereto or in connection with the transactions contemplated hereby shall be true and accurate in all respects (in the case of representations and warranties qualified by “materiality,” “in all material respects,” “material adverse effect” or similar terms or phrases, and in the case of the representations and warranties set forth in Sections 9.1 and 9.2) or in all material respects (in the case of all other representations and warranties) as of the date of this Agreement and as of the Closing as though made at and as of the Closing (except for changes contemplated by this Agreement and except for representations and warranties that by their terms speak specifically as of the date of this Agreement or some other date, in which case as of such date).

(b) Performance . NS shall have performed all obligations and complied with in all material respects all covenants required by this Agreement to be performed or complied with by NS on or prior to the Closing Date.

(c) Certificate . NS shall have delivered to KCS a certificate, dated the Closing Date, signed on behalf of KCS by an officer of NS, certifying that the conditions specified in Sections 11.3(a) and (b) of this Agreement have been satisfied.

(d) No Material Adverse Effect . There shall have been no Material Adverse Effect on NS or AGS.

(e) Opinions of Counsel . KCS shall have received an opinion of Skadden, Arps, Slate, Meagher & Flom LLP, dated as of the Closing Date, substantially in the form attached as Exhibit R hereto an opinion of the Vice President and Corporate Counsel of NS, dated as of the Closing Date, substantially in the form of Exhibit S hereto and an opinion of Cabannis, Johnston, Gardner, Dumas & O’Neal LLP, dated as of the Closing Date, substantially in the form of Exhibit T hereto.

12. Survival of Representations and Warranties; Indemnity .

12.1 Survival of Representations and Warranties . All representations and warranties made in this Agreement or made in any document delivered pursuant to this Agreement by or on behalf of any party shall survive the execution and delivery of this Agreement and the Closing, regardless of notice of or any investigation or right of investigation made after the date of this Agreement by or on behalf of any party, and shall terminate and expire one (1) year following the Closing Date, except that the representations and warranties made in Section 8.2(b)(ii) as they relate to the Indentures shall terminate and expire on the earlier of the date that is four (4) years following the Closing Date and the Maturity Date (as such term is defined in the Company Agreement) and the representations and warranties made in Sections 8.7, 8.10 and 8.14 shall terminate and expire sixty (60) days after the termination of the applicable statute of limitations, in each case, after which date they shall be of no further force or effect (except for bona fide claims of which a party has provided written notice in good faith to the other parties prior to the relevant expiration date).

12.2 Indemnification by KCS .

(a) KCS and KCSR shall indemnify, save and hold harmless (i) NS and its Affiliates, and each of their respective officers, directors, employees and agents, and each of their respective successors and assigns (collectively, the “NS Indemnified Parties”), from and against any and all costs, losses, claims, liabilities, damages, fines, penalties, expenses and Cleanup costs (including any interest which may be imposed in connection therewith and court costs and reasonable fees and disbursements of counsel) (“Damages,” which shall not include any claim of diminution of value of a Member’s interest in the Company unless the Company shall have incurred actual loss) incurred in connection with, arising out of, resulting from or incident to: (A) any breach of the representations or warranties of KCS and KCSR in this Agreement, except for Section 8.7, (in each case, solely for the purpose of calculating the amount of Damages, without regard to any qualification or limitation with respect to “materiality,” whether by reference to “material,” “in all material respects” or “Material Adverse Effect”), or (B) any breach or default in any covenants or agreements made by KCS in this Agreement; and (ii) the Company and its Affiliates, and each of their respective officers, directors, employees and agents (other than KCS or its Subsidiaries) and each of their respective successors and assigns (collectively, the “Company Indemnified Parties”) and any NS Indemnified Parties from and against any and all Damages incurred in connection with, arising out of, resulting from or incident to any obligation or liability, other than the Assumed Liabilities, incurred in connection with, arising out of, resulting from or incident to any act or omission by KCS or KCSR, any of its Affiliates prior to the Closing relating to the Assets, whether fixed or contingent, recorded or unrecorded, known or unknown.

(b) KCS and KCSR shall defend, indemnify and hold harmless any NS Indemnified Parties and any Company Indemnified Parties for, from, and against all Damages asserted against, resulting to, imposed on, or incurred by NS or the Company in connection with: (i) any misrepresentation or breach of any environmental representation or warranty set forth in Section 8.7 of this Agreement; (ii) (A) the Release or threatened Release of any Hazardous Materials prior to the Closing Date on, from or under the Properties or in connection with the operation of the Assets or (B) the Release of any Hazardous Materials on, from or under any other property where, prior to the Closing Date, Hazardous Materials are or were Released, discharged or disposed of which, on or prior to the Closing date, have impacted the Property or the Assets or (C) the Release or threatened Release of any Hazardous Materials on, from or under any other property where, prior to the Closing Date, Hazardous Materials are or were Released, threatened to be Released, discharged or disposed of in connection with disposal activities related to the Properties or the Assets, whether or not, in any case covered by this clause (ii), such Release, threatened Release, discharge or disposal was in compliance with Environmental Law; (iii) the violation prior to the Closing of any Environmental Law in effect prior to the Closing by KCS or KCSR, any of their Subsidiaries or any other Person in connection with the Properties or the Assets; and (iv) any Environmental Claim relating to the Properties or the Assets against any Person whose liability for such Environmental Claim KCS, KCSR or any of their respective Subsidiaries has retained or assumed either contractually or by operation of Law.

(c) KCS and KCSR shall have no obligation to indemnify the NS Indemnified Parties under Section 12.2(a)(i)(A) until the NS Indemnified Parties have suffered Damages in excess of $2,000,000 in the aggregate, and then KCS and KCSR will be obligated to indemnify the NS Indemnified Parties for Damages only in excess of such amount, but KCS and KCSR shall not be liable for indemnification under Section 12.2(a)(i)(A) for Damages in excess of $300,000,000 in the aggregate; provided , that such $2,000,000 threshold shall not apply to any Damages arising from any breach of any representation or warranty in Section 8.10. If KCS and KCSR are obligated to indemnify the NS Indemnified Parties, then KCS and KCSR may, at their election, (i) pay such indemnification directly to the NS Indemnified Parties or the Company Indemnified Parties, as the case may be, (ii) pay any Damages arising from any liability or any Third Party Claim directly to the applicable third party (to the extent that such Damages are owed to such third party), or (iii) contribute amounts to the Company and cause the Company to pay any Damages arising from any liability or any Third Party Claim directly to the applicable third party (to the extent that such Damages are owed to such third party); provided, that the foregoing shall not limit in any way the obligation of KCS and KCSR to satisfy all such indemnification obligations.

(d) Except for fraud, injunctive and provisional relief and remedies that cannot be waived as a matter of Law, if the Closing occurs, this Section 12.2 shall be the exclusive remedy for any breach of any of KCS’ or KCSR’s representations and warranties or any breach of KCS’ or KCSR’s covenants contained in this Agreement.

12.3 Indemnification by NS .

(a) NS shall indemnify, save and hold harmless KCS and its Affiliates, and each of their respective officers, directors, employees and agents and each of their respective successors and assigns, from and against any and all Damages incurred in connection with, arising out of, resulting from or incident to: (i) any breach of or any inaccuracy in any of, the representations or warranties of NS in this Agreement (in each case, solely for the purpose of calculating the amount of Damages, without regard to any qualification or limitation with respect to “materiality,” whether by reference to “material,” “in all material respects” or “Material Adverse Effect”); or (ii) any breach or default in covenants or agreements made by NS in this Agreement.

(b) Except for fraud, injunctive and provisional relief and remedies that cannot be waived as a matter of Law, if the Closing occurs, this Section 12.3 shall be the exclusive remedy for any breach of any of NS’ representations and warranties or any breach of NS’ covenants contained in this Agreement.

12.4 Notification of Claims . A party entitled to indemnification under Sections 12.2 or 12.3 (an “Indemnified Party”) shall notify the other party (the “Indemnifying Party”) within a reasonable period of time after becoming aware of any Damages which the Indemnified Party shall have determined has given or could give rise to a claim for indemnification under Sections 12.2 or 12.3 hereof. Such notice shall include an estimate of the Damages that the Indemnified Party has determined may be

incurred to the extent then known or reasonably determinable. The failure to so notify the Indemnifying Party will not relieve the Indemnifying Party of any liability that it may have to any Indemnified Party, except to the extent of any prejudice to the Indemnifying Party resulting from such delay. As soon as practicable after the date of such notice, the Indemnified Party shall provide to the Indemnifying Party all information and documentation necessary to support and verify the Damages so claimed and the Indemnifying Party and its agents shall be given access to all books and records in the possession or control of the Indemnified Party which the Indemnifying Party reasonably determines to be related to such claim.

12.5 Matters Involving Third Parties .

(a) If any third party shall commence an Action against any Indemnified Party with respect to any matter (a “Third Party Claim”) which may give rise to a claim for indemnification under Sections 12.2 or 12.3, or if an Indemnified Party otherwise becomes aware that a Third Party Claim may be asserted against the Indemnified Party, the Indemnified Party shall notify the Indemnifying Party in writing as soon as practicable. The failure to so notify the Indemnifying Party will not relieve the Indemnifying Party of any liability that it may have to any Indemnified Party, except to the extent of any prejudice to the Indemnifying Party resulting from such delay. If the Indemnifying Party notifies the Indemnified Party that it does not dispute the claim, or fails to notify the Indemnified Party within 30 days after delivery of such notice by the Indemnified Party whether the Indemnifying Party disputes the claim, all Damages incurred in connection with, arising out of, resulting from or incident to such Third Party Claim will be conclusively deemed a liability of the Indemnifying Party and the Indemnifying Party shall pay the amount of such Damages to the Indemnified Party promptly upon the final determination thereof.

(b) If the Indemnifying Party does not respond to the notice or elects not to assume the defense of such claim or demand, in each case within the period allowed after delivery of the notice, the Indemnified Party shall have the right to defend such claim or demand by appropriate proceedings or to settle or pay any such claim or demand for such an amount as the Indemnified Party shall deem appropriate, in either case at the sole cost and expense of the Indemnifying Party, provided that the Indemnified Party shall not settle any such claim without the prior written consent of the Indemnifying Party, which consent will not be unreasonably withheld, conditioned or delayed. In the event that the Indemnifying Party does not assume the defense of such claim or demand, the Indemnifying Party shall have the right to participate in such defense (including with counsel of its choice), at its own expense, and the Indemnified Party shall reasonably cooperate with the Indemnifying Party in connection with such participation.

(c) If the Indemnifying Party notifies the Indemnified Party that it desires to defend against such claim or demand, then the Indemnifying Party shall be entitled to participate in or, at the Indemnifying Party’s option, assume at its own cost and expense the defense of any such claim or demand with counsel of its own choosing (which shall be reasonably acceptable to the Indemnified Party), provided , that, if the

Indemnifying Party assumes the defense of such claim or demand it shall reimburse the Indemnified Party for out of pocket expenses incurred by the Indemnified Party (such as travel costs, but not internal time charges) and the Indemnified Party (i) shall reasonably cooperate with the Indemnifying Party; and (ii) may elect to participate in any such defense at its sole cost and expense, but the control of such defense and its settlement or resolution shall rest with the Indemnifying Party. In the event there is a significant conflict of interest between the Indemnified Party and the Indemnifying Party in the conduct of the defense of such claim or demand, the reasonable fees and disbursements of one counsel of the Indemnified Party shall be at the expense of the Indemnifying Party. The Indemnifying Party shall not compromise or settle any such claim or demand without the prior written consent of the Indemnified Party (which consent shall not be unreasonably withheld, conditioned or delayed), unless such settlement or compromise does not subject the Indemnified Party to any monetary liability, will not impose on the Indemnified Party any obligation, admission, restriction or further Damages and includes a complete, unconditional release of the Indemnified Party from all liability with respect to such claim or demand.

(d) In all cases the Indemnified Party and the Indemnifying Party shall keep each other reasonably informed as to all matters concerning any Third Party Claim and shall promptly notify the other party in writing of any and all significant developments relating thereto.

12.6 Taxes . If any indemnity payment pursuant to this Article 12 is determined to be taxable to any Indemnified Party by any Governmental Authority, the indemnity payment shall be increased by such amount as is necessary so that, after taking into account the Tax liability imposed upon such Indemnified Party upon receipt of such indemnity payment, the Indemnified Party receives an amount equal to the amount it would have received had such indemnity payment not been subject to Tax (after taking into account, in accordance with Section 12.7(a), any Tax benefits and/or insurance coverage that may be available to the Indemnified Party).

12.7 Other Limits on Indemnification .

(a) The amount of any Damages sustained by a Indemnified Party shall be reduced (i) by any amount received by such Indemnified Party with respect thereto under any insurance coverage relating thereto (other than insurance coverage provided by an Affiliate (other than Company) of such indemnitee) or from any other party alleged to be responsible therefor and (ii) by the amount of any Tax benefit actually realized with respect to the Damages. An Indemnified Party shall use its commercially reasonable efforts to collect any amounts available under such insurance coverage and from such other party alleged to have responsibility and to realize any Tax benefit with respect to the Damages. If an Indemnified Party realizes a Tax benefit or receives an amount under insurance coverage or from such other party with respect to Damages sustained at any time subsequent to any indemnification provided pursuant to this Article 12, then such Indemnified Party shall promptly reimburse the applicable Indemnifying Party for any payment made by such Indemnifying Party in connection with providing such indemnification up to such amount realized or received by the Indemnified Party.

Nothing in this Section 12.7(a) shall limit in any way the ability of KCS, NS or the Company to (i) take (or refrain from taking, as the case may be) any reasonable position for Tax purposes that KCS, NS or the Company determines to take (or refrain from taking) in its sole discretion or (ii) refrain from pursuing any third party insurance recovery that KCS, NS or the Company, as the case may be, determines would be commercially inadvisable to pursue.

(b) Each Indemnified Party shall use its commercially reasonable efforts to mitigate any claim or liability that an Indemnified Party asserts or may assert under this Article 12. In the event that an Indemnified Party shall fail to make such commercially reasonable efforts to mitigate any such claim or liability, then notwithstanding anything contained in this Agreement to the contrary, the Indemnifying Party shall not be required to indemnify any Indemnified Party for that portion of any Damages that would reasonably be expected to have been avoided if the Indemnified Party had made such efforts.

13. Termination .

13.1 Termination by Mutual Consent . This Agreement may be terminated at any time prior to the Closing by the mutual agreement, in writing, of each of KCS and NS.

13.2 Termination by Final Order . This Agreement may be terminated by KCS or NS upon written notice to the other party that any final, non-appealable Law shall have been enacted, entered, promulgated or enforced by any Governmental Authority of competent jurisdiction which prohibits, restricts or makes illegal the consummation of the Closing or any of the material transactions contemplated thereby, or by the Company Agreement or any of the Ancillary Agreements; provided , that the right to terminate this Agreement under this Section 13.2 shall not be available to any party whose breach of any provision or whose failure to perform any obligation under this Agreement (or the breach or failure of any Affiliate thereof) has been the cause of such Law.

13.3 Termination by NS . NS may (but shall not be obligated to) terminate this Agreement prior to the Closing by giving written notice to KCS if:

(a) there has been a material violation or breach by KCS or KCSR of any of their agreements or covenants contained in this Agreement or there has been a material violation or breach by KCS or KCSR of any of their representations or warranties contained in this Agreement such that it is reasonably likely that either of the conditions set forth in Section 11.2(a) or 11.2(b) cannot be satisfied, and such violation or breach shall not have been cured or corrected within twenty days after receipt of notice thereof;

(other than any conditions which, by their terms, may only be satisfied on the Closing Date) if any of the Required Governmental Consents required by Section 11.1(c) have not been obtained by such date, such date shall be extended in additional one-month increments without any further action by the parties through February 1, 2007; and, provided , further , that the non-occurrence of the Closing is not due to a breach by NS of any condition or covenant hereunder;

(c) there has been imposed by a Governmental Authority a condition to any Required Governmental Consent, which condition is not acceptable to NS in NS’ reasonable judgment; or

(d) there has been a Material Adverse Effect on KCS or KCSR which shall not have been cured or corrected within twenty days after receipt of notice thereof; provided that such Material Adverse Effect is not due to a breach by NS of any condition or covenant hereunder.

13.4 Termination by KCS . KCS may (but shall not be obligated to) terminate this Agreement prior to the Closing by giving written notice to NS if:

(a) there has been a material violation or breach by NS of any of its respective agreements or covenants contained in this Agreement or there has been a material violation or breach by NS of any of its representations or warranties contained in this Agreement such that it is reasonably likely that either of the conditions set forth in Section 11.3(a) and (b) cannot be satisfied, and such violation or breach shall not have been cured or corrected within twenty days after receipt of notice thereof;

(b) the Closing does not occur on or prior to September 1, 2006, or such later date as may be agreed to in writing by the parties; provided , that, notwithstanding the satisfaction of the other conditions set forth in Sections 11.1 and 11.3 (other than any conditions which, by their terms, may only be satisfied on the Closing Date) if any of the Required Governmental Consents required by Section 11.1(c) have not been obtained by such date, such date shall be extended in additional one-month increments without any further action by the parties through February 1, 2007; and, provided , further , that the non-occurrence of the Closing is not due to a breach by KCS or KCSR of any condition or covenant hereunder;

(c) there has been imposed by a Governmental Authority a condition to any Required Governmental Consent, which condition is not acceptable to KCS in KCS’ reasonable judgment; or

(d) there has been a Material Adverse Effect on NS or AGS which shall not have been cured or corrected within twenty days after receipt of notice thereof; provided that such Material Adverse Effect is not due to a breach by KCS or KCSR of any condition or covenant hereunder.

13.5 Effect of Termination . In the event of the termination of this Agreement as permitted by this Article 13, no party shall have any obligation under, or liability to any other in respect to, this Agreement, except with respect to, any willful breach of this Agreement that gives rise to such termination and except for the provisions of the Confidentiality Agreement and the confidentiality obligations contained in Section 10.2(a), this Section 13.5 and Article 14 hereof, which shall survive the termination of this Agreement.

14. Miscellaneous .

14.1 Notices . All notices, requests, demands and other communications (collectively, “Notices”) given pursuant to this Agreement shall be in writing, and shall be delivered by personal service, courier, overnight delivery service, facsimile transmission (which must be confirmed) or by United States registered or certified mail, postage prepaid, return receipt requested, to the following addresses:

(i) if to NS, to:

Norfolk Southern Corporation
Three Commercial Place
Norfolk, Virginia 23510
Facsimile No.: (757) 533-4872
Attn: James A. Squires, Esq.

with a copy to:

Skadden, Arps, Slate, Meagher & Flom LLP
4 Times Square
New York, New York 10036-6522
Facsimile No.: (212) 735-2000
Attn: Eric J. Friedman, Esq.

(ii) if to KCS or KCSR, to:

Kansas City Southern
427 West 12 ^th Street
Kansas City, Missouri 64105
Facsimile No.: (816) 983-1227
Attn: Robert B. Terry, Esq.

with a copy to:

Sonnenschein Nath & Rosenthal LLP
4520 Main Street, Suite 1100
Kansas City, MO 64111

Facsimile No.: (816) 531-7545
Attn: John F. Marvin, Esq.

Any Notice, other than a Notice sent by registered or certified mail, shall be effective when received; a Notice sent by registered or certified mail, postage prepaid return receipt requested, shall be effective on the earlier of when received or the third day following deposit in the United States mails. Any party may from time to time change its address for further Notices hereunder by giving notice to the other parties in the manner prescribed in this Section.

14.2 Entire Agreement . This Agreement, the Company Agreement, the Ancillary Agreements and the Confidentiality Agreement, in each case including any attached exhibits and schedules, contain the sole and entire agreement and understanding of the parties with respect to the entire subject matter of this Agreement, and any and all prior discussions, negotiations, commitments and understandings, whether oral or otherwise, related to the subject matter of this Agreement are hereby merged herein. Nothing in this Agreement, express or implied, is intended to confer upon any Person other than the parties hereto any rights or remedies under or by way of this Agreement.

14.3 Assignment . No party may assign its rights or obligations under this Agreement, and any attempted or purported assignment or any delegation of any party’s duties or obligations arising under this Agreement to any third party or entity shall be deemed to be null and void, and shall constitute a material breach by such party of its duties and obligations under this Agreement; provided that NS may assign its rights to any wholly-owned Subsidiary of NS.

14.4 Extension, Waiver and Amendment . At any time prior to the Closing, the parties hereto may (a) extend the time for the performance of any of the obligations or other acts of any other party hereto, (b) waive any inaccuracies in the representations and warranties of any other party hereto contained herein or in any document delivered pursuant hereto, and (c) waive compliance by any other party hereto with any of the agreements or conditions contained herein. Any agreement on the part of a party hereto to any such extension or waiver shall be valid if set forth in writing in an instrument signed by or on behalf of such party. The waiver by any party hereto of a breach of this Agreement shall not operate or be construed as a waiver of any subsequent breach. This Agreement may be amended only by a written agreement executed by all of the parties to this Agreement.

14.5 Governing Law; Submission to Jurisdiction .

(a) THE LAWS OF THE STATE OF DELAWARE SHALL GOVERN THE VALIDITY OF THIS AGREEMENT, THE CONSTRUCTION OF ITS TERMS AND THE INTERPRETATION OF THE RIGHTS AND DUTIES ARISING HEREUNDER.

(b) Subject to Section 14.13, each of the parties hereto (i) consents to submit itself to the exclusive jurisdiction of any Federal or state court located in the State of Delaware (the “Delaware Courts”) in any action to enforce or in aid of the agreement to arbitrate in Section 14.13 herein or for provisional relief to maintain the status quo or prevent irreparable harm pending the appointment of the arbitrators, and to the non-exclusive jurisdiction of the Delaware Courts for enforcement of any award issued hereunder (ii) will not attempt to deny or defeat such personal jurisdiction by motion or other request for leave from any such court, and (iii) waives any objection based on forum non conveniens or any other objection to venue thereof.

14.6 Specific Performance; Injunctive Relief . Each of the parties hereto acknowledges, understands and agrees that any breach or threatened breach by such party or such party’s Affiliates of the covenants contained herein will cause irreparable injury to the other party and that money damages will not provide an adequate remedy therefor. Accordingly, in the event of any such breach or threatened breach, a non-breaching party shall have the right and remedy (in addition to any other rights or remedies available at Law or in equity, including, money damages), subject to the provisions of Section 14.13, to have the provisions of this Agreement specifically enforced by, and to seek injunctive relief and other equitable remedies in, any court having competent jurisdiction. Each party further agrees to waive any requirement for the securing or posting of any bond or other security in connection with seeking such remedies.

14.7 Severability . Whenever possible each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable Law, but if any provision of this Agreement shall be or become prohibited or invalid under applicable Law, such provision shall be ineffective to the extent of such prohibition or invalidity without invalidating the remainder of such provision or the remaining provisions of this Agreement.

14.8 Captions . The various captions of this Agreement are for reference only and shall not be considered or referred to in resolving questions of interpretation of this Agreement.

14.9 Counterparts . This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one and the same instrument.

14.10 Costs and Attorneys’ Fees . Whether or not the transactions contemplated hereby are consummated, each of the parties shall bear and pay all costs and expenses incurred by it or on its behalf in connection with the transactions contemplated hereunder, including fees and expenses of its own financial or other consultants, investment bankers, accountants and counsel.

14.11 Judicial Interpretation . Should any provision of this Agreement require judicial interpretation, it is agreed that a court or other tribunal, as described in Section 14.13, interpreting or construing the same shall not apply a presumption that the terms hereof shall be more strictly construed against any Person by reason of the rule of

construction that a document is to be construed more strictly against the Person who itself or through its agent prepared the same, it being agreed that all parties have participated in the preparation of this Agreement.

14.12 No Third Party Beneficiaries . Except as expressly provided in this Agreement, this Agreement shall not benefit or create any right or cause of action in or on behalf of any Person other than the parties hereto; provided , however , that this Agreement will be binding upon, inure to the benefit of, and be enforceable by, the parties and their respective successors and permitted assigns.

14.13 Dispute Resolution . Each of the parties hereto stipulates and agrees that any dispute controversy or claim, arising out of or relating to this Agreement or the breach, termination or validity thereof (“Dispute”) that is not resolved by negotiations between senior officers of the parties within twenty (20) days after receipt by a party of written notice (“Dispute Notice”) of such Dispute, will be submitted to mediation in accordance with the Commercial Mediation Procedures of the American Arbitration Association (“AAA”). If such dispute is not resolved within twenty (20) days after appointment of a mediator, or within sixty (60) days of receipt of Dispute Notice (whichever comes sooner), each of the parties hereto agrees that, at the demand of any party, such Dispute will be submitted to mandatory and binding arbitration before the AAA, in New York, New York by three arbitrators, under the Commercial Arbitration Rules and the Large Complex Case Procedures of the AAA then in effect (the “Rules”), under the following terms and conditions:

(a) Selection of Arbitrators . A panel of three independent arbitrators shall be appointed by the AAA using the listing, ranking and striking procedure in the Rules. Any arbitrator appointed by the AAA shall be a retired judge or a practicing attorney with no less than fifteen years of experience with large commercial cases and an experienced arbitrator.

(b) Conduct of Arbitration . The arbitration shall be held and the award shall be issued in New York, New York. In addition to Damages, the arbitral tribunal may award any remedy provided for under applicable Law and the terms of this Agreement, including, without limitation, specific performance or other forms of injunctive relief. The arbitrators shall apply the Law of the State of Delaware to the substance of the Dispute and will have no power or authority, under the rules of the AAA or otherwise, to amend or disregard any provision of this Agreement.

(c) Replacement of Arbitrator(s) . Should any of the arbitrator(s) refuse or be unable to proceed with arbitration proceedings, replacement arbitrator(s) will be selected using the same method of selection as the original arbitrator(s).

(d) Findings and Conclusions . The arbitrators will, after reaching judgment and award, prepare and distribute to the parties a written award including the findings of fact and conclusions of Law relevant to such award and containing an opinion setting forth the reasons for the giving or denial of any award.

(e) Time is of the Essence . The arbitrators are hereby instructed that time is of the essence in the arbitration proceeding, and that the arbitrators will have the right and authority to issue monetary sanctions against any party if, upon a showing that such party is unreasonably delaying the proceeding.

(f) Temporary Equitable Relief . By agreeing to arbitration, the parties do not intend to deprive any Delaware Court of its jurisdiction to issue a pre- arbitral injunction, pre-arbitral attachment, or other order in aid of arbitration proceedings and the enforcement of any award. Without prejudice to such provisional remedies as may be available under the jurisdiction of a Delaware Court, the arbitral tribunal shall have full authority to grant provisional remedies and to direct the parties to request that any court modify or vacate any temporary or preliminary relief issued by such court, and to award Damages for the failure of any party to respect the arbitral tribunal’s orders to that effect.

(g) Consolidation . The parties hereto are committed to the prompt and efficient resolution of disputes. Accordingly, if one or more disputes arises under this Agreement, the Company Agreement or any of the Ancillary Agreements such disputes may be brought in a single arbitration. If more than one arbitration is brought with respect to disputes under this Agreement, the Company Agreement or any of the Ancillary Agreements, then any party hereto may request that any arbitration or any new dispute arising under this Agreement, the Company Agreement or any of the Ancillary Agreements be consolidated into any prior arbitration. The new dispute or arbitration shall be so consolidated, provided that the arbitral tribunal for the prior (or first filed) arbitration determines that (i) the new dispute or arbitration presents significant issues of Law or fact common with those in the pending arbitration; (ii) no party would be unduly prejudiced and (iii) consolidation under such circumstances would not result in undue delay for the prior arbitration. Any order of consolidation issued by such arbitral tribunal shall be final and binding upon the parties. Unless the parties otherwise agree, the arbitral tribunal appointed first in time shall serve as the arbitral tribunal for the consolidated arbitration. The parties waive any right they have to appeal or to seek interpretation, revision or annulment of such order of consolidation under the Rules or in any court. The parties hereto agree that upon such an order of consolidation, they will promptly dismiss any arbitration brought under this Agreement, the subject of which has been consolidated into another arbitral proceeding.

(h) Discovery . Recognizing the express desire of the parties for an expeditious means of dispute resolution, the arbitrators will allow for limited discovery as may be reasonable under the circumstances.

(i) Costs and Attorneys’ Fees . Notwithstanding any rule of the AAA to the contrary, the arbitrators rendering judgment under this Section 14.13 will have the power to award the costs of the arbitration, including reasonable attorneys’ fees and expenses to the prevailing party or parties in the arbitration. In any action to enforce this agreement to arbitrate or any arbitral award rendered hereunder, the court may award costs and attorneys’ fees against the party resisting enforcement.

[Signature Page Follows]

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written.


KANSAS CITY SOUTHERN

By:	/s/ Michael R. Haverty

	Name:	Michael R. Haverty
	Title:	Chairman, President and Chief Executive Officer

THE KANSAS CITY SOUTHERN RAILWAY COMPANY

By:	/s/ Michael R. Haverty

	Name:	Michael R. Haverty
	Title:	Chairman of the Board

NORFOLK SOUTHERN CORPORATION

By:	/s/ C.W. Moorman

	Name:	C. W. Moorman
	Title:	President and Chief Executive Officer

THE ALABAMA GREAT SOUTHERN RAILROAD COMPANY

By:	/s/ James A. Squires

	Name:	James A. Squires
	Title:	Vice President

Exhibit 10.47

AMENDMENT NO. 1 TO
TRANSACTION AGREEMENT

THIS AMENDMENT NO. 1 TO TRANSACTION AGREEMENT (this “ Amendment ”), is made and entered into as of January 17, 2006, by and among KANSAS CITY SOUTHERN, a Delaware corporation (“ KCS ”), THE KANSAS CITY SOUTHERN RAILWAY COMPANY, a Missouri corporation (“ KCSR ”), NORFOLK SOUTHERN CORPORATION, a Virginia corporation (“ NS ”), and THE ALABAMA GREAT SOUTHERN RAILROAD COMPANY, an Alabama corporation and Subsidiary of NS (“ AGS ”), with reference to the following facts:

A. KCS, KCSR, NS and AGS are parties to that certain Transaction Agreement entered into as of December 1, 2005 (the “ Transaction Agreement ”), pursuant to the terms of which the parties thereto have agreed to form a joint venture for purposes of owning and operating certain Assets.

B. The Transaction Agreement and the related Company Agreement to be entered into at Closing contemplated that KCS will make certain capital improvements to the Line after the Closing and NS has agreed to contribute certain amounts to the Company, among other things, to pay for such improvements.

C. KCS has determined those capital improvements to the Line set forth on Exhibit D of the Company Agreement will be undertaken in advance of the Closing as part of its 2006 infrastructure program and irrespective of the transaction among the parties to the Transaction Agreement. The parties have determined that it is in the best interest of all parties for KCS to begin making such capital improvements to the Line prior to the Closing. Further, the parties have determined that, should all Required Governmental Consents be obtained, including the approval of the United States Surface Transportation Board, these capital projects should be eligible to be reimbursed from the proceeds of the transactions contemplated by the Transaction Agreement. In order to do so, the Transaction Agreement and the form of Company Agreement attached as Exhibit A hereto must each be amended such that KCS will be reimbursed by the Company following Closing for making such capital improvements to the Line prior to Closing.

NOW, THEREFORE, with reference to the foregoing facts and in consideration of the mutual agreements and understanding set forth herein, the parties hereto, intending to be legally bound, hereby agree as follows:

1. Defined Terms .

Capitalized terms used herein but not otherwise defined herein shall have the meaning assigned to such terms in the Transaction Agreement.

2. Amendments .

2.1 Section 1 of the Transaction Agreement is hereby amended by inserting the following new definitions therein in the appropriate alphabetical order:

“ Budget ” shall have the meaning given to that term in the Company Agreement.

“ Business Plan ” shall have the meaning given to that term in the Company Agreement.

“ Fiscal Year ” shall have the meaning given to that term in the Company Agreement.

“ Pre-Closing Capital Expenditures ” shall have the meaning given to that term in the Company Agreement.

2.2 Section 2.2 of the Transaction Agreement is hereby amended by deleting the first and second sentences thereof and inserting in lieu thereof the following two new sentences:

“KCS and NS shall cause the Company to use $260,000,000 (less any Pre-Closing Capital Expenditures for which the Company reimburses KCS pursuant to clause (b) of the following sentence) of the proceeds from the sale of the NS Interest plus any interest earned thereon from time to time (the “Capital Proceeds”) for the capital expenditures anticipated to be made in accordance with the Company Agreement and the Budgets (including any Rollover Budgets) and Business Plans (as each such term is defined in the Company Agreement) for the Company contemplated thereby. KCS and NS shall cause at Closing (a) up to $40,000,000 of the proceeds from the sale of the NS Interest to be paid to reimburse KCS for capital expenditures other than Pre-Closing Capital Expenditures made by KCS on the Line within the two-year period ending on the Closing Date (none of which shall have been made in anticipation of this Agreement) as presented on a schedule delivered to NS prior to the Closing Date, which schedule shall be final and binding on NS if it accurately sets forth expenditures made in accordance with the principles expressed in this sentence (the different between $40,000,000 and such reimbursement shall be the “Excess Proceeds”), (b) up to $20,000,000 of the proceeds from the sale of the NS Interest equal to the Pre-Closing Capital Expenditures to be paid to reimburse KCS for Pre-Closing Capital Expenditures made by KCS prior to the Closing Date in respect of the Proposed Capital Projects listed in Exhibit D to the Company Agreement as set forth in the Company Agreement, the Budget for the first Fiscal Year and the Business Plan for the first Fiscal Year, which amount shall be presented on a schedule delivered to NS prior to the Closing Date, which schedule shall be final and binding on NS if it accurately sets forth expenditures made in accordance with the principles set forth in this sentence, and (c) the Excess Proceeds and any portion of the Capital Proceeds not allocated at such time for capital expenditures in accordance with the then current Budget or any Rollover Budget, as the case may be, and Business Plan (in the aggregate, the “Excess Capital”) to be made available by the Company to provide the Partner Financing pursuant to Article 4 below.

2.3 Section 3.1(a) of the Transaction Agreement is hereby amended by deleting the first sentence thereof and inserting in lieu thereof the following new first sentence:

“Subject to the terms and conditions of this Agreement, at the Closing, KCS and KCSR shall , and shall cause their respective Subsidiaries, as applicable, to, transfer, convey, assign and delivery to the Company, all of their respective right, title and interest in the

Assets, free and clear of all Liens other than Permitted Liens, and in exchange for the Assets, KCS and NS shall cause the Company to issue to KCS a membership interest in the Company determined in accordance with Section 2.1(a) (as adjusted pursuant to Section 2.1(b) and together with the Preferred Return, the “KCS Interest”).

2.4 Exhibit A to the Transaction Agreement is hereby amended by amending and restating such Exhibit in its entirety to read as set forth on Exhibit A attached hereto.

2.5 Section 8.1 of the Transaction Agreement is hereby amended by inserting the following new third sentence:

“Since the date of its formation, the Company has been a wholly-owned subsidiary of KCS and has not (i) engaged in any business, (ii) conducted any operations, (iii) incurred any liabilities or (iv) entered into any agreements or arrangements, other than, in each case, in connection with the letter agreement by and between KCS and NS dated January 17, 2006, this Agreement and the transactions contemplated by this Agreement.”

3. Limitation of Amendments .

The amendments set forth in Section 2 above are effective for the purposes set forth herein and will be limited precisely as written and will not be deemed to (a) be a consent to any amendment, waiver or modification of any other term or condition of the Transaction Agreement, (b) otherwise prejudice any right or remedy that any party to the Transaction Agreement may now have or may have in the future under or on in connection with the Transaction Agreement, or (c) be a consent to any future amendment, waiver or modification of any other term or condition of the Transaction Agreement.

4. Entire Agreement .

This Amendment, together with the Transaction Agreement, the Company Agreement, the Ancillary Agreements and the Confidentiality Agreement, in each case including any attached exhibits and schedules, contain the sole and entire agreement and understanding of the parties with respect to the entire subject matter contained herein and therein, and any and all prior discussions, negotiations, commitments and understandings, whether oral or otherwise, related to the subject matter contained herein and therein are hereby merged herein and therein. Nothing in this amendment, express or implied, is intended to confer upon any Person other than the parties hereto any rights or remedies under or by way of this Amendment.

5. Assignment .

No party may assign its rights or obligations under this Amendment, and any attempted or purported assignment or any delegation of any party’s duties or obligations arising under this Amendment to any third party or entity shall be deemed to be null and void, and shall constitute a material breach by such party of its duties and obligations under this Amendment; provided that NS may assign its rights to any wholly-owned Subsidiary of NS.

6. Governing Law .

THE LAWS OF THE STATE OF DELAWARE SHALL GOVERN THE VALIDITY OF THIS AMENDMENT, THE CONSTRUCTION OF ITS TERMS AND THE INTERPRETATION OF THE RIGHTS AND DUTIES ARISING HEREUNDER.

7. Severability .

Whenever possible each provision of this Amendment shall be interpreted in such manner as to be effective and valid under applicable Law, but if any provision of this Amendment shall be or become prohibited or invalid under applicable Law, such provision shall be ineffective to the extent of such prohibition or invalidity without invalidating the remainder of such provision or the remaining provisions of this Amendment.

8. Captions .

The various captions of this Amendment are for reference only and shall not be considered or referred to in resolving questions of interpretation of this Amendment.

9. Counterparts .

This Amendment may be executed in any number of counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one and the same instrument.

10. Judicial Interpretation .

Should any provision of this Amendment require judicial interpretation, it is agreed that a court or other tribunal, as described in Section 14.13 of the Transaction Agreement, interpreting or construing the same shall not apply a presumption that the terms hereof shall be more strictly construed against any Person by reason of the rule of construction that a document is to be construed more strictly against the Person who itself or through its agent prepared the same, it being agreed that all parties have participated in the preparation of this Amendment.

11. Dispute Resolution.

Each of the parties hereto stipulates and agrees that the dispute resolution procedures set forth in Section 14.13 of the Transaction Agreement shall apply to any dispute, controversy or claim arising out of or relating to this Amendment or the breach, termination or validity thereof.

[Signature Page Follows]

IN WITNESS WHEREOF , the parties have executed this Amendment No. 1 to Transaction Agreement as of the date first above written.


		KANSAS CITY SOUTHERN

		By:

				Name: Michael R. Haverty
				Title: Chairman, President and
				Chief Executive Officer

		THE KANSAS CITY SOUTHERN RAILWAY COMPANY

		By:

				Name: Michael R. Haverty
				Title: Chairman of the Board

		NORFOLK SOUTHERN CORPORATION

		By:

				Name: Kathryn B. McQuade
				Title: Executive Vice President Planning and Chief Information Officer


		THE ALABAMA GREAT SOUTHERN RAILROAD COMPANY

		By:

				Name: James A. Squires
				Title: Vice President

EXHIBIT A

COMPANY AGREEMENT

[See Attached]

Exhibit 10.48

PARTICIPATION AGREEMENT
(KCSR 2005-1)

dated as of December 20, 2005

among

THE KANSAS CITY SOUTHERN RAILWAY COMPANY,
as Lessee

KCSR TRUST 2005-1 , acting through
WILMINGTON TRUST COMPANY,
not in its individual capacity, except as otherwise
expressly provided herein, but solely as Owner Trustee ,

GS LEASING (KCSR 2005-1) LLC,
as Owner Participant

WELLS FARGO BANK NORTHWEST, NATIONAL ASSOCIATION,

as Indenture Trustee

and

EXPORT DEVELOPMENT CANADA

and

KFW (also known as KREDITANSTALT FüR WIEDERAUFBAU),
as Loan Participants

SD70MAC Locomotives

TABLE OF CONTENTS


Section		Page
Parties			1

Recitals			1

ARTICLE I. DEFINITIONS; INTERPRETATION OF THIS AGREEMENT			3
Section 1.1	Definitions		3
Section 1.2	Directly or Indirectly		3

ARTICLE II. SALE AND PURCHASE; PARTICIPATION IN THE EQUIPMENT COST; CLOSING DATE; TRANSACTION COSTS; ADJUSTMENTS			3
Section 2.1	Sale and Purchase		3
Section 2.2	Participation in Equipment Cost		3
Section 2.3	Closing Date; Procedure for Participation		3
Section 2.4	Owner Participant’s Instructions to Owner Trustee; Satisfaction of Conditions		5
Section 2.5	Expenses		5
Section 2.6	Calculation of Adjustments to Basic Rent, Stipulated Loss Value, Termination Value and Fixed Purchase Price; Confirmation and Verification		8
Section 2.7	Optional Postponement of Closing Date		10

ARTICLE III. REPRESENTATIONS AND WARRANTIES			11
Section 3.1	Representations and Warranties of Trust Company and Owner Trustee		11
Section 3.2	Representations and Warranties of Lessee		13
Section 3.3	Representations and Warranties of Indenture Trustee		16
Section 3.4	Representations, Warranties and Covenants Regarding Beneficial Interest		17
Section 3.5	[Reserved]		17
Section 3.6	Representations and Warranties of Owner Participant		17
Section 3.7	Opinion Acknowledgment		19
Section 3.8	Representations and Warranties of the Loan Participants		19

ARTICLE IV. CONDITIONS PRECEDENT			19
Section 4.1	Conditions Precedent to First Delivery Date; Conditions of Each Participant and Indenture Trustee to any Closing Date		19
Section 4.2	Additional Conditions Precedent to the Obligations of Loan Participants		24
Section 4.3	Additional Conditions Precedent to the Obligations of Owner Participant		25
Section 4.4	Conditions Precedent to the Obligation of Lessee		25

ARTICLE V. FINANCIAL AND OTHER REPORTS OF LESSEE			26


Participation Agreement (KCSR 2005-1)		- i -


Section		Page
ARTICLE VI. CERTAIN COVENANTS OF THE PARTICIPANTS, TRUSTEES AND LESSEE			27
Section 6.1	Restrictions on Transfer of Beneficial Interest		27
Section 6.2	Lessor’s Liens Attributable to Owner Participant		29
Section 6.3	Lessor’s Liens Attributable to Trust Company		30
Section 6.4	Liens Created by Indenture Trustee and Loan Participants		30
Section 6.5	Covenants of Owner Trustee, Trust Company, Owner Participant and Indenture Trustee		31
Section 6.6	Amendments to Operative Agreements		31
Section 6.7	Section 1168		32
Section 6.8	Merger Covenant		32
Section 6.9	Additional Filings		32
Section 6.10	Owner Participant an Affiliate of Lessee		33
Section 6.11	Taxes		33
Section 6.12	Direct Loan		33
Section 6.13	Transfers by KfW		33

ARTICLE VII. LESSEE’S INDEMNITIES			34
Section 7.1	General Tax Indemnity		34
Section 7.2	General Indemnification and Waiver of Certain Claims		39

ARTICLE VIII. LESSEE’S RIGHT OF QUIET ENJOYMENT			44

ARTICLE IX. [ RESERVED ]			44

ARTICLE X. SUCCESSOR INDENTURE TRUSTEE			44

ARTICLE XI. MISCELLANEOUS			44
Section 11.1	Consents		44
Section 11.2	Refinancing		45
Section 11.3	Amendments and Waivers		47
Section 11.4	Notices		47
Section 11.5	Survival		48
Section 11.6	No Guarantee of Debt		48
Section 11.7	Successors and Assigns		49
Section 11.8	Business Day		49
Section 11.9	GOVERNING LAW		49
Section 11.10	Severability		49
Section 11.11	Counterparts		49
Section 11.12	Headings and Table of Contents		49
Section 11.13	Limitations of Liability		49
Section 11.14	Reproduction of Documents		50
Section 11.15	Tax Disclosure		50
Section 11.16	Bankruptcy of Trust or Trust Estate		51


Participation Agreement (KCSR 2005-1)		- ii -

Attachments to Participation Agreement:


Schedule 1	—	Description of Equipment; Equipment Cost
Schedule 2	—	Participants’ Commitments
Schedule 3	—	Pricing Assumptions and Indicative Schedules
Schedule 4	—	UCC Filings
Exhibit A	—	Certificate of Acceptance


Participation Agreement (KCSR 2005-1)		- iii -

PARTICIPATION AGREEMENT
(KCSR 2005-1)

This PARTICIPATION AGREEMENT (KCSR 2005-1), dated as of December 20, 2005 (this “ Agreement ” or this “ Participation Agreement ”), among (i) THE KANSAS CITY SOUTHERN RAILWAY COMPANY, a Missouri corporation (herein, together with its permitted successors and assigns, called the “ Lessee ” and “ Seller ”), (ii) KCSR TRUST 2005-1, a Delaware statutory trust (the “ Trust ”), acting through WILMINGTON TRUST COMPANY, a Delaware banking corporation, not in its individual capacity except as expressly stated herein, but solely as trustee created under the Trust Agreement (as hereinafter defined) (in its individual capacity “ Trust Company ” and as Owner Trustee, together with its successors and permitted assigns, called the “ Owner Trustee ”), (iii) GS LEASING (KCSR 2005-1) LLC, a Delaware limited liability company (herein, together with its successors and permitted assigns, called the “ Owner Participant ”), (iv) WELLS FARGO BANK NORTHWEST, NATIONAL ASSOCIATION, a national banking association, not in its individual capacity as expressly provided herein but as trustee under the Indenture (as hereinafter defined) (herein in such capacity, together with its successors and permitted assigns, called the “ Indenture Trustee ”), and (v) EXPORT DEVELOPMENT CANADA, a corporation established by an Act of Parliament of Canada (“ EDC ”), and KFW (also known as KREDITANSTALT FüR WIEDERAUFBAU), a public law corporation organized under the laws of the Federal Republic of Germany (“ KfW ”, and herein each of EDC and KfW, together with its successors and permitted assigns, each a “ Loan Participant ” and collectively the “ Loan Participants ”).

WITNESSETH:

WHEREAS, the following transactions have occurred prior to the date hereof:

(i) On November 2, 2005, Lessee and its Affiliate, NAFTA Rail, S.A. de C.V. a Mexico corporation (“ NAFTA Rail ”), owned all right, title and interest in and to twenty-five (25), in the case of Lessee, and fifty (50) (now forty-eight due to two casualties), in the case of NAFTA Rail, of the SD70MAC locomotives more particularly described on Schedule 1 hereto (the “ Units ”);

(ii) On November 2, 2005, Lessee and NAFTA Rail, as borrowers, and Loan Participants, as lenders, entered into an Amended and Restated Loan Agreement (the “ Direct Loan Agreement ”), evidencing the joint and several borrowing by Lessee and NAFTA Rail of $63,962,452.85 from EDC and $31,981,635.06 from KfW (the “ Direct Loan ”), which Direct Loan and other obligations under the Direct Loan Agreement are secured by a lien on the Units created pursuant to a Mortgage and Security Agreement, dated November 2, 2005, executed by Lessee and NAFTA Rail in favor of the Loan Participants (the “ Direct Mortgage ”);

(iii) On or prior to the Delivery Date of any Unit, NAFTA Rail will have transferred all of its right, title and interest in such Unit to Seller;

WHEREAS, concurrently with the execution and delivery of this Agreement, the parties identified below are entering into the following agreements:


Participation Agreement (KCSR 2005-1)

(i) the Trust Agreement, between Owner Participant and Trust Company creating the Trust;

(ii) the Lease between the Trust and Lessee;

(iii) the Indenture between the Trust and Indenture Trustee; and

(iv) the Tax Indemnity Agreement between Owner Participant and Lessee;

WHEREAS, subject to the terms and conditions herein provided, from time to time after the date hereof, Lessee will (i) on behalf of the Trust, accept delivery of each Unit from Seller to the Trust, subject to the lien of the Direct Mortgage, and (ii) lease such Unit from the Trust pursuant to the Lease.

WHEREAS, subject to the terms and conditions herein provided, the parties hereto will enter into the following transactions on one or two Closing Dates, such transactions being deemed to occur in the order listed, but each such transaction conditioned on the completion of each of the other such transactions, and all such transactions to be consummated simultaneously:

(i) Lessee will pay, or cause to be paid, all accrued interest and other accrued amounts, other than principal, payable under the Direct Loan relating to each of the Units theretofore delivered and accepted under the Lease but for which settlement of the purchase price has not occurred;

(ii) Owner Participant will contribute to the Trust an amount equal to Owner Participant’s Commitment with respect to such Units;

(iii) The Trust will (x) issue to each Loan Participant an Equipment Note as evidence of the loan made by such Loan Participant to Owner Trustee on such Closing Date in an amount equal to such Loan Participant’s Commitment with respect to such Units, and (y) execute and deliver an Indenture Supplement granting to Indenture Trustee a security interest in such Units;

(iv) The Trust, with the proceeds of the Equipment Notes and the equity contribution made by Owner Participant, will pay to Seller a purchase price for such Units equal to their Equipment Cost;

(v) Seller shall pay in full all amounts due on the Direct Loan in respect of such Units;

(vi) Loan Participants will execute and deliver an instrument, in recordable form, terminating the Direct Mortgage in respect of such Units; and

(vii) The Trust and Lessee will execute and deliver the Lease, and a Lease Supplement with respect to such Units;

Now, THEREFORE, in consideration of the mutual agreements herein contained and other good and valuable consideration, receipt of which is acknowledged, the parties hereto agree as follows:


Participation Agreement (KCSR 2005-1)		- 2 -

ARTICLE I.
DEFINITIONS; INTERPRETATION OF THIS AGREEMENT

Section 1.1 Definitions . The capitalized terms used in this Agreement (including the foregoing recitals) and not otherwise defined herein shall have the respective meanings specified in Appendix A to the Lease, unless the context hereof shall otherwise require. All references to Sections, Schedules and Exhibits herein are to Sections, Schedules and Exhibits of this Agreement unless otherwise indicated.

Section 1.2 Directly or Indirectly . Where any provision in this Agreement refers to action to be taken by any Person, or which such Person is prohibited from taking, such provision shall be applicable whether such action is taken directly or indirectly by such Person.

ARTICLE II.
SALE AND PURCHASE; PARTICIPATION IN THE EQUIPMENT COST;
CLOSING DATE; TRANSACTION COSTS; ADJUSTMENTS

Section 2.1 Sale and Purchase.

(a) Delivery and Acceptance . Subject to the terms and conditions hereof and on the basis of the representations and warranties set forth herein, the Trust agrees to purchase each Unit from Seller and Lessee agrees to accept delivery of such Unit under the Lease, such lease, delivery and acceptance of the Units under the Lease to be conclusively evidenced by the execution and delivery by Lessee of a Certificate of Acceptance covering such Unit in the form attached hereto as Exhibit A (a “ Certificate of Acceptance ”) and dated the date of such delivery and acceptance (the “ Delivery Date ” for such Unit), subject to the condition subsequent that Seller shall receive the purchase price for such Unit as herein provided.

(b) Settlement of Purchase Price . Subject to the terms and conditions hereof and on the basis of the representations and warranties set forth herein, on the date specified in the Closing Date Notice delivered by Lessee pursuant to Section 2.3 (each a “ Closing Date ”), the Trust will pay to Seller a purchase price equal to the Equipment Cost with respect to each Unit theretofor delivered by Seller and accepted under the Lease but which settlement of the purchase price has not occurred; provided , however , that the Trust shall not be obligated to pay the purchase price for any Unit that shall suffer an Event of Loss on or prior to such Closing Date, and provided further , in the event that a Closing Date does not occur on or before February 15, 2006 with respect to any Unit for which a Delivery Date shall have occurred, the delivery and acceptance of such Unit under the Lease shall automatically, without further action, be rescinded and all right, title and interest to such Unit shall revert to Seller. There shall be no more than two Closing Dates. The first Closing Date shall occur on or prior to December 31, 2005. The second Closing Date shall occur on or prior to February 15, 2006.

