KANSAS CITY SOUTHERN (Form: 10-Q, Received: 11/09/2006 14:24:00)

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 30, 2006
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 12th Street, Kansas City, Missouri (Address of principal executive offices)		64105 (Zip Code)

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

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

Indicate by check mark whether the 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 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. (Check one):


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

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


Class	Outstanding at October 31, 2006

Common Stock, $0.01 per share par value		75,834,470 Shares

KANSAS CITY SOUTHERN

FORM 10-Q

September 30, 2006

INDEX


			Page

		PART I — FINANCIAL INFORMATION
	Item 1.	Financial Statements		3
		Introductory Comments		3
		Consolidated Statements of Income — Three and nine months ended September 30, 2006 and 2005		4
		Consolidated Balance Sheets — September 30, 2006 and December 31, 2005		5
		Consolidated Statements of Cash Flows — Nine months ended September 30, 2006 and 2005		6
		Consolidated Statement of Changes in Stockholders’ Equity — Nine months ended September 30, 2006		7
		Notes to Consolidated Financial Statements		8-28
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		29-39
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		39
	Item 4.	Controls and Procedures		39
		PART II — OTHER INFORMATION
	Item 1.	Legal Proceedings		40
	Item 1A.	Risk Factors		40
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		40
	Item 3.	Defaults Upon Senior Securities		40
	Item 4.	Submission of matters to a Vote of Security Holders		40
	Item 5.	Other Information		40
	Item 6.	Exhibits		40
SIGNATURES				42
Participation Agreement
Equipment and Lease Agreement
Principal Executive Officer's Certification
Principal Financial Officer's Certification
Principal Executive Officer's Certification
Principal Financial Officer's Certification
Updated Risk Factors

KANSAS CITY SOUTHERN

FORM 10-Q

September 30, 2006

PART I — FINANCIAL INFORMATION


ITEM 1.	*FINANCIAL STATEMENTS*

Introductory Comments

The Consolidated Financial Statements included herein have been prepared by Kansas City Southern (“we,” “our,” “KCS” or the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed, or omitted pursuant to such rules and regulations. The Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented. These Consolidated Financial Statements should be read in conjunction with the consolidated financial statements and the notes thereto, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-Q. For the three and nine months ended September 30, 2006, these financial statements include the results of operations and cash flows of Grupo KCSM, S.A. de C.V. (“Grupo KCSM”), formerly known as Grupo Transportacion Ferroviaria Mexicana, S.A. de C.V. Grupo KCSM was consolidated on April 1, 2005, as a result of the acquisition of a controlling interest by KCS as of that date. Accordingly, the results of operations for the nine months ended September 30, 2005 include Grupo KCSM on a consolidated basis for the six months ended September 30, 2005 and as an equity method investment for the three months ended March 31, 2005. Results for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results expected for the full year 2006.

KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF INCOME

(In millions, except share and per share data)

(Unaudited)


	Three Months						Nine Months
	Ended September 30						Ended September 30
	2006			2005			2006			2005

Revenues	$	415.7		$	384.6		$	1,217.3		$	963.9
Operating expenses:
Compensation and benefits		97.1			94.0			284.1			248.7
Fuel		66.4			59.6			187.8			142.6
Purchased services		56.6			57.0			163.9			133.3
Equipment costs		46.1			46.6			130.1			105.2
Depreciation and amortization		37.7			40.5			112.9			95.3
Casualties and insurance		12.0			55.3			40.1			90.0
KCSM employees’ statutory profit sharing		(0.6	)		2.2			5.0			41.0
Other		23.1			31.3			77.3			93.3

Total operating expenses		338.4			386.5			1,001.2			949.4

Operating income (loss)		77.3			(1.9	)		216.1			14.5
Equity in net earnings of unconsolidated affiliates		3.2			1.3			5.7			0.7
Interest expense		(42.3	)		(39.5	)		(123.5	)		(90.5	)
Debt retirement costs		—			—			(2.2	)		(3.9	)
VAT/put settlement gain, net		—			131.9			—			131.9
Exchange gain (loss)		4.5			(1.5	)		(6.7	)		2.8
Other income		3.5			2.6			9.3			9.7

Income before income taxes and minority interest		46.2			92.9			98.7			65.2
Income tax provision (benefit)		14.7			(19.8	)		30.2			(12.7	)

Income before minority interest		31.5			112.7			68.5			77.9
Minority interest		0.2			—			0.2			(17.8	)

Net income		31.3			112.7			68.3			95.7
Preferred stock dividends		4.9			2.2			14.6			6.6

Net income available to common shareholders	$	26.4		$	110.5		$	53.7		$	89.1

Per Share Data
Earnings per common share — basic	$	0.35		$	1.35		$	0.72		$	1.18

Earnings per share — diluted	$	0.32		$	1.14		$	0.67		$	1.05

Weighted average common shares outstanding (in thousands)
Basic		75,178			81,795			74,490			75,664
Potential dilutive common shares		16,411			17,703			16,431			16,432

Diluted		91,589			99,498			90,921			92,096

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

CONSOLIDATED BALANCE SHEETS

(In millions, except share amounts)

(Unaudited)


	September 30,			December 31,
	2006			2005

ASSETS
Current assets:
Cash and cash equivalents	$	64.2		$	31.1
Restricted funds		51.7			—
Accounts receivable, net		335.1			315.7
Inventories		78.1			73.9
Other current assets		36.2			46.1

Total current assets		565.3			466.8

Investments		66.7			60.3
Property and equipment, net		2,358.7			2,298.3
Concession rights, net		1,318.3			1,360.4
Goodwill		10.6			10.6
Deferred income tax asset		138.6			152.2
Restricted funds		3.0			9.0
Other assets		64.2			66.0

Total assets	$	4,525.4		$	4,423.6


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Debt due within one year	$	186.2		$	38.0
Accounts and wages payable		178.3			215.7
Current liability related to Grupo KCSM acquisition		50.3			78.3
Accrued liabilities		307.2			241.7

Total current liabilities		722.0			573.7

Other liabilities:
Long-term debt		1,490.5			1,663.9
Long-term liability related to Grupo KCSM acquisition		32.8			80.4
Deferred income taxes		421.3			409.2
KCSM employees’ deferred statutory profit sharing		39.3			29.0
Other noncurrent liabilities and deferred credits		189.6			241.2

Total other liabilities		2,173.5			2,423.7

Minority interest		100.2			—
Stockholders’ equity:
$25 par, 4% noncumulative, preferred stock, 840,000 shares authorized, 649,736 shares issued, 242,170 shares outstanding at September 30, 2006 and December 31, 2005, respectively		6.1			6.1
$1 par, 4.25%, series C — redeemable cumulative convertible perpetual preferred stock, 400,000 shares authorized, issued and outstanding, liquidation preference of $200 million at September 30, 2006 and December 31, 2005, respectively		0.4			0.4
$1 par, 5.125%, series D — cumulative convertible perpetual preferred stock, 210,000 shares authorized, issued and outstanding, liquidation preference of $210 million at September 30, 2006 and December 31, 2005, respectively		0.2			0.2
$.01 par, common stock, 400,000,000 shares authorized, 91,369,116 shares issued, 75,832,354 and 73,412,081 shares outstanding at September 30, 2006 and December 31, 2005, respectively		0.7			0.7
Paid in capital		522.6			473.1
Retained earnings		999.8			946.1
Accumulated other comprehensive loss		(0.1	)		(0.4	)

Total stockholders’ equity		1,529.7			1,426.2

Total liabilities and stockholders’ equity	$	4,525.4		$	4,423.6

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)


	Nine Months Ended
	September 30
	2006			2005

CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Net income	$	68.3		$	95.7
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		112.9			95.3
Deferred income taxes		30.9			6.4
KCSM employees statutory profit sharing		5.0			41.0
Equity in undistributed earnings of unconsolidated affiliates		(5.7	)		(0.7	)
VAT/put settlement gain		—			(131.9	)
Changes in working capital items:
Accounts receivable		(19.4	)		38.7
Inventories		(4.2	)		(18.6	)
Other current assets		9.4			3.2
Accounts and wages payable		(33.9	)		1.8
Accrued liabilities		65.5			26.6
Other, net		(58.3	)		(13.3	)

Net cash provided by operating activities		170.5			144.2

INVESTING ACTIVITIES:
Property acquisitions		(150.9	)		(138.4	)
Investments from minority interests		100.0			—
Funding of restricted cash — MSLLC		(48.7	)		—
Proceeds from disposal of property		0.4			5.9
Investment in and loans to affiliates		—			(10.1	)
Other, net		7.7			—

Net cash used for investing activities		(91.5	)		(142.6	)

FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt		410.3			623.0
Repayment of long-term debt		(451.8	)		(570.4	)
Debt issuance costs		(7.5	)		(14.7	)
Proceeds from stock plans		7.4			0.9
Dividends paid		(4.3	)		(6.6	)

Net cash provided by (used for) financing activities		(45.9	)		32.2

CASH AND CASH EQUIVALENTS:
Net increase in cash and cash equivalents		33.1			33.8
At beginning of year		31.1			38.6

At end of period	$	64.2		$	72.4

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(In millions, except share amounts)

(Unaudited)


							Common					Accumulated
	$25 Par		Preferred Stock				Stock and					Other			Total
	Preferred		Series C		Series D		Paid in		Retained			Comprehensive			Stockholders’
	Stock		4.25%		5.125%		Capital		Earnings			Income (Loss)			Equity

Balance at December 31, 2005	$	6.1	$	0.4	$	0.2	$	473.8	$	946.1		$	(0.4	)	$	1,426.2
Comprehensive income:
Net income before minority interest										68.5
Loss related to interest rate swaps													0.3
Comprehensive income																68.8
Minority interest										(0.2	)					(0.2	)
Dividends on $25 par preferred stock ($0.75/share)										(0.2	)					(0.2	)
Dividends on $1 par series C cumulative convertible preferred stock ($15.94/share)										(6.3	)					(6.3	)
Dividends on $1 par series D cumulative convertible preferred stock ($38.44/share)										(8.1	)					(8.1	)
Stock issued in acquisition of Grupo KCSM								35.0								35.0
Share-based compensation								3.6								3.6
Options exercised and ESPP stock subscribed								7.4								7.4
Tax benefit on options exercised								3.5								3.5

Balance at September 30, 2006	$	6.1	$	0.4	$	0.2	$	523.3	$	999.8		$	(0.1	)	$	1,529.7

See accompanying notes to consolidated financial statements.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.	Accounting Policies and Interim Financial Statements.

In the opinion of the management of KCS, the accompanying unaudited consolidated financial statements contain all adjustments necessary, which are of a normal and recurring nature, to present fairly the financial position of the Company and its subsidiary companies as of September 30, 2006 and December 31, 2005, the results of operations for the three and nine months ended September 30, 2006 and 2005, cash flows for the nine months ended September 30, 2006 and 2005, and changes in stockholders’ equity for the nine months ended September 30, 2006. The accompanying consolidated financial statements have been prepared consistently with accounting policies described in Note 2 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2005 except for the Company’s adoption of Statement of Financial Accounting Standards No. 123R (Revised), Share-Based Payments , on January 1, 2006. The results of operations for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results to be expected for the full year 2006. For information regarding the Company’s critical accounting policies and estimates, please see Item 7 of the Company’s Annual Report on Form 10-K “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates.” Certain prior year amounts have been reclassified to conform to the current year presentation.

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. 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. KCS completed the purchase of the controlling interest in Grupo KCSM on April 1, 2005. Beginning April 1, 2005, the financial results of Grupo KCSM have been consolidated into KCS. Prior to April 1, 2005, the investment for Grupo KCSM was accounted for under the equity method.

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

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

Restricted Funds — JSIB Consulting. In connection with KCS’ acquisition of the controlling interest in Grupo KCSM (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 Jose Serrano, Chairman of the Board of Grupo TMM, S.A. (“TMM”), which became effective April 1, 2005. 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. On January 12, 2006, the first $3.0 million annual fee was released from the escrow account. Accordingly the balance in restricted cash was $6.0 million, of which $3.0 million was included in current assets and $3.0 million was included in noncurrent assets on September 30, 2006. 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.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Restricted Funds — MSLLC. On December 1, 2005, KCS and its wholly-owned subsidiary The Kansas City Southern Railway Company (“KCSR”), entered into a transaction agreement (the “Transaction Agreement”) with NS and its wholly-owned subsidiary, AGS, providing for, among other things, the formation of a limited liability company between the parties relating to the ownership and improvement of the KCSR rail line between Meridian, Mississippi and Shreveport, Louisiana (the “Line”), which is the portion of the KCSR rail line between Dallas, Texas and Meridian known as the “Meridian Speedway”.

In connection with the formation of the Meridian Speedway, LLC (“MSLLC”), Norfolk Southern Corporation (“NS”) through its wholly-owned subsidiary, The Alabama Great Southern Railroad Company (“AGS”) contributed $100.0 million to MSLLC, representing the initial NS investment in the joint venture. Of this initial investment, $51.3 million has been distributed to KCS as reimbursement for capital expenditures that have been made to MSLLC by KCS. The balance of the NS investment of $48.7 million is recorded as restricted funds as of September 30, 2006. Substantially all of these funds will be used for capital improvements over the next nine months to increase capacity and improve transit times over the Meridian Speedway, the rail line between Shreveport, Louisiana and Meridian, Mississippi, owned by MSLLC. AGS, per the agreement, will make additional cash contributions over time, resulting in a total cash investment of $300 million.

Liabilities Related to the Grupo KCSM Acquisition. In connection with the acquisition of Grupo KCSM and the final resolution of the VAT Claim and Put, as defined in the Amended and Restated Acquisition Agreement dated December 15, 2004 (“Acquisition Agreement”), the Company has recorded certain liabilities payable to TMM, as summarized below.


	•	Escrow Notes $47.0 million, which are subject to reduction for certain potential losses related to breaches of certain representations, warranties, or covenants in the Acquisition Agreement by TMM, or claims relating thereto, or under other conditions. The $47.0 million 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 September 30, 2006, the Company has recorded $50.3 million for this liability and the related accrued interest in the accompanying balance sheet.

	•	A contingent payment of up to $110.0 million 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 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, at December 31, 2005 the liability was 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.

On March 13, 2006, in settlement of the 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. Accordingly, at September 30, 2006 the Company has recorded a non-current liability of $32.8 million to be settled in 5 years.


	•	A one time incentive payment to JSIB of $9.0 million became payable upon final resolution of the VAT Claim and Put. On March 13, 2006, KCS paid $9.0 million in cash to JSIB.

Stock-Based Compensation. The Company adopted Statement of Financial Accounting Standards No. 123R (Revised) (“SFAS 123R”), Share-Based Payments , on January 1, 2006. This statement requires KCS to recognize the cost of employee services received in exchange for the Company’s equity instruments. Under SFAS 123R, KCS is required to record compensation expense over an award’s vesting period based on the award’s fair value at the date of grant. KCS has elected to adopt SFAS 123R on a modified prospective basis; accordingly, the financial

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

statements for periods prior to January 1, 2006, will not include compensation cost calculated under the fair value method.

Prior to January 1, 2006, the Company applied Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees , and, therefore, recorded the intrinsic value of stock-based compensation as expense. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123R to stock-based employee compensation prior to January 1, 2006:


	Three Months Ended			Nine Months Ended
	September 30, 2005			September 30, 2005

Net income (in millions) :
As reported	$	112.7		$	95.7
Total stock-based compensation expense determined under fair value method, net of income taxes		(0.3	)		(0.7	)

Pro forma	$	112.4		$	95.0

Earnings per basic share:
As reported	$	1.35		$	1.18
Pro forma		1.35			1.17
Earnings per diluted share:
As reported	$	1.14		$	1.05
Pro forma		1.13			1.04


2.	Stock-Based Compensation.

Effective January 1, 2006, SFAS 123R was adopted requiring the Company to measure the cost of equity classified stock-based compensation awards at grant date fair value in exchange for employee services rendered. All stock options and nonvested stock awards are granted at their market value on the date of grant. Their fair value is determined on the date of grant and recorded as compensation expense over the vesting period. Stock options and ESPP awards are valued at their fair value as determined using the Black-Scholes pricing model.

Nonvested Stock Awards

Three new Nonvested Stock Awards were granted in the third quarter of 2006 bringing the year to date total to 10 grants under the Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(the “Plan”). Under the Plan, 16 million shares are authorized to be awarded under various equity incentive plans. Nonvested stock granted in 2006 is summarized in the following table.


			Market Price
	Shares		at Date
Grant Date	Granted		of Grant

January 19		208,502	$	25.92
February 17		40,000		24.19
May 1		20,000		24.35
May 4		30,000		27.43
May 15		20,000		26.18
June 9		60,000		25.80
June 13		10,000		25.05
August 1		10,000		23.48
August 28		7,500		26.13
September 5		15,000		26.40

Awards granted under the plan typically have a 5 year cliff vesting period. Compensation cost, net of tax, for the three and nine months ended September 30, 2006 totaled $0.3 million and $1.5 million, respectively, compared with $0.2 million and $0.6 million for the three and nine months ended September 30, 2005, respectively.

As of September 30, 2006, there was $12.6 million of unrecognized compensation cost related to the Company’s outstanding nonvested stock. This cost is expected to be recognized over a weighted-average period of 2.22 years. The total intrinsic value of the nonvested stock outstanding at September 30, 2006 and 2005 was $17.4 million and $8.6 million, respectively. The fair value of shares vested in the three and nine months ended September 30, 2006 was $0.1 million and $1.4 million, respectively.

The weighted average grant date fair value of the outstanding nonvested stock follows:


	2006					2005
				Weighted					Weighted
				Average Grant					Average Grant
	Number of			Date Fair		Number of			Date Fair
	Shares			Value		Shares			Value

Nonvested stock at beginning of year		392,151		$	20.57		—		$	—
Granted		421,002			25.73		380,032			20.16
Vested		(54,788	)		20.10		(7,440	)		18.56
Forfeited		(119,965	)		22.23		(5,441	)		19.44

Nonvested stock at end of period		638,400			23.70		367,151			20.21

Stock Options and ESPP Awards

Stock options granted under the plan typically have a 5 year cliff vesting period and a 10 year contractual term. Unrecognized compensation expense for all unvested options outstanding as of the date of adoption of SFAS 123R, was determined and accounted for under the “Modified Prospective Method,” while compensation cost for each outstanding grant will be ratably recognized over each award’s remaining vesting period. Compensation expense, net of tax, recognized for options and ESPP awards for the three and nine months ended September 30, 2006 was $0.4 million and $1.0 million, respectively.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During the first quarter of 2006, the Company awarded 140,867 shares to substantially all full-time employees under the Seventeenth Offering of the Employee Stock Purchase Program (“ESPP”) granted at 90% of the average market price on either the exercise date or the offering date, whichever is lower. This award vests ratably over one year. Under SFAS 123R both the 10% discount in grant price and the 90% share option are valued to derive the award’s fair value. Total fair value per share was $5.12. The related stock based compensation expense, net of tax, for the three and nine months ended September 30, 2006 was $0.1 million and $0.3 million, respectively.

The fair value of each option and ESPP award is estimated on the date of grant using the Black-Scholes option-pricing model. The following assumptions apply to the options grated for the periods presented.


	Three Months					Nine Months
	Ended September 30,					Ended September 30,
	2006			2005		2006			2005

Weighted average expected dividends		0.00	%		—		0.00	%		0.00	%
Weighted average expected volatility		37.05	%		—		32.09	%		26.78	%
Weighted average risk free interest rate		4.75	%		—		4.47	%		3.41	%
Weighted average expected life (years)		6.86			—		3.41			5.43

The following summarizes stock option activity for the year to date 2006:


				Weighted-		Weighted-
				Average		Average		Aggregate
				Exercise		Remaining		Intrinsic
	Shares			Price		Contractual Term		Value
						(in years)		(In millions)

Outstanding at beginning of year		3,707,393		$	9.11
Exercised		(515,743	)	$	10.66
Canceled/expired		(223,604	)	$	12.78
Granted		90,800		$	26.03

Outstanding at end of period		3,058,846		$	9.08		4.89	$	55.73

Exercisable at end of period		2,612,658		$	7.90		4.48	$	50.70

The total intrinsic value of options exercised for the nine months ended September 30, 2006, was $8.6 million. Unrecognized compensation cost for stock options at September 30, 2006, was $2.5 million.


3.	Earnings per Share Data.

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

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

shares used for the basic earnings per share computation to the shares used for the diluted earnings per share computation (in thousands) :


	Three Months				Nine Months
	Ended September 30,				Ended September 30,
	2006		2005		2006		2005

Basic shares		75,178		81,795		74,490		75,664
Effect of dilution		16,411		17,703		16,431		16,432

Diluted shares		91,589		99,498		90,921		92,096

Potentially dilutive shares excluded from the calculation:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005

Stock options where the exercise price is greater than the average market price of common shares		204,396		—		260,896		—

Convertible debt instruments which are anti-dilutive		1,477,978		—		1,477,978		—

Convertible preferred stock which is anti-dilutive		7,000,000		—		7,000,000		—

The following reconciles 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 (in millions) :


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005

Net income available to common shareholders for purposes of computing basic earnings per share	$	26.4	$	110.5	$	53.7	$	89.1
Effect of dividends on conversion of convertible preferred stock		2.1		2.1		6.4		6.4
Effect of interest expense on conversion of $47.0 million escrow note		0.4		0.4		1.1		0.7
Effect of interest expense on conversion of note payable to TMM for VAT/put settlement		—		0.1		—		0.1

Net income available to common shareholders for purposes of computing diluted earnings per share	$	28.9	$	113.1	$	61.2	$	96.3


4.	Investments.

Investments in unconsolidated affiliates and certain other investments accounted for under the equity method generally include all entities in which the Company or its subsidiaries have significant influence, but not more than 50% voting control. Investments in unconsolidated affiliates at September 30, 2006 include equity interests in Southern Capital Corporation, LLC (“Southern Capital”), the Panama Canal Railway Company (“PCRC”) and the Mexico Valley Railway and Terminal (Ferrocarril y Terminal del Valle de México, S.A. de C.V., “FTVM”).

