The following is a discussion of Kansas City Southern'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 8 of this Form 10-K. This discussion should be read in conjunction with the included consolidated financial statements, the related notes, and other information included in this report. Certain prior year amounts have been reclassified to conform to the current year presentation.
CAUTIONARY INFORMATION
The discussions set forth in this Annual Report on Form 10-K may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, management may make forward-looking statements orally or in other writings, including, but not limited to, in press releases, quarterly earnings calls, executive presentations, in the annual report to stockholders and in other filings with the Securities and Exchange Commission. Readers can identify these forward-looking statements by the use of such verbs as "expects," "anticipates," "believes" or similar verbs or conjugations of such verbs. These statements involve a number of risks and uncertainties. Actual results could materially differ from those anticipated by such forward-looking statements. Such differences could be caused by a number of factors or combination of factors including, but not limited to, the factors identified below and those discussed under Item 1A of this Form 10-K, "Risk Factors." Readers are strongly encouraged to consider these factors and the following factors when evaluating any forward-looking statements concerning the Company:
• fluctuations in the market price for the Company's common stock;

• KCS's dividend policy and limitations on its ability to pay dividends on its common stock;

• KCS's potential need for and ability to obtain additional financing;

• KCS's ability to successfully implement its business strategy, including the strategy to convert customers from using trucking services to rail transportation services;

• the impact of competition, including competition from other rail carriers, trucking companies and maritime shippers in the United States and Mexico;

• United States, Mexican and global economic, political and social conditions;

• the effects of the North American Free Trade Agreement, or NAFTA, on the level of trade among the United States, Mexico and Canada;

• uncertainties regarding the litigation KCS faces and any future claims and litigation;

• the effects of employee training, stability of the existing information technology systems, technological improvements and capital expenditures on labor productivity, operating efficiencies and service reliability;

• the adverse impact of any termination or revocation of KCSM's Concession by the Mexican government;

• legal or regulatory developments in the United States, Mexico or Canada;

• KCS's ability to generate sufficient cash, including its ability to collect on its customer receivables, to pay principal and interest on its debt, meet its obligations and fund its other liquidity needs;

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

• material adverse changes in economic and industry conditions, including the availability of short and long-term financing, both within the United States and Mexico and globally;

• natural events such as severe weather, fire, floods, hurricanes, earthquakes or other disruptions to the Company's operating systems, structures and equipment or the ability of customers to produce or deliver their products;

• market and regulatory responses to climate change;

• disruption in fuel supplies, changes in fuel prices and the Company's ability to assess fuel surcharges;

• KCS's ability to attract and retain qualified management personnel;

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

• credit risk of customers and counterparties and their failure to meet their financial obligations;

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

• acts of terrorism, violence or crime or risk of such activities;

• war or risk of war;

• political and economic conditions in Mexico and the level of trade between the United States and Mexico; and

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

Forward-looking statements reflect the information only as of the date on which they are made. The Company does not undertake any obligation to update any forward-looking statements to reflect future events, developments, or other information. If KCS does update one or more forward-looking statements, no inference should be drawn that additional updates will be made regarding that statement or any other forward-looking statements.
CORPORATE OVERVIEW
Kansas City Southern, a Delaware corporation, is a transportation holding company that has railroad investments in the U.S., Mexico and Panama. In the U.S., the Company serves the central and south central U.S. Its international holdings serve northeastern and central Mexico and the port cities of Lazaro Cardenas, Tampico and Veracruz, and a fifty percent interest in Panama Canal Railway Company provides ocean-to-ocean freight and passenger service along the Panama Canal. KCS'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. Its principal subsidiaries and affiliates include the following:
• The Kansas City Southern Railway Company ("KCSR"), a wholly-owned subsidiary;

• Kansas City Southern de Mιxico, S.A. de C.V. ("KCSM"), a wholly-owned subsidiary;

• Mexrail, Inc. ("Mexrail"), a wholly-owned consolidated subsidiary; which, in turn, wholly owns The Texas Mexican Railway Company ("Tex-Mex");

• Meridian Speedway, LLC ("MSLLC"), a seventy percent-owned consolidated affiliate;

• KCSM Servicios, S.A. de C.V. ("KCSM Servicios"), a wholly-owned subsidiary;

