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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 June 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 FileNumber 333-08322-01
Grupo Transportación Ferroviaria Mexicana, S.A. de C.V.
(Exact name of Company as specified in its charter)
Mexican Railway Transportation Group
(Translation of Registrant’s name into English)
México | N/A | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
Montes Urales 625
Lomas de Chapultepec
11000 México, D.F.
México
(Address of Principal Executive Offices)
(5255) 9178-5836
(Company’s telephone number, including area code)
No Changes
(Former name, former address and former fiscal year, if changed since last report.)
Indicate by check mark whether the Company (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ |
Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o Noþ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Grupo Transportación Ferroviaria Mexicana, S.A. de C.V. meets the conditions set forth in General Instruction H(1)(a) and (b) ofForm 10-Q and is therefore filing this form with the reduced disclosure format.
GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S.A. DE C.V. AND SUBSIDIARIES
FORM 10-Q
June 30, 2006
INDEX
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GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S.A. DE C.V. AND SUBSIDIARIES
FORM 10-Q
JUNE 30, 2006
PART I — FINANCIAL INFORMATION
ITEM 1. | Financial Statements. |
Introductory comments.
The consolidated financial statements included herein have been prepared by Grupo Transportación Ferroviaria Mexicana, S.A. de C.V. (“the Company”, “Grupo TFM”, “we” or “our”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosure normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been 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 onForm 10-K for the year ended December 31, 2005 and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in thisForm 10-Q. Results for the three and six months ended June 30, 2006 are not necessarily indicative of the results expected for the full year 2006.
Due to the acquisition of Grupo TFM by Kansas City Southern (“KCS”) on April 1, 2005, as mentioned in Note 1 to the consolidated financial statements and the effects of the push down accounting to the Company, the consolidated financial statements included herein are not comparable to the consolidated financial statements for periods prior to April 1, 2005. The Company’s consolidated financial statements are separated between “Successor” and “Predecessor” to reflect the Company’s results and financial position before and after the change in control. For the three and six months ended June 30, 2006, the consolidated financial statements include the effects of the push down of the purchase accounting allocation to the Company by KCS, as more fully described in Note 3 to the consolidated financial statements. Accordingly, results for the interim periods are not indicative of the results expected for the full year.
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GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S.A. DE C.V. AND SUBSIDIARIES
(Amounts in millions of US dollars, except share data)
Successor | ||||||||
June 30, | December 31, | |||||||
2006 | 2005 | |||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 16.3 | 7.2 | |||||
Accounts receivable, net of allowance for doubtful accounts of $19.8 and $13.0, respectively | 112.9 | 93.0 | ||||||
Related company receivable | 31.6 | 35.8 | ||||||
Other accounts receivable, net | 27.5 | 44.6 | ||||||
Inventories | 22.3 | 18.8 | ||||||
Other current assets | 15.3 | 17.6 | ||||||
Total current assets | 225.9 | 217.0 | ||||||
Concession value, net of accumulated amortization of $70.6 and $41.2, respectively | 1,331.3 | 1,360.4 | ||||||
Property, machinery and equipment, net of accumulated depreciation of $31.9 and $21.8, respectively | 604.3 | 593.4 | ||||||
Investments held in associated companies | 41.0 | 38.0 | ||||||
Deferred charges | 15.6 | 16.9 | ||||||
Other assets | 33.8 | 37.3 | ||||||
Deferred income tax | 146.7 | 150.6 | ||||||
Total assets | $ | 2,398.6 | 2,413.6 | |||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Short-term debt and capital lease due within one year | $ | 165.3 | 4.5 | |||||
Interest payable | 10.0 | 9.9 | ||||||
Accounts payable | 103.9 | 145.2 | ||||||
Related company payable | 25.7 | 13.3 | ||||||
Other current liabilities | 20.0 | 22.4 | ||||||
Total current liabilities | 324.9 | 195.3 | ||||||
Non current liabilities: | ||||||||
Long-term debt | 743.0 | 903.7 | ||||||
Deferred statutory profit sharing | 40.0 | 28.9 | ||||||
Other long-term liabilities and deferred credits | 73.6 | 87.2 | ||||||
Total long-term liabilities | 856.6 | 1,019.8 | ||||||
Total liabilities | 1,181.5 | 1,215.1 | ||||||
Stockholders’ equity: | ||||||||
Common stock, 57,350,802 shares authorized, issued without par value | 807.0 | 807.0 | ||||||
Treasury shares | (256.1 | ) | (256.1 | ) | ||||
Additional paid in capital | 320.7 | 323.9 | ||||||
Retained earnings | 345.5 | 323.7 | ||||||
Total stockholders’ equity | 1,217.1 | 1,198.5 | ||||||
Contingencies | ||||||||
Total liabilities and stockholders’ equity | $ | 2,398.6 | 2,413.6 | |||||
See accompanying notes to the consolidated financial statements.
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GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S.A. DE C.V. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in millions of US dollars)
(Unaudited)
Successor | Predecessor | ||||||||||||||||
Three Months | Three Months | Six Months | Three Months | ||||||||||||||
Ended | Ended | Ended | Ended | ||||||||||||||
June 30, | June 30, | June 30, | March 31, | ||||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||||||
Transportation revenues | $ | 194.9 | 184.1 | 370.7 | 170.1 | ||||||||||||
Operating expenses: | |||||||||||||||||
Salaries, wages and employee benefits | 28.3 | 31.2 | 58.2 | 28.8 | |||||||||||||
Purchased services | 29.5 | 33.8 | 63.5 | 36.8 | |||||||||||||
Fuel, material and supplies | 29.1 | 30.9 | 57.6 | 24.9 | |||||||||||||
Other costs | 36.7 | 88.4 | 65.0 | 31.5 | |||||||||||||
Depreciation and amortization | 21.5 | 25.9 | 44.6 | 22.1 | |||||||||||||
Total operating expenses | 145.1 | 210.2 | 288.9 | 144.1 | |||||||||||||
Operating income (loss) | 49.8 | (26.1 | ) | 81.8 | 26.0 | ||||||||||||
Interest expense | (23.2 | ) | (28.3 | ) | (46.2 | ) | (27.4 | ) | |||||||||
Interest income | 0.6 | 0.3 | 1.1 | 0.4 | |||||||||||||
Exchange (loss) gain — net | (7.0 | ) | 4.3 | (11.2 | ) | 0.2 | |||||||||||
Net financing cost | (29.6 | ) | (23.7 | ) | (56.3 | ) | (26.8 | ) | |||||||||
Net earnings of unconsolidated affiliates | 1.9 | 1.1 | 3.0 | — | |||||||||||||
Income (loss) before income taxes and minority interest | 22.1 | (48.7 | ) | 28.5 | (0.8 | ) | |||||||||||
Income tax expense (benefit) | 4.7 | (0.9 | ) | 6.7 | (1.1 | ) | |||||||||||
Income (loss) before minority interest | 17.4 | (47.8 | ) | 21.8 | 0.3 | ||||||||||||
Minority interest | — | 17.8 | — | (0.2 | ) | ||||||||||||
Net income (loss) for the period | $ | 17.4 | (30.0 | ) | 21.8 | 0.1 | |||||||||||
See accompanying notes to the consolidated financial statements.