Section 2.2 Participation in Equipment Cost.

(a) Equity Participation . Subject to the terms and conditions hereof and on the basis of the representations and warranties set forth herein, Owner Participant agrees to participate in the payment of the Equipment Cost for each Unit on the applicable Closing Date by making an equity investment in the beneficial ownership of the Trust in an amount equal to


Participation Agreement (KCSR 2005-1)		- 3 -

the product of the Equipment Cost of such Unit and the applicable percentage set forth on Schedule 2 hereto (which product equals the excess of the Equipment Cost of such Unit over the Direct Loan Balance as of the date hereof allocable to such Unit, and is herein referred to as the “ Owner Participant’s Commitment ”). The aggregate amount of the Owner Participant’s Commitment required to be made as above shall not exceed $31,755,000.00. In no event shall the Equipment Cost for any Unit exceed the fair market value of such Unit as set forth in the Appraisal referred to in Section 4.3(a) hereof. The Owner Participant’s Commitment to be paid by Owner Participant on each Closing Date shall be paid to Owner Trustee at an account with Owner Trustee to be held and applied by Owner Trustee as provided in Section 2.3.

(b) Debt Participation . Subject to the terms and conditions hereof and on the basis of the representations and warranties set forth herein, each Loan Participant severally agrees to participate on the applicable Closing Date, in the payment of the Equipment Cost of each Unit by making a secured loan, to be evidenced by an Equipment Note, to Owner Trustee in an amount equal to the product of the Equipment Cost of such Unit and the applicable percentage set forth on Schedule 2 hereto (which product equals the Direct Loan Balance as of the date hereof allocable to such Unit, and is herein referred to, with respect to a Loan Participant, as its “ Loan Participant’s Commitment ” and collectively, the “ Loan Participants’ Commitment ”). The aggregate amount of each Loan Participant’s Commitment required to be made as above provided in the payment of the Equipment Cost on any Closing Date shall equal the Direct Loan Balance allocable to Units for which settlement is made on such Closing Date, which amounts, in the aggregate, are set forth opposite such Loan Participant’s name on Schedule 2 hereto.

Section 2.3 Closing Date; Procedure for Participation .

(a) Closing Date Notice . Not later than 1:00 P.M., New York City time, on the third Business Day preceding each Closing Date, Lessee shall give Owner Participant, Indenture Trustee, Owner Trustee and Loan Participants notice (a “ Closing Date Notice ”) by telex, telegraph, facsimile or other form of telecommunication or telephone (to be promptly confirmed in writing) of such Closing Date, which Closing Date Notice shall specify in reasonable detail the Units to be delivered and accepted under the Lease for which settlement of the purchase price will be made on such date, the aggregate Equipment Cost of such Units, and the respective amounts of the Owner Participant’s Commitment and each Loan Participant’s Commitment required to be paid with respect to such Units. Prior to 11:00 A.M., New York City time, on such Closing Date, Owner Participant shall make the amount of the Owner Participant’s Commitment and each Loan Participant shall make the amount of its Loan Participant’s Commitment required to be paid on such Closing Date available to Owner Trustee, by transferring or delivering such amounts, in funds immediately available, to Owner Trustee, at Wilmington Trust Company, Rodney Square North, 1100 North Market Street, Wilmington, DE 19890, Ph: (302) 636-6302, Fax: (302) 636-4140, Account Number: 074580-000, Account Name: KCSR 2005-1 Trust.

(b) Closing . The settlement with respect to the payment of the purchase price of the applicable Units on a Closing Date (a “ Closing ”) shall take place at 11:00 A.M., New York City time on each Closing Date at the offices of Thelen Reid & Priest LLP, 875 Third Avenue, New York, New York 10022 or at such other place or time as the parties hereto shall agree. Upon receipt by Owner Trustee on such Closing Date of the full amount of the Owner Participant’s Commitment and each Loan Participant’s Commitment in respect of the Units for which settlement will be made on such Closing Date, and subject to the conditions set forth in Section 4 to be fulfilled on such Closing Date having been fulfilled to the satisfaction of Owner Participant and Loan Participants or waived by Owner


Participation Agreement (KCSR 2005-1)		- 4 -

Participant or Loan Participants, as the case may be, (i) the Trust shall, pay to, or to the order of, Seller, from the funds then held by it, in immediately available funds, an amount equal to the Equipment Cost for such Units purchased from such Seller, (ii) Seller shall direct the Trust to pay such amount, on behalf of Seller, directly to the Loan Participants in payment of the Direct Loan Balance allocable to such Units together with all other amounts due and payable to such Loan Participants under the Direct Loan and (iii) each Loan Participant shall deliver to Lessee, and Lessee shall cause to be filed promptly, where appropriate, a Direct Mortgage Termination and Release with respect to such Units. Each of Owner Participant, Owner Trustee, Loan Participants, Indenture Trustee, and Lessee shall take all actions required to be taken by it in connection therewith and pursuant to this Section 2.3(b).

Section 2.4 Owner Participant’s Instructions to Owner Trustee; Satisfaction of Conditions .

(a) Owner Participant agrees that the making available to Owner Trustee of the amount of its Commitment for the Units delivered on or prior to each Closing Date in accordance with the terms of this Section 2 shall constitute, without further act, authorization and direction by Owner Participant to Owner Trustee, subject, on such Closing Date, to the conditions set forth in Section 4 to be fulfilled on such Closing Date having been fulfilled on such Closing Date to the satisfaction of Owner Participant or waived by Owner Participant, to take the applicable actions specified in Section 3.01 of the Trust Agreement with respect to the Units on each Closing Date.

(b) Owner Participant agrees, in the case of any Replacement Unit substituted pursuant to Section 11.2 of the Lease, that Owner Trustee is authorized and directed to take the actions specified in Section 11.4 of the Lease with respect to such Replacement Unit upon due compliance with the terms and conditions set forth in such Section 11.4 of the Lease with respect to such Replacement Unit.

(c) Owner Participant agrees that the authorization by Owner Participant or its counsel to Owner Trustee to release to Lessee, the Owner Participant’s Commitment with respect to the Units delivered on or prior to each Closing Date shall constitute, without further act, notice and confirmation that all conditions set forth in Section 4 to be fulfilled on such Closing Date were either met to the satisfaction of Owner Participant or, if not so met, were in any event waived by it with respect to such Units.

Section 2.5 Expenses.

(a) If Owner Participant shall have made its investment provided for in Section 2.2(a) and the transactions contemplated by this Agreement are consummated, either Owner Participant will promptly pay, or Owner Trustee will promptly pay, with funds Owner Participant hereby agrees to pay to Owner Trustee, the following (the “ Transaction Costs ”):


Participation Agreement (KCSR 2005-1)		- 5 -

(i) the cost of reproducing and printing the Operative Agreements, the Equipment Notes, if any, including all costs and fees in connection with the initial filing and recording of appropriate evidence of the Lease, the Indenture and any other document required to be filed or recorded pursuant to the provisions hereof or of any other Operative Agreement;

(ii) the reasonable fees and expenses of Thelen Reid & Priest LLP and Davis Polk & Wardwell, special counsel to Owner Participant and OP Guarantor (in the amount separately agreed to by Owner Participant and Lessee) and the reasonable fees and expenses of local counsel to Owner Participant, if any, (in the amount separately agreed to by Owner Participant and Lessee), for their services rendered in connection with the negotiation, execution and delivery of this Participation Agreement and the Operative Agreements related hereto;

(iii) the reasonable fees and expenses of Vedder Price Kaufman & Kammholz, P.C., special counsel to the Loan Participants, for their services rendered in connection with the negotiation, execution and delivery of this Participation Agreement and the Operative Agreements related hereto;

(iv) the reasonable fees and expenses of Ray, Quinney & Nebeker, special counsel to Indenture Trustee (up to the amount separately agreed to by Indenture Trustee and Lessee), for their services rendered in connection with the negotiation, execution and delivery of this Participation Agreement and the Operative Agreements related hereto;

(v) the reasonable fees and expenses of DLA Piper Rudnick Gray Cary US LLP, special counsel to Lessee, for their services rendered in connection with the negotiation, execution and delivery of this Participation Agreement and the Operative Agreements related hereto;

(vi) the reasonable fees and expenses of Morris, James, Hitchens, & Williams, LLP, special counsel to Owner Trustee (up to the amount separately agreed to by Owner Trustee and Lessee), for their services rendered in connection with the negotiation, execution and delivery of this Participation Agreement and the Operative Agreements related hereto;

(vii) the initial fees and expenses of Owner Trustee;

(viii) the initial fees and expenses of Indenture Trustee;

(ix) the fees of an equipment appraiser, for their services rendered in connection with delivering the Appraisal required by Section 4.3(a);

(x) the fees of AMA Capital Partners;

(xi) the reasonable fees and expenses of Alvord and Alvord, special STB counsel, for their services rendered in connection with the consummation of the transactions contemplated by the Operative Agreements;


Participation Agreement (KCSR 2005-1)		- 6 -

(xii) the reasonable fees and expenses of McCarthy Tétrault, special Canadian counsel, for their services rendered in connection with the consummation of the transactions contemplated by the Operative Agreements; and

(xiii) the out-of-pocket expenses of Goldman Sachs & Co. and the fees of Cornerstone Financial Advisors L.P.;

provided , however , that if such Transaction Costs exceed the amount of Transaction Costs used in calculating Basic Rent and other amounts pursuant to Section 2.6(a) hereof on each Closing Date, Lessee shall pay such excess; provided further , however , that, in such event, Owner Participant shall designate which Transaction Costs shall be payable by Lessee.

Notwithstanding the foregoing, Transaction Costs shall not include internal costs and expenses such as salaries and overhead of whatsoever kind or nature nor costs incurred by parties to this Participation Agreement pursuant to arrangements with third parties for services (other than those expressly referred to above), such as computer time procurement, financial analysis and consulting, advisory services, and costs of a similar nature.

(b) Upon the consummation of the transactions contemplated by this Agreement, Lessee agrees to pay when due: (i) the reasonable expenses of Owner Trustee, Indenture Trustee and the Participants incurred subsequent to the delivery of the Equipment, including reasonable fees and expenses of their counsel, in connection with any waivers, supplements, amendments, modifications or alterations which are (A) requested by Lessee in connection with any of the Operative Agreements or (B) necessary or required to comply with Applicable Law or to effectuate the purpose or intent of any Operative Agreement (excluding costs incurred in connection with any adjustment pursuant to Section 2.6, except as expressly provided in Section 2.6(b)); (ii) the reasonable ongoing fees and expenses of Owner Trustee under the Trust Agreement, including fees and expenses incurred in connection with the enforcement of obligations of Lessee under the Operative Agreements; and (iii) the reasonable ongoing fees and expenses of Indenture Trustee under the Operative Agreements, including fees and expenses incurred in connection with the enforcement of obligations of Lessee under the Operative Agreements.

(c) Notwithstanding the foregoing provisions of this Section 2.5, except as specifically provided in Section 7.2, Lessee shall have no liability for any costs or expenses relating to any voluntary transfer of Owner Participant’s interest in the Equipment including any transfer prior to any Closing Date of Owner Participant’s obligation to fund its participation pursuant to Section 2 (other than during the continuance of an Event of Default or in connection with the exercise of remedies as provided in Section 15 of the Lease, Lessee’s exercise of any purchase option pursuant to Section 23 of the Lease, Lessee’s exercise of its termination rights pursuant to Section 10 of the Lease or the transfer to Lessee of any Unit which has been the subject of an Event of Loss pursuant to Section 11 of the Lease) and no such costs or expenses shall constitute Transaction Costs and Lessee will not have any obligation with respect to the costs and expenses resulting from any voluntary transfer of any equity interest by any transferee of Owner Participant, whenever occurring (other than during the continuance of an Event of Default or in connection with the exercise of remedies as provided in Section 15 of the Lease, Lessee’s exercise of any purchase option pursuant to Section 23 of the Lease, Lessee’s exercise


Participation Agreement (KCSR 2005-1)		- 7 -

of its termination rights pursuant to Section 10 of the Lease or the transfer to Lessee of any Unit which has been the subject of an Event of Loss pursuant to Section 11 of the Lease).

Section 2.6 Calculation of Adjustments to Basic Rent, Stipulated Loss Value, Termination Value and Fixed Purchase Price; Confirmation and Verification .

(a) Schedules . Basic Rent, Stipulated Loss Values, Termination Values and EBO Fixed Purchase Price, amortization schedules for the Equipment Notes, and Pricing Assumptions for the first Closing Date are set forth on Schedule 3 hereto, and such schedules shall operate as indicative schedules for each Closing Date (the “ Indicative Schedules ”). Basic Rent, Stipulated Loss Values, Termination Values and EBO Fixed Purchase Price, amortization schedules for the Equipment Notes for each subsequent Closing Date will be adjusted as provided below. On each Closing Date, (i) Lessee and Owner Trustee shall enter into a Lease Supplement which shall include as exhibits thereto schedules in the forms of Schedule 3 hereto which include the actual Basic Rent, Rent Payment Dates, Stipulated Loss Values, Termination Values, Allocated Rent, Lessee and Lessor Loan Balances, EBO Fixed Purchase Price, EBO Fixed Purchase Price Date, and amortization schedules for the Equipment Notes, in each case in respect of the Units to be settled on such Closing Date, and shall attach a list of the Units to be financed on such date and (ii) Owner Trustee shall enter into an Indenture Supplement which shall attach a list of the Units to be financed on such date.

(b) Calculation of Adjustments . In the event that (A) any Pricing Assumption relating to the Units to be settled on any Closing Date is determined to be inaccurate with respect to such Closing Date, or (B) prior to any Closing Date: (1) there shall have occurred a Change in Tax Law and (2) after having been advised in writing by Owner Participant of such Change in Tax Law and the proposed adjustment to the payments of Basic Rent resulting therefrom, Lessee shall have waived its right under Section 4.4 of this Agreement to decline to proceed with the transaction, or (C) a refinancing or refunding as contemplated by Section 11.2 occurs, or (D) any amount is paid by Lessee to Owner Participant pursuant to Section 5.5(i) or 5.5(iii) of the Tax Indemnity Agreement, or (E) Lessee elects to make payments to Owner Participant pursuant to Section 5.5(ii) of the Tax Indemnity Agreement, then, in each case, Owner Participant shall recalculate the payments or amounts, as the case may be, of Basic Rent, Stipulated Loss Values, Termination Values and EBO Fixed Purchase Price (except that in the case of events described in clause (D) or (E) above, Owner Participant shall recalculate the Stipulated Loss Values, Termination Values and EBO Fixed Purchase Price only):

(i) to preserve the Net Economic Return that Owner Participant would have realized had there been no change in the Pricing Assumptions or had such Change in Tax Law not occurred or had such refunding or refinancing not occurred or had such amount not been paid by Lessee under Section 5.5(i) or 5.5(iii) of the Tax Indemnity Agreement or had Lessee not elected to make such payment under Section 5.5(ii) of the Tax Indemnity Agreement or had a reoptimization of the debt not occurred, and

(ii) to minimize to the greatest extent possible, consistent with the foregoing clause (i), the sum of the present value of the payments of Basic Rent through and including the EBO Fixed Purchase Price Date, and the EBO Fixed Purchase Price (all present values


Participation Agreement (KCSR 2005-1)		- 8 -

for purposes of the foregoing being computed using the relevant Debt Rate, semiannually compounded, and discounting to the date hereof).

In performing any such recalculation and in determining Owner Participant’s Net Economic Return, Owner Participant shall utilize the same methods, tax constraints and assumptions originally used to calculate the payments of Basic Rent, Stipulated Loss Values, Termination Values and EBO Fixed Purchase Price with respect to the Basic Term (other than those assumptions changed as a result of any of the events described in clauses (A) through (E) of the preceding sentence necessitating such recalculation; it being agreed that such recalculation shall reflect solely any changes of assumptions or facts resulting directly from the event or events necessitating such recalculation). Such adjustments shall comply (to the extent the original structure complied) with section 467 of the Code and the Regulations and the requirements of sections 4.02(5), 4.07(1) and (2) and 4.08(1) of Revenue Procedure 2001-29, as amended ((and such that the Lease could not be treated as a “disqualified leaseback” or “long term agreement” within the meaning of section 467 of the Code), and in the case of any refinancing governed by Section 11.2, shall comply with Treasury Regulation sections 1.467-1(f)(6)(i) and 1.861-10(T)(b)(9) or any successor thereto) whether the term of the Lease is deemed to commence with respect to any Unit on the Closing Date therefor and end on the Basic Term Expiration Date or is deemed to commence on the date of the refinancing and end on the Basic Term Expiration Date.

(c) Confirmation and Verification . Upon completion of any recalculation described above in this Section 2.6, a duly authorized officer of Owner Participant shall provide a certificate to Lessee either (x) stating that the payments of Basic Rent, Stipulated Loss Values, Termination Values and EBO Fixed Purchase Price with respect to the Basic Term as are then set forth in the Lease do not require change, or (y) setting forth such adjustments to the payments of Basic Rent, Stipulated Loss Values, Termination Values or EBO Fixed Purchase Price with respect to the Basic Term as have been calculated by Owner Participant in accordance with Section 2.6(a) above. Such certificate shall describe in reasonable detail the basis for any such adjustments. If Lessee shall so request, the recalculation of any such adjustments described in this Section 2.6 shall be verified by a nationally recognized firm of independent accountants selected by Owner Participant and reasonably acceptable to Lessee and any such recalculation of such adjustment as so verified shall be binding on Lessee and Owner Participant. Such accounting firm shall be requested to make its determination within 30 days. Owner Participant shall provide to a representative of such accounting firm, on a confidential basis, such information as it may reasonably require (but excluding any books, records or tax returns), including the original assumptions used by Owner Participant and the methods used by Owner Participant in the original calculation of, and any recalculation of, Basic Rent, Stipulated Loss Values, Termination Values and EBO Fixed Purchase Price and such other information as is necessary to determine whether the computation is accurate and in conformity with the provisions of this Agreement. The reasonable costs of such verification shall be borne by Lessee, unless as a result of such verification process (1) the payments of Basic Rent certified by Owner Participant pursuant to this Section 2.6(b) are adjusted and such adjustment causes the sum of the present value of the payments of Basic Rent through and including the EBO Fixed Purchase Price Date and the present value of the EBO Fixed Purchase Price (all present values for purposes of the foregoing being computed using the relevant Debt Rate, semiannually compounded, and discounting to the date hereof) to decline by 10 basis points or more from the


Participation Agreement (KCSR 2005-1)		- 9 -

sum of the present value of the payments of Basic Rent through and including the EBO Fixed Purchase Price Date and the present value of the EBO Fixed Purchase Price (all present values for purposes of the foregoing being computed using the relevant Debt Rate, semiannually compounded, and discounting to the date hereof) certified by Owner Participant pursuant to this Section 2.6(b), or (2) any payment of Stipulated Loss Value, Termination Value or EBO Fixed Purchase Price is adjusted and such adjustment causes such Stipulated Loss Value, Termination Value or EBO Fixed Purchase Price to decline by 10 basis points or more from such Stipulated Loss Value, Termination Value or EBO Fixed Purchase Price certified by Owner Participant pursuant to this Section 2.6(b), in which case Owner Participant shall be responsible for the reasonable costs of such verification.

(d) Notwithstanding the foregoing, any adjustment made to the payments of Basic Rent or to Stipulated Loss Values or Termination Values or EBO Fixed Purchase Price with respect to the Basic Term, pursuant to the foregoing, shall comply with the following requirements: (i) each installment of Basic Rent, as so adjusted, under any circumstances and in any event, will be in an amount at least sufficient for Owner Trustee to pay in full as of the due date of such installment any payment of principal of and interest on the Equipment Notes required to be paid on the due date of such installment of Basic Rent and (ii) Stipulated Loss Value and Termination Value, as so adjusted, under any circumstances and in any event, will be an amount which, together with any other amounts required to be paid by Lessee under the Lease in connection with a deemed Event of Loss pursuant to Section 9.1 of the Lease or any other Event of Loss or a termination of the Lease, as the case may be, will be at least sufficient to pay in full, as of the date of payment thereof, the aggregate unpaid principal of the Equipment Notes, Make-Whole Amount, if any, and all unpaid interest on the Equipment Notes, accrued to the date on which Stipulated Loss Value or Termination Value, as the case may be, is paid in accordance with the terms of the Lease.

(e) Invoices . All invoices in respect of Transaction Costs shall be directed to Owner Participant at the address set forth herein, with a copy to Lessee.

Section 2.7 Optional Postponement of Closing Date .

(a) Any scheduled Closing Date may be postponed from time to time for any reason (but to no later than February 15, 2006) if Lessee gives Owner Participant, Indenture Trustee, Loan Participants and Owner Trustee telex, telegraphic, facsimile or telephonic (confirmed in writing) notice of such postponement and notice of the date to which such Closing Date has been postponed, such notice of postponement to be received by each party no later than 5:00 P.M., New York City time, on the Business Day immediately before the originally scheduled Closing Date or subsequent scheduled Closing Date, and in the event of such postponement, the term “ Closing Date ” as used in this Agreement shall mean such postponed “ Closing Date ”.

(b) In the event of any postponement of any Closing Date pursuant to this Section 2.7, or if on the originally scheduled Closing Date or subsequent scheduled Closing Date not postponed as above provided any Unit is not delivered or, if delivered, is not accepted by Owner Trustee’s representative for any reason (the originally scheduled Closing Date being referred to as the “ Scheduled Closing Date ” for the purposes of this Section 2.7): (i) Lessee will


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reimburse each Participant for the loss of the use of its funds with respect to each such Unit occasioned by such postponement or failure to deliver or accept (unless such failure to accept is caused by a default by such Participant hereunder) by paying to such Participant on demand interest at an interest rate equal to the Debt Rate for the period from and including the Scheduled Closing Date to but excluding the earlier of the date upon which such funds are returned prior to 1:00 P.M. (New York City time) or the actual date of delivery; provided that Lessee shall in any event pay to such Participant at least one (1) day’s interest at such rate on the amount of such funds, unless such Participant shall have received, prior to 12:00 P.M. (New York City time) on the Business Day preceding the Scheduled Closing Date, a notice of postponement of the Scheduled Closing Date pursuant to Section 2.7(a), and (ii) Owner Trustee will return on the earlier of the second Business Day following the Scheduled Closing Date or February 15, 2006, or earlier, if so instructed by Lessee, any funds which it shall have received from such Participant as its Commitment for such Units payable to each Participant, absent joint instruction from Lessee and such Participant to retain such funds until the specified date of postponement established under Section 2.7(a).

(c) Owner Trustee agrees that, in the event it has received telephonic notice (to be confirmed promptly in writing) from Lessee on the Scheduled Closing Date for any Unit or Units that such Unit or Units have not been tendered for delivery, it will if instructed in the aforementioned notice from Lessee (which notice shall specify the Securities to be purchased) use reasonable best efforts to invest, at the risk of Lessee (except as provided below with respect to Indenture Trustee’s gross negligence or willful misconduct), the funds received by it from any Participant with respect to such Unit or Units in Permitted Investments in accordance with Lessee’s instructions. Any such Permitted Investments purchased by Owner Trustee upon instructions from Lessee shall be held in trust by Owner Trustee for the benefit of such Participant. Lessee shall pay to Owner Trustee on such Closing Date (if such Unit or Units are delivered and accepted pursuant hereto) the amount of any net loss on the investment of such funds invested at the instruction of Lessee. If the funds furnished by any Participant with respect to such Unit or Units are required to be returned to such Participant, Lessee shall, on the date on which such funds are so required to be returned, reimburse Owner Trustee, for the benefit of such Participant, for any net losses incurred on such investments. Owner Trustee shall not be liable for failure to invest such funds or for any losses incurred on such investments except for its own willful misconduct or gross negligence. In order to obtain funds for the payment of the Equipment Cost for such Unit or Units or to return funds furnished by such Participant to Owner Trustee for the benefit of such Participant with respect to such Unit or Units, Owner Trustee is authorized to sell any Permitted Investments purchased as aforesaid with the funds received by it from such Participant in connection with such Unit or Units.

(d) Notwithstanding the provisions of Section 2.7(a), no Participant shall be under any obligation to make its Commitment available beyond 5:00 P.M. (New York City time) on February 15, 2006.

ARTICLE III.
REPRESENTATIONS AND WARRANTIES

Section 3.1 Representations and Warranties of Trust Company and Owner Trustee . Trust Company (except with respect to clause (c) below) and as Owner Trustee, (with respect to


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clause (c) below) represents and warrants to Owner Participant, Indenture Trustee, Loan Participants and Lessee, notwithstanding the provisions of Section 11.13 or any similar provision in any other Operative Agreement, that, as of the date hereof and as of each Closing Date (unless any such representation is specifically made as of one date):

(a) Trust Company is a Delaware banking corporation duly organized and validly existing in good standing under the laws of the State of Delaware and has full corporate power and authority to carry on its business as now conducted and to enter into and perform its obligations hereunder and under the Trust Agreement and (assuming due authorization, execution and delivery of the Trust Agreement by Owner Participant) has full power and authority, as Owner Trustee and/or, to the extent expressly provided herein or therein to enter into and perform its obligations under each of the Owner Trustee Agreements;

(b) Owner Trustee and, to the extent expressly provided therein, Trust Company, has duly authorized, executed and delivered the Trust Agreement and (assuming the due authorization, execution and delivery of the Trust Agreement by Owner Participant) has duly authorized, executed and delivered, or in the case of the Lease Supplement and the Indenture Supplement will on each Closing Date execute and deliver, each of the other Owner Trustee Agreements (other than the Equipment Notes) and, as of each Closing Date, the Equipment Notes to be delivered on such Closing Date; and the Trust Agreement constitutes a legal, valid and binding obligation of Trust Company, enforceable against Trust Company or Owner Trustee, as the case may be, in accordance with its terms except as the same may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the rights of creditors generally and by general equity principles;

(c) assuming the due authorization, execution and delivery of the Trust Agreement by Owner Participant, each of the Owner Trustee Agreements (other than the Trust Agreement) to which it is a party constitutes, or when entered into will constitute, a legal, valid and binding obligation of Trust Company or as Owner Trustee, as the case may be, enforceable against Trust Company or Owner Trustee, as the case may be, in accordance with its terms except as the same may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the rights of creditors generally and by general equity principles;

(d) neither the execution and delivery by Trust Company or Owner Trustee, as the case may be, of the Owner Trustee Agreements or the Equipment Notes to be delivered on each Closing Date, nor the consummation by Trust Company or Owner Trustee, as the case may be, of any of the transactions contemplated hereby or thereby, nor the compliance by Trust Company or Owner Trustee, as the case may be, with any of the terms and provisions hereof and thereof, (i) requires or will require any approval of its stockholders, or approval or consent of any trustees or holders of any indebtedness or obligations of it, or (ii) violates or will violate its Certificate of Incorporation or by-laws, or contravenes or will contravene any provision of, or constitutes or will constitute a default under, or results or will result in any breach of, or results or will result in the creation of any Lien (other than as permitted under the Lease) upon its property under any indenture, mortgage, chattel mortgage, deed of trust, conditional sale contract, bank loan or credit agreement, license or other agreement or instrument to which it is a party or by which it is bound, or contravenes or will contravene any law, governmental rule or


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regulation of the State of Delaware governing the banking or trust powers of Owner Trustee, or any judgment or order applicable to or binding on it;

(e) there are no pending or threatened actions or proceedings against Trust Company or Owner Trustee before any court or administrative agency which individually or in the aggregate, if determined adversely to it, would materially adversely affect the ability of Trust Company or Owner Trustee, as the case may be, to perform its obligations under the Trust Agreement, the other Owner Trustee Agreements or the Equipment Notes to be delivered on each Closing Date;

(f) its location as such term is used in Section 9-307 of the Uniform Commercial Code is located in Delaware and the place where its records concerning the Equipment and all its interest in, to and under all documents relating to the Trust Estate, is located at Rodney Square North, 1100 North Market Street, Wilmington, Delaware 19890, and Trust Company agrees to give Owner Participant, Indenture Trustee and Lessee written notice of any relocation of said location or said place from its present location within 60 days of the date thereof;

(g) no consent, approval, order or authorization of, giving of notice to, or registration with, or taking of any other action in respect of, governmental authority or agency or any State of Delaware governmental authority or agency regulating the banking or trust powers of Trust Company, is required for the execution and delivery of, or the carrying out by, Trust Company or Owner Trustee, as the case may be, of any of the transactions contemplated hereby or by the Trust Agreement or of any of the transactions contemplated by any of the other Owner Trustee Agreements, other than any such consent, approval, order, authorization, registration, notice or action as has been duly obtained, given or taken;

(h) on each Delivery Date, Owner Trustee’s right, title and interest in and to the Equipment delivered on such Delivery Date shall be free of any Lessor’s Liens attributable to Trust Company;

(i) on each Closing Date, the proceeds received by Owner Trustee from Owner Participant on such Closing Date pursuant to the Trust Agreement will be administered by it in accordance with Article IV of the Trust Agreement; and

(j) on each Delivery Date, the Trust shall receive from Seller such title to the Units of Equipment delivered on such Delivery Date as was conveyed to it by Seller, subject to the rights of Owner Trustee and Lessee under the Lease and the security interest created pursuant to the Indenture and each Indenture Supplement.

Section 3.2 Representations and Warranties of Lessee . Lessee represents and warrants to Owner Trustee, Trust Company, Indenture Trustee, Loan Participants and Owner Participant that, as of the date hereof and as of each Closing Date (unless any such representation is specifically made as of one date):

(a) Lessee is a corporation duly organized, validly existing, and in good standing under the laws of the State of Missouri, is a Class I railroad as defined in 49 CFR Part 12011-1, is duly licensed or qualified and in good standing in each jurisdiction in which the


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failure to so qualify would have a material adverse effect on its ability to enter into and perform its obligations under the Lessee Agreements, has the corporate power and authority to carry on its business as now conducted, and has the requisite power and authority to execute, deliver and perform its obligations under the Lessee Agreements;

(b) the Lessee Agreements have been duly authorized by all necessary corporate action (no shareholder approval being required), executed and delivered (or in the case of the Lease Supplement will on each Closing Date have been duly executed and delivered) by Lessee, and constitute (or in the case of the Lease Supplement will on each Closing Date constitute) the legal, valid and binding obligation of Lessee, enforceable against Lessee in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency and similar laws and by general principles of equity;

(c) the execution, delivery and performance by Lessee of each Lessee Agreement and compliance by Lessee with all of the provisions thereof do not and will not contravene any law or regulation, or any order of any court or governmental authority or agency applicable to or binding on Lessee or any of its properties, or contravene the provisions of, or constitute a default by Lessee under, or result in the creation of any Lien (except for Permitted Liens) upon the property of Lessee under its Certificate of Incorporation or by-laws or any material indenture, mortgage, contract or other agreement or instrument to which Lessee is a party or by which Lessee or any of its property is bound or affected;

(d) except for those matters discussed in the financial statements provided to the Participants under Section 3.2(e), there are no proceedings pending or, to the knowledge of Lessee, threatened against Lessee in any court or before any governmental authority or arbitration board or tribunal which individually or in the aggregate would materially and adversely affect the financial condition of Lessee or impair the ability of Lessee to perform its obligations under the Lessee Agreements or which questions the validity of any Lessee Agreement or any action taken or to be taken pursuant thereto;

(e) the audited consolidated balance sheet and consolidated statements of income and retained earnings and cash flows of KCS for the fiscal year ended December 31, 2004, fairly present, in conformity with generally accepted accounting principles, the consolidated financial position of KCS as of such date and the results of its operations for the period then ended. The unaudited consolidated balance sheet and consolidated statements of income and retained earnings and cash flows of KCS for the nine months ended September 30, 2005, fairly present, in conformity with generally accepted accounting principles, the consolidated financial position of KCS as of such date and the results of its operations for the period then ended, subject to normal year-end adjustments;

(f) neither the nature of Lessee nor its businesses or properties, nor any relationship between Lessee and any other Person, nor any circumstances in connection with the execution and delivery by Lessee of the Lessee Agreements, is such as to require a consent, approval or authorization of, or filing, registration or qualification with, or the giving of notice to, any governmental authority on the part of Lessee in connection with the execution and delivery by Lessee of the Lessee Agreements, other than notices required to be filed with the


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STB, which notices shall have been filed on or prior to each Closing Date and except as contemplated by Section 3.2(g) hereof;

(g) all filings and other actions necessary to protect the rights of Owner Trustee under the Lease, and to perfect the security interest of Indenture Trustee under the Indenture in the Indenture Estate as against creditors of and purchasers from Owner Trustee, will have been made on or prior to each Closing Date and the Indenture will on each Closing Date create a valid and perfected lien and security interest in the Indenture Estate, subject to any Lessor’s Liens and Permitted Liens;

(h) on each Delivery Date, the Equipment is covered by the insurance required by Section 12 of the Lease and all premiums due prior to each Delivery Date in respect of such insurance shall have been paid in full;

(i) Lessee has timely filed all United States Federal income tax returns and all other material tax returns which (to its knowledge) are required to be filed by it and has paid all taxes due pursuant to such returns or pursuant to any assessment made against Lessee or any of its assets (other than assessments, the payment of which is being contested in good faith by Lessee) and no tax liens have been filed and no claims are being asserted with respect to any such taxes, fees or other charges which could reasonably be expected to have a materially adverse effect on its ability to perform its obligations under the Lessee Agreements;

(j) the (i) “location” (as such term is used in Section 9-307 of the Uniform Commercial Code) of Lessee is the State of Missouri, and the place where its records concerning the Equipment and all of its interests in, to and under all documents relating to the Equipment are and will be kept, is located at Kansas City, Missouri, and (ii) The Kansas City Southern Railway Company is its true legal name as registered in the jurisdiction of its organization, its federal employer identification number is 44-6000758 and its organizational identification number designated by its jurisdiction of organization is R00000513;

(k) no Lease Default has occurred and is continuing and no Event of Loss has occurred;

(l) Lessee is not an “investment company” or an “affiliated person” of an “investment company” within the meaning of the Investment Company Act of 1940;

(m) the acquisition by Owner Participant of the Beneficial Interest for its own account will not constitute a prohibited transaction within the meaning of section 4975(c)(1)(A) through (D) of the Code. The representation made by Lessee in the preceding clause is made in reliance upon and subject to the accuracy of the representation of Owner Participant in Section 3.6(g) of this Agreement;

(n) on each Delivery Date, after giving effect to the transactions contemplated hereby, Owner Trustee shall have good and marketable title to the Units being delivered on or such Delivery Date, in each case free and clear of all claims, Liens and encumbrances of any nature, except Permitted Liens of the type described in clauses (iii), (iv) or (v) of the definition thereof;


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(o) each Unit has been manufactured to meet the Design Specifications;

(p) the Equipment Cost for each Unit is equal to the purchase price on November 2, 2005, paid by Lessee and NAFTA Rail to El-Mo-Mex, Inc. in connection with the purchase of the Units; and

(q) the only expected use outside the United States of any Unit is use in Canada or Mexico on a temporary basis which is not expected to exceed a total of 90 days in any calendar year.

Section 3.3 Representations and Warranties of Indenture Trustee . Indenture Trustee represents and warrants to Owner Participant, Owner Trustee, Trust Company, Loan Participants and Lessee that, as of the date hereof and as of each Closing Date (unless any such representation is specifically made as of one date):

(a) Indenture Trustee is a national banking association duly organized and validly existing and in good standing under the laws of the United States and has the full corporate power, authority and legal right under the laws of the State of Utah and the laws of the United States pertaining to its banking, trust and fiduciary powers to execute, deliver and carry out the terms of each of the Indenture Trustee Agreements;

(b) the execution, delivery and performance by Indenture Trustee of each of the Indenture Trustee Agreements have been duly authorized by Indenture Trustee and will not violate its Certificate of Incorporation or by-laws or the provisions of any indenture, mortgage, contract or other agreement to which it is a party or by which it is bound or any laws, rules or regulations of the United States or the State of Utah (or any governmental subdivision of either thereof) pertaining to its banking, trust or fiduciary powers;

(c) each Indenture Trustee Agreement, when executed and delivered, will constitute its legal, valid and binding obligation enforceable against it in accordance with its terms;

(d) there are no proceedings pending or, to the knowledge of Indenture Trustee, threatened, and to the knowledge of Indenture Trustee there is no existing basis for any such proceedings, against or affecting Indenture Trustee in or before any court or before any governmental authority or arbitration board or tribunal which, individually or in the aggregate, if adversely determined, might impair the ability of Indenture Trustee to perform its obligations under the Indenture Trustee Agreements;

(e) no authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body of the United States or the State of Utah, in required for the due execution, delivery and performance by Indenture Trustee of the Indenture Trustee Agreements, except as have been previously obtained, given or taken;

(f) Indenture Trustee is not in default under any of the Indenture Trustee Agreements;


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(g) neither Indenture Trustee, nor any Person authorized to act on behalf of Indenture Trustee, has directly or indirectly offered any interest in the Trust Estate or the Equipment Notes or any other Operative Agreement or any security similar to either thereof for sale to, or solicited offers to buy any of the same from, or otherwise approached or negotiated with respect to any of the same with, any Person other than the Loan Participants; and

(h) there are no Taxes which may be imposed on or asserted against the Indenture Estate or any part thereof or any interest therein, Trust Company, Owner Trustee or Owner Participant by any state or local government or taxing authority in connection with the execution, delivery or performance by Indenture Trustee of the Indenture Trustee Agreements or the authentication of the Equipment Notes.

Section 3.4 Representations, Warranties and Covenants Regarding Beneficial Interest .

(a) Owner Trustee represents and warrants to Lessee, Indenture Trustee, Loan Participants and Owner Participant that, as of the date hereof and as of each Closing Date, neither Owner Trustee nor any Person authorized or employed by Owner Trustee as agent or otherwise in connection with the placement of the Beneficial Interest or any similar interest has offered any of the Beneficial Interest or any similar interest or any of the Equipment Notes or any similar interest for sale to, or solicited offers to buy any thereof from, or otherwise approached or negotiated with respect thereto with, any prospective purchaser.

(b) Lessee represents and warrants to Owner Trustee, Indenture Trustee, Loan Participants and Owner Participant that, as of the date hereof and as of each Closing Date, it has not offered any of the Beneficial Interest for sale to, or solicited offers to buy any thereof from, any Person other than Owner Participant and not more than 35 other prospective institutional investors.

(c) Both Owner Trustee and Lessee agree severally but not jointly that neither Owner Trustee nor Lessee nor anyone acting on behalf of Owner Trustee or Lessee will offer the Beneficial Interest or any part thereof or any similar interest for issue or sale to any prospective purchaser, or solicit any offer to acquire any of the Beneficial Interest or any part thereof so as to bring the issuance and sale of the Beneficial Interest or any part thereof within the provisions of Section 5 of the Securities Act of 1933, as amended.

(d) Lessee has not retained or employed any broker, finder or financial advisor (other than AMA Capital) to act on its behalf in connection with the transactions contemplated hereby and it has not authorized any broker, finder or financial advisor retained or employed by any other Person to so act.

Section 3.5 [Reserved] .

Section 3.6 Representations and Warranties of Owner Participant . Owner Participant represents and warrants to Owner Trustee, Trust Company, Indenture Trustee, Loan Participants and Lessee that, as of the date hereof and as of each Closing Date (unless any such representation is specifically made as of one date):


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(a) Owner Participant is a limited liability company duly organized, validly existing and in good standing under the laws of the State of Delaware and has the power and authority to carry on its business as now conducted;

(b) Owner Participant has the power and authority to enter into the Owner Participant Agreements and to perform its obligations thereunder, and such execution, delivery and performance do not and will not contravene any law or any order of any court or governmental authority or agency applicable to or binding on Owner Participant, or contravene the provisions of, or constitute a default under, or result in the creation of any Lien (other than the leasehold interest of Lessee under the Lease and the security interest of Indenture Trustee under the Indenture) upon the Equipment under, its organization documents or any material indenture, mortgage, contract or other agreement or instrument to which Owner Participant is a party or by which it or any of its property or the Equipment may be bound or affected;

(c) the Owner Participant Agreements have been duly authorized by all necessary action on the part of Owner Participant, do not require any approval not already obtained of the members of Owner Participant or any approval or consent not already obtained of any trustee or holders of indebtedness or obligations of Owner Participant, have been duly executed and delivered by Owner Participant and (assuming the due authorization, execution and delivery by each other party thereto) constitute the legal, valid and binding obligations of Owner Participant, enforceable against Owner Participant in accordance with their respective terms except as enforceability may be limited by applicable bankruptcy, insolvency and similar laws and by general principles of equity;

(d) no authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for the due execution, delivery or performance by Owner Participant of the Trust Agreement, the Tax Indemnity Agreement and this Agreement, it being understood that no representation or warranty is being made herein with respect to the ICC Termination Act or any other laws, governmental rules or regulations specific to the Equipment;

(e) the Trust Estate is free of any Lessor’s Liens attributable to Owner Participant;

(f) there are no pending or, to the knowledge of Owner Participant, threatened actions or proceedings before any court or administrative agency which would materially adversely affect Owner Participant’s financial condition or its ability to perform its obligations under the Trust Agreement, the Tax Indemnity Agreement, this Agreement or any other Owner Participant Agreement;

(g) as of each Closing Date, Owner Participant is purchasing the Beneficial Interest to be acquired by it on such Closing Date for its account with no present intention of distributing such Beneficial Interest or any part thereof in any manner which would violate the Securities Act of 1933, as amended, but without prejudice, however, to the right of Owner Participant at all times to sell or otherwise dispose of all or any part of such Beneficial Interest under a registration statement under the Securities Act of 1933, as amended, or under an exemption from such registration available under such Act. Owner Participant acknowledges


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that its Beneficial Interest has not been registered under the Securities Act of 1933, as amended, and that neither Owner Trustee nor Lessee contemplates filing, or is legally required to file, any such registration statement;

(h) with respect to the sources of the amount to be advanced by Owner Participant pursuant to Section 2.2(a), no part of such amounts constitutes assets of any employee benefit plan (other than a government plan exempt from the coverage of ERISA); and

(i) OP Guarantor has a tangible net worth of not less than $75,000,000.

Section 3.7 Opinion Acknowledgment . Each of the parties hereto, with respect to such party, expressly consents to the rendering by its counsel of the opinions referred to in Section 4.1(a)(2) and Section 4.1(b)(8) and acknowledges that such opinions shall be deemed to be rendered at the request and upon the instructions of such party, each of whom has consulted with and has been advised by its counsel as to the consequences of such request, instructions and consent.

Section 3.8 Representations and Warranties of the Loan Participants . Each Loan Participant represents and warrants to Owner Trustee, Indenture Trustee, Owner Participant and Lessee that, as of the date hereof and as of each Closing Date (and the purchase of an Equipment Note by such Loan Participant on each Closing Date shall constitute a reaffirmation by such Loan Participant of each of these representations and warranties as of such date):

(a) such Loan Participant is duly organized and validly existing under the laws of its jurisdiction of organization, and has the full power, authority and legal right under the laws of its jurisdiction of organization to execute, deliver and perform the terms of this Agreement;

(b) such Loan Participant is acquiring the Equipment Notes to be issued to it on each Closing Date for the purpose of investment and not with a view to the distribution thereof, and that, except as permitted or contemplated by the terms of the Operative Agreements, such Loan Participant has no present intention of selling, negotiating or otherwise disposing of such Equipment Notes; it being understood, however, that the disposition of such Loan Participant’s property shall at all times be and remain within its control; and

(c) such Loan Participant is acquiring the Equipment Notes with funds that do not constitute plan assets, and the term “plan assets” shall have the meaning specified in Department of Labor Regulation §2510.3-101.

ARTICLE IV.
CONDITIONS PRECEDENT

Section 4.1 Conditions Precedent to First Delivery Date; Conditions of Each Participant and Indenture Trustee to any Closing Date.


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(a) First Delivery Date Conditions . No Delivery Date shall occur until the following conditions precedent shall have been satisfied:

(1) Execution of Operative Agreements . This Agreement, the Trust Agreement, the OP Guaranty, the Lease, the Indenture, shall each be satisfactory in form and substance to the parties thereto, shall have been duly executed and delivered by the parties thereto, shall each be in full force and effect and executed counterparts of each shall have been delivered to each such party or its counsel; and no event shall have occurred and be continuing that constitutes a Lease Default or an Indenture Default.

(2) Opinions of Counsel . Owner Trustee, Indenture Trustee, Loan Participants, Owner Participant and Lessee shall have received the favorable written opinion of each of (A) internal counsel to Lessee and special counsel to Lessee, (B) counsel to Owner Trustee, (C) internal counsel to OP Guarantor and special counsel to Owner Participant and OP Guarantor and (D) counsel to Indenture Trustee, each in form and scope satisfactory to such Participant; provided that receipt by a party hereto of a favorable written opinion from counsel to such party shall not be a condition precedent to such party’s obligations hereunder; provided further that, such opinions shall be dated the date of the agreements set forth in Section 4.1(a)(1) hereof.

(3) Tax Indemnity Agreement . The Tax Indemnity Agreement shall be satisfactory in form and substance to Owner Participant and Lessee, shall have been duly executed and delivered by Lessee and Owner Participant, and shall be in full force and effect.

(4) Corporate Documents . Each of the parties shall have received such documents and evidence with respect to Lessee, Owner Participant, OP Guarantor, Owner Trustee and Indenture Trustee as such party may reasonably request in order to establish the authority for the consummation of the transactions contemplated by this Agreement and the other Operative Agreements, the taking of all corporate and other proceedings in connection therewith and compliance with the conditions herein or therein set forth and the incumbency of all officers signing any of the Operative Agreements.

(b) Closing Date Conditions . The obligation of each Participant to participate in the transactions contemplated hereby on any Closing Date shall be subject to the following conditions precedent (except that paragraph (17) shall not be a condition precedent to Owner Participant’s obligations hereunder and paragraph (18) shall not be a condition precedent to either Loan Participant’s obligations):

(1) Execution of Operative Agreements . On or before such Closing Date, each of the documents referred to in Section 4.1(a)(1) and Section 4.1(a)(3) shall be in full force and effect and the Equipment Notes to be issued on such Closing Date, the Lease Supplement, the Indenture Supplement, a Direct Mortgage Termination and Release in each case with respect of the Units for which settlement will be made on such Closing Date shall each be satisfactory in form and substance to such Participant and Indenture Trustee, shall have been duly executed and delivered by the parties thereto (except that the execution and delivery of the documents referred to above by a party


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thereto shall not be a condition precedent to such party’s obligations hereunder), shall each be in full force and effect and executed counterparts of each shall have been delivered to such Participant and Indenture Trustee or its counsel on or before such Closing Date; and no event shall have occurred and be continuing that constitutes a Lease Default or an Indenture Default.

(2) Recordation and Filing . On or before such Closing Date, Lessee will cause the Lease, the Lease Supplement with respect to the Units for which settlement will be made on such Closing Date, the Indenture, the Indenture Supplement with respect to the Units for which settlement will be made on such Closing Date, and the Direct Mortgage Termination and Release with respect to the Units for which settlement will be made on such Closing Date or appropriate evidence thereof, to be duly filed, recorded and deposited (A) with the Surface Transportation Board in conformity with 49 U.S.C. § 11301, (B) with the Registrar General of Canada pursuant to Section 105 of the Canada Transportation Act and provision will have been made for publication of notice of such deposit in The Canada Gazette in accordance with said Section 105 and (C) in such other places within the United States, Canada or Mexico as Owner Trustee, Indenture Trustee and any Participant may reasonably request for the protection of Owner Trustee’s title to the Equipment and interest in the Lease, or the security interest of Indenture Trustee in the Equipment and the Lease, and will furnish Indenture Trustee, Owner Trustee and each Participant proof thereof.

(3) Uniform Commercial Code Statements . On such Closing Date, (i) a financing statement or statements covering all the security interests created by or pursuant to the Indenture shall have been delivered naming the Trust, as debtor, and Indenture Trustee, as a secured party, shall have been duly filed in the jurisdictions set forth in Schedule 4 attached hereto and all Taxes with respect to such filings shall have been paid and reasonably satisfactory evidence thereof shall have been delivered to the Participants; and (ii) a uniform commercial code protective financing statement or statements describing the Lease as a lease shall have been delivered naming Indenture Trustee (as assignee of the Trust) as lessor or secured party and Lessee as lessee or debtor, shall have been duly filed in the jurisdictions set forth in Schedule 4 attached hereto and all Taxes with respect to such filings shall have been paid and reasonably satisfactory evidence thereof shall have been delivered to such Participant.

(4) Officer’s Certificate of Lessee . On such Closing Date, Owner Trustee, Indenture Trustee, Loan Participants and Owner Participant shall have received an Officer’s Certificate dated such date from Lessee, to the effect that the representations and warranties of Lessee contained in Section 3.2 and Section 3.4(b) are true and correct in all material respects on such Closing Date with the same effect as though made on and as of said date, except to the extent that such representations and warranties relate solely to an earlier date (in which case such representations and warranties were true and correct on and as of such earlier date), and that Lessee has performed and complied with all agreements and conditions herein contained which are required to be performed or complied with by Lessee on or before said date.


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(5) Officer’s Certificate of Owner Trustee . On such Closing Date, Lessee, Indenture Trustee, Loan Participants and Owner Participant shall have received an Officer’s Certificate dated such date from Owner Trustee, to the effect that the representations and warranties of Owner Trustee contained in Section 3.1 and Section 3.4(a) are true and correct in all material respects on such Closing Date with the same effect as though made on and as of said date, except to the extent that such representations and warranties relate solely to an earlier date (in which case such representations and warranties were true and correct on and as of such earlier date), and that Owner Trustee has performed and complied with all agreements and conditions herein contained which are required to be performed or complied with by Owner Trustee on or before said date.

(6) Officer’s Certificate of Indenture Trustee . On such Closing Date, Lessee, Owner Trustee, Loan Participants and Owner Participant shall have received an Officer’s Certificate dated such date from Indenture Trustee, to the effect that the representations and warranties of Indenture Trustee contained in Section 3.3 are true and correct in all material respects on such Closing Date with the same effect as though made on and as of said date, except to the extent that such representations and warranties relate solely to an earlier date (in which case such representations and warranties were true and correct on and as of such earlier date), and that Indenture Trustee has performed and complied with all agreements and conditions herein contained which are required to be performed or complied with by Indenture Trustee on or before said date.

(7) Officer’s Certificate of Owner Participant . On such Closing Date, Lessee, Owner Trustee, Indenture Trustee, and Loan Participants shall have received an Officer’s Certificate dated such date from Owner Participant, to the effect that the representations and warranties of Owner Participant contained in Section 3.6 are true and correct in all material respects on such Closing Date with the same effect as though made on and as of said date, except to the extent that such representations and warranties relate solely to an earlier date (in which case such representations and warranties were true and correct on and as of such earlier date), and that Owner Participant has performed and complied with all agreements and conditions herein contained which are required to be performed or complied with by Owner Participant on or before said date.