• Panama Canal Railway Company ("PCRC"), a fifty percent-owned unconsolidated affiliate, that provides international container shipping companies with a railway transportation option in lieu of the Panama Canal and the operations of PCRC's wholly-owned subsidiary, Panarail Tourism Company ("Panarail");

• Southern Capital Corporation, LLC ("Southern Capital"), a fifty percent-owned unconsolidated affiliate that owns and leases locomotives and other equipment;

• Ferrocarril y Terminal del Valle de Mιxico, S.A. de C.V. ("FTVM"), a twenty-five percent-owned unconsolidated affiliate that provides railroad services as well as ancillary services in the greater Mexico City area; and

• PTC-220, LLC ("PTC-220"), a fourteen percent-owned unconsolidated affiliate that holds the licenses to large blocks of radio spectrum and other assets for the deployment of positive train control.

EXECUTIVE SUMMARY
2012 Financial Overview
In 2012, the Company recognized record-high volumes and revenues. Record-breaking revenues of $2.2 billion were driven by strong growth in automotive and intermodal traffic. As revenues grew in most of the business units during the year, the Company's continued focus on operating expense control resulted in operating expenses as a percentage of revenues of 68.0%. Revenues in 2012 increased 7% over 2011, driven primarily by positive pricing impacts, increased carloads/unit volumes and fuel surcharge, partially offset by the effect of fluctuations in the value of the Mexican peso against the U.S. dollar for revenues denominated in Mexican pesos. Operating expenses increased 2% compared to the same period in 2011 due primarily to higher diesel fuel prices and volumes. In addition, in 2011, the Company recognized a $25.6 million pre-tax gain on

insurance recoveries within operating expenses as a result of the settlement of an insurance claim related to the 2010 hurricane damage. These increases were partially offset by a $43.0 million net reduction to operating expense due to the elimination of a deferred statutory profit sharing liability as a result of the organizational restructuring in the second quarter of 2012 and the effect of fluctuations in the value of the Mexican peso against the U.S. dollar for operating expenses denominated in Mexican pesos.
KCSM's revenues and operating expenses are affected by fluctuations in the value of the Mexican peso against the U.S. dollar. Based on the volume of revenue and expense transactions denominated in Mexican pesos, revenue and expense fluctuations generally offset, with insignificant net impacts to operating income.
The Company reported 2012 earnings of $3.43 per diluted share on consolidated net income attributable to Kansas City Southern and subsidiaries of $377.3 million for the year ended December 31, 2012, compared to annual earnings of $3.00 per diluted share on consolidated net income attributable to Kansas City Southern and subsidiaries of $330.3 million for 2011.
During 2012, the Company's Board of Directors declared quarterly cash dividends of $0.195 per share on its common stock.
During the past three years, KCS has consistently focused on opportunities to refinance or repay outstanding debt and strengthen its financial position. These efforts reduced interest expense for the year ended December 31, 2012 by $28.7 million compared to the prior year. Additionally during 2012, the Company further strengthened its financial position and flexibility by amending its KCSR and KCSM revolver facilities which extended the maturity dates, eliminated or modified a number of restrictive covenants in its facilities in order to achieve consistency between its facilities and firms with investment grade ratings, and allows for the facilities to convert from secured to unsecured obligations upon attainment of investment grade credit ratings. In the fourth quarter of 2012, the KCSR credit facility converted from a secured to an unsecured obligation.

RESULTS OF OPERATIONS
Year Ended December 31, 2012, compared with the Year Ended December 31, 2011 The following summarizes KCS's consolidated income statement components (in millions):

                                                                                 Change
                                                2012             2011           Dollars
Revenues                                   $    2,238.6     $    2,098.3     $      140.3
Operating expenses                              1,522.7          1,486.7             36.0
Operating income                                  715.9            611.6            104.3
Equity in net earnings of unconsolidated
affiliates                                         19.3             18.2              1.1
Interest expense                                 (100.4 )         (129.1 )           28.7
Debt retirement costs                             (20.1 )          (38.7 )           18.6
Foreign exchange gain (loss)                        2.7             (9.2 )           11.9
Other income (expense), net                        (1.0 )            2.2             (3.2 )
Income before income taxes                        616.4            455.0            161.4
Income tax expense                                237.0            123.1            113.9
Net income                                        379.4            331.9             47.5
Less: Net income attributable to
noncontrolling interest                             2.1              1.6              0.5
Net income attributable to Kansas City
Southern and subsidiaries                  $      377.3     $      330.3     $       47.0