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GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S.A. DE C.V. AND SUBSIDIARIES
(Amounts in millions of US dollars)
(Unaudited)
Successor | Predecessor | ||||||||||||
Six Months | Three Months | Three Months | |||||||||||
Ended | Ended | Ended | |||||||||||
June 30, | June 30, | March 31, | |||||||||||
2006 | 2005 | 2005 | |||||||||||
Operating activities: | |||||||||||||
Net income (loss) | 21.8 | (30.0 | ) | 0.1 | |||||||||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | |||||||||||||
Depreciation and amortization | 44.6 | 25.9 | 22.1 | ||||||||||
Deferred income tax | 6.7 | (0.9 | ) | (1.1 | ) | ||||||||
Deferred statutory profit sharing | 5.6 | 38.7 | 0.5 | ||||||||||
Minority interest | — | (17.8 | ) | 0.2 | |||||||||
Equity earnings in associates | (3.0 | ) | (1.1 | ) | — | ||||||||
Loss on sale and write-off of cost of properties, net | — | 3.6 | 0.7 | ||||||||||
Changes in assets and liabilities: | |||||||||||||
Accounts receivable, net | (19.9 | ) | 7.8 | (10.5 | ) | ||||||||
Amounts receivable/payable to/from related parties | 16.7 | (9.4 | ) | 0.1 | |||||||||
Other accounts receivable, net | 22.5 | 21.3 | 3.0 | ||||||||||
Inventories | (3.5 | ) | 3.0 | (3.6 | ) | ||||||||
Other current assets | (3.4 | ) | (2.5 | ) | (3.0 | ) | |||||||
Accounts payable and accrued expenses | (43.9 | ) | (6.6 | ) | 28.1 | ||||||||
Other non-current assets and long-term liabilities | (9.7 | ) | (26.8 | ) | (0.7 | ) | |||||||
Net cash provided by operating activities | 34.5 | 5.2 | 35.9 | ||||||||||
Investing activities: | |||||||||||||
Acquisitions of property and equipment | (28.5 | ) | (10.2 | ) | (9.2 | ) | |||||||
Proceeds from sale of equipment | 0.3 | 0.2 | 0.2 | ||||||||||
Net cash used in investing activities | (28.2 | ) | (10.0 | ) | (9.0 | ) | |||||||
Financing activities: | |||||||||||||
Proceeds from senior notes | — | 460.0 | — | ||||||||||
Payment of senior discount debentures | — | (443.5 | ) | — | |||||||||
Payment of term loan | — | — | (35.5 | ) | |||||||||
Proceeds from credit agreement | 2.9 | — | — | ||||||||||
Payments under capital lease obligations | (0.1 | ) | — | (0.1 | ) | ||||||||
Net cash provided by (used in) financing activities | 2.8 | 16.5 | (35.6 | ) | |||||||||
Increase (Decrease) in cash and cash equivalents | 9.1 | 11.7 | (8.7 | ) | |||||||||
Cash and cash equivalents: | |||||||||||||
At beginning of the period | 7.2 | 5.5 | 14.2 | ||||||||||
At end of the period | 16.3 | 17.2 | 5.5 | ||||||||||
See accompanying notes to the consolidated financial statements.
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GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S.A. DE C.V. AND SUBSIDIARIES
(Amounts in millions of US dollars)
(Unaudited)
Common | Treasury | Additional | Retained | |||||||||||||||||
Stock | Shares | Paid in Capital | Earnings | Total | ||||||||||||||||
Successor: | ||||||||||||||||||||
Balances at December 31, 2005 | $ | 807.0 | (256.1 | ) | 323.9 | 323.7 | 1,198.5 | |||||||||||||
Push down of additional basis from acquisition by shareholders | — | — | (3.2 | ) | — | (3.2 | ) | |||||||||||||
Net income for the period | — | — | — | 21.8 | 21.8 | |||||||||||||||
Balances at June 30, 2006 | $ | 807.0 | (256.1 | ) | 320.7 | 345.5 | 1,217.1 | |||||||||||||
See accompanying notes to the consolidated financial statements.
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GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S.A. DE C.V. AND SUBSIDIARIES
(Amounts in millions of US dollars, except number of shares)
(Unaudited)
1. | Interim Consolidated Financial Statements and Basis of Presentation. |
In the opinion of the management of Grupo Transportación Ferroviaria Mexicana, S.A. de C.V. (“Grupo TFM”, “we”, “our”, or “the Company”), the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the financial position of Grupo TFM and its subsidiaries as of June 30, 2006 and December 31, 2005, the results of its operations for the three and six months ended June 30, 2006, and for the three months ended June 30, 2005 and March 31, 2005, its cash flows for the six months ended June 30, 2006, and for the three months ended June 30, 2005 and March 31, 2005, and its changes in stockholders’ equity for the six months ended June 30, 2006. The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP. The results of operations for the three and six months ended June 30, 2006 are not indicative of the results to be expected for the full year 2006. For information regarding the Company’s significant accounting policies and estimates, see Note 4 of these notes to the consolidated financial statements. Certain prior year amounts have been reclassified to conform to the current year presentation.
On April 1, 2005, KCS and Grupo TMM completed a transaction under which KCS acquired control of Grupo TFM through the purchase of shares of the common stock of Grupo TFM belonging to Grupo TMM, representing a 48.5% effective interest (51% of the shares of Grupo TFM entitled to full voting rights) (“the Acquisition”). As a result of the Acquisition and the subsequent purchase and elimination of the Mexican government’s ownership of KCSM resulting from the September 12, 2005 settlement of certain disputes among Grupo TMM, Grupo TFM, KCSM and the Mexican government (the “VAT/Put Settlement”), KCS has controlled KCSM since April 1, 2005, and indirectly owned 100% of the common stock of KCSM since September 12, 2005.
Due to the acquisition of Grupo TFM by KCS on April 1, 2005, and the effects of the push down accounting to the Company, the consolidated financial statements included herein are not comparable to the financial statements for periods prior to April 1, 2005. The Company’s consolidated financial statements are separated between “Successor” and “Predecessor” to reflect the Company’s results and financial position before and after the change in control. For the three and six months ended June 30, 2006, the consolidated financial statements include the effects of the push down of the purchase accounting allocation of the Company by KCS, as more fully described in Note 3 to the consolidated financial statements.
2. | Description of the Company and its subsidiaries. |
Grupo TFM was incorporated on July 12, 1996. In December 1996, Grupo TFM was awarded the right to acquire (the “Acquisition”) an 80% interest inKansas City Southern de México,S.A. de C.V. (“KCSM”) (formerly known as TFM, S.A. de C.V.), pursuant to a stock purchase agreement. Ninety nine percent of the capital stock of KCSM is owned by Grupo TFM. The remaining stock of KCSM is owned by our affiliate,Arrendadora TFM, S.A. de C.V. (“Arrendadora TFM”).
Grupo TFM is a non-operating holding company with no material assets or operations other than its investment in KCSM and Arrendadora TFM.