(8) Opinions of Counsel . On such Closing Date, Owner Trustee, Indenture Trustee, Loan Participants and Owner Participant shall have received the favorable written opinion of each of (A) internal counsel to Lessee and special counsel to Lessee, (B) counsel to Owner Trustee, and (C) counsel to Indenture Trustee, in form and scope satisfactory to each Participant, (D) Alvord and Alvord, special STB counsel, and (E) McCarthy Tétrault, special Canadian counsel; provided that receipt by a party hereto of a favorable written opinion from counsel to such party shall not be a condition precedent to such party’s obligations hereunder.

(9) Title . On such Closing Date, after giving effect to the transactions contemplated hereby and by the other Operative Agreements, Owner Trustee shall have good and marketable title to each Unit to be settled on such Closing Date, free and clear


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of all Liens, except Permitted Liens of the type described in clause (iii), (iv) and (v) of the definition thereof.

(10) Bills of Sale . On such Closing Date, Seller shall have delivered to Owner Trustee (with copies to Indenture Trustee, Loan Participants and Owner Participant) a Bill of Sale with respect to each Unit being settled on such Closing Date, such Bill of Sale dated the Closing Date for such Unit, transferring to Owner Trustee good and marketable title to such Units and warranting to Owner Trustee that at the time of delivery of each such Unit, Seller had legal title thereto and good and lawful right to sell the same, and title thereto was free of all claims, liens and encumbrances of any nature, except Permitted Liens of the type describe in clause (iii) and (iv) of the definition thereof.

(11) Certificates of Acceptance . On such Closing Date, Lessee shall have delivered to Owner Trustee (with copies to Indenture Trustee, Loan Participants and Owner Participant) a Certificate of Acceptance with respect to each Unit being settled on such Closing Date, such Certificate of Acceptance executed on and dated the Delivery Date for such Unit.

(12) Insurance Certificate . On or before such Closing Date, Indenture Trustee, Loan Participants, Owner Trustee and Owner Participant shall have received any certificate relating to insurance that is required pursuant to Section 12 of the Lease.

(13) Corporate Documents . Each of the Participants shall have received such documents and evidence with respect to Lessee, Owner Participant, OP Guarantor, Owner Trustee and Indenture Trustee as the Participants may reasonably request in order to establish the authority for the consummation of the transactions contemplated by this Agreement and the other Operative Agreements, the taking of all corporate and other proceedings in connection therewith and compliance with the conditions herein or therein set forth and the incumbency of all officers signing any of the Operative Agreements.

(14) No Threatened Proceedings . No action or proceeding shall have been instituted nor shall governmental action be threatened before any court or governmental agency, nor shall any order, judgment or decree have been issued or proposed to be issued by any court or governmental agency at the time of such Closing Date, to set aside, restrain, enjoin or prevent the completion and consummation of this Agreement or any of the other Operative Agreements or the transactions contemplated hereby or thereby.

(15) Closing Date Notice . Prior to such Closing Date, Indenture Trustee and the Participants shall have received the written notice of such Closing Date required pursuant to Section 2.3(a).

(16) No Illegality . No change shall have occurred after the date of the execution and delivery of this Agreement in applicable law or regulations thereunder or interpretations thereof by regulatory authorities that, in the opinion of such Participant or its counsel, would make it illegal for such Participant to enter into any transaction contemplated by the Operative Agreements.


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(17) Owner Participant’s Investments . Owner Participant shall have made available its Commitment with respect to the Units delivered on such Closing Date in accordance with Sections 2.2(a) and 2.3.

(18) Loan Participants’ Investment . Each Loan Participant shall have made available its Commitment with respect to the Units delivered on such Closing Date in accordance with Sections 2.2(b) and 2.3.

(19) Consents . All approvals and consents of any trustees or holders of any indebtedness or obligations of Lessee which are required in connection with the transactions contemplated by this Agreement and the other Operative Agreements shall have been duly obtained and be in full force and effect.

(20) Governmental Actions . All actions, if any, required to have been taken on or prior to such Closing Date in connection with the transactions contemplated by this Agreement and the other Operative Agreements on such Closing Date shall have been taken by any governmental or political agency, subdivision or instrumentality of the United States and all orders, permits, waivers, exemptions, authorizations and approvals of such entities required to be in effect on such Closing Date in connection with such transactions contemplated by this Agreement and the other Operative Agreements on such Closing Date shall have been issued, and all such orders, permits, waivers, exemptions, authorizations and approvals shall be in full force and effect, on such Closing Date.

Section 4.2 Additional Conditions Precedent to the Obligations of Loan Participants . The obligation of each Loan Participant to advance funds for the Equipment Notes to be purchased by it pursuant to Section 2.2(b) on any Closing Date shall be subject to the additional conditions that:

(a) Equipment Notes . The Equipment Notes to be delivered on such Closing Date shall have been duly authorized, executed and delivered to such Loan Participant by a duly authorized officer of Owner Trustee and duly authenticated by Indenture Trustee.

(b) Debt Appraisal Letter . On or before such Closing Date, each Loan Participant shall have received a letter from the equipment appraiser setting forth the appraiser’s opinion as to the fair market value of the applicable Units and that such fair market value is not less than the Equipment Cost for the applicable Equipment.

(c) Loan Participants’ Fee . Lessee shall have paid to each Loan Participant (i) the fee payable to each Loan Participant in connection with its making of the loan contemplated hereby, as provided in Section 9.04(f) of the Direct Loan Agreement and (ii) all accrued and unpaid interest and other accrued amounts payable under the Direct Loan Agreement in respect of the Units to be delivered and accepted under the Lease on such Closing Date.

(d) Opinion . On such Closing Date, each Loan Participant shall have received the opinion of Vedder, Price, Kaufman & Kammholz, P.C., addressed to each Loan Participant, in form and substance satisfactory to such Loan Participant.


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Section 4.3 Additional Conditions Precedent to the Obligations of Owner Participant . The obligation of Owner Participant to provide the funds specified with respect to it in Section 2.2(a) on each Closing Date with respect to any Unit to be settled on such Closing Date shall be subject to the following additional conditions:

(a) Appraisal . On or before such Closing Date, Owner Participant shall have received an opinion (the “ Appraisal ”) of an equipment appraiser reasonably satisfactory in form and substance to Owner Participant.

(b) Opinion with Respect to Certain Tax Aspects . On such Closing Date, Owner Participant shall have received the opinion of Thelen Reid & Priest LLP, addressed to Owner Participant, in form and substance satisfactory to Owner Participant, containing such counsel’s favorable opinion with respect to the Federal income tax aspects of the transaction contemplated hereby.

(c) No Tax Law Change . No Change in Tax Law shall have occurred nor shall a judicial opinion on a tax issue have been rendered on or prior to such Closing Date which change, if enacted, adopted or made effective, or such judicial opinion, would, in the reasonable opinion of Owner Participant, render it disadvantageous or inadvisable for Owner Participant to enter into the transactions contemplated by the Operative Agreements unless Lessee shall indemnify Owner Participant to Owner Participant’s reasonable satisfaction for such Change in Tax Law or, if such change can be compensated for by an adjustment to Basic Rent, unless Lessee agrees to an adjustment to Basic Rent in accordance with the principles of Section 2.6 of this Agreement to preserve Owner Participant’s Net Economic Return.

Section 4.4 Conditions Precedent to the Obligation of Lessee . The obligation of Lessee to participate in the transactions contemplated hereby on any Closing Date shall be subject to the following conditions precedent:

(a) Corporate Documents . On or before such Closing Date, Lessee shall have received such documents and evidence with respect to Owner Participant, OP Guarantor, Owner Trustee and Indenture Trustee as Lessee may reasonably request in order to establish the consummation of the transactions contemplated by this Agreement, the taking of all corporate and other proceedings in connection therewith and compliance with the conditions herein or therein set forth.

(b) Operative Agreements . On or before such Closing Date, each of the documents referred to in Section 4.1(b)(1) shall be in full force and effect.

(c) Representations and Warranties True . On such Closing Date, the representations and warranties of Owner Trustee, Indenture Trustee, Loan Participants and Owner Participant contained in Section 3 hereof and OP Guarantor contained in the OP Guaranty shall be true and correct in all material respects as of such Closing Date as though made on and as of such date, and Lessee shall have received an Officer’s Certificate dated such date from each of Owner Trustee as described in Section 4.1(b)(5), Owner Participant as described in Section 4.1(b)(7) and Indenture Trustee as described in Section 4.1(b)(6), addressed to Lessee


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and certifying as to the foregoing matters insofar as they relate to Owner Trustee, Owner Participant and Indenture Trustee, as the case may be.

(d) Opinions of Counsel . On such Closing Date, Lessee shall have received the opinions of counsel for Owner Trustee and Indenture Trustee referred to in Section 4.1(b)(8), addressed to Lessee.

(e) No Threatened Proceedings . No action or proceeding shall have been instituted nor shall governmental action be threatened before any court or governmental agency, nor shall any order, judgment or decree have been issued or proposed to be issued by any court or governmental agency at the time of such Closing Date, to set aside, restrain, enjoin or prevent the completion and consummation of this Agreement or the transactions contemplated hereby.

(f) No Tax Law Change . Lessee shall not be obligated to carry out the transactions contemplated on such Closing Date if a Change in Tax Law shall have occurred after the date of execution hereof and on or prior to such Closing Date which would, in the reasonable opinion of Lessee, result in an adjustment pursuant to Section 2.6 which would increase by more than 50 basis points the present value (discounted at an interest rate per annum equal to the Debt Rate) of all payments of Basic Rent payable for the Units to be delivered on such Closing Date.

ARTICLE V.
FINANCIAL AND OTHER REPORTS OF LESSEE

Lessee agrees that it will furnish directly to each Participant the following:

(a) unless included in a Form 10-Q delivered or deemed delivered under clause (c) below, as soon as available and in any event within 60 days after the end of each quarterly period, except the last, of each fiscal year, consolidated balance sheets of KCS, and its consolidated Subsidiaries as at the end of such period, together with the related consolidated statements of income and cash flows of KCS and its consolidated Subsidiaries for the period beginning on the first day of such fiscal year and ending on the last day of such quarterly period, setting forth in each case (except for the consolidated balance sheet) in comparative form the figures for the corresponding periods of the previous fiscal year, all in reasonable detail and prepared in accordance with generally accepted accounting principles and certified by any Vice President, the Treasurer, the Chief Financial Officer or any Assistant Treasurer of KCS;

(b) unless included in a Form 10-K delivered or deemed delivered under clause (c) below, as soon as available and in any event within 120 days after the last day of each fiscal year, a copy of KCS’s annual audited report covering the operations of KCS and its consolidated Subsidiaries, including consolidated balance sheets, and related consolidated statements of income and retained earnings and consolidated statement of cash flows of KCS and its consolidated Subsidiaries for such fiscal year, setting forth in each case in comparative form the figures for the previous fiscal year, all in reasonable detail and prepared in accordance with generally accepted accounting principles applied on a consistent basis, which statements will have been certified by a firm of independent public accountants of recognized national standing selected by KCS;


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(c) as soon as available, one copy of each Annual Report on Form 10-K (or any successor form), Quarterly Report on Form 10-Q (or any successor form) and Form 8-K filed by KCS with the SEC or any successor agency, provided that, as long as KCS is subject to informational requirements of the Securities Exchange Act of 1934 and in accordance therewith files reports and other information with the SEC each Participant shall be deemed to have been furnished the foregoing reports and forms and each Participant may electronically access such reports and forms by means of the SEC’s homepage on the internet or at KCS’s homepage on the internet, provided , further , in the event that KCS shall cease to be subject to such informational requirements, Lessee will provide each Participant with 90 days’ advance written notice and thereafter Lessee shall directly furnish such reports and forms to each Participant; and

(d) as soon as available and in any event within 120 days after the last day of each fiscal year, a certificate signed by any Vice President, the Treasurer, the Chief Financial Officer or any Assistant Treasurer of Lessee stating that he/she has reviewed the activities of Lessee during such year and that Lessee during such year has kept, observed, performed and fulfilled each and every covenant, obligation and condition contained herein and in the Lease, or if a Lease Event of Default shall exist or if an event has occurred and is continuing which, with the giving of notice or the passage of time or both, would constitute a Lease Event of Default, specifying such Lease Event of Default and all such events and the nature and status thereof.

If at any time Lessee shall become subject to the public reporting requirements of the Securities and Exchange Commission or Lessee shall cease to be a consolidated subsidiary of KCS, then the reporting requirements of paragraphs (a) through (c) above shall apply directly to Lessee.

ARTICLE VI.
CERTAIN COVENANTS OF THE PARTICIPANTS,
TRUSTEES AND LESSEE

Section 6.1 Restrictions on Transfer of Beneficial Interest . Owner Participant agrees that it shall not sell, convey, assign, pledge, mortgage or otherwise transfer any of its Beneficial Interest, except to Lessee in accordance with Section 23(c) of the Lease (to which transfer Indenture Trustee hereby consents), unless:

(a) the Person to whom such transfer is to be made (a “ Transferee ”) is (i) a Person that is an institutional investor organized as a corporation, limited liability company, partnership or other legal entity under the laws of the United States or any state or territory thereof or the District of Columbia with tangible net worth or, in the case of a bank or lending institution, combined capital or surplus at the time of such transfer of at least US $75,000,000, all of the foregoing determined in accordance with generally accepted accounting principles or (ii) any United States subsidiary or United States affiliate of any such institutional or corporate investor if such investor guarantees the obligations so assumed by such subsidiary or affiliate pursuant to an instrument or instruments reasonably satisfactory to Lessee, Owner Trustee and Indenture Trustee or (iii) any United States subsidiary or United States affiliate of the original Owner Participant if the original Owner Participant remains liable for all obligations of Owner Participant under each of the Operative Agreements or OP Guarantor guarantees the obligations of the Transferee;


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(b) neither the Transferee nor any of its Affiliates shall be (i) directly involved in the transportation business (it being understood that operating lessors and passive equity and debt investors (including lessors) in railroad rolling stock and facilities are not directly involved in the transportation business), (ii) a competitor of Lessee in Lessee’s primary business, (iii) at the time of the proposed transfer, a substantial investor in Lessee or any Affiliate of Lessee attempting a merger, acquisition or other takeover of Lessee or any Affiliate of Lessee which merger, acquisition or other takeover shall not have been approved by the Board of Directors of Lessee or such Affiliate or otherwise be perceived by Lessee or such Affiliate to be hostile to the management of Lessee or such Affiliate, (iv) an adverse plaintiff or defendant in any then-existing litigation or any then-existing third-party arbitration involving Lessee or an Affiliate of Lessee, or (v) the potential plaintiff in any litigation which has been threatened, in writing, against Lessee or an Affiliate of Lessee; provided that if a Specified Default or an Event of Default shall have occurred and be continuing, the requirements set forth in this subsection (b) above shall not apply to such transfer;

(c) Indenture Trustee, Lessee and Owner Trustee shall have received 30 days’ (10 days in the case of a transfer to an Affiliate) prior written notice of such transfer specifying the name and address of any proposed transferee and such additional information as shall be necessary to determine whether the proposed transfer satisfies the requirements of this Section 6.1 and Section 8.01 of the Trust Agreement;

(d) such Transferee enters into an agreement or agreements in form and substance reasonably satisfactory to Lessee, Owner Trustee and Indenture Trustee whereby such Transferee confirms that it shall be deemed a party to this Agreement and each other Operative Agreement to which the transferring Owner Participant is a party, and agrees to be bound by all the terms of, and to undertake all of the obligations and liabilities of the transferring Owner Participant contained in, this Agreement and such other Operative Agreements and in which the Transferee shall make representations and warranties comparable to those of Owner Participant contained herein and therein;

(e) such transfer complies in all respects with and does not violate any applicable law, including any applicable Federal securities law and the securities law of any applicable state;

(f) an opinion of counsel of the Transferee (which counsel shall be either Thelen Reid & Priest LLP, internal counsel to the Transferee or another counsel reasonably acceptable to Lessee and Indenture Trustee), confirming (i) the existence, power and authority of, and due authorization, execution and delivery of all relevant documentation by, the Transferee (with appropriate reliance on certificates of corporate officers or public officials as to matters of fact), (ii) that each agreement referred to in subparagraph (d) above is the legal, valid, binding and enforceable obligation of the Transferee subject to the customary exceptions, (iii) compliance of the transfer with the registration provisions of applicable laws and regulations including Federal securities laws and securities laws of the Transferee’s domicile and other jurisdictions reasonably identified by Lessee as potentially applicable to the transfer, and (iv) other matters as Lessee or Indenture Trustee may reasonably request, shall be provided, prior to such transfer, to Lessee, Indenture Trustee and Owner Trustee, which opinion shall be in form and substance reasonably satisfactory to each of them;


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(g) except as specifically consented to in writing by Lessee and Indenture Trustee, the terms of the Operative Agreements shall not be altered;

(h) all fees, expenses and charges of the parties hereto (including without limitation, legal fees and expenses of special counsel) incurred in connection with each transfer of such Beneficial Interest shall be paid by Owner Participant;

(i) such transfer (i) does not involve the use of an amount which constitutes assets of an employee benefit plan (other than a government plan exempt from the coverage of ERISA) or (ii) will not constitute a prohibited transaction; and

(j) as a result of such transfer, no Indenture Default attributable to Owner Participant or Owner Trustee shall have occurred and be continuing.

Upon any such transfer, (i) except as the context otherwise requires, such Transferee shall be deemed the “ Owner Participant ” for all purposes, and shall enjoy the rights and privileges and perform the obligations of Owner Participant to the extent of the interest transferred hereunder and under each other Operative Agreement to which such Owner Participant is a party, and, except as the context otherwise requires, each reference in this Agreement and each other Operative Agreement to the “ Owner Participant ” shall thereafter be deemed to include such Transferee for all purposes to the extent of the interest transferred and (ii) the transferor, except as provided in Section 6.1(h) hereof, shall be released from all obligations hereunder and under each other Operative Agreement to which such transferor is a party or by which such transferor is bound to the extent such obligations are expressly assumed by a Transferee; and provided , further , that in no event shall any such transfer or assignment waive or release the transferor from any liability on account of any breach existing immediately prior to such transfer of any of its representations, warranties, covenants or obligations set forth in the Operative Agreements or for any fraudulent or willful misconduct. Any transfer or assignment of the Beneficial Interest in violation of this Section 6.1 shall be void and of no effect.

Section 6.2 Lessor’s Liens Attributable to Owner Participant . Owner Participant hereby unconditionally agrees with and for the benefit of the other parties to this Agreement that Owner Participant will not directly or indirectly create, incur, assume or suffer to exist any Lessor’s Liens on or against any part of the Trust Estate or the Equipment arising out of any act or omission of or claim against Owner Participant, and Owner Participant agrees that it will, at its own cost and expense, take such action as may be necessary to duly discharge and satisfy in full any such Lessor’s Lien (by bonding or otherwise, so long as Lessee’s operation and use of the Equipment is not impaired); provided that Owner Participant may contest any such Lessor’s Lien in good faith by appropriate proceedings so long as such proceedings do not involve any material danger of the sale, forfeiture or loss of the Equipment or any interest therein and do not interfere with the use, operation, or possession of the Equipment by Lessee under the Lease or the rights of Indenture Trustee under the Indenture and the other Operative Agreements or the rights of the Loan Participants under the Operative Agreements. Owner Participant hereby indemnifies and holds harmless Lessee, Indenture Trustee, Indenture Estate, Owner Trustee and each Loan Participant from and against any loss, cost or expense (including reasonable legal fees and expenses but excluding consequential damages) which may be suffered or incurred by any of


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them as the result of the failure of Owner Participant to discharge and satisfy any such Lessor’s Lien.

Section 6.3 Lessor’s Liens Attributable to Trust Company . Trust Company, hereby unconditionally agrees with and for the benefit of the other parties to this Agreement that Trust Company will not directly or indirectly create, incur, assume or suffer to exist any Lessor’s Liens on or against any part of the Trust Estate or the Equipment arising out of any act or omission of or claim against Trust Company, and Trust Company agrees that it will, at its own cost and expense, take such action as may be necessary to duly discharge and satisfy in full (i) any such Lessor’s Lien attributable to Trust Company (by bonding or otherwise, so long as Lessee’s operation and use of the Equipment is not impaired) and (ii) any other liens or encumbrances attributable to Trust Company on any part of the Trust Estate or the Indenture Estate which result from claims against Trust Company not related to the ownership of the Equipment, the administration of the Trust Estate or the Indenture Estate or the transactions contemplated by the Operative Agreements; provided that Owner Trustee may contest any such Lessor’s Lien in good faith by appropriate proceedings so long as such proceedings do not involve any material danger of the sale, forfeiture or loss of the Equipment or any interest therein and do not interfere with the use, operation, or possession of the Equipment by Lessee under the Lease or the rights of Indenture Trustee under the Indenture and the other Operative Agreements or the rights of the Loan Participants under the Operative Agreements. Trust Company hereby indemnifies and holds harmless Lessee, Indenture Trustee, the Indenture Estate, Owner Participant, Seller and each Loan Participant from and against any loss, cost or expense (including reasonable legal fees and expenses) which may be suffered or incurred by any of them as the result of the failure of Owner Trustee to discharge and satisfy any such Lessor’s Lien.

Section 6.4 Liens Created by Indenture Trustee and Loan Participants .

(a) Indenture Trustee covenants and agrees with Lessee, Owner Trustee, Owner Participant and each Loan Participant that it shall not cause or permit to exist any Lien on the Equipment or all or any portion of the Trust Estate or the Indenture Estate arising as a result of (i) claims against Indenture Trustee not related to its interest in the Equipment and the Trust Estate, or to the administration of the Indenture Estate pursuant to the Indenture, (ii) acts of Indenture Trustee not contemplated by, or failure of Indenture Trustee to take any action it is expressly required to perform by, the Operative Agreements, (iii) claims against Indenture Trustee relating to Taxes or expenses that are not indemnified against by Lessee pursuant to Section 7 attributable to the actions of Indenture Trustee, or (iv) claims against Indenture Trustee arising out of the transfer by Indenture Trustee of all or any portion of its interest in the Equipment, the Indenture Estate or the Operative Agreements, other than a transfer permitted by the Operative Agreements and that Indenture Trustee will, at its own cost and expense (and without any right of reimbursement from any other party hereto), promptly take such action as may be necessary duly to discharge any such Lien. Indenture Trustee further agrees to indemnify and hold harmless each of the other parties hereto from and against any loss, out-of-pocket cost and expenses (including reasonable legal fees and expenses) incurred, in each case, as a result of the imposition or enforcement of any such Lien.

(b) Each Loan Participant covenants and agrees with Lessee, Owner Trustee, Owner Participant and Indenture Trustee that it shall not cause or permit to exist any Lien on the


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Equipment or all or any portion of the Trust Estate or the Indenture Estate arising as a result of (i) claims against such Loan Participant not related to its interest in the Equipment and the Trust Estate, (ii) acts of such Loan Participant not contemplated by, or failure of such Loan Participant to take any action it is expressly required to perform under, the Operative Agreements, (iii) claims against such Loan Participant relating to Taxes or expenses that are not indemnified against by Lessee pursuant to Section 7 or (iv) claims against such Loan Participant arising out of the transfer by such Loan Participant of all or any portion of its interest in the Equipment, the Indenture Estate or the Operative Agreements, other than a transfer permitted by the Operative Agreements and that such Loan Participant will, at its own cost and expense (and without any right of reimbursement from Lessee), promptly take such action as may be necessary duly to discharge any such Lien. Each Loan Participant further agrees to indemnify and hold harmless each of the other parties hereto from and against any loss, out-of-pocket cost and expenses (including reasonable legal fees and expenses) incurred, in each case, as a result of the imposition or enforcement of any such Lien.

Section 6.5 Covenants of Owner Trustee, Trust Company, Owner Participant and Indenture Trustee . Owner Participant, and Owner Trustee and Trust Company, hereby agree, severally and not jointly, with Lessee, Loan Participants and Indenture Trustee (i) to comply with all of the terms of the Trust Agreement applicable to it in its respective capacity, (ii) not to amend, supplement, or otherwise modify any provision of the Trust Agreement in such a manner as to adversely affect the rights of any such party without the prior written consent of such party and (iii) not to terminate or revoke the Trust Agreement or the trust created by the Trust Agreement and such trust shall not be subject to revocation or termination by Owner Participant prior to the payment in full and discharge of the Equipment Notes and all other indebtedness secured by the Indenture and the final discharge thereof pursuant to Section 10.01 thereof or prior to the expiration or early termination of the Lease and the payment in full and discharge of the Equipment Notes and all other indebtedness secured by the Indenture and the final discharge thereof pursuant to Section 10.01 thereof. Each of Owner Trustee and Indenture Trustee agrees, for the benefit of Lessee and Owner Participant, to comply with the provisions of the Indenture and not to amend, supplement, or otherwise modify any provision of the Indenture in such a manner as to adversely affect the rights of any such party without the prior written consent of such party. Notwithstanding any provision herein or in any of the Operative Agreements to the contrary, Indenture Trustee’s obligation to take or refrain from taking any actions, or to use its discretion (including, but not limited to, the giving or withholding of consent or approval and the exercise of any rights or remedies under such Operative Agreements), and any liability therefor, shall, in addition to any other limitations provided herein or in the other Operative Agreements, be limited by the provisions of the Indenture.

Section 6.6 Amendments to Operative Agreements . The Trustees and Participants will not terminate the Operative Agreements to which Lessee is not or will not be a party, except in accordance with the Operative Agreements in effect on the date hereof (as amended, modified or supplemented from time to time in accordance with the terms hereof and of the other Operative Agreements), or amend, supplement, waive or modify such Operative Agreements in any manner that increases the obligations or liabilities, or decreases the rights, of Lessee under the Operative Agreements, without, in each such case, the prior written consent of Lessee. Owner Participant and the Trustees (as applicable) agree that, in any event, they will not amend


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Section 2.10 or Article IX of the Indenture or Article IX of the Trust Agreement without the prior written consent of Lessee.

Section 6.7 Section 1168 . Lessee shall at all times remain a “railroad”, as such term is defined in Section 101 (44) of the U.S. Bankruptcy Code, such that Lessee’s obligations under the Lease shall be subject to the provisions of Section 1168 of the U.S. Bankruptcy Code. Lessee shall not take any action which would cause Section 1168 to cease to be applicable to this transaction or, in connection with any bankruptcy proceedings involving Lessee or any of its Affiliates, take a position in the United State Bankruptcy Court that is inconsistent with the rights of Lessor under such Section 1168.

Section 6.8 Merger Covenant . Lessee shall not consolidate with or merge into any other Person or convey, transfer or lease substantially all of its assets as an entirety to any Person unless (i) the Person formed by such consolidation or into which Lessee is merged or the Person which acquires by conveyance, transfer or lease substantially all of the assets of Lessee as an entirety shall execute and deliver to Owner Trustee, Owner Participant, Loan Participants and Indenture Trustee an agreement containing the assumption by such successor corporation of the due and punctual performance and observance of each covenant and condition of this Agreement and each of the other Lessee Agreements to be performed or observed by Lessee, (ii) immediately after giving effect to such transaction, no Lease Event of Default shall have occurred solely as a result of such consolidation or merger or such conveyance, transfer or lease and (iii) Lessor shall be entitled to the benefits of Section 1168 of the Bankruptcy Code to same extent as immediately prior to such merger, consolidation or transfer. Upon such consolidation or merger, or any conveyance, transfer or lease of substantially all of the assets of Lessee as an entirety in accordance with this Section 6.8, the successor corporation formed by such consolidation or into which Lessee is merged or to which such conveyance, transfer or lease is made shall succeed to, and be substituted for, and may exercise every right and power of, Lessee under this Agreement and the other Operative Agreements with the same effect as if such successor corporation had been named as Lessee herein. If Lessee shall have consolidated with or merged into any other Person or conveyed, transferred or leased substantially all of its assets, such assets to include Lessee’s leasehold interest in the Lease, the Person owning such leasehold interest after such event shall deliver to Owner Participant, Loan Participants and Indenture Trustee, an opinion of counsel (which counsel may be such Person’s in-house counsel) confirming that the assumption agreement pursuant to which such Person assumed the obligations of Lessee shall have been duly authorized, executed and delivered by such Person and that such agreement is the legal, valid and binding obligation of such Person, enforceable against such Person in accordance with its terms.

Section 6.9 Additional Filings . In the event that during the Lease Term (i) a central filing system becomes available in Mexico for the filing or recording of security interests or ownership rights in railroad rolling stock and (ii) Lessee elects as a business practice to conduct such filings or recordings with respect to equipment owned or leased by Lessee that is used in a manner similar to the Units, then Lessee will take, or cause to be taken, at Lessee’s cost and expense, such action with respect to the filing or recording of the Lease, the Indenture or any supplements thereto and any other instruments as may be necessary or reasonably required to maintain, so long as the Indenture or the Lease is in effect and such central filing system remains available, the benefit of such filing or recording in Mexico for the protection of the security interest created by the Indenture and any security


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interest that may be claimed to have been created by the Lease and the ownership interest of Owner Trustee in each Unit to the extent such protection is available pursuant to such filing or recording in Mexico.

Section 6.10 Owner Participant an Affiliate of Lessee . If at any time the original or any successor Owner Participant shall be an affiliate of Lessee, such Owner Participant and Lessee agree that, notwithstanding any provision of the Indenture to the contrary, they will not modify, amend or supplement any provision of the Lease or this Agreement or give, or permit Owner Trustee to give, any consent, waiver, authorization or approval thereunder if any such action would adversely affect in a material manner Indenture Trustee or any holder of an Equipment Note unless such action shall have been consented to by a Majority in Interest.

Section 6.11 Taxes . Lessee shall pay and discharge all Taxes imposed upon Lessee or upon its income, profits or properties prior to the date on which penalties attach thereto except for those Taxes which are being contested in good faith through appropriate proceedings and for which adequate reserves are being maintained.

Section 6.12 Direct Loan . If any Closing Date shall have occurred, Lessee shall cause the Direct Loan to be paid in full and discharged on or before February 15, 2006.

Section 6.13 Transfers by KfW . Notwithstanding anything else to the contrary, in addition to any other right or privilege granted to KfW herein or in the other Operative Agreements, the parties hereto agree that KfW may transfer or assign any or all of its rights and obligations under the Operative Agreements to any other entity (the “ KfW Assignee ”) that may lawfully receive and perform the rights and obligations being transferred or assigned (including, without limitation, any company that qualifies as a “Subsidiary” of KfW within the meaning of section 15 ff. of the German Stock Corporation Act (Aktiengesetz) in that such Subsidiary is directly or indirectly (i) majority owned (im Mehrheitsbesitz) by KfW or (ii) controlled (abhängig) by KfW); provided , however , that in connection with any such assignment or transfer:

(1) KfW will provide to all other parties hereto timely notice of such assignment or transfer and the KfW Assignee shall becomes a party to this Participation Agreement;

(2) If, by reason of circumstances already existing at the time of such assignment or transfer, Lessee and Owner Trustee would be obligated to make a payment to the KfW Assignee under Section 7.02 of the Indenture or Section 7.1(j) of the Participation Agreement, Lessee’s and Owner Trustee’s obligation to the KfW Assignee under such Section shall be limited to the amount that Lessee and Owner Trustee would have been required to pay to KfW under such Section assuming such assignment or transfer had not occurred; and

(3) KfW will pay the reasonable costs of the parties hereto in connection with any such assignment or transfer.


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ARTICLE VII.
LESSEE’S INDEMNITIES

Section 7.1 General Tax Indemnity .

(a) Tax Indemnitee Defined . For purposes of this Section 7.1, “ Tax Indemnitee ” means Owner Participant, each Affiliate, Owner Trustee, Trust Company, the Trust, the Trust Estate, Indenture Trustee, each Loan Participant, and each of their respective successors or assigns permitted under the terms of the Operative Agreements and, with respect to any taxes, shall also include any affiliated or combined group of which such Tax Indemnitee is, or may become, a member if consolidated or combined returns are filed for such group for purposes of such taxes.

(b) Taxes Indemnified . Subject to the exclusions stated in subsection (c) below (except with respect to clause (v) of subsection (b), which shall apply without regard to the exclusions set forth in subsection (c)), Lessee agrees to indemnify and hold harmless each Tax Indemnitee, taking into account all taxes payable by the Tax Indemnitee as a result of the accrual or receipt of an indemnity payment hereunder, against all fees, taxes, levies, assessments, charges or withholdings of any nature, together with any penalties, fines or interest thereon or additions thereto (“ Taxes ”) imposed upon any Tax Indemnitee, Lessee or all or any part of the Equipment by any federal, state or local government, political subdivision, or taxing authority in the United States, by any government or taxing authority of or in a foreign country or by any international authority, upon, with respect to or in connection with:

(i) the Equipment or any part of any of the Equipment or interest therein;

(ii) the acquisition, financing, use or operation with respect to the Equipment or any part of any of the Equipment or interest therein;

(iii) payments of Rent or the receipts, income or earnings arising therefrom;

(iv) any or all of the Operative Agreements or any payments made with respect to the Equipment Notes; or otherwise with respect to the transactions contemplated by or resulting from the Operative Agreements, including any payments thereunder and the exercise of rights and remedies thereunder; or

(v) in the case of Owner Participant and Owner Trustee, any withholding tax and penalties and interest thereon imposed in respect of Loan Certificates held by a non-U.S. Loan Participant.

(i) Taxes which are based upon, measured by or in respect to gross or net income or gross or net receipts; Taxes on items of preference or any minimum tax; value added taxes; business and occupation taxes; franchise taxes; or Taxes based upon Owner


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Participant’s or Lessor’s capital stock or net worth; provided that there shall not be excluded under this subparagraph (i) any sales, use, property, value added, license, rental, ad valorem or Taxes in the nature thereof, Taxes which are in the nature of withholding Taxes imposed with respect to any payment of principal, interest or other amounts due under the Equipment Notes, or any Taxes imposed by any government or taxing authority of or in a foreign country if, and to the extent, such Taxes are imposed as a result of (A) the operation, presence or registration in such jurisdiction of any Unit or part thereof, (B) the presence in such jurisdiction of a permanent establishment or fixed place of business of any Lessee Person, (C) the residence, nationality or place of management and control of any Lessee Person, (D) the payment by any Lessee Person of any amount due under the Operative Agreements which is treated as paid from such jurisdiction or (E) any combination of factors (A)-(D) (it being agreed, solely for the avoidance of doubt, that any value added tax imposed by Mexico or any political subdivision of Mexico with respect to any transaction involving the Equipment on or prior to the Closing Date described in the recitals in the first three pages of this Agreement shall be treated as described in this proviso and thus as not excluded under this subparagraph (i));

(ii) Taxes imposed with respect to any period after the earliest of (x) the return of possession of the Equipment to Owner Participant or the placement of the Equipment in storage at the request of Owner Participant, in either case pursuant to Section 6 of the Lease and only so long as no Lease Event of Default shall have occurred and be continuing, (y) the termination of the Lease Term pursuant to Section 22.1 of the Lease, or (z) the discharge in full of Lessee’s obligation to pay the Termination Value or the Stipulated Loss Value and all other amounts due, if any, under Section 10 or 11.2 of the Lease, as the case may be, with respect to the Equipment; provided that the exclusion set forth in this clause (ii) shall not apply to Taxes to the extent such Taxes relate to events occurring or matters arising prior to or simultaneously with such time (including Taxes on or with respect to any payment to a Tax Indemnitee due after the termination or expiration of the Lease if such payment relates to events occurring or matters arising prior to or simultaneously with such time);

(iii) Taxes of a Tax Indemnitee which arise out of or are caused by any breach by such Tax Indemnitee of any of its representations, warranties or covenants in any of the Operative Agreements, or the gross negligence or willful misconduct of such Tax Indemnitee;

(iv) Taxes which become payable as a result of a sale, assignment, transfer or other disposition (whether voluntary or involuntary) by a Tax Indemnitee of all or any portion of its interest in the Equipment or any part thereof, the Trust Estate or any of the Operative Agreements or rights created thereunder other than a disposition attributable to (v) a Lease Event of Default (but only while a Lease Event of Default has occurred and is continuing), (w) an Event of Loss, (x) the exercise by Lessee of the termination right pursuant to Section 10 of the Lease, (y) the exercise by Lessee of the purchase right pursuant to Section 23 of the Lease and (z) the replacement, substitution, subleasing or interchange of any Unit by any Lessee Person (as defined in the Tax Indemnity Agreement);

(v) Taxes imposed with respect to any fees received by Indenture Trustee or Owner Trustee for services rendered in its capacity as trustee;


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(vi) Taxes which have been included in the Equipment Cost;

(vii) Taxes for which Lessee is obligated to indemnify Owner Participant under the Tax Indemnity Agreement;

(viii) Taxes which result from Owner Trustee’s engaging on behalf of the Trust Estate acting upon the instruction of Owner Participant in transactions other than those permitted or contemplated by the Operative Agreements unless attributable to the exercise of default remedies pursuant to Article V of the Trust Agreement;

(ix) Taxes imposed pursuant to sections 6707, 6707A or 6708 of the Code;

(x) Taxes imposed against a particular Indemnified Person resulting from any prohibited transaction, within the meaning of section 4975(c)(1) of the Code, occurring with respect to the purchase or holding of Equipment Notes or circumstances when such Indemnified Person or any Person in such Indemnified Person’s Related Indemnitee Group caused such purchase or holding and knew it would constitute such a prohibited transaction.

(d) Reserved.

(e) Reverse Indemnity . If any Tax Indemnitee shall realize an actual reduction in tax liabilities paid as a result of any Taxes paid or indemnified against by Lessee under this Section 7.1 (whether by way of deduction, credit, allocation or apportionment or otherwise), such Tax Indemnitee shall pay to Lessee an amount equal to the amount of such tax benefit, increased by the Tax Indemnitee’s additional saved taxes attributable to the payment being made to Lessee hereunder (a “ reverse gross-up ”), provided that (i) the Tax Indemnitee shall not be obligated to make a payment to Lessee pursuant to this subsection (e) as long as a Lease Event of Default shall have occurred and be continuing or (ii) to the extent the amount of such payment by the Tax Indemnitee to Lessee would exceed the amount of all prior payments by Lessee to the Tax Indemnitee pursuant to paragraph (b) less the amount of all prior payments by the Tax Indemnitee of tax benefits pursuant to this paragraph (e), such excess shall not be paid but shall instead be carried forward and shall reduce Lessee’s obligations to make subsequent payments under paragraph (b) to the Tax Indemnitee. The foregoing proviso shall not apply to any reverse gross-up. The Tax Indemnitee shall in good faith use diligence in filing its tax returns and in dealing with taxing authorities to seek and claim any such tax benefit and to minimize the Taxes indemnifiable by Lessee under paragraph (b). Any subsequent loss or disallowance of such reduction in Taxes realized by the Tax Indemnitee shall be treated as Taxes subject to Lessee’s indemnity obligation pursuant to this Section 7.1.

(f) Refund . Upon receipt by a Tax Indemnitee of a refund or credit of all or part of any Taxes paid or indemnified against by Lessee, such Tax Indemnitee shall pay to Lessee an amount equal to the amount of such refund plus any interest received by or credited to such Tax Indemnitee with respect to such refund increased or decreased, as the case may be, by the Tax Indemnitee’s net additional or saved taxes attributable to the receipt of such amounts from the taxing authority and the payment being made to Lessee hereunder. The Tax Indemnitee shall in good faith use diligence in filing its Tax returns and in dealing with taxing authorities to


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seek and claim any such refund and to minimize the Taxes indemnifiable by Lessee pursuant to paragraph (b).

(g) Procedures . Any amount payable to a Tax Indemnitee pursuant to paragraph (b) shall be paid within 30 days after receipt of a written demand therefor from such Tax Indemnitee accompanied by a written statement describing in reasonable detail the basis for such indemnity and the computation of the amount so payable, provided that such amount need not be paid prior to the later of (i) the date which is 3 days prior to the date on which such Taxes are required to be paid or (ii) in the case of amounts which are being contested pursuant to paragraph (h) hereof, the time such contest (including all appeals) is finally resolved. Any amount payable to Lessee pursuant to paragraph (e) or (f) shall be paid within 30 days after the Tax Indemnitee realizes a tax benefit giving rise to a payment under paragraph (e) or receives a refund giving rise to a payment under paragraph (f), as the case may be, and shall be accompanied by a written statement by the Tax Indemnitee setting forth in reasonable detail the basis for computing the amount of such payment. Within 15 days following Lessee’s receipt of any computation from the Tax Indemnitee, Lessee may request that an accounting firm selected by Lessee and reasonably acceptable to the Tax Indemnitee determine whether such computations of the Tax Indemnitee are correct. Such accounting firm shall be requested to make the determination contemplated by this paragraph (g) within 30 days of its selection. In the event such accounting firm shall determine that such computations are incorrect, then such firm shall determine what it believes to be the correct computations. The Tax Indemnitee shall cooperate with such accounting firm and supply it with all information necessary to permit it to accomplish such determination, provided that such accounting firm shall have entered into a confidentiality agreement reasonably satisfactory to such Tax Indemnitee. The computations of such accounting firm shall be final, binding and conclusive upon the parties and Lessee shall have no right to inspect the books, records or tax returns of the Tax Indemnitee to verify such computation or for any other purpose. All fees and expenses of the accounting firm payable under this Section 7.1(g) shall be borne by Lessee, provided , however , that such fees and expenses shall be borne by the Tax Indemnitee if the amount determined by such firm is (1) in the case of any amount payable by Lessee, less than the amount determined by the Tax Indemnitee by 5% of the amount determined by such firm, and (2) in the case of any amount payable by the Tax Indemnitee, more than the amount determined by the Tax Indemnitee by 5% of the amount determined by such firm.

(h) Contest . If a written claim is made against a Tax Indemnitee for Taxes with respect to which Lessee may be liable for indemnity hereunder, the Tax Indemnitee shall promptly give Lessee notice in writing of such claim after its receipt and shall furnish Lessee with copies of the claim and all other writings received from the taxing authority relating to the claim; provided , however , that failure to notify Lessee shall not relieve Lessee of any obligation to indemnify the Tax Indemnitee hereunder unless such failure shall effectively preclude Lessee’s ability to initiate or continue the contest of such claim. The Tax Indemnitee shall not pay such claim prior to 30 days after providing Lessee with such written notice, unless required to do so by law or unless deferral of payment would cause adverse consequences to the Tax Indemnitee. The Tax Indemnitee shall in good faith, with due diligence and at Lessee’s expense, if requested in writing by Lessee, contest (including pursuing all appeals, other than to the United States Supreme Court) in the name of the Tax Indemnitee (or, if requested by Lessee and permissible as a matter of law, in the name of Lessee), or shall at Lessee’s option permit Lessee


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to contest in either the name of Lessee or with the Tax Indemnitee’s consent, which consent shall not be unreasonably withheld, in the name of the Tax Indemnitee, the validity, applicability or amount of such Taxes by,

(i) resisting payment thereof if practical;

(ii) not paying the same except under protest if protest is necessary and proper;

(iii) if the payment be made, using reasonable efforts to obtain a refund thereof in appropriate administrative and judicial proceedings; or

(iv) taking such other reasonable action as is reasonably requested by Lessee from time to time;

Notwithstanding the foregoing provisions of this paragraph (h), the Tax Indemnitee shall not be required to contest, or permit Lessee to contest, a claim unless (A) Lessee shall have agreed in writing to pay on an after-tax basis to the Tax Indemnitee on demand all reasonable out-of-pocket costs and expenses which the Tax Indemnitee may incur in connection with contesting such claim, and (B) no Specified Default or Lease Event of Default shall have occurred and be continuing, (C) such contest will not result in any material danger of the sale, forfeiture or loss of any of the Units unless Lessee shall have provided security reasonably acceptable to the Tax Indemnitee, and there is no risk of imposition of any criminal penalties as a result of such Tax Claim, (D) if such contest involves payment of such Tax, Lessee will either lend to the Tax Indemnitee on an interest-free basis (without reduction for any Tax savings that the Tax Indemnitee may realize as a result of the payment of such Tax), which loan will be repaid in full by the Tax Indemnitee upon the conclusion of the contest or pay such Tax Indemnitee the amount payable by Lessee pursuant to Section 7.1(a) above with respect to such Tax, and (E) upon request of a Tax Indemnitee, Lessee furnishes such Tax Indemnitee with an opinion of Lessee’s counsel that there is a reasonable basis for the position to be asserted in such contest and in the case of an appeal, that there is a substantial likelihood that the adverse decision will be reversed or substantially modified on appeal. If a Tax Indemnitee is obligated to contest a claim under this paragraph (h), such Tax Indemnitee shall not compromise or settle such claim without the express written permission of Lessee. If it does so in the absence of such permission, Lessee’s obligation to indemnify with respect to such claim shall terminate. If a Tax Indemnitee is obligated to contest a claim under this paragraph (h), such Tax Indemnitee may at any time decline to take further action with respect to the contest of such claim if such Tax Indemnitee shall first waive in writing its right to any indemnity payment by Lessee in respect of such claim (other than the expenses of such contest).

(i) Reports . In case any report, return or statement is required to be filed with respect to Taxes for which Lessee has an indemnity obligation under this Section 7.1, Lessee shall at Lessee’s expense timely file the same (except for any such report, return or statement (x) which the relevant Tax Indemnitee has notified in writing Lessee that such Tax Indemnitee intends to file or (y) which Lessee is not permitted to file, in which event Lessee shall timely (but in no event later than 30 days prior to the due date for such report, return or statement) provide at Lessee’s expense such Tax Indemnitee with such information reasonably available to Lessee as


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is reasonably necessary for preparing such report, return or statement), provided that such Tax Indemnitee shall have furnished Lessee with such information, not within the control of Lessee, as is in such Tax Indemnitee’s control and is reasonably available to such Tax Indemnitee and reasonably necessary to file such report, return or statement. Lessee shall either file such report, return or statement so as to show the ownership of the Equipment by the Trust or, where Lessee is not permitted to so file, shall notify the Tax Indemnitee of such requirement and prepare and deliver such report, return or statement to the Tax Indemnitee within a reasonable time prior to the time such report, return or statement is to be filed.

(j) Withholding . Lessee covenants and agrees to pay or cause to be paid all present or future Taxes which are in the nature of withholding Taxes imposed on or with respect to the payment of principal or interest under the Equipment Notes or of any other sums payable to Loan Participants by Lessee or Owner Trustee under the Operative Agreements, including all additional amounts and penalties payable in respect of any delay or failure of Lessee to pay any such Taxes; provided , however , neither Lessee nor Owner Trustee shall have any liability for any such Canadian Taxes in respect of EDC or German Taxes in respect of KfW payable by withholding or otherwise. Lessee shall not be required to pay or discharge any such withholding Taxes so long as it shall in good faith and by appropriate administrative or legal proceedings contest the validity thereof in a reasonable manner which will not affect or endanger the right, title or interest of Owner Trustee or the security interest of Indenture Trustee in the Indenture Estate, and Lessee shall reimburse Owner Trustee and Loan Participants for any damages or expenses resulting from such failure to pay or discharge. If any such withholding Taxes are deducted or withheld from any such payments, Lessee hereby agrees to promptly remit to the applicable Loan Participant the equivalent of the amounts so deducted or withheld such that the applicable Loan Participant receives a net sum equal to the sum which it would have received had no such deduction or withholding been made, and Lessee shall pay all such withholding Taxes and deliver to the applicable Loan Participant proof of payment of all such withholding Taxes within 30 days of the due date for such payment; provided , however , Lessee shall be released from its obligations under this Section 7.1(j) with respect to U.S. withholding Taxes resulting from the failure of such Loan Participant to provide at Lessee’s request a properly completed form W-8BEN or W-8ECI or such other information or certificates permitted under applicable law that would exempt or reduce such withholding. Notwithstanding any provision to the contrary in the Operative Agreements, neither Owner Participant nor Owner Trustee shall have any liability with respect to any such withholding Taxes and Lessee will indemnify Owner Trustee and Owner Participant for any such withholding Taxes.

Section 7.2 General Indemnification and Waiver of Certain Claims .

(a) Claims Defined . For the purposes of this Section 7.2, “ Claims ” shall mean any and all costs, expenses, liabilities, obligations, losses, damages, penalties, actions or suits or claims of whatsoever kind or nature (whether or not on the basis of negligence, strict or absolute liability or liability in tort) which may be imposed on, incurred by, suffered by, or asserted against an Indemnified Person, as defined herein, or any Unit and, except as otherwise expressly provided in this Section 7.2, shall include, but not be limited to, all reasonable out-of-pocket costs, disbursements and expenses (including legal fees and expenses) paid or incurred by an Indemnified Person in connection therewith or related thereto.


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(b) Indemnified Person Defined . For the purposes of this Section 7.2, “ Indemnified Person ” means Owner Participant, Owner Trustee, Trust Company, the Trust, Indenture Trustee, each Loan Participant, and each of their respective directors, officers, employees, shareholders, constituent investors or partners, Affiliates, successors and permitted assigns, agents and servants, the Trust Estate and the Indenture Estate (the respective directors, officers, employees, shareholders, constituent investors or partners, Affiliates, successors and permitted assigns, agents and servants of Owner Participant, Owner Trustee and Indenture Trustee, as applicable, together with Owner Participant, Owner Trustee but not Wilmington Trust Company, and Indenture Trustee, as the case may be, being referred to herein collectively as the “ Related Indemnitee Group ” of Owner Participant, Indenture Trustee and Owner Trustee, but not Wilmington Trust Company respectively), provided that as a condition of any obligations of Lessee to pay any indemnity or perform any action under this Section 7.2 with respect to any persons who are not signatories hereto, such persons at the written request of Lessee shall expressly agree in writing to be bound by all the terms of this Section 7.2. In the event that any Indemnified Person fails, after notice to such Indemnified Person referring to this sentence, to comply with any duty or obligation under Section 7.2(e) and (f), such Indemnified Person shall not be entitled to indemnity under this Section 7.2 to the extent such failure to comply has a material adverse effect on Lessee’s ability to defend any such Claim.

(c) Claims Indemnified . Whether or not any Unit is accepted under the Lease, or a closing occurs with respect thereto, and subject to the exclusions stated in subsection (d) below, Lessee agrees to indemnify, protect, defend and hold harmless each Indemnified Person on an after-tax basis against Claims resulting from or arising out of or related to (whether or not such Indemnified Person shall be indemnified as to such Claim by any other Person):

(i) this Agreement or any other Operative Agreement, the Direct Loan Agreement, the Direct Mortgage, the Trust Agreement or any of the transactions contemplated hereby and thereby or resulting herefrom or therefrom and the enforcement thereof and hereof;

(ii) the ownership, lease, operation, possession, modification, use, non-use, maintenance, sublease, financing, substitution, control, repair, storage, alteration, violation of law with respect to any Unit (including applicable securities laws, ERISA and environmental law), transfer or other disposition of any Unit, return, overhaul, testing or registration of any Unit (including, without limitation, injury, death or property damage of passengers, shippers or others, and environmental control, noise and pollution regulations) whether or not in compliance with the terms of the Lease;

(iii) the manufacture, design, purchase, acceptance, rejection, delivery, nondelivery or condition of any Unit (including, without limitation, latent and other defects, whether or not discoverable, and any claim for patent, trademark or copyright infringement);

(iv) any breach of or failure to perform or observe, or any other noncompliance with, any covenant, condition or agreement to be performed by, or other obligation of, Lessee under any of the Operative Agreements, or the falsity when made of any representation or warranty of Lessee in any of the Operative Agreements or in any document or certificate delivered in connection therewith other than representations and warranties in the Tax Indemnity Agreement; and


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(v) the offer, sale or delivery of any Equipment Notes or any interest in the Trust Estate.