Revenues
The following summarizes revenues (in millions), carload/unit statistics (in
thousands) and revenue per carload/unit:
                                Revenues                           Carloads and Units                  Revenue per Carload/Unit
                    2012           2011        % Change      2012        2011       % Change        2012          2011       % Change
Chemical and
petroleum       $     410.3     $   396.3         4 %        246.8       252.1        (2 %)     $     1,662     $ 1,572         6 %
Industrial and
consumer
products              551.1         503.6         9 %        336.1       326.6         3 %            1,640       1,542         6 %
Agriculture and
minerals              400.5         415.6        (4 %)       218.9       238.6        (8 %)           1,830       1,742         5 %
Energy (i)            312.8         317.4        (1 %)       292.4       312.0        (6 %)           1,070       1,017         5 %
Intermodal            306.5         251.8        22 %        914.2       798.8        14 %              335         315         6 %
Automotive            174.4         139.2        25 %        103.7        85.6        21 %            1,682       1,626         3 %
Carload
revenues,
carloads and
units               2,155.6       2,023.9         7 %      2,112.1     2,013.7         5 %      $     1,021     $ 1,005         2 %
Other revenue          83.0          74.4        12 %
Total revenues
(ii)            $   2,238.6     $ 2,098.3         7 %

(ii) Included
in revenues:
Fuel surcharge  $     282.1     $   244.6

(i) Effective January 1, 2012, the Company established the Energy commodity group, which includes the previous Coal commodity group and certain amounts previously included within the Agriculture and minerals and Chemical and petroleum commodity groups. Prior period amounts have been reclassified to conform to the current year presentation.

Freight revenues include both revenue for transportation services and fuel surcharges. For the year ended December 31, 2012, revenues increased $140.3 million compared to the prior year, primarily due to positive pricing impacts, increased carloads/unit volumes and fuel surcharge, partially offset by the effect of fluctuations in the value of the Mexican peso against the U.S. dollar for revenues denominated in Mexican pesos. Revenue per carload/unit increased by 2% for the year ended December 31, 2012, compared to the prior year, reflecting commodity mix.
KCS's fuel surcharge is a mechanism to adjust revenue based upon changing fuel prices. Fuel surcharges are calculated differently depending on the type of commodity transported. For most commodities, fuel surcharge is calculated using a fuel price from a prior time period that can be up to 60 days earlier. In a period of volatile fuel prices or changing customer business mix, changes in fuel expense and fuel surcharge may differ.
The following discussion provides an analysis of revenues by commodity group:
Revenues by commodity
group for 2012
Chemical and petroleum. Revenues increased $14.0 million for the year ended December 31, 2012, compared to 2011, primarily due to increases in pricing and fuel surcharge, partially offset by decreases in volume and fluctuations in the value of the Mexican peso [[Image Removed]] against the U.S. dollar. Revenues increased due to positive pricing impacts for plastics, gases and chemicals used to manufacture glass and other industrial products. Petroleum volumes decreased primarily due to a
customer's lost business.

Revenues by commodity
group for 2012
Industrial and consumer products. Revenues
increased $47.5 million for the year ended
December 31, 2012, compared to 2011, primarily
due to increases in pricing, volume and fuel
surcharge. Metals and scrap revenues grew              [[Image Removed]]
primarily due to increases in pricing and high
demand for slab and steel coil driven by
strength in the automotive and oil and gas
industries. Paper product revenue increased
primarily due to improved pricing.


Agriculture and minerals. Revenues decreased
$15.1 million for the year ended December 31,
2012, compared to 2011, primarily due to
decreases in volume and fluctuations in the
value of the Mexican peso against the U.S.
dollar, partially offset by increases in
pricing and fuel surcharge. Food products
volumes decreased due to lost cross border             [[Image Removed]]
corn syrup business and lower dried distillers
grain volume. In addition, ores and minerals
volumes decreased primarily due to a
customer's lost business and grain volumes
decreased primarily as a result of the severe
drought conditions experienced in the United
States.