KCSM
KCSM was established by the Mexican government in November 1996 in connection with the privatization of the Mexican rail system, which had been operated byFerrocarriles Nacionales de México(“FNM”). On December 2, 1996, the Mexican government granted KCSM a50-year concession, renewable subject to certain conditions for additional periods of up to 50 years, to provide freight transportation services over rail lines running through the North and Central portions of Mexico and agreed to transfer to KCSM related railroad equipment and other assets as well as 25% of the share capital ofFerrocarril y Terminal del Valle de México, S.A de C.V.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(“FTVM”). KCSM has an exclusive right to provide such services for the first 30 years of the concession. KCSM commenced operations on June 24, 1997.
Arrendadora TFM
Arrendadora TFM was incorporated on September 27, 2002 as asociedad anónima de capital variableunder the laws of Mexico and its only operation is the leasing to KCSM locomotives and freight cars. Ninety eight percent of the capital stock of Arrendadora TFM is owned by KCSM and 2% is owned by Grupo TFM.
Mexrail, Inc. (“Mexrail”)
Grupo TMM, S.A. (“Grupo TMM”) and KCS entered into a Stock Purchase Agreement on August 16, 2004 (“Mexrail Stock Purchase Agreement”). Pursuant to the Mexrail Stock Purchase Agreement, KCS purchased from KCSM 51% of the outstanding shares of Mexrail for $32.7 million, and placed these shares into trust pending Surface Transportation Board (“STB”) approval of KCS’ common control of The Kansas City Southern Railway Company (“KCSR”), the Gateway Eastern Railway Company and Mexrail’s wholly owned rail subsidiary, The Texas Mexican Railway Company (“Tex-Mex”). KCSM did not have any right or obligation to repurchase the Mexrail shares sold to KCS, and KCSM retained ownership of 49% of Mexrail’s shares.
With the completion of the acquisition of Grupo TFM, KCS has indirect ownership of Grupo TFM’s remaining 49% interest in Mexrail. For the three and six months ended June 30, 2006, Grupo TFM recognized its 49% interest under the equity method of accounting and has included in its income statement $1.5 million of income and $2.1 million of income, respectively. No income was recognized in the three months ended June 30, 2005 or the three months ended March 31, 2005.
FTVM
FTVM was incorporated as asociedad anónima de capital variableunder the laws of Mexico. The corporate purpose of the company is to provide railroad services as well ancillary services, including those related to interchange, switching and haulage services. Through its subsidiary KCSM, Grupo TFM holds 25% of the share capital of this company. The other shareholders of the company, each holding 25% areFerrocarril Mexicano, S.A. de C.V. (“Ferromex”),Ferrosur,S.A. de C.V. (“Ferrosur”) and the Mexican government. Ferrosur and Ferromex are currently under the common control ofGrupo Mexico,S.A. de C.V. (“Grupo México”). For the three and six months ended June 30, 2006, Grupo TFM recognized its 25% interest under the equity method of accounting and has included in its income statement $1.3 million of income and $0.9 million of income, respectively. For the three months ended June 30, 2005, Grupo TFM recognized its 25% interest under the equity method of accounting and has included in its income statement $1.1 million of income. No income was recognized in the three months ended March 31, 2005.
3. | Push down accounting and allocation of purchase price. |
In accordance with the principles of push-down accounting, the Company has allocated the purchase price 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 based on management’s estimates of fair value and published market prices.
As of March 31, 2006, KCS and the Company finalized its purchase price allocation relating to the acquisition of both the 38.8% interest of Grupo TMM and the acquisition of the 23.9% interest of the Mexican government. KCS’s purchase price was reduced by $3.2 million, relating primarily to a decrease in the liability for severance of $3.7 million and an increase of $0.5 million in the liability for relocation costs. These final adjustments did not have a material impact on the financial statements in the current period. The liability for severance and relocation cost
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
was $3.4 million and $9.9 million at June 30, 2006 and December 31, 2005, respectively. The Company expects to substantially complete the settlement of these liabilities prior to December 31, 2006.
Deferred Assets and Liabilities.
In connection with the Acquisition Agreement, KCS assessed the fair value of KCSM’s long term contractual relationships, including debt, locomotive and railcar leases and maintenance contracts for locomotives determined based on current market rates and other management estimates. Accordingly, KCSM has recorded necessary valuation reserves for the related contracts which are reflected in the December 31, 2005 consolidated financial statements. The amortization of these deferred credits and charges did not have a material effect on the periods presented.
4. | Summary of significant accounting policies. |
Following the acquisition by KCS on April 1, 2005, Grupo TFM and its subsidiaries have prepared the accompanying consolidated financial statements in accordance with U.S. GAAP.
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.
a. Overhead capitalization.
The Company capitalizes certain overhead costs representing the indirect costs associated with construction and improvement projects. Overhead factors are periodically reviewed and adjusted to reflect current costs.
b. Deferred income taxes.
Deferred income taxes are provided using the liability method on temporary differences arising between the tax basis of assets and liabilities and their carrying amounts in the consolidated financial statements. Currently enacted tax rates are used in the determination of deferred income tax.
Deferred tax assets are recognized to the extent that it is more likely than not that future taxable profit, against which the temporary differences can be utilized, will be available. Deferred income tax is provided on temporary differences arising on investments in subsidiaries and associates, except where the timing of the reversal of the temporary difference can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future.
c. Employees’ statutory profit sharing.
Employees’ statutory profit sharing is determined at the statutory rate of ten percent (10%) of taxable income, adjusted as prescribed by Mexican law and included in operating expenses.
d. Minority interest.
Minority interest reflects the Mexican government’s 20% ownership of KCSM and its 4.9% indirect ownership interest in Grupo TFM through KCSM. In connection with the VAT/Put Settlement in September of 2005, the minority interest of the Mexican government has been eliminated.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
e. Use of estimates.
The preparation of the consolidated financial statements requires management to make earnings estimates and assumptions that could affect the reported amounts of assets and liabilities at the date of the financial statements. Actual results could differ from these estimates.
f. Claim accruals.
Based on management’s estimates, accruals for claims from customers for merchandise damaged during transportation, legal claims and property damage claims as a result of derailments are recognized net of expected insurance recoveries, when KCSM has a present legal or constructive obligation as a result of past events and it is probable that an outflow of resources will be required to settle the obligation.
g. Financial instruments and hedging activities.
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 it may enter into such transactions more frequently as deemed appropriate.
Foreign exchange contracts.
The purpose of Grupo TFM’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 June 30, 2006, Grupo TFM had two Mexican peso call options outstanding in the notional amount of $1.7 million and $1.2 million, based on the average exchange rate of 14.50 and 13.00 Mexican pesos per U.S. dollar, respectively. These options expire on May 30, 2007 and September 6, 2006, respectively. The premiums paid were $25 thousand and $16 thousand, respectively, and were expensed since these contracts did not qualify for hedge accounting. As of June 30, 2006, Grupo TFM did not have any outstanding forward contracts.
Foreign currency balance.
At June 30, 2006, Grupo TFM had monetary assets and liabilities denominated in Mexican pesos of Ps1,038 million and Ps340 million, respectively. At June 30, 2006, the exchange rate was 11.27 Mexican pesos per U.S. dollar. At December 31, 2005 Grupo TFM 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 11.14 Mexican pesos per U.S. dollar.
h. Concentration of risk.
Over 12.2% of Grupo TFM’s transportation revenues are generated by the automotive industry, which is made up of a relatively small number of customers. KCSM performs ongoing credit valuations of its customers and maintains an allowance for uncollectible receivables. As of June 30, 2006, the Company has no customers that represent more than 10% of its revenues.