Condensed financial information of certain unconsolidated affiliates is shown below (in millions ). All amounts are presented under U.S. GAAP except where an adjustment for comparability has been made. Financial information of immaterial unconsolidated affiliates has been omitted.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Financial Condition:


	September 30, 2006						December 31, 2005
					Southern						Southern
	FTVM		PCRC		Capital		FTVM		PCRC		Capital

Current assets	$	39.0	$	4.6	$	12.6	$	35.4	$	5.2	$	5.2
Non-current assets		32.7		82.1		88.7		28.1		81.5		92.8

Assets	$	71.7	$	86.7	$	101.3	$	63.5	$	86.7	$	98.0

Current liabilities	$	9.5	$	12.2	$	2.7	$	9.3	$	13.9	$	1.0
Non-current liabilities		16.8		72.8		34.5		15.8		71.5		41.2
Equity of stockholders and partners		45.4		1.7		64.1		38.4		1.3		55.8

Liabilities and equity	$	71.7	$	86.7	$	101.3	$	63.5	$	86.7	$	98.0

KCS’ investment	$	12.8	$	0.8	$	32.1	$	10.9	$	0.6	$	27.9

Operating Results:


	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2006			2005			2006		2005

Revenues and other income:
Southern Capital	$	4.6		$	4.6		$	13.1	$	22.7
PCRC		4.1			4.3			14.5		11.1
FTVM		10.5			14.1			38.8		39.6
Operating costs and other expenses:
Southern Capital ⁽¹⁾	$	2.7		$	3.4		$	7.5	$	8.9
PCRC		4.7			4.5			14.2		15.5
FTVM		6.6			11.9			28.6		35.1
Net income (loss):
Southern Capital	$	1.9		$	1.2		$	5.6	$	13.8
PCRC		(0.6	)		(0.2	)		0.3		(4.4	)
FTVM		3.9			2.2			10.2		4.5


(1)		For comparison of the periods presented, the 2005 and 2006 amounts shown above reflect an adjustment to exclude a change related to depreciation in the third quarter of 2006.

Formation of MSLLC. On December 1, 2005, KCS and its wholly-owned subsidiary The Kansas City Southern Railway Company (“KCSR”), entered into a transaction agreement (the “Transaction Agreement”) with NS and its wholly-owned subsidiary, AGS, providing for, among other things, the formation of a limited liability company between the parties relating to the ownership and improvement of the KCSR rail line between Meridian, Mississippi and Shreveport, Louisiana (the “Line”), which is the portion of the KCSR rail line between Dallas, Texas and Meridian known as the “Meridian Speedway”. MSLLC is fully consolidated by KCS.


5.	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 fair values assigned to assets acquired and liabilities assumed were

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

based on valuations prepared by independent third party appraisal firms, published market prices and management estimates.

As of April 1, 2006, the Company finalized its purchase price allocation relating to its acquisition of both the 38.8% interest of TMM and the 23.9% interest of the Mexican Government. Remaining severance costs related to the acquisition were $2.1 million at September 30, 2006. The Company expects to substantially complete the settlement of the remainder of these liabilities prior to December 31, 2006.


6.	Noncash Investing and Financing Activities.

The Company initiated the Seventeenth Offering of KCS common stock under the Employee Stock Purchase Plan (“ESPP”) during 2006. Approximately 140,000 shares, with an aggregate purchase price of $2.8 million were subscribed under the Seventeenth Offering. Shares under the Seventeenth Offering will be issued to employees in 2007. Under the Seventeenth Offering, for the nine months ended September 30, 2006, the Company received $1.8 million from payroll deductions.

In the first quarter of 2006, the Company issued 107,344 shares of KCS common stock under the Sixteenth Offering of the ESPP. These shares, with an aggregate purchase price of $1.7 million, were subscribed and paid for through employee payroll deductions in 2005.


7.	Derivative Financial Instruments.

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

Fuel Derivative Transactions. Given the significance of diesel fuel to KCS’ operations and the historical volatility of fuel prices, the Company enters into hedges periodically to partially mitigate the risk of fluctuations in the price of fuel. Subsequent to September 30, 2006, the Company entered into fuel swap agreements covering 20,000 barrels of diesel fuel per month for the three months ending December 31, 2006.

Foreign Exchange Contracts. The purpose of Grupo 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 September 30, 2006, Grupo KCSM had one Mexican peso call option outstanding in the notional amount of $1.7 million, based on the average exchange rate of 14.50 Mexican pesos per U.S. dollar. This option expires May 29, 2007. The premium paid, $25.0 thousand, was expensed since this contract did not qualify for hedge accounting. As of September 30, 2006, Grupo KCSM did not have any outstanding forward contracts.

Foreign Currency Balance. At September 30, 2006, Grupo KCSM had monetary assets and liabilities denominated in Mexican pesos of Ps1,121 million and Ps461 million, respectively. At September 30, 2006, the exchange rate was 10.99 Mexican pesos per U.S. dollar. At December 31, 2005, Grupo KCSM had monetary assets and liabilities denominated in Mexican pesos of Ps1,088 million and Ps549 million, respectively. At December 31, 2005, the exchange rate was 10.64 Mexican pesos per U.S. dollar.


8.	Tex-Mex Loan Agreement.

On June 28, 2005, the Texas Mexican Railway Company (“Tex-Mex”) (a wholly-owned and consolidated subsidiary) entered into an agreement with the Federal Railroad Administration (“FRA”), to borrow $50.0 million to be used for safety and infrastructure improvements. These improvements are expected to increase efficiency and

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

capacity in order to accommodate growing cross-border freight rail traffic. The loan was granted under the Railroad Rehabilitation and Improvement Financing Program administered by the FRA. The loan is guaranteed by Mexrail, Inc (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. On June 26, 2006, Tex-Mex received the final distribution of the full loan amount of $50.0 million.


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 position, results of operations and cash flows.

Reinsurance Litigation. As the Company has previously reported, insurance companies who provided insurance to the Company filed an action in federal court in Vermont (the “Reinsurance Litigation”) seeking a declaration that they have no obligation to indemnify the Company concerning a particular casualty claim. That claim, styled Kemp, et al v. The Kansas City Southern Railway Company, et al , has been pending in the Circuit Court of Jackson County, Missouri (the “Kemp Litigation”) and went to trial in September 2006. The Company has now reached a settlement with the plaintiffs in the Kemp Litigation. The Company has also reached settlements with various parties, including several of the insurance companies involved in the Reinsurance Litigation, to indemnify the Company for a significant portion of the settlement. The Kemp settlement is fully reflected in the Company’s third quarter financial statements and the Company has no further risk associated with this litigation. The Company is, however, continuing the Reinsurance Litigation against certain other insurance companies, seeking to establish their obligation to indemnify the Company for their share of the settlement with Kemp.

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 payments. 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. Activity in the reserve follows (in millions) :


	Nine Months
	Ended September 30,
	2006			2005

Balance at beginning of year	$	103.1		$	65.3
Accruals, net (includes the impact of actuarial studies)		28.4			51.3
Payments		(15.8	)		(17.5	)

Balance at end of period	$	115.7		$	99.1

Based on an updated study of casualty reserves for data through August 31, 2006, and the settlement of the Kemp case, the reserves for FELA, third-party, and occupational illness claims are reflected in the table above for the nine months ended September 30, 2006. The changes to the reserve in the current year reflect the Kemp settlements and a favorable loss experience since the date of the prior study.

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

KCS/KCSR 2006 Credit Agreement. On April 28, 2006, KCS and KCSR entered into an amended and restated credit agreement, (the “2006 KCS Credit Agreement”), equal to $371.1 million with The Bank of Nova Scotia and other lenders named in the 2006 KCS Credit Agreement. Proceeds from the 2006 Credit Agreement were used to refinance existing credit facilities. The 2006 KCS Credit Agreement consists of (a) a $125.0 million revolving credit facility with a letter of credit sublimit of $25.0 million, a swing line advance sublimit of up to $15.0 million, and a maturity date of April 28, 2011 and (b) a $246.1 million term loan facility with a maturity date of April 28, 2013.

The 2006 KCS Credit Agreement contains covenants that restrict or prohibit certain actions, including, but not limited to, KCS’ 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. In addition, KCS must meet certain consolidated interest coverage ratios, and consolidated leverage ratios. Failure to maintain compliance with covenants could 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 2006 KCS Credit Agreement. As of September 30, 2006, KCS had $50 million available under the revolving credit facility.

Acquisition of New Locomotives. On August 23, 2006, KCSR entered into an agreement with Electro-Motive Diesel, Inc. to acquire 30 locomotives to be delivered June 2007 through September 2007 at a total cost of $61.4 million. On August 14, 2006, KCSM entered into an agreement with General Electric Company to acquire 30 locomotives to be delivered to KCSM in December 2006 and January 2007 at an aggregate cost of approximately $63.7 million. The Company intends to finance the acquisition of these locomotives with equipment lease financings treated as operating leases.

On August 11, 2006, KCSR entered into a participation agreement (the “Agreement”) to sell 3 locomotives to a trust and an unrelated party agreed to sell 30 locomotives to the trust for an aggregate purchase price of $59.4 million. As part of the Agreement, HSH Nordbank AG, New York Branch contributed $17.2 million to the trust in exchange for 100% ownership of the beneficial interest of the trust. DVB Bank AG agreed to loan the trust the remaining $42.2 million. KCSR and the trust also entered into an equipment lease agreement in which KCSR agreed to lease the 33 locomotives from the trust for an initial term of approximately 20 years. KCSR is obligated to pay rent on the locomotives bi-annually with the first rent payment due and payable on January 15, 2007, and the remaining rent payments due on July 15 and January 15 of each year during the term of the lease with the final rent payment due on November 11, 2026. The aggregate rent payments under the operating lease are approximately $88.7 million.

Letter of intent. On September 28, 2006, KCSR and KCSM entered into a letter of intent with General Electric Company to acquire an aggregate of 80 locomotives to be delivered in late 2007 through August 2008 at an aggregate cost of approximately $160.8 million. KCSR intends to acquire 30 of these locomotives, and KCSM intends to acquire 50 of these locomotives. The letter of intent also provides KCSR and KCSM with an option to acquire an additional aggregate 40 locomotives. If such option is exercised, the additional 40 locomotives would be delivered in 2008. KCSR and KCSM each anticipate entering into purchase agreements with General Electric Company in the fourth quarter of 2007 with respect to the 80 locomotives.


10.	Other Post Employment Benefits.

The Company provides certain medical, life and other post employment benefits other than pensions to its retirees. The medical and life plans are available to employees, not covered under collective bargaining arrangements, who have attained age 60 and rendered at least ten years of service. Individuals employed at 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,

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

coinsurance and coordination with Medicare. The life insurance plan is non-contributory and covers retirees only. The Company’s policy is to fund benefits payable under these plans as the obligations become due. However, certain plan assets (money market funds held by a life insurance company) exist with respect to life insurance benefits. A life insurance company holds these assets and the Company receives an investment return on these assets based on the six-month Treasury Bill rate plus 25 basis points.

Net periodic post employment benefit cost (including service cost, interest cost and expected return on plan assets) was not material for the quarter or year to date periods ending September 30, 2006 and September 30, 2005.

Under collective bargaining agreements, The Kansas City Southern Railway Company (“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 in the year ended December 31, 2005.


11.	Business Segments.

Prior to April 1, 2005, KCS operated under one reportable segment, the United States (or “U.S.”). Subsequent to the acquisition of a controlling interest in Grupo KCSM on April 1, 2005, KCS has two reportable segments, U.S. and Mexico. Appropriate eliminations are recorded in deriving consolidated data. The U.S. segment consists of KCSR, Mexrail, the Gateway Eastern Railway Company, Tex-Mex and MSLLC as well as U.S. corporate expenses. The Mexico segment consists of Grupo KCSM, KCSM and Arrendadora KCSM and Mexico corporate expenses. Each of these segments is comprised of companies with separate boards of directors, operates and serves different geographical regions and is subject to different customs, laws and tax regulations. Key information regarding these segments follows (in million s ) :


	Three Months Ended September 30, 2006
	U.S.		Mexico			Elimination			Consolidated

Revenue	$	224.8	$	190.9		$	—		$	415.7
Operating expenses:
Compensation and benefits		65.6		31.5			—			97.1
Fuel		37.9		28.5			—			66.4
Purchased services		22.3		33.1			1.2			56.6
Equipment costs		19.4		26.7			—			46.1
Depreciation and amortization		16.1		21.6			—			37.7
Casualties and insurance		8.1		3.9			—			12.0
KCSM employees’ deferred statutory profit sharing		—		(0.6	)		—			(0.6	)
Other		20.1		4.2			(1.2	)		23.1

Total operating expenses		189.5		148.9			—			338.4

Operating income	$	35.3	$	42.0		$	—		$	77.3

Capital expenditures	$	18.6	$	28.9		$	—		$	47.5

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Three Months Ended September 30, 2005

U.S. Mexico Elimination Consolidated

Revenue
$ 201.8 $ 182.8 $ — $ 384.6

Operating expenses:

Compensation and benefits
63.5 30.5 — 94.0

Fuel
32.2 27.4 — 59.6

Purchased services
19.3 37.8 (0.1 ) 57.0

Equipment costs
20.3 26.3 — 46.6

Depreciation and amortization
14.6 25.9 — 40.5

Casualties and insurance
50.6 4.7 — 55.3

KCSM employees’ deferred statutory profit sharing
— 2.2 — 2.2

Other
22.3 8.9 0.1 31.3

Total operating expenses
222.8 163.7 — 386.5

Operating income (loss)
$ (21.0 ) $ 19.1 $ — $ (1.9 )

Capital expenditures
$ 50.4 $ 20.9 $ — $ 71.3


	Nine Months Ended September 30, 2006
	U.S.		Mexico		Elimination			Consolidated

Revenue	$	655.7	$	561.6	$	—		$	1,217.3
Operating expenses:
Compensation and benefits		194.4		89.7		—			284.1
Fuel		105.3		82.5		—			187.8
Purchased services		63.7		96.6		3.6			163.9
Equipment costs		62.9		67.2		—			130.1
Depreciation and amortization		46.7		66.2		—			112.9
Casualties and insurance		29.9		10.2		—			40.1
KCSM employees’ deferred statutory profit sharing		—		5.0		—			5.0
Other		60.5		20.4		(3.6	)		77.3

Total operating expenses		563.4		437.8		—			1,001.2

Operating income	$	92.3	$	123.8	$	—		$	216.1

Capital expenditures	$	93.5	$	57.4	$	—		$	150.9

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Nine Months Ended September 30, 2005

U.S. Mexico Elimination Consolidated

Revenue
$ 597.0 $ 366.9 $ — $ 963.9

Operating expenses:

Compensation and benefits
187.0 61.7 — 248.7

Fuel
87.3 55.3 — 142.6

Purchased services
62.0 71.5 (0.2 ) 133.3

Equipment costs
52.1 53.1 — 105.2

Depreciation and amortization
43.5 51.8 — 95.3

Casualties and insurance
78.2 11.8 — 90.0

KCSM employees’ deferred statutory profit sharing
— 41.0 — 41.0

Other
65.4 27.7 0.2 93.3

Total operating expenses
575.5 373.9 — 949.4

Operating income (loss)
$ 21.5 $ (7.0 ) $ — $ 14.5

Capital expenditures
$ 107.3 $ 31.1 $ — $ 138.4


	September 30, 2006
	U.S.		Mexico		Elimination			Consolidated

Total assets	$	3,478.1	$	2,430.3	$	(1,383.0	)	$	4,525.4
Total liabilities		1,848.2		1,196.1		(148.8	)		2,895.5


	September 30, 2005
	U.S.		Mexico		Elimination			Consolidated

Total assets	$	3,153.0	$	2,389.0	$	(1,236.1	)	$	4,305.9
Total liabilities		1,729.5		1,203.5		(50.6	)		2,882.4


12.	Transaction with Affiliates.

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 locomotives leased by KCSM from El-Mo. KCSR and an affiliate paid cash of $32.6 million and assumed $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 refinance for its own account, 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.


13.	Condensed Consolidating Financial Information.

KCSR has outstanding $200.0 million of 9 1 / 2 % Senior Notes due 2008 and $200.0 million of 7 1 / 2 % Senior Notes due 2009. Both of these note issues are unsecured obligations of KCSR, however, they are also jointly and severally, and fully and unconditionally guaranteed on an unsecured senior basis by KCS and certain of the subsidiaries (all of which are wholly-owned) within the KCS consolidated group. Grupo KCSM, KCSM, Mexrail, Tex-Mex and MSLLC are non-guarantor subsidiaries. These notes were registered with the SEC and issued in exchange for

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

privately placed notes having substantially identical terms and associated guarantees to the respective exchange note issues.

The accompanying condensed consolidating financial information (in millions) has been prepared and presented pursuant to SEC Regulation S-X, Rule 3-10 “Financial statements of guarantors and issuers of guaranteed securities registered or being registered.”

CONDENSED CONSOLIDATING STATEMENTS OF INCOME


	Three Months Ended September 30, 2006
							Guarantor			Non-Guarantor			Consolidating			Consolidated
	Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

Revenues	$	—		$	199.3		$	2.5		$	218.3		$	(4.4	)	$	415.7
Operating expenses		2.9			159.6			4.9			175.4			(4.4	)		338.4

Operating income (loss)		(2.9	)		39.7			(2.4	)		42.9			—			77.3
Equity in net earnings of unconsolidated affiliates and subsidiaries		34.1			0.9			—			0.5			(32.3	)		3.2
Interest expense		(1.2	)		(16.9	)		(0.3	)		(24.3	)		0.4			(42.3	)
Exchange gain		—			—			—			4.5			—			4.5
Other income		0.2			1.2			—			2.5			(0.4	)		3.5

Income (loss) before income taxes		30.2			24.9			(2.7	)		26.1			(32.3	)		46.2
Income tax provision (benefit)		(1.3	)		9.2			(1.0	)		7.8			—			14.7

Income (loss) before minority interest		31.5			15.7			(1.7	)		18.3			(32.3	)		31.5
Minority interest		0.2			—			—			—			—			0.2

Net income (loss)	$	31.3		$	15.7		$	(1.7	)	$	18.3		$	(32.3	)	$	31.3

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Three Months Ended September 30, 2005

Guarantor
Non-Guarantor
Consolidating
Consolidated

Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

Revenues
$ — $ 182.9 $ 5.7 $ 205.1 $ (9.1 ) $ 384.6

Operating expenses
4.6 195.7 5.5 189.8 (9.1 ) 386.5

Operating income (loss)
(4.6 ) (12.8 ) 0.2 15.3 — (1.9 )

Equity in net earnings of unconsolidated affiliates and subsidiaries
120.2 0.9 — 0.7 (120.5 ) 1.3

Interest income (expense)
(2.7 ) (16.1 ) 2.9 (24.0 ) 0.4 (39.5 )

VAT/put settlement gain, net
— — — 131.9 — 131.9

Exchange loss
— — — (1.5 ) — (1.5 )

Other income (expense)
(8.8 ) 1.1 — 10.7 (0.4 ) 2.6

Income (loss) before income taxes and minority interest
104.1 (26.9 ) 3.1 133.1 (120.5 ) 92.9

Income tax provision (benefit)
(8.6 ) (9.5 ) 1.1 (2.8 ) — (19.8 )

Income (loss) before minority interest
112.7 (17.4 ) 2.0 135.9 (120.5 ) 112.7

Minority interest
— — — — — —

Net income (loss)
$ 112.7 $ (17.4 ) $ 2.0 $ 135.9 $ (120.5 ) $ 112.7


	Nine Months Ended September 30, 2006
							Guarantor			Non-Guarantor			Consolidating			Consolidated
	Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments			KCS

Revenues	$	—		$	585.4		$	7.7		$	639.6		$	(15.4	)	$	1,217.3
Operating expenses		11.9			481.3			14.6			508.8			(15.4	)		1,001.2

Operating income (loss)		(11.9	)		104.1			(6.9	)		130.8			—			216.1
Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries		81.7			(0.7	)		—			3.9			(79.2	)		5.7
Interest expense		(4.9	)		(48.1	)		(0.9	)		(70.7	)		1.1			(123.5	)
Debt retirement costs		—			(2.2	)					—			—			(2.2	)
Exchange loss		—			—			—			(6.7	)		—			(6.7	)
Other income		0.6			4.3			—			5.5			(1.1	)		9.3

Income (loss) before income taxes		65.5			57.4			(7.8	)		62.8			(79.2	)		98.7
Income tax provision (benefit)		(3.0	)		19.4			(2.7	)		16.5			—			30.2

Income (loss) before minority interest		68.5			38.0			(5.1	)		46.3			(79.2	)		68.5
Minority interest		0.2			—			—			—			—			0.2

Net income (loss)	$	68.3		$	38.0		$	(5.1	)	$	46.3		$	(79.2	)	$	68.3

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Nine Months Ended September 30, 2005

Guarantor
Non-Guarantor
Consolidating
Consolidated

Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

Revenues
$ — $ 540.6 $ 15.4 $ 431.3 $ (23.4 ) $ 963.9

Operating expenses
13.6 498.2 14.8 446.2 (23.4 ) 949.4

Operating income (loss)
(13.6 ) 42.4 0.6 (14.9 ) — 14.5

Equity in net earnings (losses) of unconsolidated affiliates and subsidiaries
108.7 0.5 — (1.4 ) (107.1 ) 0.7

Interest income (expense)
(3.6 ) (41.9 ) 2.7 (49.0 ) 1.3 (90.5 )

Debt retirement costs
— — — (3.9 ) — (3.9 )

VAT/put settlement gain, net
— — — 131.9 — 131.9

Exchange gain
— — — 2.8 — 2.8

Other income (expense)
(6.9 ) 4.4 — 13.4 (1.2 ) 9.7

Income before income taxes and minority interest
84.6 5.4 3.3 78.9 (107.0 ) 65.2

Income tax provision (benefit)
(11.1 ) 2.5 1.1 (5.2 ) — (12.7 )

Income before minority interest
95.7 2.9 2.2 84.1 (107.0 ) 77.9

Minority interest
— — — (17.8 ) — (17.8 )

Net income
$ 95.7 $ 2.9 $ 2.2 $ 101.9 $ (107.0 ) $ 95.7

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

CONDENSED CONSOLIDATING BALANCE SHEETS


	September 30, 2006
						Guarantor			Non-Guarantor		Consolidating			Consolidated
	Parent			KCSR		Subsidiaries			Subsidiaries		Adjustments			KCS

ASSETS
Current assets	$	4.6		$	868.0	$	47.6		$	436.6	$	(791.5	)	$	565.3
Investments		1,923.4			435.3		—			463.1		(2,755.1	)		66.7
Properties, net		0.6			1,169.1		230.7			958.8		(0.5	)		2,358.7
Concession rights		—			—		—			1,318.3		—			1,318.3
Other assets		4.9			27.7		5.0			194.5		(15.7	)		216.4