(d) Lessee’s Claims Excluded . The following are excluded from the agreement to indemnify under this Section 7.2:

(i) Claims with respect to any Unit to the extent attributable to acts or events occurring after (A) in the case of the exercise by Lessee of a purchase option with respect to such Unit under Section 23 of the Lease, the exercise by Lessee of an early termination option with respect to such Unit under Section 10 of the Lease or the occurrence of an Event of Loss with respect to such Unit under Section 11 of the Lease, the last to occur of (w) if an Event of Default exists, the elimination of such Event of Default and the payment of all amounts due under the Operative Agreements, (x) the payment of all amounts due from Lessee in connection with any such event and (y) the release of the lien of the Indenture on such Unit or (B) in all other cases, with respect to such Unit the last to occur of (w) if an Event of Default exists, the elimination of such Event of Default and the payment of all amounts due under the Operative Agreements, (x) the earlier to occur of the termination of the Lease or the expiration of the Lease Term, (y) the return of such Unit to Lessor in accordance with the terms of the Lease (it being understood that the date of the placement of such Unit in storage as provided in Section 6 of the Lease constitutes the date of return of such Unit under the Lease) and (z) the release of the lien of the Indenture on such Unit;

(ii) with respect to any particular Indemnified Person, Claims which are Taxes or Losses, whether or not Lessee is required to indemnify therefor under Section 7.1 hereof or the Tax Indemnity Agreement, except, subject to subparagraph (xii) below, Taxes arising by reason of ERISA and not related to such Indemnified Person’s making or holding its investment as contemplated by the Operative Agreements or in accordance with the instructions of Lessee. Except as expressly provided in the Operative Agreements (including the foregoing sentence), Lessee’s entire obligation with respect to taxes and losses of tax benefits being fully set out in such Section 7.1 or the Tax Indemnity Agreement;

(iii) with respect to any particular Indemnified Person, Claims to the extent attributable to the gross negligence or willful misconduct of (other than gross negligence or willful misconduct imputed as a matter of law to such Indemnified Person solely by reason of its interest in the Equipment), or to the breach of any contractual obligation by, or the falsity or inaccuracy of any representation or warranty of such Indemnified Person or any of such Indemnified Person’s Related Indemnitee Group;

(iv) with respect to any particular Indemnified Person, Claims to the extent attributable to any breach by such Indemnified Person of the warranty of quiet enjoyment set forth in Section 8 or any transfer (other than pursuant to Section 10, 11, 15 or 23 of the Lease or pursuant to the Indenture) by such Indemnified Person of any interest in the Trust Estate;

(v) with respect to any particular Indemnified Person, any Claim to the extent attributable to the offer, sale or disposition (voluntary or involuntary) by or on behalf of such Indemnified Person of any Equipment Note or any interest in the Trust Estate or the Trust Agreement, or any similar security, other than a transfer by such Indemnified Person of its


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interests in any Unit pursuant to Section 10, 11 or 23 of the Lease and Section 11 of the Indenture or otherwise attributable to a Lease Event of Default that has occurred and is continuing;

(vi) any Claim by Owner Trustee or Owner Participant and the Related Indemnitee Group of such Indemnified Person to the extent attributable to a failure on the part of Owner Trustee to distribute in accordance with the Trust Agreement any amounts received and distributable by it thereunder;

(vii) any Claim (other than to the extent any such Claim is brought against Owner Participant or Owner Trustee and the Related Indemnitee Group of such Indemnified Person) to the extent attributable to a failure on the part of Indenture Trustee to distribute in accordance with the Indenture any amounts received and distributable by it thereunder;

(viii) any Claim to the extent attributable to the authorization or giving or unreasonable withholding by such Indemnified Person of any future amendments, supplements, modifications, alterations, waivers or consents with respect to any of this Agreement and the other Operative Agreements, other than such as have been requested by or consented to by Lessee or necessary or required to comply with applicable laws or to effectuate the purpose or intent of any Operative Agreement or as are expressly required by any Operative Agreements;

(ix) any Claim to the extent attributable to an Indenture Default that does not also constitute a Lease Default;

(x) any Claim which relates to a cost, fee or expense payable by a Person other than Lessee pursuant to this Agreement, the Lease or any other Operative Agreement;

(xi) any Claim which is an ordinary and usual operating or overhead expense of such Indemnified Person other than such expenses attributable to the occurrence of an Event of Default; or

(xii) with respect to a particular Indemnified Person and such Indemnified Person’s Related Indemnitee Group, Claims resulting from any prohibited transaction, within the meaning of section 4975(c)(I) of the Code, occurring with respect to the purchase or holding of Equipment Notes under circumstances when such Indemnified Person caused such purchase or holding and knew it would constitute such a prohibited transaction.

(e) Insured Claims . In the case of any Claim indemnified by Lessee hereunder which is covered by a policy of insurance maintained by Lessee pursuant to Section 12 of the Lease or otherwise, each Indemnified Person agrees to provide reasonable cooperation, at the expense and risk of Lessee, to the insurers in the exercise of their rights to investigate, defend or compromise such Claim as may be required to retain the benefits of such insurance with respect to such Claim.


Participation Agreement (KCSR 2005-1)		- 42 -

(f) Claims Procedure . An Indemnified Person shall promptly notify Lessee of any Claim as to which indemnification is sought; provided , however , that, notwithstanding the last sentence of Section 7.2(b), the failure to give such notice shall not release Lessee from any of its obligations under this Section 7, except to the extent that such failure to give notice shall have a material adverse effect on Lessee’s ability to defend such claim. Subject to the rights of insurers under policies of insurance maintained by Lessee, Lessee shall have the right in each case at Lessee’s sole expense to investigate, and the right in its sole discretion to defend or compromise, any Claim for which indemnification is sought under this Section 7.2 and the Indemnified Person shall cooperate with all reasonable requests of Lessee in connection therewith; provided that no right to defend or compromise such Claim shall exist on the part of Lessee with respect to any Indemnified Person if (1) a Lease Event of Default shall have occurred and be continuing or (2) such Claim would entail a significant risk to Owner Participant, any Loan Participant or any Affiliate thereof of any criminal liability; provided , further , that no right to compromise or settle such Claim shall exist unless Lessee agrees in writing to pay the amount of such settlement or compromise. In any case in which any action, suit or proceeding is brought against any Indemnified Person in connection with any Claim, Lessee may and, upon such Indemnified Person’s request, will at Lessee’s expense resist and defend such action, suit or proceeding, or cause the same to be resisted or defended by counsel selected by Lessee and reasonably acceptable to such Indemnified Person and, in the event of any failure by Lessee to do so, Lessee shall pay all costs and expenses (including, without limitation, reasonable attorneys’ fees and expenses) incurred by such Indemnified Person in connection with such action, suit or proceeding. Where Lessee or the insurers under a policy of insurance maintained by Lessee undertake the defense of an Indemnified Person with respect to a Claim, no additional legal fees or expenses of such Indemnified Person in connection with the defense of such Claim shall be indemnified hereunder unless such fees or expenses were incurred at the request of Lessee or such insurers; provided , however , that if in the written opinion of counsel to such Indemnified Person an actual or potential material conflict exists where it is advisable for such Indemnified Person to be represented by separate counsel, the reasonable fees and expenses of any such separate counsel shall be paid by Lessee. Subject to the requirements of any policy of insurance, an Indemnified Person may participate at its own expense in any judicial proceeding controlled by Lessee pursuant to the preceding provisions; provided that such party’s participation does not, in the opinion of the independent counsel appointed by Lessee or its insurers to conduct such proceedings, interfere with such control; and such participation shall not constitute a waiver of the indemnification provided in this Section 7.2(f). Nothing contained in this Section 7.2(f) shall be deemed to require an Indemnified Person to contest any Claim or to assume responsibility for or control of any judicial proceeding with respect thereto.

(g) Subrogation . If a Claim indemnified by Lessee under this Section 7.2 is paid by Lessee and/or an insurer under a policy of insurance maintained by Lessee, Lessee and/or such insurer, as the case may be, shall be subrogated to the extent of such payment to the rights and remedies of the Indemnified Person (other than under insurance policies maintained by such Indemnified Person) on whose behalf such Claim was paid with respect to the transaction or event giving rise to such Claim. So long as no Lease Event of Default shall have occurred and be continuing, should an Indemnified Person receive any refund, in whole or in part, with respect to any Claim paid by Lessee hereunder, it shall promptly pay over the amount refunded (but not in excess of the amount Lessee or any of its insurers has paid in respect of such Claim paid or payable by such Indemnified Person on account of such refund) to Lessee.


Participation Agreement (KCSR 2005-1)		- 43 -

(h) Waiver of Certain Claims . Lessee hereby waives and releases any Claim now or hereafter existing against any Indemnified Person arising out of death or personal injury to personnel of Lessee, loss or damage to property of Lessee, or the loss of use of any property of Lessee, which may result from or arise out of the condition, use or operation of the Equipment during the Lease Term, including without limitation any latent or patent defect whether or not discoverable.

(i) Conflicting Provisions . The general indemnification provisions of this Section 7.2 are not intended to waive or supersede any specific provisions of, or any rights or remedies of Lessee under, the Lease, this Agreement or any other Operative Agreement to the extent such provisions apply to any Claim. The general indemnification provisions of this Section 7.2 do not constitute a guaranty by Lessee that the principal of, interest on or any amounts payable with respect to the Equipment Notes will be paid.

ARTICLE VIII.
LESSEE’S RIGHT OF QUIET ENJOYMENT

Each party to this Agreement acknowledges notice of, and consents in all respects to, the terms of the Lease, and expressly, severally and as to its own actions only, agrees that, so long as no Lease Event of Default has occurred and is continuing, it shall not take or cause to be taken any action contrary to Lessee’s rights under the Lease, including, without limitation, the right to possession, use and quiet enjoyment by Lessee or any permitted sublessee.

ARTICLE IX.
[ RESERVED ]

ARTICLE X.
SUCCESSOR INDENTURE TRUSTEE

(a) In the event that Indenture Trustee gives notice of its resignation pursuant to Section 8.02(a) of the Trust Indenture, Owner Trustee shall promptly appoint a successor Indenture Trustee reasonably acceptable to Lessee and to the Loan Participants.

(b) In the event that any of Owner Trustee, Loan Participants or Lessee obtains actual knowledge of the existence of any of the grounds for removal of Indenture Trustee set forth in Section 8.02(a) of the Indenture, Owner Trustee, Loan Participants or Lessee, as the case may be, shall promptly notify the others by telephone, confirmed in writing and Owner Trustee shall promptly thereafter remove Indenture Trustee and appoint a successor Indenture Trustee reasonably acceptable to Lessee and to the Loan Participants.

ARTICLE XI.
MISCELLANEOUS

Section 11.1 Consents . Each Participant covenants and agrees that it shall not unreasonably withhold its consent to any consent requested of Owner Trustee or Indenture Trustee, as the case may be, under the terms of the Operative Agreements that by its terms is not to be unreasonably withheld by Owner Trustee or Indenture Trustee.


Participation Agreement (KCSR 2005-1)		- 44 -

Section 11.2 Refinancing .

(a) Generally . Provided no Specified Default or Event of Default shall have occurred or be continuing, Lessee shall have the right at any time during the Lease Term to request Owner Participant and Owner Trustee to effect an optional prepayment of all of the Equipment Notes pursuant to Section 2.10(d) of the Indenture as part of a refunding or refinancing operation. Promptly on receipt of such request, Owner Participant will conclude an agreement with Lessee as to the terms of such refunding or refinancing operation, and upon such agreement:

(i) Lessee, Owner Participant, Indenture Trustee, Owner Trustee, and any other appropriate parties will enter into a financing or loan agreement which shall be without recourse or warranty as to Owner Participant (which may involve an underwriting agreement in connection with a public offering) providing for (x) the issuance and sale by Owner Trustee or such other party as may be appropriate to such institution or institutions on the date specified in such agreement (for the purposes of this Section 11.2, the “ Refunding Date ”) of debt Securities in an aggregate principal amount (in the lawful currency of the United States) equal to the principal amount of the Equipment Notes outstanding on the Refunding Date, and (y) the application of the proceeds of the sale of such debt Securities to the prepayment of all such Equipment Notes on the Refunding Date, and (z) payment by Lessee to the Person or Persons entitled thereto on behalf of Owner Trustee as Supplemental Rent of all other amounts in respect of accrued interest, and any Make-Whole Amount with respect to any Equipment Note payable on such Refunding Date;

(ii) Lessee and Owner Trustee will amend the Lease such that (w) if the Refunding Date is not a Rent Payment Date, Lessee shall on the Refunding Date prepay that portion of the next succeeding installment of Basic Rent as shall equal the aggregate interest accrued on the Equipment Notes outstanding to the Refunding Date, (x) Basic Rent payable in respect of the period from and after the Refunding Date shall be recalculated to preserve the Net Economic Return which Owner Participant would have realized had such refunding not occurred, provided that the net present value of Basic Rent shall be minimized to the extent consistent therewith, and (y) the EBO Fixed Purchase Price and amounts payable in respect of Stipulated Loss Value and Termination Value from and after the Refunding Date shall be appropriately recalculated to preserve the Net Economic Return which Owner Participant would have realized had such refunding not occurred (it being agreed that any recalculations pursuant to subclauses (x) and (y) of this clause (ii) shall be performed in accordance with the requirements of Section 2.6 hereof);

(iii) Owner Participant will cause Owner Trustee to enter into an agreement to provide for the securing thereunder of the debt Securities issued by Owner Trustee pursuant to clause (a) of this Section 11.2 in like manner as the Equipment Notes and/or will enter into such amendments and supplements to the Indenture which shall be without recourse or warranty as to Owner Participant as may be necessary to effect such refunding or refinancing; provided that, notwithstanding the foregoing, Lessee reserves the right to set the economic terms and other terms not customarily negotiated between an owner participant and a lender of the refunding or refinancing transaction to be so offered; provided , further , that no such amendment


Participation Agreement (KCSR 2005-1)		- 45 -

or supplement will increase the obligations or impair the rights of Owner Participant or Owner Trustee under the Operative Agreements without the consent of Owner Participant;

(iv) in the case of a refunding or refinancing involving a public offering of debt Securities, the offering materials (including any registration statement) for the refunding or refinancing transaction shall be reasonably acceptable to Owner Participant to the extent of any description or statement contained therein describing Owner Participant or Owner Trustee or the terms of the transaction among Owner Participant, Owner Trustee and Lessee; and

(v) unless otherwise agreed by Owner Participant, Lessee shall pay to Owner Trustee as Supplemental Rent an amount equal to the Make-Whole Amount, if any, payable in respect of Equipment Notes outstanding on the Refunding Date, and all reasonable fees, costs, expenses of such refunding or refinancing and in the case of Owner Participant, an administrative fee of $10,000.00 on each Refunding Date other than the first Refunding Date; provided , however , that (u) any such refinancing shall not adversely affect the rights or increase the obligations or risks of Owner Participant under the Operative Agreements; (v) such refinancing shall not create or increase Owner Participant’s risk of any adverse tax consequences (including any adverse tax consequences under section 467 or section 861 of the Code or the Regulations) unless such risks are indemnified by Lessee in a manner satisfactory to Owner Participant; (w) Lessee may only enter into a refunding or refinancing operation under this Section 11.2(a) on no more than two occasions; (x) Lessee shall pay to or reimburse the Participants, Owner Trustee and Indenture Trustee for all costs and expenses (including reasonable attorneys’ and advisors’ fees) paid or incurred by them in connection with such refinancing; (y) no refinancing shall cause Owner Participant to account for the transaction contemplated hereby as other than a “leveraged lease” under the Financial Accounting Standards Board (“ FASB ”) Statement No. 13, as amended (including any amendment effected by means of the adoption by FASB of a new statement in lieu of FASB Statement No. 13); and (z) such refinancing shall not (A) create Replacement Notes with a maturity longer than the Notes, (B) create Replacements Notes with an average life more than three (3) months longer than the average life of the Notes (C) require any additional investment by Owner Participant or (D) increase the amount of premium payable in connection with a prepayment of the Notes. In addition to the foregoing, in the case of any refunding or refinancing of the Equipment Notes pursuant to this Section 11, the party purchasing the Equipment Notes shall represent either that (i) no part of its purchase consists of assets of any “employee benefit plan” (as defined in Section 3(3) of ERISA) or any other entity subject to section 4975 of the Code other than a “governmental plan” or “church plan” (as defined in section 3(32) of ERISA) organized in a jurisdiction not having prohibition on transactions with such governmental plan or church plan substantially similar to those contained in section 406 of ERISA or section 4975 of the Code, (ii) the purchase of such Equipment Notes does not constitute a non-exempt prohibited transaction under section 406 of ERISA or section 4975 of the Code, or (iii) the source of funds for its purchase is an “insurance company general account” within the meaning of proposed Department of Labor Prohibited Transaction Exemption (“ PTE ”) 95-60 (issued July 12, 1995) and it has identified that there is no employee benefit plan, treating as a single employee benefit plan, all employee benefit plans maintained by the same employer or affiliates thereof or employee organization, with respect to which the amount of the reserves for all contracts held by or on behalf of such employee benefit plan exceed 10% of the total liabilities of such general account. Accordingly, Owner Participant agrees to cooperate in good faith with Lessee in


Participation Agreement (KCSR 2005-1)		- 46 -

effecting any such refunding or refinancing and, in connection therewith, at the request of Lessee made at least 30 days prior to any proposed Refunding Date, (A) to cooperate with the reasonable requests of any advisor selected by Lessee after consultation with Owner Participant to obtain commitments from financial institutions to lend to Owner Trustee funds sufficient to permit Owner Trustee to prepay, in whole, the outstanding Equipment Notes in accordance with their terms in connection with any such refunding or refinancing and (B) to make the adjustments contemplated by this Section 11.2 in connection with any such refunding or refinancing.

(b) Other Prepayments, Redemptions, Etc . No prepayment or redemption and cancellation by Owner Trustee or Owner Participant of any Equipment Note (other than pursuant to Section 2.10(b) of the Indenture and this Section 11.2) shall be made without the prior written consent of Lessee.

Section 11.3 Amendments and Waivers . No term, covenant, agreement or condition of this Agreement may be terminated, amended or compliance therewith waived (either generally or in a particular instance, retroactively or prospectively) except by an instrument or instruments in writing executed by each party hereto.

Section 11.4 Notices . Unless otherwise expressly specified or permitted by the terms hereof, all communications and notices provided for herein shall be in writing or by a telecommunications device capable of creating a written record (including electronic mail), and any such notice shall become effective (a) upon personal delivery thereof, including, without limitation, by overnight mail and courier service, (b) in the case of notice by United States mail, certified or registered, postage prepaid, return receipt requested, upon receipt thereof, or (c) in the case of notice by such a telecommunications device, upon transmission thereof, provided such transmission is promptly confirmed by either of the methods set forth in clauses (a) or (b) above, in each case addressed to each party hereto at its address set forth below or, in the case of any such party hereto, at such other address as such party may from time to time designate by written notice to the other parties hereto:


If to Lessee:		Address of Lessee for Mail Delivery :
		The Kansas City Southern Railway Company
		P.O. Box 219335
		Kansas City, MO 64121-9335
		Attention: Senior Vice President — Finance & Treasurer
		Facsimile No.: (816) 983-1198
		Telephone No.: (816) 983-1802

		Address of Lessee for Courier and Similar Delivery :
		The Kansas City Southern Railway Company
		427 West 12 ^th Street
		Kansas City, MO 64105
		Attention: Senior Vice President — Finance & Treasurer
		Facsimile No.: (816) 983-1198
		Telephone No.: (816) 983-1802


Participation Agreement (KCSR 2005-1)		- 47 -


With a copy to:
		The Kansas City Southern Railway Company
		427 West 12 ^th Street
		Kansas City, MO 64105
		Attention: Senior Vice President & General Counsel
		Facsimile No.: (816) 983-1227
		Telephone No.: (816) 983-1303

If to Owner Trustee:		Wilmington Trust Company
		Rodney Square North
		1100 North Market Street
		Wilmington, DE 19890-0001
		Attention: Corporate Trust Administration
		Facsimile No.: (302) 636-4140
		Telephone No.: (302) 636-6000

with a copy to:		Owner Participant at the address set forth below

If to Owner Participant:		GS Leasing (KCSR 2005-1) LLC
		c/o The Goldman Sachs Group Inc.
		85 Broad Street
		New York, NY 10004
		Attention: Robert Emer,
		Fixed Income, Currency and Commodities
		Facsimile: 212-256-4853
		Telephone No.: 212-902-0047

If to a Loan Participant:		at the addresses set forth in Annex B to the Indenture

If to Indenture Trustee:		Wells Fargo Bank Northwest, National Association
		299 South Main Street, 12 ^th Floor
		MAC: U1228-120
		Salt Lake City, Utah, 84111
		Attention: Corporate Trust Department
		Facsimile No.: 801-246-5053
		Telephone No.: 801-246-5630

Section 11.5 Survival . All warranties, representations, indemnities and covenants made by any party hereto, herein or in any certificate or other instrument delivered by any such party or on the behalf of any such party under this Agreement, shall be considered to have been relied upon by each other party hereto and shall survive the consummation of the transactions contemplated hereby on the date hereof and on each Closing Date regardless of any investigation made by any such party or on behalf of any such party.

Section 11.6 No Guarantee of Debt . Nothing contained herein or in the Lease, the Trust Indenture, the Trust Agreement or the Tax Indemnity Agreement or in any certificate or other statement delivered by Lessee in connection with the transactions contemplated hereby


Participation Agreement (KCSR 2005-1)		- 48-

shall be deemed to be (a) a guarantee by Lessee to Owner Trustee, Owner Participant, Indenture Trustee or any Loan Participant that the Equipment will have any residual value or useful life, or (b) a guarantee by Indenture Trustee or Lessee of payment of the principal or Make-Whole Amount, if any, with respect to any Equipment Note, or interest on the Equipment Notes.

Section 11.7 Successors and Assigns . This Agreement shall be binding upon and shall inure to the benefit of, and shall be enforceable by, the parties hereto and their respective successors and assigns as permitted by and in accordance with the terms hereof, including each successive holder of the Beneficial Interest permitted under Section 6.1 hereof and Section 23(c) of the Lease and each successive holder of any Equipment Note issued and delivered pursuant to this Agreement or the Indenture. Except as expressly provided herein or in the other Operative Agreements, no party hereto may assign their interests herein without the consent of the parties hereto.

Section 11.8 Business Day . Notwithstanding anything herein or in any other Operative Agreement to the contrary, if the date on which any payment is to be made pursuant to this Agreement or any other Operative Agreement is not a Business Day, the payment otherwise payable on such date shall be payable on the next succeeding Business Day with the same force and effect as if made on such scheduled date and (provided such payment is made on such succeeding Business Day) no interest shall accrue on the amount of such payment from and after such scheduled date to the time of such payment on such next succeeding Business Day.

Section 11.9 GOVERNING LAW . THIS AGREEMENT SHALL BE IN ALL RESPECTS GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK INCLUDING ALL MATTERS OF CONSTRUCTION, VALIDITY AND PERFORMANCE; PROVIDED , HOWEVER , THAT THE PARTIES HERETO SHALL BE ENTITLED TO ALL RIGHTS CONFERRED BY ANY APPLICABLE FEDERAL STATUTE, RULE OR REGULATION.

Section 11.10 Severability . Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Agreement.

Section 11.11 Counterparts . This Agreement may be executed in any number of counterparts, each executed counterpart constituting an original but all together only one Agreement.

Section 11.12 Headings and Table of Contents . The headings of the sections of this Agreement and the Table of Contents are inserted for purposes of convenience only and shall not be construed to affect the meaning or construction of any of the provisions hereof.

Section 11.13 Limitations of Liability .

(a) Liabilities of the Participants . Neither Indenture Trustee, Trust Company, Owner Trustee nor any Participant shall have any obligation or duty to Lessee, to any other Participant or to others with respect to the transactions contemplated hereby, except those


Participation Agreement (KCSR 2005-1)		- 49 -

obligations or duties of such Participant expressly set forth in this Agreement and the other Operative Agreements, and neither Indenture Trustee, Trust Company, Owner Trustee nor any Participant shall be liable for performance by any other party hereto of such other party’s obligations or duties hereunder. Without limitation of the generality of the foregoing, under no circumstances whatsoever shall Indenture Trustee or any Participant be liable to Lessee for any action or inaction on the part of Owner Trustee in connection with the transactions contemplated herein, whether or not such action or inaction is caused by willful misconduct or gross negligence of Owner Trustee unless such action or inaction is at the direction of Indenture Trustee or any Participant, as the case may be, and such direction is expressly permitted hereby.

(b) No Recourse to Owner Trustee . It is expressly understood and agreed by and between Owner Trustee, Lessee, Owner Participant, Indenture Trustee, and each Loan Participant, and their respective successors and permitted assigns, that, subject to the proviso contained in this Section 11.13(b), all representations, warranties and undertakings of Owner Trustee hereunder shall be binding upon Owner Trustee, only in its capacity as Owner Trustee under the Trust Agreement, and (except as expressly provided herein) Trust Company for any breach thereof, except for its gross negligence or willful misconduct, or for breach of its covenants, representations and warranties contained herein, except to the extent covenanted or made in its individual capacity; provided , however , that nothing in this Section 11.13(b) shall be construed to limit in scope or substance those representations and warranties of Trust Company made expressly in its individual capacity set forth herein. The term “Owner Trustee” as used in this Agreement shall include any successor trustee under the Trust Agreement, or Owner Participant if the trust created thereby is revoked.

Section 11.14 Reproduction of Documents . This Agreement and all documents relating thereto, including, without limitation, (a) consents, waivers and modifications that may hereafter be executed, (b) documents received by the parties hereto on the date hereof (except the Equipment Notes), and (c) financial statements, certificates and other information previously or hereafter furnished pursuant hereto, may be reproduced by the parties hereto by any photographic, photostatic, microfilm, microcard, miniature photographic, electronic or other similar process and the parties hereto may destroy any original document so reproduced. The parties agree to accept delivery of all of the foregoing documents in electronic format in lieu of original closing transcripts. The parties further agree and stipulate that, to the extent permitted by applicable law, any such reproduction, in electronic format or otherwise, shall be admissible in evidence as the original itself in any judicial or administrative proceeding (whether or not the original is in existence and whether or not such reproduction was made in the regular course of business) and any enlargement, facsimile or further reproduction of such reproduction shall likewise be admissible in evidence. This Section 11.14 shall not prohibit the parties hereto or any holder of Equipment Notes from contesting any such reproduction to the same extent that it could contest the original, or from introducing evidence to demonstrate the inaccuracy of any such reproduction.

Section 11.15 Tax Disclosure . Notwithstanding anything herein to the contrary, each party hereto (and each employee, representative or other agent of such person) may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transactions described in this Agreement, and all materials of any kind (including opinions or other tax analyses) that are provided to the person related to such tax treatment and tax structure.


Participation Agreement (KCSR 2005-1)		- 50 -

The preceding sentence is intended to cause the transaction contemplated hereby to be treated as not having been offered under conditions of confidentiality for purposes of U.S. Treasury Regulation §1.6011-4(b)(3) and shall be construed in a manner consistent with such purpose.

Section 11.16 Bankruptcy of Trust or Trust Estate . If (i) all or any part of the Trust Estate becomes the property of a debtor, or the Trust becomes a debtor, subject to the reorganization provisions of Title 11 of the United States Code, as amended from time to time, (ii) pursuant to such reorganization provisions Owner Participant is required, by reason of Owner Participant being held to have recourse liability to the debtor or the trustee of the debtor directly or indirectly, to make payment on account of any amount payable as principal of or interest on any Equipment Note, and (iii) Indenture Trustee or any Loan Participant actually receives any Excess Amount as defined below, which reflects any payment by Owner Participant on account of clause (ii) above, Indenture Trustee or such Loan Participant, as the case may be, shall promptly refund to Owner Participant such Excess Amount. For purposes of this Section 11.16, “Excess Amount” means the amount by which such payment exceeds the amount which would have been received by Indenture Trustee or such Loan Participant if Owner Participant has not become subject to the recourse liability referred to in clause (ii) above.


Participation Agreement (KCSR 2005-1)		- 51 -

IN WITNESS WHEREOF, the parties hereto have caused this Participation Agreement to be executed and delivered, all as of the date first above written.


Lessee:	THE KANSAS CITY SOUTHERN RAILWAY COMPANY

	By:	/s/ Ronald G. Russ

		Name: Ronald G. Russ
		Title: Executive Vice President & CFO

Owner Trustee:	KCSR TRUST 2005-1, acting through WILMINGTON TRUST COMPANY, not in its individual capacity, except where otherwise expressly provided, but solely as Owner Trustee

	By:	/s/ Michele C. Harra

		Name: Michele C. Harra
		Title: Financial Services Officer

Owner Participant:	GS LEASING (KCSR 2005-1) LLC

	By:	/s/ Vijay Radhakishun
		Name: Vijay Radhakishun
		Title: Vice President


Participation Agreement (KCSR 2005-1)


Indenture Trustee:	WELLS FARGO BANK NORTHWEST, NATIONAL
	ASSOCIATION

	By:	/s/ Brett R. King

		Name: Brett R. King
		Title: Vice President

Loan Participant:	EXPORT DEVELOPMENT CANADA

	By:	/s/ Ian Cameron

		Name: Ian Cameron
		Title: Asset Management

	By:	/s/ Roman Chomyn

		Name: Roman Chomyn
		Title: Portfolio Manager

Loan Participant:	KFW

	By:	/s/ Martin Kloster

		Name: Martin Kloster
		Title: First Vice President

	By:	/s/ Dr. Inga Conrady

		Name: Dr. Inga Conrady
		Title: Vice President


Participation Agreement (KCSR 2005-1)

Exhibit 10.49

EQUIPMENT LEASE AGREEMENT
(KCSR 2005-1)

dated as of December 20, 2005

between

KCSR TRUST 2005-1 , acting through
WILMINGTON TRUST COMPANY,
not in its individual capacity, except as otherwise
expressly provided herein, but solely as Owner Trustee,
Lessor

and

THE KANSAS CITY SOUTHERN RAILWAY COMPANY ,
Lessee

SD70MAC Locomotives

CERTAIN OF THE RIGHT, TITLE AND INTEREST OF LESSOR IN AND TO THIS LEASE, THE EQUIPMENT COVERED HEREBY AND THE RENT DUE AND TO BECOME DUE HEREUNDER HAVE BEEN ASSIGNED AS COLLATERAL SECURITY TO, AND ARE SUBJECT TO A SECURITY INTEREST IN FAVOR OF, WELLS FARGO BANK NORTHWEST, NATIONAL ASSOCIATION, AS INDENTURE TRUSTEE UNDER A TRUST INDENTURE AND SECURITY AGREEMENT (KCSR 2005-1), DATED AS OF DECEMBER 20, 2005 BETWEEN SAID INDENTURE TRUSTEE, AS SECURED PARTY, AND LESSOR, AS DEBTOR. INFORMATION CONCERNING SUCH SECURITY INTEREST MAY BE OBTAINED FROM INDENTURE TRUSTEE AT ITS ADDRESS SET FORTH IN SECTION 20 OF THIS LEASE. THIS LEASE AGREEMENT HAS BEEN EXECUTED IN SEVERAL COUNTERPARTS, ONLY THAT COUNTERPART TO BE DEEMED THE ORIGINAL COUNTERPART FOR CHATTEL PAPER PURPOSES CONTAINS THE RECEIPT THEREFOR EXECUTED BY WELLS FARGO BANK NORTHWEST, NATIONAL ASSOCIATION, AS INDENTURE TRUSTEE, ON THE SIGNATURE PAGE THEREOF. SEE SECTION 26.2 FOR INFORMATION CONCERNING THE RIGHTS OF THE ORIGINAL HOLDER AND THE HOLDERS OF THE VARIOUS COUNTERPARTS HEREOF.

Memorandum of Equipment Lease Agreement (KCSR 2005-1) filed with the Surface Transportation Board pursuant to 49 U.S.C. § 11301 on December 21, 2005 at 3:24PM., Recordation Number 26046, and deposited in the Office of the Registrar General of Canada pursuant to Section 105 of the Canada Transportation Act on December 21, 2005.

TABLE OF CONTENTS


SECTION	HEADING	PAGE
Parties			1

SECTION 1.	DEFINITIONS.		1

SECTION 2.	ACCEPTANCE AND LEASING OF EQUIPMENT		1

SECTION 3.	TERM AND RENT		1

Section 3.1.	Lease Term		1
Section 3.2.	Basic Rent		2
Section 3.3.	Supplemental Rent		3
Section 3.4.	Adjustment of Rent		4
Section 3.5.	Manner of Payments		4

SECTION 4.	OWNERSHIP AND MARKING OF EQUIPMENT		5

Section 4.1.	Retention of Title		5
Section 4.2.	Duty to Number and Mark Equipment		5
Section 4.3.	Prohibition against Certain Designations		5

SECTION 5.	DISCLAIMER OF WARRANTIES; RIGHT OF QUIET ENJOYMENT		5

Section 5.1.	Disclaimer of Warranties		5
Section 5.2.	Quiet Enjoyment		6

SECTION 6.	RETURN OF EQUIPMENT; STORAGE		6

Section 6.1.	General		6
Section 6.2.	Condition of Equipment		7
Section 6.3.	Storage		7

SECTION 7.	LIENS		8

SECTION 8.	MAINTENANCE; OPERATION; SUBLEASE		8

Section 8.1.	Maintenance		8
Section 8.2.	Operation		9
Section 8.3.	Sublease		9

SECTION 9.	MODIFICATIONS		10

Section 9.1.	Required Modifications		10
Section 9.2.	Optional Modifications		10
Section 9.3.	Removal of Proprietary and Communications Equipment		11
Section 9.4.	Retention of Equipment by Lessor		11



Equipment Lease Agreement (KCSR 2005-1)


SECTION	HEADING	PAGE
SECTION 10.	VOLUNTARY TERMINATION		11

Section 10.1.	Right of Termination		11
Section 10.2.	Sale of Equipment		12
Section 10.3.	Retention of Equipment by Lessor		12
Section 10.4.	Termination of Lease		13

SECTION 11.	LOSS, DESTRUCTION, REQUISITION, ETC.		13

Section 11.1.	Event of Loss		13
Section 11.2.	Replacement or Payment upon Event of Loss		13
Section 11.3.	Rent Termination		15
Section 11.4.	Disposition of Equipment; Replacement of Unit		15
Section 11.5.	Eminent Domain		16

SECTION 12.	INSURANCE		16

Section 12.1.	Property Damage and Public Liability Insurance		16
Section 12.2.	Proceeds of Insurance		17
Section 12.3.	Additional Insurance		18

SECTION 13.	REPORTS; INSPECTION		18

Section 13.1.	Duty of Lessee to Furnish		18
Section 13.2.	Lessor’s Inspection Rights		18

SECTION 14.	EVENTS OF DEFAULT		19

SECTION 15.	REMEDIES		20

Section 15.1.	Remedies		20
Section 15.2.	Cumulative Remedies		23
Section 15.3.	No Waiver		23
Section 15.4.	Lessee’s Duty to Return Equipment Upon Default		23
Section 15.5.	Specific Performance; Lessor Appointed Lessee’s Agent		23

SECTION 16.	FILINGS; FURTHER ASSURANCES		24

Section 16.1.	Filings		24
Section 16.2.	Further Assurances		24
Section 16.3.	Expenses		24

SECTION 17.	LESSOR’S RIGHT TO PERFORM		24

SECTION 18.	ASSIGNMENT		25

Section 18.1.	Assignment by Lessor		25
Section 18.2.	Assignment by Lessee		25
Section 18.3.	Sublessee’s Performance and Rights		25



Equipment Lease Agreement (KCSR 2005-1)		- ii -


SECTION	HEADING	PAGE
SECTION 19.	NET LEASE, ETC.		25

SECTION 20.	NOTICES		26

SECTION 21.	CONCERNING INDENTURE TRUSTEE		27

Section 21.1.	Limitation of Indenture Trustee’s Liabilities		27
Section 21.2.	Right, Title and Interest of Indenture Trustee under Lease		28

SECTION 22.	TERMINATION UPON PURCHASE BY LESSEE; OPTIONS TO RENEW		28

Section 22.1.	Termination upon Purchase by Lessee		28
Section 22.2.	Renewal Option at Expiration of Basic Term		28
Section 22.3.	[Reserved]		28
Section 22.4.	Determination of Fair Market Rental Value		29
Section 22.5.	Stipulated Loss Value During Renewal Term		29

SECTION 23.	LESSEE’S OPTIONS TO PURCHASE EQUIPMENT; PURCHASE OF BENEFICIAL INTEREST		29

SECTION 24.	LIMITATION OF LESSOR’S LIABILITY		30

SECTION 25.	FILING IN MEXICO		31

SECTION 26.	MISCELLANEOUS		31

Section 26.1.	Governing Law; Severability		31
Section 26.2.	Execution in Counterparts		31
Section 26.3.	Headings and Table of Contents; Section References		31
Section 26.4.	Successors and Assigns		32
Section 26.5.	True Lease		32
Section 26.6.	Amendments and Waivers		32
Section 26.7.	Survival		32
Section 26.8.	Business Days		32
Section 26.9.	Directly or Indirectly		32
Section 26.10.	Incorporation by Reference		32
Section 26.11.	Entitlement to §1168 Benefits		32
Section 26.12.	Waiver of Jury Trial		33

ATTACHMENTS TO EQUIPMENT LEASE AGREEMENT:

Exhibit A – Form of Lease Supplement

Appendix A – Definitions



Equipment Lease Agreement (KCSR 2005-1)		- iii -

EQUIPMENT LEASE AGREEMENT
(KCSR 2005-1)

This EQUIPMENT LEASE AGREEMENT (KCSR 2005-1), dated as of December 20, 2005 (this “ Lease ”), between KCSR TRUST 2005-1, a Delaware statutory trust (“ Lessor ”), acting through WILMINGTON TRUST COMPANY, a Delaware banking corporation, not in its individual capacity except as expressly stated herein, but solely as trustee created under the Trust Agreement (as hereinafter defined) (in its individual capacity “ Trust Company ” and as Owner Trustee, together with its permitted successors and assigns, called the “ Owner Trustee ”), and THE KANSAS CITY SOUTHERN RAILWAY COMPANY, a Missouri corporation (“ Lessee ”),

W I T N E S S E T H:


SECTION 1.		DEFINITIONS.

Unless the context otherwise requires, all capitalized terms used herein without definition shall have the respective meanings set forth in Appendix A hereto for all purposes of this Lease.


SECTION 2.		ACCEPTANCE AND LEASING OF EQUIPMENT.

Lessor hereby agrees (subject to satisfaction or waiver of the conditions applicable to the Delivery Date set forth in Section 4.1 of the Participation Agreement), simultaneously with the delivery of each Unit of Equipment from Seller to Lessor, and acceptance thereof by Lessor, to accept on behalf of Lessor delivery of such Unit of Equipment from Seller, as evidenced by the execution and delivery by Lessee (as the authorized representative of Lessor) of a Certificate of Acceptance with respect to such Unit and thereafter to lease such Unit to Lessee hereunder. Lessee further agrees (subject to satisfaction or waiver of the conditions applicable to the Closing Date for such Unit set forth in Article IV of the Participation Agreement) to execute and deliver a Lease Supplement covering such Unit. Lessor hereby authorizes one or more employees or agents of Lessee, designated by Lessee, to act on behalf of Lessor as its authorized representative or representatives to accept delivery of the Equipment and to execute and deliver such Certificate of Acceptance, all in accordance with Section 2.3(b) of the Participation Agreement. Lessee hereby agrees that such acceptance of delivery by such authorized representative or representatives on behalf of Lessor shall, without further act, irrevocably constitute acceptance by Lessee of such Unit for all purposes of this Lease.


SECTION 3.		TERM AND RENT.

Section 3.1. Lease Term . The interim term of this Lease (the “ Interim Term ”) shall commence for each Unit on the Delivery Date for such Unit and shall terminate at 11:59 P.M. (New York City time) on the day before the Basic Term Commencement Date for such Unit. The basic term of this Lease (the “ Basic Term ”) for each Unit shall commence on the Closing Date for such Unit and, subject to earlier termination pursuant to Sections 10, 11, 15, and 22.1, shall expire at 11:59 P.M. (New York City time) on the Basic Term Expiration Date for such Unit. Subject and pursuant to Section 22.2, Lessee may elect one or more Renewal Terms with respect to any Unit.



Equipment Lease Agreement (KCSR 2005-1)

Section 3.2. Basic Rent . (a) Lessee and Lessor hereby agree that no Rent (other than Supplemental Rent, if any) shall be payable to Lessor during the Interim Term. Lessee hereby agrees to pay Lessor Basic Rent for each Unit throughout the Basic Term applicable thereto on the first Rent Payment Date and in consecutive semi-annual installments thereafter payable on each Rent Payment Date. Each such payment of Basic Rent shall be in an amount equal to the product of the Equipment Cost for such Unit multiplied by the Basic Rent percentage for such Unit set forth opposite such Rent Payment Date on Schedule 2 to the Lease Supplement for such Unit (as such Schedule 2 shall be adjusted pursuant to Section 2.6 of the Participation Agreement). Basic Rent shall be payable on the Rent Payment Dates as set forth in Schedule 2 to the Lease Supplement for such Unit. Basic Rent shall be allocated and accrued for use of the Units as specified in Schedule 5 to the Lease Supplement for such Unit (“ Allocated Rent ”). For the avoidance of doubt, and notwithstanding anything to the contrary herein, the parties agree that irrespective of Lessee’s payment obligation on each Rent Payment Date, Lessee’s liability on account of the use of each Unit shall be allocated to each Lease Period in the amount of Allocated Rent set forth in Schedule 5 to the Lease Supplement for such Unit. Basic Rent allocated to any Lease Period shall be further allocated ratably to each day within such Lease period. Basic Rent shall be allocated to each calendar year in the Lease Term based upon the assumption that each calendar year in the Lease Term is 360 days, consisting of four 90-day quarters and twelve 30-day months.

(b) It is the intention of Lessor and Lessee that: (i) for purposes of Section 467 of the Code the Allocated Rent derived by multiplying Equipment Cost by the percentage set forth for each Lease Period on Schedule 5 to the applicable Lease Supplement under the caption “Allocated Rent” constitutes a specific allocation of “fixed rent” within the meaning of Treasury Regulation section 1.467-1(c)(2)(ii) with the effect that each of Lessor and Lessee shall accrue rental income and rental expense, respectively, in the amount equal to Equipment Cost multiplied by the percentage as set forth for each Lease Period under the column with the heading “Allocated Rent” on Schedule 5 to the applicable Lease Supplement.

(c) Lessor and Lessee agree that a prepaid or deferred rent balance may exist at certain times during the Basic Term. It is the intention of Lessor and Lessee that any such prepaid or deferred rent balance shall (A) in the case of a prepaid rent balance, give rise to a loan from Lessee to Lessor in the amount of any positive loan balance (the “ Lessor Loan Balance ”) computed by multiplying the percentage set forth in Schedule 6 to the applicable Lease Supplement under the caption “Loan Balance” by the Equipment Cost, and in the case of a deferred rent balance, shall give rise to a loan from Lessor to Lessee in the amount of any negative loan balance (the “ Lessee Loan Balance ”) computed by multiplying the percentage set forth in Schedule 6 to the applicable Lease Supplement under the caption “Loan Balance” by the Equipment Cost and (B) such loan shall provide for “adequate stated interest” within the meaning of Treasury Regulation section 1.467-2(b)(ii). If there shall be an outstanding Lessor Loan Balance, Lessor shall deduct interest expense and Lessee shall include interest income, in each case, in an amount equal to the product of Equipment Cost multiplied by the percentage set forth under the caption “Interest Amount” for the applicable period identified on Schedule 6 to the applicable Lease Supplement. If there shall be an outstanding Lessee Loan Balance, Lessee shall deduct interest expense and Lessor shall include interest income, in each case, in an amount equal to the product of Equipment Cost multiplied by the percentage set forth under the caption



Equipment Lease Agreement (KCSR 2005-1)		- 2 -

“Interest Amount” for the applicable period identified on Schedule 6 to the applicable Lease Supplement.

(d) The obligations of Lessor to Lessee under this Section 3.2 (including Lessor’s obligation with respect to any loan from Lessee as represented by any Lessor Loan Balance) (i) are subject and subordinate to the obligations of Lessor under the Indenture and of Lessee to Lessor under any other Operative Agreement, (ii) are payable exclusively from amounts distributable under clause “second” of Section 3.01 of the Indenture or clause “fourth” of Section 3.03 of the Indenture, (iii) shall be suspended at any time a Specified Default or an Event of Default is continuing (unless all amounts payable to the Loan Participants under Section 3.03 of the Indenture shall have been satisfied in full and Lessee has paid Lessor all amounts due to Lessor and Owner Participant under the Operative Agreements), and (iv) shall not be enforceable by Lessee other than by written demand unless all amounts payable to the Loan Participants under Section 3.03 of the Indenture shall have been satisfied in full and Lessee has paid Lessor all amounts due to Lessor and Owner Participant under the Operative Agreements. Lessee acknowledges, consents and agrees to the subordination and other terms set forth in the previous sentence.

The EBO Fixed Purchase Price, each Stipulated Loss Value and each Termination Value, as of any Determination Date, reflects the subtraction of any Lessor Loan Balance and accrued interest thereon and the addition of any Lessee Loan Balance, accrued interest thereon and accrued Basic Rent; and the payment thereof, or any amount calculated by reference thereto, by Lessee as and when due hereunder in connection with a termination of this Lease with respect to any Unit pursuant to Section 10, 11, 15 or 22.1 shall effect a repayment, by offset, of the Lessor Loan Balance or a repayment of the Lessee Loan Balance, as the case may be.

(e) In the event that the amount of fixed rent payable under the Lease is deemed to be less than or more than the aggregate amount of Basic Rent identified on Schedule 2 to the applicable Lease Supplement (and such increase is deemed to be fixed rent within the meaning of Treasury Regulation section 1.467-1(h)(3) or such decrease is deemed to be a decrease of fixed rent within the meaning of Treasury Regulation section 1.467-1(h)(3)), the amount of Allocated Rent for each Lease Period shall be increased or decreased, as the case may be, by an amount equal to the deemed increase or decrease in Basic Rent payments multiplied by a fraction, the numerator of which is equal to the amount of Allocated Rent for such Lease Periods and the denominator of which is the aggregate amount of Allocated Rent for all Lease Periods. The adjusted Allocated Rent shall constitute Allocated Rent for all purposes of this Lease.

(f) Anything contained herein or in the Participation Agreement to the contrary notwithstanding, each installment of Basic Rent (both before and after any adjustment pursuant to Section 2.6 of the Participation Agreement) shall be, under any circumstances and in any event, in an amount at least sufficient for Lessor to pay in full as of the due date of such installment, any payment of principal of and interest on the Equipment Notes required to be paid by Lessor pursuant to the Indenture on such due date.

Section 3.3. Supplemental Rent . Lessee also agrees to pay to Lessor, or to whomsoever shall be entitled thereto, any and all Supplemental Rent, promptly as the same shall become due and owing, or where no due date is specified, promptly after demand by the Person entitled



Equipment Lease Agreement (KCSR 2005-1)		- 3 -

thereto, and in the event of any failure on the part of Lessee to pay any Supplemental Rent, Lessor shall have all rights, powers and remedies provided for herein or by law or equity or otherwise as in the case of nonpayment of Basic Rent. Without limiting the generality of the foregoing, Lessee will pay, as Supplemental Rent, (i) on demand, to the extent permitted by applicable law, an amount equal to interest at the applicable Late Rate on any part of any installment of Basic Rent not paid when due for any period for which the same shall be overdue and on any payment of Supplemental Rent not paid when due or demanded, as the case may be, for the period from such due date or demand until the same shall be paid, (ii) an amount equal to any Make-Whole Amount due under Section 2.10(c) of the Indenture to the extent not paid by Lessee, (iii) in the case of the termination of this Lease with respect to any Unit pursuant to Section 10, on the applicable Termination Date, an amount equal to the Make-Whole Amount, if any, with respect to the principal amount of each Equipment Note to be prepaid as a result of such termination, (iv) in the case of a termination of this Lease with respect to any Unit pursuant to Section 22.1, on the date such Unit is purchased, an amount equal to the Make-Whole Amount, if any, with respect to any Equipment Note to be prepaid on such date, (v) in the case of any refunding or refinancing pursuant to Section 11.2 of the Participation Agreement or any prepayment pursuant to Section 2.10(d) of the Indenture, on the date specified in the agreement referred to in Section 11.2(a) of the Participation Agreement or Section 2.10(d) of the Indenture, as applicable, an amount equal to the Make-Whole Amount, if any, with respect to the principal amount of each Equipment Note outstanding on the Refunding Date, and (vi) on demand, any payments required under the Tax Indemnity Agreement or Section 7 of the Participation Agreement and (vi) all amounts payable by Lessor under Section 7.02 of the Indenture. All Supplemental Rent to be paid pursuant to this Section 3.3 shall be payable in the type of funds and in the manner set forth in Section 3.5.

Section 3.4. Adjustment of Rent . Lessee and Lessor agree that the Basic Rent, Stipulated Loss Value and Termination Value percentages shall be adjusted to the extent provided in Section 2.6 of the Participation Agreement.

Section 3.5. Manner of Payments . All Rent (other than Supplemental Rent payable to Persons other than Lessor, which shall be payable to such other Persons in accordance with written instructions furnished to Lessee by such Persons, as otherwise provided in any of the Operative Agreements or as required by law) shall be paid by Lessee to Lessor at its office at Rodney Square North, 1100 North Market Street, Wilmington, DE 19890-0001, Attention: Corporate Trust Administration. All Rent shall be paid by Lessee in funds consisting of lawful currency of the United States of America, which shall be immediately available to the recipient not later than 12:00 noon (New York City time) on the date of such payment, provided that so long as the Indenture shall not have been discharged pursuant to the terms thereof, Lessor hereby directs, and Lessee agrees, that all Rent (excluding Excepted Property) payable to Lessor and assigned to Indenture Trustee shall be paid directly to Indenture Trustee at the times and in funds of the type specified in this Section 3.5 at the office of Indenture Trustee at 299 South Main Street, 12 ^th Floor, MAC: U1228-120, Salt Lake City, Utah 84111, Attention: Corporate Trust Department, or at such other location in the United States of America as Indenture Trustee may otherwise direct.



Equipment Lease Agreement (KCSR 2005-1)		- 4 -


SECTION 4.		OWNERSHIP AND MARKING OF EQUIPMENT.

Section 4.1. Retention of Title . Lessor shall and hereby does retain full legal title to and ownership of the Equipment notwithstanding the delivery of the Equipment to Lessee hereunder.