5. | Financing. |
On April 7, 2006, KCSM entered into a Waiver and Amendment (the “Waiver and Amendment”) to its new $106.0 million credit agreement dated October 24, 2005 (the “KCSM 2005 Credit Agreement”). The KCSM Credit Agreement was amended to (i) exclude certain payment obligations accrued under two locomotive maintenance
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
agreements and under a track maintenance rehabilitation agreement from the definition of indebtedness, (ii) eliminate certain minimum and multiple borrowing thresholds for Mexican peso borrowings under the revolving credit facility and (iii) eliminate the reporting requirement to provide unaudited consolidated financial statements for the fourth fiscal quarter. Pursuant to the Waiver and Amendment, the Company’s lenders under the KCSM Credit Agreement waived (iv) certain reporting requirements, including the requirement to provide audited consolidated financial statements 90 days after the end of the 2005 fiscal year, provided such reports were delivered by April 30, 2006, and (v) compliance with the Consolidated Leverage Ratio obligations of Section 7.1(c) of the KCSM 2005 Credit Agreement for the four quarters ending December 31, 2005, if the compliance was calculated without giving effect to the amendment to the definition of “Indebtedness” in the Waiver and Amendment, provided that KCSM was in compliance with those obligations after giving effect to the Waiver and Amendment. As of June 30, 2006, the Company did not have any changes related to the Waiver and Amendment and the Company is in compliance with the Consolidated Leverage Ratio after giving effect to the Waiver and Amendment.
Covenants.
The agreements related to the above-mentioned loans include certain affirmative and negative covenants and customary covenants and require the Company to maintain certain financial ratios. KCSM and its subsidiary were in compliance with these covenants as of June 30, 2006.
6. | Balances with related parties. |
Related party balances as of June 30, 2006 and December 31, 2005, are as follows:
June 30, | December 31, | |||||||
2006 | 2005 | |||||||
Accounts receivable: | ||||||||
Tex Mex | $ | 0.7 | 1.3 | |||||
NAFTA Rail | 13.7 | 13.6 | ||||||
KCS | 17.2 | 20.9 | ||||||
Total | $ | 31.6 | 35.8 | |||||
Accounts payable: | ||||||||
KCS | 24.4 | 12.9 | ||||||
Ferrocarril y Terminal del Valle de México, S.A de C.V. | 1.3 | 0.4 | ||||||
Total | $ | 25.7 | 13.3 | |||||
7. | Income tax, asset tax and tax loss carryforwards. |
Income tax.
For financial reporting purposes, the difference between tax income (loss) and book income (loss) is due principally to the inflation gain or loss recognized for tax purposes, the difference between book and tax depreciation and amortization, non-deductible expenses and temporary differences for certain items that are reported in different periods for financial reporting and income tax purposes.
The Company has recognized deferred tax assets related to its tax loss carryforwards, net of effects derived from the temporary differences arising from concession value and property, machinery and equipment, after evaluating the reversal of existing taxable temporary differences. To the extent that the balance of the deferred tax assets exceeds the existing temporary differences, management has evaluated the recoverability of such amounts by estimating future taxable profits expected in the foreseeable future and the remaining tax loss carryforwards periods
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GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S.A. DE C.V. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
that extend between 2012 through 2046. The future taxable profits include estimates of profitability and macroeconomic assumptions which are based on management’s best estimate as of this date.
In June 2006, the FASB issued 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 currently evaluating the impact of adopting FIN 48 on the financial statements.
8. | Contingencies. |
Through KCSM, the Company is a party to various other legal proceedings and administrative actions arising in the ordinary course of business. Although it is impossible to predict the outcome of any legal proceeding or administrative action, in management’s opinion, such proceedings and actions should not, either individually or in the aggregate, have a material adverse effect on the Company’s financial statements. The Company has had no material changes in its outstanding litigation or other commitments and contingencies from those previously reported in Note 19 to the consolidated financial statements included in the Company’s Annual Report onForm 10-K for the year ended December 31, 2005, except as described in the following paragraphs:
A) Ferromex disputes.
Disputes Relating to Payments for the Use of Trackage and Haulage Rights and Interline Services. KCSM and Ferromex both initiated administrative proceedings seeking a determination by theSecretaria de Comunicaciones y Transportes(“Secretary of Communications and Transports” or “SCT”) of the rates that each company should pay each other in connection with the use of trackage and haulage rights and interline and terminal services. The SCT, on March 13, 2002, issued a ruling setting the rates for trackage and haulage rights. On August 5, 2002, the SCT issued a ruling setting the rates for interline and terminal services. KCSM and Ferromex appealed both rulings and, following trial and appellate court decisions, the Mexican Supreme Court on February 24, 2006, in a ruling from the bench, sustained KCSM’s appeal of the SCT’s trackage and haulage rights ruling, vacating the SCT ruling and ordering the SCT to issue a new ruling consistent with the Court’s opinion. KCSM has not yet received the written notice of the Mexican Supreme Court decision regarding the interline and terminal services appeal. The Company believes that even if the rates set in 2002 become effective, there will be no material adverse effect on its financial statements.
Disputes Relating to the Exercise of Trackage Rights. KCSM and Ferromex are also parties to various civil cases involving disputes over the application and proper interpretation of the mandatory trackage rights, none of which the Company believes to be material individually or in the aggregate.
Disputes Relating to the Scope of the Mandatory Trackage Rights. In August 2002, the SCT issued rulings determining Ferromex’s trackage rights in Monterrey and KCSM’s trackage rights in Altamira. KCSM and Ferromex both appealed the SCT’s rulings. At the administrative federal court level, KCSM obtained favorable rulings in both cases. Ferromex appealed these rulings. In connection with the Altamira proceedings, on August 10, 2005, an appellate court granted Ferromex’s appeal and ordered the Administrative Federal Court to vacate its prior resolution and issue a new resolution, in order to establish that KCSM should not have access to the Port of Altamira, and to declare as null and void the SCT’s determination that KCSM’s trackage rights should include access to the Port of Altamira. In connection with the Monterrey proceedings, the case was remanded to the Administrative Federal Court with instructions to consider additional arguments before issuing its ruling. KCSM is
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GRUPO TRANSPORTACIÓN FERROVIARIA MEXICANA, S.A. DE C.V. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
still awaiting that ruling but does not expect that the ruling will have a material adverse effect on our financial statements.
B) SCT Sanction Proceedings.
On April 6, 2006 and April 7, 2006, the SCT initiated sanction proceedings against Grupo TFM and KCSM, arguing that KCSM failed in the years 2004 and 2005 to make the capital investments projected under KCSM’s five year plan filed with the SCT. On April 27 and 28, 2006, Grupo TFM and KCSM responded to the SCT notices, in each case providing the SCT with more detailed information concerning KCSM’s capital investment program and explained why it is not appropriate for the SCT to sanction the Company or KCSM. Grupo TFM believes that even if the threatened SCT sanctions become effective, there will be no material adverse effect on its financial statements.
C) Mancera’s Proceeding.