Total assets	$	1,933.5		$	2,500.1	$	283.3		$	3,371.3	$	(3,562.8	)	$	4,525.4


LIABILITIES AND EQUITY
Current liabilities	$	374.2		$	355.7	$	265.6		$	563.8	$	(837.3	)	$	722.0
Long-term debt		0.2			719.2		0.6			770.5		—			1,490.5
Payable to affiliates		32.8			—		—			—		—			32.8
Deferred income taxes		(9.6	)		443.9		(3.7	)		6.4		(15.7	)		421.3
Deferred profit sharing		—			—		—			39.3		—			39.3
Other liabilities		6.2			91.6		16.6			75.2		—			189.6
Minority interest		—			—		—			100.2		—			100.2
Stockholders’ equity		1,529.7			889.7		4.2			1,815.9		(2,709.8	)		1,529.7

Total liabilities and equity	$	1,933.5		$	2,500.1	$	283.3		$	3,371.3	$	(3,562.8	)	$	4,525.4

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

December 31, 2005

Guarantor
Non-Guarantor
Consolidating
Consolidated

Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

ASSETS

Current assets
$ 2.4 $ 476.1 $ 20.3 $ 233.3 $ (265.3 ) $ 466.8

Investments
1,715.4 435.8 — 464.2 (2,555.1 ) 60.3

Properties, net
0.1 1,334.0 239.3 724.9 — 2,298.3

Concession rights
— — — 1,360.4 — 1,360.4

Restricted funds
9.0 — — — — 9.0

Other assets
1.9 19.6 5.3 218.0 (16.0 ) 228.8

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
98.1 — 0.7 26.6 (45.0 ) 80.4

Deferred income taxes
(3.5 ) 424.6 (0.5 ) 4.5 (15.9 ) 409.2

Other liabilities
5.6 110.5 14.6 139.5 — 270.2

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

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS


	Nine Months Ended September 30, 2006
							Guarantor			Non-Guarantor			Consolidating		Consolidated
	Parent			KCSR			Subsidiaries			Subsidiaries			Adjustments		KCS

CASH FLOWS PROVIDED BY (USED FOR):
OPERATING ACTIVITIES:
Excluding intercompany activity	$	(132.5	)	$	269.9		$	1.6		$	31.5		$	—	$	170.5
Intercompany activity		172.8			(183.9	)		(.6	)		11.7			—		—

Net cash flows provided by operating activities		40.3			86.0			1.0			43.2			—		170.5

INVESTING ACTIVITIES:
Property additions		—			(65.8	)		(.2	)		(84.9	)		—		(150.9	)
Sale of investment in MSLLC		—			—			—			100.0			—		100.0
Funding of restricted cash — MSLLC		—			—			—			(48.7	)		—		(48.7	)
Other, net		—			7.8			—			.3			—		8.1

Net		—			(58.0	)		(.2	)		(33.3	)		—		(91.5	)

FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt		—			379.2			—			31.1			—		410.3
Repayment of long-term debt		(44.0	)		(398.1	)		—			(9.7	)		—		(451.8	)
Debt issuance costs		—			(7.5	)		—						—		(7.5	)
Proceeds from stock plans		7.4			—			—			—			—		7.4
Cash dividends paid		(4.3	)		—			—			—			—		(4.3	)

Net		(40.9	)		(26.4	)					21.4			—		(45.9	)

CASH AND CASH EQUIVALENTS:
Net increase (decrease)		(.6	)		1.6			.8			31.3			—		33.1
At beginning of year		0.7			20.7			(0.9	)		10.6			—		31.1

At end of period	$	.1		$	22.3		$	(.1	)	$	41.9		$	—	$	64.2

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Nine Months Ended September 30, 2005

Guarantor
Non-Guarantor
Consolidating
Consolidated

Parent KCSR Subsidiaries Subsidiaries Adjustments KCS

CASH FLOWS PROVIDED BY (USED FOR):

OPERATING ACTIVITIES:

Excluding intercompany activity
$ (2.7 ) $ 70.3 $ 11.5 $ 65.1 $ — $ 144.2

Intercompany activity
16.1 (13.2 ) (9.3 ) 6.4 — 0.0

Net cash flows provided by operating activities
13.4 57.1 2.2 71.5 — 144.2

INVESTING ACTIVITIES:

Property additions
— (96.0 ) (0.4 ) (42.0 ) — (138.4 )

Proceeds from disposal of property
— 5.7 0.2 — 5.9

Investments in and loans to affiliates
(5.5 ) (3.9 ) (11.4 ) 10.7 (10.1 )

Acquisition costs
(8.5 ) — — — — (8.5 )

Cash acquired from Mexrail
— — — 3.0 — 3.0

Cash acquired from Grupo KCSM
— — — 5.5 — 5.5

Repayment of loans to affiliates
— 10.6 6.7 (17.3 ) —

Other, net
— (3.5 ) 4.2 (0.7 ) — 0.0

Net
(14.0 ) (87.1 ) 3.8 (38.7 ) (6.6 ) (142.6 )

FINANCING ACTIVITIES:

Proceeds from issuance of long-term debt
— 122.0 — 501.0 — 623.0

Repayment of long-term debt
(1.0 ) (94.6 ) — (474.8 ) — (570.4 )

Capital contribution
— — — 5.5 (5.5 ) —

Proceeds from loans from affiliates
5.2 — — — (5.2 ) —

Repayment of loans from affiliates
(6.7 ) — — (10.6 ) 17.3 —

Debt issuance costs
— (2.3 ) — (12.4 ) — (14.7 )

Proceeds from stock plans
0.9 — — — — 0.9

Cash dividends paid
(6.6 ) — — — — (6.6 )

Net
(8.2 ) 25.1 — 8.7 6.6 32.2

CASH AND CASH EQUIVALENTS:

Net increase (decrease)
(8.8 ) (4.9 ) 6.0 41.5 — 33.8

At beginning of year
10.5 27.5 0.2 0.4 — 38.6

At end of period
$ 1.7 $ 22.6 $ 6.2 $ 41.9 $ — $ 72.4

KANSAS CITY SOUTHERN

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

14. New Accounting Pronouncements.

FASB 158. In September 2006, the Financial Accounting Standards Board issued Financial Accounting Standard No. 158 (SFAS 158), Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106 and 132(R ) which requires the recognition of the overfunded or underfunded status of a defined benefit postretirement plan in the Company’s balance sheet. This portion of the new guidance is effective for the Company on December 31, 2006. Additionally, the pronouncement eliminates the option for the Company to use a measurement date prior to the Company’s fiscal year end effective December 31, 2008. The Standard provides two approaches to transition to a fiscal year end measurement date, both of which are to be applied prospectively. The Company is evaluating the impact of adopting SFAS No. 158, and based on initial evaluation does not anticipate a material impact to its financial statements.

FIN 48. In June 2006, the Financial Accounting Standards Board issued Interpretation 48 (FIN 48), Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109, Accounting for Income Taxes , which clarifies the accounting for uncertainties in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation requires that the Company recognize in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective beginning January 1, 2007 with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is evaluating the impact of FIN 48 on all of its open tax positions and expects to complete that analysis in the fourth quarter. Based on initial evaluation the Company does not anticipate a material impact to its financial statements.


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

The discussion set forth below, as well as other portions of this Form 10-Q, contain forward-looking statements that are not based upon historical information. Such forward-looking statements are based upon information currently available to management and management’s perception thereof as of the date of this Form 10-Q. Readers can identify these forward-looking statements by the use of such verbs as expects, anticipates, believes or similar verbs or conjugations of such verbs. The actual results of operations of Kansas City Southern (“we”, “our”, “KCS” or the “Company”) could materially differ from those indicated in forward-looking statements. The differences could be caused by a number of factors or combination of factors including, but not limited to, those factors identified in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s annual report on Form 10-K for the year ended December 31, 2005, which is on file with the U.S. Securities and Exchange Commission (File No. 1-4717) incorporated by reference herein and in Part II Item 1A — “Risk Factors” in this Form 10-Q. Readers are strongly encouraged to consider these factors when evaluating forward-looking statements. We will not update any forward-looking statements set forth in this Form 10-Q.

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

Overview

Through 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 KCSM, S.A. de C.V. (“Grupo KCSM”), we began operating under two reportable business segments, which are defined geographically as United States (“U.S.”) and Mexico. The U.S. segment consists primarily of The Kansas City Southern Railway Company (“KCSR”), Mexrail Inc., (“Mexrail”) and Meridian Speedway, LLC (“MSLLC”) while the Mexico segment includes primarily Grupo KCSM and its operating subsidiary Kansas City Southern de México, S.A. de C.V. (“KCSM”) and Arrendadora KCSM, S.A. de C.V. (“Arrendadora 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 throughout North America directly and 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. Appropriate eliminations of revenue and reclassifications of operating revenues and expenses have been recorded in deriving consolidated data. Each of these segments is comprised of companies with separate boards of directors, operates and serves different geographical regions, and is subject to different customs, laws, and tax regulations.

For the first quarter of 2005, Grupo KCSM was an unconsolidated affiliate, and we used the equity method of accounting to recognize our proportionate share of Grupo KCSM’s earnings. On completion of the acquisition of a controlling interest in Grupo KCSM on April 1, 2005, KCS began including the operating revenues and expenses of Grupo KCSM in its consolidated financial statements. Accordingly, the historical financial information for the nine months ended September 30, 2006 is not comparable to the nine months ended September 30, 2005 due to the acquisition of Grupo KCSM. In addition, effective January 1, 2005, the financial results of Mexrail are included in the U.S. segment of the consolidated financial statements of KCS.

Third Quarter Analysis

Consolidated net income for the third quarter 2006 decreased $81.4 million compared to the third quarter of 2005 primarily due to a one-time, non-cash gain of $131.9 million as a result of a VAT claim and put settlement. The VAT claim and put settlement with the Mexican Government recorded in the third quarter of 2005, resulted in KCS attaining 100% ownership of KCSM. The Company also recorded, based upon an actuarial study, an expense of

$37.8 million for personal injury liabilities in the third quarter of 2005. These items had a $14.5 million tax benefit on the consolidation as reported.

Revenue growth for the third quarter of 2006 was driven by a 1.9% increase in volumes, and a continued recognition of the value of Kansas City Southern’s freight services. Consolidated operating expenses decreased reflecting reductions in all cost categories except: fuel driven by higher prices, and compensation and benefits inflation.

2006 Outlook

For the remainder of 2006, management expects the growth in the North American economy to yield improvements in operating income. Since uniting KCSR, Grupo KCSM and Mexrail under the common control of KCS, we continue to see the results of a stronger, more competitive railway network. We expect the continued strength of the North American economy to continue to drive increased demand for rail transportation services. With certain exceptions, primarily fuel, increases in variable operating expenses should be lower than changes in the volume reflecting an improving operating ratio. Gains in operating efficiencies are expected to be achieved as a result of process improvement initiatives in Mexico and the U.S. in 2006. However, volatility in fuel prices could continue to have an impact on our operating expenses.

Since completion of our joint venture with Norfolk Southern Corporation (“NS”), our position in the southeastern U.S. has further strengthened and capital enhancements in the corridor between Meridian, Mississippi and Shreveport, Louisiana are being done on schedule and creating new capacity. We believe that this partnership with NS will provide increased volume with NS, as well as strengthen our ability to recognize our competitive advantage for multimodal shipments from the ports of Mexico to destinations throughout the U.S. and Canada.

Recent Developments

Tender Offer. On October 23, 2006, pursuant to an offer to purchase dated such date, KCSM commenced a cash tender offer and consent solicitation for any and all outstanding $150.0 million aggregate principal amount of its 10 1 / 4 % Senior Notes due 2007 (“2007 Senior Notes”). The consent solicitation expired on November 3, 2006. KCSM received consents in connection with the tender offer and consent solicitation from holders of over 97% of the 2007 Senior Notes to amend the indenture under which the 2007 Senior Notes were issued (the “2007 Indenture”), to eliminate substantially all of the restrictive covenants included in the 2007 Indenture. The supplemental indenture relating to the 2007 Senior Notes containing the proposed changes (the “2007 Supplemental Indenture”) is anticipated to become effective on November 21, 2006. The tender offer will expire at midnight, New York City time, on November 20, 2006 unless extended, and KCSM expects to purchase tendered notes on November 21, 2006, in accordance with the terms of the tender offer. The consummation of the tender offer and consent solicitation is subject to a number of conditions, including obtaining sufficient funds to pay for the 2007 Senior Notes tendered. We intend to obtain such funds through new debt financing.

Results of Operations

Consolidated Net Income. Consolidated net income for the third quarter 2006 decreased $81.4 million compared to the prior year third quarter as discussed above.

The following summarizes KCS’ income statement (in millions) :


	Three Months
	Ended September 30,						Change
	2006			2005			Dollars			Percent

Revenues	$	415.7		$	384.6		$	31.1			8.1	%
Operating expenses		338.4			386.5			(48.1	)		(12.4	)%

Operating income (loss)		77.3			(1.9	)		79.2			4168.4	%
Equity in net earnings of unconsolidated affiliates		3.2			1.3			1.9			146.2	%
Interest expense		(42.3	)		(39.5	)		(2.8	)		(7.1	)%
VAT/put settlement gain, net		—			131.9			(131.9	)		(100.0	)%
Exchange gain (loss)		4.5			(1.5	)		6.0			400.0	%
Other income		3.5			2.6			0.9			34.6	%

Income before income taxes and minority interest		46.2			92.9			(46.7	)		(50.3	)%
Income tax provision (benefit)		14.7			(19.8	)		34.5			174.2	%

Income before minority interest		31.5			112.7			(81.2	)		(72.0	)%
Minority interest		0.2			—			0.2			—

Net Income	$	31.3		$	112.7		$	(81.4	)		(72.2	)%

Consolidated net income for the nine months ended September 30, 2006 decreased $27.4 million compared to the same period in 2005. The U.S. operating income for the nine months ended September 30, 2006 increased $70.8 million compared to the same period in 2005, while the Mexico segment operating income increased $130.8 million. The increase in the Mexico segment reflects the impact of the consolidation of Grupo KCSM in the second quarter of 2005, accordingly, the year to date periods ended September 30, 2006 and 2005 are not comparable.

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


	Nine Months
	Ended
	September 30,						Change
	2006			2005			Dollars			Percent

Revenues	$	1,217.3		$	963.9		$	253.4			26.3	%
Operating expenses		1,001.2			949.4			51.8			5.5	%

Operating income		216.1			14.5			201.6			1390.3	%
Equity in net earnings of unconsolidated affiliates		5.7			0.7			5.0			714.3	%
Interest expense		(123.5	)		(90.5	)		(33.0	)		(36.5	)%
Debt retirement costs		(2.2	)		(3.9	)		1.7			43.6	%
VAT/put settlement gain, net		—			131.9			(131.9	)		(100.0	)%
Foreign exchange gains (losses)		(6.7	)		2.8			(9.5	)		(339.3	)%
Other income		9.3			9.7			(0.4	)		(4.1	)%

Income before income taxes and minority interest		98.7			65.2			33.5			51.4	%
Income tax provision (benefit)		30.2			(12.7	)		42.9			337.8	%

Income before minority interest		68.5			77.9			(9.4	)		(12.1	)%
Minority interest		0.2			(17.8	)		18.0			101.1	%

Net Income	$	68.3		$	95.7		$	(27.4	)		(28.6	)%

U.S. Segment. Operating income for the U.S. segment was $35.3 million for the three months ended September 30, 2006, compared to a $21.0 million operating loss in the prior year’s same period.

U.S. Revenues. Revenue for our U.S. segment constituted 54.1% and 52.5% of KCS’ consolidated revenue for the three months ended September 30, 2006 and 2005, respectively. The following summarizes U.S. revenues (in millions) , including the consolidated revenues (in millions) and carload statistics of KCSR and Mexrail (in thousands).


	Revenues									Carloads and Intermodal Units
	Three Months									Three Months
	Ended September 30,				Change					Ended September 30,				Change
	2006		2005		Dollars		Percent			2006		2005		Units			Percent

General commodities:
Chemical and petroleum	$	44.4	$	38.4	$	6.0		15.6	%		40.7		38.4		2.3			6.0	%
Forest products and metals		61.0		55.4		5.6		10.1	%		50.5		51.7		(1.2	)		(2.3	)%
Agricultural and mineral		49.4		42.6		6.8		16.0	%		42.3		42.0		0.3			0.7	%

Total general commodities		154.8		136.4		18.4		13.5	%		133.5		132.1		1.4			1.1	%
Intermodal and automotive		20.5		18.6		1.9		10.2	%		91.0		80.5		10.5			13.0	%
Coal		34.4		33.0		1.4		4.2	%		63.6		61.1		2.5			4.1	%

Carload revenues and carload and intermodal units		209.7		188.0		21.7		11.5	%		288.1		273.7		14.4			5.3	%

Other revenues		15.1		13.8		1.3		9.3	%

U.S. revenues	$	224.8	$	201.8	$	23.0		11.4	%

The following summarizes U.S. revenues, including the consolidated revenues (in millions) and carload statistics of KCSR and Mexrail (in thousands).


	Revenues										Carloads and Intermodal Units
	Nine Months										Nine Months
	Ended September 30,				Change						Ended September 30,				Change
	2006		2005		Dollars			Percent			2006		2005		Units			Percent

General commodities:
Chemical and petroleum	$	129.8	$	116.4	$	13.4			11.5	%		120.2		120.8		(0.6	)		(0.5	)%
Forest products and metals		179.6		161.8		17.8			11.0	%		150.1		161.5		(11.4	)		(7.1	)%
Agricultural and mineral		146.7		132.3		14.4			10.9	%		129.3		139.4		(10.1	)		(7.2	)%

Total general commodities		456.1		410.5		45.6			11.1	%		399.6		421.7		(22.1	)		(5.2	)%
Intermodal and automotive		55.5		56.3		(0.8	)		(1.4	)%		248.9		248.7		0.2			0.1	%
Coal		100.4		90.7		9.7			10.7	%		187.4		173.3		14.1			8.1	%

Carload revenues and carload and intermodal units		612.0		557.5		54.5			9.8	%		835.9		843.7		(7.8	)		(0.9	)%

Other revenues		43.7		39.5		4.2			10.6	%

U.S. revenues	$	655.7	$	597.0	$	58.7			9.8	%

U.S. operations experienced revenue increases in all commodity groups except for automotive due to strategic price adjustments, increased fuel surcharge revenue, and volume increases in coal. The following discussion provides an analysis of our revenues by commodity group.

Chemical and Petroleum Products. For the three and nine months ended September 30, 2006 U.S. chemical and petroleum products experienced strong price increases as well as new business, which was somewhat offset by volume declines for the nine months. Earlier in the year unit volume declines were primarily reflected in the petroleum and plastic groups, as plants along the Gulf Coast continued to recover from the hurricane.

Forest Products and Metals. For the three and nine months ended September 30, 2006, forest products and metals revenue for the U.S. segment increased despite carload volumes that were flat to slightly decreased in most commodities with the exception of lower logs and chips volumes. Declines in logs and chips carload volumes, which comprised the most volume decline in this commodity group, were due to targeted rate adjustments strategically made to improve revenue quality.

Agricultural and Mineral Products. For the three and nine months ended September 30, 2006, agriculture and mineral products for the U.S. segment experienced a continued favorable environment which more than offset any volume changes.

Coal. For the three and nine months ended September 30, 2006, increases in U.S. coal revenues were primarily due 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 at certain electric generating stations driven by strong demand.

U.S. Operating Expenses. For the quarter ended September 30, 2006, U.S. operating expenses decreased $33.3 million when compared to the same period in 2005 as shown below (in millions).


	Three Months
	Ended September 30,				Change
	2006		2005		Dollars			Percent

Compensation and benefits	$	65.6	$	63.5	$	2.1			3.3	%
Fuel		37.9		32.2		5.7			17.7	%
Purchased services		22.3		19.3		3.0			15.5	%
Equipment costs		19.4		20.3		(0.9	)		(4.4	)%
Depreciation and amortization		16.1		14.6		1.5			10.3	%
Casualties and insurance		8.1		50.6		(42.5	)		(84.0	)%
Other		20.1		22.3		(2.2	)		(9.9	)%

Total U.S. operating expenses	$	189.5	$	222.8	$	(33.3	)		(14.9	)%

The following summarizes U.S. segment operating expenses (in millions).


	Nine Months
	Ended September 30,				Change
	2006		2005		Dollars			Percent

Compensation and benefits	$	194.4	$	187.0	$	7.4			4.0	%
Fuel		105.3		87.3		18.0			20.6	%
Purchased services		63.7		62.0		1.7			2.7	%
Equipment costs		62.9		52.1		10.8			20.7	%
Depreciation and amortization		46.7		43.5		3.2			7.4	%
Casualties and insurance		29.9		78.2		(48.3	)		(61.8	)%
Other		60.5		65.4		(4.9	)		(7.5	)%

Total U.S. operating expenses	$	563.4	$	575.5	$	(12.1	)		(2.1	)%

Compensation and Benefits. Compensation and benefits expense increased for the three and nine months ended September 30, 2006 compared to the same period in 2005 primarily as a result of inflation.

Fuel. Fuel expense increased for the three and nine months ended September 30, 2006 as a result of higher fuel prices versus the prior year, somewhat offset by improving fuel efficiency as a result of operations initiations.

Purchased Services. Purchased services expense for the three and nine months ended September 30, 2006, increased compared to the same period in 2005, primarily due to increases in legal expense.

Equipment Costs. Equipment costs declined for the three months ended September 30, 2006 but increased for the nine months compared to the same periods in 2005, primarily due to additions to the U.S. locomotive fleet, including 73 units that were transferred from Mexico to the U.S. in January 2006.

Depreciation and Amortization. Depreciation and amortization expense for the three and nine months ended September 30, 2006 increased compared to the same period in 2005, primarily reflecting a higher asset base.

Casualties and Insurance. Casualty and insurance expense decreased for the three and nine months ended September 30, 2006 compared to the same period in 2005. The change primarily reflects a non-cash adjustment of $37.8 million for personal injury liabilities based upon an actuarial study in 2005 and a lower number and severity of derailments in 2006 as compared with the prior year.

Mexico Segment. KCS acquired a controlling interest in Grupo KCSM effective April 1, 2005. The three month period ended September 30, 2005 results reflect the impact of charges and costs associated with the acquisition, as well as the effect of fair value adjustments as required by purchase accounting. Management evaluates the results of its Mexico operations based on its operating performance during the current quarter and comparison to plan. Operating income for the quarter ended September 30, 2006 was $42.0 million.