Section 4.2. Duty to Number and Mark Equipment . On or before each Closing Date, Lessee shall cause each Unit to be numbered with the reporting mark shown on the Lease Supplement for such Unit dated such Closing Date and, within 30 days of the applicable Closing Date and at all times thereafter, shall cause each Unit to be plainly, distinctly, permanently and conspicuously marked by a plate or stencil printed in contrasting colors upon each side of each Unit, in letters not less than one inch in height, a legend substantially as follows:

“SUBJECT TO A SECURITY AGREEMENT RECORDED
WITH THE SURFACE TRANSPORTATION BOARD”
or
“OWNERSHIP SUBJECT TO A SECURITY AGREEMENT FILED
WITH THE SURFACE TRANSPORTATION BOARD”

with appropriate changes thereof and additions thereto as from time to time may be required by law in order to protect Lessor’s right, title and interest in and to such Unit, its rights under this Lease and the rights of Indenture Trustee. Except as provided hereinabove, Lessee will not place any such Units in operation or exercise any control or dominion over the same until the required legend shall have been so marked on both sides thereof, and will replace promptly any such word or words in such legend which may be removed, defaced, obliterated or destroyed. Lessee will not change the reporting mark of any Unit except in accordance with a statement of new reporting marks to be substituted therefor, which statement shall be delivered to Lessor by Lessee and a supplement to this Lease and the Indenture with respect to such new reporting marks shall be filed or recorded by Lessee in all public offices where this Lease and the Indenture shall have been filed or recorded, in each case promptly after a Responsible Officer of Lessee obtains actual knowledge of such change.

Section 4.3. Prohibition against Certain Designations . Except as above provided, Lessee will not allow the name of any Person to be placed on any Unit as a designation that might reasonably be interpreted as a claim of ownership; provided , however , that subject to the delivery of the statement specified in the last sentence of Section 4.2, Lessee may cause the Equipment to be lettered with the names or initials or other insignia customarily used by Lessee or any permitted sublessees or any of their respective Affiliates on railroad equipment used by it of the same or a similar type.


SECTION 5.		DISCLAIMER OF WARRANTIES; RIGHT OF QUIET ENJOYMENT.

Section 5.1. Disclaimer of Warranties . Without waiving any claim Lessee may have against any seller, supplier or manufacturer, LESSEE ACKNOWLEDGES AND AGREES THAT, (i) EACH UNIT IS OF A SIZE, DESIGN, CAPACITY AND MANUFACTURE SELECTED BY AND ACCEPTABLE TO LESSEE, (ii) LESSEE IS SATISFIED THAT EACH UNIT IS SUITABLE FOR ITS PURPOSES, (iii) NEITHER LESSOR NOR OWNER



Equipment Lease Agreement (KCSR 2005-1)		- 5 -

PARTICIPANT IS A MANUFACTURER OR A DEALER IN PROPERTY OF SUCH KIND, (iv) EACH UNIT IS LEASED HEREUNDER SUBJECT TO ALL APPLICABLE LAWS AND GOVERNMENTAL REGULATIONS NOW IN EFFECT OR HEREINAFTER ADOPTED, AND (v) LESSOR LEASES AND LESSEE TAKES EACH UNIT “AS-IS”, “WHERE-IS” AND “WITH ALL FAULTS”, AND LESSEE ACKNOWLEDGES THAT NEITHER LESSOR, AS LESSOR OR IN ITS INDIVIDUAL CAPACITY, NOR OWNER PARTICIPANT MAKES NOR SHALL BE DEEMED TO HAVE MADE, AND EACH EXPRESSLY DISCLAIMS, ANY AND ALL RIGHTS, CLAIMS, WARRANTIES OR REPRESENTATIONS EITHER EXPRESS OR IMPLIED, AS TO THE VALUE, CONDITION, FITNESS FOR ANY PARTICULAR PURPOSE, DESIGN, OPERATION, MERCHANTABILITY THEREOF OR AS TO THE TITLE OF THE EQUIPMENT, THE QUALITY OF THE MATERIAL OR WORKMANSHIP THEREOF OR CONFORMITY THEREOF TO SPECIFICATIONS, FREEDOM FROM PATENT, COPYRIGHT OR TRADEMARK INFRINGEMENT, THE ABSENCE OF ANY LATENT OR OTHER DEFECT, WHETHER OR NOT DISCOVERABLE, OR AS TO THE ABSENCE OF ANY OBLIGATIONS BASED ON STRICT LIABILITY IN TORT OR ANY OTHER EXPRESS OR IMPLIED REPRESENTATION OR WARRANTY WHATSOEVER WITH RESPECT THERETO, except that Lessor, in its individual capacity, represents and warrants that on the Delivery Date, Lessor shall have received whatever title to the Equipment delivered on or prior to the Delivery Date as was conveyed to Lessor by Seller and each Unit will be free of Lessor’s Liens attributable to Lessor in its individual capacity. During the Lease Term so long as no Event of Default shall have occurred and be continuing, Lessor hereby appoints and constitutes Lessee its agent and attorney-in-fact during the Lease Term to assert and enforce, from time to time, in the name and for the account of Lessor and Lessee, as their interests may appear, but in all cases at the sole cost and expense of Lessee, whatever claims and rights Lessor may have as owner of the Equipment against the manufacturers or any prior owner thereof.

Section 5.2. Quiet Enjoyment . Each party to this Agreement acknowledges notice of, and consents in all respects to, the terms of this Lease, and expressly, severally and as to its own actions only, agrees that, notwithstanding any other provision of any of the Operative Agreements, so long as no Lease Event of Default has occurred and is continuing, it shall not take or cause to be taken any action inconsistent with Lessee’s rights under this Lease or otherwise through its own actions in any way interfere with or interrupt the quiet enjoyment of the use, operation and possession of any Unit by Lessee.


SECTION 6.		RETURN OF EQUIPMENT; STORAGE.

Section 6.1. General. (a) On the expiration of the Lease Term with respect to any Unit which has not been purchased by Lessee, Lessee will, at its own cost and expense, deliver possession of such Unit to Lessor at not more than three interchange points on the tracks of Lessee in the U.S., f.o.b. such interchange point, as Lessor may reasonably designate to Lessee in writing at least 90 days before the end of the Lease Term or, in the absence of such designation, as Lessee may select or, if Lessor has requested storage pursuant to Section 6.3, to the location determined in accordance with Section 6.3. Upon expiration of the Lease Term with respect to such Unit, compliance with the terms hereof and tender of such Unit at the location determined in accordance with this Section 6.1(a), this Lease and the obligation to pay Basic Rent and all other Rent for such Unit accruing subsequent to such expiration (except for Supplemental Rent



Equipment Lease Agreement (KCSR 2005-1)		- 6 -

obligations with respect to such Unit surviving pursuant to the Participation Agreement or the Tax Indemnity Agreement or which have otherwise accrued but not been paid as of the date of the expiration of the Lease Term) shall terminate.

(b) In the event any Unit is not returned as hereinabove provided at the expiration of the Lease Term with respect to such Unit, Lessee may retain custody and control of such Unit so long as Lessee is attempting to remedy any condition delaying such return, and in any case the covenants of Lessee (other than with respect to Basic Rent) under this Lease (including those pertaining to indemnities, Liens, maintenance and insurance) shall continue with respect to such Unit until such return of such Unit and, regardless of whether such delay shall be attributable to Lessee or any permitted sublessee, Lessee shall pay holdover rent to Lessor for the first 30 days in an amount equal to the daily equivalent of rent during the preceding term, and thereafter in an amount equal to 120% of the daily equivalent of the greater of (i) the arithmetic average of the Basic Rent during the Basic Term for such Unit (or, if the failure to return occurs after a Renewal Term, the arithmetic average of the Basic Rent paid during the Renewal Term for such Unit) and (ii) the Fair Market Rental Value for such Unit. The provision for payment pursuant to the immediately preceding sentence shall not be in abrogation of Lessor’s right under Section 6.1 (a) to have such Unit returned to it hereunder.

Section 6.2. Condition of Equipment . Each Unit when returned to Lessor pursuant to Section 6.1(a) shall (i) be capable of performing the functions for which it was designed, at its originally rated horsepower without material degradation, with all mechanical and electrical components in good working order, (ii) have no broken glass or material corrosion, (iii) have installed all required operational software (with paid-in-full site licenses) necessary for the operation of the Unit in compliance with the return provisions of this Lease, (iv) otherwise be in the condition required by Sections 8.1 and 9.3 and (v) be free and clear of all Liens except Lessor’s Liens and Permitted Liens, provided that Lessee agrees to promptly discharge any such Permitted Lien upon return of the Unit and Lessor’s sole remedy for any breach of this clause (v) being damages at law or specific performance at equity. In addition, Lessee shall return with each Unit all maintenance and overhaul records for such Unit. Except as expressly provided in this Section 6.2, there will be no further requirements imposed upon Lessee with respect to the condition of any Unit upon its return in accordance with the provisions of Section 6.1 hereof and this Section 6.2.

Section 6.3. Storage . Upon the expiration of the Lease Term with respect to each Unit, upon written request of Lessor received at least 60 days prior to the end of the Lease Term with respect to such Unit, Lessee shall permit Lessor to store each such Unit, free of charge, except as provided below, at such location on the tracks of Lessee used by Lessee for the storage of surplus rolling stock or locomotives or rolling stock or locomotives available for sale as shall be reasonably designated by Lessor (taking into account, among other things, Lessee’s storage capacity, security and access) in its request for storage pursuant to this Section 6.3 for a period (the “ Storage Period ”) beginning on the expiration of the Lease Term and ending not more than 60 days after the later of the expiration of the Lease Term or the date on which 50% of all Units to be returned at the expiration of the Lease Term have been returned; provided that, with respect to any Unit returned after the expiration of the Lease Term for such Unit, the Storage Period for such Unit shall begin on the date of return of such Unit and end not more than 60 days thereafter. Any storage facilities provided by Lessee pursuant to this Section 6.3 shall, in all cases, be at the



Equipment Lease Agreement (KCSR 2005-1)		- 7 -

cost to Lessor of insurance and Lessee’s out-of-pocket costs in connection with providing any services not contemplated hereby to be provided during the Storage Period and at the risk of Lessor, including but not limited to any deterioration of any Unit caused by moisture or any weather-related cost to the extent such cost arises during such period of storage and not as a result of Lessee’s violation of its obligations under this Lease (except, with respect to any injury to, or death of, any person exercising, either on behalf of Lessor or any prospective purchaser or user, the inspection rights granted pursuant to this Section 6.3, Lessee’s gross negligence or willful misconduct). With respect to the Units stored pursuant hereto, Lessee will carry and maintain with respect to stored Units, during the Storage Period, under Lessee’s insurance policies, property damage insurance and public liability insurance with respect to third party personal and property damage as Lessee then maintains in respect of equipment owned or leased by it similar in type to the Equipment; provided that (i) Lessor pays all incremental costs associated with such insurance coverage, (ii) such insurance coverage does not negatively impact upon Lessee’s loss insurance rating and (iii) any coverage provided is above Lessee’s deductibles or self-insurance retention amounts. On not more than one occasion with respect to each stored Unit and upon not less than 15 days’ prior written notice from Lessor to Lessee (which notice shall specify the transportation of no less than all of the Units), Lessee will, during the Storage Period, transport such Units, at Lessee’s cost and expense, to a destination or interchange point, f.o.b., such destination or interchange point, on Lessee’s lines specified by Lessor, whereupon Lessee shall have no further liability or obligation with respect to such Units. During the Storage Period, Lessee will permit Lessor or any person designated by it, including the authorized representative or representatives of any prospective purchaser or user of such Unit, to inspect the same; provided , however , that such inspection shall not interfere with the normal conduct of Lessee’s business and such person shall be insured to the reasonable satisfaction of Lessee with respect to any risks incurred in connection with any such inspections and Lessee (except in the case of Lessee’s gross negligence or willful misconduct) shall not be liable for any injury to, or the death of, any person exercising, either on behalf of Lessor or any prospective purchaser or user, the rights of inspection granted pursuant hereto. Lessee shall not be required to store the Equipment after the Storage Period. If Lessee stores any Unit after the Storage Period, such storage shall be at the sole expense and risk of Lessor.


SECTION 7.		LIENS.

Lessee will not directly or indirectly create, incur, assume or suffer to exist any Lien on or with respect to any Units or Lessee’s leasehold interest therein under this Lease or on the Trust Estate, except Permitted Liens, and Lessee shall promptly, at its own expense, take such action as may be necessary to duly discharge (by bonding or otherwise) any such Lien not excepted above if the same shall arise at any time.


SECTION 8.		MAINTENANCE; OPERATION; SUBLEASE.

Section 8.1. Maintenance . Lessee, at its own cost and expense, shall service, maintain, repair and keep each Unit (i) in good repair and operating condition, ordinary wear and tear excepted, (ii) in accordance with (a) prudent Class I railroad industry maintenance practices in existence from time to time and (b) manufacturer’s recommendations to the extent required to maintain such manufacturer’s warranties in effect with respect to such Unit, (iii) in a manner consistent with service, maintenance, overhaul and repair practices used by Lessee in respect of



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equipment owned or leased by Lessee similar in type to such Unit and without discrimination between owned and leased Units, (iv) in compliance, in all material respects, with all applicable laws and regulations, including any applicable United States EPA Regulations and any applicable AAR Mechanical Standards and Federal Railroad Administration regulations as applicable to continued use by Lessee; provided , however , that Lessee may, in good faith and by appropriate proceedings diligently conducted, contest the validity or application of any such law, regulation, requirement or rule in any reasonable manner which does not materially adversely affect the rights or interests of Lessor and Indenture Trustee in the Equipment or hereunder or otherwise expose Lessor, Indenture Trustee or any Participant to criminal sanctions or release Lessee from the obligation to return the Equipment in compliance with the provisions of Section 6.2.

Section 8.2. Operation . Lessee shall be entitled to the possession of the Equipment and to the use of the Equipment by it or any Affiliate in the general operation of Lessee’s or any such Affiliate’s freight rail business upon lines of railroad owned or operated by it or any such Affiliate, upon lines of railroad over which Lessee or any such Affiliate has trackage or other operating rights or over which railroad equipment of Lessee or any such Affiliate is regularly operated pursuant to contract and on railroad lines of other railroads (including in connection with barge-related rail transportation) in the United States, Canada and Mexico, in the usual interchange of traffic or in through or run-through service and shall be entitled to permit the use of the Equipment upon lines of railroad of connecting and other carriers in the usual interchange of traffic or pursuant to through or run-through agreements; provided Lessee shall use the Equipment only for the purpose and in the manner for which it was designed and intended and in compliance, in all material respects, with all laws, regulations and guidelines of any governmental body, the Association of American Railroads, the Federal Railroad Administration and the Surface Transportation Board and their successors and assigns. Nothing in this Section 8.2 shall be deemed to constitute permission by Lessor to any Person that acquires possession of any Unit to take any action inconsistent with the terms and provisions of this Lease and any of the other Operative Agreements. The rights of any person that acquires possession of any Unit pursuant to this Section 8.2 shall be subject and subordinate to the rights of Lessor hereunder.

Section 8.3. Sublease . So long as no Specified Default or Event of Default shall have occurred and be continuing, Lessee shall have the right, without the prior written consent of Lessor, to sublease any Unit to or permit its use by a user incorporated under the federal laws or the laws of any state of the United States, organized under the federal laws or the laws of any province of Canada or organized under the federal laws or the laws of any state of Mexico, for use by such sublessee upon lines of railroad owned or operated by Lessee, any Affiliate of Lessee, such sublessee or by a railroad company or companies incorporated under the federal laws or laws of any state of the United States, organized under the federal laws or the laws of any province in Canada or organized under the federal laws or the laws of any state of Mexico, over which Lessee, such Affiliate of Lessee, such sublessee or such railroad company or companies has trackage or other operating rights, and upon lines of railroad of connecting and other carriers in the usual interchange of traffic or pursuant to through or run-through service agreements; provided such sublessee shall not, at the time of such sublease, be insolvent or subject to insolvency or bankruptcy proceedings. Each sublease shall be subject and subordinate to this Lease (including the duration of the sublease term, which term may not expire after the expiration of the Basic Term or any Renewal Term then in effect) and no such sublease shall



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contain a purchase option. Lessee shall give Lessor and Indenture Trustee reasonably contemporaneous notice upon entering into a sublease for a period in excess of one year. Each such sublease shall be entered into on the expectation that no Unit shall operate outside of the U.S. for more than 90 days in any calendar year. No sublease shall in any way discharge or diminish any of Lessee’s obligations hereunder, and Lessee shall remain primarily liable hereunder for the performance of all the terms, conditions and provisions of this Lease and the other Lessee Agreements to the same extent as if such sublease had not been entered into. Nothing in this Section 8.3 shall be deemed to constitute permission to any Person in possession of any Unit pursuant to any such sublease to take any action inconsistent with the terms and provisions of this Lease or any of the other Operative Agreements.


SECTION 9.		MODIFICATIONS.

Section 9.1. Required Modifications . In the event the Association of American Railroads, the United States Department of Transportation, or any other United States, Canadian or Mexican federal, state or local governmental authority having jurisdiction over the operation, safety or use of any Unit requires that such Unit be altered, replaced or modified (a “ Required Modification ”), Lessee agrees to make such Required Modification at its own expense; provided , however , that Lessee may, in good faith and by appropriate proceedings diligently conducted, contest the validity or application of any such law, regulation, requirement or rule in any reasonable manner which does not materially adversely affect the rights or interests of Lessor and Indenture Trustee in the Equipment or hereunder or otherwise expose Lessor, Indenture Trustee or any Participant to criminal sanctions or relieve Lessee of the obligation to return the Equipment in compliance with the provisions of Section 6.2. Title to any Required Modification shall immediately vest in Lessor. Notwithstanding anything herein to the contrary, if Lessee determines in good faith that any Required Modification to a Unit would be economically impractical, it shall provide written notice of such determination to Lessor and the parties hereto shall treat such Unit as if an Event of Loss had occurred as of the date of such written notice with respect to such Unit and the provisions of Sections 11.2, 11.3 and 11.4 with respect to rent, termination and disposition shall apply with respect to such Unit unless Lessor, within 15 Business Days of such notice, elects to retain such Unit pursuant to Section 9.4.

Section 9.2. Optional Modifications . Lessee at any time may modify, alter or improve any Unit (a “ Modification ”); provided that no Modification shall diminish in more than a de minimis respect the current fair market value, estimated residual value, utility, or remaining useful life of such Unit below the current fair market value, estimated residual value, utility, or remaining useful life thereof immediately prior to such Modification, assuming such Unit was then in the condition required to be maintained by the terms of this Lease. Title to any Non-Severable Modifications shall be immediately vested in Lessor. Title to any Severable Modifications shall remain with Lessee. If Lessee shall at its cost cause such Severable Modifications to be made to any Unit and such Severable Modifications are reasonably necessary for the economic operation of any such Unit, Lessor shall have the right, prior to the return of such Unit to Lessor hereunder, to purchase such Severable Modifications (other than Severable Modifications consisting of proprietary or communications equipment) at their then Fair Market Sales Value (taking into account their actual condition). If Lessor does not elect to purchase such Severable Modifications, Lessee may remove, and shall remove if requested by Lessor, such Severable Modifications at Lessee’s cost and expense.



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Section 9.3. Removal of Proprietary and Communications Equipment. Notwithstanding anything to the contrary contained herein, Lessee shall at all times own and be entitled to remove at Lessee’s cost and expense, any Severable Modification consisting of proprietary or communications equipment from any Unit prior to the return of such Unit; provided that if Lessee removes such Severable Modification that is (i) a Required Modification and (ii) such equipment is not customarily provided by the user, Lessee shall replace such proprietary or communications equipment with non-proprietary equipment of comparable utility.

Section 9.4. Retention of Equipment by Lessor . Notwithstanding the provisions of the last sentence of Section 9.1, Lessor may irrevocably elect by written notice to Lessee, no later than 15 Business Days after receipt of Lessee’s notice of determination of economic impracticality pursuant to Section 9.1, not to declare an Event of Loss as provided in Section 9.1, whereupon Lessee shall not be liable for the Stipulated Loss Value for the affected Units but shall (i) deliver the affected Units to Lessor in the same manner and in the same condition as if delivery were made pursuant to Section 6 (except that Lessee shall not be required to correct the conditions which gave rise to the notice of economic impracticality), treating the applicable date for payment specified in Section 11.2(ii) as the termination date of the Lease Term with respect to the affected Units, and (ii) pay to Lessor, or to the Persons entitled thereto, all Basic Rent and Supplemental Rent due and owing on such termination date and unpaid, but without any Make-Whole Amount in respect of the principal amount of the Equipment Notes to be prepaid in accordance with Section 2.10(b) of the Indenture. If Lessor elects to retain the affected Units as provided in this Section 9.4, then Lessor shall pay, or cause to be paid, to Indenture Trustee in funds of the type and in an amount equal to the outstanding principal amount of the Equipment Notes issued in respect of such affected Units and all accrued interest to the date of prepayment of such Equipment Note on such termination date but without any Make-Whole Amount. If Lessor shall fail to perform any of its obligations pursuant to this Section 9.4 on the scheduled termination date for any affected Unit, the parties hereto shall treat such Unit as if an Event of Loss had occurred as of the date of Lessee’s written notice with respect to such Unit pursuant to Section 9.1 and the provisions of Sections 11.2, 11.3 and 11.4 with respect to rent, termination and disposition shall apply with respect to such Unit and Lessor shall thereafter no longer be entitled to exercise its election to retain such affected Units.


SECTION 10.		VOLUNTARY TERMINATION.

Section 10.1. Right of Termination . So long as no Specified Default or Event of Default shall have occurred and be continuing, Lessee shall have the right, at its option at any time or from time to time on or after the fifth anniversary of the applicable Closing Date, to terminate this Lease with respect to, at the sole discretion of Lessee, either all or a Minimum Number of Units of Equipment (the “ Terminated Units ”), if Lessee determines in good faith (as evidenced by a certificate executed by the Chief Financial Officer of Lessee), that such Units have become obsolete or surplus to Lessee’s requirements, by delivering at least 90 days’ prior notice to Lessor and Indenture Trustee specifying a proposed date of termination for such Units (the “ Termination Date ”), which date shall be a Determination Date, any such termination to be effective on the Termination Date. Except as expressly provided herein, there will be no conditions to Lessee’s right to terminate this Lease with respect to the Terminated Units pursuant to this Section 10.1. So long as Lessor shall not have given Lessee a notice of election to retain the Terminated Units in accordance with Section 10.3, Lessee may withdraw the termination



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notice referred to above not later than 30 days prior to the Termination Date, whereupon this Lease shall continue in full force and effect; provided that Lessee shall pay all reasonable costs of Lessor, Indenture Trustee, Loan Participants and Owner Participant incurred in connection with any proposed or withdrawn termination; and provided further that Lessee may not withdraw a termination notice hereunder more than twice.

Section 10.2. Sale of Equipment . During the period from the date of such notice given pursuant to Section 10.1 to the Termination Date, Lessee, as exclusive agent for Lessor and at Lessee’s sole cost and expense, shall use reasonable efforts to obtain bids from Persons other than Lessee or Affiliates thereof for the cash purchase of the Terminated Units, and Lessee shall promptly, and in any event at least five Business Days prior to the proposed date of sale, certify to Lessor in writing the amount and terms of each such bid, the proposed date of such sale and the name and address of the party submitting such bid. Unless Lessor shall have elected to retain the Terminated Units in accordance with Section 10.3, on the Termination Date: (i) Lessee shall, subject to receipt (x) by Lessor of all amounts owing to Lessor pursuant to the next sentence, and (y) by the persons entitled thereto of all unpaid Supplemental Rent due on or before the Termination Date, deliver the Terminated Units to the bidder, if any, which shall have submitted the highest all cash bid prior to such date (or to such other bidder as Lessee and Lessor shall agree), in the same manner and condition as if delivery were made to Lessor pursuant to Section 6 and (ii) Lessor shall, without recourse or warranty (except as to the absence of any Lessor’s Lien) simultaneously therewith sell the Terminated Units to such bidder. The total selling price realized at such sale shall be paid to Lessor for distribution pursuant to Section 3.02 of the Indenture and, in addition and anything to the contrary notwithstanding, on the Termination Date, Lessee shall pay to Lessor, or to the Persons entitled thereto, (A) all unpaid Basic Rent with respect to such Terminated Units due and payable prior to the Termination Date, (B) the excess, if any, of (1) the Termination Value for the Terminated Units computed as of the Termination Date, over (2) the net cash sales proceeds (after deduction of applicable transaction expenses and sales or transfer taxes, if any, due or to become due as a consequence of such sale) of the Terminated Units, (C) an amount equal to the Make-Whole Amount, if any, in respect of the principal amount of the Equipment Notes to be prepaid in accordance with Section 2.10(a) of the Indenture and (D) any other Supplemental Rent due and payable as of such Termination Date. If no sale shall have occurred, this Lease shall continue in full force and effect with respect to such Units; provided that if such sale shall not have occurred solely because of Lessee’s failure to pay the amounts required to be paid pursuant to the immediately preceding sentence, Lessee shall have no further right to terminate this Lease with respect to such Units, and such failure to pay such amounts shall be deemed a withdrawal of the termination notice referred to in Section 10.1. On the Termination Date, upon receipt by Lessor of the amounts owing to Lessor pursuant to the third sentence of this Section 10.2, Lessor shall pay, or cause to be paid, to Indenture Trustee in immediately available funds an amount equal to the outstanding principal amount of the Equipment Notes issued in respect of such Terminated Units, all accrued interest to the date of prepayment of such Equipment Notes and the Make-Whole Amount, if any, in respect of such Equipment Notes on such Termination Date.

Section 10.3. Retention of Equipment by Lessor . Notwithstanding the provisions of Sections 10.1 and 10.2, Lessor may irrevocably elect by written notice to Lessee, no later than 30 days after receipt of Lessee’s notice of termination, not to sell the Terminated Units on the Termination Date, whereupon Lessee shall (i) deliver the Terminated Units to Lessor in the same



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manner and condition as if delivery were made to Lessor pursuant to Section 6, treating the Termination Date as the termination date of the Lease Term with respect to the Terminated Units, and (ii) pay to Lessor, or to the Persons entitled thereto, all Basic Rent and Supplemental Rent due and owing on the Termination Date and unpaid including an amount equal to any Make-Whole Amount in respect of the principal amount of the Equipment Notes to be prepaid in accordance with Section 2.10(a) of the Indenture. If Lessor elects not to sell the Terminated Units as provided in this Section 10.3, then Lessor shall pay, or cause to be paid, to Indenture Trustee in immediately available funds an amount equal to the outstanding principal amount of the Equipment Notes issued in respect of such Terminated Units and all accrued interest to the date of prepayment of such Equipment Note on such Termination Date. If Lessor shall fail to perform any of its obligations pursuant to this Section 10.3 and as a result thereof this Lease shall not be terminated with respect to the Terminated Units on a proposed Termination Date, Lessor shall thereafter no longer be entitled to exercise its election to retain such Terminated Units and Lessee may at its option at any time thereafter submit a new termination notice pursuant to Section 10.1 with respect to such Terminated Units specifying a proposed Termination Date occurring not earlier than five days from the date of such notice.

Section 10.4. Termination of Lease . In the event of any such sale and receipt by Lessor and Indenture Trustee of all of the amounts provided herein, and upon compliance by Lessee with the other provisions of this Section 10, the Lease Term for the Terminated Units shall end and the obligation to pay Basic Rent and all other Rent for such Terminated Units (except for Supplemental Rent obligations with respect to such Terminated Units surviving pursuant to the Participation Agreement or the Tax Indemnity Agreement or which have otherwise accrued but not been paid as of the date of the expiration of the Lease Term) shall terminate.


SECTION 11.		LOSS, DESTRUCTION, REQUISITION, ETC.

Section 11.1. Event of Loss . In the event that any Unit (i) shall suffer destruction, damage, contamination or wear which, in Lessee’s good faith opinion, makes repair uneconomic or renders such Unit unfit for commercial use, (ii) shall suffer theft or disappearance, (iii) shall be permanently returned to the manufacturer pursuant to any warranty or patent indemnity provisions, (iv) shall have title thereto taken or appropriated by any governmental authority under the power of eminent domain or otherwise, (v) shall be taken or requisitioned for use by any governmental authority (other than the United States government or any agency or instrumentality thereof) under the power of eminent domain or otherwise and such taking or requisition is continuing in excess of 180 days or, if earlier, on the last day of the Basic Term or any Renewal Term then in effect, or (vi) shall be taken or requisitioned for use by the United States government or any agency or instrumentality thereof and such taking or requisition is continuing on the last day of the Basic Term or any Renewal Term then in effect (any such occurrence being hereinafter called an “ Event of Loss ”), Lessee, in accordance with the terms of Section 11.2, shall promptly and fully inform Lessor and Indenture Trustee of such Event of Loss.

Section 11.2. Replacement or Payment upon Event of Loss . Upon the occurrence of an Event of Loss or the deemed occurrence of an Event of Loss pursuant to Section 9.1 with respect to any Unit, Lessee shall within 60 days after a Responsible Officer of Lessee shall have actual knowledge of such occurrence or deemed occurrence give Lessor and Indenture Trustee notice of



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such occurrence or deemed occurrence of such Event of Loss and of its election to perform one of the following options (it being agreed that if Lessee shall not have given notice of such election within such 60 days after notice of such occurrence or deemed occurrence, Lessee shall be deemed to have elected to perform the option set forth in the following paragraph (ii)):

(i) So long as no Specified Default or Event of Default shall have occurred and be continuing, as promptly as practicable, and in any event on or before the Business Day next preceding the 91st day next following the date of such notice, Lessee shall comply with Section 11.4(b) and shall convey or cause to be conveyed to Lessor a Replacement Unit to be leased to Lessee hereunder, such Replacement Unit to be free and clear of all Liens (other than Permitted Liens) and to have a current fair market value, estimated residual value, utility, and remaining useful life at least equal to the Unit so replaced (assuming such Unit was in the condition required to be maintained by the terms of this Lease); provided that, if Lessee shall not perform its obligation to effect such replacement under this paragraph (i) during the period of time provided herein, then Lessee shall pay on the next succeeding Determination Date that is at least 30 days after the end of such period to Lessor, or in the case of Supplemental Rent, to the Person entitled thereto, the amounts specified in paragraph (ii) below; or

(ii) on or before the next succeeding Determination Date that is at least 30 days after the date of notice of such Event of Loss or deemed Event of Loss or on the date specified in the proviso to paragraph (i) above, Lessee shall pay or cause to be paid on the applicable Determination Date to Lessor or, in the case of Supplemental Rent, to the Persons entitled thereto, in funds of the type specified in Section 3.5, (A) an amount equal to the Stipulated Loss Value of each such Unit determined as of such Determination Date, (B) all unpaid Basic Rent with respect to each such Unit due prior to such Determination Date, and (C) without duplication, all Supplemental Rent due and payable as of such Determination Date, it being understood that until such Stipulated Loss Value is paid, there shall be no abatement or reduction of Basic Rent; provided , at such time that the aggregate number of Units that have suffered an Event of Loss exceeds 15, Lessee shall pay with respect to each additional Unit that suffers an Event of Loss, in addition to the amounts required to be paid under this paragraph (ii), a Make-Whole Amount with respect to the prepayment of the Equipment Notes on account of such Event of Loss.



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Section 11.3. Rent Termination . Upon the payment of all sums required to be paid pursuant to Section 11.2(ii) hereof in respect of any Unit or Units for which Lessee has elected to pay or deemed to have elected to pay pursuant to the proviso to Section 11.2(i) the amounts specified in paragraph 11.2(ii), the Lease Term with respect to such Unit or Units and the obligation to pay Rent for such Unit or Units (except for Supplemental Rent obligations with respect to such Unit or Units surviving pursuant to the Participation Agreement or the Tax Indemnity Agreement or which have otherwise accrued but not been paid as of the date of the expiration of the Lease Term) shall terminate; provided that Lessee shall be obligated to pay all Rent in respect of such Unit or Units which has accrued up to and including the date of payment of Stipulated Loss Value pursuant to Section 11.2.

Section 11.4. Disposition of Equipment; Replacement of Unit . (a) Upon the payment of all sums required to be paid pursuant to Section 11.2 in respect of any Unit or Units, Lessor will convey to Lessee or its designee all right, title and interest of Lessor in and to such Unit or Units, “as is”, “where is”, without recourse or warranty, except for a warranty against Lessor’s Liens, and shall execute and deliver to Lessee or its designee such bills of sale and other documents and instruments as Lessee or its designee may reasonably request to evidence such conveyance. As to each separate Unit so disposed of, Lessee or its designee shall be entitled to any amounts arising from such disposition, plus any awards, insurance (other than insurance maintained by Lessor or Owner Participant for its own account in accordance with Section 12.3) or other proceeds and damages (including any Association of American Railroads interline settlement paid upon an Event of Loss) received by Lessee, Lessor or Indenture Trustee by reason of such Event of Loss after having paid the Stipulated Loss Value attributable thereto.

(b) At the time of or prior to any replacement of any Unit, Lessee, at its own expense, will (A) furnish Lessor with a full warranty bill of sale and an assignment of warranties with respect to the Replacement Unit, (B) cause a Lease Supplement substantially in the form of Exhibit A hereto, subjecting such Replacement Unit to this Lease, duly executed by Lessee, to be delivered to Lessor for execution and, upon such execution, to be filed for recordation in the same manner as provided for the original Lease Supplement in Section 16.1, (C) so long as the Indenture shall not have been satisfied and discharged, cause an Indenture Supplement substantially in the form of Exhibit A to the Indenture for such Replacement Unit, to be delivered to Lessor and to Indenture Trustee for execution and, upon such execution, to be filed for recordation in the same manner as provided for the original Indenture Supplement in Section 16.1, (D) furnish Lessor with an opinion of Lessee’s counsel (which may be Lessee’s General Counsel), to the effect that (w) Lessor (and Indenture Trustee, as assignee of Lessor) shall be entitled to the benefits of Section 1168 of the Bankruptcy Code in respect of such Replacement Unit to the same extent that Lessor (and Indenture Trustee, as assignee of Lessor) was entitled to such benefits in respect of the Unit being replaced, (x) the bill of sale referred to in clause (A) above constitutes an effective instrument for the conveyance of title to the Replacement Unit to Lessor, (y) good and marketable title to the Replacement Unit has been delivered to Lessor, free and clear of all Liens (other than Permitted Liens), and (z) all filings, recordings and other action necessary or appropriate to perfect and protect Lessor’s and Indenture Trustee’s respective interests in the Replacement Unit have been accomplished, and (E) furnish Lessor with a certificate of a qualified engineer (who may be the system chief mechanical officer of Lessee) certifying that the Replacement Unit has a fair market value, utility and remaining useful life at least equal to the Unit so replaced (assuming such Unit was in the



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condition required to be maintained by the terms of this Lease). For all purposes hereof, upon passage of title thereto to Lessor, the Replacement Unit shall be deemed part of the property leased hereunder and the Replacement Unit shall be deemed a “ Unit ” of Equipment as defined herein. Upon such passage of title, Lessor will transfer to Lessee, without recourse or warranty (except as to Lessor’s Liens), all Lessor’s right, title and interest in and to the replaced Unit, and upon such transfer, Lessor will request in writing that Indenture Trustee execute and deliver to Lessee an appropriate instrument releasing such replaced Unit from the lien of the Indenture.

Section 11.5. Eminent Domain . In the event that during the Lease Term the use of any Unit is requisitioned or taken by any governmental authority under the power of eminent domain or otherwise for a period which does not constitute an Event of Loss, Lessee’s obligation to pay all installments of Basic Rent shall continue for the duration of such requisitioning or taking. Lessee shall be entitled to receive and retain for its own account all sums payable for any such period by such governmental authority as compensation for requisition or taking of possession. Any amount referred to in this Section 11.5 which is payable to Lessee shall not be paid to Lessee, or if it has been previously paid directly to Lessee, shall not be retained by Lessee, if at the time of such payment a Specified Default or an Event of Default shall have occurred and be continuing, but shall be paid to and held by Lessor as security for the obligations of Lessee under this Lease.


SECTION 12.		INSURANCE.

Section 12.1. Property Damage and Public Liability Insurance .

(a) Coverages . Lessee will, at all times prior to the return of the Units to Lessor, at its own expense, cause to be carried and maintained all risk property insurance in respect of the Units in an amount not less that the Stipulated Loss Value for such Units and public liability insurance against loss or damage for personal injury, death or property damage suffered upon, in or about any premises occupied by Lessee or occurring as a result of the use, maintenance or operation of the Units in an amount not less than $200,000,000, and otherwise against such risks, with such insurance companies and with such terms (including co-insurance, deductibles, limits of liability and loss payment provisions) as are customary under Lessee’s risk management program and in keeping with risks assumed by Class I railroads generally; provided , however , that Lessee may self insure with respect to any or all of the above risks if customary under such risk management program and in keeping with risks assumed by Class I railroads generally; provided that in no event shall such self-insurance or policy deductibles exceed $10,000,000 per occurrence in the case of property insurance and $15,000,000 per deductible in the case of public liability insurance. Such coverage may provide for deductible amounts as are customary under Lessee’s risk management program and in keeping with risks assumed by Class I railroads generally. Notwithstanding the foregoing, all insurance coverages (including, without limitation, self-insurance) with respect to the Units required under this Lease shall be comparable to, and no less favorable than, insurance coverages applicable to equipment owned or leased by Lessee which is comparable to the Units. Lessee shall, at its own expense, be entitled to make all proofs of loss and take all other steps necessary to collect the proceeds of such insurance.

If any insurance required by this Lease shall not be available to Lessee at renewal on a commercially reasonable basis on substantially the same terms and conditions as then carried by



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Lessee and the obtaining of such insurance is, in Lessee’s reasonable judgment, commercially impracticable (taking into account both terms and premiums), Lessee shall obtain a written report of an independent insurance advisor of recognized national standing, chosen by Lessee and reasonably acceptable to Lessor confirming in reasonable detail that such insurance, in respect of amount or scope of coverage, is not so available on a commercially reasonable basis from insurers of recognized standing who provide insurance to the railroad industry. During any period with respect to which any insurance is not so available, Lessee shall nevertheless maintain such insurance to the extent, with respect to amount and scope of coverage, that is available on a commercially reasonable basis from insurers of recognized standing who provide insurance to the railroad industry. If any insurance which was previously discontinued because of its commercial unavailability later becomes available on a commercially reasonable basis, Lessee shall reinstate such insurance.

(b) Certificate of Insurance . Lessee shall, on or prior to the Delivery Date for any Unit, furnish Lessor and Indenture Trustee with a certificate signed by the insurer or an independent insurance broker showing the insurance then maintained, if any, with respect to the Units delivered on the Delivery Date. Lessor or Indenture Trustee may, but not more than once in any twelve-month period, request from Lessee and Lessee shall promptly thereafter furnish to Lessor and Indenture Trustee, an Officer’s Certificate or, at Lessee’s option, such a certificate signed by an independent insurance broker, setting forth all insurance maintained by Lessee pursuant to Section 12.1(a) above and describing such policies, if any, including the amounts of coverage, any deductible amounts and the names of the insurance providers. Such public liability insurance and all risk property insurance shall name Owner Participant, each Loan Participant, Lessor, Wilmington Trust Company and Indenture Trustee (each, an “ Insured Party ”) as an additional insured with respect to such public liability insurance then maintained as their respective interests may appear. Lessee agrees that such insurer or such broker will provide written notice to each Insured Party at least 30 days prior to the cancellation or lapse of any insurance required to be maintained by Lessee in accordance with Section 12.1(a) above. Any insurance maintained pursuant to this Section 12 shall (i) provide insurer’s waiver of its right of subrogation with respect to public liability insurance and all risk property insurance, set-off or counterclaim or any other deduction, whether by attachment or otherwise, in respect of any liability against any additional insured except for claims as shall arise from the willful misconduct or gross negligence of such additional insured, (ii) to the extent commercially available, provide that such all risk property insurance as to the interest of Lessor, Owner Participant, each Loan Participant, Wilmington Trust Company and Indenture Trustee shall not be invalidated by any action or inaction of Lessee or any other Person (other than such claimant), regardless of any breach or violation of any warranty, declaration or condition contained in such policies by Lessee or any other Person (other than such claimant), and (iii) provide that all such insurance is primary without right of contribution from any other insurance which might otherwise be maintained by Lessor, Indenture Trustee or Owner Participant and shall expressly provide a severability of interest clause. Any insurance maintained by Lessor or Owner Participant shall not be considered co-insurance with any insurance maintained by Lessee.

Section 12.2. Proceeds of Insurance . The entire proceeds of any property insurance or third-party payments for damages or an Event of Loss with respect to any Unit (including any Association of American Railroads interline settlements) received by Lessor or Indenture Trustee shall be promptly paid over to, and retained by, Lessee; provided , however , any such amount



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which is payable to Lessee shall not be paid to Lessee, or if it has been previously paid directly to Lessee, shall not be retained by Lessee, if at the time of such payment a Specified Default or an Event of Default shall have occurred and be continuing, but shall be paid to and held by Lessor as security for the obligations of Lessee under this Lease.

Section 12.3. Additional Insurance . At any time Lessor (either directly or in the name of Owner Participant), Indenture Trustee or Owner Participant may at its own expense carry insurance with respect to its interest in the Units, provided that such insurance does not interfere with Lessee’s ability to insure the Units as required by this Section 12 or adversely affect Lessee’s insurance or the cost thereof, it being understood that all salvage rights to each Unit and all primary subrogation rights shall remain with Lessee’s insurers at all times. Any insurance payments received from policies maintained by Lessor, Indenture Trustee or Owner Participant pursuant to the previous sentence shall be retained by Lessor, Indenture Trustee or Owner Participant, as the case may be, without reducing or otherwise affecting Lessee’s obligations hereunder.


SECTION 13.		REPORTS; INSPECTION.

Section 13.1. Duty of Lessee to Furnish . On or before June 30, 2006, and on or before each June 30 thereafter, Lessee will furnish to Lessor, Owner Participant, each Loan Participant and Indenture Trustee (i) an accurate statement, as of the preceding December 31, showing the reporting marks of the Units then leased hereunder, identifying each Unit that may have suffered an Event of Loss during the 12 months ending on such December 31 (or since the Delivery Date, in the case of the first such statement), (ii) a statement confirming whether or not the only expected use of any Units outside the United States is use by a person in Canada or Mexico on a temporary basis which is not expected to exceed 90 days in the following calendar year, and (iii) such other information regarding the condition or repair of the Equipment as Lessor or Owner Participant may reasonably request.

Section 13.2. Lessor’s Inspection Rights . Lessor, Owner Participant and Indenture Trustee each shall have the right, but not the obligation, at their respective sole cost and expense (unless, in the case of any such expense, a Specified Default or an Event of Default shall have occurred and be continuing) and risk (including, without limitation, the risk of personal injury or death), by their respective authorized representatives, to the extent within Lessee’s control: on not more than one occasion in any 12-month period (unless a Specified Default or an Event of Default shall have occurred and be continuing or during the last 12 months of the Lease Term), to inspect the Equipment and Lessee’s records with respect thereto, during Lessee’s normal business hours and upon reasonable prior notice to Lessee; provided , however , that Lessee shall not be liable for any injury to, or the death of, any Person exercising, either on behalf of Lessor, Owner Participant, Indenture Trustee, Loan Participants or any prospective user, the rights of inspection granted under this Section 13.2 except as may result or arise from Lessee’s gross negligence or willful misconduct. No inspection pursuant to this Section 13.2 shall interfere with the use, operation or maintenance of the Equipment or the normal conduct of Lessee’s business, and Lessee shall not be required to undertake or incur any additional liabilities in connection therewith.



Equipment Lease Agreement (KCSR 2005-1)		- 18 -


SECTION 14.		EVENTS OF DEFAULT.

The following events shall constitute Events of Default hereunder (whether any such event shall be voluntary or involuntary or come about or be effected by operation of law or pursuant to or in compliance with any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body) and each such Event of Default shall be deemed to exist and continue so long as, but only as long as, it shall not have been remedied:

(a) Lessee shall fail to make any payment of Basic Rent, the EBO Fixed Purchase Price, or any payment of Stipulated Loss Value or Termination Value within 5 Business Days after the same shall have become due and payable; or

(b) Lessee shall fail to make any other payment of Supplemental Rent, including indemnity or tax indemnity payments, after the same shall have become due and such failure shall continue unremedied for a period of 10 days after receipt by Lessee of written notice of such failure from Lessor, Owner Participant or Indenture Trustee (provided that notice of non-payment of any Excepted Payment may only be given by Owner Participant); or

(c) Lessee shall (i) make or permit any unauthorized assignment or transfer of this Lease in violation of Section 18.2 and such unauthorized assignment or transfer shall continue unremedied for 30 days, (ii) fail to carry the insurance as required herein, or (iii) breach its covenant set forth in Section 6.7 of the Participation Agreement; or

(d) any representation or warranty made by Lessee in this Lease or in the Participation Agreement is untrue or incorrect in any material respect as of the date of issuance or making thereof and such untruth or incorrectness shall continue to be material and unremedied for a period of 30 days after receipt by Lessee of written notice thereof from Lessor, Owner Participant or Indenture Trustee; provided that, if such failure is capable of being remedied but only in a manner other than by the payment of money, no such failure shall constitute an Event of Default hereunder for a period of 180 days after receipt of such notice so long as Lessee is diligently proceeding to remedy such failure; or

(e) Lessee shall (i) commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect, or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or (ii) consent to any such relief or to the appointment of or taking possession by any such official in any voluntary case or other proceeding commenced against it, or (iii) admit in writing its inability to pay its debts generally as they come due, or (iv) make a general assignment for the benefit of creditors, or (v) take any corporate action to authorize any of the foregoing; or

(f) an involuntary case or other proceeding shall be commenced against Lessee seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect, or



Equipment Lease Agreement (KCSR 2005-1)		- 19 -

seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of 90 days;

(g) Lessee shall fail to observe or perform any other of the covenants or agreements to be observed or performed by Lessee hereunder or under the Participation Agreement and such failure shall continue unremedied for 30 days after notice from Lessor, Owner Participant or Indenture Trustee to Lessee, specifying the failure and demanding the same to be remedied; provided that, if such failure is capable of being remedied but only in a manner other than by the payment of money, no such failure shall constitute an Event of Default hereunder for a period of 180 days after receipt of such notice so long as Lessee is diligently proceeding to remedy such failure;

(h) a Change of Control of Lessee occurs without the prior written consent of the Loan Participants; or

(i) there occurs under the Direct Loan Agreement, an Event of Default (as such term is defined therein) which has not been duly waived or cured thereunder;

provided that, notwithstanding anything to the contrary contained in this Lease, any failure of Lessee to perform or observe any covenant or agreement herein shall not constitute an Event of Default if such failure is caused solely by reason of an event referred to in the definition of “ Event of Loss ” so long as Lessee is continuing to comply with the applicable terms of Section 11. Lessor (or, for so long as rent payments are being made directly to it, Indenture Trustee) shall notify Lessee promptly upon Lessee’s failure to make any payment of Basic Rent, after the same shall have become due; provided that the giving of such notice by Lessor or Indenture Trustee, as applicable, shall not be a condition to the start of the 10 Business Days period referred to in paragraph (a) of this Section 14 and the failure or delay in giving such notice shall not affect the occurrence of an Event of Default under such Section 14(a) and Lessee agrees Lessor and Indenture Trustee shall incur no liability nor be in breach hereunder for failure or delay in giving such notice.


SECTION 15.		REMEDIES.

Section 15.1. Remedies . Upon the occurrence of any Event of Default and at any time thereafter so long as the same shall be continuing, Lessor may, at its option, declare this Lease to be in default by a written notice to Lessee (provided that upon the occurrence of an Event of Default under Section 14(e) or 14(f), this Lease shall automatically be in default without the need for any declaration by Lessor and any giving of notice); and at any time thereafter, Lessor may do one or more of the following as Lessor in its sole discretion shall elect, to the extent permitted by, and subject to compliance with any mandatory requirements of, applicable law then in effect:

(a) proceed by appropriate court action or actions, either at law or in equity, to enforce performance by Lessee of the applicable covenants of this Lease or to recover damages for the breach thereof;

(b) by notice in writing to Lessee, cancel this Lease, whereupon all right of Lessee to the possession and use of the Equipment shall absolutely cease and terminate,



Equipment Lease Agreement (KCSR 2005-1)		- 20 -

but Lessee shall remain liable as hereinafter provided; and thereupon, Lessor may demand that Lessee, and Lessee shall, upon written demand of Lessor and at Lessee’s expense forthwith return all of the Equipment to Lessor or its order in the manner and condition required by, and otherwise in accordance with all of the provisions of Section 6, except Section 6.1(b) and those provisions relating to periods of notice; or Lessor may by its agents enter upon the premises of Lessee or other premises where any of the Equipment may be located and take possession of and remove all or any of the Units and thenceforth hold, possess and enjoy the same free from any right of Lessee, or its successor or assigns, to use such Units for any purpose whatever;

(c) sell any Unit at public or private sale, as Lessor may determine, free and clear of any rights of Lessee and without any duty to account to Lessee with respect to such sale or for the proceeds thereof (except to the extent required by paragraph (f) below if Lessor elects to exercise its rights under said paragraph in which case such sale shall be conducted at arm’s length and on a commercially reasonable basis), in which event Lessee’s obligation to pay Basic Rent and Supplemental Rent (other than any Supplemental Rent owed with respect to Lessee’s indemnification obligations under Section 7.1 or 7.2 of the Participation Agreement, except for claims in respect of such Unit attributable to acts or events occurring after the delivery of such Unit to the purchaser thereof) with respect to such Unit hereunder due for any periods subsequent to the date of such sale shall terminate;

(d) hold, keep idle or lease to others any Unit as Lessor in its sole discretion may determine, free and clear of any rights of Lessee and without any duty to account to Lessee with respect to such action or inaction or for any proceeds with respect thereto, except that Lessee’s obligation to pay Basic Rent and Supplemental Rent (other than any Supplemental Rent owed with respect to Lessee’s indemnification obligations under Section 7.1 or 7.2 of the Participation Agreement, except for claims in respect of such Unit attributable to acts or events occurring after the return of such Unit to Lessor in accordance with the terms hereof) with respect to such Unit due for any periods subsequent to the date upon which Lessee shall have been deprived of possession and use of such Unit pursuant to this Section 15 and prior to the Determination Date specified in paragraph (e) or (g) below shall be reduced by the net proceeds, if any, received by Lessor from leasing such Unit to any Person other than Lessee;

(e) whether or not Lessor shall have exercised, or shall thereafter at any time exercise, any of its rights under paragraph (a), (b) or (c) above with respect to any Unit, Lessor, by written notice to Lessee specifying a payment date (which date shall be a Determination Date for the purposes of computing Stipulated Loss Value) which shall be not earlier than 30 days after the date of such notice, may demand that Lessee pay to Lessor, and Lessee shall pay to Lessor, on the payment date specified in such notice, as liquidated damages for loss of a bargain and not as a penalty (in lieu of the Basic Rent for such Unit due on or after the Determination Date), (x) any unpaid Basic Rent due prior to the Determination Date so specified, plus (y) whichever of the amounts referred to in subparagraphs (i) and (ii) below as Lessor, in its sole discretion, shall specify in such notice, plus (iii) all other Supplemental Rent due as of the date of payment, including interest, to the extent permitted by applicable law, at the Late Rate on such amounts from



Equipment Lease Agreement (KCSR 2005-1)		- 21 -

the date due (and in the case of the amount referred to in subparagraphs (i) and (ii) below, such Determination Date) to the date of actual payment:

(i) an amount with respect to each Unit which represents the excess of the present value, at the time of such payment date, of all rentals for such Unit which would otherwise have accrued hereunder from such payment date for the remainder of the Basic Term or any Renewal Term then in effect over the then present value of the then Fair Market Rental Value of such Unit (taking into account its actual condition) for such period computed by discounting from the end of such Term to such payment date rentals which Lessor reasonably estimates to be obtainable for the use of such Unit during such period, such present value to be computed in each case on a basis of a rate per annum equal to 6% per annum, compounded semiannually from the respective dates upon which rentals should have been payable hereunder had this Lease not been terminated; or

(ii) an amount equal to the excess, if any, of the Stipulated Loss Value for such Unit computed as of the payment date specified in such notice over the Fair Market Sales Value of such Unit (taking into account its actual condition) as of the payment date specified in such notice;

(f) so long as any Unit has not been sold pursuant to paragraph (c) above, by notice to Lessee, require Lessee to pay to Lessor on demand on any Determination Date, and Lessee hereby agrees that it will so pay Lessor, as liquidated damages for loss of a bargain and not as a penalty (in lieu of Basic Rent due on or after such Determination Date) (i) any unpaid Basic Rent due prior to the Determination Date so specified, plus (ii) an amount equal to the Stipulated Loss Value for such Unit computed as of such Determination Date, plus (iii) all other Supplemental Rent due as of the date of payment, including interest, to the extent permitted by applicable law, at the Late Rate on such amounts from the date due (and in the case of the amount referred to in clause (ii), such Determination Date) to the date of actual payment; and upon such payment of liquidated damages, Lessor shall transfer, or cause to be transferred, to Lessee, at Lessee’s cost and expense, on an “as-is, where-is” basis and without recourse or warranty (except as to the absence of Lessor’s Liens), the rights and interests of Lessor in and to the Equipment and the Lease, and Lessor and Owner Participant, at Lessee’s cost and expense, shall execute and deliver such documents evidencing such transfer and take such further action as may be required to effect such transfer.; and

(g) if Lessor shall have sold any Unit pursuant to paragraph (c) above, Lessor, in lieu of exercising its rights under paragraph (e) above with respect to such Unit may, if it shall so elect, demand that Lessee pay to Lessor, and Lessee shall pay to Lessor, as liquidated damages for loss of a bargain and not as a penalty (in lieu of Basic Rent due on or after the date of such sale) (i) any unpaid Basic Rent due prior to the date of such sale, plus (ii) the amount, if any, by which the Stipulated Loss Value of such Unit computed as of the Determination Date immediately preceding the date of such sale or, if such sale occurs on a Determination Date, then computed as of such Determination Date, exceeds the net proceeds of such sale, plus (iii) all other Supplemental Rent due as of the date of payment, including interest, to the extent permitted by applicable law, at the Late Rate on



Equipment Lease Agreement (KCSR 2005-1)		- 22 -

such amounts from the date due (and in the case of the amount referred to in clause (ii), such Determination Date) to the date of actual payment.