On March 6, 2006, Mancera Ernst & Young, S.C. (“Mancera”) filed a claim against KCSM requesting the payment of a success fee of $11.7 million or 129.0 million Mexican pesos plus costs and expenses derived from Mancera’s representation of the Company in the Company’s value added tax claim against the Mexican government. On March 16, 2006, the Company responded to the claim and the parties are currently in the evidence stage of the trial. Management believes that it has adequately reserved for the Company’s obligation under the engagement agreement with Mancera and does not believe that the resolution of this claim will have a material adverse effect on the Company’s financial statements.
D) Labor obligation
There is a contingent liability arising from the labor obligations mentioned in Note 2(m) to the consolidated financial statements included in the Company’s Annual Report for the fiscal year ended December 31, 2005.
E) Income Taxes
The five-year period prior to the Company’s most recent income tax return filed is open to governmental tax examination.
In accordance with the Mexican Income Tax Law, companies that carry out transactions with related parties are subject to certain requirements as to the determination of prices, since such prices must be similar to those that would be used in arm’s-length transactions. If the tax authorities examine the Company’s related transactions and reject the related-party prices, they could assess additional taxes plus the related inflation adjustment and interest, in addition to penalties of up to 100% of the omitted taxes.
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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 thisForm 10-Q, contain forward-looking comments that are not based upon historical information. Such forward-looking comments are based upon information currently available to management and management’s perception thereof as of the date of thisForm 10-Q. Readers can identify these forward-looking comments by the use of such verbs as expects, anticipates, believes or similar verbs or conjugations of such verbs. The actual results of operations of Grupo Transportación Ferroviaria Mexicana, S.A. de C.V. (“the Company”, “Grupo TFM”, “our”, or “we”) could materially differ from those indicated in forward-looking comments. The differences could be caused by a number of factors or combination of factors including, but not limited to, those factors identified in Item 1A — “Risk Factors” and Item 7 — “Management Discussion and Analysis of Financial Condition and Results of Operation — Cautionary Information” of the Company’s Annual Report onForm 10-K for the year ended December 31, 2005, which is on file with the U.S. Securities and Exchange Commission (File No.333-08322-01) and which “Risk Factors“and “Cautionary Information” sections are incorporated by reference herein. Readers are strongly encouraged to consider these factors when evaluating forward looking comments. The Company will not update any forward-looking comments set forth in thisForm 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 thisForm 10-Q. This discussion should be read in conjunction with these consolidated financial statements and the related notes thereto, and is qualified by reference thereto.
Corporate Overview.
Through KCSM, we operate the primary commercial corridor of the Mexican railroad system, which allows us to participate significantly in the growing freight traffic between Mexico, the U.S. and Canada. We provide freight transportation services under a50-year concession, during the first 30 years of which we are the exclusive provider, subject to certain trackage rights of other freight carriers. Our concession is renewable for an additional period of up to 50 years subject to certain conditions.
We intend to establish our railroad as the primary inland freight transporter linking Mexico with the U.S. and Canadian markets. As the operator of the primary and most direct rail corridor from Mexico City to the U.S. border, our route structure enables us to benefit from continuing growth in NAFTA trade. We are the only Mexican railroad that serves the Mexico-U.S. border crossing at Nuevo Laredo-Laredo, which is the largest freight exchange point between Mexico and the U.S. Through KCS’ U.S. rail freight operations, as well as through interchanges with other major U.S. railroads, we provide customers with access to an extensive network through which they may distribute products throughout North America and overseas.
EXECUTIVE SUMMARY.
Overview.
Our revenues are derived from the movement of a diversified mix of commodities and products predominantly attributable to cross-border traffic with the U.S. We transport goods in the product categories of agro-industrial products, cement, metals and minerals, chemical and petrochemical products, automotive products, manufactured products, industrial products and intermodal freight. Our customers include leading international and Mexican corporations.
Our business is subject to a number of macroeconomic factors that affect our operating results, including those described in Item 1A of the Company’s Annual Report onForm 10-K. Certain of the factors are outside of our control, such as (i) the impact of inflation, political developments, exchange rates and other factors tied to Mexico, (ii) seasonality in our business and that of our customers (iii) our dependence on global fuel prices for our operations, and (iv) our continuing obligations to the Mexican government arising out of the privatization of our rail lines in 1997 and our concession, including our obligations in respect of required capital expenditures.
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Critical Accounting Policies.
The Company had no significant changes in its key accounting policies from that previously reported in Note 2 to the consolidated financial statements included in the Company’s Annual Report onForm 10-K for the year ended December 31, 2005.
2006 Outlook.
We believe that the current trend of a strengthening North American economy will continue to drive improvements and gains in our operating income. Management expects overall KCSM revenues to continue to show year over year increases.
As a result of placing KCSM, KCSR and Tex-Mex under the common control of KCS, management believes KCSM will be a stronger, more competitive railway network with improved operating efficiencies resulting from common control and ownership. Furthermore, management believes that common control of these railroads will enhance competition and give shippers a stronger transportation alternative in moving goods between Mexico, the United States, and Canada. However, factors that affect the Mexican economy and business climate, such as foreign exchange rates, tax laws and inflation will directly impact our consolidated results.
Assuming normalized rail operations, variable costs and expenses are expected to change proportionate to increases in revenue volumes. Material changes in the market price for fuel will impact our operating costs. To mitigate this risk, in 2006, we expect fuel surcharges to continue to be the primary hedge against fuel price volatility.
RECENT DEVELOPMENTS.
On May 12, 2006, KCS announced the departure of Mr. Ronald G. Russ as Executive Vice President and Chief Financial Officer of KCS. The departure of Mr. Russ terminated his position as Chief Financial Officer of Grupo TFM and KCSM. On May 12, 2006, KCS announced that it had appointed Mr. Patrick J. Ottensmeyer as Executive Vice President and Chief Financial Officer. Mr. Ottensmeyer has also been appointed as Chief Financial Officer of Grupo TFM and KCSM.
RESULTS OF OPERATIONS.
Due to the acquisition of Grupo TFM by KCS on April 1, 2005, and the related effects of the push down accounting to the Company, the consolidated financial statements included herein are not comparable to the financial statements for periods prior to April 1, 2005. The Company’s consolidated financial statements are separated between “Successor” and “Predecessor” to reflect the Company’s results and financial position before and after the change in control. For the three months ended June 30, 2006, the consolidated financial statements include the effects of the push down of the purchase accounting allocations. Accordingly, results for the interim periods are not indicative of the results expected for the full year.
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The following table summarizes the income statement components of the Company for the three and six months ended June 30, 2006, and for the three months ended June 30, 2005 and March 31, 2005 (in millions):
Successor | Predecessor | ||||||||||||||||
Three Months | Six Months | Three Months | Three Months | ||||||||||||||
Ended | Ended | Ended | Ended | ||||||||||||||
June 30, | June 30, | June 30, | March 31, | ||||||||||||||
2006 | 2006 | 2005 | 2005 | ||||||||||||||
Transportation revenues | $ | 194.9 | 370.7 | 184.1 | 170.1 | ||||||||||||
Operating expenses | 123.6 | 244.3 | 184.3 | 122.0 | |||||||||||||
Depreciation and amortization | 21.5 | 44.6 | 25.9 | 22.1 | |||||||||||||
Total operating expenses | 145.1 | 288.9 | 210.2 | 144.1 | |||||||||||||
Operating income | 49.8 | 81.8 | (26.1 | ) | 26.0 | ||||||||||||
Net financing cost | (29.6 | ) | (56.3 | ) | (23.7 | ) | (26.8 | ) | |||||||||
Equity earnings in affiliates | 1.9 | 3.0 | 1.1 | — | |||||||||||||
Income before income taxes and minority interest | 22.1 | 28.5 | (48.7 | ) | (0.8 | ) | |||||||||||
Income tax expense (benefit) | 4.7 | 6.7 | (0.9 | ) | (1.1 | ) | |||||||||||
Income (loss) before minority interest | 17.4 | 21.8 | (47.8 | ) | 0.3 | ||||||||||||
Minority interest | — | — | 17.8 | (0.2 | ) | ||||||||||||
Net income for the period | $ | 17.4 | 21.8 | (30.0 | ) | 0.1 | |||||||||||
Revenues.