Energy. Revenues decreased $4.6 million for
the year ended December 31, 2012, compared to
2011, primarily due to a decrease in volume
and fluctuations in the value of the Mexican
peso against the U.S. dollar, partially offset
by increases in pricing and fuel surcharge.
Utility coal revenues decreased due to a
reduction in demand as a result of utility              [[Image Removed]]
maintenance outages, historic low natural gas
prices and a warmer than average winter. Frac
sand volumes and pricing increased as a result
of new business and a strong demand due to
higher crude oil prices. Crude oil volume
increased as a result of higher demand for
domestic crude oil delivered by rail.

Intermodal. Revenues increased $54.7 million for the year ended December 31, 2012, compared to 2011, primarily due to increases in volume due to strong cross border auto parts business, conversion of truck traffic to rail and Trans-Pacific imports via the Port of Lazaro Cardenas.
Automotive. Revenues increased $35.2 million for the year ended December 31, 2012, compared to 2011, primarily due to increases in volume and pricing, partially offset by fluctuations in the value of the Mexican peso against the U.S. dollar. The increase was driven by strong year over year growth in North American automobile sales for Original Equipment Manufacturers, increased import/export volume through the Port of Lazaro Cardenas and increased length of haul through new cross border vehicle routings.

Operating Expenses
Operating expenses, as shown below (in millions), increased $36.0 million for the year ended December 31, 2012, when compared to the same period in 2011, primarily due to the gain on insurance recoveries recognized in 2011 related to the 2010 hurricane damage, higher diesel fuel prices and carload/unit volumes. These increases were partially offset by the elimination of the deferred Mexican statutory profit sharing liability as a result of the organizational restructuring in 2012. In addition, increases in operating expenses for the year ended December 31, 2012, compared to the same period in 2011, were partially offset by the fluctuations in the value of the Mexican peso against the U.S. dollar for operating expenses denominated in Mexican pesos.

                                                                                Change
                                            2012           2011          Dollars        Percent
Compensation and benefits               $    430.5     $    423.8     $       6.7            2 %
Purchased services                           219.8          204.8            15.0            7 %
Fuel                                         359.6          346.5            13.1            4 %
Equipment costs                              167.1          172.0            (4.9 )         (3 %)
Depreciation and amortization                198.8          186.2            12.6            7 %
Materials and other                          189.9          179.0            10.9            6 %
Elimination of deferred statutory
profit sharing liability, net                (43.0 )            -           (43.0 )        100 %
Gain on insurance recoveries related to
hurricane damage                                 -          (25.6 )          25.6         (100 %)
Total operating expenses                $  1,522.7     $  1,486.7     $      36.0            2 %

Compensation and benefits. Compensation and benefits increased $6.7 million for the year ended December 31, 2012, compared to 2011, primarily due to increased incentive compensation expense, annual salary and benefit rate increases and increased carload/unit volumes. These increases were partially offset by reduced Mexican statutory profit sharing expense as a result of the organizational restructuring in the second quarter of 2012, and the fluctuations in the value of the Mexican peso against the U.S. dollar.
Purchased services. Purchased services increased $15.0 million for the year ended December 31, 2012, compared to 2011, due to higher joint facility income recognized in the second half of 2011 as a result of non-recurring usage of certain trackage rights and increases in volume-sensitive costs, primarily joint facility expenses and security services.
Fuel. Fuel expense increased $13.1 million for the year ended December 31, 2012, compared to 2011, primarily due to higher diesel fuel prices and higher consumption. These increases were partially offset by the fluctuations in the value of the Mexican peso against the U.S. dollar and improved fuel efficiency. The net average fuel price per gallon increased by approximately 4% in 2012 as compared to 2011.
Equipment costs. Equipment costs decreased $4.9 million for the year ended December 31, 2012, compared to 2011, primarily due to lower locomotive lease expense due to the acquisition of 75 locomotives during the third quarter of 2011, which were previously leased by the Company under an operating lease agreement. This decrease was partially offset by an increase in the use of other railroads' freight cars due to increased traffic volumes.
Depreciation and amortization. Depreciation and amortization increased $12.6 million for the year ended December 31, 2012, compared to 2011, primarily due to a larger asset base.
Materials and other. Materials and other increased $10.9 million for the year ended December 31, 2012, compared to 2011, primarily due to the recognition of a larger reduction in the personal injury liability during the year ended December 31, 2011, as compared to the same period in 2012, and increases in concession duty expense, employee expenses, bulk-handling facility expense and property tax expense. These increases were partially offset by lower casualty expense. KCSM paid concession duty expense of 0.5% of gross revenues for the first 15 years of the Concession period, and on June 24, 2012, KCSM began paying 1.25% of gross revenues, which is effective for the remaining years of the Concession.