In addition, Lessee shall be liable, except as otherwise provided above, for any and all unpaid Rent due hereunder before or during the exercise of any of the foregoing remedies, and for legal fees and other costs and expenses incurred by reason of the occurrence of any Event of Default or the exercise of Lessor’s remedies with respect thereto, including without limitation the repayment in full of any costs and expenses necessary to be expended in repairing any Unit in order to cause it to be in compliance with all maintenance and regulatory standards imposed by this Lease.

Section 15.2. Cumulative Remedies . The remedies in this Lease provided in favor of Lessor shall not be deemed exclusive, but shall be cumulative and shall be in addition to all other remedies in its favor existing at law or in equity.

Section 15.3. No Waiver . No delay or omission to exercise any right, power or remedy accruing to Lessor upon any breach or default by Lessee under this Lease shall impair any such right, power or remedy of Lessor, nor shall any such delay or omission be construed as a waiver of any breach or default, or of any similar breach or default hereafter occurring; nor shall any waiver of a single breach or default be deemed a waiver of any subsequent breach or default.

Section 15.4. Lessee’s Duty to Return Equipment Upon Default . If Lessor or any assignee of Lessor shall terminate this Lease pursuant to this Section 15 and shall have provided to Lessee the written demand specified in Section 15.1(b), Lessee shall forthwith deliver possession of such Units to Lessor. For the purpose of delivering possession of any Unit to Lessor as above required, Lessee shall at its own cost, expense and risk:

(i) forthwith place such Equipment upon such storage tracks of Lessee or, at the expense of Lessee, on any other storage tracks, as Lessee may select;

(ii) permit Lessor to store such Equipment on such tracks without charge for insurance, rent or storage until the earlier of (x) six months after such demand for storage and (y) the date such Equipment is sold, leased or otherwise disposed of by Lessor and during such period of storage Lessee shall continue to maintain all insurance required by Section 12 hereof; and

(iii) transport the Equipment to any point of interchange on Lessee’s lines in the 48 contiguous United States with a railroad, when directed by Lessor.

All Equipment returned shall be in the condition required by Section 6.2 hereof.

Section 15.5. Specific Performance; Lessor Appointed Lessee’s Agent . The assembling, delivery, storage and transporting of the Equipment as provided in Section 15.4 are of the essence of this Lease, and upon application to any court of equity having jurisdiction in the premises, Lessor shall be entitled to a decree against Lessee requiring specific performance of the covenants of Lessee so to assemble, deliver, store and transport the Equipment. Without in any way limiting the obligation of Lessee under the provisions of Section 15.4, Lessee hereby irrevocably appoints Lessor as the agent and attorney of Lessee, with full power and authority, at



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any time while Lessee is obligated to deliver possession of any Units to Lessor pursuant to this Section 15, to demand and take possession of such Unit in the name and on behalf of Lessee from whosoever shall be at the time in possession of such Unit.


SECTION 16.		FILINGS; FURTHER ASSURANCES.

Section 16.1. Filings . On or prior to the Closing Date for each Unit, Lessee will (i) cause this Lease, the Lease Supplement dated such Closing Date, the Indenture and the Indenture Supplement dated such Closing Date, or appropriate evidence thereof, to be duly filed and recorded with the STB in accordance with 49 U.S.C. § 11301, (ii) cause this Lease, the Lease Supplement dated such Closing Date, the Indenture and the Indenture Supplement dated such Closing Date, or appropriate evidence thereof, to be deposited with the Registrar General of Canada pursuant to Section 105 of the Canada Transportation Act and cause notice of such deposit to be forthwith given in The Canada Gazette in accordance with said Section 105, and (iii) cause or permit such other filings and notices, including Uniform Commercial Code financing statements, to be filed or made as necessary or appropriate to perfect the right, title and interest of Indenture Trustee in the Indenture Estate and to protect the interests of Owner Participant, and will furnish Lessor and Indenture Trustee proof thereof.

Section 16.2. Further Assurances . Lessee will duly execute and deliver to Lessor such further documents and assurances and take such further action as Lessor may from time to time reasonably request in order to effectively carry out the intent and purpose of this Lease and to establish and protect the rights and remedies created in favor of Lessor hereunder, including, without limitation, if requested by Lessor, the execution and delivery of supplements or amendments hereto, in recordable form, subjecting to this Lease any Replacement Unit and the recording or filing of counterparts hereof or thereof in accordance with the laws of such jurisdiction as Lessor may from time to time deem advisable; provided that this sentence is not intended to impose upon Lessee any additional liabilities not otherwise contemplated by this Lease.

Section 16.3. Expenses . Except as provided in Section 2.5 of the Participation Agreement, Lessee will pay all costs, charges and expenses (including reasonable attorneys’ fees) incident to any such filing, refiling, recording and rerecording or depositing and redepositing of any such instruments or incident to the taking of such action.


SECTION 17.		LESSOR’S RIGHT TO PERFORM.

If Lessee fails to make any payment required to be made by it hereunder or fails to perform or comply with any of its other agreements contained herein and such failure can be cured with the payment of money, Lessor or Indenture Trustee may itself make such payment or perform or comply with such agreement, after giving not less than five Business Days’ prior notice thereof to Lessee (except in the event that an Indenture Event of Default resulting solely from an Event of Default shall have occurred and be continuing, in which event Lessor or Indenture Trustee may effect such payment, performance or compliance to the extent necessary to cure such Indenture Event of Default with notice given concurrently with such payment, performance or compliance) in a reasonable manner, but shall not be obligated hereunder to do so, and the amount of such payment and of the reasonable expenses of Lessor or Indenture



Equipment Lease Agreement (KCSR 2005-1)		- 24 -

Trustee, as the case may be, incurred in connection with such payment or the performance of or compliance with such agreement, as the case may be, together with interest thereon at the Late Rate, to the extent permitted by applicable law, shall be deemed to be Supplemental Rent, payable by Lessee to Lessor or Indenture Trustee, as the case may be, on demand.


SECTION 18.		ASSIGNMENT.

Section 18.1. Assignment by Lessor . Lessee and Lessor hereby confirm that concurrently with the execution and delivery of this Lease, Lessor has executed and delivered to Indenture Trustee the Indenture, which assigns as collateral security and grants a security interest to Indenture Trustee in, to and under this Lease and certain of the Rent payable hereunder, all as more explicitly set forth in the Granting Clause of the Indenture. Lessor agrees that it shall not otherwise assign or convey its right, title and interest in and to this Lease, the Equipment or any Unit, except as expressly permitted by and subject to the provisions of this Lease, the Participation Agreement, the Trust Agreement and the Indenture.

Section 18.2. Assignment by Lessee . Except as otherwise provided in Section 8.3 or in the case of any requisition for use by an agency or instrumentality of the United States government referred to in Section 11.1, Lessee will not, without the prior written consent of Lessor, assign any of its rights hereunder, except as provided in Section 6.8 of the Participation Agreement.

Section 18.3. Sublessee’s Performance and Rights . Any obligation imposed on Lessee in this Lease shall require only that Lessee perform or cause to be performed such obligation, even if stated herein as a direct obligation, and the performance of any such obligation by any permitted assignee, sublessee or transferee under an assignment, sublease or transfer agreement then in effect and permitted by the terms of this Lease shall constitute performance by Lessee and discharge such obligation by Lessee. Except as otherwise expressly provided herein, any right granted to Lessee in this Lease shall grant Lessee the right to exercise such right or permit such right to be exercised by any such assignee, sublessee or transferee, provided that Lessee’s renewal option set forth in Section 22.2 may be exercised only by Lessee itself or by any assignee or transferee of, or successor to, Lessee in a transaction permitted by Section 6.8 of the Participation Agreement. The inclusion of specific references to obligations or rights of any such assignee, sublessee or transferee in certain provisions of this Lease shall not in any way prevent or diminish the application of the provisions of the two sentences immediately preceding with respect to obligations or rights in respect of which specific reference to any such assignee, sublessee or transferee has not been made in this Lease.


SECTION 19.		NET LEASE, ETC.

This Lease is a net lease and Lessee’s obligation to pay all Rent payable hereunder shall be absolute and unconditional under any and all circumstances of any character including, without limitation, any abatement of Rent or setoff against Rent; nor, except as otherwise expressly provided herein, shall this Lease terminate, or the respective obligations of Lessor or Lessee be otherwise affected, by reason of any defect in, damage to or loss or destruction of, or requisitioning of, any Unit, by condemnation or otherwise, the prohibition of Lessee’s use of any Unit, the interference with such use by any Person or the lack of right, power or authority of



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Lessor or any other Person to enter into this Lease or any other Operative Agreement, or for any other cause, whether similar or dissimilar to the foregoing, any present or future law to the contrary notwithstanding, it being the intention of the parties hereto that the Rent payable by Lessee hereunder shall continue to be payable in all events unless the obligation to pay the same shall be terminated in accordance with the terms of this Lease. To the extent permitted by applicable law, Lessee hereby waives any and all rights which it may now have or which at any time hereafter may be conferred upon it, by statute or otherwise, to terminate, cancel, quit or surrender this Lease with respect to any Unit, except in accordance with the express terms hereof. If for any reason whatsoever this Lease shall be terminated in whole or in part by operation of law or otherwise, except as specifically provided herein, Lessee nonetheless agrees to the maximum extent permitted by law, to pay to Lessor or to Indenture Trustee, as the case may be, an amount equal to each installment of Basic Rent and all Supplemental Rent due and owing, at the time such payment would have become due and payable in accordance with the terms hereof had this Lease not been terminated in whole or in part. Nothing contained herein shall be construed to waive any claim which Lessee might have under any of the Operative Agreements or otherwise or to limit the right of Lessee to make any claim it might have against Lessor or any other Person or to pursue such claim in such manner as Lessee shall deem appropriate.


SECTION 20.		NOTICES.

Unless otherwise expressly specified or permitted by the terms hereof, all communications and notices provided for herein shall be in writing or by a telecommunications device capable of creating a written record (including electronic mail), and any such notice shall become effective (a) upon personal delivery thereof, including, without limitation, by overnight mail and courier service, (b) in the case of notice by United States mail, certified or registered, postage prepaid, return receipt requested, upon receipt thereof, or (c) in the case of notice by such a telecommunications device, upon transmission thereof, provided such transmission is promptly confirmed in writing by either of the methods set forth in clauses (a) and (b) above, in each case addressed to the following Person at its respective address set forth below or at such other address as such Person may from time to time designate by written notice to the other Persons listed below:


		If to Lessor:		KCSR Trust 2005-1
				c/o Wilmington Trust Company
				Rodney Square North
				1100 North Market Street
				Wilmington, DE 19890-0001
				Attention: Corporate Trust Administration
				Facsimile No.: (302) 636-4140
				Telephone No.: (302) 636-6000



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		With copies to:		GS Leasing (KCSR 2005-1) LLC
				c/o The Goldman Sachs Group Inc.
				85 Broad Street
				New York, NY 10004
				Attention: Robert Emer,
				Fixed Income, Currency and Commodities
				Facsimile: 212-256-4853
				Telephone No.: 212-902-0047

		If to Indenture Trustee:		Wells Fargo Bank Northwest, National Association
				299 South Main Street, 12 ^th Floor
				MAC: U1228-120
				Salt Lake City, Utah 84111
				Attention: Corporate Trust Department
				Facsimile No.: (801) 246-5053
				Telephone No.: (801) 246-5630

		If to Lessee:		Address of Lessee for Mail Delivery :
				The Kansas City Southern Railway Company
				P.O. Box 219335
				Kansas City, MO 64121-9335
				Attention: Senior Vice President – Finance Treasurer
				Facsimile No.: (816) 983-1198
				Telephone No.: (816) 983-1802

				Address of Lessee for Courier and Similar Delivery :
				The Kansas City Southern Railway Company
				427 West 12 ^th Street
				Kansas City, MO 64105
				Attention: Senior Vice President – Finance Treasurer
				Facsimile No.: (816) 983-1198
				Telephone No.: (816) 983-1802

				with a copy to:

				The Kansas City Southern Railway Company
				427 West 12 ^th Street
				Kansas City, MO 64105
				Attention: Senior Vice President & General Counsel
				Facsimile No.: (816) 983-1227
				Telephone No.: (816) 983-1303


SECTION 21.		CONCERNING INDENTURE TRUSTEE.

Section 21.1. Limitation of Indenture Trustee’s Liabilities . Notwithstanding any provision herein or in any of the other Operative Agreements to the contrary, Indenture Trustee’s obligation to take or refrain from taking any actions, or to use its discretion (including, but not



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limited to, the giving or withholding of consent or approval and the exercise of any rights or remedies under such Operative Agreements), and any liability therefor, shall, in addition to any other limitations provided herein or in the other Operative Agreements, be limited by the provisions of the Indenture, including, but not limited to, Article VI thereof.

Section 21.2. Right, Title and Interest of Indenture Trustee under Lease . It is understood and agreed that the right, title and interest of Indenture Trustee in, to and under this Lease and the Rent due and to become due hereunder shall by the express terms granting and conveying the same be subject to the interest of Lessee in and to the Equipment.


SECTION 22.		TERMINATION UPON PURCHASE BY LESSEE; OPTIONS TO RENEW.

Section 22.1. Termination upon Purchase by Lessee . If Lessee shall have exercised its option to purchase any Unit pursuant to Section 23 and shall not have elected to purchase Owner Participant’s Beneficial Interest pursuant to Section 23(c), upon payment by Lessee of the purchase price with respect to such Unit as provided in Section 23, and upon payment by Lessee of all Rent then due and payable under this Lease with respect to such Unit, the Lease Term shall end with respect to such Unit and the obligations of Lessee to pay Rent hereunder with respect to such Unit (except for Supplemental Rent obligations surviving pursuant to the Participation Agreement or the Tax Indemnity Agreement or which have otherwise accrued but not been paid as of the date of such payment) shall cease.

Section 22.2. Renewal Option at Expiration of Basic Term . (a) [ Reserved ].

(b) So long as no Specified Default or Event of Default shall have occurred and be continuing, Lessee shall have the right, upon not less than 180 days’ prior irrevocable notice to Lessor at the end of the Basic Term or any Fair Market Renewal Term, pursuant to this Section, to renew this Lease with respect to, at the sole discretion of Lessee, either all or a Minimum Number for one or more successive Renewal Terms of not less than one year each (each a “ Fair Market Renewal Term ”), commencing at the end of the Basic Term or the end of any Fair Market Renewal Term, as the case may be; provided that the aggregate duration of the Fair Market Renewal Terms for such Units, when added to the duration of the Basic Term and all prior Fair Market Renewal Terms for such Units, shall not in any event exceed either (i) 80% of the estimated useful life of such Units, or (ii) the point at which such Units are estimated to have a Fair Market Sales Value of 20% of the original Equipment Cost of such Units (without giving effect to inflation or deflation since the Delivery Date for such Units), in each case as determined by appraisal (in accordance with the procedures set forth in the definition of “ Fair Market Sales Value ”), completed at a point prior to the end of the Basic Term or the current Fair Market Renewal Term, as the case may be, selected by Lessee. Basic Rent for any such Renewal Term shall be equal to the then Fair Market Rental Value for such Units and shall be payable in semiannual installments in arrears. All other provisions of this Lease, other than Section 10, shall be applicable during any such Renewal Term for such Units, except that the Stipulated Loss Values for such Units shall be determined in accordance with Section 22.5.

Section 22.3. [Reserved] .



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Section 22.4. Determination of Fair Market Rental Value . Lessee may notify Lessor that Lessee desires a determination of the Fair Market Rental Value of such Units for a. Renewal Term commencing upon the Renewal Term Commencement Date. Lessee’s request for a determination of Fair Market Rental Value shall not obligate Lessee to exercise any of the options provided in Section 22.2.

Section 22.5. Stipulated Loss Value During Renewal Term . During any Fair Market Renewal Term, the Stipulated Loss Value of any Unit shall be determined by amortizing the Fair Market Sales Value of such Unit as of the first day of such Renewal Term down to the Fair Market Sales Value of such Unit as of the last day of such Renewal Term at the implicit interest rate imputed when discounting on a monthly basis the renewal rents and the Fair Market Sales Value as of the last day of such Renewal Term back to the Fair Market Sales Value as of the first day of such Renewal Term.


SECTION 23.		LESSEE’S OPTIONS TO PURCHASE EQUIPMENT; PURCHASE OF BENEFICIAL INTEREST.

(a) So long as no Specified Default or Event of Default shall have occurred and be continuing, Lessee shall have the option:

(i) upon not less than 180 days’ nor more than 360 days’ prior irrevocable notice to Lessor to purchase on the Basic Term Expiration Date or the Business Day next following the expiration of any Renewal Term then in effect, either all or a Minimum Number of Units at a price equal to the Fair Market Sales Value for such Units;

(ii) upon not less than 90 days’ nor more than 360 days’ prior irrevocable notice to Lessor to purchase on the EBO Fixed Purchase Price Date, at the sole discretion of Lessee, either all of the Units of Equipment or a Minimum Number of Units on the EBO Fixed Purchase Price Date at a price equal to the EBO Fixed Purchase Price (as such EBO Fixed Purchase Price may be adjusted from time to time pursuant to and in accordance with Section 2.6 of the Participation Agreement); and

(iii) upon not less than 90 days’ nor more than 360 days’ prior irrevocable notice to Lessor at any time after the EBO Fixed Purchase Price Date, any Unit of Equipment if Lessee determines and provides to Owner Trustee and Owner Participant a certificate executed by the Chief Financial Officer of Lessee to the effect that the cost of any improvements thereto required by Section 8.1(iv) would exceed 20% of the Fair Market Sales Value of such Unit as of such date, at a price equal to the higher of the Fair Market Sales Value or Termination Value as of such date for such Unit.

(b) If Lessee shall have exercised its option to purchase any Unit pursuant to Sections 23(a)(i) or 23(a)(iii) and shall have requested a determination of Fair Market Sales Value at least 180 days prior to the date of such purchase, Owner Trustee and Lessee shall comply in a timely manner with their respective obligations set forth in the definition of “Fair Market Sales Value.” If Lessee shall have exercised its option to purchase any Unit hereunder, and so long as Lessee has not exercised its option to purchase the Beneficial Interest pursuant to Section 23(c) below, on the date of such purchase (x) Owner Trustee shall, subject to the



Equipment Lease Agreement (KCSR 2005-1)		- 29 -

payment in full of all amounts referred to in clauses (y) and (z) below, assign, transfer and convey to Lessee all right, title and interest of Owner Trustee in and to each Unit being purchased on such date on an “as is, where is” basis, without recourse or warranty except as to Lessor’s Liens attributable to Owner Trustee or Owner Participant other than Permitted Liens, (y) Lessee shall pay, by 12:00 noon (New York City time) on such date by wire transfer in immediately available funds, to Owner Trustee the Fair Market Sales Value or the EBO Fixed Purchase Price, as the case may be, with respect to the Units purchased on such date plus any sales, use or other similar taxes imposed on such purchase or transfer, and (z) Lessee shall pay pursuant to Section 22.1 (i) all Basic Rent due and payable prior to such date of purchase plus all other Supplemental Rent due and payable as of such date of purchase, including, in respect of any Make-Whole Amount with respect to any Equipment Note due and payable on such date of purchase.

(c) If Lessee shall have exercised its option pursuant to Section 23(a)(ii) above and shall have elected to purchase all but not less than all of the Units, Lessee shall have the option to purchase the Beneficial Interest from Owner Participant and shall assume all of the rights and obligations of Owner Participant under each of the Operative Agreements to which Owner Participant is a party (other than any obligations or liabilities of Owner Participant incurred on or prior to the applicable purchase date, which obligations and liabilities shall remain the sole responsibility of Owner Participant); provided , however , Lessee shall not entitled to exercise such option unless Indenture Trustee and the Loan Participants shall have received an opinion of counsel stating that Indenture Trustee and Loan Participants shall be entitled to the benefits of Section 1168 of the Bankruptcy Code (or any successor provision) to the same extent as immediately prior to Lessee’s exercise of this option, such opinion to be reasonably satisfactory to Indenture Trustee and the Loan Participants. On the applicable purchase date (x) Lessee shall pay any unpaid Basic Rent due and payable prior to such date of purchase and any other Rent then due and payable and such amounts shall be distributed as provided in the Indenture and the Trust Agreement and (y) Lessee shall pay to Owner Participant, in immediately available funds, an amount equal to the excess of the applicable purchase price over an amount equal to the sum of the principal of, and any accrued and unpaid interest on, the outstanding Equipment Notes on such date after taking into account any payments of principal or interest made in respect of the outstanding Equipment Notes on such date plus any sales, use or other similar taxes imposed on such purchase or transfer, and upon payment and (in the case of clause (x) above) distribution of the amounts set forth in clauses (x) and (y) above, Owner Participant will assign, transfer and convey to Lessee, without recourse or warranty except as to Lessor’s Liens attributable to Owner Trustee or Owner Participant other than Permitted Liens, all of Owner Participant’s right, title and interest in and to the Beneficial Interest. If Lessee shall have exercised the option to purchase the Beneficial Interest from Owner Participant as described above, Owner Participant shall receive on the applicable purchase date a release in form and substance satisfactory to it, from all liabilities under the Operative Agreements (other than those liabilities set forth in the first sentence of this Section 23(c)).


SECTION 24.		LIMITATION OF LESSOR’S LIABILITY.

It is expressly agreed and understood that all representations, warranties and undertakings of Lessor hereunder (except as expressly provided herein) shall be binding upon Lessor only in its capacity as Owner Trustee under the Trust Agreement and in no case shall Wilmington Trust



Equipment Lease Agreement (KCSR 2005-1)		- 30 -

Company be personally liable for or on account of any statements, representations, warranties, covenants or obligations stated to be those of Lessor hereunder, except that Lessor (or any successor Owner Trustee) shall be personally liable for its gross negligence or willful misconduct or for its breach of its covenants, representations and warranties contained herein to the extent covenanted or made in its individual capacity.


SECTION 25.		FILING IN MEXICO.

In the event that during the Lease Term (A) a central filing system becomes available in Mexico for the filing or recording of security interests or ownership rights in railroad rolling stock, (B) Lessee elects as a business practice to conduct such filings or recordings with respect to equipment owned or leased by Lessee that is used in a manner similar to the Units and (C) Lessee has not previously taken such action in accordance with the requirements of Section 16.1 hereof, then Lessee will take, or cause to be taken, at Lessee’s cost and expense, such action with respect to the filing or recording of this Lease, the Indenture or any supplements hereto or thereto (or appropriate evidence thereof) and any financing statements or other instruments as may be necessary or reasonably required to maintain, so long as the Indenture or this Lease is in effect and such central filing system remains available, the benefit of such filing or recording in Mexico for the protection of the security interest created by the Indenture and any security interest that may be claimed to have been created by this Lease and the ownership interest of Lessor in each Unit to the extent such protection is available pursuant to such filing or recording in Mexico.


SECTION 26.		MISCELLANEOUS.

Section 26.1. Governing Law; Severability . This Lease and any extensions, amendments, modifications, renewals or supplements hereto shall be governed by and construed in accordance with the internal laws and decisions (as opposed to conflicts of law provisions) of the State of New York; provided , however , that the parties shall be entitled to all rights conferred by any applicable Federal statute, rule or regulation. Whenever possible, each provision of this Lease shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Lease shall be prohibited by or invalid under the laws of any jurisdiction, such provision, as to such jurisdiction, shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Lease in any other jurisdiction.

Section 26.2. Execution in Counterparts . This Lease may be executed in any number of counterparts, each executed counterpart constituting an original and in each case such counterparts shall constitute but one and the same instrument; provided , however , that to the extent that this Lease constitutes chattel paper (as such term is defined in the Uniform Commercial Code) no security interest in this Lease may be created through the transfer or possession of any counterpart hereof other than the counterpart bearing the receipt therefor executed by Indenture Trustee on the signature page hereof, which counterpart shall constitute the only “original” hereof for purposes of the Uniform Commercial Code.

Section 26.3. Headings and Table of Contents; Section References . The headings of the sections of this Lease and the Table of Contents are inserted for purposes of convenience only



Equipment Lease Agreement (KCSR 2005-1)		- 31 -

and shall not be construed to affect the meaning or construction of any of the provisions hereof. All references herein to numbered sections, unless otherwise indicated, are to sections of this Lease.

Section 26.4. Successors and Assigns . This Lease shall be binding upon and shall inure to the benefit of, and shall be enforceable by, the parties hereto and their respective permitted successors and assigns.

Section 26.5. True Lease . It is the intent of the parties to this Lease that it be, and this Lease shall be, a single and indivisible true lease of the Equipment for all purposes, including, without limitation, for Federal income tax purposes. Lessor shall at all times be the owner of each Unit which is the subject of this Lease for all purposes, this Lease conveying to Lessee no right, title or interest in any Unit except as lessee. Nothing contained in this Section 26.5 shall be construed to limit Lessee’s use or operation of any Unit or constitute a representation, warranty or covenant by Lessee as to tax consequences.

Section 26.6. Amendments and Waivers . No term, covenant, agreement or condition of this Lease may be terminated, amended or compliance therewith waived (either generally or in a particular instance, retroactively or prospectively) except by an instrument or instruments in writing executed by each party hereto; provided , however , that any breach or default, once waived in writing, unless otherwise specified in such waiver, shall not be deemed continuing for any purpose of the Operative Agreements.

Section 26.7. Survival . All warranties, representations, indemnities and covenants made by any party hereto, herein or in any certificate or other instrument delivered by any such party or on the behalf of any such party under this Lease, shall be considered to have been relied upon by each other party hereto and shall survive the consummation of the transactions contemplated hereby on any Closing Date regardless of any investigation made by any such party or on behalf of any such party.

Section 26.8. Business Days . If any payment is to be made hereunder or any action is to be taken hereunder on any date that is not a Business Day, such payment or action otherwise required to be made or taken on such date shall be made or taken on the immediately succeeding Business Day with the same force and effect as if made or taken on such scheduled date and as to any payment (provided any such payment is made on such succeeding Business Day) no interest shall accrue on the amount of such payment from and after such scheduled date to the time of such payment on such next succeeding Business Day.

Section 26.9. Directly or Indirectly . Where any provision in this Lease refers to action to be taken by any Person, or which such Person is prohibited from taking, such provision shall be applicable whether such action is taken directly or indirectly by such Person.

Section 26.10. Incorporation by Reference . The payment obligations set forth in the Tax Indemnity Agreement and Sections 7.1 and 7.2 of the Participation Agreement are hereby incorporated by reference.

Section 26.11. Entitlement to §1168 Benefits . It is the intent of the parties that Lessor (and Indenture Trustee as assignee of Lessor under the Indenture) shall be entitled to the benefits



Equipment Lease Agreement (KCSR 2005-1)		- 32 -

of Section 1168 of the Bankruptcy Code with respect to the right to repossess any Unit and to enforce any of its other rights or remedies as provided herein, and in any circumstances where more than one construction of the terms and conditions of this Lease is possible, a construction which would preserve such benefits shall control over any construction which would not preserve such benefits or would render them doubtful. To the extent consistent with the provisions of Section 1168 of the Bankruptcy Code or any analogous section of the Bankruptcy Code or other applicable law, it is hereby expressly agreed and provided that, notwithstanding any other provision of the Bankruptcy Code, any right of Lessor to take possession of any Unit and to enforce any of its other rights or remedies in compliance with the provisions of this Lease shall not be affected by the provisions of Section 362 or 363 of the Bankruptcy Code or any analogous provision of any superseding statute or any power of a bankruptcy court to enjoin such undertaking or possession.

Section 26.12. Waiver of Jury Trial . THE PARTIES HERETO VOLUNTARILY AND INTENTIONALLY WAIVE ANY RIGHTS THEY MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER, OR IN CONNECTION WITH THIS LEASE OR ANY OTHER OPERATIVE AGREEMENT, OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF ANY OF THE PARTIES HERETO AND THERETO. THE PARTIES HERETO HEREBY AGREE THAT THEY WILL NOT SEEK TO CONSOLIDATE ANY SUCH LITIGATION WITH ANY OTHER LITIGATION IN WHICH A JURY TRIAL HAS NOT OR CANNOT BE WAIVED.



Equipment Lease Agreement (KCSR 2005-1)		- 33 -

IN WITNESS WHEREOF, Lessor and Lessee have caused this Lease to be duly executed and delivered on the day and year first above written.



		LESSOR:

		KCSR TRUST 2005-1,acting through
		WILMINGTON TRUST COMPANY, not in its
		individual capacity, but solely as Owner Trustee

		By:		/s/ Michele C. Harra

				Name: Michele C. Harra
				Title: Financial Services Officer

		LESSEE

		THE KANSAS CITY SOUTHERN RAILWAY COMPANY

		By:		/s/ Ronald G. Russ

				Name: Ronald G. Russ
				Title: Executive Vice President & CFO

Receipt of the original counterpart
of the foregoing Lease is hereby
acknowledged this 20th day of
December, 2005.



WELLS FARGO BANK NORTHWEST, NATIONAL
ASSOCIATION, as Indenture Trustee

By:		/s/ Jon Creasmun

		Name: Jon Creasmun
		Title: Assistant Vice President



Equipment Lease Agreement (KCSR 2005-1)

STATE OF DELAWARE                  )
                                                             ) ss:
COUNTY OF NEW CASTLE           )

On this 19th day of December, 2005, before me personally appeared Michele C. Harra to me personally known, who being by me duly sworn, says that he/she is a Financial Services Officer of Wilmington Trust Company, that said instrument was signed and sealed on December 19, 2005, on behalf of said association by authority of its Board of Directors; and he/she acknowledged that the execution of the foregoing instrument was the free act and deed of said association

(SEAL)

My Commission Expires: March 7, 2007.

STATE OF MISSOURI                        )
                                                               ) ss:
COUNTY OF JACKSON                     )

On this 19th day of December, 2005, before me personally appeared Paul J. Weyandt to me personally known, who being by me duly sworn, says that he is the Senior Vice President-Finance & Treasurer of THE KANSAS CITY SOUTHERN RAILWAY COMPANY, that said instrument was signed and sealed on December 19, 2005, on behalf of said corporation by authority of its Board of Directors; and he acknowledged that the execution of the foregoing instrument was the free act and deed of said corporation.

(SEAL)

My Commission Expires: August 4, 2006.



Equipment Lease Agreement (KCSR 2005-1)

Exhibit 10.50

EXECUTION COPY

THE BANK OF NOVA SCOTIA

600 Peachtree Street, N.E.

Suite 2700

Atlanta, Georgia 30308

March 17, 2006

The Kansas City Southern Railway Company
427 West 12 ^th Street
Kansas City, Missouri 64105
Attention: Paul J. Weyandt

Ladies and Gentlemen:

You have advised The Bank of Nova Scotia (“ Scotia ”) regarding the desire of The Kansas City Southern Railway Company, a Missouri corporation (the “Borrower ”), to amend and restate its existing $250 million Credit Agreement dated as of March 30, 2004 (as amended by (i) Amendment and Waiver No. 1 to the Credit Agreement and Amendment No. 1 to the Security Agreement, dated as of December 22, 2004, (ii) Amendment and Waiver No. 2 to the Credit Agreement, dated as of September 30, 2005, (iii) Amendment No. 3 to the Credit Agreement, dated as of November 4, 2005, (iv) Waiver No. 3 to the Credit Agreement, dated as of December 8, 2005, and (v) Waiver No. 4 to the Credit Agreement, dated as of March 1, 2006, and as may be further amended or otherwise modified from time to time, the “ Existing Credit Facility ”). In order to amend and restate the Existing Credit Facility (the “ Restatement ”) in its entirety, you have requested that Scotia (a) provide you with its financing commitment for the entire $371.2 million of Senior Bank Financing (as hereinafter defined) described in this letter and in the summary of certain terms and conditions attached hereto as Exhibit A (the “ Summary of Terms ” and, together with this letter, this “ Commitment Letter ”) and (b) provide you with its best efforts undertaking to arrange a syndicate (in such capacity, the “ Lead Arranger ”) of Lenders (as defined under the section “ Lenders ” in the Summary of Terms) for the Senior Bank Financing.

We understand that the funding required to effect the Restatement, to pay the fees and expenses incurred in connection therewith and to provide for the ongoing working capital and general corporate needs of the Borrower (as defined in the Summary of Terms) and its subsidiaries shall be provided from the incurrence by the Borrower of the Senior Bank Financing.

We further understand that the senior secured bank financing (the “ Senior Bank Financing ”) will be in the form of (i) a term loan facility in the amount of $246.2 million (the “ Term Loan B Facility ”), and (ii) a revolving credit facility in the amount of $125 million (the “ Revolving Credit Facility ”, together with the Term Loan B Facility, the “ Credit Facilities ”).

Scotia is pleased to commit to provide, subject to and upon the terms and conditions set forth herein and in the Summary of Terms, the entire amount of (i) the Revolving Credit Facility and (ii) the Term Loan B Facility, in each case, on the terms and conditions set forth herein and in the Summary of Terms. It is understood that (i) Scotia shall act as sole lead arranger and sole bookrunner for the Senior Bank Financing (the “ Lead Arranger ”) and (ii) Scotia will act as administrative agent for the Senior Bank Financing. It is further understood that the Lead Arranger shall be permitted to designate (after

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Commitment Letter

consultation with and agreement of the Borrower, such agreement not to be unreasonably withheld) one or more Lenders as agents or co-agents, as the case may be, with respect to the Senior Bank Financing, and that no titles may be given, or compensation paid, to Lenders without the Lead Arranger’s consent.

The Lead Arranger reserves the right, prior to or after execution of the definitive credit documentation for the Senior Banking Financing, to syndicate all or part of its commitments for the Senior Bank Financing to one or more lending institutions of which you shall approve, such approval not to be unreasonably withheld, that will become parties to such definitive credit documentation pursuant to a syndication to be managed by the Lead Arranger, and the commitments of the Lead Arranger hereunder shall be reduced as and when commitments are received from the Lenders as described in the immediately preceding paragraph. The Lead Arranger shall commence syndication efforts promptly after the execution of this Commitment Letter by you and you agree actively to assist the Lead Arranger in achieving a syndication that is satisfactory to the Lead Arranger. To assist the Lead Arranger in its syndication efforts, you hereby agree (a) to provide and cause your advisors to provide the Lead Arranger and the other syndicate members upon request with all information reasonably deemed necessary by the Lead Arranger to complete syndication, including but not limited to information and evaluations prepared by you and your advisors or on your behalf relating to the transactions contemplated hereby, (b) to assist the Lead Arranger upon request in the preparation of an Information Memorandum to be used in connection with the syndication of the Senior Bank Financing, (c) to use your commercially reasonable efforts to ensure that the syndication efforts of the Lead Arranger benefit materially from your existing lending relationships, (d) to make available your senior officers, representatives and advisors, in each case from time to time, and to attend and make presentations regarding the business and prospects of the Borrower at a meeting or meetings of lenders or prospective lenders and (e) to make available your senior officers and representatives in connection with discussions with the rating agencies; subject, in each case, to the agreement of the Lead Arranger and the other syndicate members and their advisors to keep all non-public information confidential as more fully set forth below. In addition, you agree that no financing for the Borrower or any of its respective subsidiaries or affiliates shall be syndicated, privately placed or publicly offered to the extent that such financing could have an adverse effect on the syndication of the Senior Bank Financing.

Those matters that are not covered or made clear herein or in the attached Summary of Terms are subject to mutual agreement of the parties. The terms and conditions of this commitment may be modified only in writing. In addition, this commitment is subject to (a) the preparation, execution and delivery of mutually acceptable loan documentation, including a credit agreement incorporating substantially the terms and conditions outlined herein and in the Summary of Terms, and (b) the accuracy and completeness in all material respects of all representations that you make to us and all information that you furnish to us in connection with this commitment and your compliance with the terms of this Commitment Letter. The Lead Arranger’s commitment set forth in this Commitment Letter will terminate on April 30, 2006, unless the Restatement closes on or before such date. The Lead Arranger shall not be responsible or liable for any consequential damages which may be alleged as a result of its failure to provide the Senior Bank Financing.

To induce the Lead Arranger to issue this Commitment Letter and to continue with its due diligence efforts, you hereby agree that all reasonable out-of-pocket fees and expenses (including the reasonable fees and expenses of counsel and consultants) of the Lead Arranger and its affiliates arising in connection with this Commitment Letter (and its due diligence and syndication efforts in connection herewith) and in connection with the Senior Bank Financing and the other transactions described herein shall be for your account, whether or not the Restatement is consummated, the Senior Bank Financing is made available or definitive credit documents are executed. In addition, you hereby agree to pay when and as due the fees described in the fee letter (the “ Fee Letter ”) executed simultaneously herewith. You further agree to indemnify and hold harmless each of the Lenders (including, in any event, the Lead

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Commitment Letter

Arranger) and each director, officer, employee and affiliate thereof (each an “ Indemnified Person ”) from and against any and all actions, suits, proceedings (including any investigations or inquiries), claims, losses, damages, liabilities or expenses of any kind or nature whatsoever which may be incurred by or asserted against or involve any such Indemnified Person as a result of or arising out of or in any way related to or resulting from this Commitment Letter, the Restatement or the extension or syndication of the Senior Bank Financing contemplated by this Commitment Letter, or in any way arise from any use or intended use of this Commitment Letter or the proceeds of the Senior Bank Financing contemplated by this Commitment Letter, and you agree to reimburse each Indemnified Person upon demand for any reasonable legal or other reasonable out-of-pocket expenses incurred in connection with investigating, defending or preparing to defend any such action, suit, proceeding (including any inquiry or investigation) or claim (whether or not Scotia or any such other Indemnified Person is a party to any action or proceeding out of which any such expenses arise) (collectively, an “ Action ”); provided , however , that you shall not have to indemnify any Indemnified Person against any loss, claim, damage, expense or liability to the extent finally determined by a court of competent jurisdiction to have resulted from the gross negligence or willful misconduct of such Indemnified Person. This Commitment Letter is issued for your benefit only and no other person or entity may rely hereon. Neither Scotia nor any Lender shall be responsible or liable to the Borrower or any other person for consequential damages that may be alleged as a result of this Commitment Letter.

The Lead Arranger reserves the right to employ the services of its affiliates in providing services contemplated by this Commitment Letter and to allocate, in whole or in part, to such affiliates certain fees payable to the Lead Arranger in such manner as the Lead Arranger and such affiliates may agree in their sole discretion. Each of you acknowledges that the Lead Arranger may share with any of its affiliates, and such affiliates may share with the Lead Arranger, any information related to the Restatement, the Borrower, any of its subsidiaries or affiliates or any of the matters contemplated hereby in connection with the Restatement.

The provisions of the immediately preceding two paragraphs shall survive any termination of this Commitment Letter.

You represent and warrant that (a) all information that has been or will hereafter be made available by or on behalf of you or by any of your representatives in connection with the Restatement and the other transactions contemplated hereby to the Lead Arranger or any of its affiliates or representatives or to any Lender or any potential Lender is and will be complete and correct in all material respects and does not and will not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading in light of the circumstances under which such statements were or are made and (b) all financial projections, if any, that have been or will be prepared by you or on your behalf or by any of your representatives and made available to the Lead Arranger or any of its affiliates or representatives or to any Lender or any potential Lender in connection with the Restatement and the other transactions contemplated hereby have been or will be prepared in good faith based upon reasonable assumptions (it being understood that such projections are subject to significant uncertainties and contingencies, many of which are beyond your control, and that no assurance can be given that any particular projections will be realized). You agree to supplement the information and projections from time to time so that the representations and warranties contained in this paragraph remain complete and correct in all material respects.

In issuing these commitments, the Lead Arranger is relying on the accuracy of the information furnished to it by you or on your behalf or by or on behalf of the Borrower (collectively, the “ Pre-Commitment Information ”). The obligations of the Lead Arranger under this Commitment Letter and of any Lender that issues a commitment for the Senior Bank Financing are made solely for your benefit and may not be relied upon or enforced by any other person or entity.

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Commitment Letter

Scotia hereby notifies you that pursuant to the requirements of the USA Patriot Act, Title III of Pub. L. 107-56 (signed into law October 26, 2001) (the “ Patriot Act ”), Scotia may be, and each Lender is, required to obtain, verify and record information that identifies you, which information includes the name, address, tax identification number and other information regarding you that will allow Scotia or such Lender to identify you in accordance with the Patriot Act. This notice is given in accordance with the requirements of the Patriot Act and is effective as to Scotia and each Lender.

You, on behalf of yourself and your affiliates, acknowledge and agree that in connection with all aspects of the transactions contemplated by this Commitment Letter, you, Scotia, the Lenders, and any affiliate through which any of them may be acting (each, a “ Transaction Affiliate ”), have an arm’s-length business relationship that creates no fiduciary duty on the part of Scotia, any Lender or any other Transaction Affiliate and each expressly disclaims any fiduciary relationship.

You acknowledge that Scotia and its affiliates may be providing debt financing, equity capital or other services (including financial advisory services) to other companies in respect of which you may have conflicting interests regarding the transactions described herein and otherwise. Neither we nor any of our affiliates will use confidential information obtained from you by virtue of the transactions contemplated by this Commitment Letter or our other relationships with you in connection with the performance by us of services for other companies, and we will not furnish any such information to other companies. You also acknowledge that neither we nor any of our affiliates has any obligation to use in connection with the transactions contemplated by this Commitment Letter, or to furnish to you, confidential information obtained by us from other companies.

You are not authorized to show or circulate this Commitment Letter to any other person or entity (other than your legal and financial advisors in connection with your evaluation hereof and except as required by law or stock exchange requirements) until such time as you have accepted this Commitment Letter as provided in the immediately succeeding paragraph. The Lead Arranger, on behalf of itself and its affiliates, hereby agrees that it will not disclose to any person or entity any confidential, proprietary or non-public information of Kansas City Southern, a Delaware corporation (“ Holdings ”) and its subsidiaries furnished to the Lead Arranger by the Borrower (such information collectively, “ Company Information ”), except that the Lead Arranger may disclose Company Information (i) to its and its affiliates’ officers, directors, employees, agents, accountants, attorneys, and other advisors (collectively “ Lead Arranger Representatives ”) who have a need to know such Company Information for the purpose of assisting in the negotiation and completion of the Senior Bank Financing, (ii) to actual or potential Lenders who have agreed to hold the Company Information in confidence on substantially the same terms as provided herein, and (iii) to the extent any portion of such Company Information (A) is or becomes generally available to the public on a non-confidential basis other than as a result of a breach of this paragraph by any Lead Arranger or the Lead Arranger Representatives, (B) is or becomes available to the Lead Arranger or any Lead Arranger Representatives on a non-confidential basis from a source other than the Borrower or (C) is required to be disclosed by law, regulation or judicial order or is requested by any regulatory body with jurisdiction over any Lead Arranger or a Lead Arranger Representative. Notwithstanding anything to the contrary in this Commitment Letter, the Lead Arranger’s obligations under this paragraph shall terminate on the earlier of (i) the first anniversary of the date of this Commitment Letter and (ii) if definitive agreements are entered into for the Senior Bank Financing, the date such definitive agreements are executed (in which case the confidentiality obligations of the Lead Arranger under this paragraph shall be superseded by the confidentiality obligations in such definitive agreements).

If this Commitment Letter is not accepted by you as provided in the immediately succeeding paragraph, you are to immediately return this Commitment Letter (and any copies hereof) to the undersigned. This Commitment Letter may be executed in any number of counterparts, and by the

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Commitment Letter

different parties hereto on separate counterparts, each of which counterpart shall be an original, but all of which shall together constitute one and the same instrument.

If you are in agreement with the foregoing, please sign and return to the Lead Arranger (including by way of facsimile transmission) the enclosed copy of this Commitment Letter, together with the Fee Letter, no later than noon, New York time, on March 17, 2006. Our commitments set forth in this Commitment Letter shall terminate at the time and on the date referenced in the immediately preceding sentence unless this Commitment Letter and the Fee Letter are executed and returned by you as provided in such sentence.

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Commitment Letter

This Commitment Letter and the Fee Letter shall be governed by, and construed in accordance with the laws of the state of New York, and any right to trial by jury with respect to any claim, action, suit or proceeding arising out of or contemplated by this Commitment Letter and/or the related Fee Letter is hereby waived. The parties hereto hereby submit to the non-exclusive jurisdiction of the federal and New York State courts located in the City of New York in connection with any dispute related to this Commitment Letter or the Fee Letter or any matters contemplated hereby or thereby. Delivery of an executed counterpart of this Commitment Letter by facsimile or other electronic transmission shall be effective as delivery of a manually executed counterpart of this Commitment Letter.


		Very truly yours,

		THE BANK OF NOVA SCOTIA

		By		/s/ V.H. Gibson
				Title: V.H. Gibson, Assistant Agent

Agreed to and Accepted this
17 ^th day of March, 2006


THE KANSAS CITY SOUTHERN RAILWAY COMPANY

By		/s/ Paul J. Weyandt
		Title: Senior Vice President-Finance & Treasurer

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Commitment Letter

EXHIBIT A

SUMMARY OF CERTAIN TERMS AND CONDITIONS ¹

I. The Parties


*Borrower* :		The Kansas City Southern Railway Company, a Missouri corporation
		(“ *Kansas City Southern* ”).

*Holdings* :		Kansas City Southern, a Delaware corporation.

*Lead Arranger*
*And Bookrunner* :		Scotia Capital.

*Syndication Agent* :		To be determined.

*Administrative Agent* :		The Bank of Nova Scotia.

*Documentation Agent* :		To be determined.

*Lenders* :		The Bank of Nova Scotia and a syndicate of financial institutions and institutional lenders arranged by the Lead Arranger in consultation with the Borrower.

*Guarantors* :		Similar to the $250 million Credit Agreement dated as of March 30, 2004 (as amended by (i) Amendment and Waiver No. 1 to the Credit Agreement and Amendment No. 1 to the Security Agreement, dated as of December 22, 2004, (ii) Amendment and Waiver No. 2 to the Credit Agreement, dated as of September 30, 2005, (iii) Amendment No. 3 to the Credit Agreement, dated as of November 4, 2005, (iv) Waiver No. 3 to the Credit Agreement, dated as of December 8, 2005, and (v) Waiver No. 4 to the Credit Agreement, dated as of March 1, 2006, and as may be further amended or otherwise modified from time to time, the “ *Existing Credit Facility* ”), all obligations under the Senior Bank Financing shall be unconditionally guaranteed by Holdings and each of Holdings’ and the Borrower’s direct and indirect wholly-owned domestic subsidiaries (Holdings and all of such subsidiaries being, collectively, the “ *Guarantors* ”), subject to customary exceptions and exclusions (consistent with the Existing Credit Facility) and release mechanics for transactions of this type and subject to the exclusion of certain subsidiaries to be agreed.


¹		Terms used herein and not otherwise defined being used as defined in the Commitment Letter to which this Exhibit A is attached.

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions

II. Description of Credit Facilities Comprising the Senior Bank Financing

A. Term Loan Facility


*Term Loan B Facility* :		$246.2 million Term Loan B Facility.

*Maturity and Amortization* :		The final maturity of the Term Loan B Facility shall be the date which occurs seven years after the Closing Date. The loans under the Term Loan B Facility (the “ *Term B Loans* ”), shall be repaid during the final year of the Term B Loans in equal quarterly amounts, subject to amortization of approximately 1% per year prior to such final year.

*Use of Proceeds* :		The Term B Loans shall only be utilized (i) to effect the amendment and restatement of the Existing Credit Facility (the “ *Restatement* ”) and to pay fees and expenses incurred in connection with the Restatement, and (ii) for general corporate purposes.

*Availability* :		Term B Loans may only be borrowed on the Closing Date. No amount of Term B Loans once repaid may be reborrowed.

B. Revolving Credit Facility


Revolving Credit Facility :		$125 million Revolving Credit Facility, with a letter of credit sublimit of $25 million and a swingline of $15 million.

*Maturity* :		The final maturity of the Revolving Credit Facility shall be the date which occurs five years after the Closing Date. Loans made pursuant to the Revolving Credit Facility (the “ *Revolving Loans* ”) shall be repaid in full on the fifth anniversary of the Closing Date, and all letters of credit issued thereunder shall terminate prior to such time.

*Use of Proceeds* :		The Revolving Loans shall be utilized solely for the Borrower’s and its subsidiaries’ working capital requirements and other general corporate purposes.