The following tables summarize consolidated KCSM revenues, including carloads statistics, for the three and six months ended June 30, 2006 and 2005 respectively. Because the revenue recognition policies were consistent, in all material respects, between the “Predecessor” and “Successor” companies, revenue and commodity statistics for the six months ended June 30, 2005 are presented for comparison purposes.
Three Months Ended June 30, | ||||||||||||||||||||||||
2006 | 2005 | |||||||||||||||||||||||
% of | % of | |||||||||||||||||||||||
Business Segment | Carloads | Revenues | Revenues | Carloads | Revenues | Revenues | ||||||||||||||||||
(In millions) | (In millions) | |||||||||||||||||||||||
Agro-industrial products | 31,467 | $ | 42.7 | 21.9 | 30,059 | $ | 40.6 | 22.1 | ||||||||||||||||
Cements, metals and minerals | 41,447 | 38.4 | 19.7 | 45,358 | 35.9 | 19.5 | ||||||||||||||||||
Chemical and petrochemical products | 26,474 | 37.8 | 19.4 | 24,749 | 29.9 | 16.2 | ||||||||||||||||||
Automotive products | 23,971 | 23.7 | 12.2 | 31,011 | 32.0 | 17.4 | ||||||||||||||||||
Manufactured products, industrial products | 25,032 | 28.5 | 14.6 | 29,165 | 25.8 | 14.0 | ||||||||||||||||||
Intermodal freight | 52,596 | 15.9 | 8.2 | 58,491 | 15.9 | 8.6 | ||||||||||||||||||
Other | — | 7.9 | 4.0 | — | 4.0 | 2.2 | ||||||||||||||||||
Total | 200,987 | $ | 194.9 | 100.0 | % | 218,833 | $ | 184.1 | 100.0 | % | ||||||||||||||
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Six Months Ended June 30, | ||||||||||||||||||||||||
2006 | 2005 | |||||||||||||||||||||||
% of | % of | |||||||||||||||||||||||
Business Segment | Carloads | Revenues | Revenues | Carloads | Revenues | Revenues | ||||||||||||||||||
(In millions) | (In millions) | |||||||||||||||||||||||
Agro-industrial products | 59,122 | $ | 78.0 | 21.0 | 57,653 | $ | 76.7 | 21.7 | ||||||||||||||||
Cements, metals and minerals | 84,204 | 77.6 | 21.0 | 90,578 | 72.7 | 20.5 | ||||||||||||||||||
Chemical and petrochemical products | 50,895 | 69.9 | 18.9 | 50,391 | 62.0 | 17.5 | ||||||||||||||||||
Automotive products | 49,093 | 47.9 | 12.9 | 58,104 | 59.2 | 16.7 | ||||||||||||||||||
Manufactured products, industrial products | 50,644 | 55.4 | 14.9 | 53,982 | 47.9 | 13.5 | ||||||||||||||||||
Intermodal freight | 101,220 | 29.9 | 8.1 | 107,985 | 29.8 | 8.4 | ||||||||||||||||||
Other | — | 12.0 | 3.2 | — | 5.9 | 1.7 | ||||||||||||||||||
Total | 395,178 | $ | 370.7 | 100.0 | % | 418,693 | $ | 354.2 | 100.0 | % | ||||||||||||||
Revenues for the three and six months ended June 30, 2006 totaled $194.9 million and $370.7 million, respectively, compared to $184.1 million and $354.2, respectively, for the same periods in 2005. Our 2006 revenues increased $10.8 million and $16.5, respectively, or 5.9% and 4.7%, respectively, over the same periods in 2005. The increases are attributable mainly to the increased industrial production, freight rate increases and fuel surcharge increases partially offset by a decrease in carloads volume. Revenue from fuel surcharges were $10.4 million and $19.1 million for the three and six month periods ended June 30, 2006, respectively, compared to $7.0 million and $12.6 million for the three and six month periods ended June 30, 2005 respectively.
Agro-industrial Products. Revenues from agro-industrial products increased 5.2% and 1.7% for the three and six months ended June 30, 2006, respectively, as compared to the same periods of 2005. 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 six months ended June 30, 2006.
Cements, Metals and Minerals. Revenues generated in this product category for the three and six months ended on June 30, 2006 increased by 7.0% and 6.7%, respectively, from the same periods of 2005. Steel slab revenues increased due to higher international traffic, resulting from the higher consumption by manufacturing industries, as well as certain targeted rate increases during the second quarter 2006. Domestic production for metals, minerals and ores was severely affected by labor strikes, which lowered production at many of our customer’s facilities.
Chemical and Petrochemical Products. For the three and six months ended June 30, 2006, our revenues increased by 26.4% and 12.7%, respectively, from the same periods of 2005. Revenue increases for these periods were mainly driven 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 and pet coke.
Automotive Products. For the three and six months ended June 30, 2006, automotive revenues decreased by 25.9% and 19.1%, respectively, from the same periods of 2005, primarily due to a reduction in the movement of finished vehicles for exportation to the U.S. and Canadian markets. Additionally, the importation of finished vehicles, as well as the domestic distribution of these vehicles, has declined.
Manufactured Products and Industrial Products. Our revenues generated in this product category increased for the three and six months ended June 30, 2006 by 10.4% and 15.6%, respectively, from the same periods of 2005. Revenue increases for these periods were driven mainly by rate increases of paper and pulpwood. In addition, beer exportation traffic increased due to higher demand in the U.S. market.
Intermodal Freight. For the three and six month periods ended June 30, 2006, intermodal revenue remained almost the same compared to 2005, despite a decrease in volume. Revenue of intermodal traffic maintained 2005
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performance levels principally due to the increase in the longer haul volume of maritime shipments that arrived at Port Lázaro Cardenas.
Other. Other revenues include complementary railroad services such as haulage, demurrage and switching. Other revenues during the three and six months ended June 30, 2006 increased by $3.9 million and $6.1 million, respectively, from the same periods of 2005. Miscellaneous revenue increases for these periods were driven mainly by increased billing of demurrages consistent with the corporate guidelines that commenced in April 2006.
Operating expenses.
The following table summarizes KCSM’s consolidated operating expenses (in millions) for the three and six months ended June 30, 2006, and for the three months ended June 30, 2005 and March 31, 2005. Certain prior period amounts have been reclassified to conform to the current year presentation.