Elimination of deferred statutory profit sharing liability, net. As a result of the organizational restructuring in the second quarter of 2012, KCSM's obligation to pay Mexican statutory profit sharing terminated as of May 1, 2012, and accordingly, KCSM recognized a $43.0 million net reduction to operating expense. This reduction includes the elimination of $47.8 million of the deferred Mexican statutory profit sharing liability, net of $4.8 million of transaction costs.
Gain on insurance recoveries related to hurricane damage. In the third quarter of 2011, the Company settled its insurance claims related to the 2010 hurricane damage and recognized a $25.6 million gain on insurance recoveries which primarily represented the recovery of lost profits and the replacement value of property in excess of its carrying value, net of the self-insured retentions.

Non-Operating Expenses
Equity in net earnings of unconsolidated affiliates. Equity in net earnings from unconsolidated affiliates increased $1.1 million for the year ended December 31, 2012, compared to 2011. Significant components of this change were as follows:
• Equity in earnings of Southern Capital increased by $0.6 million for the year ended December 31, 2012, compared to 2011, primarily due to increased gain on sale of assets.

• Equity in earnings of FTVM increased by $0.4 million for the year ended December 31, 2012, compared to 2011, primarily due to an increase in volumes.

Interest expense. Interest expense decreased $28.7 million for the year ended December 31, 2012, compared to 2011, primarily due to lower average interest rates as a result of the Company's refinancing activities and the redemption of the 13.0% senior unsecured notes due December 15, 2013 (the "13.0% Senior Notes") on December 15, 2011.
Debt retirement costs. Debt retirement costs were $20.1 million and $38.7 million for the years ended December 31, 2012 and 2011, respectively. During the fourth quarter of 2012, KCSR and KCSM entered into amended and restated credit agreements and recognized $2.1 million in debt issuance costs related to the amended credit agreements. On June 1, 2012, the Company redeemed the remaining $100.3 million principal amount of the outstanding 8.0% Senior Notes due June 1, 2015 (the "8.0% Senior Notes"), issued by KCSR, and recognized debt retirement costs of $5.1 million related to the call premium and the write-off of unamortized debt issuance costs. On February 24, 2012, KCSR purchased $174.7 million principal amount of the 8.0% Senior Notes, and recognized debt retirement costs of $12.9 million related to the tender premium and the write-off of unamortized debt issuance costs. On December 15, 2011, the Company redeemed all of the outstanding $123.5 million aggregate principal amount of the 13.0% Senior Notes and recognized $24.5 million in debt retirement costs related to the call premium and the write-off of unamortized debt issuance costs. On July 12, 2011, KCSR entered into an amended and restated credit agreement and wrote off $3.9 million in unamortized debt issuance costs related to the previous credit agreement. During 2011, KCSM purchased and redeemed the remaining $32.4 million principal amount of its 75/8% senior unsecured notes due December 1, 2013 (the "75/8% Senior Notes") and all of the outstanding $165.0 million aggregate principal amount of its 73/8% senior unsecured notes due June 1, 2014 (the "73/8% Senior Notes"). KCSM recognized associated debt retirement cost of $10.3 million related to the call and tender premiums and the write-off of unamortized debt issuance costs.
Foreign exchange. Fluctuations in the value of the Mexican peso against the U.S. dollar for the years ended December 31, 2012 and 2011 resulted in a foreign exchange gain of $2.7 million and a foreign exchange loss of $9.2 million, respectively.
Other income (expense), net. Other income (expense), net, decreased $3.2 million for the year ended December 31, 2012 compared to the same period in 2011, . . .