*Availability* :		Revolving Loans may be borrowed, repaid and reborrowed on and after the Closing Date.

III. Terms Applicable to the Entire Senior Bank Financing


*Closing Date*	On or before April 30, 2006.

*Security* :	Similar to the Existing Credit Facility, the Borrower and each of the Guarantors shall grant the Administrative Agent and the Lenders a valid and perfected first priority (subject to certain exceptions to be set forth in the loan documentation) lien and security interest in all of the following:

	(a)	All shares of capital stock of (or other ownership interests in) and intercompany debt of the Borrower and each present and future domestic subsidiary of the Borrower or such Guarantor

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions


		(excluding, for the avoidance of doubt, the Meridian Speedway Joint Venture (as defined in the Existing Credit Facility)).

	(b)	All present and future property and assets, real and personal, of the Borrower or such Guarantor, including, but not limited to, machinery and equipment (including, without limitation, rolling stock equipment and accessories), inventory and other goods, accounts receivable, owned real estate, leaseholds, fixtures, bank accounts, general intangibles, license rights, patents, trademarks, tradenames, copyrights, chattel paper, insurance proceeds, contract rights, hedge agreements, documents, instruments, indemnification rights, tax refunds and cash, but excluding rolling stock acquired after the Closing Date that is subject to purchase money financing within 180 days of acquisition.

	(c)	All proceeds and products of the property and assets described in clauses (a) and (b) above.

	In addition, Holdings shall not pledge, or permit any of its subsidiaries to pledge, the equity interests in the Meridian Speedway Joint Venture to any third party without the prior written consent of the Administrative Agent.

	Notwithstanding the foregoing, the Lead Arranger may agree to exclude particular assets from time to time acquired by the Borrower or any Guarantor from the collateral package if it determines that the cost of including such assets would be excessive relative to the benefits to the Lenders of including such assets as collateral.

*Interest Rates* :	At the option of the Borrower, the Revolving Loans and the Term Loan (collectively, the “ *Loans* ”) may be maintained from time to time as (x) Base Rate Loans which shall bear interest at the Applicable Margin in excess of the Base Rate in effect from time to time or (y) Eurodollar Loans which shall bear interest at the Applicable Margin in excess of the Eurodollar Rate (adjusted for maximum reserves) as determined by the Administrative Agent for the respective interest period, provided that until the earlier to occur of (x) the 30th day following the Closing Date and (y) that date upon which the Lead Arranger has determined (and notifies the Borrower) that the primary syndication of the Senior Bank Financing (and the resultant addition of institutions as Lenders) has been completed no Eurodollar Loans having an interest period greater than one month may be incurred.

	“ *Base Rate* ” shall mean the higher of (x) 1/2 of 1% in excess of the federal funds rate or (y) the rate that the Administrative Agent announces from time to time as its prime or base commercial lending rate, as in effect from time to time.

	The “ *Applicable Margin* ” means at any time (a) with respect to the Revolving Credit Facility, (i) until the first date after the Closing Date when the Borrower delivers the financial statements and related

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions


		certificates and schedules required by the loan documentation for the Senior Bank Financing, 1.50% per annum in the case of Eurodollar Rate Loans and 0.50% per annum in the case of Base Rate Loans, and (ii) thereafter, the applicable percentage per annum determined in accordance with the step-ups and step-downs reflected on the pricing grid set forth in Annex A hereto and (b) with respect to the Term B Facility, 1.50% per annum in the case of Eurodollar Rate Loans and 0.50% per annum in the case of Base Rate Loans.

		Interest will accrue, in the case of overdue amounts, at the otherwise applicable rate plus 2% per annum.

		Interest periods of 1, 2, 3 and 6 months (or such shorter periods as may be available and acceptable to the Lenders) shall be available in the case of Eurodollar Loans.

		Interest in respect of Base Rate Loans shall be payable quarterly in arrears on the last business day of each quarter. Interest in respect of Eurodollar Loans shall be payable in arrears at the end of the applicable interest period and every three months in the case of interest periods in excess of three months. Interest will also be payable at the time of repayment of any Loans, and at maturity. All interest accruing by reference to the Eurodollar Rate and other fee calculations shall be based on a 360-day year and all interest accruing by reference to the Base Rate shall be calculated based on a 365/366 day year.

Unused Commitment Fees :		The applicable percentage per annum determined in accordance with the step-ups and step-downs reflected on the pricing grid set forth in Annex A hereto on the unused portion of each Lender’s share of the Senior Bank Financing from and after the Closing Date, payable (a) quarterly in arrears and (b) on the date of termination or expiration of the commitments.

*Letter of Credit Fees* :		Applicable Margin for Eurodollar Loans which are Revolving Loans on the aggregate outstanding stated amounts of letters of credit plus an additional 1/4 of 1% on the aggregate outstanding stated amounts of letters of credit to be paid as a fronting fee to the issuing bank.

Voluntary Commit- ment Reductions :		Substantially similar to the Existing Credit Facility.

*Voluntary Prepayment* :		Substantially similar to the Existing Credit Facility.

Mandatory Prepayment :		Substantially similar to the Existing Credit Facility, all net cash proceeds (a) from sales of property and assets of Holdings and its subsidiaries (except for sales of inventory, non-operating assets and non-income producing assets in the ordinary course of business and subject to a reinvestment provision to be negotiated and an additional annual basket of an amount to be agreed), (b) property insurance and condemnation

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions


	proceeds (subject to a reinvestment provision to be negotiated), and (c) from the issuance after the Closing Date of additional debt of Holdings and its subsidiaries otherwise permitted under the loan documentation (subject to exceptions to be agreed and except that proceeds not exceeding $125 million received in connection with indebtedness incurred by Holdings or its subsidiaries owing to the Meridian Speedway Joint Venture (as defined in the Existing Credit Facility) and as currently permitted by the Existing Credit Facility shall not be subject to a mandatory prepayment of the Term Loan B Facility), and 50% of Excess Cash Flow (to be defined in the loan documentation) of the Borrower and its subsidiaries for so long as the total leverage ratio is greater than 4.00:1:00, shall be applied to prepay the Senior Bank Financing, ratably to the principal repayment installments of the Term B Facility on a pro rata basis and then to the Revolving Credit Facility.

*Documentation* :	Each of the commitments will be subject to the negotiation, execution and delivery of definitive financing agreements (and related security documentation, guaranties, etc.) consistent with this Summary of Certain Terms and Conditions, in each case prepared by counsel to the Lead Arranger.

*Conditions Precedent to Initial Extension of Credit*	The final loan documentation will contain the following conditions precedent:
:

	(a)	The final terms and conditions of the Restatement, including, without limitation, all legal and tax aspects thereof, shall be as described in the Commitment Letter and otherwise consistent with the description thereof received in writing as part of the information furnished by or on behalf of the Borrower (the “ *Pre-Commitment Information* ”).

	(b)	All of the capital stock of the Borrower shall be owned by Holdings and all capital stock of the Borrower’s subsidiaries shall be owned by the Borrower, Holdings, or one or more of the Borrower’s subsidiaries, in each case free and clear of any lien, charge or encumbrance, other than the liens and security interests created under the loan documentation; the Lenders shall have a valid and perfected first priority (subject to certain exceptions to be set forth in the loan documentation) lien and security interest in such capital stock (other than the stock of the Meridian Speedway Joint Venture) and in the other collateral referred to under the section “ *Security* ” above; all filings, recordations and searches necessary or desirable in connection with such liens and security interests shall have been duly made; and all filing and recording fees and taxes shall have been duly paid. Notwithstanding the foregoing, the Lead Arranger may grant reasonable extensions of time for the perfection of liens on real property and other particular assets where perfection cannot be accomplished by the Closing Date.

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions


		(c)		All governmental and third party consents and approvals necessary in connection with the Restatement and the Senior Bank Financing shall have been obtained (without the imposition of any conditions that are not acceptable to the Lenders) and shall remain in effect; all applicable waiting periods shall have expired without any adverse action being taken by any competent authority; and no law or regulation shall be applicable in the judgment of the Lenders that restrains, prevents or imposes materially adverse conditions upon the Restatement or the Senior Bank Financing.

		(d)		The Borrower and each Guarantor shall have delivered certificates, in form and substance satisfactory to the Lenders, attesting to the Solvency (as hereinafter defined) of the Borrower and such Guarantor, as the case may be, in each case individually and together with its subsidiaries, taken as a whole, immediately before and immediately after giving effect to the Restatement, from their respective chief financial officers. As used herein, the term “ *Solvency* ” of any person means (i) the fair value of the property of such person exceeds its total liabilities (including, without limitation, contingent liabilities), (ii) the present fair saleable value of the assets of such person is not less than the amount that will be required to pay its probable liability on its debts as they become absolute and matured, (iii) such person does not intend to, and does not believe that it will, incur debts or liabilities beyond its ability to pay as such debts and liabilities mature and (iv) such person is not engaged, and is not about to engage, in business or a transaction for which its property would constitute an unreasonably small capital.

		(e)		The Lenders shall have been given such access to the management, records, books of account, contracts and properties of Holdings and its subsidiaries and shall have received such financial, business and other information regarding each of the foregoing persons as they shall have requested, including, without limitation, information as to possible contingent liabilities, tax matters, collective bargaining agreements and other arrangements with employees, annual financial statements dated December 31, 2005, accompanied by an unqualified opinion of independent auditors of Holdings and its subsidiaries, pro forma consolidated financial statements as to the Borrower and its subsidiaries, and forecasts prepared by management of the Borrower, in a form satisfactory to the Lenders, of balance sheets, income statements and cash flow statements on a quarterly basis for the first year following the Closing Date and on an annual basis for the three succeeding years thereafter.

		(f)		The Lenders shall have received (i) satisfactory opinions of counsel for the Borrower and the Guarantors as to the transactions contemplated hereby and (ii) such corporate

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions


		resolutions, certificates and other documents as the Lenders shall reasonably request.

	(g)	The Borrower shall have, and shall have caused each other obligor under the security documents to, execute and deliver any and all further documents, financing statements, agreements and instruments, and take all such further actions that may be required to cause the collateral to have a perfected, first priority security interest in favor of the Secured Parties (to be defined in the Senior Bank Financing).

	(h)	There shall exist no default under any of the loan documentation, and the representations and warranties of the Borrower and each of the Guarantors therein shall be true and correct immediately prior to, and after giving effect to, the initial extension of credit under the loan documentation.

	(i)	All accrued fees and expenses of the Administrative Agent, the Lead Arranger and the Lenders (including the fees and expenses of counsel for the Lead Arranger and local counsel for the Lenders) shall have been paid.

	(j)	The Senior Bank Financing shall have received debt ratings from Moody’s and S&P.

*Conditions Precedent to Subsequent Extensions of Credit* :	There shall exist no default under any of the loan documentation, and the representations and warranties of the Borrower and each of the Guarantors therein shall be true and correct immediately prior to, and after giving effect to, such extension of credit.

*Representations and Warranties, Covenants and Events of Default* :	Substantially similar to the Existing Credit Facility except that:

	(k)	Covenant thresholds/levels shall be determined upon a review of revised projections.

	(l)	The definition of “Debt” in the documentation in respect of the Senior Bank Financing shall exclude certain indebtedness in respect of purchase agreement indemnity and other claims that may be satisfied by Kansas City Southern or its subsidiaries with the issuance of stock or other equity interests of Kansas City Southern or its subsidiaries; provided that such indebtedness must be repaid with such stock or equity interests unless (i) after giving effect to any payment in cash, the Parent would have been in compliance with the financial covenants (including the leverage ratio) as determined on a pro forma basis as of the most recently ended fiscal quarter as if such indebtedness had constituted “Debt” or (ii) if the Revolving Credit Facility would

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions


		remain undrawn after such repayment and have availability thereunder of not less than $25 million.

	(m)	If the ratings of the Senior Bank Financing are less than Ba3 from Moody’s and BB+ from S&P, in each case with stable outlook, at such time, the Senior Bank Financing shall mature on the date that is 90 days prior to the maturity date of any public debt securities of the Borrower unless (i) such debt securities are successfully refinanced on or prior to such date or (ii) an amount sufficient to indefeasibly repay such debt securities has been deposited with the applicable bond trustee on or prior to such date and, after giving pro forma effect to such deposit, the Borrower is in pro forma compliance with all financial covenants.

*Expenses* :	The Borrower shall pay all of the Administrative Agent’s and the Lead Arranger’s reasonable fees and all other out-of-pocket expenses incurred by the Administrative Agent or the Lead Arranger (including the fees and expenses of counsel for the Lead Arranger) in connection with syndicating and documenting the Senior Bank Financing, whether or not any of the transactions contemplated hereby are consummated, as well as all reasonable expenses of the Administrative Agent in connection with the administration of the loan documentation. The Borrower shall also pay the reasonable expenses of the Administrative Agent, the Lead Arranger and the Lenders in connection with the enforcement of any of the loan documentation.

*Indemnity* :	The Borrower will indemnify and hold harmless the Administrative Agent, the Lead Arranger, each Lender and each of their affiliates and their officers, directors, employees, agents and advisors from claims and losses relating to the Restatement or the Senior Bank Financing other than to the extent such claims or losses have been finally determined by a court of competent jurisdiction to have resulted directly and primarily from the gross negligence or willful misconduct of such person.

*Required Lenders* :	Lenders holding more than 50% of the aggregate amount of loans and commitments under the Senior Bank Financing.

*Waivers & Amendments* :	Substantially similar to the Existing Credit Facility.

*Assignments and Participations* :	Assignments must be to Eligible Assignees (as defined in the Existing Credit Facility) approved by the Borrower for so long as no event of default has occurred and been continuing (such approval not to be unreasonably withheld) and, in each case other than an assignment to a Lender or an assignment of the entirety of a Lender’s interest in the Senior Bank Financing, in a minimum amount equal to $1 million. Each Lender will also have the right, without consent of the Borrower or the Administrative Agent, to assign (i) as security all or part of its rights under the loan documentation to any Federal Reserve Bank and (ii) all or

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions


		part of its rights or obligations under the loan documentation to any of its affiliates. No participation shall include voting rights, other than for reductions or postponements of amounts payable or releases of all or substantially all of the collateral.

*Taxes* :		All payments to be free and clear of any present or future taxes, withholdings or other deductions whatsoever (other than income taxes in the jurisdiction of the Lender’s applicable lending office). The Lenders will use reasonable efforts (consistent with their respective internal policies and legal and regulatory restrictions and so long as such efforts would not otherwise be disadvantageous to such Lenders) to minimize to the extent possible any applicable taxes and the Borrower will indemnify the Lenders and the Administrative Agent for such taxes paid by the Lenders or the Administrative Agent.

*Miscellaneous* :		Standard yield protection (including compliance with risk-based capital guidelines, increased costs, payments free and clear of withholding taxes and interest period breakage indemnities), eurodollar illegality and similar provisions, defaulting lender provisions, waiver of jury trial, submission to jurisdiction and judgment currency provisions.

*Governing Law* :		New York.

Counsel for the Lead Arranger :		Shearman & Sterling LLP.

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions

Annex A

Pricing Grid


	Applicable			Applicable
	Margin for			Margin for			Unused
	Base Rate			Eurodollar			Commitment
Leverage Ratio	Loans			Rate Loans			Fee
Level I greater than 5.25: 1.00		0.500	%		1.500	%		0.500	%

Level II greater than 4.25: 1.00 but less than or equal to 5.25: 1.00		0.250	%		1.250	%		0.500	%

Level III greater than 3.25: 1.00 but less than or equal to 4.25:1.00		0.000	%		1.000	%		0.375	%

Level IV less than or equal to 3.25: 1.00		0.000	%		0.875	%		0.375	%

THE KANSAS CITY SOUTHERN RAILWAY COMPANY
Summary of Certain Terms and Conditions

EXHIBIT 12.1

KANSAS CITY SOUTHERN
AND SUBSIDIARY COMPANIES
COMPUTATION OF COMBINED RATIO OF EARNINGS TO FIXED CHARGES


	As of December 31st
	2001		2002		2003				2004		2005

Pretax income/(loss) from continuing operations, excluding equity in earnings of unconsolidated affiliates	$	6.8	$	20.7	$	(10.5	)		$	52.5	$	73.1

Interest Expense on Indebtedness		52.8		45.0		46.4				44.4		133.5

Portion of Rents Representative of an Appropriate Interest Factor		18.9		18.3		19.1				19.2		34.3

Distributed income of equity investments		3.0		—		—				8.8		8.3


Income (Loss) as Adjusted	$	81.5	$	84.0	$	55.0			$	124.9	$	249.2


Fixed Charges:

Interest Expense on Indebtedness	$	52.8	$	45.0	$	46.4			$	44.4	$	133.5

Capitalized Interest		4.2		1.7		—				—		—

Portion of Rents Representative of an Appropriate Interest Factor		18.9		18.3		19.1				19.2		34.3

Preferred Security Dividend as defined by Item 503(d)(B) of Regulation S-K		0.4		0.4		7.7				14.2		15.4


Total Fixed Charges	$	76.3	$	65.4	$	73.2			$	77.8	$	183.2


Ratio of Earnings to Fixed Charges and preference dividends		1.1		1.3		0.8		(a)		1.6		1.4


Ratio of Earnings to Fixed Charges		1.1		1.3		0.8				2.0		1.5

Note: Excludes amortization expense on debt discount due to immateriality

(i)		Income from continuing operations for the year ended December 31, 2005, reflects the acquisition of Grupo TFM, effective April 1, 2005 and Mexrail effective January 1, 2005. The acquisitions were accounted for as purchases and are included in the consolidated results of operations for periods following the respective acquisition dates.

(ii)		The ratio of earnings to fixed charges is computed by dividing earnings by fixed charges. For this purpose “earnings” represent the sum of (i) pretax income from continuing operations adjusted for income (loss) from unconsolidated affiliates, (ii) fixed charges, (iii) distributed income from unconsolidated affiliates and (iv) amortization of capitalized interest, less capitalized interest. “Fixed charges” represent the sum of (i) interest expensed, (ii) capitalized interest, (iii) amortization of deferred debt issuance costs and (iv) one-third of our annual rental expense, which management believes is representative of the interest component of rental expense.

(iii)		For the year ended December 31, 2003, the ratio of earnings to fixed charges was less than 1:1. The ratio of earnings to fixed charges would have been 1:1 if a deficiency of $10.5 million was eliminated.

(iv)		The ratio of earnings to combined fixed charges and preference dividends is computed by dividing earnings by combined fixed charges and preference dividends. For this purpose “earnings” represent the sum of (i) pretax income from continuing operations adjusted for income (loss) from unconsolidated affiliates, (ii) fixed charges, (iii) distributed income from unconsolidated affiliates and (iv) amortization of capitalized interest, less capitalized interest. “Fixed charges” represent the sum of (i) interest expensed, (ii) capitalized interest, (iii) amortization of deferred debt issuance costs, (iv) one-third of our annual rental expense, which management believes is representative of the interest component of rental expense and (v) the amount of pre-tax earnings that is required to pay the dividends on outstanding preferred stock.

(v)		For the year ended December 31, 2003, the ratio of earnings to combined fixed charges and preference dividends was less than 1:1. The ratio of earnings to combined fixed charges and preference dividends would have been 1:1 if a deficiency of $18.2 million was eliminated.

Page 1

Exhibit 21.1

Subsidiaries of the Company

Kansas City Southern, a Delaware corporation, has no parent. All subsidiaries of the Company listed below are included in the consolidated financial statements unless otherwise indicated


	Percentage of		State or other Jurisdiction of
	Ownership		Incorporation or Organization
Arrendadora TFM, S.A. de C.V. (12)		100	Mexico
Canama Transportation (6)		100	Cayman Islands
Caymex Transportation, Inc. (1)		100	Delaware
Gateway Eastern Railway Company (1)		100	Illinois
Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V.		100	Mexico
Joplin Union Depot *		33	Missouri
Kansas City Southern de Mexico, S.A. de C.V. (5)		100	Mexico
Kansas City Southern International, Inc		100	Delaware
KARA Sub, Inc.		100	Delaware
KCS Investment I, Ltd. (11)		100	Delaware
KCSRC y Compania, S, de N.C. de C.V. (1)		100	Mexico
KC Terminal Railway (9)		16	Missouri
Merician Speedway, LLC (1)		100	Delaware
Mexrail, Inc.		100	Delaware
NAFTA Rail, S.A. de C.V. (6)		100	Mexico
North American Freight Transportation		100	Delaware
PABTEX GP, LLC (2)		100	Texas
PABTEX L.P. (11)		100	Delaware
Panama Canal Railway Company *(7)		50	Cayman Islands
Panarail Tourism Company (8)		100	Cayman Islands
Port Arthur Bulk Marine Terminal Co. (1)		80	Partnership
SIS Bulk Holding, Inc. (2)		100	Delaware
Southern Capital Corporation, LLC *(1)		50	Colorado
Southern Development Company (1)		100	Missouri
Southern Industrial Services, Inc.		100	Delaware
The Kansas City Southern Railway Company		100	Missouri
The Texas Mexican Railway Company (4)		100	Texas
TransFin Insurance, Ltd.		100	Vermont
Trans-Serve, Inc. (2) (3)		100	Delaware
Veals, Inc.		100	Delaware


*		Unconsolidated Affiliate, Accounted for Using the Equity Method

(1)		Subsidiary of The Kansas City Southern Railway Company

(2)		Subsidiary of Southern Industrial Services, Inc.

(3)		Conducting business as Superior Tie & Timber

(4)		Subsidiary of Mexrail, Inc.

(5)		Subsidiary of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V.

(6)		Subsidiary of Caymex Transportation, Inc.

(7)		Unconsolidated affiliate of Canama Transportation

(8)		Subsidiary of Panama Canal Railway Company

(9)		Unconsolidated affiliate of The Kansas City Southern Railway Company

(10)		Subsidiary of SIS Bulk Holding, Inc.

(11)		Subsidiary of Kansas City Southern de Mexico, S.A. de C.V.

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Kansas City Southern:

We consent to the incorporation by reference in the registration statements on Form S-8 (Nos. 33-50517, 33-50519, 33-64511, 333-73122, 333-58250, 333-51854, 333-91478, and 333-126207) and on Form S-3 (Nos. 33-69648, 333-61006, 333-107573, and 333-130112) of Kansas City Southern of our reports dated April 17, 2006 with respect to the consolidated balance sheets of Kansas City Southern and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005, and management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2005 and the effectiveness of internal control over financial reporting as of December 31, 2005, which reports appear in the December 31, 2005 annual report on Form 10-K of Kansas City Southern. The financial statements of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (Grupo TFM), a 46.6% owned investee company, as of December 31, 2004 and for the years ended December 31, 2004 and 2003 were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Grupo TFM as of December 31, 2004 and for the years ended December 31, 2004 and 2003, is based solely on the reports of other auditors.

Our report dated April 7, 2006, on management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting as of December 31, 2005, expresses our opinion that Kansas City Southern did not maintain effective internal control over financial reporting as of December 31, 2005 because of the effect of a material weakness on the achievement of the objectives of the control criteria and contains an explanatory paragraph that states that the Company lacked sufficient personnel with adequate expertise in accounting for income taxes, effective reconciliation procedures related to income tax accounts and sufficient oversight of the income tax accounting function by management. As a result, the Company is restating the opening retained earnings balance for the year ended December 31, 2003 in connection with issuing the 2005 consolidated financial statements to reflect the correction of errors in the accounting for income taxes. Additionally, a material misstatement was identified in the income tax provision in the 2005 consolidated financial statements.

Our report dated April 7, 2006 on management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting as of December 31, 2005 contains an explanatory paragraph that the Company acquired control of Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. (Grupo TFM) and its subsidiary, Kansas City Southern de Mexico, S.A. de C.V. (KCSM) on April 1, 2005. Management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 Grupo TFM’s and KCSM’s internal control over financial

reporting which represents 53% of the Company’s consolidated total assets and 41% of the Company’s consolidated total revenues included in the consolidated financial statements of the Company and its subsidiaries as of and for the year ended December 31, 2005. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Grupo TFM and KCSM.

Our report dated April 7, 2006 on the consolidated financial statements contains an explanatory paragraph stating that, as discussed in note 2 to the consolidated financial statements, effective January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations .

Our report dated April 7, 2006 on the consolidated financial statements also contains an explanatory paragraph stating that, as discussed in note 13 to the consolidated financial statements, the Company restated its balance sheet as of December 31, 2004 and its statement of stockholders’ equity for the years ended December 31, 2004 and 2003.

/s/ KPMG LLP

Kansas City, Missouri
April 7, 2006

Exhibit 23.2

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-50517, 33-50519, 33-64511, 333-91993, 333-73122, 333-58250, 333-51854, 333-91478 and 333-126207) and on Form S-3 (Nos. 33-69648, 333-61006, 333-107573 and 333-130112) of Kansas City Southern of our report dated April 16, 2005, with respect to the consolidated balance sheets of Grupo Transportación Ferroviaria Mexicana, S.A. de C.V., as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for each of the years in the two-year period ended December 31, 2004, which are included in this Annual Report on Form 10-K. We also consent to the references to us under the headings “Experts” in such Registration Statements.

Mexico City, April 7, 2006

/s/ PricewaterhouseCoopers, S.C.

Exhibit 31.1

CERTIFICATIONS

I, Michael R. Haverty, certify that:

1.		I have reviewed this annual report on Form 10-K of Kansas City Southern (the “registrant”);

2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.		The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	(a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)		Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	(c)		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(d)		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and;

The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting, which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: April 7, 2006


		/s/ Michael R. Haverty
		Michael R. Haverty
		Chairman, President and Chief Executive Officer

Exhibit 31.2

CERTIFICATIONS

I, Ronald G. Russ, certify that:

1.		I have reviewed this annual report on Form 10-K of Kansas City Southern (the “registrant”);

2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.		The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	(c)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(d)		Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	(c)		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(d)		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: April 7, 2006


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

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

In connection with the Annual Report of Kansas City Southern (the “Company”) on Form 10-K for the year ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, Michael R. Haverty, Chairman, President and Chief Executive Officer of the Company, and Ronald G. Russ, Executive Vice President and Chief Financial Officer of the Company, each hereby certifies that, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

	(1)		The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 other than the requirement related to the filing of this 10-K and Annual Report within the time period specified in the appropriate report form; and

	(2)		The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Michael R. Haverty
Michael R. Haverty
Chairman, President and Chief Executive Officer
April 7, 2006

/s/ Ronald G. Russ
Ronald G. Russ
Executive Vice President and Chief Financial Officer
April 7, 2006

A signed original of this written statement required by Section 906 has been provided to Kansas City Southern and will be retained by Kansas City Southern and furnished to the Securities and Exchange Commission or its staff upon request.

Exhibit 99.1

GRUPO TRANSPORTACIÓN FERROVIARIA
MEXICANA, S. A. DE C. V.

COMBINED AND CONSOLIDATED
FINANCIAL STATEMENTS

DECEMBER 31, 2002, 2003 AND 2004

GRUPO TRANSPORTACIÓN FERROVIARIA
MEXICANA, S. A. DE C. V.

COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2002, 2003 AND 2004

INDEX


Contents	Page

Report of Independent Registered Public Accounting Firm		1

Consolidated Balance Sheets		2

Combined and Consolidated Statements of Operations		3

Consolidated Statements of Cash Flows		4

Combined and Consolidated Statements of Changes in Stockholders’ Equity		5

Notes to the Combined and Consolidated Financial Statements		6 to 42

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Grupo Transportación Ferroviaria Mexicana, S. A. de C. V.

We have audited the accompanying consolidated balance sheets of Grupo Transportación Ferroviaria Mexicana, S. A. de C. V. and subsidiaries as of December 31, 2004 and 2003, and the related combined and consolidated statements of income, of cash flows and of changes in stockholders’ equity for each of the three years in the period ended December 31, 2004, all expressed in US dollars. These combined and consolidated financial statements are the responsibility of the Company’s Management. Our responsibility is to express an opinion on these combined and consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by Management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the aforementioned combined and consolidated financial statements present fairly, in all material respects, the consolidated financial position of Grupo Transportación Ferroviaria Mexicana, S. A. de C. V. and subsidiaries as of December 31, 2004 and 2003, and the combined and consolidated results of their operations, their cash flows and the changes in their stockholders’ equity for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.

/s/ PricewaterhouseCoopers, S. C.

PricewaterhouseCoopers, S. C.

Mexico City, April 16, 2005

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

CONSOLIDATED BALANCE SHEETS
(Note 1)

(Amounts in thousands of US dollars, except share amount)


	December 31,
Assets	2003			2004

Current assets:
Cash and cash equivalents	$	3,597		$	14,245
Accounts receivable — net of allowance for doubtful accounts of $3,921 in 2003 and $3,871 in 2004		101,595			106,014
Accounts receivable from related parties (Note 11)		1,550			31,569
Taxes recoverable (Note 3)		51,244			41,902
Other accounts receivable — Net (Note 4)		34,046			30,155
Inventories (Note 5)		16,693			21,738
Other current assets (Note 6)		13,090			7,036


Total current assets		221,815			252,659

Concession rights and related assets, net (Note 7)		1,174,217			1,130,917
Properties, net (Note 8)		660,294			558,669
Investments held in associate company (Note 2a.)		8,020			8,061
Deferred income taxes and employee statutory profit sharing (Note 15)		238,474			255,081
Debt issuance cost and other assets		30,844			29,575


Total assets	$	2,333,664		$	2,234,962


Current liabilities:
Current portion of long-term debt (Note 9)	$	194,666		$	66,376
Interest payable		3,912			4,073
Current portion of capital lease obligations (Note 16)		414			373
Payable to related parties (Note 11)		6,150			3,907
Suppliers		76,902			57,169
Accounts payable and advance payments from customers		38,706			46,930
Provisions and accrued expenses (Note 12)		38,079			32,574


Total current liabilities		358,829			211,402


Long-term debt (Note 9)		771,380			838,940
Long-term portion of capital lease obligations (Note 16)		1,556			1,255
Liability under association in participation agreement		118,688			118,688
Other long-term liabilities (Note 13)		33,724			25,204


Total long-term liabilities		925,348			984,087


Total liabilities		1,284,177			1,195,489


Minority interest (Note 2r.)		236,301			234,633


Commitments and contingencies (Note 16)

Stockholders’ equity (Note 14):
Common stock, 10,063,570 shares authorized, issued without par value		807,008			807,008
Treasury shares		(204,904	)		(204,904	)
Effect on purchase of subsidiary shares		(17,115	)		(17,115	)
Retained earnings		228,197			219,851


Total stockholders’ equity		813,186			804,840


Total liabilities and stockholders’ equity	$	2,333,664		$	2,234,962

The accompanying notes are an integral part of these consolidated financial statements.

(2)

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

COMBINED AND CONSOLIDATED STATEMENTS OF OPERATIONS
(Note 1)

(Amounts in thousands of US dollars)


	Year ended December 31,
	2002			2003			2004

Revenues	$	712,140		$	698,528		$	699,225


Operating expenses:
Purchased services		178,358			190,344			165,396
Compensation and benefits		98,338			110,234			110,830
Depreciation and amortization		83,011			87,166			88,732
Fuel, material and supplies		58,594			71,843			89,381
Other leases		55,738			56,884			53,027
Car hire		42,245			42,378			41,986
Other costs		37,960			32,387			43,818


		554,244			591,236			593,170


Operating income		157,896			107,292			106,055


Equity in net earnings of unconsolidated affiliates (Note 2a.)		1,269			282			41
Interest income		4,974			1,509			514
Interest expense		(100,789	)		(112,641	)		(112,296	)
Exchange (loss) gain — Net		(17,411	)		(13,695	)		429


Income (loss) before income taxes and minority interest		45,939			(17,253	)		(5,257	)

Income tax (benefit) provision (Note 15)		(91,505	)		(51,489	)		4,710


Income (loss) before minority interest		137,444			34,236			(9,967	)
Minority interest		(27,260	)		(6,922	)		1,621


Net income (loss) for the year	$	110,184		$	27,314		$	(8,346	)

The accompanying notes are an integral part of these combined and consolidated financial statements.

(3)

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Note 1)

(Amounts in thousands of US dollars)


	Year ended December 31,
	2002			2003			2004
Cash flows from operating activities:
Net income (loss) for the year	$	110,184		$	27,314			($8,346	)


Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		83,011			87,166			88,732
Amortization of discount on senior unsecured debentures and commercial paper		23,158			370			47
Income tax and deferred income tax expense and statutory profit sharing (benefit)		(117,297	)		(73,780	)		(9,476	)
Minority interest		27,260			6,922			(1,621	)
Loss on sale of properties and write off of cost of properties, net		6,897			2,909			3,704
Gain on sale of Mexrail’s shares								12,221
Changes in working capital items:
Accounts receivable		12,966			(10,999	)		(12,399	)
Other accounts receivable		(36,915	)		21,338			7,680
Inventories		3,068			3,568			(5,696	)
Other current assets		(2,170	)		(957	)		(5,792	)
Amounts receivable to related parties		(4,180	)		741			(14,217	)
Accounts payable and accrued expenses		13,811			38,032			3,717
Other non-current assets and long-term liabilities		22,671			(2,960	)		28,923


Total adjustments		32,280			72,350			95,823


Net cash provided by operating activities		142,464			99,664			87,477


Cash flows from investing activities:

Proceeds from sale of Mexrail’s shares net of cash								27,147
Investment in Mexrail		(44,000	)
Proceeds from sale of properties		642			2,390			420
Acquisition of properties		(89,355	)		(73,121	)		(41,143	)


Net cash used in investing activities		(132,713	)		(70,731	)		(13,576	)


Cash flows from financing activities:

Payments under commercial paper		(340,000	)		(37,001	)		(10,000	)
Proceeds from commercial paper		196,738						20,000
Proceeds from senior notes		175,241
Proceeds from term loan facility		128,000
Principal payment of term loan facility					(18,286	)		(71,129	)
Principal payments under capital lease obligations		(298	)		(298	)		(339	)
Debt issuance cost		(29,718	)					(1,785	)
Acquisition of treasury shares		(162,575	)


Net cash provided by (used in) financing activities		(32,612	)		(55,585	)		(63,253	)


(Decrease) increase in cash and cash equivalents		(22,861	)		(26,652	)		10,648
Cash and cash equivalents:
At beginning of year		53,110			30,249			3,597


At end of the period	$	30,249		$	3,597		$	14,245


Supplemental information:

Cash paid during the year for interest	$	58,525		$	98,626		$	97,604


Non-cash transactions:

Due from Mexican Government	$	93,555

Due from related parties	$	20,000

Assets acquired through capital lease obligation				$	120

The accompanying notes are an integral part of these combined and consolidated financial statements.

(4)

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

COMBINED AND CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED
DECEMBER 31, 2002, 2003 AND 2004
(Notes 1 and 14)

(Amounts in thousands of US dollars)


						Effect on
						purchase of
	Common		Treasury			subsidiary			Retained
	stock		shares			shares			earnings			Total

Balance at December 31, 2001	$	807,008				$	17,912		$	90,421		$	915,341

Effect on purchase of subsidiary shares							(35,027	)		278			(34,749	)

Treasury shares			$	(204,904	)								(204,904	)

Net loss for the year										110,184			110,184


Balance at December 31, 2002		807,008		(204,904	)		(17,115	)		200,883			785,872

Net loss for the year										27,314			27,314


Balance at December 31, 2003		807,008		(204,904	)		(17,115	)		228,197			813,186

Net income for the year										(8,346	)		(8,346	)


Balance at December 31, 2004	$	807,008	$	(204,904	)	$	(17,115	)	$	219,851		$	804,840

The accompanying notes are an integral part of these combined and consolidated financial statements.

(5)

GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S. A. DE C. V.

NOTES TO THE COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004

(Amounts in thousands of US dollars ($) or thousands of pesos (Ps),
except number of shares)

NOTE 1 — THE COMPANY :

Grupo Transportación Ferroviaria Mexicana, S. A. de C. V. (“Grupo TFM”) was incorporated on July 12, 1996. In December 1996, Grupo TFM was awarded the right to acquire (the “Acquisition”) an 80% interest in TFM, S. A. de C. V. (“TFM” or the “Company”), formerly Ferrocarril del Noreste, S. A. de C. V. pursuant to a stock purchase agreement.

Grupo TFM is a non-operating holding company with no material assets or operations other than its investment in the Company and Arrendadora TFM, S. A. de C. V. (“Arrendadora TFM”). The stockholders of Grupo TFM are TMM Multimodal, S. A. de C. V. (“TMM Multimodal”), an indirect subsidiary of Grupo TMM, S. A. de C. V. (“Grupo TMM”), Nafta Rail, S. A. de C. V. (“Nafta”), an indirect subsidiary of Kansas City Southern (“KCS”) and TFM. See Note 14.

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 previously transferred by TFM (locomotives in 2002 and cars in 2003). Arrendadora TFM is a subsidiary of TFM.

TFM lines form a strategically important rail link within Mexico and to the North American Free Trade Agreement corridor. TFM lines directly link Mexico City and Monterrey (as well as Guadalajara through trackage rights) with the ports of Lázaro Cárdenas, Veracruz and Támpico and the Mexican/United States border crossings of Nuevo Laredo-Laredo, Texas and Matamoros-Brownsville, Texas.

A significant portion of the Company’s employees are covered under a collective bargaining agreement dated July 1, 2003. Under this labor agreement, the compensation terms of the collective bargaining agreement are subject to renegotiation on an annual basis, whereas all other terms are to be renegotiated every two years.

(6)

On February 27, 2002, Grupo TMM and KCS announced that they had agreed to sell Mexrail Inc. (a US company), and its wholly owned subsidiary, the Tex-Mex Railway, to TFM for an aggregate price of $64 million ($32.6 million to Grupo TMM and $31.4 million to KCS). The sale was completed on March 27, 2002 and the purchase price was paid by crediting an account receivable amounting to $20,000 due from Grupo TMM, and the remaining balance of $44,000 was paid in cash. As a result, Mexrail, Inc., with its wholly owned subsidiary, the Tex-Mex Railway, became wholly owned subsidiaries of TFM.

The purchase of Mexrail by TFM was recorded as purchase accounting with partial fair value step-up (49%), being recognized for the assets and liabilities being acquired for the portion deemed purchased from KCS. Thus, excess amount was recorded as an increase of fixed assets of $20,557 and a corresponding deferred income tax liability for $9,249. The portion sold by Grupo TMM to TFM (51%) was accounted for on a historical carryover basis since both Mexrail and TFM are under the common control of Grupo TMM. The transaction resulted in a reduction of stockholders’ equity, at TFM level amounting to $41,952 representing the difference between the historical carrying value of the assets and liabilities acquired and the purchase price of $64,000. Thus, the transaction at the Grupo TFM level was accounted as a reduction of stockholders’ equity amounting to $33,562 and to minority interest amounting to $8,390.

For financial reporting purposes, the transaction has been retroactively reflected for all the previous periods on a historical cost basis in a manner similar to a pooling of interest.

On May 9, 2003, TFM sold a 51% interest in Mexrail to KCS for $32.6 million. Within two years of the date of this agreement, TFM had the right to repurchase all of the shares from KCS at any time for an amount equal to the purchase price. Since the sale was conditional on obtaining approval of the transaction by the U.S. Safety Transportation Board (STB), TFM recognized a liability for the net present value of the purchase price. Proceeds from the sale were re-invested in TFM. In September 2003, TFM reacquired for $32.6 million the shares previously transferred to KCS.

Grupo TMM and TFM entered into a new Stock Purchase Agreement on August 16, 2004 (“New Mexrail Stock Purchase Agreement”). Pursuant to the terms of the agreement, KCS purchased from TFM 51% of the outstanding shares of Mexrail Inc., for $32.7 million, and placed these shares into trust pending STB approval. The terms of the new Mexrail Stock Purchase Agreement are substantially similar to the May 9, 2003 Stock Purchase Agreement, but TFM does not have any right to repurchase the Mexrail shares sold to KCS and KCS is obligated to purchase the remaining shares of Mexrail owned by TFM on or before October 31, 2005.

As a result of the sale of Mexrail, in August 2004, Grupo TFM derecognized the assets and liabilities associated with this business and recognized a net loss of $6.8 million (net of legal fees) related to the sale of the 51%, consisting of the net proceeds over the carrying value of 51% of the investment. As for the remaining 49%, given that the sale price is fixed and determinable, the carrying value was written down to the expected proceeds of $31.4 million, for an additional loss amount of $5.4 million. Effective August 2004, Grupo TFM has no significant involvement with its remaining investment in Mexrail and hence, ceased applying equity method accounting.

(7)

NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES :

a. Principles of Consolidation

The consolidated financial statements include subsidiaries which are fully consolidated from the date on which control is transferred to Grupo TFM. All intercompany accounts and transactions have been eliminated.

Subsidiaries

Subsidiaries are all entities over which Grupo TFM has the power to govern the financial and operating policies generally accompanying a shareholding of more than one half of the the voting rights. They are de-consolidated from the date that control ceases.

The purchase method of accounting is used to account for the acquisition of subsidiaries by Grupo TFM, except for the acquisition of Mexrail in 2002 which was considered a business reorganization of companies under the same control group. Therefore such transaction was accounted at historical cost.

The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any minority interest.

All intercompany transactions, balances and unrealized gains on transaction between group companies are eliminated. Unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by Grupo TFM.

b. Investments held in Associate Company

Associates are all entities over which TFM has significant influence but not control, generally arising when the company controls between 20% and 50% of the voting rights. Investments in associates are accounted for by the equity method of accounting and are initially recognized at cost.

When Grupo TFM’s share of losses in an associate equals or exceeds its interest in the associate, including any other unsecured receivables, the Group does not recognized further losses, unless it has incurred obligations or made payments on behalf of the associate.

Unrealized gains on transactions between Grupo TFM and its associates are eliminated to the extent of Grupo TFM’s interest in the associates. Unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred.

(8)

c. Translation

Although Grupo TFM and subsidiaries are required to maintain their books and records for tax purposes in Mexican pesos (“Ps”), except Mexrail and its subsidiary until August 2004, Grupo TFM and subsidiaries keep records and use the US dollar as their functional and reporting currency as 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. Non monetary assets or liabilities originally denominated in Mexican pesos are translated into US dollars using the historical exchange rate at the date of the transaction. Capital stock transactions and minority interest are translated at historical rates. Results of operations are mainly translated at the monthly average exchange rates. Depreciation and amortization of non-monetary assets are translated at the historical rate.

d. Cash and cash equivalents

Cash and cash equivalents represent highly liquid interest-bearing deposits and investments with an original maturity of less than three months.

e. Accounts receivable, net

Accounts receivable, net includes accounts receivable reduced by an allowance for uncollectible accounts as determined based on historical experience and may be adjusted for economic uncertainties or known trends. Accounts are charged to the allowance for bad debts when a customer enters bankruptcy, when an account has been transferred to a collection agent or submitted for legal action and in certain other cases, when a customer is significantly past due and all available means of collection have been exhausted.

f. Inventories

Materials and supplies, consisting mainly of fuel and items for maintenance of property and equipment, are valued at the lower of the average cost and net realizable value.

g. 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 (see Notes 7 and 8). 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 (see Note 7) based on their estimated fair value.

(9)

The assets acquired and liabilities assumed include:

(i)		The tangible assets acquired pursuant to the asset purchase agreement, consisting of locomotives, railcars 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.

h. Properties, net

Machinery and equipment acquired through the asset purchase agreement were initially recorded at their estimated fair value. Subsequent acquisitions are stated at cost. Depreciation is calculated by the straight-line method based on the estimated useful lives of the respective fixed assets (see Note 8).

Recurring maintenance and repair expenditures are charged to operating expenses as incurred. The cost of rebuilding locomotives is capitalized once the expenditure is incurred and is amortized over the period in which benefits are expected to be received (estimated to be eight years).

Gains and losses on disposals are determined by comparing proceeds with carrying amount. These are included in the income statement (see Note 15).

i. Debt issuance costs

Debt issuance costs, which are included in other assets, are amortized using the interest method over the term of the related debt.

j. 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.

Deferred tax assets are recognized to the extent that it is more likely than not that future taxable income against which the temporary differences can be utilized, will be available.

(10)

Deferred income tax is provided on temporary differences arising on investment in subsidiaries and associates, except where the timing of the reversal of the temporary difference can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future.

Deferred tax assets or liabilities are not recognized for differences related to assets and liabilities that are remeasured from the local currency into the functional currency using historical exchange rates and that result from changes in exchange rates or the indexation for tax purposes. Consequently, the book basis of the temporary differences is based on the historical local currency amount and the tax indexing of the non-monetary items are eliminated.

k. Employees’ statutory profit sharing

Employees’ statutory profit sharing is determined at the statutory rate of 10% of temporary differences and NOLs. The Tax Authorities had challenged the Company’s calculation of deferred profit sharing in the late 1990’s, but the Company prevailed with a Supreme Court ruling in 1999, followed by a Tax Authority Release acknowledging the Company’s ability to continue to calculate profit sharing the way it had been, as well as the Company’s ability to utilize NOL carryforwards in the calculation of Profit Sharing. Due to a technical amendment to the Tax Law in 2002, the Tax Authorities have been able to reassert their earlier objections. At this time, their objections are limited to whether the Company may deduct NOL carryforwards in the calculation of the Profit Sharing. The Company, after consultation with legal counsel, believes that the Constitution supports the Company’s ability to deduct NOL’s. Given this, and the Supreme Court’s earlier ruling, the Company believes the Tax Authorities’ claims are without merit.

The statutory rate is adjusted as prescribed by the Mexican Income Tax Law.

l. Debt

Debt is recognized initially as the proceeds received, net of transactions costs incurred. Debt is subsequently stated at amortized cost using the effective yield method; any difference between proceeds and the redemption value is recognized in the income statement over the period of the debt.

m. Seniority premiums

Seniority premiums to which employees are entitled upon termination of employment after 15 years of service are expensed in the years in which the services are rendered. At December 31, 2003 and 2004, the Company had a provision of $847 and $1,037, respectively, which is included in other long-term liabilities on the consolidated balance sheets.

(11)

Other compensations based on length of service to which employees may be entitled in the event of dismissal, in accordance with the Mexican Federal Law, are charged to the income statement in the year in which it is probable that they will become payable.

n. Deferred financing charges

Legal fees are expensed as incurred.

o. Revenue recognition

Revenue comprises the fair value for services, net of rebates and discounts and after the elimination of revenue within subsidiaries. Revenue is recognized based upon the percentage of completion of a commodity movement.

p. Intangible assets and long-lived assets

The carrying value of definite lived intangible assets and long-lived assets in use are periodically reviewed by the Company and impairments are recognized whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An impairment loss is recognized for the amount by which the carrying amount of the assets exceeds its fair value in use. For the purpose of assessing impairment, assets are grouped at the lowest level for which there are separately identifiable discounted cash flows.

q. Leases

Leases of property, machinery and equipment where the Company has assumed substantially all the risks and rewards of ownership are classified as capital leases. Capital leases are capitalized at the inception of the lease at the lower of the fair value of the leased property and the present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges so as to achieve a constant rate on the finance balance outstanding. The interest element of the finance cost is charged to the income statement over the lease period so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period.

Leases where the lessor retains a significant portion of the risks and rewards of ownership are classified as operating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the period of the lease.

r. Minority interest

The minority interest reflects the 20% share of the Company held by the Government.

(12)

s. Use of estimates

The preparation of the combined and consolidated financial statements requires Management to make estimates and assumptions that could affect the reported amounts of assets and liabilities at the date of the financial statements. Actual results could differ from these estimates.

t. Provisions

Provisions for insurance claims from customers for merchandise damages during the freight transportation and legal claims and property damage are recognized when Grupo TFM has a present legal or constructive obligation as a result of past events; it is more likely than not that an outflow of resources will be required to settle the obligation; and the amount has been reliably estimated.

Where there are a number of similar obligations, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations as a whole. A provision is recognized even if the likelihood of an outflow with respect to any one item included in the same class of obligations may be small.

u. Share capital

Ordinary shares are classified as equity. Grupo TFM does not have other equity instruments besides common stock.

Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds. Incremental costs directly attributable to the issue of new shares or options, or for the acquisition of a business, are included in the cost of acquisition as part of the purchase consideration.

Where any subsidiary purchases Grupo TFM equity share capital (Treasury shares), the consideration paid, including any directly attributable incremental costs (net of income taxes,) is deducted from equity attributable to the equity holders until the shares are cancelled, reissued or disposed of. Where such shares are subsequently sold or reissued, any consideration received, net of any directly attributable incremental transaction costs and the related income tax effects, is included in equity attributable to the equity holders. During 2002, 2003 and 2004 Grupo TFM has not cancelled, reissued or disposed of treasury shares.

v. Financial instruments and hedging activities

Derivative financial instruments are initially recognized in the balance sheet at cost and subsequently are remeasured at their fair value. The method of recognizing the resulting gain or loss is dependent on the nature of the item being hedged. The Company may occasionally designate certain derivatives as either (1) a hedge of the fair value of a recognized asset or liability (fair value hedge), or (2) a hedge of a forecasted transaction or of a firm commitment (cash flow hedge).

(13)

Changes in the fair value of derivatives that are designated and qualify as fair value hedges and that are highly effective, are recorded in the income statement, along with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. Changes in the fair value of derivatives that are designated and qualify as cash flow hedges and that are highly effective, are recognized in equity. Where the forecasted transaction or firm commitment results in the recognition of an asset (for example, property, plant and equipment) or of a liability, the gains and losses previously deferred in equity are transferred from equity and included in the initial measurement of the cost of the asset or liability. Otherwise, amounts deferred in equity are transferred to the income statement and classified as revenue or expense in the same periods during which the hedged firm commitment or forecasted transaction affects the income statement (for example, when the forecasted sale takes place).

w. Segments

Grupo TFM is organized into one business segment (railways) and operates in one geographical segment (Mexico).

x. Financial risk management

(i) Financial risk factors

Grupo TFM enters into financial and commodity derivative instruments as a part of its risk management program including currency exchange contracts, interest rate arrangements and U.S. based fuel futures.

(ii) Foreign exchange risk

Grupo TFM operates internationally and is exposed to foreign exchange risk arising from exposure primarily with respect to the Mexican peso. Grupo TFM occasionally enters into derivative instruments to cover a portion of this risk.

These contracts meet Grupo TFM’s policy for financial instruments, however did not meet the conditions to qualify for hedge accounting. Consequently, the instruments are mark to market and resulting gains and losses related to such transactions are recognized in the income statement. See Note 10.

(iii) Interest-rate risk

The Company’s income and operating cash flows are substantially independent of changes in market interest rates. The interest rates of the finance leases to which TFM is lessor are fixed at the inception of the lease. TFM’s policy is to maintain at least 75% of its borrowings in fixed-rate instruments. At year end December 31, 2003 and 2004, 80% and 85%, respectively, were at fixed rates.

(14)

(iv) Concentration of risk

Over 15.9% of the Company’s transportation revenues are generated by the automotive industry, which is made up of a relatively small number of customers. In addition, the Company’s largest customer accounted for approximately 8% of transportation revenues. The Company performs ongoing credit valuations of its customers’ financial conditions and maintains a provision for impairment of those receivables.

y. New accounting pronouncements

In November 2004, the FASB issued SFAS No. 151, Inventory Costs. The statement amends Accounting Research Bulletin (ARB) No. 43, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material.