Successor | Predecessor | |||||||||||||||
Three Months | Six Months | Three Months | Three Months | |||||||||||||
Ended | Ended | Ended | Ended | |||||||||||||
June 30, | June 30, | June 30, | March 31, | |||||||||||||
2006 | 2006 | 2005 | 2005 | |||||||||||||
Salaries, wages and employee benefits | $ | 28.3 | 58.2 | 31.2 | 28.8 | |||||||||||
Purchased services | 29.5 | 63.5 | 33.8 | 36.8 | ||||||||||||
Fuel | 27.2 | 54.0 | 27.9 | 23.2 | ||||||||||||
Materials and supplies | 1.9 | 3.6 | 3.0 | 1.7 | ||||||||||||
Car hire — net | 5.2 | 11.7 | 11.8 | 8.6 | ||||||||||||
Rents other than car hire | 16.2 | 30.8 | 15.8 | 13.8 | ||||||||||||
Casualties and insurance | 2.5 | 6.3 | 7.0 | 2.2 | ||||||||||||
Employees’ statutory profit sharing | 4.6 | 5.6 | 38.7 | 0.5 | ||||||||||||
Other costs | 8.2 | 10.6 | 15.1 | 6.4 | ||||||||||||
Depreciation and amortization | 21.5 | 44.6 | 25.9 | 22.1 | ||||||||||||
Total operating expenses | $ | 145.1 | 288.9 | 210.2 | 144.1 | |||||||||||
Salaries, wages and employee benefits. For the three and six months ended June 30, 2006, salaries, wages and employee benefits decreased $2.9 million (9.2%) and $1.8 million (3.0%), respectively, compared to the same periods in 2005. These decreases were mainly attributable to a reduction in the number of employees. For the three and six months ended June 30, 2006, the number of employees decreased by 113 and 379, respectively, compared to the same periods in 2005. The decrease in employees headcount and depreciation effect of the Mexican peso against the U.S. dollar of 2.7% during the second quarter ended June 30, 2006 compared with the same period in 2005 resulted in additional decreases in compensation expense. These decreases were offset by the annual salary increases (4% in June 2005) and the increase in wages and fringe benefits resulting from labor negotiations in July 2005 (4.5% in wages and 2% in fringe benefits).
Purchased services. For the three and six months ended June 30, 2006, purchased services decreased $4.3 million (12.7%) and $7.1 million (10.1%), respectively, compared to the same periods in 2005. The decreases include the amortization of deferred credits related to locomotive and freight car leases established in connection with the push down of purchase accounting by KCS of $2.2 million in the three months ended June 30, 2006. The decrease in the second quarter 2006 of our locomotives maintenance expenses by $1.3 million was a result of the termination on November 2, 2005 of the El-Mo-Mex, Inc. Locomotive Operating Lease Agreement, which covered 75 locomotives. Additionally, as a result of the capitalization of certain overhead costs, we reduced purchased services by $1.6 million. These decreases were partially offset by the increase of $2.9 million in management and professional fees allocated from KCS.
Fuel. Fuel expenses decreased 2.5% for the three month period ended June 30, 2006 compared to the same period in 2005, attributable mainly to a reduction in consumption due to lower freight car volumes. Our fuel expenses increased 5.7% in the six months ended June 30, 2006 compared to the same period in 2005. This increase
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was primarily due to the increase in the average fuel price per gallon of 9.0% over 2005 offset by a 2.8% decrease in fuel consumption.
Materials and supplies. Costs of materials and supplies for the three and six months ended June 30, 2006, was primarily due to a decrease in to the revaluation of the inventory of parts associated with the maintenance of the catenary line in the second quarter of 2005, resulting in a charge of $1.6 million after purchase accounting.
Car hire — net. Our car hire — net expenses include costs incurred by us to use the freight cars of other railroads to move freight, net of car hire income and recoveries we receive from other railroads for use of our freight cars to move freight. Our car hire — net expenses are affected by the volume of our business, the number of cars we own or lease, traffic flows and the time it takes to move traffic. Car hire — net expenses for the three and six months ended June 30, 2006, decreased $6.6 million (55.9%) and $8.7 million (42.6%), respectively, compared to the same periods in 2005. These variances are attributed mainly to a reduction in hours used in the second quarter of 2006, due to a 15% improvement in system velocity in 2006 over the same period in 2005, and to a reduction in miles used in the second quarter of 2006 due to the reduction in usage of multi-level cars for General Motors traffic at Silao.
Rents other than car hire. For the three and six months ended June 30, 2006, rents other than car hire increased $0.4 million (2.5%) and $1.2 million (4.1%), respectively, compared to the same periods in 2005. The increase includes the amortization of certain deferred charges and credits established in connection with the push down of purchase accounting related to the fair value of operating leases for locomotives and freight cars. This resulted in an additional rental charge of $1.0 million in the second quarter of 2006. A similar charge will occur in subsequent quarters until the expiration of all of the related leases. Additionally, in the second quarter of 2006, we recorded $0.9 million of certain costs associated with the container movements in the intermodal terminal located in San Luis Potosi. These increases were offset by a lower number of locomotives and freight cars leased in 2006 compared to 2005, which decreased expenses by $1.5 million.
Casualties and insurance. For the three and six months ended June 30, 2006, casualties and insurance decreased $4.5 million (64.3%) and $2.9 million (31.5%), respectively, compared to the same periods in 2005. This decrease was primarily the result of costs associated with three derailments that occurred during the second quarter of 2005 totaling $4.3 million. In addition, last year KCSM increased its claims reserve by $2.4 million, primarily for automobile damage resulting from minor derailments, theft and vandalism, which was offset by a reduction of $2.5 million in KCSM’s allowance for doubtful insurance claims reserve.
Other costs. Other costs consist primarily of employee expenses, such as the cost of meals, lodging and travel, as well as the concession duty payable to the Mexican government, loss on the sales of properties and equipment and the allowance for doubtful accounts. For the three and six months ended June 30, 2006, other costs decreased $6.9 million (45.7%) and $10.9 million (50.7%), respectively, compared to the same periods in 2005. This decrease was mainly attributable to the reduction in the second quarter of 2005 of the value of certain assets in the amount of $2.3 million, after the purchase accounting. In the second quarter of 2005, in connection with continuing litigation against the Mexican government, KCSM had a $4.9 million receivable for recoverable withholding tax associated with car hire payments made prior to 2003. In light of the change of control, management determined that it was unlikely that it would be successful in collecting this amount. Therefore, the decision was made to increase the allowance for doubtful other accounts receivable by $4.9 million. This decrease was offset by management’s decision in the second quarter of 2006 to increase the allowance for doubtful accounts by $5.5 million.
Depreciation and amortization. For the three and six months ended June 30, 2006, depreciation and amortization decreased $4.4 million (17.0%) and $3.4 million (7.1%), respectively, compared to the same periods in 2005. This decrease was mainly attributable to changes in the estimated useful lives of properties, machinery, equipment and concession value, resulting in a $4.7 million reduction in depreciation expense in the six months ended June 30, 2006 compared to the same period of 2005.
Statutory profit sharing. The decrease in our employee statutory profit sharing expense in the three and six months ended June 30, 2006 compared to the same periods in 2005 was 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 as a
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result of the court rulings and we wrote off our deferred profit sharing asset associated with these NOL’s. This resulted in a charge to income of $35.6 million.