Mexico Revenues. Revenue for our Mexico segment constituted 45.9% of KCS’ consolidated revenue for the quarter ended September 30, 2006 and 47.5% for the same period in 2005.

The following summarizes consolidated Mexico revenues (in millions) and carload statistics (in thousands).


	Revenues										Carloads and Intermodal Units
	Three Months										Three Months
	Ended September 30,				Change						Ended September 30,				Change
	2006		2005		Dollars			Percent			2006		2005		Units			Percent

General commodities:
Chemical and petroleum	$	34.3	$	34.2	$	0.1			0.3	%		25.7		24.8		0.9			3.6	%
Forest products and metals		52.4		47.3		5.1			10.8	%		44.2		46.7		(2.5	)		(5.4	)%
Agricultural and mineral		60.5		57.3		3.2			5.6	%		48.2		50.1		(1.9	)		(3.8	)%

Total general commodities		147.2		138.8		8.4			6.1	%		118.1		121.6		(3.5	)		(2.9	)%
Intermodal and automotive		40.8		40.6		0.2			0.5	%		77.2		79.2		(2.0	)		(2.5	)%

Carload revenues and carload and intermodal units		188.0		179.4		8.6			4.8	%		195.3		200.8		(5.5	)		(2.7	)%

Other revenues		2.9		3.4		(0.5	)		(14.7	)%

Mexico revenues	$	190.9	$	182.8	$	8.1			4.4	%

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 for the nine months ended September 30, 2005 are presented for purposes of comparison. The following summarizes Mexico revenues (in millions) and carloads (in thousands).


	Revenues										Carloads and Intermodal Units
	Nine Months										Nine Months
	Ended September 30,				Change						Ended September 30,				Change
	2006		2005		Dollars			Percent			2006		2005		Units			Percent

General commodities:
Chemical and petroleum	$	104.3	$	96.2	$	8.1			8.4	%		76.6		75.2		1.4			1.9	%
Forest products and metals		157.1		138.9		18.2			13.1	%		142.4		150.1		(7.7	)		(5.1	)%
Agricultural and mineral		166.8		163.1		3.7			2.3	%		144.0		148.9		(4.9	)		(3.3	)%

Total general commodities		428.2		398.2		30.0			7.5	%		363.0		374.2		(11.2	)		(3.0	)%
Intermodal and automotive		118.6		129.7		(11.1	)		(8.6	)%		227.5		245.3		(17.8	)		(7.3	)%

Carload revenues and carload and intermodal units		546.8		527.9		18.9			3.6	%		590.5		619.5		(29.0	)		(4.7	)%

Other revenues		14.8		9.1		5.7			62.6	%

Mexico revenues	$	561.6	$	537.0	$	24.6			4.6	%

Mexico revenues for the three and nine months ended September 30, 2006 increased $8.1 million and $24.6 million, respectively, or 4.4% and 4.6%, respectively, over the same periods in 2005. These increases are attributable mainly to increased industrial production, rate increases and fuel surcharge increases, partially offset by decreases in carload volumes. Revenues from fuel surcharges were $10.7 million and $29.8 million for the three and nine month periods ended September 30, 2006 compared to $8.1 million and $20.7 million for the three and nine month periods ended September 30, 2005, respectively.

Chemical and Petroleum. Revenue increases for the three and nine months ended September 30, 2006, were driven mainly by freight rate increases in the chemical and petrochemical products, the recovery of the plastics industry from natural disasters, the movement of fertilizers and an increase of imports and movement of chemical compounds, petroleum coke and domestic fuel oil.

Forest Products and Metals. Steel slab revenues increased due to higher international traffic, resulting from higher consumption by manufacturing industries, as well as certain targeted rate increases during the second quarter 2006. Shipments of metals, minerals and ores were affected by lower production at many of our Mexican customers’ facilities.

Agriculture and Mineral. Revenues derived from corn, soybeans and other agro-industrial products such as corn syrup, increased as a result of higher import volumes related to lower domestic harvests and higher consumption during these periods. This increase was partially offset by a reduction in import shipments of wheat products during the three and nine months ended September 30, 2006.

Intermodal and Automotive. Revenue decreased for the three and nine months ended September 30, 2006 due to a decrease in automotive revenue which was partially offset by an increase in intemodal revenue. Automotive revenue decreased mainly due to a reduction in the movement of finished vehicles for exportation to the U.S. and Canadian markets. Additionally, the importing of finished vehicles as well as the domestic distribution of these vehicles has declined. This decrease partially offset by intermodal revenue which increased due to steamship peak season in Lazaro Cardenas, mostly related to imports for the upcoming holiday season. Scheduled intermodal train service has also had a positive impact by providing reliability to our customers.

For the three and nine months ended September 30, 2006, automotive revenues were lower principally due to a reduction in the movement of finished vehicles for export to the U.S. and Canadian markets. Additionally, the

import of finished vehicles, as well as the domestic distribution of these vehicles, has declined compared to the prior year.

Mexico Operating Expenses. For the quarter ended September 30, 2006, Mexico operating expenses decreased $14.8 million when compared to the same period in 2005 as shown below (in millions).


	Three Months
	Ended September 30,					Change
	2006			2005		Dollars			Percent

Compensation and benefits	$	31.5		$	30.5	$	1.0			3.3	%
Fuel		28.5			27.4		1.1			4.0	%
Purchased services		33.1			37.8		(4.7	)		(12.4	)%
Equipment costs		26.7			26.3		0.4			1.5	%
Depreciation and amortization		21.6			25.9		(4.3	)		(16.6	)%
Casualties and insurance		3.9			4.7		(0.8	)		(17.0	)%
KCSM employees’ deferred statutory profit sharing		(0.6	)		2.2		(2.8	)		(127.3	)%
Other		4.2			8.9		(4.7	)		(52.8	)%

Total Mexico operating expenses	$	148.9		$	163.7	$	(14.8	)		(9.0	)%

The following summarizes Mexico segment operating expenses for the nine months (in millions).


	Nine Months
	Ended September 30,				Change
	2006		2005		Dollars			Percent

Compensation and benefits	$	89.7	$	90.5	$	(0.8	)		(0.9	)%
Fuel		82.5		78.5		4.0			5.1	%
Purchased services		96.6		108.3		(11.7	)		(10.8	)%
Equipment costs		67.2		74.6		(7.4	)		(9.9	)%
Depreciation and amortization		66.2		73.9		(7.7	)		(10.4	)%
Casualties and insurance		10.2		14.1		(3.9	)		(27.7	)%
KCSM employees’ deferred statutory porofit sharing		5.0		41.5		(36.5	)		(88.0	)%
Other		20.4		36.6		(16.2	)		(44.3	)%

Total Mexico operating expenses	$	437.8	$	518.0	$	(80.2	)		(15.5	)%

KCS completed the purchase of the controlling interest in Grupo KCSM on April 1, 2005. Since that date the financial results of Grupo KCSM have been consolidated into KCS. Prior to April 1, 2005, the investment for Grupo KCSM was accounted for under the equity method. As more fully described in our 2005 Annual Report on Form 10-K, KCS has made certain adjustments to the accounting policies of Grupo KCSM to conform the accounting for certain expense items, such as depreciation, to our existing policies for U.S. operations. The pro forma expenses for the nine months ended September 30, 2005, which include the three months prior to April 1, 2005, are presented for comparative purposes.

Compensation and Benefits. Compensation and benefits increased for the third quarter as a result of annual salary increase and increased wages and employee benefits resulting from labor negotiations in July 2006. This increase was partially offset by the reduction in the number of employees and a 2.3% depreciation of the Mexican peso against the U.S. dollar. Compensation and benefits decreased for the nine months largely due to a reduction in employees. This decrease was partially offset by annual raises and increased wages and benefits resulting from labor negotiations in July 2005.

Fuel. Fuel expense increased for the quarter primarily due to an increase in consumption due to increases in freight car volume. This expense increased for the nine months largely due to increased fuel prices.

Purchased Services. Purchased services decreased for the three and nine months ended September 30, 2006 due to the amortization of deferred credits related to locomotive maintenance established in connection with the push down of purchase accounting by KCS. In addition, locomotive maintenance expense decreased due to the termination in November 2005 of the El-Mo-Mex Locomotive Operating Lease Agreement which covered 75 locomotives. Certain trackage rights were not used during the third quarter, which resulted in a decrease in the expense.

Equipment Costs. Equipment costs increased in the third quarter principally from an increase in the amortization related to locomotive and freight car leases established in connection with the push down of purchase accounting by KCS. A similar charge will occur in subsequent quarters until the expiration of all of the related leases. The decrease for the nine months is due to the decrease in car hire expense which includes costs incurred to use the freight cars of other railroads to move freight, net of car income and receipts received from other railroads for use of our freight cars. Car hire is affected by the volume of business, the number of cars owned or leased, traffic flows and the time it takes to move traffic. The decrease is due to a reduction in hours used in the period due to a decrease in cycle time as a consequence of traffic diminution in Silao.

Depreciation and Amortization. Depreciation and amortization decreased in the third quarter and nine months due to an updated depreciation study performed by a third party which resulted in changes to the estimated useful lives of properties, equipment and concession rights.

Casualties and Insurance. Casualties and insurance expenses decreased in the third quarter and nine months due to improved derailment experience.

KCSM Employees’ Deferred Statutory Profit Sharing. Deferred profit sharing decreased in the third quarter and nine months as a result of four Supreme Court decisions in May of last year which denied the deductibility of NOL’s in calculating a company’s profit sharing liability. As a result of the court rulings, we decreased our deferred profit sharing asset associated with these NOL’s resulting in a $35.6 million non-cash charge to income in 2005.

Consolidated Non-operating Expenses.

Interest Expense. Interest expense for the quarter ended September 30, 2006 increased $2.8 million compared to the quarter ended September 30, 2005 due to increased borrowings under the revolving credit facility and higher variable interest rates. The year to date increase of $33.0 million is primarily due to the purchase of Grupo KCSM and inclusion of nine month’s interest expense in the nine months ended September 30, 2006 versus only six months in the nine months ended September 30, 2005.

Foreign Exchange Gain. For the three and nine months ended September 30, 2006, foreign exchange gain (loss) changed $6.0 million and $9.5 million, respectively, compared to the same periods in 2005. During the third quarter 2006, the U.S. dollar appreciated 2.5% relative to the Mexican peso compared to the same period in 2005.

Income Tax Provision (Benefit). For the quarter ended September 30, 2006, KCS’ income tax provision was $14.7 million as compared to a $19.8 million benefit for the quarter ended September 30, 2005. The effective income tax rate was 31.8% and (21.3%) for the quarters ended September 30, 2006 and 2005, respectively. In the third quarter of 2005, the Company recorded a one-time, non-cash gain of $131.9 million as a result of a VAT settlement. The VAT settlement with the Mexican Government resulted in KCS attaining 100% ownership of KCSM. The Company believes, based upon opinions of outside legal counsel and other factors that this settlement is not taxable to the Company for U.S. income tax purposes. Excluding the $131.9 million gain from net income for income tax purposes for the three and nine months ended September 30, 2005, the Company had a net loss and recorded an income tax benefit.

Liquidity and Capital Resources

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 September 30, 2006, our total available liquidity, defined as the cash balance plus revolving credit facility availability, was approximately $114 million.

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


	Nine Months
	Ended
	September 30,
	2006			2005

Cash flows provided by (used for):
Operating activities	$	170.5		$	144.2
Investing activities		(91.5	)		(142.6	)
Financing activities		(45.9	)		32.2

Cash and cash equivalents:
Net increase		33.1			33.8
At beginning of year		31.1			38.6

At end of period	$	64.2		$	72.4

During the nine months ended September 30, 2006, KCS’ consolidated cash position increased $33.1 million from December 31, 2005, primarily attributable to strong cash flow from operating activities. As compared to the nine months ended September 30, 2005, cash flow from operating activities increased $26.3 million primarily as a result of improved operating performance. Net investing cash outflows decreased $51.1 million due primarily to the increase in property acquisitions of $12.5 million being more than offset by the investment by AGS in MSLLC of $100.0 million and the recognition of the restricted cash related to the AGS investment in MSLLC of $48.7 million. Financing activity cash flows decreased due to the repayment of debt related to the Grupo KCSM acquisition in 2006 versus net debt issuance in 2005.

The following summarizes the cash capital expenditures by type (in millions) :


	Nine Months
	Ended September 30,
	2006		2005

Track infrastructure	$	118.8	$	87.6
Locomotives, freight cars and other equipment		16.8		31.8
Information technology		5.3		6.3
Facilities and improvements		4.0		3.7
Other		6.0		9.0

Total capital expenditures	$	150.9	$	138.4

Capital improvements for track structures have historically been funded with cash flows from operations and external debt. KCS has historically used internally generated cash flows, external debt, or leasing for the acquisition of locomotives and rolling stock.

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

On April 4, 2006, Standard & Poor’s Rating Services (“S&P”) placed the ratings for KCS, KCSR and KCSM on CreditWatch with negative implications. On April 10, 2006, S&P lowered its corporate credit rating on KCS,

KCSR and KCSM to ‘B’ from ‘BB−’. The senior secured debt rating of KCS, KCSR and KCSM was lowered to ‘BB−’ from ‘BB+’ and the senior unsecured debt rating was lowered to ‘B−’ from ‘B+’. S&P also kept all credit ratings on CreditWatch with negative implications. On September 1, 2006 S&P affirmed KCS’, KCSR’s and KCSM’s ratings and removed them from CreditWatch. S&P’s outlook remains negative.

On May 18, 2006 S&P lowered its preferred stock rating on KCS to ‘D’ from ‘C’ and removed the ratings from CreditWatch where they were initially placed on March 23, 2006. This rating action followed the Company’s failure to make preferred stock dividend payments on its Series C Preferred Stock and Series D Preferred Stock on May 15, 2006. The Company was precluded from making the payments because of note indenture covenant restrictions.

On April 5, 2006, Moody’s Investors Service (“Moody’s”) placed all of the ratings for KCS, KCSR and KCSM under review for a possible downgrade. On April 28, 2006, Moody’s Investor Service lowered its ratings on KCS and subsidiaries (“Corporate Family”) to ‘B2’ from ‘B1’ and lowered its ratings on the companies’ senior secured debt to ‘B1’ from ‘Ba3’ and senior unsecured debt to ‘B3’ from ‘B2’. Moody’s outlook remains negative. These rating actions completed the review of KCS’ rating by Moody’s Investor Service which was initiated on April 5, 2006.

In September 2006 Moody’s raised the ratings on our senior secured debt to ‘Ba2’ from ‘B1’ and on our preferred stock to ‘Caa1’ from ‘Caa2’.


Item 3.	*Quantitative and Qualitative Disclosures about Market Risk.*

There was no material change during the quarter from the information set forth in Part II, Item 7A. “Quantitative and Qualitative Disclosure about Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2005.


Item 4.	*Controls and Procedures*

As of the end of the fiscal quarter for which this Quarterly Report on Form 10-Q is filed, the Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

KCS management considers the acquisition of Grupo KCSM on April 1, 2005 to be material to the results of operations, financial position and cash flows from the date of acquisition through September 30, 2006 and considers the internal controls and procedures of Grupo KCSM to have a material effect 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. To meet our quarterly certification requirements and in anticipation of incorporating Grupo KCSM into our 2006 Sarbanes-Oxley compliance process, we will also be performing a detailed review of Grupo KCSM’s internal control structure to ensure that its controls over financial reporting are consistent with KCS’ policies and procedures. Although this process is ongoing, we may identify control deficiencies during this process. KCS intends to extend its Sarbanes-Oxley Act Section 404 compliance program to include Grupo KCSM with an effective date no later than December 31, 2006.

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


	•	KCS deployed its new Revenue Management System (RMS) on its U.S. segment during the quarter. Benefits of the system include more accurate and timely revenue projections and improved cash collections. RMS enhances the transportation waybill and matches it against a new central price repository, which consists of both KCS published prices and foreign prices that are electronically transmitted and received through the


		Rate EDI Network (REN). The system utilizes this re-engineered revenue waybill to drive downstream revenue accounting, financial reporting and decision support processes. Management has implemented new or revised internal controls in connection with the implementation of this system.

PART II — OTHER INFORMATION


Item 1.	*Legal Proceedings*

Reinsurance Litigation. As the Company has previously reported, insurance companies who provided insurance to the Company filed an action in federal court in Vermont (the “Reinsurance Litigation”) seeking a declaration that they have no obligation to indemnify the Company concerning a particular casualty claim. That claim, styled Kemp, et al v. The Kansas City Southern Railway Company, et al , has been pending in the Circuit Court of Jackson County, Missouri (the “Kemp Litigation”) and went to trial in September, 2006. The Company has now reached a settlement with the plaintiffs in the Kemp Litigation. The Company has also reached settlements with various parties, including several of the insurance companies involved in the Reinsurance Litigation, to indemnify the Company for a significant portion of the settlement. The Kemp settlement is fully reflected in the Company’s third quarter financial statements and the Company has no further risk associated with this litigation. The Company is however continuing the Reinsurance Litigation against certain other insurance companies, seeking to establish their obligation to indemnify the Company for their share of the settlement with Kemp.


Item 1A.	*Risk Factors*

Attached to this report as Exhibit 99.1 and incorporated by reference herein is an updated list of risk factors.


Item 2.	*Unregistered Sale of Equity Securities and Use of Proceeds*

None


Item 3.	*Defaults Upon Senior Securities*

Following completion of the preparation of our 2005 financial statements, we determined that our Consolidated Coverage Ratio for the last twelve months (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, we were restricted from paying cash dividends on our 4.25% Redeemable Cumulative Convertible Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”), or our 5 1 / 8 % Cumulative Convertible Perpetual Preferred Stock, Series D (“Series D Preferred Stock”), since February 15, 2006. Based on our financial results for the quarter ended September 30, 2006, our Consolidated Coverage Ratio for the last twelve months will be greater than 2.0:1, and as of November 15, 2006, we believe we will no longer be restricted from paying such dividends. As of the date of the filing of this Form 10-Q, the aggregate amount of dividends in arrears on the Series C Preferred Stock and Series D Preferred stock was $10.3 million.


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

None


Item 5.	*Other Information*

None


Item 6.	*Exhibits*


Exhibit No.

	3	.1	Amended and Restated By-Laws, as amended through June 13, 2006 (filed as Exhibit 3.2 to KCS’ current Report on Form 8-K dated June 13, 2006 and incorporated by reference).
	10	.1	Employment Agreement entered into on the 15th day of May, 2006, between The Kansas City Southern Railway Company and Patrick J. Ottensmeyer (filed as Exhibit 10.1 to KCS’ Current Report on Form 8-K dated June 7, 2006 and incorporated by reference).


Exhibit No.

	10	.2	Employment Agreement entered into on the 15th day of May, 2006, between The Kansas City Southern Railway Company, Kansas City Southern and Daniel W. Avramovich (filed as Exhibit 10.2 to KCS’ Current Report on Form 8-K dated June 7, 2006 and incorporated by reference).
	10	.3	Employment Agreement entered into on the 11th day of September, 2006, between The Kansas City Southern Railway Company, Kansas City Southern and Michael K. Borrows (filed as Exhibit 10.1 to KCS’ Current Report on Form 8-K dated September 15, 2006 and incorporated by reference).
	10	.4	Participation Agreement, dated August 2, 2006, among KCSR, KCSR Trust 2006-1 (acting through Wilmington Trust Company, as owner trustee) (“Trust”), HSH Nordbank AG, New York Branch, Wells Fargo Bank Northwest, National Association, DVB Bank AG, is attached hereto as Exhibit 10.4.
	10	.41	Equipment and Lease Agreement, dated as of August 2, 2006, by and between KCSR and the Trust, is attached hereto as Exhibit 10.41.
	31	.1	Principal Executive Officer’s Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 is attached as Exhibit 31.1.
	31	.2	Principal Financial Officer’s Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 is attached as Exhibit 31.2.
	32	.1	Principal Executive Officer’s Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is attached as Exhibit 32.1.
	32	.2	Principal Financial Officer’s Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is attached as Exhibit 32.2.
	99	.1	Updated Risk Factors

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized and in the capacities indicated on November 9, 2006.

