KANSAS CITY SOUTHERN 2005 Annual Report Kansas City Southern is a transportation holding company that has railroad investments in the U.S., Mexico and Panama. Its primary U.S. hold- ing is The Kansas City Southern Railway Company, serving the central and south central U.S. Its inter- national holdings include Kansas City Southern de México, serving northeastern and central Mexico and the port cities of Lázaro Cárdenas, Tampico and Veracruz, and a 50 percent interest in Panama Canal Railway Company, providing ocean-to-ocean freight and passenger service along the Panama Canal. Kansas City Southern’s North American rail holdings and strategic alliances are primary components of a NAFTA Railway system, linking the commercial and industrial centers of the U.S., Canada and Mexico. 2005 FINANCIAL HIGHLIGHTS Dollars in Millions, Except per Share Amounts, Years Ended December 31 2005 2004 2003 2002 OPERATIONS (i) Revenues $ 1,352.0 $ 639.5 $ 581.3 $ 566.2 Operating income 62.3 83.5 29.1 48.0 Income from continuing operations before cumulative effect of accounting change 83.1 24.4 3.3 57.2 Net income (ii) 100.9 24.4 12.2 57.2 FINANCIAL CONDITION Working capital $ (106.9) $ 7.8 $ 133.3 $ 29.9 Total assets 4,423.6 2,440.6 2,152.9 2,008.8 Total debt 1,860.6 665.7 523.4 582.6 Common stockholders’ equity (iii) 1,025.1 817.4 756.6 738.8 Total stockholders’ equity (iii) 1,426.2 1,016.5 955.7 744.9 PER COMMON SHARE (i) Earnings (loss) per diluted share from continuing operations before cumulative effect of accounting change $ 1.10 $ 0.25 $ (0.04) $ 0.91 Dividends per share – – – – Book value (iii) 13.96 12.92 12.17 12.09 STOCK PRICE RANGES (i) Preferred - High $ 24.00 $ 21.75 $ 20.50 $ 20.75 Preferred - Low 21.45 19.45 16.90 16.25 Common - High 25.71 18.08 14.97 17.35 Common - Low 16.05 12.60 10.60 12.00 COMMON STOCKHOLDER INFORMATION AT YEAR END (i) Stockholders 4,529 4,809 5,316 5,323 Shares outstanding (in thousands) 73,412 63,270 62,176 61,103 Diluted shares (in thousands) 92,741 63,983 61,725 62,318 (i) The information included in this table of KCS’s financial highlights includes only the continuing operations of the Company unless otherwise indicated. Certain information has been reclassified to conform to the current year presentation. Common share and per share information have been restated for all periods presented to reflect the spin-off of Stilwell Financial Inc. (“Stilwell”) on July 12, 2000, as well as the one-for-two reverse stock split effective July 12, 2000. (ii) Net income for 2003 and 2001 includes an $8.9 million benefit and a $0.4 million charge, respectively, for the cumulative effect of accounting change. (iii) Total stockholders' equity restated for prior period adjustment through 2002. 1 LETTER TO OUR SHAREHOLDERS In 1887, Arthur Stilwell founded the railroad company which was to become Kansas City Southern (KCS). Unlike the 19th century business moguls who built predominantly east-west oriented railroads, Stilwell envisioned a railroad operating on a north-south axis Michael R. Haverty Chairman, President from the U.S. heartland to the Gulf of Mexico. He was & Chief Executive Officer Kansas City Southern successful in achieving this dream by building a railroad from Kansas City to Port Arthur, Texas, on the Gulf. A Century-Old Arthur L. Shoener President & Chief Executive Officer The Kansas City Southern Railway Company; Executive Vice President & Chief Operating Officer Kansas City Southern 2 Later, he envisioned a railroad from could not be achieved unless the U.S. and Mexican railroads functioned as a single entity under common control. To Kansas City all the way to a Pacifi c maximize the potential of the joint enterprise, it was imperative to seek out cross-border business opportunities. Separately, Ocean port on the coast of Mexico. KCSR and TFM were essentially mid-haul railroads with lengths That part of Stilwell’s dream remained dormant until 1995 when of hauls in the 500 mile range. Only by working together could Mexico announced its intention to privatize its primary rail lines. hauls be extended to 1,000 to 2,000 miles or more. Unfortunately, In anticipation of this, KCS and Grupo TMM, S.A. de C.V. (Grupo a joint venture arrangement was not conducive to promoting TMM) formed a joint venture for the express purpose of pursuing these opportunities. As a result, the growth of traffi c over ownership of Mexico’s premier rail property, the Northeast Line. the separate railroads lagged far behind the market potential. In 1995, KCS also became a 49% owner of the Texas Mexican Concluding that the enormous potential of the U.S.