Interest expense net. For the three and six months ended June 30, 2006, interest expense net decreased $5.4 million (19.3%) and $9.9 million (18.0%), respectively, compared to the same periods in 2005. This decrease was attributable to the refinancing $443.5 million of our 11.75% Senior discount debentures in April 2005, reducing our interest rate to 93/8%.
Exchange gain (loss) — net. For the three and six months ended June 30, 2006, exchange loss increased $11.3 million and $15.7 million, respectively, compared to the same periods in 2005. During the second quarter of 2006, the U.S. dollar appreciated 2.7% relative to the Mexican peso compared the same period in 2005.
Income tax expense. Our net income tax expense for the three and six months ended June 30, 2006 was $4.7 million and $6.7 million, respectively, compared to a net income tax benefit of $0.9 million and $2.0 million for the same periods in 2005. The $8.7 million income tax increase was mainly due to the effects of inflation on depreciation and amortization of $6.6 million and the increase in the permanent differences related to inflationary components and non-deductible expenses of $8.8 million. This increase in income tax expenses was partially offset by the effects of inflation on tax loss carryforwards of $1.0 million.
LIQUIDITY AND CAPITAL RESOURCES (amounts are in millions).
Summary cash flow data for the Company is as follows:
Successor | Predecessor | ||||||||||||
Six Months | Three Months | Three Months | |||||||||||
Ended June 30, | Ended June 30, | Ended March 31, | |||||||||||
2006 | 2005 | 2005 | |||||||||||
Cash flows provided by (used for): | |||||||||||||
Operating activities | $ | 34.5 | 5.2 | 35.9 | |||||||||
Investing activities | (28.2 | ) | (10.0 | ) | (9.0 | ) | |||||||
Financing activities | 2.8 | 16.5 | (35.6 | ) | |||||||||
Cash and cash equivalents: | |||||||||||||
Net increase (decrease) | 9.1 | 11.7 | (8.7 | ) | |||||||||
Balance at beginning of period | 7.2 | 5.5 | 14.2 | ||||||||||
Balance at end of period | $ | 16.3 | 17.2 | 5.5 | |||||||||
We generated positive cash flows from operating activities of $34.5 million during the six month period ended June 30, 2006, compared to $41.1 million for the same period in 2005, the decrease in cash flows in these periods resulted primarily from increases in working capital and a decrease in operating expenses.
The following table set forth our capital expenditures during the six month period ended June 30, 2006 and the three month periods ended June 30, 2005 and March 31, 2005. Current capital expenditures are being financed with funds from operating cash flows.
Successor | Predecessor | ||||||||||||
Six Months | Three Months | Three Months | |||||||||||
Ended June 30, | Ended June 30, | Ended March 31, | |||||||||||
2006 | 2005 | 2005 | |||||||||||
Capital Expenditures: | |||||||||||||
Locomotives and freight cars | $ | 7.4 | 0.5 | 0.7 | |||||||||
Track structure | 19.8 | 8.8 | 7.7 | ||||||||||
Telecommunication | 0.5 | 0.2 | 0.4 | ||||||||||
Other | 0.8 | 0.7 | 0.4 | ||||||||||
Total | $ | 28.5 | 10.2 | 9.2 | |||||||||
Capital expenditures do not include locomotives or freight cars leased under operating leases.
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Cash Flows from Investing Activities.
Net cash used in investing activities during the six months ended June 30, 2006 was $28.2 million, which consisted mainly of capital expenditures. We made capital expenditures in an aggregate amount of $28.5 million, representing 7.9% of our transportation revenues in the six month period ended June 30, 2006, including $19.8 million for track improvements, siding extensions, track equipment and signaling equipment as well as $7.4 million for upgrades of our locomotives and freight cars.
Net cash used in investing activities during the six month period ended June 30, 2005 was $19.0 million. This consisted principally of capital expenditures. We made capital expenditures in the aggregate amount of $19.4 million, representing 5.5% of our transportation revenues in the six month period ended June 30, 2005, including $16.5 million for track improvements, siding extensions, track equipment acquisition, undercutting and signaling equipment acquisition and $1.2 million for upgrades of our locomotives and freight cars.
Cash Flows from Financing Activities.
Net cash flows provided by financing activities during the six month period ended June 30, 2006 was $2.8 million. This increase in cash resulted from proceeds of $2.9 million from the KCSM 2005 Credit Agreement
Net cash flows used in financing activities during the six month period ended June 30, 2005 were $19.1 million. This decrease in cash resulted from the repayment of all outstanding $443.5 million principal amount of our 11.75% senior discount debentures due April 2009 and principal payments of $35.5 million under our term loan facility in the first quarter of 2005. These repayments were partially offset by the issuance of $460.0 million of 93/8% senior notes due 2012.
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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk. |
Omitted pursuant to General Instruction H(2)(c).
Item 4. | Controls and Procedures. |
The Company’s President and Executive Representative and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined inRules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the fiscal quarter for which this quarterly report onForm 10-Q is filed. Based on that evaluation, the President and Executive Representative 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 President and Executive Representative and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
We are continuing to evaluate possible changes that we may have to undertake in the Company’s internal controls and accounting policies and procedures as a result of the acquisition by KCS on April 1, 2005. Grupo TFM intends to complete its Sarbanes-Oxley Act Section 404 compliance program no later than December 31, 2006. These changes in internal control are not expected to have a material effect, or are not reasonably likely to materially affect the Company’s internal control over financial reporting.
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• | The KCS tax department implemented the remediation plan, as described in Item 9A of KCS’s most recent Form 10-K, to address the material weakness in the Company’s internal controls over financial reporting at December 31, 2005. | |
• | KCSM implemented the MCS transportation operating system to facilitate the control and improvement of the Company’s operations in Mexico. Although there are no direct implications to the controls over financial reporting, we believe this will provide enhanced controls over operations and have implemented new or revised internal controls in connection with this deployment. |
Except as set forth above, there have not been any changes in the Company’s internal control over financial reporting that occurred during the fiscal quarter for which this Quarterly Report on Form 10-Q is filed that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II — OTHER INFORMATION.
Item 1. | Legal Proceedings. |
Part I, Item 1. “Financial Statements,” Note 8 to the Consolidated Financial Statements of thisForm 10-Q is hereby incorporated herein by reference.
Item 1A. | Risk Factors. |
There are no material changes to the Risk Factors disclosed under Item 1A in Grupo TFM’s Annual Report onForm 10-K for the fiscal year ended December 31, 2005.
Item 2. | Unregistered Sale of Equity Securities and Use of Proceeds. |
Omitted pursuant to General Instruction H(2)(b).
Item 3. | Defaults Upon Senior Securities. |
Omitted pursuant to General Instruction H(2)(b).
Item 4. | Submission of Matters to a Vote of Security Holders. |
Omitted pursuant to General Instruction H(2)(b).
Item 5. | Other Information. |
None.
Item 6. | Exhibits. |
Exhibit 31.1 | President and Executive Representative Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
Exhibit 31.2 | CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
Exhibit 32.1 | President and Executive Representative Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
Exhibit 32.2 | CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized and in the capacities indicated on August 8, 2006.
Grupo Transportación Ferroviaria Mexicana,
S.A. de C.V.
/s/ José Guillermo Zozaya Delano
President and Executive Representative
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