Kansas City Southern

/s/ Patrick J. Ottensmeyer

Patrick J. Ottensmeyer

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)

/s/ Michael K. Borrows

Michael K. Borrows

Vice President and Chief Accounting Officer

(Principal Accounting Officer)

Exhibit 10.4

Participation Agreement
(KCSR 2006-1)

dated as of August 2, 2006

among

The Kansas City Southern Railway Company,
as Lessee

KCSR Trust 2006-1, acting through
Wilmington Trust Company,
not in its individual capacity, except as otherwise
expressly provided herein, but solely as Owner Trustee ,

HSH Nordbank AG, New York Branch ,
as Owner Participant

Wells Fargo Bank Northwest, National Association,
as Indenture Trustee

and

DVB Bank AG ,
as Loan Participant

33 SD70ACe Locomotives

Table of Contents


Section	Heading	Page

Article I	Definitions; Interpretation of This Agreement		2

Section 1.1.	Definitions		2
Section 1.2.	Directly or Indirectly		2

Article II	Sale and Purchase; Participation in the Equipment Cost;		2

Section 2.1.	Sale and Purchase		2
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		4
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		7
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		15
Section 3.4.	Representations, Warranties and Covenants Regarding Beneficial Interest		16
Section 3.5.	Representations and Warranties of Loan Participant		17
Section 3.6.	Representations and Warranties of Owner Participant		18
Section 3.7.	Opinion Acknowledgment		19

Article IV	Conditions Precedent		19

Section 4.1.	Conditions Precedent to First Delivery Date; Conditions Precedent of Each Participant and Indenture Trustee to the Closing Date		19
Section 4.2.	Additional Conditions Precedent to the Obligations of Loan Participant		23
Section 4.3.	Additional Conditions Precedent to the Obligations of Owner Participant		24
Section 4.4.	Conditions Precedent to the Obligation of Lessee		25

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Section	Heading	Page

Article V	Financial and Other Reports of Lessee		26

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 Participant		30
Section 6.5.	Covenants of Owner Trustee, Trust Company, Owner Participant and Indenture Trustee		31
Section 6.6.	Amendments to Operative Agreements		32
Section 6.7.	Section 1168		32
Section 6.8.	Merger Covenant		32
Section 6.9.	Additional Filings		33
Section 6.10.	Owner Participant an Affiliate of Lessee		33
Section 6.11.	Taxes		33
Section 6.12.	Negative Make-Whole Amount		33

Article VII	Lessee’s Indemnities		34

Section 7.1.	General Tax Indemnity		34
Section 7.2.	General Indemnification and Waiver of Certain Claims		41

Article VIII	Lessee’s Right of Quiet Enjoyment		46

Article IX	[ Reserved ]		46

Article X	Successor Indenture Trustee		46

Article XI	Miscellaneous		47

Section 11.1.	Consents		47
Section 11.2.	Refinancing		47
Section 11.3	Amendments and Waivers		49
Section 11.4.	Notices		49
Section 11.5.	Survival		51
Section 11.6.	No Guarantee of Debt		51
Section 11.7.	Successors and Assigns		51
Section 11.8.	Business Day		51
Section 11.9.	Governing Law		52
Section 11.10.	Severability		52
Section 11.11.	Counterparts		52
Section 11.12.	Headings and Table of Contents		52
Section 11.13.	Limitations of Liability		52
Section 11.14.	Reproduction of Documents		53

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Section	Heading	Page

Section 11.15.	Tax Disclosure		53
Section 11.16.	Bankruptcy of Trust or Trust Estate		53
Section 11.17.	Transaction Intent		54
Section 11.18.	Jurisdiction, Court Proceedings		54
Section 11.19.	Increased Costs		54

Attachments To Participation Agreement:


Schedule 1A	—	Description of Equipment; Equipment Cost (Type A)
Schedule 1B	—	Description of Equipment; Equipment Cost (Type B)
Schedule 2	—	Participants’ Commitments
Exhibit A	—	Certificate of Acceptance
Exhibit B	—	Bill of Sale

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Participation Agreement
(KCSR 2006-1)

This Participation Agreement (KCSR 2006-1), dated as of August 2, 2006 (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 ”), (ii) KCSR TRUST 2006-1, 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 of the Trust 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 ”), (iii) HSH Nordbank AG, New York Branch , a banking corporation organized under the laws of Germany (herein, together with its permitted successors and assigns, called the “ Owner Participant ”), (iv) Wells Fargo Bank Northwest, National Association , a national banking association, not in its individual capacity except as expressly provided herein, but as trustee under the Indenture (as hereinafter defined) (herein in such capacity, together with its permitted successors and assigns, called the “ Indenture Trustee ”), and (v) DVB Bank AG , a German banking institution (together with its permitted successors and assigns, the “ Loan Participant ”).

Witnesseth:

Whereas , concurrently with the execution and delivery of this Agreement, Owner Participant and Trust Company have entered into the Trust Agreement (KCSR 2006-1) pursuant to which Owner Trustee agrees, among other things, to hold the Trust Estate for the benefit of Owner Participant thereunder on the terms specified in the Trust Agreement, subject, however, to the lien created under the Indenture and, on the Closing Date, subject to the terms and conditions hereof, to purchase the Equipment from each Seller and concurrently therewith lease the Equipment to Lessee;

Whereas , concurrently with the execution and delivery of this Agreement, the Trust has entered into the Indenture with Indenture Trustee pursuant to which the Trust agrees, among other things, for the benefit of the holder or holders of the Equipment Notes (i) to issue to Loan Participant on the Closing Date an Equipment Note as evidence of the loan made by Loan Participant on the Closing Date in connection with the financing of the Equipment Cost of the Units of Equipment to be delivered on or prior to the Closing Date and (ii) on the Closing Date, to execute and deliver an Indenture Supplement granting to Indenture Trustee a security interest in all of the Units of Equipment delivered on or prior to the Closing Date (and it is the intention of the parties hereto that Indenture Trustee have, for the benefit of the holders of the Equipment Notes, such a security interest in all of the Units of Equipment delivered on or prior to the Closing Date);

Whereas , pursuant to the terms of the Trust Agreement, Owner Trustee, on behalf of the Trust, is authorized and directed by Owner Participant (i) on the Closing Date, to accept delivery of each Bill of Sale evidencing the purchase and transfer of title of each Unit of Equipment to the

Trust; and (ii) to execute and deliver the Lease relating to the Equipment pursuant to which, subject to the terms and conditions set forth therein, the Trust agrees to lease to Lessee, and Lessee agrees to lease from the Trust, on such date, each Unit of Equipment to be delivered on or prior to the Closing Date, such lease and delivery to be evidenced by the execution and delivery of a Lease Supplement covering such Units subject to the condition subsequent that each Seller shall receive the purchase price for the applicable Equipment on the Closing Date;

Whereas , concurrently with the execution and delivery of this Agreement, Lessee and Owner Participant have entered into the Tax Indemnity Agreement relating to the Equipment;

Whereas , the proceeds from the sale of the Equipment Notes to Loan Participant on the Closing Date will be applied, together with the equity contribution made by Owner Participant pursuant to this Agreement on the Closing Date, to effect the purchase of the Units of Equipment to be delivered on or prior to the Closing Date contemplated hereby;

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:

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) 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 the applicable 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

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of such delivery and acceptance, subject to the condition subsequent that each 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 (the “Closing Date” ), the Trust will pay to each Seller a purchase price equal to the Equipment Cost with respect to each Unit theretofor delivered by such 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 the Closing Date, and provided further , in the event that the Closing Date does not occur on or before September 29, 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 the applicable Seller. The Closing Date shall occur on or prior to September 29, 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 the Units on the Closing Date by making an equity investment in the beneficial ownership of the Trust in an amount equal to the product of the Equipment Cost for the Units of each Type delivered on or prior to the Closing Date and the percentage set forth opposite Owner Participant’s name on Schedule 2 hereto for such Type (the “ Owner Participant’s Commitment ”). The aggregate amount of Owner Participant’s Commitment required to be made as above provided in the payment of the Equipment Cost on the Closing Date shall not exceed $17,162,938.91 (plus up to $683,100 in Transaction Costs). 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. Owner Participant’s Commitment to be paid by Owner Participant on the 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, Loan Participant severally agrees to participate on the Closing Date, in the payment of the Equipment Cost for the Units by making a secured loan, to be evidenced by an Equipment Note of each Series, to Owner Trustee in an amount equal to the product of the Equipment Cost for the Units of each Type delivered on or prior to the Closing Date and the percentage set forth opposite Loan Participant’s name on Schedule 2 hereto for such Type (the “Loan Participant’s Commitment" ). The aggregate amount of Loan Participant’s Commitment required to be made as above provided in the payment of the Equipment Cost on the Closing Date shall not exceed the amount set forth opposite Loan Participant’s name on Schedule 2 hereto.

Section 2.3. Closing Date; Procedure for Participation. (a) Closing Date Notice. Not later than 11:00 A.M., New York City time, on the third Business Day preceding the Closing Date, Lessee shall give Owner Participant, Indenture Trustee, Owner Trustee and Loan

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Participant notice (a “ Closing Date Notice ”) by telex, telegraph, facsimile or other form of telecommunication or telephone (to be promptly confirmed in writing) of the Closing Date, which Closing Date Notice shall specify in reasonable detail the number and type of 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 Owner Participant’s Commitment and Loan Participant’s Commitment required to be paid with respect to such Units. Concurrently with the delivery of the Closing Date Notice, Lessee shall deliver to Loan Participant a funding indemnity letter, in form and substance satisfactory to Loan Participant, pursuant to which Lessee indemnifies Loan Participant against any loss, cost or expense in (x) terminating Loan Participant’s funding (which, for the avoidance of doubt, includes both LIBOR funding and a long term LIBOR to fixed rate swap) if the Closing does not occur on the date specified or (y) partially terminating Loan Participant’s funding if the Closing occurs on the date specified but not all Units are delivered or resetting Loan Participant’s funding. Prior to 11:00 A.M., New York City time, on the Closing Date, Owner Participant shall make the amount of Owner Participant’s Commitment and Loan Participant shall make the amount of its Loan Participant’s Commitment required to be paid on the 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, ABA #031100092, Account Number: 077533-000, Account Name: KCSR 2006-1 Trust. The making available by Owner Participant of the amount of its Commitment for the Equipment Cost shall be deemed a waiver of the Closing Date Notice by Owner Participant and Owner Trustee and the making available by Loan Participant of the amount of its Commitment for the Equipment Cost shall be deemed a waiver of the Closing Date Notice by Loan Participant and Indenture Trustee (with respect to Loan Participant).

(b) Closing. The settlement with respect to the payment of the purchase price of the applicable Units on the Closing Date (the “Closing" ) shall take place at 11:00 A.M., New York City time on the Closing Date at the offices of Chapman and Cutler LLP, 111 West Monroe Street, Chicago, Illinois 60603, or at such other place or time as the parties hereto shall agree. Upon receipt by Owner Trustee on the Closing Date of the full amount of Owner Participant’s Commitment and Loan Participant’s Commitment in respect of the Units for which settlement will be made on the Closing Date, and subject to the conditions set forth in Section 4 to be fulfilled on the Closing Date having been fulfilled to the satisfaction of Owner Participant and Loan Participant or waived by Owner Participant or Loan Participant, as the case may be, the Trust shall, pay to, or to the order of, each 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. Each of Owner Participant, Owner Trustee, Loan Participant, 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 the Closing Date in accordance with the terms of this Article II shall constitute, without further act, authorization and direction by Owner Participant to Owner Trustee, subject, on the Closing Date, to the conditions set forth

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in Sections 4.1 and 4.3 to be fulfilled on the Closing Date having been fulfilled on the 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 the Closing Date.

(b) Owner Participant agrees, in the case of any Replacement Unit substituted pursuant to Section 11.4 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 each Seller, the Owner Participant’s Commitment with respect to the Units delivered on or prior to the Closing Date shall constitute, without further act, notice and confirmation that all conditions set forth in Sections 4.1 and 4.3 to be fulfilled on the 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 ”):

(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, special counsel to Owner Participant (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 Loan Participant, 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 P.C., 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;

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(v) the reasonable fees and expenses of Chapman and Cutler 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 upfront fee payable to the Loan Participant;

(ix) the initial fees and expenses of Indenture Trustee;

(x) the fees of an equipment appraiser, for their services rendered in connection with delivering the Appraisal required by Section 4.3(a);

(xi) the fees of AMA Capital Partners, L.L.C.;

(xii) 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;

(xiii) 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

(xiv) the reasonable fees and expenses of Lessee’s independent accountants, in connection with the transactions contemplated by the Operative Agreements;

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 the 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

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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 the Closing Date of Owner Participant’s obligation to fund its participation pursuant to Article II (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 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. On the Closing Date, (i) Lessee and Owner Trustee shall enter into a Lease Supplement which shall include as exhibits thereto schedules which include the actual Basic Rent, Rent Payment Dates, Stipulated Loss Values, Termination Values, EBO Fixed Purchase Price, EBO Fixed Purchase Price Date, allocation of Rent, in each case in respect of the Units to be settled on the Closing Date, and shall attach a list of the Units to be financed on such date and (ii) the Trust 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) the Transaction Costs paid by Owner Participant pursuant to Section 2.5 are less or more than 1.15% of the total Equipment Cost, or (B) prior to the 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

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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 the Transaction Costs equaled 1.15% of the Total Equipment Cost 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, 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 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

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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(b) 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(c) 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 Closing Date) to decline by 10 basis points or more from 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 Closing Date) certified by Owner Participant pursuant to this Section 2.6(c), 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(c), 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, Positive Make-Whole Amount, if any, and all unpaid interest on the Equipment Notes, accrued to the date on which Stipulated

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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 in Section 11.4, with a copy to Lessee.

Section 2.7. Optional Postponement of Closing Date. (a) The originally scheduled Closing Date (the originally scheduled Closing Date being referred to as the “ Scheduled Closing Date ” for the purposes of this Section 2.7) may be postponed from time to time for any reason (but to a date no later than September 29, 2006) if Lessee gives Owner Participant, Indenture Trustee, Loan Participant and Owner Trustee telex, telegraphic, facsimile or telephonic (confirmed in writing) notice of such postponement and notice of the date to which the Scheduled 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 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 the date to which the Scheduled Closing Date has been postponed.

(b) In the event of any postponement of the 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: (i) Lessee will reimburse Owner 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 Owner Participant hereunder) by paying to Owner 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 Owner Participant at least one (1) day’s interest at such rate on the amount of such funds, unless Owner 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 September 29, 2006, or earlier, if so instructed by Lessee, any funds which it shall have received from Owner Participant as its Commitment for such Units payable to Owner Participant, absent joint instruction from Lessee and Owner 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 Owner Trustee’s gross negligence or willful misconduct), the funds received by it from Owner 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

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instructions from Lessee shall be held in trust by Owner Trustee for the benefit of Owner Participant. Lessee shall pay to Owner Trustee on the 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 Owner Participant with respect to such Unit or Units are required to be returned to Owner Participant, Lessee shall, on the date on which such funds are so required to be returned, reimburse Owner Trustee, for the benefit of Owner 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 Owner Participant to Owner Trustee for the benefit of Owner 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 Owner 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 September 29, 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 Owner Trustee (with respect to clause (c) below) represents and warrants to Owner Participant, Indenture Trustee, Loan Participant 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 the 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 the Closing Date execute and deliver, each of the other Owner Trustee Agreements (other than the Equipment Notes) and, as of the Closing Date, the Equipment Notes to be delivered on the 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,

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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 the 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 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 the 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

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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 the Closing Date, the proceeds received by Owner Trustee from Owner Participant on the Closing Date pursuant to the Trust Agreement will be administered by it in accordance with Article IV of the Trust Agreement;

(j) on the Closing Date, the Trust shall receive from each Seller such title to the Units of Equipment delivered on or prior to such Delivery Date as was conveyed to it by such 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; and

(k) the Trust is a Delaware Statutory Trust in good standing created pursuant to the Delaware Statutory Trust Act, 12 Del. C. Section 3801 et seq. and the Trust Agreement.

Section 3.2. Representations and Warranties of Lessee. Lessee represents and warrants to Owner Trustee, Trust Company, Indenture Trustee, Loan Participant and Owner Participant that, as of the date hereof and as of the 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 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 the Closing Date have been duly executed and delivered) by Lessee, and constitute (or in the case of the Lease Supplement will on the 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,

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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, 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. The unaudited consolidated balance sheet and consolidated statements of income and retained earnings and cash flows of KCS for the six months ended June 30, 2006, 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 STB, which notices shall have been filed on or prior to the Closing Date and except as contemplated by Section 3.2(g) hereof;

(g) all filings and other actions necessary to protect the rights of Trust 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 the Closing Date and the Indenture will on the 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,

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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; and

(o) each Unit has been manufactured to meet the Design Specifications.

Section 3.3. Representations and Warranties of Indenture Trustee. Indenture Trustee represents and warrants to Owner Participant, Owner Trustee, Trust Company, Loan Participant and Lessee that, as of the date hereof and as of the 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 Articles of Association 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

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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 each case pertaining to the banking, trust or fiduciary powers of Indenture Trustee, is 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;

(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 Loan Participant; 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) The Trust represents and warrants to Lessee, Indenture Trustee, Loan Participant and Owner Participant that, as of the date hereof and as of the Closing Date, neither the Trust nor any Person authorized or employed by the Trust 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 Participant and Owner Participant that, as of the date hereof and as of the Closing Date, it has not offered any of the Beneficial Interest for sale to, or solicited offers to buy any thereof from, any

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Person other than Owner Participant and not more than 33 other prospective institutional investors.

(c) Both the Trust and Lessee agree severally but not jointly that neither the Trust nor Lessee nor anyone acting on behalf of the Trust 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 Partners, L.L.C.) 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. Representations and Warranties of Loan Participant. Loan Participant represents and warrants to Owner Trustee, Indenture Trustee, Owner Participant and Lessee that, as of the date hereof and as of the Closing Date (and the purchase of an Equipment Note by Loan Participant on the Closing Date shall constitute a reaffirmation by Loan Participant of each of these representations and warranties as of such date):

(a) 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) the execution and delivery by Loan Participant of this Agreement and its performance hereunder and under the Equipment Notes have been duly authorized by all necessary corporate action. It has duly and validly executed and delivered this Agreement.

(c) assuming the due authorization, execution and delivery by the other parties hereto, this Agreement constitutes, and its obligations under the Equipment Notes will constitute, its legal, valid, and binding obligations enforceable against it in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency and similar laws and by general principles of equity.

(d) Loan Participant is acquiring the Equipment Notes to be issued to it on the 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, Loan Participant has no present intention of selling, negotiating or otherwise disposing of such Equipment Notes; it being understood, however, that the disposition of Loan Participant’s property shall at all times be and remain within its control; and

(e) 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.

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Section 3.6. Representations and Warranties of Owner Participant. Owner Participant represents and warrants to Owner Trustee, Trust Company, Indenture Trustee, Loan Participant and Lessee that, as of the date hereof and as of the Closing Date (unless any such representation is specifically made as of one date):

(a) Owner Participant is a banking corporation duly organized, validly existing and in good standing under the laws of Germany and has the power and authority to carry on its business as now conducted;

(b) Owner Participant has the corporate 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 corporate action on the part of Owner Participant, do not require any approval not already obtained of the stockholders 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 the Closing Date, Owner Participant is purchasing the Beneficial Interest to be acquired by it on the Closing Date for its account with no present intention of distributing such

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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 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) Owner Participant 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.

Article IV

Conditions Precedent

Section 4.1. Conditions Precedent to First Delivery Date; Conditions Precedent of Each Participant and Indenture Trustee to the Closing Date.

(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 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 Participant, 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 Owner Participant and special counsel to Owner Participant and (D) counsel to Indenture Trustee, each in form and scope satisfactory to the parties hereto; 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

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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, Owner Trustee, the Trust 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 and Indenture Trustee to participate in the transactions contemplated hereby on the Closing Date shall be subject to the following conditions precedent (except that paragraph (16) shall not be a condition precedent to Owner Participant’s obligations hereunder and paragraph (17), as it relates to a Loan Participant, shall not be a condition precedent to Loan Participant’s obligations):

(1) Execution of Operative Agreements. On or before the 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 the Closing Date, the Lease Supplement, the Indenture Supplement, in each case with respect of the Units for which settlement will be made on the 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 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 the 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 the Closing Date, Lessee will cause the Lease, the Lease Supplement with respect to the Units for which settlement will be made on the Closing Date, the Indenture, the Indenture Supplement with respect to the Units for which settlement will be made on the 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 the Trust’s title to the Equipment and interest in the Lease, or the security

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interest of Indenture Trustee in the Equipment and the Lease, and will furnish Indenture Trustee, Owner Trustee and each Participant proof thereof.

(3) Officer’s Certificate of Lessee. On the Closing Date, Owner Trustee, Indenture Trustee, Loan Participant 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 the 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.

(4) Officer’s Certificate of Owner Trustee. On the Closing Date, Lessee, Indenture Trustee, Loan Participant 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 the 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.

(5) Officer’s Certificate of Indenture Trustee. On the Closing Date, Lessee, Owner Trustee, Loan Participant 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 the 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.

(6) Officer’s Certificate of Owner Participant. On the Closing Date, Lessee, Owner Trustee, Indenture Trustee, and Loan Participant 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 the 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

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all agreements and conditions herein contained which are required to be performed or complied with by Owner Participant on or before said date.

(7) Opinions of Counsel. On the Closing Date, Owner Trustee, Indenture Trustee, Loan Participant 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, (C) internal counsel to Owner Participant and special counsel to Owner Participant and (D) counsel to Indenture Trustee, each in form and scope satisfactory to each Participant, (E) Alvord and Alvord, special STB counsel, and (F) 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.

(8) Title. On the 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 the Closing Date, free and clear of all Liens, except Permitted Liens of the type described in clause (iii), (iv) and (v) of the definition thereof.

(9) Bills of Sale. On the Closing Date, each Seller shall have delivered to Owner Trustee (with copies to Indenture Trustee, Loan Participant and Owner Participant) a Bill of Sale in the form attached hereto as Exhibit B with respect to the applicable Units being settled on the Closing Date, such Bill of Sale dated the Closing Date for such Units, 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, such 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.

(10) Certificates of Acceptance. On the Closing Date, Lessee shall have delivered to Owner Trustee (with copies to Indenture Trustee, Loan Participant and Owner Participant) a Certificate of Acceptance with respect to each Unit being settled on the Closing Date, such Certificate of Acceptance executed on and dated the Delivery Date for such Unit.

(11) Insurance Certificate. On or before the Closing Date, Indenture Trustee, Loan Participant, Owner Trustee and Owner Participant shall have received a certificate relating to insurance that is required pursuant to Section 12 of the Lease.

(12) Corporate Documents. Each of the Participants shall have received such documents and evidence with respect to Lessee, Owner Participant, 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.

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(13) 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 the 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.

(14) Closing Date Notice. Prior to the Closing Date, Indenture Trustee and the Participants shall have received the written notice of the Closing Date required pursuant to Section 2.3(a).

(15) 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.

(16) Owner Participant’s Investments. Owner Participant shall have made available its Commitment with respect to the Units delivered on the Closing Date in accordance with Sections 2.2(a) and 2.3.

(17) Loan Participant’ Investment. Loan Participant shall have made available its Commitment with respect to the Units delivered on the Closing Date in accordance with Sections 2.2(b) and 2.3.

(18) 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.

(19) Governmental Actions. All actions, if any, required to have been taken on or prior to the Closing Date in connection with the transactions contemplated by this Agreement and the other Operative Agreements on the 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 the Closing Date in connection with such transactions contemplated by this Agreement and the other Operative Agreements on the Closing Date shall have been issued, and all such orders, permits, waivers, exemptions, authorizations and approvals shall be in full force and effect, on the Closing Date.

Section 4.2. Additional Conditions Precedent to the Obligations of Loan Participant. The obligation of Loan Participant to advance funds for the Equipment Notes to be purchased by it pursuant to Section 2.2(b) on the Closing Date shall be subject to the additional conditions that:

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(a) Equipment Notes. The Equipment Notes to be delivered on the Closing Date shall have been duly authorized, executed and delivered to Loan Participant by a duly authorized officer of Owner Trustee and duly authenticated by Indenture Trustee.

(b) Debt Appraisal Letter. On or before the Closing Date, 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 such Units.

(c) Original Counterparts of Lease and Lease Supplement . The “original” counterpart of the Lease and each Lease Supplement shall have been delivered to Indenture Trustee.