-Mexican Railway (Tex Mex), the connection between The Kansas City rail line could be unlocked only through a single ownership, Southern Railway Company (KCSR) and the Northeast Mexican Kansas City Southern’s management essentially returned to Dream Realized railroad at Laredo, Texas. After conducting an exhaustive study Stilwell’s century-old dream of creating a railroad stretching of the Mexican freight transportation market, the partners from Kansas City through Mexico to a Pacifi c Coast port. submitted an aggressive bid, and in late 1996 were notifi ed by The process of putting the three railroads together under a the Mexican government that they had won the rights to the single owner and operator has been extensively chronicled. Northeast concession. In June 1997, Transportacion Ferrovaria It was at times diffi cult and frustrating, but throughout the Mexicana S.A. de C.V. (TFM) began commercial operation. multi-year process KCS management remained steadfast in In large part due to a pent-up demand for reliable rail service its determination to create a seamless railroad network. in Mexico, TFM was successful right out of the gate, with Negotiations between the two owners to combine the railroads revenues growing in the double digits during the fi rst few years. began in 2002, which resulted in the fi rst TFM acquisition Because of years of unreliable performance prior to privatization, agreement announced in April 2003. Differences soon arose the percentage of total inter-city freight tonnage handled by Mexi- between the partners, which led to delays, further negotiations, can railroads was a paltry 12%, compared to U.S. railroads, legal proceedings, and arbitration. Finally, in December 2004, which at that time handled approximately 40% of the U.S. an amended TFM acquisition agreement was signed, setting freight tonnage. By providing an improved service product, the stage for KCS to become the owner and operator of TFM immediately began to increase its market share. the combined rail system. This, in turn, led directly to three milestone events in 2005. Nevertheless, even in the early days of TFM’s operations, KCS management recognized the full potential of the investment 3 First, on January 1, Mexrail, Inc., the holding company for the Tex Mex, was con- THREE solidated into KCS. Second, on April 1, KCS acquired Grupo TMM’s shares of Grupo MILESTONE Transportacion Ferroviaria Mexicana, S.A. de C.V. (Grupo TFM), making KCS the majority owner of TFM. And, third, on September 12, KCS and the Mexican Government EVENTS resolved a number of longstanding disputes, which resulted in a settlement that gave KCS full control of TFM. In December 2005, KCS changed the name of its Mexican OCCURED subsidiary from TFM to Kansas City Southern de México (KCSM) to better position it IN 2005 as an integral component of the total KCS international rail network. As a result of these momentous events, the KCS dream, and Arthur Stilwell’s vision, was realized. More than a century after Stilwell gave birth to his dream of a railroad connecting the U.S. heartland with key commercial centers and a Pacifi c port in Mexico, Kansas City Southern has put just such a network together. Fulfi llment of this long-sought-after vision validates the prodigious efforts of generations of KCS people who tirelessly fought to ensure the survival of KCS as an independent company. Where many looked at KCS as an anachronism destined to be swallowed up by the seemingly more viable giants surrounding it, the KCS people saw the potential of their company and dedicated themselves to its survival and expansion. Without the dedication and unswerving commitment of these people, the milestone events of 2005 would not have taken place. Achieving sole ownership of the combined network also validates the resolve of KCS management and its Board of Directors. While the Company always enjoyed the sup- port of a loyal group of shareholders who understood its potential, many within the fi nancial community and transportation industry questioned whether KCS would, or even should, survive. The questioning became even more intense as investors watched the railroad industry undergo widespread consolidations in the 1990s. With full aware- ness of these concerns, management and the Board carefully studied alternatives before deciding in 1995 to pursue a course of continued independence and expansion. Once the decision was made, there was no wavering. Through periods of success and frustration, management never strayed from its strategic goals and constantly strove to deliver on its promises. Finally, in 2005, KCS was able to pull off an accomplishment with historic implications within the transportation industry. The Stilwell dream, the KCS dream, of a railroad from the middle of the United States to the heart of Mexico and beyond had been realized. 4 5 THE ROAD AHEAD – A NEW VISION IS BORN But the story does not end there – not by a long shot.