ARB No. 43 previously stated that these costs must be so abnormal as to require treatment as current-period charges. SFAS No. 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of so abnormal. In addition, this statement requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted for fiscal years beginning after the issue date of the statement. The adoption of SFAS No. 151 is not expected to have any impact on the Company’s current financial condition or results of operations.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an Amendment of APB Opinion No. 29. APB Opinion No. 29, Accounting for Non-monetary Transactions, is based on the opinion that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. SFAS No. 153 amends opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 is not expected to have any impact on the Company’s current financial condition or results of operations.

In December 2004, the FASB revised its SFAS No. 123 (SFAS No. 123R), Accounting for Stock Based Compensation. The revision establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, particularly transactions in which an entity obtains employee services in share-based payment transactions. The revised statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is to be recognized over the period during which the employee is required to provide service in exchange for the award. Changes in fair value during the requisite service period are to be recognized as compensation cost over that period. In addition, the revised statement amends

(15)

SFAS No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as a financing cash flow rather than as a reduction of taxes paid. The provisions of the revised statements are effective for financial statements issued for the first interim or annual reporting period beginning after June 15, 2005, with early adoption encouraged. The adoption of SFAS 123R will not have a material impact on the consolidated financial statements.

In March 2004, the Emerging Issues Task Force (EITF) ratified EITF Issue No. 03-1 (EITF 03-1). The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. EITF 03-1 provides a three-step process for determining whether investments, including debt securities, are other than temporarily impaired and requires additional disclosures in annual financial statements. The recognition and measurement guidance in Issue 03-1 should be applied to other-than-temporary impairment evaluations in reporting periods beginning after June 15, 2004. The Company does not expect the adoption of EITF 03-1 to have a material impact on its financial position or results of operations because the Company does not hold any applicable investments.

In June 2004, the FASB issued Emerging Issues Task Force Issue No. 02-14 (EITF 02-14), Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock. EITF 02-14 addresses whether the equity method of accounting applies when an investor does not have an investment in voting common stock of an investee but exercises significant influence through other means. EITF 02-14 states that an investor should only apply the equity method of accounting when it has investments in either common stock or in-substance common stock of a corporation, provided that the investor has the ability to exercise significant influence over the operating and financial policies of the investee. The accounting provisions of EITF 02-14 are effective for reporting periods beginning after September 15, 2004. We do not expect the adoption of EITF 02-14 to have a material impact on our consolidated financial position, results of operations or cash flows.

In November 2004, the EITF reached a final conclusion on Issue 04-8, Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect of Diluted Earnings per Share. This issue addresses when the dilutive effect of contingently convertible debt with a market price trigger should be included in diluted earnings per share calculations. The EITF’s conclusion is that the market price trigger should be ignored and that these securities should be treated as convertible securities and included in diluted earnings per share regardless or whether the conversion contingencies have been met. EITF Issue No. 04-8 is effective for periods ending after December 15, 2004 and would be applied by retrospectively restating previously reported diluted earnings per share. The adoption of EITF Issue No. 04-8 did not have a material impact on our consolidated financial position, results of operations or cash flows.

(16)

NOTE 3 — TAXES RECOVERABLE :

Taxes recoverable are summarized below:


	December 31,
	2003		2004

Special tax on production and services	$	31,000	$	27,700
Withholding tax (Car Hire)		4,917		4,957
Payroll taxes		5,013		5,064
Withholding tax on the sale of Mexrail’s shares				3,268
Value added tax — Net		9,884		83
Other		430		830


	$	51,244	$	41,902

NOTE 4 — OTHER ACCOUNTS RECEIVABLE — NET :


	December 31,
	2003		2004

Services to foreign railroads	$	12,786	$	12,150
Car repairs		4,842		8,701
Insurance claims		9,794		3,670
Helm Financial Corporation		2,100		3,600
Employees Union		828		682
Other		3,696		1,352


	$	34,046	$	30,155

NOTE 5 — INVENTORIES :


	December 31,
	2003			2004

General inventory	$	15,742		$	19,994
Locomotive fuel stock		1,810			2,603
Inventory reserve		(859	)		(859	)


	$	16,693		$	21,738

(17)

NOTE 6 — OTHER CURRENT ASSETS :


	December 31,
	2003		2004

Prepaid expenses	$	4,815	$	3,413
Advance to suppliers		5,602		1,623
Prepaid insurance premiums		2,673		2,000


	$	13,090	$	7,036

NOTE 7 — CONCESSION RIGHTS AND RELATED ASSETS :

In December 1996, the Mexican Government or the Government, granted TFM the Concession, or the Concession, to operate the northeast rail lines for an initial period of fifty years, exclusive for thirty years, renewable, subject to certain conditions, for a second period of equal length. Under the terms of the Concession, the Company has the right to use and is obligated to maintain the right of way, track structure, buildings and related maintenance facilities to the operational standards specified in the concession agreement and to return the assets in that condition at the end of the concession period. The company had complied with its obligations and there was no outstanding obligation to carry out maintenance work at the end of 2004.

Concession rights and related assets are summarized below:

Amortization of concession rights was $39,769, $41,070, and $39,630 for the years ended December 31, 2002, 2003 and 2004, respectively.


	December 31,
							Estimated useful
	2003			2004			life (years)

Land	$	132,878		$	132,878			50
Buildings		33,113			33,113			27-30
Bridges		75,350			75,350			41
Tunnels		94,043			94,043			40
Rail		317,268			317,268			29
Concrete and wood ties		137,351			137,351			27
Yards		106,174			106,174			35
Ballast		107,189			107,189			27
Grading		391,808			391,808			50
Culverts		14,942			14,942			21
Signals		1,418			1,418			26
Others		57,537			57,537


		1,469,071			1,469,071

Accumulated amortization		(294,854	)		(338,154	)


Concession rights and related assets — net	$	1,174,217		$	1,130,917

(18)

NOTE 8 — PROPERTIES, NET :

Pursuant to the asset purchase agreement, the Company obtained the right to acquire locomotives and railcars and various materials and supplies, formerly owned by FNM. The Company also agreed to assume the outstanding indebtedness, as of the commencement of operations, relating to certain locomotives originally acquired by FNM under capital lease arrangements (see Note 16). Legal title to the purchased assets was transferred to TFM at that time.


	December 31,
							Estimated useful
	2003			2004			life (years)

Locomotives	$	178,843		$	174,939			14
Freight cars		92,502			87,136			12-16
Machinery of workshop		18,111			17,651			8
Machinery of road		31,004			34,517			14
Terminal and other equipment		94,526			73,837			1-15
Track improvement		315,951			288,065			15-48
Buildings		6,604			5,283			20
Overhaul		88,581			94,191			8


		826,122			775,619

Accumulated depreciation		(240,936	)		(259,425	)


		585,186			516,194
Land (1)		38,406			26,907
Construction in progress		36,702			15,568


	$	660,294		$	558,669


(1)		Includes land under capital lease amounting to $2,981 and $2,981 in 2003 and 2004, respectively.

Depreciation of property, machinery and equipment was $42,781 in 2002, $46,957 in 2003 and $46,871 in 2004.

(19)

NOTE 9 — DEBT :

Financing is summarized as follows:


	December 31,
	2003		2004
	Net		Net
	Borrowings		Borrowings
Short-term debt:

Commercial paper (1)	$	84,953

Current portion of long-term debt:

First Amended and Restated Credit Agreement (3)			$	66,376
Term loan facility (2)		109,713


	$	194,666	$	66,376


Long-term debt:

Senior notes due 2007 (4)	$	150,000	$	150,000
Senior discount debentures (5)		443,500		443,500
Senior notes due 2012 (6)		177,880		178,131
First Amended and Restated Credit Agreement (3)				67,309


	$	771,380	$	838,940

(1) Commercial paper

The commercial paper program consists of a two-year facility in the amount of $122,000, which is supported by a letter of credit issued under the bank facility. The commercial paper facility allows the Company to draw-down advances from time to time, subject to certain terms and conditions. The obligations of the commercial paper facility rank at least pari passu with the other senior unsecured indebtedness. The average interest rate for the years ended December 31, 2003 and 2004 was 1.28% and 1.17%, respectively. See (3) for refinancing and (2) for term loan facility.

(2) Term loan facility

The term loan facility is a four-year term loan in the amount of $128,000. The term loan is payable in semi-annual installments beginning in September 2003 and ending in September 2006 and bearing interest at Libor plus applicable margin. The obligations of the term loan facility rank at least pari passu with the other senior unsecured indebtedness. The average interest rate for the year ended December 31, 2003 and 2004 was 3.97% and 3.78%, respectively. See (3) for refinancing.

(20)

(3) First Amended and Restated Credit Agreement due 2006

On June 24, 2004 the Company concluded negotiating with its lender for the amendments to the Term Loan and also the refinancing of its Commercial Paper Program to extend the final maturity date to September 17, 2006. Under the amendment, both facilities are comprised under one single term loan named First Amended and Restated Credit Agreement or FARCA. Amounts outstanding under the FARCA facility are secured by a first priority conditional pledge on the locomotives and other rolling stock owned by Arrendadora TFM.

The FARCA is a two year term loan in the amount of $186,429 ($162,570 in US dollars and $23,858 in Pesos). The dollar loan as well as the peso loan shall be payable in consecutive semi-annual installments beginning in September 2004 and ending in September 2006 and bearing interest at Libor plus applicable margin. The obligations of the FARCA rank at least pari passu with the other senior unsecured indebtedness.

The average interest rate for the year ended December 31, 2004 was 4.42% for the US dollar portion and 9.96% for peso portion.

Interest expense related with the FARCA amounted to $4,285, for the year ended December 31, 2004.

(4) Senior notes due 2007

In June 1997 the Company issued US dollar denominated securities bearing interest semiannually at a fixed rate of 10.25% and maturing on June 15, 2007.

Interest expense related with the senior notes amounted $16,167, for each one of the years ended December 31, 2002, 2003 and 2004.

(5) Senior discount debentures or SDDs

The US dollar denominated SDDs were sold in June 1997, at a substantial discount from their principal amount of $443,501, and no interest was payable thereon prior to June 15, 2002. The SDD will mature on June 15, 2009. The SDD yield 11.75% fixed rate at semiannual specified date an accreted value, computed on the basis of semiannual compounding and maturing on June 15, 2002. Interest on the SDDs is payable semiannually at a fixed rate of 11.75%, commencing on December 15, 2002. The SDDs are redeemable at the option of the Company, in whole or in part, at any time on or after June 15, 2002, at a certain redemption price of 100% starting on June 15, 2004 from and thereafter (expressed in percentages of principal amount at maturity), plus accrued and unpaid interest, if any.

Interest expense related with the SDDs amounted $53,406, $54,796 and $54,796 during 2002, 2003 and 2004, respectively.

(21)

(6) Senior notes due 2012

In 2002, TFM completed a solicitation of consents of holders of 10.25% Senior Notes due 2007 and 11.75% SDDs due 2009 to an amendment providing for certain changes to the “Limitation on Restricted Payments”, “Limitation on Indebtedness”, and “Limitation on Liens” covenants in each of the indentures pursuant to which the securities were issued. TFM obtained the requisite consents and paid a fee of $16,972 to allow it to issue additional $180,000 in new debt and to purchase the call option shares in Grupo TFM held by the Government (see Note 14).

In June 2002, TFM issued senior notes for an aggregate principal amount of $180,000. The senior notes are denominated in dollars, bear interest semi-annually at a fixed rate of 12.50% and mature on June 15, 2012. The senior notes are redeemable at TFM’s option on or after June 15, 2007 and, subject to certain limitations. The senior notes were issued at a discount of $2.5 million, which is being amortized based on the interest method over its term.

The Company incurred and accounted for as transaction costs $25.1 million in consent and professional services fees in connection with the issuance of these notes. These transaction costs are being amortized based on the interest method over the term of the senior notes.

Interest expense related with the senior notes due 2012 amounted to $23,659, for the year ended December 31, 2003 and 2004.

Covenants

The agreements related to the above-mentioned loans include certain affirmative and negative customary covenants and maintenance of certain financial conditions, including, among other things, dividend and other payment restrictions affecting restricted subsidiaries, limitation on affiliate transactions and restrictions and asset sales.

Maturity of long-term debt as of December 31, 2004 is as follows:


	2004

2006	$	67,309
2007		150,000
2008
2009		443,500
2010 and thereafter		178,131


	$	838,940

(22)

NOTE 10 — FINANCIAL INSTRUMENTS :

Fuel swap contracts

The Company may occasionally seek to assure itself of more predictable fuel expenses through U.S. fuel swap contracts. TFM’s fuel hedging program covers approximately 25% of estimated fuel purchases. Hedge positions are also closely monitored to ensure that they will not exceed actual fuel requirements in any period.

As a result of the fuel swaps contracts acquired during 2003, the realized gain was $849.

The Company had not acquired any fuel future contracts during 2004 therefore, the Company did not have any fuel futures contracts at December 31, 2004.

Foreign exchange contracts

The purpose of the Company’s foreign exchange contracts is to limit the risks arising from its peso-denominated monetary assets and liabilities.

The nature and quantity of any hedging transactions will be determined by Management based upon net assets exposure and market conditions.

As of December 31, 2002, the Company had one Mexican peso call option outstanding in the notional amount of $1.7 million, based on the average exchange rate of Ps11.0 per dollar. This option expired in May 29, 2003.

Additionally, as of December 31, 2002, the Company had one forward contract outstanding in the notional amount of $10 million, based on the exchange rate of Ps9.769 per dollar. This forward expired on February 13, 2003.

As of December 31, 2003, the Company had two Mexican peso call options outstanding in the notional amount of $11.8 million and $1.7 million, respectively, based on the exchange rate of Ps13.00 and Ps.12.50 per dollar. These options expired on September 8, and May 29, 2004, respectively. The premiums paid were $250 and $40, respectively.

As of December 31, 2004, the Company had two Mexican peso call options outstanding in the notional amount of $1.2 million and $1.7 million, respectively, based on the average exchange rate of Ps13.50 per dollar. These options will expire in September 12 and May 30, 2005, respectively. The premiums paid were $24 and $35, respectively, and were expensed since these contracts did not qualify for hedge accounting.

As of December 31, 2003 and 2004 the Company did not have any outstanding forward contracts.

(23)

Fair value of financial instruments

The fair values of cash and cash equivalents, accounts receivable, short-term debt and accounts payable approximate carrying values because of the short maturity of these financial instruments.

The related fair value based on the quoted market prices for the Senior notes due 2007 and SDD or similar issues at December 31, 2003 was $142,922 and $446,956, respectively and at December 31, 2004 was $159,750 and $451,816, respectively. The related fair value based on the quoted market prices for the senior notes due 2012 at December 31, 2003 and 2004 was $205,200 and $209,700, respectively. The fair value based on the quoted market prices for the first amended and restated credit agreement (FARCA) at December 31, 2004 was $133,685.

Foreign currency balances

The company had monetary assets and liabilities denominated in Mexican pesos of Ps1,325 million and Ps261 million and Ps1,137 million and Ps 374 million, at December 31, 2003 and 2004, respectively. At December 31, 2003 and 2004 the exchange rate was Ps11.23 and Ps11.14 per US dollar, respectively.

NOTE 11 — BALANCES AND TRANSACTIONS WITH RELATED PARTIES :


	December 31,
	2003		2004

Accounts receivable: (1)

Terminal Ferroviaria del Valle de México, S. A. de C. V.	$	1,550
KCS — receivable related to Mexrail (2)			$	31,398
Other Grupo TMM’s subsidiaries				171


	$	1,550	$	31,569


Accounts payable: (1)

KCS	$	4,345	$	746
Terminal Ferroviaria del Valle de México, S. A. de C. V.				3,068
Other Grupo TMM’s subsidiaries		1,805
Tex-Mex Railway				93


	$	6,150	$	3,907


(1)		The accounts receivable and payable due from or due to related parties were driven by the services disclosed in the transactions with related parties.

(2)		Account receivable related to the remaining 49% interest in Mexrail.

(24)

The most important transactions with related parties are summarized as follows:


	Year ended December 31,
	2002			2003			2004

Transportation revenues	$	10,375		$	13,784		$	8,148

Terminal service	$	(9,933	)	$	(8,605	)	$	(10,713	)

Car lease	$	(1,947	)	$	(2,256	)	$	(2,482	)

Locomotive and car repair	$	(49	)	$	8		$	123

Management fee (a)	$	(2,500	)	$	(2,500	)	$	(2,500	)

Locomotive equipment lease	$	(1,834	)	$	2,127		$	3,638

Other	$	295		$	299		$	448

The principal services sold by TFM were general freight and locomotive equipment lease and the principal services received by TFM were terminal services, car hire and management services. These services are usually negotiated with related parties on a cost-plus basis.

(a) Grupo TMM management services agreement

The Company and Grupo TMM entered into a management services agreement pursuant to which Grupo TMM provides certain consulting and management services to the Company commencing in May 1997 for a term of 12 months and which may be renewed for additional one-year periods by agreement of the parties. Under the terms of the agreement, Grupo TMM is to be reimbursed for its costs and expenses incurred in the performance of such services.

KCS Transportation Company (“KCSTC”) management services agreement

The Company and KCSTC, a wholly owned subsidiary of KCS, entered into a management services agreement pursuant to which KCSTC makes available to the Company certain railroad consulting and management services commencing May 1997 for a term of 12 months and which may be renewed for additional one-year periods by agreement of the parties. Under the terms of the agreement, KCSTC is to be reimbursed for its costs and expenses incurred in the performance of such services.

Amendments

On April 30, 2002, TFM and KCS, as successor in interest through merger with KCSTC, as well as TFM and Grupo TMM, entered into amendments to the management services agreements that provide for automatic annual renewal of the agreements and compensates KCS and Grupo TMM for their services under the agreements. The amendments state that KCS and Grupo TMM each are entitled to receive management fees equivalent to an annual rate of $1,250,000. The management services agreements are terminable by either party upon 60 days written notice.

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NOTE 12 — PROVISION AND ACCRUED EXPENSES :


	December 31,
	2003		2004

Provisions

Insurance claims from customers for merchandise damages during the freight	$	2,512	$	4,746
Others		1,980		332


	$	4,492	$	5,078


Accrued Expenses

Salaries and wages	$	8,397	$	6,561
Purchased services		18,179		14,207
Car repair and locomotive maintenance		7,011		6,728


	$	33,587	$	27,496


Total provisions and accrued expenses	$	38,079	$	32,574

NOTE 13 — OTHER LONG-TERM LIABILITIES :


	December 31,
	2003		2004

Alstom Transportes (1)	$	21,828	$	13,867
Tax payable (2)		9,956		9,956
Seniority premium		847		1,037
Other		1,093		344


	$	33,724	$	25,204


(1)		Relates to an account payable due for track maintenance and rehabilitation agreement.

(2)		Withholding tax payable derived from senior discount debentures due in 2009. (See Note 9).

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NOTE 14 — STOCKHOLDERS’ EQUITY :

Grupo TFM’s capital stock is variable with a fixed minimum of Ps50,000 and an unlimited maximum. The capital stock of Grupo TFM is divided into series without par value, whose principal differences relate to: a) Series “A” shares with voting rights, which can be held only by persons or companies of Mexican nationality and represent up to 51% of the capital stock of Grupo TFM; b) Series “B” shares with voting rights, which can be held by persons or companies of non-Mexican nationality and represent up to 49% of the capital stock of Grupo TFM, unless authorized by the National Commission of Foreign Investments, in which case the percentage can be higher, and c) Series “L” shares with restricted voting rights, which are not entitled to a dividend preference.

In connection with the original formation of Grupo TFM, the Government purchased a 24.63% non-voting interest in Grupo TFM for $198.8 million. The Government also granted the original shareholders of Grupo TFM an option (the “call option”) to purchase the Government’s equity interest in Grupo TFM. TFM has been appointed as the purchaser and, on July 29, 2002, purchased all of the call option shares for an aggregate purchase price of $256.1 million. The purchase price for the call option shares was financed through (1) a portion ($162,575) of the proceeds of the issuance of $180,000 of debt securities by TFM (see Note 9) and approximately $93,555 was applied against note receivables from the Government. Thus, the shares acquired by TFM are being considered as treasury shares.

At December 31, 2004 the capital stock of Grupo TFM is represented by 10,063,570 shares as follows:


	Number of shares		Number of shares
Stockholders	(fixed portion of capital stock)		(variable portion of capital stock)

	Series “A”		Series “A”

TMM Multimodal		25,500		3,842,901

	Series “B”		Sub-series “B”

Nafta		24,500		3,692,199

			Sub-series “L-2”

TFM (treasury shares)				2,478,470


Total		50,000		10,013,570

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Pursuant to the new shares sub-series “L-2” granted to TFM, the voting rights attached to these shares are limited to the following matters: (i) extension of the duration of the Company; (ii) premature dissolution of the Company; (iii) change in the object of the Company; (iv) change of nationality of the Company; (v) transformation of the Company; (vi) merger with another company; (vii) the split-up of the Company and (viii) the cancellation of the registration of the shares with the Mexican Stock Exchange or any foreign stock exchange of the shares which might be registered. Except as described above, holders of Sub-series “L-2” shares have no voting rights. Grupo TFM Sub-series “L-2” shares do not confer upon the holders thereof any right to preference dividends.

The sub-series “L-1” shares that were previously held the by Government were cancelled as the call option was exercised by TFM.

The Government retained a 20% interest in TFM’s shares and reserved the right to sell such shares by October 31, 2003 in a public offering. In the event that such public offering does not occur by October 31, 2003, Grupo TFM may purchase the Government’s equity interest in TFM at a purchase price equal to the per share price initially paid by Grupo TFM, indexed based on Mexican inflation. If Grupo TFM does not purchase the Government’s TFM interest, the Government may require Grupo TMM and KCS to purchase the TFM shares at the price discussed above. See Note 17.

Dividends paid are not subject to income tax if paid from the Net Tax Profit Account and will be taxed at a rate that fluctuates between 4.62% and 7.69% if they arise from the Reinvested Net Tax Profit Account dividends paid in excess of this account are subject to a tax equivalent to 42.85%, 40.84% or 38.91% depending on whether paid in 2005, 2006 or 2007 , respectively. The tax is payable by the Company and may be credited against its income tax in the same year or the following two years. Dividends paid from previously taxed profits are not subject to tax withholding or additional tax payment.

In the event of a capital reduction, any excess of stockholders’ equity over capital contributions, the latter restated in accordance with the provisions of the Income Tax Law, is accorded the same treatment as dividend.

NOTE 15 — INCOME TAX, EMPLOYEES STATUTORY PROFIT SHARING, ASSET TAX, AND TAX LOSS CARRYFORWARDS :

Income tax

Grupo TFM and its subsidiaries compute income tax on an individual Company basis. However, Grupo TFM and its subsidiaries (except Mexrail and its subsidiary) are consolidated within tax results of Grupo TMM equal to 60% of Grupo TMM’s ownership interest in each subsidiary. Thus, Arrendadora TFM owes income tax of $2,551 and $1,814 to Grupo TMM as of December 31, 2003 and has made advanced during 2004 amounting $1,841 which will be credited by TMM in the annual tax return.

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Grupo TFM and its subsidiaries had historical consolidated losses (income) for tax purposes of $401,415, $234,403 and ($50,222) for the years ended December 31, 2002, 2003 and 2004, respectively. The difference between tax losses and book income (loss) is due principally to the inflation gain or loss recognized for tax purposes, the difference between book and tax depreciation and amortization, non-deductible expenses and temporary differences for certain items that are reported in different periods for financial reporting and income tax purposes.

The (benefit) expense for income tax charged to income was as follows:


	Year ended December 31,
	2002			2003			2004

Current income tax expense	$	—		$	10,763		$	7,630
Deferred income tax expense		(91,505	)		(62,252	)		(2,920	)


Net income tax (benefit) expense	$	(91,505	)	$	(51,489	)	$	4,710

Reconciliation of the income tax expense based on the statutory income tax rate to recorded income tax expense was as follows:


	Year ended December 31,
	2002			2003			2004

Income (loss) before income tax	$	45,939		$	(17,253	)	$	(5,257	)


Income tax at 35% in 2002 and 34% in 2003 and 33% in 2004	$	16,079		$	(5,866	)	$	(1,735	)

(Decrease) increase resulting from:
Effects of inflationary and devaluation components		15,896			14,122			14,925
Profit sharing					3,804			(1,967	)
Tax indexation of depreciation and amortization		(79,240	)		(89,313	)		(17,597	)
Net exchanges losses		(17,396	)		(11,472	)		7,337
Effects of inflation and remeasurement of tax loss carryforwards		(30,054	)		39,507			(25,098	)
Non-deductible expenses		1,414			1,863			453
Change in tax rates		1,223			(3,398	)		25,221
Other — Net		573			(736	)		3,171


Net deferred income tax expense (benefit)	$	(91,505	)	$	(51,489	)	$	4,710

According to the amendments to the Mexican Income Tax Law enacted in 2004, the income tax rate will decrease one percent per year from 30% in 2005 down to 28% in 2007.

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The components of deferred tax (assets) and liabilities are the following:


	December 31,
	2003			2004

Tax-loss carryforwards	$	(479,076	)	$	(443,785	)
Inventories and provisions — Net		(23,474	)		(30,130	)
Machinery and equipment		43,857			36,140
Concession rights		262,721			239,037
Other		9,426


Net deferred income tax asset	$	(186,546	)	$	(198,738	)


Current deferred income tax asset	$	8,210		$	(147,431	)
Long term deferred income tax asset		(194,756	)		(51,307	)

The Company has recognized deferred tax assets related to its tax loss carryforwards and other items after evaluating the reversal of existing taxable temporary differences. To the extent that the balance of the deferred tax assets exceeds the existing temporary differences, Management has evaluated the recoverability of such amounts by estimating future taxable income expected in the foreseeable future and the remaining tax loss carryforwards periods which extend between 2012 through 2046. The taxable income includes estimates of profitability and macroeconomic assumptions which are based on Management’s best estimate as of this date.

Employees’ Statutory Profit Sharing

The components of employees’ statutory profit sharing expense, for the years ended December 31, 2002, 2003 and 2004 are as follows:


	For the years ended
	December 31,
	2002			2003			2004

Deferred	$	(25,792	)	$	(11,528	)	$	(6,556	)

The effects of temporary differences that give rise to significant deferred employees’ statutory profit sharing assets, at December 31, 2003 and 2004 are as follows:

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	December 31,
	2003			2004

Tax-loss carryforwards	$	(144,292	)	$	(151,991	)
Inventories and provisions		(1,657	)		(1,025	)
Properties, net		17,564			20,293
Concession rights		76,457			76,380


Net deferred employees statutory profit sharing asset	$	(51,928	)	$	(56,343	)


Current deferred employees statutory profit sharing asset	$	7,292		$	(44,096	)
Long term deferred employees statutory profit sharing asset		(59,220	)		(12,247	)

The Company recognizes deferred profit sharing taxes for the 10% profit sharing effect of temporary differences and NOLs. The Mexican Tax Authorities challenged the Company’s calculation of deferred profit sharing in the late 1990’s, but the Company prevailed with a Supreme Court ruling in 1999, followed by a Tax Authority Release acknowledging the Company’s ability to continue to calculate profit sharing the way it had been, as well as the Company’s ability to utilize NOL carryforwards in the calculation of Profit Sharing. Due to a technical amendment to the Tax Law in 2002, the Mexican Tax Authorities have been able to reassert their earlier objections. At this time, their objections are limited to whether the Company may deduct NOL carryforwards in the calculation of the Profit Sharing. The Company, after consultation with legal counsel, believes that the Constitution supports the Company’s ability to deduct NOLs. Given this and the Supreme Court’s earlier ruling, the Company believes the Tax Authorities claims are without merit.

Asset tax

The Asset Tax Law establishes a tax of 1.8% on the average of assets, less certain liabilities, which is payable when it exceeds the income tax due. There was no asset tax due in 2002, 2003 and 2004.

Tax loss carryforwards

At December 31, 2004 Grupo TFM and its subsidiaries had consolidated tax loss carryforwards, which under the Mexican Income Tax Law are inflation-indexed through the date of utilization as shown in the following table:

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	Inflation-indexed
Year in which	amounts as of		Year of
loss arose	December 31, 2004		expiration

1997	$	228,096		2046
1998		358,895		2046
1999		9,569		2046
2000		169,249		2046
2001		72,695		2046
2002		421,718		2012
2003		305,240		2046


	$	1,565,462

NOTE 16 — COMMITMENTS AND CONTINGENCIES :

Commitments :

Concession duty

Under the Concession, the Government has the right to receive a payment from the Company 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 years ended December 31, 2002, 2003 and 2004 the concession duty expense amounted to $3,267, $3,599 and $3,359, respectively, which was recorded within operating expenses.

Capital lease obligations

At December 31, 2003 and 2004, the outstanding indebtedness corresponds to two land capital leases for a period of ten years, in which TFM has the option to purchase at the end of the agreement term.

Locomotives operating leases

In May 1998 and September 1999, the Company entered into operating lease agreements for 75 locomotives each, which expire in 17 and 18 years, respectively. At the end of each contract’s term the locomotives will be returned to the lessor. As of December 31, 2004, the Company had received 150 locomotives. Rents under these agreements amounted $29.1 million in 2002, $29.1 million in 2003 and $29.1 million in 2004.

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Future minimum payments, by year and in the aggregate, under the aforementioned leases as of December 31, 2004, are as follows:


Year ending December 31,

2005	$	29,095
2006		29,095
2007		29,095
2008		29,095
2009		29,095
2010 and thereafter		285,983


	$	431,458

Railcars operating leases

The Company leases certain railcars pursuant to operating lease agreements. The term of the contracts vary between 3 and 15 years. Future minimum rental payments as of December 31, 2004, under these agreements are as follows:


Year ending December 31,

2005	$	33,871
2006		31,255
2007		27,139
2008		23,168
2009		18,233
2010 and thereafter		60,107


	$	193,773

Locomotives maintenance agreements

The Company has entered into two locomotive maintenance agreements with third-party contractors, which expire in 2004 and 2018. Under current arrangements, the contractors provide both routine maintenance and major overhauls at an established rate in a range from four to five hundred dollars per locomotive per day.

Track maintenance and rehabilitation agreement

In May 2000, the Company entered into a track maintenance and rehabilitation agreement, which expires in 2012. Under this contract, the contractor provides both routine maintenance and major rehabilitation to the Celaya — Lazaro Cardenas stretch, which is comprised of approximately 350 miles of track. Maintenance and rehabilitation expenses amounted to $35.6 million in 2002, $3.4 million in 2003 and $3.4 million in 2004. Under this agreement, the Company estimates receiving future services totaling $27 million in the following 10 years.

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Fuel purchase agreement

On December 19, 1997, the Company entered into a fuel purchase agreement with PEMEX Refinación, under which the Company has the obligation to purchase at market price a minimum of 15,000 cubic meters and a maximum of 20,000 cubic meters per month of PEMEX diesel fuel. The term of the agreement is indefinite but can be terminated for justified cause by each party with a written notification upon 90 days’ notice.

Fuel freight service agreement

On October 30, 2002, the Company entered into a freight service agreement with PEMEX Refinación, which will expire in 2006. Under this agreement the Company has the obligation to provide services amounting in pesos, by year, as shown below:


	Minimum		Maximum

2005	Ps	98,769	Ps	246,922
2006		65,756		164,390


	Ps	164,525	Ps	411,312

Contingencies :

A) Value Added Tax Lawsuit

The Company has filed a claim for the refund of approximately $262 million (Ps 2,111 million) of value added tax, or VAT, paid in connection with the Acquisition (see Note 1).

On September 25, 2002 the Mexican Magistrates Court of the First District or the Federal Court issued its judgment in favor of TFM on the VAT claim, which has been pending in the Mexican Courts since 1997. The claim arose out of the Mexican Treasury’s delivery of a VAT refund certificate to a Mexican governmental agency rather than to TFM. By an unanimous decision, a three-judge panel of the Federal Court vacated a prior judgment of the Mexican Fiscal Court (Tribunal Federal de Justicia Fiscal y Administrativa) and remanded the case to the Mexican Fiscal Court with specific instructions to enter a new decision consistent with the guidance provided by the Federal Court’s ruling. The Federal Court’s ruling required the fiscal authorities to issue the VAT refund certificate in the name of TFM. On December 6, 2002 the upper chamber of the Mexican Fiscal Court issued a ruling denying TFM’s right to receive a VAT refund from the Government. On January 8, 2003, TFM was officially notified of the new judgment of the Fiscal Court and on January 29, 2003, filed the appropriate appeal.

On June 11, 2003, the Federal Court issued a judgment in favor of TFM against the ruling of the Fiscal Court. On July 9, 2003 TFM was formally notified by a three-judge panel of the Federal Court of its June 11, 2003 judgment, which granted TFM constitutional protection (amparo)

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against the ruling of the Fiscal Court issued on December 6, 2002, which had denied TFM the right to receive the VAT refund certificate. The Federal Court found that the VAT refund certificate had not been delivered to TFM, and confirmed the Fiscal Court’s determination that TFM had the right to receive the VAT refund certificate. The Federal Court’s ruling stated that the Mexican Treasury’s decision denying delivery of the VAT refund certificate to TFM violated the Mexican Law, and it instructed that the VAT refund certificate be issued to TFM on the terms established by Article 22 of the Mexican Fiscal Code in effect at that time.

In a public session held on August 13, 2003, the Fiscal Court issued a resolution regarding TFM’s VAT lawsuit vacating its previous resolution of December 6, 2002, and in strict compliance with the ruling issued on June 11, 2003, by the Fiscal Court, resolved that TFM had proved its case, and that a “ficta denial” occurred, declaring such denial null and void as ordered by the Fiscal Court. On August 25, 2003, TFM was formally notified by the Fiscal Court of its resolution regarding TFM’s VAT lawsuit. The resolution was the result of the unanimous vote of the nine magistrates present at the public session. The Fiscal Court ordered the issuance of the VAT refund certificate to TFM under the terms established by Article 22 of the Mexican Fiscal Code in effect in 1997. On October 13, 2003, the Mexican Tax Attorney of the Federal Government (Procuraduría Fiscal de la Federación) filed for a review of the Fiscal Court’s ruling issued on August 13, 2003. On November 5, 2003, the Federal Court found no merit to the requested review and as a result, the August 13, 2003 Fiscal Court’s ruling remained in place.

On January 19, 2004, the Mexican Treasury delivered to TFM, pursuant to the August 13, 2003 Fiscal Court ruling, a Special VAT Certificate representing the historical claim amount of Ps2,111 million.

On January 20, 2004, the Mexican Fiscal Administration Service (Servicio de Administración Tributaria or SAT) issued a provisional attachment of the Special VAT Certificate, stating that the documents that support the value of the Special VAT Certificate do not comply with applicable tax requirements. In the preliminary summation finding, the SAT noted that the Company, “... wrongfully declared a VAT receivable for Ps2,111 million, which in the Company’s opinion refers to expenses that do not comply with fiscal requirements, and therefore, are not deductible. In our view, TFM did not prove its VAT claim with corresponding documentation, which incorporates fiscal requisites as to the identity of the taxpayer, its tax identification code, address of the seller and buyer of the assets in question, and the VAT shown as separate from the principal...” and as a result, the VAT cannot be credited. TFM believes the claim has no merits and as of this date, no tax liability has been levied against TFM.

On March 16, 2005, TFM was notified by the SAT that it had finished its audit of TFM’s 1997 tax returns. The SAT has not yet assessed any penalties or taxes against TFM as a result of this audit. As a part of the conclusion of the audit, the SAT confirmed its provisional attachment of the original value added tax refund certificate, which had been delivered to TFM on January 19, 2004.

(35)

On November 24, 2004, the Federal Appeals court ordered the issuance of the VAT refund certificate to TFM including the effects of inflation and interest on the original claimed amount. This resolution is final and cannot be appealed to a higher court. The Fiscal Court could not change, and did not change, the sense of the resolution of the Federal Appeals Court in its resolution on January 26, 2005. The Fiscal Court ordered the Mexican Treasury to issue to TFM a certificate including inflation and interest. After applying the formula indicated in the resolution, the face value of the Certificate would be Ps12,375 million as of December 31, 2004 (approximately $1.1 billion dollars at the then exchange rate).

On February 18, 2005 a favorable written decision of the Federal Tribunal of Fiscal and Administrative Justice or the Fiscal Court, carrying out the mandate of the Federal Court of the First Circuit (the “Federal Appellate Court”), dated November 24, 2004, recognized TFM’s legal right to receive not only the original amount of VAT refund due from the Mexican Government (approximately Ps. 2,111 million pesos), but also for inflation and interest on that amount since 1997. In its written decision, the Fiscal Court states that TFM’s legal right to receive the fully inflated VAT refund was expressly established in the Federal Appellate Court’s prior decision in this case, issued on June 11, 2003. In implementing the June 11, 2003 and November 24, 2004 Federal Appellate Court decisions, the Fiscal Court ordered the federal tax authorities to make the VAT refund to TFM through a single certificate issued in TFM’s name, and to refund through that certificate the original amount of the VAT refund due, increased for inflation and interest from the date the tax authorities should have made the refund in 1997, until the date that the refund certificate is actually delivered to TFM. The Fiscal Court also vacated its prior decisions in this matter.

As of December 31, 2004, no gain has been reflected for financial reporting purposes.

B) The Mexican Government Put

In October 2003, Grupo TFM requested that a federal judge in Mexico provide an appropriate interpretation of the Put Agreements. When the Government opened the Mexican railroad system to private investment, it retained a 20% equity interest in TFM. The intention was to sell these shares through a public offering, at such time as the Government considered it appropriate and with approval of the Comisión Nacional Bancaria y de Valores- “CNBV”, with the objective of strengthening the market for public investments in Mexico and encouraging additional investors to invest in the capital stock of TFM.

Additionally, TFM’s bid contained the following condition: “The franchise purchasers will be obligated to acquire the equity portion that cannot be placed in the Bolsa Mexicana de Valores- “BMV”, at the initial offering prices plus respective interest”.

The Company believes that under the Put Agreements, the Government agreed to comply with the following process in order to sell the equity interest that the Government retains in TFM:

1. Register the TFM shares with the BMV;

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2. Receive the approval of the CNBV to exercise the put;

3. Request that TFM provide all information necessary to place the Government’s equity stake in the equity markets; and

4. Place the number of TFM shares it is able to in the equity markets once all necessary approvals are granted.

When the above steps are completed, the Government is to notify Grupo TFM of the number of TFM shares that could not be placed in the equity markets and is to request that Grupo TFM acquire those shares at the minimum stipulated price. The Company does not believe that any of the steps described above have been carried out. As a result, the Company believes that the Government has not yet completed the steps required for it to request that Grupo TFM acquire the equity stake in TFM held by the Government.

The price of the Government’s interest, as indexed for Mexican inflation, as of December 31, 2003 was approximately 1,570.3 million UDIS (representing Ps5,264 million, or approximately $468.4 million). This amount may not be equal to the fair market value of the Mexican Government’s interest.

Nevertheless, and notwithstanding the judicial proceeding initiated by Grupo TFM in October 2003, on October 31, 2003, the SCT requested that Grupo TFM confirm whether it intends to purchase the TFM shares subject to the put rights of the Government. Grupo TFM responded that the purchase of the Government’s shares of TFM was the subject of an ongoing judicial proceeding that had yet to be resolved. On November 3, 2003, the SCT stated in a communication to Grupo TFM that it had complied with the requirements for the exercise of its put rights as set out in the Put Agreements and that all procedures required to execute the sale of the Government’s TFM shares would be made through the SAT.

Grupo TFM requested that a federal court review the SCT’s communications with respect to the Government’s put rights. On December 16, 2003, the Fourth Administrative District Court issued an injunction ordering the parties to maintain the status quo pending judicial resolution of the dispute. In order for the injunction to be effective, the Fourth Administrative District Court required that Grupo TFM post a bond for the equivalent of six months of interest on the exercise price of the Government’s put option to be calculated at an interest rate of 6% per annum (approximately Ps160 millions or approximately $14.3 million at December 31, 2003).

However, as no further action has been taken by the Government to enforce its rights in connection with the put shares, Grupo TFM’s obligation to post such a bond is considered discretionary under Mexican law. Consequently, Grupo TFM has elected, for the time being, not to post the bond so as not to incur unnecessary expense. Grupo TFM has the right to post the bond at any time while the amparo proceeding is pending. Grupo TFM will vigorously defend its view that the Government has not fulfilled the prescribed steps required to exercise its put rights. Although Grupo TFM believes that it will prevail in legal proceedings related to these matters, there can be no assurance that it will prevail.

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The Government has the right to first put the shares to Grupo TFM although Grupo TFM has not obligation to acquire such shares. In the event that Grupo TFM does not acquire the shares, Grupo TMM and KCS, or either Grupo TMM or KCS, are obligated to purchase the Government’s interest (jointly liable). Grupo TMM and KCS have cross indemnities in the event the Government requires only one of them to purchase its interest. The cross indemnities allow the party required to purchase the Government’s interest to require the other party to purchase its pro rata portion of such interest.

In 2004, those procedures continue under litigation and therefore are pending of final resolution. No amounts have been recognized in these financial statements related to the put.

C) Ferrocarril Mexicano, S. A. de C. V., or Ferromex, Disputes

TFM and Ferromex have not been able to agree upon the rates each of them is required to pay to the other for interline services and haulage and trackage rights. Therefore, in accordance with TFM’s rights under the Mexican railroad services law and regulations, in February 2001, TFM initiated and administrative proceeding requesting a determination of such rates by the SCT.

In September 2001, Ferromex filed a legal claim against TFM relating to the payments that TFM and Ferromex are required to make to each other for interline services and trackage and haulage rights. TFM believes that this legal claim is without merit, and that the payments for interline services and trackage and haulage rights owed to TFM by Ferromex exceed the amount of payments that Ferromex claims TFM owes to Ferromex for such services and rights. Accordingly, TFM believes that the outcome of this legal claim will not have a material adverse effect on the financial condition of TFM. On September 25, 2002, the Third Civil Court of Mexico City rendered its judgment in favor of TFM. Ferromex appealed the judgment and TFM prevailed in such appeal. Ferromex, as a last resource, initiated amparo proceedings before Federal Courts, and obtained a resolution that orders the higher local court to review the case again exclusively for the interline services. The higher local court issued a new ruling which both, Ferromex and TFM claimed in a new amparo proceeding at the Federal Court, and which is pending resolution. TFM cannot predict whether it will ultimately prevail.

In connection with the Ferromex claim, Ferromex temporarily prevented TFM from using certain short trackage rights which TFM has over a portion of its route running from Celaya to Silao, which is the site of a General Motors plant from where TFM transports finished vehicles to the border crossing at Nuevo Laredo. Ferromex was subsequently ordered by the court to resume giving us access, and in October 2001, TFM filed a counterclaim against Ferromex relating to these actions. TFM has also initiated several judicial and administrative proceedings at the SCT to seek the imposition sanctions against Ferromex for violations to the trackage rights in the route from Celaya to Silao, which to date have not been resolved.

TFM has also initiated several administrative and judicial proceedings (including criminal actions) against Ferromex at the SCT and the relevant Federal Courts, in connection with its trackage rights in Altamira, Topo Grande-Chipinque, Guadalajara, Arellano-Chicalote, Ramos Arizpe-Encantada, and Pedro C. Morales-Cerro de la Silla. TFM cannot predict whether it will ultimately prevail on such proceedings.

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In March 2002, the SCT issued its ruling in response to TFM’s request, establishing a rate to be charged for trackage rights using the criteria set forth in the Mexican railroad services law and regulations. TFM is appealing the ruling and requesting a suspension of the effectiveness of the ruling pending resolution of its appeal. TFM cannot predict whether it will ultimately prevail. TFM believes that even if the rates established in the ruling go into effect and TFM and Ferromex begin using the long-distance trackage rights over each other’s rail line, this will not have a material adverse effect on TFM’s results of operations. A separate ruling was issued confirming TFM’s right to use the Celaya-Silao stretch of Ferromex track, which was appealed by Ferromex before the Federal Courts, where Ferromex obtained the suspension of such ruling. TFM requested and obtained amparo proceeding against such suspension and Ferromex appealed the resolution granting the amparo to TFM. The final resolution of the appeal of Ferromex is pending. TFM cannot predict whether it will ultimately prevail in this amparo proceeding as well as on the main procedure regarding TFM’s right to use the Celaya-Silao stretch of Ferromex track.

Both Ferromex and TFM have suspended the reconciliation of their balances in 2003, and have initiated several judicial and administrative proceedings in connection with the amounts payable to each other for interline services, haulage and trackage rights.

In 2004, these proceedings continue to be litigated and therefore are pending of final resolution.

D) Dispute between Grupo TMM and KCS

On April 20, 2003, Grupo TMM entered into the Acquisition Agreement with KCS, which owns a 49% voting interest in Grupo TFM, under the terms of which Grupo TMM was to sell its entire interest in Grupo TFM, which owns 80% of TFM and through which its railroad operations are conducted. Under the agreement, KCS was to acquire the Grupo TMM’s interest in Grupo TFM in exchange for $200 million in cash and 18,000,000 shares of common stock of KCS’s successor corporation. In addition, Grupo TMM was to have the right to receive an additional earn out of up to $175 million in cash ($180 million if KCS elected to defer a portion of the payment) in the event that the pending VAT claim against the Government by TFM was successfully resolved prior to the execution by the Government of its “put” rights in certain shares of TFM and the amount of VAT Proceeds received was greater than the purchase price of the “put” shares held by the Government. Completion of the TFM sale was subject to approval by (i) holders of Grupo TMM existing notes, (ii) the shareholders of KCS and (iii) the shareholders of Grupo TMM, receipt of certain governmental approvals in the United States and Mexico and other customary conditions.

On August 18, 2003, Grupo TMM’s shareholders voted to reject the Acquisition Agreement. In addition, Grupo TMM’s Board of Directors met on August 22, 2003 and voted to terminate the Acquisition Agreement.

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KCS disputed Grupo TMM rights to terminate the Acquisition Agreement and alleged certain breaches by Grupo TMM of the Acquisition Agreement. Under the terms of the Acquisition Agreement, the parties submitted these disputes to binding arbitration.

In March 2003, Grupo TMM announced that the three-member panel in the arbitration proceeding between KCS and Grupo TMM concluded, in an interim award, that the rejection of the Acquisition Agreement by Grupo TMM’s shareholders in its vote on August 18, 2003, did not authorize Grupo TMM to terminate the Agreement. Accordingly, the three-member panel indicated the Agreement will remain in force and binding on the parties until otherwise terminated according to its terms or by law. In reaching the conclusion, the panel found it unnecessary to determine whether approval by Grupo TMM’s shareholders is a “condition” of the Agreement.

On December 15, 2004, KCS entered into a new Acquisition Agreement with Grupo TMM and other parties under which KCS ultimately would acquire control of TFM through the purchase of shares of common stock of Grupo TFM. Under the terms of the Acquisition Agreement, KCS would acquire all of the interest of Grupo TMM in Grupo TFM for $200.0 million in cash, 18 million shares of KCS common stock, $47.0 million in a two-year promissory note subject to satisfaction of conditions of an escrow agreement, and up to $110.0 million payable in a combination of cash and stock related to the final resolution of the VAT claim and PUT as such term is defined in the Acquisition Agreement.

As a consequence of the new acquisition agreement of Grupo TFM all disputes between KCS and TMM would be dismissed. (See note 17).

E) Other Legal Disputes involving KCS

Several Grupo TFM and TFM board of directors meetings have taken place since August 25, 2003. KCS and certain of its representatives have initiated judicial proceedings in Mexico seeking the nullification of such board meetings. In addition, KCS has initiated another proceeding seeking the nullification of Grupo TFM’s November 24, 2003 shareholders’ meeting. The Company believes that KCS’s claims in this connection are without merit. At present, the Company has responded to all claims concerning which the Company has been served. Although the Company cannot assure the outcome of the proceedings resulting from these claims, the Company believes that none of the underlying claims initiated by KCS in Mexico, if ultimately determined in favor of KCS, will have a material adverse effect on Grupo TFM or TFM.

As a consequence of the new acquisition agreement of Grupo TFM all disputes between KCS and Grupo TFM would be dismissed.

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F) Other legal proceedings

•		The Company is a party to various other legal proceedings and administrative actions, all of which are of an ordinary or routine nature and incidental to its operations. Although it is impossible to predict the outcome of any legal proceeding, in the opinion of the Company’s Management, such proceedings and actions should not, individually or in the aggregate, have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

•		The Company has significant transactions and relationships with related parties. Because of these relationships, in accordance with the Mexican Income Tax Law, the Company must obtain a transfer pricing study that confirms that the terms of these transactions are the same as those that would result from transactions among wholly unrelated parties. The Company has the transfer pricing study from 2003 and is in the process of updating such report.

•		In January 2004, TFM and Arrendadora TFM assumed joint and several responsibility for the prepayment of federal taxes.

•		The Secretaría of Administración Tributaria, which is empowered to verify tax returns for the last five years, is performing a review of TFM’s 2000 and 2001 tax returns. At present no final conclusion has been reached from the tax authorities; however, the Company believes that no material adverse effect would result from these reviews.

NOTE 17 — SUBSEQUENT EVENT:

a.		The shareholders of Grupo TMM approved unanimously the Board of Directors’ recommendation to sell TMM’s 51 percent voting interest in Grupo TFM to KCS at a shareholder meeting held on January 11, 2005.

b.		Mexican Supreme Court Cases Relating to Statutory Profit Sharing Accounting (unaudited) The Company calculates profit sharing liabilities as 10% of its net taxable income. In calculating the net taxable income for profit sharing purposes, the Company deducts net operating loss, or NOL, carryforwards. The application of NOL carryforwards can result in a deferred profit sharing asset for a given period instead of a profit sharing liability. The Mexican tax authorities had challenged the Company’s calculation of profit sharing liabilities in the late 1990s, but the Company prevailed with a Mexican Fiscal Court ruling in 1999 followed by a Tax Authority Release acknowledging the Company’s ability to continue to calculate profit sharing the way the Company had been, including the deduction of NOL carryforwards in the calculation of net taxable income for profit sharing purposes. However, since a technical amendment to the Mexican tax law in 2002, the Mexican tax authorities have objected to the Company’s deduction of NOL carryforwards in the calculation of net taxable income for profit sharing purposes following such amendment, which objection the Company has challenged in court. On May 3, 2005, the Mexican Supreme Court ruled in a plenary session relating to four cases that NOL carryforwards could not be deducted when

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calculating net taxable income for profit sharing liability purposes. None of the four cases involved Grupo TFM or TFM. Because these rulings took place subsequent to the issuance of the Company’s 2004 accounts, the decisions do not give rise to a restatement of any amounts recorded as of December 31, 2004. In light of these decisions, the Company’s management is currently assessing the potential impact of these rulings on the Company’s accounting practices relating to the application of NOL carryforwards for its 2005 U.S. GAAP accounting. In the event that the Company had not been able to deduct NOL carryforwards from its profit sharing liabilities in respect of its financial statements through December 31, 2004 for U.S. GAAP reconciliation purposes, such financial statements would have been negatively affected by the elimination of a cumulative amount of U.S.$72.0 million in NOL carryforwards as of December 31, 2004. There would have been no effect on the Company’s financial statements under IFRS, which does not require the establishment of assets or liabilities relating to these carryforwards.

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