(d) Security Interest . On the Closing Date, after giving effect to the transactions contemplated hereby and by the other Operative Agreements, Indenture Trustee shall have a perfected security interest in the Equipment, the Lease and the other property constituting the Indenture Estate, free of all Liens, except Permitted Liens.

(e) Opinion. On the Closing Date, Loan Participant shall have received the opinion of Vedder, Price, Kaufman & Kammholz, P.C., addressed to Loan Participant, in form and substance satisfactory to Loan Participant.

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 the Closing Date with respect to any Unit to be settled on the Closing Date shall be subject to the following additional conditions:

(a) Appraisal . On or before the 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 the 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 the 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

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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 the Closing Date shall be subject to the following conditions precedent:

(a) Corporate Documents . On or before the Closing Date, Lessee shall have received such documents and evidence with respect to Owner Participant, 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 the 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 the Closing Date, the representations and warranties of Owner Trustee, Indenture Trustee, Loan Participant and Owner Participant contained in Section 3 hereof shall be true and correct in all material respects as of the 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)(4), Owner Participant as described in Section 4.1(b)(6) and Indenture Trustee as described in Section 4.1(b)(5), addressed to Lessee 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 the Closing Date, Lessee shall have received the opinions of counsel for Owner Trustee and Indenture Trustee referred to in Section 4.1(b)(7), 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 the 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 the Closing Date if a Change in Tax Law shall have occurred after the date of execution hereof and on or prior to the 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 the Closing Date.

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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;

(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 at the time such 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;

(d) as soon as available and in any event within 120 days after the last day of each calendar year, a copy of Lessee’s Class I Railroad Annual Report R-1 filed by the Lessee with the Surface Transportation Board;

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(e) 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; and

(f) from time to time, such additional information kept by Lessee in the ordinary course of business reasonably related to the transactions contemplated hereby as Lessor, Owner Participant, Loan Participant, Owner Trustee or Indenture Trustee may reasonably request.

If at any time Lessee shall become subject to the public reporting requirements of the SEC 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 transferring Owner Participant if the transferring Owner Participant remains liable for all obligations of Owner Participant under each of the Operative Agreements;

(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

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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;

(j) such transfer shall be of all, but not less than all, of the entire Beneficial Interest of Owner Participant;

(k) such transfer shall not occur prior to the Closing Date;

(l) as a result of such transfer, no Indenture Default attributable to Owner Participant or Owner Trustee shall have occurred and be continuing; and

(m) Owner Participant shall deliver an Officer’s Certificate to the parties hereto certifying as to compliance with the transfer requirements contained herein.

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

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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 Loan Participant under the Operative Agreements. Owner Participant hereby indemnifies and holds harmless Lessee, Indenture Trustee, Indenture Estate, Owner Trustee and 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 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 Loan Participant under the Operative Agreements. Trust Company hereby indemnifies and holds harmless Lessee, Indenture Trustee, the Indenture Estate, Owner Participant and 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 Participant . (a) Indenture Trustee covenants and agrees with Lessee, Owner Trustee, Owner Participant and 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

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such Lien; provided that Indenture Trustee may contest any such 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, the rights of the Trust under the Operative Agreements or the rights of Loan Participant under the Operative Agreements. 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) 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 Equipment or all or any portion of the Trust Estate or the Indenture Estate arising as a result of (i) claims against Loan Participant not related to its interest in the Equipment and the Trust Estate, (ii) acts of Loan Participant not contemplated by, or failure of Loan Participant to take any action it is expressly required to perform under, the Operative Agreements, (iii) claims against Loan Participant relating to Taxes or expenses that are not indemnified against by Lessee pursuant to Article VII or (iv) claims against Loan Participant arising out of the transfer by 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 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; provided that Loan Participant may contest any such 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 the Trust or Indenture Trustee under the Operative Agreements. 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 Participant 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. Notwithstanding any provision herein or in any of the Operative Agreements to the contrary,

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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 Section 2.01, 2.02, 2.05, 2.10, the provisions of the proviso of Section 4.3(a), Article III, Article IX of the Indenture or Section 4.01, 9.01, 10.01 or 12.01 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 Participant 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 (and Indenture Trustee, as assignee of Lessor) shall be entitled to the benefits of Section 1168 of the Bankruptcy Code to the 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

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interest in the Lease, the Person owning such leasehold interest after such event shall deliver to Owner Participant, Loan Participant 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 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. Negative Make-Whole Amount . Loan Participant hereby agrees, and the other parties hereby acknowledge, that in the event of any prepayment of the Equipment Notes pursuant to Section 2.10 of the Indenture, any acceleration of the Equipment Notes pursuant to Section 4.02 of the Indenture or any purchase of the Equipment Notes pursuant to Section 4.04(b) of the Indenture, if the calculation of the Make-Whole Amount results in Negative Make-Whole Amount, then such Negative Make-Whole Amount shall be due on the date of such prepayment as provided for in Section 2.10 of the Indenture, the date of payment under Section 4.02 of the Indenture in the case of such acceleration or the date of such purchase as provided in Section 4.04(b) of the Indenture, as the case may be, and such Negative Make-Whole Amount shall be paid in U.S. dollars on such date by the holders of the Equipment Notes (each such holder to pay its ratable portion of such Negative Make-Whole Amount in accordance with its percentage of the Equipment Notes then being prepaid or purchased) directly to the Lessee free of the Lien of the Indenture or, if such acceleration pursuant to Section 4.02 of the

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Indenture results from a Lease Event of Default, to the Owner Trustee or, in the case of Section 4.04(b) of the Indenture, to the Owner Participant; provided that if at any time that the Owner Trustee is required to make a payment of the aggregate unpaid principal amount of all Equipment Notes then outstanding plus the accrued but unpaid interest thereon in connection with any acceleration of the Equipment Notes pursuant to Section 4.02 of the Indenture, there shall exist an obligation of the holders of the Equipment Notes to pay any Negative Make-Whole Amount, there shall be deducted from such payment of the aggregate unpaid principal amount of all Equipment Notes then outstanding plus the accrued but unpaid interest thereon an amount equal to the aggregate amount of such Negative Make-Whole Amount owed by the holders of the Equipment Notes at such time (with the same effect as if such amount had been distributed pursuant to the provisions of Section 3.03 of the Indenture) .

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, its Affiliates, Owner Trustee, Trust Company, the Trust, the Trust Estate, Indenture Trustee, 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, Lessee agrees to indemnify and hold harmless each Tax Indemnitee on an After-Tax Basis 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; or

(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;

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(i) Taxes which are based upon, measured by or in respect to gross or net income or gross or net receipts (including (x) commercial activity taxes, business activity taxes and other similar taxes that are based upon, measured by or in respect of such income or receipts and (y) all Taxes which are in lieu of a gross or net income tax or gross or net receipts tax); Taxes on items of preference or any minimum tax; value added taxes; business and occupation taxes; franchise taxes; or Taxes based upon Owner Participant’s or Lessor’s capital stock or net worth; provided that there shall not be excluded under this subparagraph (i) any (x) sales, use, property, value added, license, rental, ad valorem or Taxes in the nature thereof and (y) 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); provided, further, that in the case of a Loan Participant, there shall not be excluded under this subparagraph (i) Taxes imposed by withholding or deduction.

(ii) In the case of a Loan Participant, Taxes imposed by withholding or deduction, unless and to the extent such Loan Participant is a “resident” of the Federal Republic of Germany, as defined for purposes of the Treaty as in effect on the Delivery Date in the case of the Original Loan Participant and as in effect on the date a Loan Participant other than the Original Loan Participant acquires its interest in an Equipment Note or other Operative Agreement, and such Taxes are imposed by the United States as a result of a Change in Tax Law on or with respect to the payment of principal, interest or any other sums payable under an Equipment Note or other amounts payable to such holder under the Operative Agreements by Lessee, Indenture Trustee or Owner Trustee;

(iii) 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);

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(iv) 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;

(v) 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 rights pursuant to Section 23 of the Lease and (z) the replacement, substitution, subleasing or interchange of any Unit by any Lessee Person;

(vi) Taxes imposed with respect to any fees received by Indenture Trustee or Owner Trustee for services rendered in its capacity as trustee;

(vii) Taxes which have been included in the Equipment Cost;

(viii) Taxes for which Lessee is obligated to indemnify Owner Participant or Owner Trustee under the Tax Indemnity Agreement;

(ix) 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;

(x) Taxes imposed pursuant to sections 6707, 6707A or 6708 of the Code;

(xi) As to any Tax Indemnitee any Taxes imposed as a result of any modification, amendment, supplement, consent, or waiver to any Operative Agreement entered into by such Tax Indemnitee or any related Tax Indemnitee thereof other than any modification, amendment, supplement, consent, or waiver (A) consented to in writing, requested in writing or initiated by the Lessee, (B) while a Lease Event of Default shall have occurred and is continuing or (C) that is required by the Operative Agreements or by law;

(xii) 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;

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(xiii) Taxes imposed on a Tax Indemnitee to the extent resulting from a failure of such Tax Indemnitee to provide any certificate, documentation, or other evidence requested by Lessee in a timely manner and required under applicable law as a condition to the allowance of a reduction in such Tax, but only if such Tax Indemnitee was legally eligible to provide such certificate, document or other evidence (based on a good faith judgment of such Tax Indemnitee that it is legally entitled and eligible to do so) without unindemnified adverse consequences (other than certain de minimis costs);

(xiv) Taxes imposed on a Tax Indemnitee to the extent consisting of interest, penalties, fines or additions to Tax in connection with the filing of, or failure to file, any tax return, the payment of, or failure to pay any Tax, or the conduct of any proceeding in respect thereof unless resulting from the failure by Lessee to perform its obligations under Section 7.1 hereof.

(d) All Tax Obligations in This Section, Etc. It is intended that all of Lessee’s obligations with respect to Taxes are set forth in this Section 7.1 and in the Tax Indemnity Agreement, but if Lessee shall be required under any other provision of the Operative Agreements to pay any other tax, the parties hereto agree that Section 7.1(e), (f), (h) , (j) and (k) shall apply to such taxes.

(e) Reverse Indemnity . If any Tax Indemnitee shall realize a tax benefit 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 . Provided that no Lease Event of Default has occurred and is continuing (in which event such payments shall be made when there is no continuing Lease Event of Default), 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

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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 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

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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 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, (B) no 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 or material civil liability or penalty 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

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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 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) Mitigation . Notwithstanding the provisions of Section 7.1(b) hereof:

(i) If circumstances arise which have resulted or would result in any Taxes imposed by withholding or deduction ( “Withholding Taxes" ) (other than Withholding Taxes excluded from indemnification under Section 7.1(c)) being imposed with respect to payments to a Loan Participant; then, without in any way limiting, reducing or otherwise qualifying the rights of such Loan Participant under Section 7.1(b), such Loan Participant shall promptly upon becoming aware of the same provide written notice to the Lessee (including in such notice a good faith estimate of the amount of any such Withholding Taxes)( “Withholding Notice" ). The Loan Participant and Lessee shall consult in good faith and shall each use its best efforts to avoid or mitigate the amount of any such Withholding Taxes, including, without limitation, by reaching a mutually acceptable agreement to a transfer by the Loan Participant of its Equipment Notes and its rights hereunder and under the other Operative Agreements to another existing branch, office or subsidiary of the Loan Participant, or a sale, for an amount equal to the Purchase Price (as defined in clause (ii) below), of such participation and rights to a third party reasonably acceptable to Lessee which is not affected by the circumstances having the results described above or which would be subject to a lesser amount of Withholding Taxes than the Loan Participant (any such solution, a “Mutually Acceptable Arrangement" ).

(ii) Each Loan Participant agrees that if Lessee and such Loan Participant do not reach a Mutually Acceptable Arrangement within thirty (30) days of Lessee’s receipt of a Withholding Notice, Lessee may elect by providing written notice to the Loan Participants within sixty (60) days of Lessee’s receipt of its Withholding Notice to refinance the Equipment Notes pursuant to Section 11.2 hereof (without, however, the payment of Make-Whole) or to require the affected Loan Participant to sell its Equipment Note to a third party willing to purchase the Loan Participant’s Equipment Note for a purchase price (the “Purchase Price" ) equal to the sum of the principal amount of such Loan Participant’s interest in the Equipment Note plus accrued interest thereon, if any, that would be payable to such Loan Participant if the Loan were prepaid on the date of such purchase. The affected Loan Participant may give written notice to Lessee within thirty (30) days of its receipt of Lessee’s notice of its intent to refinance the Equipment Notes or require sale of the affected Equipment Note that it waives its right to indemnification for Withholding Taxes with respect to such Change in Tax Law, in

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which event such affected Loan Participant shall not be entitled to indemnification in respect thereof and this Section 7.1(j) shall no longer apply with respect to such Withholding Taxes.

(k) Withholding . Lessee shall indemnify the Owner Trustee and Owner Participant for Taxes imposed by withholding in respect of payments on the Equipment Notes unless:

(i) such Tax is imposed because of a failure of the Owner Trustee or Owner Participant to provide any certificate, documentation, or other evidence requested by Lessee in a timely manner and required under applicable law as a condition to the allowance of a reduction in such Tax, but only if the Owner Trustee or Owner Participant was legally eligible to provide such certificate, document or other evidence (based on a good faith judgment of such the Owner Trustee or Owner Participant that it is legally entitled and eligible to do so) without unindemnified adverse consequences (other than certain de minimis costs); or

(ii) such Tax is imposed by a taxing jurisdiction outside of the United States solely because the Owner Participant is organized under the laws of Germany or because of activities unrelated to the transactions contemplated by the Operative Agreements.

If Lessee indemnifies Owner Participant or Owner Trustee pursuant to this clause (k), Lessee shall be subrogated to the extent of such payment to the rights and remedies of the Owner Participant and Owner Trustee, if any, with respect to the transaction or event giving rise to such Tax or payment thereof.

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.

(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, 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 (in the case of Owner Trustee), Owner Trustee (in the case of Owner Participant) 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,

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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 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

(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:

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(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 (xiii) 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 Article VIII 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 interests in any Unit pursuant to Section 10, 11 or 23 of the Lease or otherwise attributable to a Lease Event of Default that has occurred and is continuing;

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(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 of Owner Participant or Owner Trustee to the extent that such Claim would not have arisen but for the appointment of a successor or an additional Owner Trustee without the consent of Lessee unless such successor or additional Owner Trustee had been appointed in connection with the exercise of remedies pursuant to Section 15 of the Lease following the occurrence and continuance of a Lease Event of Default;

(xii) 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

(xiii) 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

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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.

(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 Article VII, 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, Loan Participant or any Affiliate thereof of any criminal liability or, unless indemnified against by Lessee, any civil liability or penalty; 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

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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.

(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 Loan Participant.

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(b) In the event that any of Owner Trustee, Loan Participant 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 Participant 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 Loan Participant.

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.

Section 11.2. Refinancing .

(a) Generally . Provided no Specified Default or Event of Default shall have occurred and 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 Positive 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

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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 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 Positive 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; provided, however, that (u) any such refinancing shall not adversely affect the rights or increase the obligations of Owner Participant under the Operative Agreements taken as a whole; (v) such refinancing shall not 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

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(A) create replacement Equipment Notes with a maturity longer than the outstanding Equipment Notes, (B) create replacement Equipment Notes with an average life more than three (3) months longer than the average life of the Equipment Notes (C) require any additional investment by Owner Participant or (D) increase the amount of premium payable in connection with a prepayment of the Equipment 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 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 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

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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

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

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	If to Owner Participant:		HSH Nordbank AG, New York Branch
			230 Park Avenue
			New York, New York 10169-0005
			Attn: Patricia Mooney, Loan Administration
			Facsimile No: (212) 407-6802
			Telephone No.: (212) 407-6021/(212) 407-6000
			Attn: Ed Sproull, Leasing Americas
			Facsimile No: (212) 407-6087
			Telephone No.: (212) 407-6060/(212) 407-6000

	If to a Loan Participant:		at the addresses set forth in Exhibit C 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 the 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 shall be deemed to be (a) a guarantee by Lessee to Owner Trustee, Owner Participant, Indenture Trustee or 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

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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 obligations or duties of such party 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 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

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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 Closing Date (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. 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 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 Loan Participant, as the case may be, shall promptly refund to Owner Participant such Excess Amount. For purposes of this Section 11.16, “Excess

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Amount” means the amount by which such payment exceeds the amount which would have been received by Indenture Trustee or Loan Participant if Owner Participant has not become subject to the recourse liability referred to in clause (ii) above. This Section 11.16 shall not be applicable to the extent Owner Participant is Lessee or an Affiliate of Lessee.

Section 11.17. Transaction Intent. It is the intent of Lessee that the Lease will be treated as an operating lease for accounting and financial reporting purposes. In the event that the transactions contemplated by the Operative Agreements are not treated for accounting and financial reporting purposes in a manner consistent with such intent, then, so long as no Lease Event of Default has occurred and is continuing, at Lessee’s reasonable request and at its sole cost and expense, each of the parties hereto hereby agrees that it shall reasonably cooperate with Lessee to restructure the transactions contemplated by the Operative Agreements to accomplish such intended treatment; provided that any such restructuring does not in any non- de minimis way adversely affect any of such Person’s rights or interests in the Equipment or any Operative Agreement, or cause any such Person to incur any additional risks or to incur any additional costs or expenses not otherwise satisfactorily indemnified by Lessee (which costs and expenses indemnity must be satisfactory to each such Person).

Section 11.18. Jurisdiction, Court Proceedings . Any suit, action or proceeding against any party to this Agreement or any other Operative Agreement arising out of or relating to this Agreement, any other Operative Agreement or any transaction contemplated hereby or thereby may be brought in any Federal or state court located in New York, New York, and each such party hereby submits to the nonexclusive jurisdiction of such courts for the purpose of any such suit, action or proceeding. To the extent that service of process by mail is permitted by applicable law, each such party irrevocably consents to the service of process in any such suit, action or proceeding in such courts by the mailing of such process by registered or certified mail, postage prepaid, at its address for notices provided for in Section 11.4. Each such party irrevocably agrees not to assert any objection which it may ever have to the laying of venue of any such suit, action or proceeding in any Federal or state court located in New York, New York, and any claim that any such suit, action or proceeding brought in any such court has been brought in an inconvenient forum.

Section 11.19. Increased Costs . (a) In the event of (x) a Regulatory Change or (y) a judgment being rendered after the Closing Date which subjects or imposes any increase in the actual cost to any holder of Equipment Notes of agreeing to make or making, funding or maintaining the loan evidenced by the Equipment Notes, then, within twenty (20) days after delivery to Owner Trustee, Indenture Trustee and Lessee of an Officer’s Certificate of such holder setting forth in reasonable detail the event giving rise to such increase in cost and the basis for the determination of the amount of such increase in cost, Owner Trustee shall pay to such holder such amount as shall be necessary to reimburse such holder for such increase in respect of any period which is no more than ninety (90) days prior to such demand; provided, however , that no holder shall be entitled to assert any claim under this Section 11.19(a) in respect of Taxes. Such Officer’s Certificate shall, in the absence of manifest error, be binding and conclusive on Owner Trustee. Each holder shall notify Owner Trustee, Indenture Trustee and Lessee as soon as possible of the occurrence of the event by reason of which it is entitled to make a claim as described in this Section 11.19(a), but the failure to give such notice shall not

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affect the obligations of Owner Trustee hereunder. In determining the amount of compensation payable by Owner Trustee under this Section 11.19(a), the relevant holder shall use reasonable efforts to minimize the compensation payable by Owner Trustee including using reasonable efforts to obtain refunds or credit and any compensation paid by Owner Trustee, which is later determined not to have been properly payable, shall forthwith be reimbursed by such holder to Owner Trustee.

(b) For purposes of Section 11.19(a), “ Regulatory Change ” means with respect to any holder of an Equipment Note (i) any change after the Closing Date in the laws or regulations of the United States or any State thereof or the District of Columbia or the Republic of Germany or the adoption or making after such date of any interpretation, directive or request applying to a class of banks including such holder of an Equipment Note, as the case may be, of or under any law or regulation (whether or not having the force of law) of the United States or any State thereof, or the District of Columbia or the Republic of Germany by any court or governmental or monetary authority charged with the interpretation or administration thereof and in addition, (ii) any change after the Closing Date in any regulation, guideline or requirement or in the interpretation or administration thereof (whether or not having the force of law) issued by any governmental or monetary authority applying to a class of banks including such holder of an Equipment Note, as the case may be, or the bank holding company of such holder of an Equipment Note, as the case may be (including any change after the Closing Date in the regulations, guidelines or requirements or interpretations or administration of any of the foregoing implementing the proposals for a risk-based capital framework described by the Basle Committee on Banking Regulations and Supervisory Practices in its paper entitled “International Convergence of Capital Measurement and Capital Standards” (commonly known as Basel II) dated June 2004, as modified and supplemented from time to time).

(c) The holder of any Equipment Note seeking compensation under this Section 11.19 will use commercially reasonable efforts (at its own expense) to mitigate the amount of compensation, including designating a different lending office for such holder if such designation will avoid the need for, or reduce the amount of, such compensation and will not, in the reasonable judgment of such holder, result in any non- de minimis economic, legal or regulatory disadvantage to such holder. The Owner Trustee shall not be required to make payments under this Section 11.19 to any holder of an Equipment Note if (A) a claim hereunder arises solely through circumstances peculiar to such holder and which do not affect commercial banks in the jurisdiction of organization of such holder generally or (B) the claim arises out of a voluntary relocation by such holder of its lending office (it being understood that any such relocation effected pursuant to the first sentence of this Section 11.19(c) is not “voluntary” ), or (C) such holder is not seeking similar compensation for such costs from its borrowers generally in similarly situated commercial loans.

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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/ Paul J. Weyandt
		Name:	Paul J. Weyandt
		Title:	Senior Vice President-Finance & Treasurer


Owner Trustee:	KCSR Trust 2006-1, acting through Wilmington Trust Company , not in its individual capacity, except where otherwise expressly provided, but solely as Owner Trustee

	By:	J. Christopher Murphey
		Name:	J. Christopher Murphey
		Title:	Financial Services Officer


Owner Participant:	HSH Nordbank AG, New York Branch
	By:	/s/ Edward I. Sproull
		Name:	Edward I. Sproull
		Title:	Senior Vice President, Leasing Americas



By:	/s/ Ann E. Hardy
	Name:	Ann E. Hardy
	Title:	Vice President, Leasing Americas


Indenture Trustee:	Wells Fargo Bank Northwest, National Association
	By:	/s/ Val T. Orton
		Name:	Val T. Orton
		Title:	Vice President


Loan Participant:	DVB Bank AG
	By:	/s/ Joseph P. Devoe
		Name:	Joseph P. Devoe
		Title:	Senior Vice President



By:	/s/ Alec A. Tasooji
	Name:	Alec A. Tasooji
	Title:	Assistant Vice President

Exhibit 10.41

Equipment Lease Agreement

(KCSR 2006-1)

dated as of August 2, 2006

between

KCSR Trust 2006-1, 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

33 SD70ACe 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 2006-1 ), dated as of August 2, 2006 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 2006-1) filed with the Surface Transportation Board pursuant to 49 U.S.C. § 11301 on August 10, 2006 at 9:17 a. m., Recordation Number 26496, and deposited in the Office of the Registrar General of Canada pursuant to Section 105 of the Canada Transportation Act on August 10, 2006 at 10:55 a. m.

Table of Contents


Section	Heading	Page

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		2
Section 3.4.	Adjustment of Rent		3
Section 3.5.	Manner of Payments		3

Section 4.	Ownership and Marking Of Equipment		3
Section 4.1.	Retention of Title		3
Section 4.2.	Duty to Number and Mark Equipment		3
Section 4.3.	Prohibition against Certain Designations		4

Section 5.	Disclaimer of Warranties; Right of Quiet Enjoyment		4
Section 5.1.	Disclaimer of Warranties		4
Section 5.2.	Quiet Enjoyment		5

Section 6.	Return of Equipment; Storage		5
Section 6.1.	General		5
Section 6.2.	Condition of Equipment		6
Section 6.3.	Storage		6

Section 7.	Liens		7

Section 8.	Maintenance; Operation; Sublease		7
Section 8.1.	Maintenance		7
Section 8.2.	Operation		8
Section 8.3.	Sublease		8

Section 9.	Modifications		9
Section 9.1.	Required Modifications		9
Section 9.2.	Optional Modifications		9
Section 9.3.	Removal of Proprietary and Communications Equipment		9
Section 9.4.	Retention of Equipment by Lessor		9

Section 10.	Voluntary Termination		10

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Section	Heading	Page

Section 10.1.	Right of Termination		10
Section 10.2.	Sale of Equipment		10
Section 10.3.	Retention of Equipment by Lessor		11
Section 10.4.	Termination of Lease		12

Section 11.	Loss, Destruction, Requisition, Etc		12
Section 11.1.	Event of Loss		12
Section 11.2.	Replacement or Payment upon Event of Loss		12
Section 11.3.	Rent Termination		13
Section 11.4.	Disposition of Equipment; Replacement of Unit		13
Section 11.5.	Eminent Domain		14

Section 12.	Insurance		15
Section 12.1.	Property Damage and Public Liability Insurance		15
Section 12.2.	Proceeds of Insurance		16
Section 12.3.	Additional Insurance		16

Section 13.	Reports; Inspection		17
Section 13.1.	Duty of Lessee to Furnish		17
Section 13.2.	Lessor’s Inspection Rights		17

Section 14.	Events of Default		17

Section 15.	Remedies		19
Section 15.1.	Remedies		19
Section 15.2.	Cumulative Remedies		22
Section 15.3.	No Waiver		22
Section 15.4.	Lessee’s Duty to Return Equipment Upon Default		22
Section 15.5.	Specific Performance; Lessor Appointed Lessee’s Agent		22

Section 16.	Filings; Further Assurances		23
Section 16.1.	Filings		23
Section 16.2.	Further Assurances		23
Section 16.3.	Expenses		23

Section 17.	Lessor’s Right to Perform		23

Section 18.	Assignment		24
Section 18.1.	Assignment by Lessor		24
Section 18.2.	Assignment by Lessee		24
Section 18.3.	Sublessee’s Performance and Rights		24

Section 19.	Net Lease, etc		24

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Section	Heading	Page

Section 20.	Notices		25

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		27

Section 22.	Termination Upon Purchase by Lessee; Options to Renew		27
Section 22.1.	Termination upon Purchase by Lessee		27
Section 22.2.	Renewal Option at Expiration of Basic Term		27
Section 22.3.	[Reserved]		28
Section 22.4.	Determination of Fair Market Rental Value		28
Section 22.5.	Stipulated Loss Value During Renewal Term		28

Section 23.	Lessee’s Options to Purchase Equipment; Purchase of Beneficial Interest		28

Section 24.	Limitation of Lessor’s Liability		31

Section 25.	Filing in Mexico		31

Section 26.	Miscellaneous		31
Section 26.1.	Governing Law; Severability		31
Section 26.2.	Execution in Counterparts		32
Section 26.3.	Headings and Table of Contents; Section References		32
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		33
Section 26.9.	Directly or Indirectly		33
Section 26.10.	Incorporation by Reference		33
Section 26.11.	Entitlement to §1168 Benefits		33
Section 26.12.	Waiver of Jury Trial		33

Attachments to Equipment Lease Agreement:

Exhibit A – Form of Lease Supplement
Appendix A – Definitions

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Equipment Lease Agreement
(KCSR 2006-1)

This Equipment Lease Agreement (KCSR 2006-1), dated as of August 2, 2006 (this “ Lease ”), between KCSR TRUST 2006-1, 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 ”),

Witnesseth:

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 the applicable Seller to Lessor, and acceptance thereof by Lessor, to accept on behalf of Lessor delivery of such Unit of Equipment from such 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 Sections 2.1(a) and 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, 22.1 and 23, 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.

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 Type of Equipment (as such Schedule 2 shall be adjusted pursuant to Section 2.6 of the Participation Agreement for the applicable Type of Equipment). Basic Rent shall be payable on the Rent Payment Dates as set forth in Schedule 2 to the Lease Supplement for the applicable Type of Equipment. Basic Rent shall be allocated and accrued for use of the Units as specified in Schedule 5 to the Lease Supplement for the applicable Type of Equipment. 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 set forth in Schedule 5 to the Lease Supplement for the applicable Type of Equipment. 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. It is the intention of Lessor and Lessee that the allocations of Basic Rent to each Lease period in the amount set forth in Schedule 3B constitute specific allocations of fixed rent within the meaning of Treasury Regulation section 1.467-1(c)(2)(ii).

(b) 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 amount, 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 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) in the case of the termination of this Lease with respect to any Unit on the applicable Termination Date, an amount equal to the Positive Make-Whole Amount, if any, with respect to the principal amount of each

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Equipment Note to be prepaid as a result of such termination and any Positive Make-Whole Amount due on the Equipment Notes upon their acceleration pursuant to Section 4.02 of the Indenture by reason of a Lease Event of Default (except in the case of a termination pursuant to Section 9.1 hereof and in connection with which Lessor exercises its right to retain the applicable Units pursuant to Section 9.4), (iii) 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 Positive Make-Whole Amount, if any, with respect to the principal amount of each Equipment Note outstanding on the Refunding Date, (iv) on demand, any payments required under the Tax Indemnity Agreement or Article VII of the Participation Agreement and (v) all amounts payable by Lessor under Section 11.19 of the Participation Agreement. 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, 12th 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.

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 the Closing Date, Lessee shall cause each Unit to be numbered with the reporting mark shown on the Lease Supplement for such Unit dated the Closing Date and, within 30 days of the 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:

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“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 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

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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 the applicable 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 Lease 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 reasonably 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 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 60 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

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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 in the condition required by Sections 8.1 and 9.3, (ii) be capable of performing the functions for which it was designed covered by Section 8.1 and (iii) 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 with Lessor’s sole remedy for any breach of this clause (iii) being damages at law or specific performance at equity. To the extent that any maintenance or overhaul logs are kept by Lessee with respect to any Unit returned pursuant to Section 6.1 and such maintenance logs are customarily made available to the purchaser of equipment of a type similar to such Unit, upon the request of Lessor and at Lessee’s expense, such maintenance and overhaul logs shall be made available to Lessor or its designee upon the return of 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 Lessee (taking into account, among other things, Lessee’s storage capacity, security and access) for a period (the “ Storage Period ”) beginning on the expiration of the Lease Term and ending not more than 45 days after the later of the expiration of the Lease Term with respect to Units of such Type of Equipment 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 45 days thereafter. Any storage facilities provided by Lessee pursuant to this Section 6.3 shall, in all cases, be at the 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

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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 of any or each Type of Equipment), 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 in the U.S. reasonably specified by Lessee, 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 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.

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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 or user upon lines of railroad owned or operated by Lessee, any Affiliate of Lessee, such sublessee or user 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 user 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 contain a purchase option. 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.

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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. Subject to Section 9.3, 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, utility, or remaining useful life of such Unit below the current fair market 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.

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

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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 or any Positive 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 in connection therewith 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. 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 plus any Positive 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 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 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 of any or each Type 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 notice referred to above at any time prior to five days before the scheduled 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 Participant and Owner Participant incurred in connection with any proposed or withdrawn termination.

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

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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 on or 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 Positive 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. If Lessor elects not to exercise its right to retain the Terminated Units as provided in Section 10.3, Lessee, in acting as agent for Lessor, shall have no liability to Lessor for failure to obtain the best price, shall act in its sole discretion and shall be under no duty to solicit bids publicly or in any particular market. Lessee’s sole interest in acting as agent shall be to sell the Units at a price that reduces or eliminates Lessee’s obligation to pay the amount provided in this Section 10.2. 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 Positive 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 manner and condition as if delivery were made to Lessor pursuant to Section 6, treating the

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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 Positive 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 such actual knowledge 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) As promptly as practicable, and in any event on or before the Business Day next preceding the 175th day next following the date on which a Responsible Officer of Lessee shall have actual knowledge of the occurrence or deemed occurrence of such Event of Loss, 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, 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 a Determination Date selected by Lessee that is within 180 days after a Responsible Officer of Lessee shall have actual knowledge of the occurrence or deemed occurrence of such Event of Loss 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 a Determination Date selected by Lessee that is within 180 days after a Responsible Officer of Lessee shall have actual knowledge of the occurrence or deemed occurrence of such Event of Loss, 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 on or prior to such Determination Date, and (C) without duplication, all Supplemental Rent (including any Positive Make-Whole Amount) 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.

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

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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 internal 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 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.

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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, and upon the earlier of (i) 200 days after Lessor shall have received such amount provided Lessor has not proceeded to exercise remedies under Section 15 and (ii) such time as there shall not be continuing any Specified Default or Event of Default, such amount shall be paid to Lessee.

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 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 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 but in no event shall such self-insurance or deductibles exceed $15,000,000 per occurrence; 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. 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 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 it 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

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commercial unavailability later becomes available, in Lessee’s reasonable judgment, 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, 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, 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 , if a Specified Default or an Event of Default shall have occurred and be continuing, such proceeds shall be paid over to Lessor to be held as security for Lessee’s obligations hereunder and under the other Operative Agreements.

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

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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, 2007, and on or before each June 30 thereafter, Lessee will furnish to Lessor, Owner Participant, 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) and (ii) 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, Loan 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, 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 with respect to each Type of Equipment (unless 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 Participant 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.

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 (i) Basic Rent within 5 Business Days after the same shall have become due or (ii) EBO Fixed Purchase Price, Stipulated Loss Value or Termination Value after the same shall have become due and such failure shall continue unremedied for a period of 10 Business Days after receipt by Lessee of

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written notice of such failure from Lessor, Owner Participant, Loan Participant or Indenture Trustee; or

(b) Lessee shall fail to make any payment of any other 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 30 days after receipt by Lessee of written notice of such failure from Lessor, Owner Participant, Loan Participant or Indenture Trustee (provided that notice of non-payment of any Excepted Payment may only be given by Owner Participant); or

(c) 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, Loan Participant or Indenture Trustee; provided that, if such untruth or incorrectness is capable of being remedied, no such untruth or incorrectness shall constitute an Event of Default hereunder for a period of 365 days after receipt of such notice so long as Lessee is diligently proceeding to remedy such untruth or incorrectness; or

(d) 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

(e) 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 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; or

(f) other than as set forth in clauses (g), (h), or (i), 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, no such failure shall constitute an Event of Default hereunder for a period of 365 days after receipt of such notice so long as Lessee is diligently proceeding to remedy such failure; or

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(g) Lessee shall 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 after receipt by Lessee of written notice of such violation from Lessor, Owner Participant, Loan Participant or Indenture Trustee; or

(h) Lessee shall fail to maintain the public liability insurance required by Section 12.1, if any, with respect to any Unit while such Unit is operated in service and such failure shall continue unremedied for 30 days after receipt by Lessee of written notice of such failure from Lessor, Owner Participant, Loan Participant or Indenture Trustee; or

(i) Lessee shall enter into any consolidation, merger or conveyance in violation of Section 6.8 of the Participation Agreement and such violation shall continue unremedied for 30 days after receipt by Lessee of written notice of such failure from Lessor, Owner Participant, Loan Participant or Indenture Trustee;

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(d) or 14(e), this Lease shall automatically be in default without the need for any declaration by Lessor and any giving of notice); 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, but Lessee shall remain liable as hereinafter provided; and thereupon, Lessor may

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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

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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 the Debt Rate, 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

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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.

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

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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 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 the Closing Date, the Indenture and the Indenture Supplement dated the 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 the Closing Date, the Indenture and the Indenture Supplement dated the 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 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

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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 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

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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 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 2006-1
		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:		HSH Nordbank AG, New York Branch
		230 Park Avenue
		New York, New York 10169-0005
		Attn: Patricia Mooney, Loan Administration
		Facsimile No: (212) 407-6802
		Telephone No.: (212) 407-6021/(212) 407-6000
		Attn: Ed Sproull, Leasing Americas
		Facsimile No: (212) 407-6087
		Telephone No.: (212) 407-6060/(212) 407-6000

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

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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 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) So long as no Specified Default or Event of Default shall have occurred and be continuing and subject to Section 22.1, Lessee shall have the right, upon not less than 90 days’ prior notice to Lessor prior to the end of the Basic Term for any Type of Equipment for which a renewal option is being elected hereunder, to renew this Lease with respect to, at the sole discretion of Lessee, either all of the Units or a Minimum Number of any or each Type of Equipment, for one Renewal Term of (i) either one year or five years, in the sole discretion of Lessee, in the case of Type A Equipment, and (ii) either one year or three years, in the sole discretion of Lessee, in the case of Type B Equipment (the “Fixed Rate Renewal Term” ), commencing on the Renewal Term Commencement Date for such Units. All of the provisions of this Lease, other than Section 10, shall be applicable during any such Fixed Rate Renewal Term for such Units, except that the Stipulated Loss Values for such Units shall be determined in accordance with Section 22.5 hereof, and Basic Rent for such Units shall be payable in semi-annual installments in arrears and shall be equal to the lesser of Fair Market Rental Value for such Units and the amount for such Type of Equipment set forth in Schedule 7 to Lease Supplement No. 1.

(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 90 days’ prior notice to Lessor at the end of the Basic Term, the Fixed Rate Renewal Term or any Fair Market Renewal Term with

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respect to any Type of Equipment for which a renewal option is being elected hereunder, as the case may be, pursuant to this Section, to renew this Lease with respect to, at the sole discretion of Lessee, either all of the Units or a Minimum Number of any or each Type of Equipment 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 Fixed Rate Renewal Term or the end of any Fair Market Renewal Term for such Type of Equipment, as the case may be; provided that with respect to Units of any Type of Equipment, the aggregate duration of the Fair Market Renewal Terms for such Units, when added to the duration of the Basic Term, the prior Fixed Rate Renewal 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, the Fixed Rate Renewal 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] .

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 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 semiannual 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 120 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 for any Type of Equipment for which a purchase option

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is being elected hereunder, at the sole discretion of Lessee, either all or a Minimum Number of Units of any or each Type of Equipment at a price equal to the Fair Market Sales Value for such Units;

(ii) upon not less than 90 days’ prior irrevocable notice to Lessor to purchase on the EBO Fixed Purchase Price Date for any Type of Equipment for which a purchase option is being elected hereunder, at the sole discretion of Lessee, either all of the Units of Equipment or a Minimum Number of Units of any or each Type of Equipment at a price equal to the EBO Fixed Purchase Price for such Type of Equipment (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’ prior irrevocable notice to Lessor to purchase, at any time, 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 Stipulated Loss Value as of such date for such Unit.

Not less than 180 days prior to the expiration of the Basic Term or any Renewal Term, as applicable, Lessee agrees to provide Lessor with a good faith, non-binding indication of its current intention with respect to whether it will exercise the option set forth in clause (a)(i) above.

(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 120 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 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 on or 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 Positive 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) or 23(a)(iii) 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

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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 Loan Participant shall have received an opinion of counsel stating that Indenture Trustee and Loan Participant 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 and the bankruptcy or insolvency of Lessee or Owner Participant shall not preclude Indenture Trustee, as assignor of Lessor, from exercising Lessor’s rights under the Lease, such opinion to be reasonably satisfactory to Indenture Trustee and Loan Participant. On the applicable purchase date (x) Lessee shall pay any unpaid Basic Rent due and payable on or 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)).

(d) In the event that Lessee shall exercise its option set forth in Section 23(a)(ii), Lessee may, at its option, either (i) pay the entire purchase price for such Units on the purchase date therefor or (ii) with respect to any Type of Equipment pay the purchase price for such Units in installments, each such installment to be payable on each date set forth on Schedule 8 to Lease Supplement No. 1 and in an amount equal to the product of the percentage set forth in column [4] of Schedule 8 to Lease Supplement No. 1 with respect to the applicable Type of Equipment and the Equipment Cost for such Units, provided, however , that such amount payable on the first such date for each relevant Type of Equipment shall be not less than the amount of principal on the Series of Equipment Notes corresponding to such Type of Equipment subject to prepayment on such date pursuant to Section 2.10(c) of the Indenture. Lessee shall elect its payment option in the applicable notice given pursuant to Section 23(a)(ii); provided, however , that if at the time of the exercise of Lessee’s option pursuant to Section 23(a)(ii) the senior unsecured obligations of Lessee shall not be rated at least investment grade by Standard & Poor’s Ratings Services or Moody’s Investors Service, Inc. or a comparable rating by another credit rating agency of recognized national standing, Lessee shall not be entitled to elect the option specified in clause (ii) above unless (x) as a condition to such purchase, Lessee shall secure its obligation to pay the purchase price installments by granting to Lessor a perfected security interest in the applicable Units, pursuant to documentation reasonably satisfactory to Lessor and the Owner

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Participant and, and (y) upon satisfaction of such condition, Lessor shall transfer all its right, title and interest in and to such Units to Lessee on the EBO Fixed Purchase Price Date, in accordance with and subject to the other conditions specified in this Section 23 (except that payment of the installment of the purchase price payable on the EBO Fixed Purchase Price Date shall be required in lieu of payment of the full purchase price). All reasonable costs and expenses of Lessor and the Owner Participant incurred in connection with Lessee’s election of the option specified in clause (ii) above shall be paid by Lessee.

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 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

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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 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 the Closing Date regardless of any investigation made by any such party or on behalf of any such party.

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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 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.

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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 2006-1, acting through
		Wilmington Trust company , not in
		its individual capacity, but solely as Owner Trustee

		By:		/s/ J. Christopher Murphey

				Name: J. Christopher Murphey
				Title: Financial Services Officer

		Lessee:

		The Kansas City Southern Railway Company

		By:		/s/ Paul J. Weyandt

				Name: Paul J. Weyandt
				Title: Senior Vice President-Finance & Treasurer

Receipt of the original counterpart
of the foregoing Lease is hereby
acknowledged this ___day of August,
2006.

Wells Fargo Bank Northwest, National
Association, as Indenture Trustee


By:
		Name:
		Title:

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Exhibit 31.1

PRINCIPAL EXECUTIVE OFFICER’S CERTIFICATION
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Michael R. Haverty, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Kansas City Southern (the “registrant”);

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ Michael R. Haverty

Michael R. Haverty

Chairman and Chief Executive Officer

Date: November 9, 2006

Exhibit 31.2

PRINCIPAL FINANCIAL OFFICER’S CERTIFICATION
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Patrick J. Ottensmeyer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Kansas City Southern (the “registrant”);

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ Patrick J. Ottensmeyer

Patrick J. Ottensmeyer

Executive Vice President and Chief Financial Officer

Date: November 9, 2006

Exhibit 32.1

PRINCIPAL EXECUTIVE OFFICER’S CERTIFICATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Kansas City Southern (the “Company”) on Form 10-Q for the period ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael R. Haverty, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Michael R. Haverty

Michael R. Haverty

Chairman and Chief Executive Officer

November 9, 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 32.2

PRINCIPAL FINANCIAL OFFICER’S CERTIFICATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Kansas City Southern (the “Company”) on Form 10-Q for the period ending September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Patrick J. Ottensmeyer, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Patrick J. Ottensmeyer

Patrick J. Ottensmeyer

Executive Vice President and Chief Financial Officer

November 9, 2006

Exhibit 99.1

RISK FACTORS

Risks Related to an Investment in Our Common Stock

The price of our common stock may fluctuate significantly, which may make it difficult for an investor to resell common stock when desired or at attractive prices.

The price of our common stock on the New York Stock Exchange (“NYSE”) constantly changes. We expect that the market price of our common stock will continue to fluctuate.

Our stock price can fluctuate as a result of a variety of factors, many of which are beyond our control. These factors include, but are not limited to:

	•		quarterly variations in our operating results;

	•		operating results that vary from the expectations of management, securities analysts, ratings agencies and investors;

	•		changes in expectations as to our future financial performance, including financial estimates by securities analysts, ratings agencies and investors;

	•		developments generally affecting our industry;

	•		announcements by us or our competitors of significant contracts, acquisitions, joint marketing relationships, joint ventures or capital commitments;

	•		the assertion or resolution of significant claims or proceedings against us;

	•		our dividend policy and restrictions on the payment of dividends;

	•		future sales of our equity or equity-linked securities;

	•		the issuance of common stock in payment of dividends on preferred stock or upon conversion of preferred stock; and

	•		general domestic and international economic conditions.

In addition, the stock market in general has experienced extreme volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations may adversely affect the market price of our common stock.

Our ability to pay dividends is currently restricted, and we do not anticipate paying cash dividends on our common stock in the foreseeable future.

We have agreed, and may agree again, to restrictions on our ability to pay dividends on our common stock. In addition, to maintain our credit ratings, we may be limited in our ability to pay dividends on our common stock so that we can maintain an appropriate level of debt. During the first quarter of 2000, our board of directors suspended our common stock dividends. We do not anticipate making any cash dividend payments to our common stockholders for the foreseeable future.

We have not paid dividends on our Series C Preferred Stock or Series D Preferred Stock since February 15, 2006.

Because of certain restrictions in the indentures governing notes issued by KCSR, we have not paid dividends on our Series C Preferred Stock or Series D Preferred Stock since February 15, 2006 for the fourth quarter of 2005. If dividends on our Series C Preferred Stock or Series D Preferred Stock are in arrears for six consecutive quarters (or an equivalent number of days in the aggregate, whether or not consecutive) holders of the Series C Preferred Stock or Series D Preferred Stock, as applicable, will be entitled to vote for the election of two of the authorized directors at the next annual stockholders’ meeting at which directors are elected and at each subsequent stockholders’ meeting until such time as all accumulated dividends are paid on the Series C Preferred Stock or Series D Preferred Stock, as applicable, or set aside for payment. In addition, we will not be eligible to register future offerings of securities on Form S-3 or to avail ourselves of the other benefits available to companies that qualify as “well-known seasoned issuers” under SEC rules until we resume paying such dividends and file our annual financial statements for the year in which the payment of such dividends is resumed. This could adversely affect our ability to access capital markets, and increase the cost of accessing capital markets, until we qualify as a “well-known seasoned issuer.”

Sales of substantial amounts of our common stock in the public market could adversely affect the prevailing market price of our common stock.

As of September 30, 2006, we had 10,720,859 shares of common stock issued or reserved for issuance under our 1991 Amended and Restated Stock Option and Performance Award Plan and our Employee Stock Purchase Plan, 2,023,113 shares of common stock held by executive officers and directors outside those plans, and 20,389,113 shares of common stock reserved for issuance upon conversion of our outstanding shares of convertible preferred stock.

-2-

Sales of common stock by employees upon exercise of their options, sales by our executive officers and directors subject to compliance with Rule 144 under the Securities Act, and sales of common stock that may be issued upon conversion of our outstanding preferred stock, or the perception that such sales could occur, may adversely affect the market price of our common stock.

We have provisions in our charter, bylaws and Rights Agreement that could deter, delay or prevent a third party from acquiring us and that could deprive an investor of an opportunity to obtain a takeover premium for shares of our common stock.

We have provisions in our charter and bylaws that may delay or prevent unsolicited takeover bids from third parties. These provisions may deprive our stockholders of an opportunity to sell their shares at a premium over prevailing market prices. For example, our restated certificate of incorporation provides for a classified board of directors. It further provides that the vote of 70% of the shares entitled to vote in the election of directors is required to amend our restated certificate of incorporation to increase the number of directors to more than eighteen, abolish cumulative voting for directors and abolish the classification of the board. The same vote requirement is imposed by our restated certificate of incorporation on certain transactions involving mergers, consolidations, sales or leases of assets with or to certain owners of more than 5% of our outstanding stock entitled to vote in the election of directors. Our bylaws provide that a stockholder must give us advance written notice of its intent to nominate a director or raise a matter at an annual meeting. In addition, we have adopted a Rights Agreement which under certain circumstances would significantly impair the ability of third parties to acquire control of us without prior approval of our board of directors.

Risks Related to Our Business

We compete against other railroads and other transportation providers.

Our domestic and international operations are subject to competition from other railroads, in particular the Union Pacific Railroad Company (“UP”) and BNSF Railway Company (“BNSF”) in the United States and Ferrocarril Mexicano, S.A. de C.V. (“Ferromex”) in Mexico. Many of our rail competitors are much larger and have significantly greater financial and other resources than we do. In addition, we are subject to competition from truck carriers and from barge lines and other maritime shipping. Increased competition could result 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, maritime shippers and barges are able to use public rights-of-way. The trucking industry has in the past provided effective rate and service competition to the railroad industry. Trucking requires substantially smaller capital investment and maintenance expenditures than railroads and allows for more frequent and flexible scheduling. Continuing competitive pressures, any reduction in margins due to competitive pressures, future improvements that increase the quality of alternative modes of transportation in the locations in which we operate, or legislation or regulations that provide motor carriers with additional advantages, such as increased size of vehicles and reduced weight restrictions, could have a material adverse effect on our results of operations, financial condition and liquidity.

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A material part of our growth strategy is based upon the conversion of truck traffic to rail. There can be no assurance we will have the ability to convert traffic from truck to rail transport or that we will retain the customers we have already converted. 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 revenue growth from our Mexican operations could be adversely affected. Additionally, the revenue growth attributable to our Mexican operations could be affected by, among other factors, our inability to grow our existing customer base, negative macroeconomic developments impacting the United States or 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. did not follow that timetable because of concerns over Mexico’s trucking safety standards. In February 2001, a NAFTA tribunal ruled in an 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 U.S. -Mexico border. These safety rules require Mexican motor carriers seeking to operate in the U.S. to, among other things, pass safety inspections, obtain valid insurance with a U.S. registered insurance company, conduct alcohol and drug testing for drivers and obtain a U.S. Department of Transportation identification number. Under the rules issued by the U.S. Department of Transportation, it was expected that the border would have been opened to Mexican motor carriers in 2002. However, in January 2003, in response to a lawsuit filed in May 2002 by a coalition of environmental, consumer and labor groups, the U.S. Court of Appeals for the Ninth Circuit issued a ruling which held that the rules issued by the U.S. Department of Transportation violated federal environmental laws because the Department of Transportation failed to adequately review the impact on U.S. air quality of rules allowing Mexican carriers to transport beyond the 20-mile commercial zones along the U.S.-Mexico border. The Court of Appeals ruling required the Department of Transportation to provide an Environmental Impact Statement on the Mexican truck plan and to certify compliance with the U.S. Clean Air Act. The Department of Transportation requested the U.S. Supreme Court to review the Court of Appeals ruling and, on December 15, 2003, the Supreme Court granted the Department of Transportation’s request. On June 7, 2004, the Supreme Court unanimously overturned the Court of Appeals ruling. Although the Department of Transportation is no longer required to provide an Environmental Impact Statement under the Supreme Court’s ruling, the U.S. and Mexico must still complete negotiations on safety inspections before the border is opened. We cannot predict when these negotiations will be completed. There can be no assurance that truck transport between Mexico and the United States will not increase substantially in the future if the U.S. and Mexico complete the negotiations and the border is opened. Any such increase in truck traffic could affect our ability to continue converting traffic to rail from truck transport because it may result in an expansion in the availability, or an improvement in the quality, of the trucking services offered by Mexican carriers.

Through KCSM’s Concession from the Mexican government, we have the right to control and operate the southern half of the rail-bridge at Laredo, Texas. Under the Concession, KCSM must grant to Ferromex the right to operate over a north-south portion of KCSM’s rail lines between Ramos Arizpe near Monterrey and the city of Queretaro that constitutes over 600

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kilometers of KCSM’s main track. Using these trackage rights, Ferromex may be able to compete with KCSM over KCSM’s rail lines for traffic between Mexico City and the United States. The Concession also requires KCSM to grant rights to use certain portions of its tracks to Ferrocarril del Sureste, S.A. de C.V. (“Ferrosur”) and the “belt railroad” operated in the greater Mexico City area by the Ferrocarril y Terminal del Valle de Mexico, S.A. de C.V. (“Ferrovalle”), 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.

Ferromex, the operator of the largest railway system in Mexico, is in close proximity to KCSM’s rail lines. In particular, KCSM has experienced and continues to experience competition from Ferromex with respect to the transport of a variety of products. The rail lines operated by Ferromex run from Guadalajara and Mexico City to four U.S. border crossings west of the Nuevo Laredo-Laredo crossing, providing an alternative to KCSM’s routes for the transport of freight from those cities to the U.S. border. In addition, Ferromex directly competes with KCSM in some areas of its service territory, including Tampico, Saltillo, Monterrey and Mexico City. Ferrosur competes directly with KCSM for traffic to and from southeastern Mexico. Ferrosur, like KCSM, also services Mexico City, Puebla and Veracruz.

In November 2005, Grupo Mexico, the controlling shareholder of Ferromex, acquired all of the shares of Ferrosur. The common control of Ferromex and Ferrosur would give Grupo Mexico control over a nationwide railway system in Mexico and ownership of 50% of the shares of Ferrovalle.

Grupo Mexico’s acquisition of Ferrosur is subject to the approval of the Mexican Competition Commission. KCSM filed an objection to the acquisition with the Mexican Competition Commission. The Mexican Competition Commission has ruled that the acquisition is anti-competitive, but has not ordered a divestiture of control of Ferrosur by Grupo Mexico or assessed other penalties against Ferromex, Ferrosur or the combined entity. The ruling has been challenged by both companies. Unless there is a divestiture of Grupo Mexico’s interest in Ferrosur, the newly combined railroad will control a substantial share of the Mexican railroad market and will have greater financial resources than KCSM has, which among other things may give it greater ability to reduce freight rates. There is no assurance KCSM can effectively compete against the newly combined railroad, in which event our operations in Mexico could be adversely affected.

Rate reductions by competitors could make our freight services less competitive, and we cannot assure you we would always be able to match these rate reductions. In recent years, we have experienced aggressive price competition from Ferromex in freight rates for agricultural products, which has adversely affected our results of operations. Our ability to respond to competitive pressures by decreasing our rates without adversely affecting our gross margins and operating results will depend on, among other things, our ability to reduce our operating costs. Our failure to respond to competitive pressures, and particularly rate competition, in a timely manner could have a material adverse effect on our financial condition.

In recent years, there has also 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

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and have been historically available. There can be no assurance that further consolidation in the railroad industry, whether in the United States or Mexico, 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 another rail carrier pursuant to our marketing agreement with that carrier, 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 Ferrovalle. Applicable law stipulates that Ferromex, Ferrosur and Ferrovalle are required to grant to KCSM rights to use portions of their tracks. KCSM’s Concession classifies trackage rights as short trackage rights and long-distance trackage rights. Although all of these trackage rights have been granted under the Concession, no railroad has actually operated under the long-distance trackage rights because the means of setting rates for usage and often related terms of usage have not been agreed upon. Under the Mexican railroad services law and regulations, the rates KCSM may charge for the right to use its tracks must be agreed upon in writing between KCSM and the party to which those rights are granted. However, if KCSM cannot reach an agreement on rates with rail carriers entitled to trackage rights on KCSM’s rail lines, the Mexican Ministry of Communications and Transportation (“SCT”) is entitled to set the rates in accordance with Mexican law and regulation, which rates may not adequately compensate KCSM. 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. KCSM and Ferromex both initiated civil, commercial and administrative proceedings seeking a determination by the SCT of the rates each should pay the other in connection with the use of trackage and haulage rights and interline and terminal services. On March 13, 2002, the SCT 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 to the Mexican Supreme Court. KCSM and Ferromex also requested and obtained a suspension of the effectiveness of the SCT rulings pending resolution of the litigation. In February 2006, the Mexican Supreme Court sustained KCSM’s appeal of the SCT’s trackage and haulage rights ruling, vacated the SCT ruling and ordered the SCT to issue a new ruling consistent with the Court’s opinion. We have not yet received the written opinion of the Mexican Supreme Court on the February 2006 ruling, nor has the Court decided the interline and terminal services appeal. On October 2, 2006, KCSM was served with a claim by Ferromex asking for an accounting of the rates, costs and money owed to Ferromex concerning interline

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traffic between January 1, 2002 and December 31, 2004. We cannot predict the ultimate outcome of these matters, or whether the rates KCSM is ultimately permitted to charge will be sufficient to compensate it.

We are highly leveraged and have significant debt service obligations. 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, exposes us to the risk of increased interest rates, makes us more vulnerable to general economic downturns and adverse industry conditions, and could reduce our flexibility in planning for, or responding to, changing business and economic conditions. 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, 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 of exchange rate fluctuations, because any devaluation of the peso would cause the cost of KCSM’s dollar-denominated debt to increase, and could 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.

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.

We have funded, and expect to continue to fund, capital expenditures with funds from operating cash flows, leases and, to a lesser extent, vendor financing. We may not be able to generate sufficient cash flows from our operations or obtain sufficient funds from external sources to fund our capital expenditure requirements. If financing is available, it may not be obtainable on terms acceptable to us and within the limitations contained in the indentures and other agreements relating to our debt. If we are unable to complete our planned capital improvement projects, our ability to service our existing customers or accommodate increases in our traffic volumes may be limited or impaired.

KCSM’s Concession from the Mexican government requires KCSM to make investments and undertake capital projects, including capital projects described in a business plan filed every

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five years with the SCT. If KCSM is unable to make such capital investments, KCSM’s business plan commitments with the Mexican government may be at risk, requiring KCSM to seek waivers of its business plan, if possible. KCSM may defer capital expenditures under its business plan with the permission of the SCT. However, the SCT might not grant this permission, and any failure by KCSM to comply with the capital investment commitments in its business plan could result in sanctions imposed by the SCT. We cannot assure you that the Mexican government would grant any such permission or waiver. If such permission or waiver is not obtained in any instance and KCSM is sanctioned, its Concession might be at risk. This would adversely affect our financial condition and results of operations. See “KCSM’s Mexican Concession is subject to revocation or termination in certain circumstances” below.

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. The relative strength or weakness of the United States and Mexican economies affect the businesses served by us. PCRC and Panarail are directly affected by the Panamanian local economy. Our investments in Mexico and Panama expose us to risks associated with operating in Mexico and Panama, including, among others, cultural differences, varying labor and operating practices, political risk and differences between the United States, Mexican 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 may also be affected by natural disasters or adverse weather conditions. We operate in and along the Gulf Coast of the United States, and our facilities may be adversely affected by hurricanes and other extreme weather conditions. For example, hurricanes have adversely affected some of our shippers located along the Gulf Coast and caused interruptions in the flow of traffic within the southern United States and between the United States 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. 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, housing and agricultural industries. Any downturn in these industries 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

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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 these 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 achieved. 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 occur as a result of such 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, certain of 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 life or 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.

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

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at certain sites identified as posing a threat to the environment or public health. CERCLA imposes joint, strict and several liability 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 parties, which cannot be assured. We cannot assure you that the costs associated with these obligations will not be material or exceed the accruals we have established.

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 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. We are also subject to the laws of various jurisdictions and international conferences with respect to the discharge of materials into the environment. KCSM is also subject to environmental laws and regulations issued by the governments of each of the Mexican states in which KCSM’s facilities are located. The terms of KCSM’s Concession from the Mexican government also impose environmental compliance obligations on KCSM. 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. Significant price increases for fuel may have a material adverse effect on our operating results. Fuel expense increased from approximately 15% of our consolidated operating costs for the first nine months of 2005 to approximately 19% of our consolidated operating costs for the first nine months of 2006. We have been able to pass approximately 75% of these fuel cost increases on to customers in the form of fuel surcharges applied to our customer billings. If we are unable to continue the existing fuel surcharge

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program for KCSR and expand the fuel surcharge program for KCSM, our operating results could be materially adversely affected.

The U.S. Surface Transportation Board (“STB”) is currently evaluating potential changes in its standards for regulating fuel surcharge programs in our industry. We cannot predict the impact that any such changes may have on our business.

Fuel costs are affected by traffic levels, efficiency of operations and equipment, and petroleum market conditions. The supply and cost of fuel are subject to market conditions and are 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. 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 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.

The loss of key personnel could negatively affect our business.

Our success substantially depends on our ability to attract and retain key members of our senior management team and the principals of our foreign subsidiaries. Recruiting, motivating and retaining qualified management personnel, particularly those with expertise in the railroad industry, are vital to our operations and success. There is substantial competition for qualified management personnel and there can be no assurance that we will always be able to attract or retain qualified personnel. Our employment agreements with senior management are terminable at any time by us or the executive. If we lose one or more of these key executives or principals, our ability to successfully implement our business plans and the value of our common stock 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 United States and Mexico. As of September 30, 2006, approximately 82% of KCSR employees and approximately 74% of KCSM employees were covered by collective labor contracts. We may be subject to, among other things, strikes, work stoppages or work slowdowns as a result of disputes under these collective bargaining agreements and labor contracts or our potential inability to negotiate acceptable contracts with these unions. In the U.S., because such

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agreements are generally negotiated on an industry-wide basis, determination of the terms and conditions of labor agreements have been and could continue to be beyond our control. We may, therefore, be subject to terms and conditions in industry-wide 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 United States or Mexico were to engage in a strike, work stoppage or other slowdown, if other employees were to become unionized, or if the terms and conditions in future labor agreements were renegotiated, we could experience a significant disruption of our operations and higher ongoing labor costs. Although the U.S. Railway Labor Act imposes restrictions on the right of U.S. railway workers to strike, there is no law in Mexico imposing similar restrictions on the right of railway workers in that country to strike.

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 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, or any liability in excess of insurance limits or liability reserves, 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 liabilities resulting from crossing collisions, as well as claims related to personal property damage and other casualties, are a substantial expense to KCS. Personal injury and casualty claims are subject to a significant degree of uncertainty, especially estimates related to personal injuries that have occurred but not yet been reported, in which the degree of injuries 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 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 terrorism coverage currently maintained by us could increase dramatically or certain coverage may not be available in the future.

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KCSM’s Mexican Concession is subject to revocation or termination in certain circumstances.

KCSM operates under a 50-year Concession granted by the Mexican government. The Concession gives KCSM exclusive rights to provide freight transportation services over its rail lines for 30 years of the 50-year Concession, subject to certain trackage rights. The SCT is principally responsible for regulating railroad services in Mexico. The SCT has broad powers to monitor KCSM’s compliance with the Concession and it can require KCSM to supply it with any technical, administrative and financial information it requests. KCSM must comply with the investment commitments established in its business plan, which forms an integral part of the Concession, and must update the plan every five years. SCT treats KCSM’s business plans confidentially, The SCT monitors KCSM’s compliance with efficiency and safety standards established in the Concession. The SCT reviews, and may amend, these standards every five years.

The Mexican railroad services law and regulations provide the Mexican government certain rights in its relationship with KCSM under the Concession, including the right to take over the management of KCSM and its railroad in certain extraordinary cases, such as imminent danger to national security. In the past, the Mexican government has used such power with respect to other privatized industries, including the telecommunications industry, to ensure continued service during labor disputes. In addition, under the Concession and the Mexican railroad services law and regulations, the SCT, in consultation with the Mexican Antitrust Commission, under certain circumstances may determine that there is a lack of competition in the railroad industry, in which case the SCT would have the authority to set rates for rail freight services.

The Concession is renewable for additional periods of up to 50 years, subject to certain conditions. The SCT may terminate the Concession if, among other things, there is an unjustified interruption in the operation of KCSM’s rail lines, KCSM charges tariffs higher than the tariffs it has registered with the SCT, KCSM restricts the ability of other Mexican rail operators to use its rail lines, KCSM fails to make payments for damages caused during the performance of services, KCSM fails to comply with any term or condition of the Mexican railroad services law and regulations, KCSM fails to make the capital investments required under its five-year business plan filed with the SCT, or KCSM fails to maintain an obligations compliance bond and insurance overage as specified in the Mexican railroad services law and regulations. In addition, the Concession would revoke automatically if KCSM changes its nationality or assigns or creates any lien on the Concession without the SCT’s approval. The SCT may also terminate the Concession 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. 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 KCSM’s debt. If the Concession is revoked by the SCT, KCSM would receive no revenue, and its interest in its rail lines and all other fixtures covered by the Concession, as well as all improvements made by it, would revert to the Mexican government.

On April 6, 2006 and April 7, 2006, respectively, the SCT initiated sanction proceedings against KCSM, claiming that KCSM had failed to make the minimum capital investments projected for 2004 and 2005 under its five-year business plan filed with the SCT. Although we believe KCSM made capital expenditures exceeding the amounts projected in its business plan

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for 2004 and 2005, the SCT has objected to the nature of the investments made by KCSM. KCSM has responded to the SCT by providing evidence in support of its investments and explaining why it believes sanctions are not appropriate. The SCT has not yet responded to KCSM’s arguments. KCSM has further filed a request to amend its capital expenditure plan for 2006. However, if these proceedings are determined adversely to KCSM and sanctions are imposed, KCSM could be subject to fines, and could be subject to possible future revocation of the Concession if the SCT imposes sanctions on three additional occasions over the remaining term of the Concession.

Under the Concession, KCSM has the right to operate its rail lines, but it does not own the land, roadway or associated structures. If the Mexican government legally terminates the Concession, it would own, control and manage such public domain assets used in the operation of KCSM’s rail lines. The Mexican government may also temporarily seize control of KCSM’s rail lines and its assets in the event of a natural disaster, war, significant public disturbances or imminent danger to the domestic peace or economy. In such a case, the SCT may restrict KCSM’s ability to exploit the Concession in such manner as the SCT deems necessary under the circumstances, but only for the duration of any of the foregoing events.

Mexican law requires that the Mexican government pay 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 provide that the Mexican government will indemnify an affected concessionaire for an amount equal to damages caused and losses suffered. However, these payments may not be sufficient to compensate KCSM for its losses and may not be timely made.

Our ownership of KCSM and operations in Mexico subject us to economic and political 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. 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 were again held on July 2, 2006 which were disputed by the losing presidential candidate and his supporters (see — “Recent political unrest in Mexico could have an adverse effect on our business and results of operations”). 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 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

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NAFTA, if Mexico experiences serious balance of payment difficulties or the threat of such difficulties 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 we may have to effect those conversions, and could adversely affect the Mexican economy or our investment in KCSM. 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. Some emerging market countries, including Argentina and Brazil, have experienced significant economic downturns and market volatility in the past. These events have had an adverse effect on the economic conditions and securities markets of other emerging market countries, including Mexico.

Recent political unrest in Mexico could have an adverse effect on our business and results of operations.

On July 2, 2006, Felipe Calderón narrowly defeated Andrés Manuel López Obrador in the Mexican presidential election. Mr. López Obrador alleged that the balloting was carried out in a fraudulent manner and challenged the election results before the Federal Electoral Tribunal (the “Tribunal”). On September 6, 2006, the Tribunal upheld the election results. On September 16, 2006, Mr. López Obrador’s party declared him the “legitimate President of Mexico.” Although Mr. López Obrador’s party subsequently recognized Mr. Calderón as President, many supporters of Mr. López Obrador have held protests and continue to publicly challenge the election results. If this political unrest continues in Mexico, our operations there could be adversely affected.

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. 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. 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.

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.

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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 pesos 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 to 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, were 3.3% in 2005, 5.2% in 2004, 4.0% in 2003, 5.7% in 2002 and 4.4% in 2001. 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.

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